Taxpayers Beware: New Measures on Transfer Pricing Rules in China

03 August 2009 Publication
Author(s): Zhu Julie Lee


By Z. Julie Lee and Liang (Leo) He, Foley & Lardner LLP

This article is part of our Summer 2009 edition of Legal News: China Quarterly Newsletter, Eye on China.

On January 8, 2009, the State Administration of Taxation (SAT) issued the Implementation Measures for Special Tax Adjustments (Trial), Guo Shui Fa (2009) No. 2 (Measures), which were formulated in accordance with Chapter 6 (Special Tax Adjustment) of China’s new Corporate Income Tax (CIT) Law and its Implementing Rules. The Measures contain 13 chapters and 121 articles, and provide detailed guidance on transfer pricing documentation, transfer pricing audits, advanced pricing arrangements, cost sharing, controlled foreign corporations, thin capitalization, general anti-avoidance, and so forth. The Measures have a retroactive effective date of January 1, 2008. This article summarizes key transfer pricing issues set forth in the Measures.

Definition of “Related Party” Extended — More Focus on Actual Control
The Measures adopt a broad definition of “related party,” which includes not only a relatively low share-ownership criterion (i.e., more than 25 percent), but also “effective control.” For example, an entity with effective control over the taxpayer’s senior management, purchases, sales, production, or intellectual property rights (including know-how) that are significant for the business also is treated as a related party. As such, taxpayers should carefully review their relationships with significant business partners to ensure compliance with the Measures.

Transfer Pricing Documentation and Filing Burdens Increased

Transfer Pricing Documentation.
Unless the scope of related-party transactions is relatively small or limited to China and certain other conditions are met, companies doing business in China must have transfer pricing documentation in place regarding related-party transactions. The Measures enhance the contemporaneous documentation requirements. According to the Measures, enterprises doing business in China must have relevant contemporaneous documentation in place by May 31 of the subsequent year. (For 2008, the preparation deadline can be extended to December 31, 2009.) The contemporaneous documentation should include: (1) organizational structure; (2) description of business operations; (3) information concerning related-party transactions; (4) comparability analysis; and (5) selection and application of transfer pricing methods. It also is important to note that all documentation should be prepared in Chinese and maintained for 10 years. The documentation can be kept in-house but must be submitted within 20 days upon request by the authority.

Annual Disclosure.
The Measures increase annual tax filing burdens on taxpayers by introducing nine different forms of Related Party Transaction (RPT) Disclosure Forms, which should be submitted along with the annual income tax filing package. Neither the CIT Law nor the Measures provide any de minimus exception from such related-party transaction disclosure requirement; therefore, all taxpayers having related-party transactions may be required to submit the nine forms: (1) Related Party Relationships; (2) Related Party Transaction Summary; (3) Purchases and Sales; (4) Labor Services; (5) Intangible Assets; (6) Fixed Assets; (7) Financing; (8) Overseas Investments; and (9) Overseas Payments. Some of the forms require businesses to indicate whether contemporaneous documentation has been properly prepared and to provide very detailed information on significant related-party transactions (including specification of transfer pricing methods).

Penalties for Failure to Comply.
Failure to provide transfer pricing documentation upon request may result in the tax authority adjusting a taxpayer’s taxable income using a “deemed profit method” and imposing an interest penalty equal to the sum of five percent and the normal People’s Bank of China lending rate. Additionally, taxpayers may be subject to fines up to RMB 50,000 for failure to provide Annual Disclosure Forms or transfer pricing documents.

Transfer Pricing Methods Detailed
The Measures specify the application of the following six transfer pricing methods, which have been introduced by the CIT Law and its Implementing Rules:

  • Comparable Uncontrolled Price (CUP) Method
  • Resale Price Method (RPM)
  • Cost Plus Method (CPM)
  • Transaction Net Margin Method (TNMM)
  • Profit Split Method (PSM)
  • Other methods consistent with the arm’s length principle

Among these transfer pricing methods, the Measures clarify that the application of CPM is consistent with the concept defined in the Organization for Economic Co-Operation and Development (OECD) Guidelines where the arm’s length price is determined based on reasonable costs plus the gross profits of comparable third-party transactions.

The Measures state that the selection of transfer pricing method must be reasonable, but the Measures do not specify any preference as to a particular transfer pricing method. However, taxpayers should take into account the following factors in selecting the appropriate method to use: (1) the characteristics of the assets or services involved in the transaction; (2) the functions and risks of the parties; (3) the contractual terms; (4) the economic circumstances; and (5) the enterprise’s business strategies. For each method, the Measures list applicable types of related-party transactions.

Type of Transactions

Transfer Pricing Method

Purchase, sale, or transfer of tangible assets Use of tangible assets

Transfer or use of intangible assets

Financing activities Provision of services

CUP Method

1 1 1 1 1


1 1 1 1


1 1 1 1


Usually applicable to highly integrated related-party transactions where it is difficult to separately assess the transaction result for each party.


1RPM is usually applicable to the situation in which the resellers engage in simple processing or buy-sell activities that do not involve substantial value-added processing such as alternations of shape, functions, structure, or a change of trademark.

While the Measures give taxpayers some flexibility in selecting the appropriate transfer pricing methods, taxpayers should ensure that the selected method is reasonable and adopt consistent transfer pricing methods for the same types of transactions.

The Measures extend the definition of “related parties” and significantly increase the documentation and disclosure burdens of taxpayers engaged in related-party transactions. Taxpayers should take proactive approaches to review their relationships (including pricing) with related parties to ensure compliance.