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13.4.1. Main Rules

Where intercompany charges or fees do not reflect an arm’s length arrangement, the tax authorities may make compensatory adjustments by reference to normal market rates or prices for similar services or goods.

In certain cases, the tax authorities are entitled to levy tax retroactively on transactions between affiliated companies that took place up to 10 years earlier.

Definition of Related Parties

A related party refers to an enterprise, organization or individual which has one of the following relationships with another enterprise:

  • One enterprise, directly or indirectly, holds 25% or more of the shares in the other enterprise or a third party holds 25% or more of the shares in both enterprises;
  • Debts owed by one enterprise account for 50% or more of the capital in any of the enterprises, or 10% or more of the debt of one enterprise is guaranteed by the other enterprise;
  • One enterprise has control over the production, business operations, purchases, sales, or provision of services;
  • More than half of the board (including the senior management) of one enterprise is appointed by the other enterprise; or
  • There is a dependency on the intangibles licensed by the other enterprise.

Applicable TP Methods

China has adopted the best method approach for selecting a transfer pricing method with no specific ranking. The methods which may be employed include:

  • Comparable uncontrolled price method;
  • Resale price method;
  • Cost-plus method;
  • Transactional net margin method;
  • Profit split method; and
  • Other methods consistent with the arm’s-length principle. It is clarified that other methods include valuation methods (cost, market, and income) and other methods that can appropriately reflect the principle that profits should be taxed where economic activity takes place and where value is created.

When choosing the best method, a comparability analysis is carried out, which looks at the following five factors:

  • Characteristics of the assets or services involved in the transaction;
  • Functions and risks of each party engaged in the transaction;
  • Contractual terms;
  • Economic circumstances; and
  • Business strategies.

Use and Availability of Comparable Information

Chinese tax authorities are encouraged to use the information databases of the National Bureau of Statistics and Bureau van Dijk’s OSIRIS database in transfer pricing audits. However, both public information and non-public information may be used by the Chinese tax authorities during transfer pricing investigations and evaluations. In addition, tax authorities are empowered to also collect relevant information (e.g.., contemporaneous documentation) from potential comparable companies in the same industry during an audit.