New Rules for Transfer Pricing Transparency in China – Challenges and Changes

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PwC-skatteradgivning-Globe-solid_0001_maroon.pngThe new Chinese Transfer Pricing legislation goes beyond OECD’s Based Erosion and Profit Shifting (BEPS) Action 13 in terms of transfer pricing transparency. The new Chinese compliance rule requires local taxpayers to include additionally a value chain analysis and transfer pricing considerations over several key local specific economic factors in the compliance documentation package.


China has been actively following (and participating) the BEPS project since its first introduction and it is among ones of the earliest adopting countries across the world.

In June 2016, closely in the wake of the OECD’s release of the BEPS final deliverables, China issued its new transfer pricing compliance rule (“the New Rule”) aligning largely to the guidance in the BEPS Action 13, with some key differing aspects incorporated to reflect certain local economic features and tax authority’s ulterior intentions. In the New Rule, the BEPS Action 13’s tiered documentation approach was endorsed and reinvented with some additions / changes to the following structure:

  • Tier 1 – Master File (generally follows the BEPS Action 13 guidance);
  • Tier 2 – Local File (largely follows the BEPS Action 13 guidance with two major additions namely value chain analysis and key factors affecting pricing of transactions);
  • Tier 3 – Special Issue File (new from the BEPS Action 13, for taxpayers engaged in cost sharing agreements or falling under the thin capitalisation requirement).

While the Master File generally follows the BEPS Action 13 guidance and the Special Issue File covers only small group of taxpayers under ad hoc transfer pricing arrangements, the additional disclosure requirements under the Local File would create significant extra compliance efforts for many Chinese taxpayers.

Value china analysis: to include group transaction flow, latest financial statements, measurements, and attribution of “location specific factors” contributing to value creation and the allocation of group profit across the global value chain.

Key factors affecting pricing of transactions: including intangibles, and an analysis of local China cost savings and China market premium (typical aspects include labour costs, market size, market competition, consumer purchasing power, substitutability of goods or services, regulatory environment, etc).

Chinese tax authorities’ views on value chain analysis and key affecting factors

In the past, a one-sided testing approach has been commonly adopted and relied by many multinationals in gauging appropriate transfer pricing returns of the Chinese operations, mainly on the basis that they are generally characterised / deemed as less complex, if not least, along the group value chain. With the New Rule’s promulgation, it is foreseeable that the Chinese tax authorities will put more emphasis on the global footing of the Chinese activities along the group value creation process. The information collected in this regard with enable the Chinese tax authorities to analyse and ultimately justify higher local returns or profit allocations.

Aligning with the BEPS Action 13’s guidance on the importance of identifying value drivers and analysing intangible property development, maintenance, protection and exploration activities (“DEMPE”), the New Rule also requires multinationals to describe the value drivers and the location of the DEMPE functions across the global value chain. In addition, the new rule stressed the effect of location specific factors in performing the value chain analysis. The two most common specific factors are the aforementioned local cost savings and Chinese market premium, where Chinese taxpayers should carefully weigh against their own business natures.

Additionally, Chinese tax authorities may attempt to use a holistic analysis approach to argue the existence of synergies among multiple functions being performed in Chin, whether in one or more entities.

Typical challenges towards value chain

A commonly adopted regional principle model with key strategic functions located outside the China will be subject to particular scrutiny going forward. Some typical challenges would be anticipated to target the following perspectives:

  • Compared to global and region returns, how to explain and support the lower profit of the Chinese affiliates?
  • Could any local IPs, process enhancements, exploitations, promotional activities or cost savings be attributed to the location of the Chinese activities, usually Chinese R&D and manufacturing activities?
  • Are there any unique China market development activities that might create local marketing intangibles?
  • Are there any synergies achieved for organizations with a range of activities in China (e.g. R&D, manufacturing, distribution, etc)?

The above are typically pursued by Chinese tax authorities to support their position and proposed tax adjustments. A well developed strategy to address such challenges would be crucial for multinationals in supporting their tax and transfer pricing positions in China.

PwC’s value chain analysis tools

There are two main interpretations on how to best conduct a value chain analysis; the traditional “formulaic” approach and the “empirical” approach. The formulaic approach is generally a global profit split combined with weighting and scoring techniques to allocate profit based on value drivers. The formulaic approach is a practical approach for the taxpayers but may be sensitive to challenges by the tax authorities due to its inward focus and reliance on the internal management reporting data. In contrast, the empirical approach is based primarily on third party data, which would stand stronger against potential questions / challenges.

In this end, PwC has developed its own empirical value chain analysis tool, to assist multinationals to meet the standards of the Action 13 guidance and ensure that the taxpayers are prepared to address potential questions, challenges and audit from tax authorities. The key to PwC’s empirical approach is maximising the use of arm’s length industry and third part public available information, applying traditional transfer pricing analysis to industries and peers, and supplementing this with appropriate internal management information where necessary. PwC’s empirical approach seeks to minimise inward-looking subjectivity and risk of successful tax authority challenge by tying as much as possible back to industry and third party data and analysis.

Take away

As a multinational with operations in China, your next step is critical. It is now time to strategically assess the impact of the new Chinese legislation. Given that the first filing deadline for the Chinese local file is 30 June 2017, multinational enterprises should develop their value chain analysis, ensuring it is globally justifiable and could be used to support the allocation of profit across the whole value chain. It is also important to consider whether there are any particular challenges in China (and possibly from other counterpart countries) as well as how these challenges might be addressed and incorporated into the global value chain analysis using industry and third party empirical data and analysis to the extent possible.

Do you have any questions on corporate taxation?

Pär Magnus Wiséen

Pär Magnus Wiséen

Pär Magnus Wiséen arbetar på skatteavdelningen på PwC:s kontor i Stockholm med internprissättning och frågor som uppstår i samband med omstruktureringar och förändringar inom större koncerner.
010-213 32 95
Pär Magnus Wiséen works at the tax department at PwC’s Stockholm office with transfer pricing and issues relating to restructurings and changes within major groups.
+46 10 213 32 95

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