China: Trends of transfer pricing challenges under BEPS development

published on June 29, 2018
   

Along with the BEPS development, the distribution results of multinational groups’ profits along the global value chain become more transparent. It is a new challenge for the Chinese subsidiaries (hereinafter “Subsidiaries”) to respond to the transfer pricing challenges from both the domestic tax authorities as well as their German parent companies (hereinafter “Parent companies”) and the German tax authorities, manage the compliance work, and control transfer pricing risks. 
 

 
It is noteworthy that many Subsidiaries are required by their Parent companies to make direct transfer pricing adjustments for tangible goods transactions as the high profitability of such Subsidiaries are challenged by the tax authorities of Parent companies. In this case, the Parent companies may suggest an adjustment via debit or credit notes which is generally acceptable from the German tax perspective. However, due to the strict control of State Administration of Foreign Exchange (“SAFE”), adjustment via debit or credit notes might not be feasible in China. Seeking other methods to adjust their profitability such as discount and subsidy may also lead to other tax risks in China or even double taxation. In particular, significant price adjustment may directly result in customs risks which need to be considered as well. Due to the potential customs risks, the timeline of the adjustments need to be well schemed even if such adjustments could be supported with commercial reasons from a transfer pricing perspective. 
 

In practice, it is very common that Parent companies charge their Subsidiaries for the provision of services in relation to management, admin, R&D, expatriates, marketing, etc. Inter-company service charges are under the strict supervision of Chinese tax authorities with the so-called 6 steps test. Furthermore, as OECD and Chinese tax authorities have different views on the shareholder activities, service charges in relation to finance, tax, HR and legal are often challenged by the Chinese tax authority. Those services might be deemed as non-beneficiary services by the Chinese tax authorities if they are performed for decision-making, supervision, control and compliance of the group. Thus, the Chinese tax authorities will challenge whether these services do bring benefits to the recipients.
 

According to the Chinese regulations regarding intangibles, many aspects should be considered for royalty charges, for example, economic benefits, economic ownership and legal ownership of the intangible assets, royalty rate, profit allocation, etc. It is also worth noting that, besides the “DEMPE” concept adopted by OECD for analyzing the value contribution of intangible assets, the Chinese tax authority has also taken the promotion function into consideration which is in line with its long-insisted concept of “local marketing intangibles”. In addition, High and New Technology Enterprises (“HNTE”) are very likely to be challenged by the Chinese tax authorities if they pay significant amount of technology related license fees to their related parties. Mismatch between the status of HNTEs and its performance/significant license fee payment would lead to high risks in China.
 

Because China has been actively responding to BEPS project for years, we suggest that multinational companies pay close attention to the local practice of BEPS and its development in China to avoid potential risks from different directions.