China Backs Down on Adopting Controversial Transfer Pricing Method

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Kevin A. Bell

China’s new transfer pricing rules, effective May 1, omit a controversial value contribution allocation method (VCM) proposed by the State Administration two years ago.

China’s Bulletin 6, “Administration Measures of Special Tax Investigation Adjustments and Mutual Agreement Procedures,” issued March 17, retains the five traditional OECD transfer pricing methods—the comparable uncontrolled price method (CUP), resale-minus method, cost plus method, transactional net margin method (TNMM), and profit-split method.

“Taxpayers will be pleased to see no mention of the value contribution allocation method,” Glenn DeSouza of Dentons in Shanghai, told Bloomberg BNA April 6. “To many observers this seemed like formulary apportionment by a different name.”

A hot topic of the SAT’s draft guidance issued in 2015—Draft Circular 2—was the VCM, DeSouza said. “The SAT, perhaps reacting to these concerns, has removed this method from its list.”

A noteworthy point is that Bulletin 6 deleted the VCM, said Jeff Yuan, PwC China’s transfer pricing leader. “The proposed VCM method has sparked heated discussion by the public.”

The new guidance, Bulletin 6, also permits multinational companies to use other transfer pricing methods, and identifies three transfer pricing methods that are used for valuation—the cost method, income method and market method.

Bulletin 6

The SAT published Bulletin 6 in the Chinese language on the tax agency’s website March 28.

In addition to publishing the bulletin, the SAT also published Q&As, an interpretation by the tax agency as to why they came out with Bulletin 6, and a list of accompanying forms and notices.

New Audit Targets

Windson Li, tax counsel with DLA Piper in Beijing, said Bulletin 6 includes four new transfer pricing audit targets.

“The enterprise who carries any one of nine characteristics will more likely go within the radar of special tax investigation and become the target to be investigated,” Li said. Compared to Circular 2 (2009), the following four new characteristics are newly introduced by Bulletin 6:

  •  The group’s shared benefits don’t match the allocation of corresponding costs;
  •  The related-party debt-to-equity ratio exceeds the statutory limit;
  •  A controlled foreign company does not distribute profits that it would under reasonable operational needs, or distributes less profits than it should; and
  •  Engaging in tax planning or arrangements that lack a reasonable business purpose.

Controversial Proposal

The proposed VCM was likely the most radical aspect of the SAT’s 2015 draft because it would have attributed a multinational group’s consolidated profit among its affiliated enterprises in different countries based on an analysis of the factors that contribute value to the group’s profit, such as assets, costs, expenses, revenue and employee head count.

Importantly, the 2015 draft circular represented a move away from the most commonly used OECD transfer pricing approach—a comparables-based analysis under the transactional net margin method (TNMM).

Profit-Split Method

However, multinational groups still need to tread carefully when applying the five traditional OECD transfer pricing methods.

China’s tax authorities are using the profit split transfer pricing method more often. Profit split, a two-sided transfer pricing method, is often preferred by tax authorities who are concerned that traditional one-sided bench-marking approaches like the TNMM allow companies too much control over where to place profits in a multinational group.

The VCM in the discussion draft has been “somewhat reflected in ‘general profit-split method’ under the description of the profit-split method in Bulletin 6, said PwC’s Yuan. “Certain principles under the ‘value contribution attribution method’ have been incorporated in the ‘general profit split method’ under the profit split method” in Bulletin 6.

The PwC practitioner pointed out that Bulletin 6 provides that “when it is difficult to obtain comparable transaction information but the consolidated profit can be reasonably determined, factors relevant to value contribution such as the income, cost, expenses, assets and headcount can be taken into consideration according to the actual situations to analyze the contribution of each party engaged in the related-party transactions to the value, to allocate the profits among the parties.”

Bulletin 42

“Taxpayers should remain on high alert,” said DeSouza.

In June 2016, the SAT released revised transfer pricing documentation rules in Bulletin 42. The guidance reflects the country’s interpretation of OECD recommendations for combating tax avoidance by multinational companies, or base erosion and profit shifting.

Bulletin 42 has extensive requests for value chain data, DeSouza said. “It is for sure that the tax bureaus will assess such information seriously in their deliberations.”

“Value chain will become a cornerstone of the new transfer pricing arsenal, especially in audits where the SAT has shown a proclivity for demanding lots of information on the overseas counterparties,” he said.

To contact the reporter on this story: Kevin A. Bell in Washington at

To contact the editor responsible for this story: Molly Moses at

For More Information

The Chinese text of Bulletin 6 may be found at

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