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    Wednesday 26 June 2019

    Transfer Pricing Investigations in China

    In our July 2018 transfer pricing article, we provided a general review of the state of China’s transfer pricing regulatory environment.  

    China's fast-tracking changes In this edition, we shall discuss in more detail the potential for transfer pricing special tax investigations of foreign invested companies and offshore foreign companies doing business in China, as provided in the State Administration of Taxation (SAT) Announcement [2017] #6, Administrative Measures on Special Tax Investigation, Adjustment and Mutual Agreement Procedures. Incorporating several BEPS recommendations, Announcement 6 is comprehensive, not only detailing the triggers of and methods used in transfer pricing audits, but it also covers inbound and outbound royalty and service fee payments, thin capitalization and controlled foreign company (CFC) issues, and use of general anti-avoidance rules (GAAR). In this article, we focus on factors that may trigger special tax investigations and the documentation that may be requested during such investigations.

    Risk of special tax investigations

    Through Announcement 6, local in-charge tax authorities are instructed to monitor company related party transaction declarations (required from companies during annual tax filing), company management of contemporaneous documentation, and company profit levels in order to determine whether special tax investigations or transfer pricing audits may be warranted. A company with any of the following characteristics may be particularly at risk of a special tax investigation:

    1. where a company’s related party transactions account for a large portion of the company revenues and/or expenses;
    2. where a company has a large volume of related party transactions;
    3. where a company engages in a variety of types of related party transactions;
    4. where a company incurs long-term losses, low profits or non-linear profits;
    5. where a company earns profits lower than the industry's typical level;
    6. where a company profit level does not match the functional risks borne, or where the company earnings shared do not match the costs shared;
    7. where a company carries out transactions with related parties located in low tax jurisdictions;
    8. where a company fails to declare related party transactions or prepare contemporaneous documentation as required;
    9. where a company’s debt to equity ratio exceeds the stipulated standards;
    10. where an offshore Chinese-invested and controlled company is established in a tax jurisdiction with an actual tax burden lower than 12.5% fails to distribute profits without reasonable business justification; or
    11. where a company implements any tax planning or business arrangements which do not have reasonable business objectives. 

    Should the monitoring by in-charge tax authorities uncover one or more of the above-listed situations and determine that an investigation is required, the authorities will serve an appropriate notice upon the company in question. Should the potentially offending company be a non-resident foreign company, notice may be served through a related party or other relevant party in China.

    Documentation required in special tax investigations

    During special tax investigation, authorities have the right to request the following materials from the company under investigation, its related parties, and other parties that may be pertinent to the investigation:

    1. original copies of documentary evidence
      1. originals and original duplicate copies are all considered to be original copies of documentary evidence
      2. certified true copies of the originals, photographs, and excerpts may be allowed under certain conditions
    2. where copies, photocopies, photographs or excerpts of the original copies are provided, the provider shall state the source and that the material is a "certified true copy of the original copy,” and must sign and affix the company seal on the material
    3. where documentary evidence is written in a foreign language or audio-visual materials are narrated in a foreign language, a Chinese translation must be attached, and the provider is responsible for the accuracy and integrity of the Chinese translation
    4. where overseas relevant materials are provided, the source shall be stated and tax authorities have the right to require the materials to be notarized and authenticated by the Chinese embassy.

    Furthermore, tax authorities have the right to adopt investigative methods such as onsite inspections of any hard copy or electronic data materials, accounting books, and bank account records. Where the party under investigation is a non-resident, authorities also have the right to request exchange of international tax information assistance from the overseas party’s government agencies.


    As a dramatic improvement over regulations of previous years, Announcement 6 provides relatively clear guidance to tax authorities as to when and how to conduct special tax investigations. Likewise, foreign invested companies and foreign companies doing business in China now benefit from the considerable detail offered in the announcement as they are confronted with and prepare for potential special tax investigations. In our next installment on this subject, we will examine how Chinese tax officials carry out tax investigations and make use of the various transfer pricing methods during the investigations.

    For more information, contact:
    Flora Luo and Scott Heidecke
    Nexia TS
    E: FloraLuo@nexiats.com.cn
    E: scott@nexiats.com.cn

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    In our July 2018 transfer pricing article, we provided a general review of the state of China’s transfer pricing regulatory environment.
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