China s new transfer pricing compliance requirements: impact on foreign headquarters
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1 China s new transfer pricing compliance requirements: impact on foreign headquarters On 29 June 2016, China s State Administration of Taxation (SAT) issued SAT Bulletin [2016] No. 42 (Bulletin 42), which updates China s transfer pricing compliance requirements, including both contemporaneous documentation and tax return reporting forms. Previously, we issued a Transfer Pricing Alert describing Bulletin 42 in comprehensive detail. 1 The purpose of this alert is to highlight the aspects of Bulletin 42 that have the most significant impact on the foreign headquarters of multinational groups with operations in China. There are a number of areas where it is crucial for headquarters to engage with local Chinese management and tax personnel on an expedited basis. These most important areas relate primarily to the local file that each Chinese subsidiary (or permanent establishment) that has related party transactions in excess of certain thresholds is required to prepare and maintain. Some aspects of the tax return related-party transaction reporting forms (RPT Forms) are also significant. Key issues, discussed below, are value chain analysis, location specific advantages and effective tax rate disclosures. Certain disclosures are extra-territorial in nature, including copies of related party financial statements and allocations of profit across the value chain. In addition to the local file, China has also adopted the other elements of the new global transfer pricing documentation environment, the master file and the country-by-country report (CBCR). While the master file and CBCR requirements are generally consistent with global standards, we turn to them first for completeness sake
2 Country-by-country reporting CBCR reporting requirements are a high-profile result of the base erosion and profit shifting (BEPS) project lead by the Organization for Economic Cooperation and Development (OECD), falling under BEPS Action 13. China has joined many other tax jurisdictions around the world in implementing CBCR and has done so in a manner fully in alignment with OECD recommendations. China-based multinationals with revenues in excess of RMB 5.5 billion (approx. 730 million or US$830 million at exchange rates on 22 August 2016) must file a CBCR with their annual tax return at the end of May, effective beginning the 2016 tax year. China will be exchanging CBCRs with other tax jurisdictions, either through the OECD s Multilateral Competent Authority Agreement or through bilateral information exchange agreements. Importantly, China has not implemented any local filing requirement. If a multinational has filed a CBCR either in its own country or through a surrogate filing, China will seek to obtain the CBCR through information exchange mechanisms and not from the local Chinese subsidiaries. The only exception is that Chinese tax authorities are empowered to request a local subsidiary to provide its group s CBCR in the course of an audit if the group has filed or is required to file a CBCR but information exchange mechanisms are non-existent or have failed to work. China does not have a notification requirement under which the local subsidiary would have to report to Chinese tax authorities whether its group will file a CBCR and which group entity will file it. The OECD allowed for countries to impose such a requirement in its Action 13 work. This information is however required to be included in the master file. Master file China has also followed OECD guidance very closely with respect to the master file. Under the OECD approach, the master file is generally prepared by the group s headquarters, providing an overview of the group s operations and transfer pricing policies, and then shared with all of the members of the group worldwide for the members to incorporate in their contemporaneous documentation packages. Under Bulletin 42, Chinese subsidiaries will be required to maintain a master file, translated into Chinese, if the subsidiary s related party transactions exceed RMB 1 billion (approx. 130 million or US$150 million) in related party transactions or if the headquarters already prepares a master file for another jurisdiction. Considering that many jurisdictions are requiring local subsidiaries to maintain a master file even if the ultimate parent s jurisdiction does not, including many European countries, we expect the vast majority of Chinese subsidiaries to face a master file requirement. The contents of the master file under Bulletin 42 requirements are substantially the same as under OECD guidance, except for a few nuances: More detail is provided on what types of corporate restructurings need to be disclosed, including any transfers of functions, risks or assets within the group, as well as changes in business legal forms, share acquisitions, asset acquisitions, mergers or spin-offs; Clarification is made that, among tax rulings that need to be listed and briefly described, bilateral advance pricing agreements are included (while the OECD only specifically mentions unilateral ones); As noted above, whether the group will file a CBCR and which group entity will file it needs to be disclosed. In short, while it will not generally be necessary to make significant changes to the group s master file to comply with Chinese requirements, it would nonetheless be advisable for headquarters tax personnel preparing the master file to make a high-level assessment whether the master file fully complies. Under Bulletin 42, a Chinese subsidiary must have a copy of the group s master file within 12 months of the ultimate parent company s fiscal year end. Accordingly, Chinese requirements are unlikely to put pressure on the group s timeline for preparing the master file. It should be noted, however, that Chinese local files must be completed by June 30 of the year following the Chinese subsidiary s tax year (which is always the calendar year). Therefore, it is advisable for headquarters tax personnel to take steps to confirm Chinese local files are consistent with the planned content of the master file. 2
3 Local file As for the local file, while the OECD has issued guidance on what countries might require, that guidance cannot be considered definitive; countries are free to require more detailed disclosure. Bulletin 42 s local file requirements are much more extensive than OECD guidance; but, more significantly, the requirements have an extra-territorial reach. As a result, headquarters management and tax personnel will have to make decisions about what information should be shared with Chinese tax staff and how it should be presented in the local file. A Chinese subsidiary must file a local file if its related party transactions during the year meet any of the following conditions: Annual related party transactions involving physical goods exceed RMB 200 million (approx. 26 million or US$30 million) (in the case of toll manufacturing, value should be based annual import and export prices for customs purposes) Annual related party transactions involving the transfer of financial assets or rights to intangibles exceed RMB 100 million (approx. 13 million or US$15 million) Annual related party transactions of other types (e.g., related party service transaction, royalties for use of intangibles, related party financing transactions) in aggregate exceed RMB 40 million (approx. 5.2 million or US$6 million) The extra-territorial aspects of Bulletin 42 relate to the requirements for a value chain analysis in the local file. There is no precise definition of the value chain. While the master file also requires discussion of the group s value chains, the local file analysis would presumably be tailored to the operations of the Chinese affiliate. Among the many decisions management will have to make are the following: Is the Chinese subsidiary involved in a single value chain or should multiple value chains be discussed? Is additional disclosure necessary because the Chinese subsidiary is involved in operations that are not considered material for master file purposes? Should the value chain discussed in the local file be narrower than that in the master file because the Chinese subsidiary is not involved in all of the group s lines of business? To what extent are research and development or intangible licensing operations part of the relevant value chain(s)? A notable extra-territorial aspect of Bulletin 42 is the requirement to provide the most recent financial statements of all participants in the value chain. Some have questioned whether requiring this much information on foreign affiliates is consistent with the limitations set in CBCR negotiations among countries participating in the BEPS process. In any event, headquarters management will have to determine a strategy for dealing with this sensitive information. A further aspect of the value chain analysis that is both sensitive and analytically challenging is the requirement to disclose the allocation of profits across the value chain. Again, by focusing on each individual member company rather than aggregate values for each country this requirement goes far beyond the information available in CBCRs. Even if data is available on a line of business basis, this can be a complex exercise if management decides to segment the data to capture only the portion of the value chain that involves the Chinese operations. It is highly recommended to get an early start on developing approaches and analyses for compliance with this requirement. Another special requirement of Bulletin 42 is the requirement to discuss any location specific factors and analyze how they impact transfer prices. China watchers will be quite familiar with the SAT s argument that there are significant advantages associated with operating in Chinese markets. These include location savings resulting from lower costs in certain industries, and market premium resulting from Chinese consumers willingness to pay higher prices for certain goods. Even if management determines that the company does not enjoy any location specific advantages, the Chinese local file will have to contain a discussion and analysis of the issue. It is highly recommended for headquarters to coordinate with Chinese tax personnel as to what positions should be taken and whether any adjustments to transfer pricing policies are necessary. Time is of the essence in determining how to address these local file requirements: Chinese local files for the 2016 tax year must be complete by June 30,
4 RPT Forms In addition to contemporaneous documentation requirements, Bulletin 42 also significantly expands the transfer pricing information that Chinese taxpayers must report on the RPT Forms filed with their tax return on May 31. Undoubtedly, Chinese tax personnel will need assistance from headquarters in this process. A notable new requirement is that a form (Form G112000) needs to be filed to provide information on many related parties that have transactions with the Chinese taxpayer. Specifically, a form is required for each related party that is among the top five (by transaction volume) for each type of transaction (tangible goods, royalties, etc.) Among the information required on Form G is the related party s effective tax rate. It is understood that the SAT will be entering the information from the RPT Forms into a massive database and using big data approaches to identify possible audit targets. Among other situations, the SAT will be looking for potential profit shifting through high volume transactions with related parties in low tax jurisdictions. Conclusion Bulletin 42 ushers in an era of great complexity and volume of disclosure on related party transactions by Chinese taxpayers. For multinational enterprises, management and tax personnel from both headquarters and Chinese subsidiaries will need to pro-actively manage the process and be prepared to undertake difficult analyses and make tough decisions regarding what to disclose and how. It is noteworthy that Bulletin 42 follows on from a number of transfer pricing initiatives in recent years, particularly in relation to outbound service and royalty payments. Taken together, these are the first concrete steps by the SAT in relation to BEPS implementation; further implementation measures, including in the transfer pricing space, are anticipated in due course. EY China Transfer Pricing Contacts Beijing Joanne Su joanne.su@cn.ey.com Leonard Zhang leonard.zhang@cn.ey.com Shanghai Travis Qiu travis.qiu@cn.ey.com Julian Hong julian.hong@cn.ey.com Il Kook Chung il-kook.chung@cn.ey.com Zhi Bin Yao zhibin.yao@cn.ey.com Guangzhou Hong Kong Curt B Kinsky curt.kinsky@hk.ey.com Martin Richter martin.richter@hk.ey.com Lillian Du lillian.du@cn.ey.com Kana Sakaide kana.sakaide@cn.ey.com Carter Li carter.li@cn.ey.com Kenny Wei kenny.wei@hk.ey.com Bing Kun Zhao bingkun.zhao@cn.ey.com Mark Ma mark.ma@cn.ey.com Janice Ng janice.ng@cn.ey.com David Chamberlain david-g.chamberlain@cn.ey.com Shenzhen Lawrence F Cheung lawrence-f.cheung@cn.ey.com Jean N Li jean-n.li@cn.ey.com Justin Kyte justin.kyte@hk.ey.com Taipei George Chou Ext george.chou@tw.ey.com 4
5 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com Ernst & Young, China All Rights Reserved. APAC no ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. ey.com/china
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