Closing loopholes: New transfer pricing rules target MNCs

New rules issued by the State Administration of Taxation reflect China’s localization of the Base Erosion and Profit Shifting (BEPS) Action Plan and the beginning of the nation’s transfer pricing (TP) documentation and administration regime.

The BEPS, an international tax reform project endorsed by the G-20 and led by the Organization for Economic Cooperation and Development (OECD), is aimed at fighting international tax avoidance and achieving fairness in the global tax system. The Announcement on Matters Relevant to Improving the Administration of Affiliated Party Filings and Contemporaneous Documentation (Announcement 42), released on June 29, 2016, reflects not only the experience that the Chinese tax authorities have gained in recent years but also their technical positions with respect to TP practice.

Announcement 42 revokes the relevant regulations as set out in Chapters 2 [Related Party Transaction Reporting] and 3 [Contemporaneous Documentation], Article 74 [Cost Sharing Agreement (CSA) Reporting] and 89 [Thin Capitalization Reporting] in Circular 2, released in 2009, as well as the Annual Reporting Form for Related Party Transactions by Enterprises in the PRC (Guoshuifa [2008] No.114). It will be applicable starting from the 2016 fiscal year.

While adopting the major recommendations of the BEPS Action Plan, Announcement 42 brings certain Chinese flavors by adding several specific requirements.

If an enterprise fails to report related party transactions or to submit contemporaneous documentation and other relevant information in accordance with the relevant rules, a maximum penalty of Rmb10,000 may be imposed. The authorities may also levy an additional 5% punitive interest during a special tax investigations. Taxpayers, particularly multinational companies (MNCs), should therefore ensure thorough compliance in TP documentation.

The transfer pricing impact

Announcement 42 has significant implications for companies in China. The key changes include a redefined scope of related party transactions—possibly foreshadowing the types of transactions the Chinese authorities may place emphasis on—as well as a new three-tiered TP documentation requirement consisting of a master file, local file and country-by-country (CbC) report.