New transfer pricing regulations issued by the State Administration of Taxation (SAT), the Measures for Administration of Special Tax Investigation Adjustment and Mutual Agreement Procedures (“the Measures”), came into effect on May 1, 2017.
The Measures consolidate China’s pre-existing regulations regarding self-adjustment and outbound payments with the new transfer pricing laws introduced in June 2016. In addition, the Measures integrate elements of the international BEPS program, such as regulations relating to intangibles, transfer pricing, and mutual agreement procedures, into domestic regulations.
The updates follow a year of substantial reform in China’s transfer pricing regime, bringing it further in line with international standards. The breadth of recent changes will require many taxpayers to review and adjust internal transfer pricing policies regarding affected transactions to keep in compliance with China’s rapidly changing tax landscape.
Comparing with the prior measures (guo shui fa  No.2), the scope of the special tax adjustment investigation has been expanded, including transfer pricing, cost sharing agreements of enterprises and controlled foreign enterprises, capital dilution, and general anti-tax avoidance. It also states that foreign tax residents can be subject to investigation, especially in cases relating to controlled foreign companies and general anti-avoidance matters.
According to the Measures, tax authorities implementing a special tax investigation will focus on enterprises with the following risk characteristics:
When analyzing and assessing the related party transactions of the enterprise under investigation, the tax authorities will, in consideration of the functional risks of the respective parties in the transactions, select the party with relatively simple functions as a test target. In the course of such analysis, tax authorities should give priority to the use of public information, but may also use information not made public.
In addition to the five traditional transfer pricing methods listed in the old measures, the new Measures introduce valuation methods (cost, market, and income methods) and the term ‘other methods that can align profits with economic activities and value creation’, which must be both applied consistently with the arm’s length principle.
With the basis of the corresponding BEPS actions, the new Measures modify the regulations regarding the identification and pricing method of intangible assets and services trade between related parties. The Chinese tax authorities usually emphasize the importance of country-specific impacts on pricing when conducting transfer pricing analysis, such as the idea of Local Specific Advantages (LSAs).
The Measures encourage taxpayers to adjust tax payments by themselves before being subject to an investigation. Upon receipt of the special tax adjustment risk warning by the enterprise or discovery of its special tax adjustment risks, the enterprise may take the initiative to make adjustments and top up tax payments through the new “Special Tax Adjustments Self-Payment Form”. The Measures support this by removing the 20 day limit for taxpayers to submit the corresponding-period materials.
Further, the Measures also alter the procedure of the special tax investigation, as well as some requirements for materials and evidence. For example, electronic data can now be regarded as evidence in an investigation. Although the overall structure remains similar, the implementation details of special tax adjustments tend to be more cautious in the new Measures.
Tax authorities in many jurisdictions have been stepping up their monitoring system of special tax adjustments, with areas such as Beijing and Shanghai having started dedicated development of transfer pricing investigation teams since 2009. It is thus in taxpayers’ best interests to conduct regular review of internal transfer pricing policies and to adjust accordingly in a timely manner to maintain compliance.
As special tax adjustments become more frequent and substantial, taxpayers will increasingly seek tax relief or remedies, especially in the form of mutual agreement procedures, petitions for administrative reviews, and administrative litigation. This means that taxpayers will be required to work closely and cooperatively with tax authorities to successfully obtain relief.
This article was first published on www.china-briefing.com.
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