Overview of China Transfer Pricing Developments in 2014: Trends and Observations

Author: Dr Jian Li(Kunda Tax Consulting (Shanghai) Limited)
Source: China Tax Intelligence

Standfirst: Since the Action Plan on BEPS was officially revealed by the G20, the SAT has reiterated its determination to strengthen co-operation with the OECD on the BEPS project and has also set forth its general positions to address BEPS issues in China. This is reflected in the 2014 transfer pricing regulatory and enforcement developments in the country. It is evident that the Chinese tax authorities have become more and more sophisticated and experienced on transfer pricing administration, audit and investigation.

Mini-standfirst: The impact of global developments further strengthened the resolve of the Chinese tax authorities to deal with the risk to China revenue that transfer pricing creates.

Department Heading: Transfer Pricing Developments in 2014


Since the Action Plan on Base Erosion and Profit Shifting (“BEPS”) was officially revealed by the G20, the State Administration of Taxation (“SAT”) has reiterated its determination to strengthen co-operation with the OECD on the BEPS project and has also set forth its general positions to address BEPS issues in China. This is reflected in the 2014 transfer pricing regulatory and enforcement developments in the country. This article reviews the main China transfer pricing developments in 2014 along with our observation of the trends and expectations for 2015.

Responses to the BEPS Issues from Local to State Level

The Jiangsu 2014-2015 Plan

On 29 April 2014, the Jiangsu State Taxation Bureau issued the “Administration Plan for International Taxation Compliance in 2014-2015” (“the 2014-15 Plan”). This document is considered to be an initial response from China on the BEPS initiatives of the OECD. The Plan echoes the BEPS initiatives and expresses the Chinese tax authorities’ stand on the transfer-pricing-related items. Specifically the following comments were made:

•Multinational enterprises must take market functions in value creation into full consideration in designing transfer pricing policies and allocating global profits.

The BEPS report requires consistency between transfer pricing results and value creation. The Chinese tax authority further stresses that market plays a unique and important role in enterprise value creation and profit realization. Therefore, the Plan re-emphasizes the concept of cost savings and market premium and requires multinational companies to ensure they are fully recognised in global profit distribution. In addition, market elements must be considered as key factors in using the profit split method.

•Consistency between enterprise economic activities and tax declarations

The BEPS report requires consistency between the place of business operation and the place in which the profit is declared i.e. substance. According to the Chinese tax authority, the increase of functions performed in China such as R&D, marketing and management should be reflected in an increased profitability. The Chinese tax authority also reinforces the position that the legal owner (overseas related party) of the intangible assets is not entitled to all non-routine returns simply because of legal ownership. The Chinese subsidiary who participates in development, enhancement, protection and maintenance functions of the IP should share in the “intangible related returns”. Also, certain distribution and R&D activities performed by the Chinese companies could create local intangibles and should be compensated appropriately.

•Increased transparency of transfer pricing documentation

The Chinese tax authority accepts the opinion of the BEPS report that additional information should be disclosed by taxpayers in transfer pricing documents. The Chinese tax authorities are likely to seek to leverage off the master file and Country by Country (“CbC”) reporting template concepts of the OECD initiatives to require companies to provide the global value chain information to evaluate the contributions made by Chinese entities and demand a greater portion of the residual profits in the entire value chain be allocated to China in future.

Although there is nothing new in the views of the Chinese authorities in the 2014-15 Plan, it does indicate that the Chinese authorities are largely embracing BEPS and integrating it into their approach to transfer pricing compliance and enforcement. The Plan also seeks to integrate the view of the Chinese authorities as expressed in the UN Transfer Pricing Manual on issues such as market premium and location savings. 

15 Unacceptable Tax Practices Identified

On 25 September 2014, the SAT held a seminar in Beijing to introduce the latest BEPS initiatives. At the seminar, the Head of the International Taxation Department of SAT publicly addressed some expectations of the SAT to taxpayers on international tax, especially transfer pricing matters, as China’s formal response to the BEPS initiatives at the state SAT level. With reference to the BEPS Action Plans, the senior tax officer identified 15 unacceptable tax practices, which again highlights the SAT’s pro-activeness in addressing BEPS issues in China:
•tax base erosion and profit shifting
•double or multiple non-taxation
•aggressive tax planning
•tax regimes that are not transparent
•holding structures or transactional arrangements without economic substance
•deduction of inappropriate costs
•loss incurred by Chinese subsidiaries with simple functions
•treaty abuse
•unreasonable over-pricing of intangible assets
•remuneration inconsistent with function and contribution to value creation
•high new technology enterprise with low profit margins
•China’s location specific advantages not observed
•losses transferred from foreign entities to Chinese subsidiaries
•refused to provide transfer pricing documentation to Chinese tax bureau upon requested
•hybrid mismatch arrangements for the purpose of tax avoidance

Scrutiny on intra-group outbound payments

Circular [2014] No. 146

When a Chinese subsidiary pays “excessive” fees for services or IP provided by an overseas related party, the Chinese tax authority is likely to challenge the arrangement. On 29 July 2014, the SAT released the Notice of Anti-Avoidance Examination on Significant Outbound Payments (Circular [2014] No. 146). In this Circular, the SAT instructs local tax authorities to survey substantial payments of service fees and royalties with a view to launching extensive audits, placing particular focus on payments to low tax jurisdictions and on cases where foreign related parties conduct only limited, simple functions. Also, the Chinese tax authorities may challenge the deduction of royalty payments from High and New Technology Enterprises (HNTEs) to their overseas related parties, arguing that the Chinese HNTE is supposed to own the core IP and should therefore in not pay a technology royalty.

The Six Tests

It appears that the release of Circular 146 is a follow-up action in response to a public speech earlier of a senior tax official from the International Taxation Department of SAT in relation to their concerns on the significant outbound payments of service fees and royalties to overseas related parties. The tax official said that China's tax authorities would vigorously investigate intra-group service fees charged to Chinese subsidiaries by their parent companies. The official also highlighted six tests that would be applied to determine whether such charges warrant a transfer pricing adjustment. These are:

Benefit Test

China applies a benefit test and a price test when a parent company provides a service to its Chinese subsidiary, or when a subsidiary provides a service to another subsidiary. A critical issue in determining whether a service has been rendered is whether a benefit has been provided, that is, whether the service activity provides a respective group member with economic or commercial value to enhance its commercial position. In other words, the activities performed by the overseas service provider must be examined to ensure they pass the “benefit test”. If not, a charge for their provision is not necessary.

Need Test

If the service can be outsourced to a third party at a lower price, then the Chinese subsidiary should go to the local market in China to find a company to perform the service.

Duplication Test

China's duplication test addresses the situation where management teams in subsidiaries perform management activities autonomously, with the only role performed by parent companies being approval of the decision based on authorization requirements.

In this situation, these types of management services are likely to be duplicative activities or shareholder activities and therefore should not be chargeable to the subsidiary.

Value Creation Test

An activity provides a benefit if it directly results in a reasonably identifiable increment of economic and commercial value that enhances the recipient's commercial position or that may be reasonably anticipated to do so. As with the duplication test, there is a question over whether approval from management in the parent company is sufficient to create an identifiable increment of economic or commercial value.

Remuneration Test

When analysing the intragroup services, account should be taken of whether the provision of services from the parent company to the subsidiary in China already has been remunerated through the transfer pricing policies in respect of other related party transactions.


In China, an enterprise is usually requested to provide evidence to support its tax deductions when the Chinese tax authority raises concerns on the authenticity, nature and reasonableness of such service expenses.

Following Circular 146, the Chinese tax authorities have proactively carried out examinations. At a public event, a senior SAT official indicated that the SAT would release a new Circular on its positions and instructions of actions on the outbound service fee and royalty fee payments based on the feedback from the local Chinese tax authorities on the examination results.  It is expected that the intra-group charges will continue to be under the spotlight of the Chinese tax authorities in audits and investigations for 2015 and beyond. 


On 29 August 2014, the SAT released the ‘Announcement of the State Administration of Taxation on Monitoring and Management of Special Tax Adjustments’ (known as “Announcement [2014] 54”), to state their position with respect to the monitoring and management of special tax adjustments.

When tax authorities identify a taxpayer with special tax adjustment risks they may issue a “Notice of Tax Matters” to the taxpayer to highlight the existing special tax adjustment risks.

Taxpayers should review the Notice and analyze the reasonableness of the special tax adjustment matters. At that point they may make self-adjustments for additional taxes payable if deemed appropriate. Alternatively if they believe there is no valid basis for the Notice they should analyse and document their position and arguments against any adjustment.

It should be noted however that even if the taxpayer makes self-adjustments for additional tax payment, the tax authority is still empowered to launch a special tax investigation and implement tax adjustments according to the Announcement. 

Advance Pricing Agreements (APAs)

In addition to transfer pricing administration (i.e., documentation requirements) and investigation, tools to provide transfer pricing certainty, such as Advance Pricing Arrangements (“APAs”) are also a focus of the SAT’s efforts to protect China’s tax revenues on cross-border transactions. On 5 December 2014, the SAT issued the “China Advance Pricing Arrangement Annual Report (2013)” (“2013 APA Report”). This is the fifth annual APA report released by the SAT to update taxpayers on the mechanisms, procedures and track record of the APA program in China. 

The SAT recognizes that a bilateral APA is an effective tool to achieve increased certainty on overall tax revenue allocation in the spirit of international co-operation. The ongoing and rapid development of the bilateral APA program since 2009 reflects this view.

However, what is also significant is the number of bilateral APA requests lodged that have not yet been officially accepted. There are 77 in this category, compared to 37 that have been finalised since the program began.  This is indicative of the significant resource constraints still prevalent at the SAT when it comes to dealing with transfer pricing matters and in particular bilateral APAs.

The following key trends emerge from the 2013 APA Report:

• By the end of 2013, the Chinese tax authorities had concluded 37 bilateral APAs.  Of these, 25 are with Asian countries, seven with European countries and five with North American countries.

• By 31 December 2013, the SAT had 82 APA requests that are yet to be officially accepted, of which 5 are unilateral and 77 are bilateral.

• Of the total APAs concluded:

- 65% involved transactions for tangible goods, 15% involved intangibles and 20% were for services;

- 83% related to manufacturing businesses while only 17% covered other businesses;

- almost 60% were negotiated and finalised within one year; and

- 86 involved the use of the TNMM, 17 applied the cost plus method, 5 used the CUP method, 3 used the profit split method, 1 used the resale price method and 4 involved the use of other methods.

The full statistics of the 2013 APA Report are in Appendix 1.

For taxpayers with large and unique transactions or with a high overall risk profile, an APA may be the optimal solution to address tax and transfer pricing risk.  However, it is important that taxpayers firstly perform a thorough risk assessment and cost/benefit analysis before considering embarking on the APA process.  For example, such a process could reveal that the re-design of a transfer pricing policy, supported with detailed documentation and benchmarking, is sufficient for those not in the highest risk category at this stage.


The article reviews transfer pricing regulatory and enforcement developments in China in 2014. It is evident that the Chinese tax authorities have become more and more sophisticated and experienced on transfer pricing administration, audit and investigation.  The impact of global developments, in particular the targeting of BEPS at the OECD level, has further strengthened the resolve of the Chinese tax authorities to deal with the risk to China revenue that transfer pricing creates.

To avoid potential tax audit risks, it is advisable that taxpayers take positive and proactive steps to address the practical issues relating to the actual operation of the transfer pricing legislation, and to manage their transfer pricing documentation obligations and audit risks in the Chinese business environment.  This is important now but will become essential in 2015 when the BEPS rollout continues and concepts such as CbC reporting are introduced.

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Dr Jian Li(Kunda Tax Consulting (Shanghai) Limited)
MOBILE: +86 1391 815 5492
Jian is a Senior Partner at Kunda Tax Consulting (Shanghai) Limited with more than 15 years’ experience in transfer pricing consulting. He provides transfer pricing services in the Greater China region, in both English and Chinese.

Kunda Tax Consulting (Shanghai) Limited