China: Transfer Pricing Regulation Update

On 13 July, the State Administration of Taxation issued a notice related to the long-expected adjustments in regulations of transfer pricing. With the announcement [2016] No.42, the previously valid “Implementing Measures for Special Tax Adjustments (for Trial Implementation)”, (Guo Shui Fa [2009] No. 2) effective for 8 years is partly replaced by SAT [2016] No.42 on two points:

1. The reporting on related-party transactions (business transactions between a major shareholder and the corporation, such as a contract for the shareholder’s company to perform renovations to the corporation’s offices)
2. Management of Contemporaneous Documentation (Actual project invoices, plans, and specifications, used to document the outlay of capital by a particular taxpayer for a particular construction project)

The third part of Guo Shui Fa [2009] No. 2 Regulation of cost sharing arrangements meanwhile stays untouched.

In order to judge whether a related-party transaction is existent, following the new requirements of [2016] No.42 rules about spousal relationships, connected natural persons, brothers and sisters, and other fostering and supporting relationships are added. For example, if connected natural persons jointly own an enterprise shares, shares shall be calculated together when judging the related-party relationships.
In this case, related enterprises of connected natural persons become related-parties of each other as well.

Additionally, transfers of financial assets, as a new type of related transactions, is included with account receivables, notes receivables, other receivables, equity investments, debt investments and derivative financial instruments.

Requirements on the annual reporting on related transactions are adjusted with country-by-country reporting being necessary.

Such country-by-country reports are one of the basic demands of BEPS actions. This change can be regarded as a move of State Administration of Taxation to implement BEPS. According to Announcement 42, enterprises who have obligation to fill in country-by-country reports are mainly multinational enterprise groups whose final holding companies are located in China, and whose revenue exceeded RMB 5.5 billion last year.

The requirements of contemporaneous documentation are changed to be a three-tier framework, including master file, local file and special file. When an enterprise meets the threshold of preparation for any one file, it shall prepare that file. In the following table 1, requirements are summarized for you:

What has relaxed a bit is the deadline set for preparing the reporting on related-party transactions and the contemporaneous documentation.

The Master File shall be prepared within 12 months of the ultimate parent’s financial year end. Local file and Special file shall be ready before June 30 of the following year. Contemporaneous documents shall be provided within 30 days of the date on which a request is received from the tax authority.

Our observation

In October 2015, OECD issued all 15 final reports of BEPS, which indicated that BEPS action plans were successfully accomplished and moved into implementation phase.

China always took an active part in BEPS actions, and is gradually promoting the implementation of BEPS in China. Announcement 42 is an important part of achieving its target. It will be applied to fiscal years beginning from 1 January 2016. We believe more and more regulations applying the principle of BEPS will be issued in the future. We suggest relevant enterprises keep attentions.

With the implementation of BEPS, such as auto-exchange of country-by-country reports, on some levels, related transaction reports of Chinese companies may be shared with other documents which were reported by other companies within the same group to overseas tax authorities.

Therefore, before Chinese companies report contemporaneous documents and other related party information, advanced communication within the group of companies is suggested. The documents of the Chinese company shall be prepared based on the group’s uniform policies of related-party transactions.

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