China Transfer Pricing Overview Presented by Catherine Tse Mazars Hong Kong

China Transfer Pricing Overview Presented by Catherine Tse Mazars Hong Kong

Agenda Overview of Transfer Pricing in China Transfer Pricing Framework OECD TP Guidelines Comparable Company Data Audit and Adjustments Transfer Pricing Enforcement Future Focus Advance Pricing Arrangement 2

China TP Framework In January 2009 the SAT released Guoshuifa (2009) No. 2 Implementation Measures for Special Tax Adjustments Trial (Circular 2) which supplement the new CIT laws Cover many aspects of TP including Annual reporting Documentation Audit Cost sharing agreement CFC Thin capitalization APA General anti-avoidance 3

China TP Framework (cont) Circular 2 sets out the tax filing disclosure & contemporaneous documentation requirements Nine forms for related party transactions Contemporaneous documentation Exemption for contemporaneous documentation Total annual RP sales & purchase < RMB 200m & other RPT < RMB 40m; APA in place; or Company s foreign-owned shares < 50% & RPTs with domestic related parties only 4

China TP Framework (cont) Deadline for preparation of contemporaneous documentation May 31 of the following year Intercompany agreements required as part of documentation Other forms (functional and risk analysis form, financial analysis form) need to be completed as part of the documentation Chinese language translation required if original documentation in other language 5

China TP Framework (cont) Documentation must be submitted to the tax authorities within 20 days following the request Loss-making, single function entities required to prepare & submit to the in-charge tax authorities TP documentation by 20 June of following year If enterprise not comply with the documentation requirements, an additional interest rate penalty of 5% is added to the basic interest rate on owed tax resulting from a transfer pricing adjustment 6

OECD TP Guidelines Chinese authorities do not formally endorse the OECD TP Guidelines Circular 2 application of methods and detailed explanation of each analysis of factor generally consistent with OECD TP Guidelines 7

Comparable Company Data SAT developing database of comparable company data using TP information obtained from audited Chinese entities Use of secret comparable when no public information available Continue to use public information, including OSIRIS database as much as possible in investigation cases 8

Audit and Adjustments Focus of TP investigation Significant amounts or several types of RPTs Continuous losses, low profitability or fluctuating profitability Profits level lower than others in the same industry Profits level functions & risks Transactions with RP in tax haven countries Fail to file RPT reporting forms or prepare documentation Apparent breach of arm s length principle 9

Audit and Adjustments (cont) Capital adjustment not allowed without approval Pure manufacturers should maintain certain level of profitability Payments netted off transactions should be restored When tax authorities analyse & benchmark using inter-quartile method, adjustment should be made to no lower than the median of the comparable interquartile range 10

TP Enforcement Data Recovered RMB 23.9 billion (USD 3.8 b) additional tax in 2011; RMB 10.27 billion (USD 1.57 b) in 2010 In 2011 over 120 companies sought corresponding adjustments through bilateral APA or MAP under tax treaties Only 7 reached agreement 11

TP Enforcement Plan Tertiary industries: services, trade, financial services Also target: consumer, retail, real estate, shipping, automobile component manufacturing Transaction types: IP transfers, financing transactions Enterprises: parent companies of domestic enterprises going overseas Focus on quality over quantity 12

TP Enforcement Approach Indentify low-profit industries, groups & companies Use industry data collected to conduct comparative analyses on RPT across numerous industries, years and regions Adopt systematic & efficient approach to select TP investigations 13

Future Focus Strengthen administration of RPT filing & contemporaneous TP documentation Strictly review the above to ensure a sound foundation in conducting industry-wide and group-wide audits, as well as MAP Encourage companies to comply & proactively to adjust profits & taxes Focus administration on CFC, general antiavoidance, tax haven entities 14

Future Focus (cont) Focus paying attention to domestic companies; especially those enterprises having overseas business operations TP methods explore use of quantitative valuation methods e.g. income approach, cost approach & market approach 15

APA SAT issued nation s 2010 APA annual report in Oct 2011 1 st APA report (2009) released in Dec 2010 Demonstrate tax agency s commitment to the APA program 65 APAs at pre-acceptance stage as of 31 Dec 2010 Most of APAs having pre-filing meeting in 2010 27 of 37 were unilateral 16

APA (cont) Increase in in-process agreements for application accepted in 2010 (25); 2009 (15) Processing time: 2 out of 4 bilateral agreements signed in 2010 took less than a year to complete; 2 took between 2 and 3 years to complete 3 of 4 unilateral APAs took 2 years to complete; 1 took less than a year to sign Methods: majority of APAs concluded in 2010 using TNMM and adopting either full cost mark up or return on sales as PLI 17

APA (cont) SAT encouraged to apply others; such as resale minus & profit split, may have non-routine profit potential for taxpayers in China Industries: past manufacturing & distribution activities; 2010 transfer of intangible assets or provision of services or financing exceeded the number of transactions relating to buy / sell of tangible assets 18

Number of APA Signed Year Unilateral Bilateral Multilateral Total 2005 13 1 0 14 2006 10 0 0 10 2007 7 3 0 10 2008 6 1 0 7 2009 5 7 0 12 2010 4 4 0 8 Total 45 16 0 61 19

Questions? 20

Contact Catherine Tse Mazars Tax Services Limited 42/F Central Plaza 18 Harbour Road Wanchai Hong Kong Direct line: +852 2909 5665 Email: catherine.tse@mazars.com.hk 21