Transfer Pricing in China: New challenges for the year-end adjustments of 2020 ahead

Such an adjustment may be of more importance in Fiscal Year 2020 due to the impact of covid-19 which leads the transfer price previously set at the beginning of the year significantly deviated from the forecasted result.

Year-end adjustments in China, on the other hand, are somehow difficult due to the foreign exchange control requirement, especially for trade-related items since it involves the monitoring from various authorities such as tax authority, Customs as well as State Administration of Foreign Exchange (“SAFE”) bureau. And the focus of these three authorities are not always the same, i.e. the tax authority may focus on whether the transfer price set is in line with the arm’s-length principle; the Customs usually focusing on whether the imported price is deviated from the market price of similar goods imported while the SAFE bureau/bank’s focus is the authenticity of the transactions. This therefore leads to the difficulties to implement an appropriate and reasonable year-end adjustments in China.

It is worth to note that with the increasing needs from multinational groups for year-end adjustments, the introduction of the year-end adjustments in OECD Transfer Pricing Guidelines as well as Customs Valuation and Transfer Pricing Guidelines issued by the World Trade Organization (“WTO), the Chinese SAFE bureau and the Chinese Customs have accepted certain commercial reasons for the year-end adjustments and also provide some mechanism on a case by case consultation basis. For example, Chinese Customs has introduced the Advanced Ruling Mechanism which includes the advanced ruling for the reasonableness of the transfer prices between related parties. According to the detailed guidance in relation to the application of the advanced Ruling Mechanism, transfer prices set according to the subtractive method and the computed method could be also recognized by the Customs by submission of the relevant TP Documentation. However, this may require an advanced discussion with the Customs for details how the entire mechanism shall be adopted and monitored instead of simply being implemented before the year-end. The SAFE bureau also recognizes the incoming payments as compensation for TP adjustments under certain circumstances if relevant supporting documents such as TP study could be provided.

Overall speaking, currently there are no stipulated regulations issued by either the SAFE bureau or the Customs regarding the year-end adjustments yet. Therefore, it is still recommended multinational groups to closely monitor the deviations of the transfer price set in a continuously basis and conduct periodical adjustments such as quarterly adjustments instead of a one-off year-end adjustments in China. Compared to the upwards adjustments for the Chinese entity, the one-off downwards adjustments is more difficult to be implemented in practice. It requires the advanced negotiations with both the tax authority and Customs which may even hold completely different views. Therefore, for downwards adjustments, the commercial reasons of the adjustments usually requires to be well analyzed and to see whether the adjustment could be justified and whether any location specific factors (including also the different impacts caused by covid-19) have already been fully considered so as to avoid any potential risks.

We will provide more update regarding the development of the Chinese authorities in the future. In general in case of any significant deviations from the Transfer Pricing mechanism, which may lead to significant Transfer Pricing risks in China, discussions with the relevant authorities might be considered as a possible solution if relevant supporting documents could be provided to justify the adjustments.