China: No Unnecessary Service Fees for Chinese Subsidiaries

In a recent letter to the United Nations' tax committee, China's State Administration of Taxation (SAT) made clear its position on service fees: Chinese officials need to be able to verify that the fees charged to subsidiaries from foreign parents are reasonable. The letter asked the UN Committee of Experts on International Cooperation in Tax Matters, which is preparing a practical manual on transfer pricing, to require transparency from multinationals when those fees are charged. Companies, the SAT said, must disclose the transfer pricing method used to calculate related-party service fees as well as the amount of those fees.

The letter also described several situations where service fees should not be charged to subsidiaries:

  • When a parent company provides services associated with its own strategic management, even if they are not classified as "shareholder activities" (a category for which no charge applies under OECD services guidelines), the subsidiary may benefit, but "the parent company will benefit more." Therefore, the parent should not charge service fees to the subsidiary merely because it also benefits.
  • Advisory and legal services from the parent may confer some benefit to a manufacturing company in China, but these high-end services may not satisfy a cost-benefit analysis from the subsidiary's perspective.
  • When a parent company provides intangible assets to its Chinese subsidiary and shares the associated residual profit by receiving a royalty, the parent "should not separately charge the subsidiary additional management fees."
  • Some fees for managing and controlling subsidiaries that fall outside the definition of shareholder activities, such as management and stewardship, should not. Most of the subsidiaries in developing countries have their own management teams and need only approval of decisions from their parent companies. "In this situation, we believe that these types of management services are likely to be duplicative activities or shareholder activities and, therefore, should not be charged."

Service fees are a hot-button issue in China, along with location savings. At a 2013 transfer pricing conference in Paris, Liao Tizhong, the SAT's deputy director general of international taxation, spoke in depth about the position of Chinese officials on that issue. As stated in China's chapter of the UN transfer pricing manual, companies in developing countries may be entitled to extra profit that stems from the advantage of operating in a cheaper location. Liao outlined the four-step approach SAT officials take in determining a taxpayer's "location specific advantages" for transfer pricing purposes, with LSAs including both a "costs savings" and "market premium" component. (See the prior blog post on Liao's comments.)

Liao also will address the June 4&5 North American Transfer Pricing Conference in Washington, D.C. Readers are invited to register by May 5 to take advantage of the early bird rate.

To read the full story on the SAT's letter, sign up for a free trial of Transfer Pricing Report.

Molly Moses, Managing Editor, Transfer Pricing Report.