Almost all foreign investment companies have related party transactions with the parent company or other related parties abroad or in China. We all know that transfer pricing (“TP”) is one of critical tax issues globally. Tax regulation requires that TP shall be set up based on arm’s length principle. Otherwise, tax adjustment shall be made.
To prevent tax loss arising from the intentional income transfer across the board, G20/OECD have implemented Base Erosion and Profit Shifting (BEPS) Project which intends to provide governments with solutions for closing the gaps in existing international rules that allow corporate profits to disappear or be artificially shifted to low/no tax environments, where little or no economic activity takes place. Tax authority in China set up administrative measures accordingly.
One of routine administration measures is that the entities shall report the related party transactions and transfer pricing, including the amount and relevant supporting materials timely to the tax authority. This is for tax authority to collect information and data for further analysis and inspection. Regarding the reporting requirement in China, we would introduce in this article.
1. During annual Corporate Income Tax (“CIT”) filing each year, related party transactions information shall be reported
During annual CIT filing each year, the following main information relating to the related party transactions shall be reported together with CIT annual filing documents.
a) Related party transactions incurred during the year
b) Information about the related parties, with which, transactions are incurred during the year
c) Data by transaction category: Transfer of tangible assets, intangible assets, financial assets, financing transactions, labor service, equity investment and distribution, cost allocation agreement signed and implementation
d) Payment made to overseas entities and individuals, including related parties and third parties
e) Financial analysis on related party transactions
2. Country by country report
Country by country report mainly discloses the country distribution information about all members of the multinational group which the reporting entity belongs to with respect of global income, tax and transaction activities.
During annual filing of CIT, the entities shall clarify firstly whether country by country report shall be prepared according to the tax regulations. If the conditions are satisfied, the entity shall submit the country by country report together with annual CIT filing documents. According to tax document (the state tax general bureau announcement (2016) No. 42), the following entities shall prepare country by country report
1) The entity is the ultimate holding company of a multinational group and the revenue of all categories in the prior year’s consolidated financial statement of ultimate holding company is more than RMB 5.5billion
2) The entity has been designated as the reporter of country by country report by the multinational group
For countries which have been set up correspondence on TP information sharing, the tax authority which collects the country by country report can make a sharing with the other tax authority for review. Even if the entity which does not need to submit the report according to the above tax rules, when required by the in-charge tax authority, the entity has the responsibility to complete the submission.
3. TP report
Other than the above two materials that shall be reported annually with the tax authority, detailed TP report is required for preparation for the entities which fall in the scope stated in tax rules. The materials required in TP report mostly are the supporting documents to prove that TP is set up based on arm’s length principle. If conditions are met, TP report shall be prepared annually, but need not be submitted to tax authority until required. The same as the country by country report, even if the companies do not fall in the scope of tax regulation for document preparation, when required by tax authority specifically, the companies still have responsibility to prepare and submit the documents.
TP report includes three parts, which are main document, local document and special document. If the entities satisfy the conditions, local documents and special document shall be prepared by 30 June of the following year and for main document, within 12 months after the year end. If required for submission by tax authority, the entities shall submit within 20 days.
a) Main document
Main document mainly discloses overall situation of the global transactions of the multinational group. The information required mainly includes the group organization chart, transaction and value contribution of the group members, strategy of ownership, pricing and transfer of the intangible assets, financing arrangement and financial and tax situation.
The entities which satisfy one of the following conditions shall prepare main document:
i. Cross board related party transactions incur during the current year, and the multinational group the ultimate holding company of the entity belongs to, has prepared the main document. The ultimate holding company combines the financial statement of the entity.
ii. The related party transaction of the current year exceeds RMB 10 billion.
b) Local document
Local document mainly disclose detailed information about the related party transactions, including entity organization, relationship of related parties, information for TP comparable analysis, the selection of analysis method and implementation.
The entity which satisfies one of the following conditions shall prepare local documents:
i. The amount of transfer of tangible assets exceeds RMB0.2 billion
ii. The amount of transfer of financial assets exceeds RMB 0.1 billion
iii. The amount of transfer of ownership of intangible assets exceeds RMB 40 million
c) Special document
Special document includes cost allocation document and thinning capital document. The entity which signs or implements cost allocation agreement shall prepare cost allocation document. The entity, of which, the proportion of the borrowing from related party and the capital injection exceeds the standard and the complying of the arm’s length principle needs to explain, shall prepare the thinning capital document.
According to tax document(the state tax general bureau announcement (2016) No. 42), if the entity implements a TP advance arrangement, which is an arrangement between the entity and the tax authority on the acceptance of TP to be implemented for related transactions in the future. For the related party transactions, for which, the arrangement refers to, local document and special document need not be prepared.
As foreign investment companies in China, obviously, the preparation of report for related party transactions, especially country by country report and TP report shall largely be assisted by the parent company or overseas related parties. Due to the complication on analysis of TP method and complying of the arm’s length principle, materials preparation might be time consuming due to communication, information collection from market, third party or even professional entities. Therefore, the companies which have significant related party transactions shall review the tax risk of the TP as well as the reporting requirement in China and where significant risk is noted, communication with the related parties shall be arranged as early as possible for materials preparation.
Reporting anyway is the presentation of the transactions which incurred already and cannot reduce the risk which may already exits. To reduce TP tax risk, work shall be started from designing the related party transactions and TP. Studying the details of information required on TP by tax authority in advance is also recommended.
If you need further assistance on the details of tax regulations or other concerns on TP reporting or materials required tax regulations, please contact us.
Please note that the article only represents the opinion of the writer. Regarding the implementation of the tax treatment, the consultation with the local in-charge tax authority is required.