China Seeks to Grab Bigger Slice of Global Tax Pie

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By Kevin A. Bell

July 13 — China's State Administration of Taxation radically expanded tax reporting requirements for multinational companies operating in China, imposing a value chain analysis that will cause more of a company's global profit to be taxed in China.

The SAT's “ Public Notice 42 Regarding Refining the Reporting of Related Party Transactions and Administration of Transfer Pricing Documentation ,” effective Jan. 1 and posted on the SAT's website July 12, adopts the Organization for Economic Cooperation and Development's recommendations on transfer pricing documentation, requiring a country-by-country reporting template, master file and local file.

Glenn DeSouza, managing director of Transfer Pricing Management Consulting in Shanghai, an allied firm of Baker & McKenzie LLP, said the SAT adheres to the OECD's three-tiered approach but “has taken artistic license on the local file to introduce value chain reporting, location savings analysis and market premiums, all of which can support the SAT move to having China grab a bigger share of the global profit pie.”

The new requirements also mean “a quantum increase in the compliance burden” for multinational companies, DeSouza told Bloomberg BNA. “The most important issue for multinationals is the local file documentation.”

Jeff Yuan of PricewaterhouseCoopers in Shanghai said the local file should be completed by June 30, 2017, for related-party transactions during the 2016 fiscal year—Jan. 1 through Dec. 31, 2016.

Value Chain Analysis

David Chamberlain of Ernst & Young (China) Advisory Ltd. in Shanghai noted that the value chain analysis is consistent with the approach in China's draft circular from September 2015 (189 TMIN, 9/30/15).

In addition to requiring an explanation of the activities of all related parties in the value chain, the new circular requires analysis of the allocation of profits among them, he said. “Moreover, it requires the submission of the most recent financial reports for each of them. In some respects, this would seem to go well beyond the level of information in country-by-country reports with much lower reporting thresholds,” Chamberlain said.

Yuan agreed. The local file requires “significantly greater information disclosures and transfer pricing analyses,” including the preparation of a value chain analysis.

DeSouza said the SAT believes China has become a source of multinational profits, which “don’t show up in China books because they are siphoned off by excessive royalties and over-pricing of imported components and other unacceptable practices.”

Companies will now have to complete 22 disclosure forms, “including most dangerously, the Overseas Related Party Information Form, which asks for actual tax burden and tax incentives of the overseas related parties,” DeSouza said.

The local file and these new forms provide a road map for conducting audits and making adjustments by flagging so-called unacceptable practices such as arrangements without economic substance and failure to respect the unique characteristics of the Chinese market, DeSouza said. Multinational corporations with a heavy footprint in China and with tax haven transactions “are going to be at great risk and must take this new requirement with utmost seriousness,” perhaps to the extent of switching from the transactional net margin method to the comparable uncontrolled transaction method.

Local File

Whether companies need to submit the local file depends on the type of related-party transaction, Yuan said. A local file, he said, is required for companies with:

  •  tangible asset transfers of at least 200 million yuan ($27 million);
  •  financial asset transfers of at least 100 million yuan;
  •  intangible asset transfers of at least 100 million yuan; or
  •  other related-party transactions of at least 40 million yuan.

DeSouza said the value-chain analysis must describe the physical flow of goods and cash within the group, as well as allocation principles used and the actual results of group profit allocations among the members of the global value chain. Each of the group entities involved in the value chain must provide annual financial statements for the latest fiscal year, he said.

In addition to the value-chain analysis, DeSouza said, the local file must address the impact of location-specific factors and market premiums on the pricing of transactions and the portion of value creation from location specific factors shared by the enterprise.

Third, the local file must include an equity transfer analysis that includes the background on the transfer, the participants, date, price, payment method and other factors that affect the equity transfer, DeSouza said.

Fourth, he said, the related-party services analysis must include the benefits for each party from the service transactions, the method for determining the service cost, service items, service amount, allocation standards, calculation process and results, as well as the information on any same or similar service transactions the enterprise and its group enters into with third parties.

Fifth, regarding the selected transfer pricing method, including the comparable uncontrolled transaction method, the Chinese enterprise must explain its contribution to the group's overall profit or residual profit, DeSouza said.

Chamberlain said relevant factors for describing the role of location savings and market premium include the scale of market, level of competition, consumer purchasing power, product substitutability and government controls.

Yuan noted that the local file must also disclose advance pricing agreements granted by other jurisdictions that are directly related to the tested party's transactions.

Master File

DeSouza said that the master file recommended by the OECD comprises five parts and 17 sub-parts, while China's master file has five parts and 18 sub-parts. “For all practical purposes, the China format matches the OECD format so it is likely that the global master file should basically suffice for China,” he said.

An enterprise needs to submit a master file if its parent has already prepared a master file, or if the total amount of related-party transactions of the enterprise exceeds 1 billion yuan, DeSouza said.

Yuan said the master file should be completed within 12 months of the close of the same fiscal year of the group's ultimate holding company.

Country-by-Country Reporting

Chamberlain said that the new circular implements country-by-country reporting for companies with Chinese headquarters, applying a threshold of 5.5 billion yuan.

Under the circular, China will accept surrogate filings, he said.

Chamberlain said there is no requirement to file the country-by-country report locally. However, tax authorities can request the report from the local affiliate in an audit when the parent country requires country-by-country reporting and:

  •  China has no exchange agreement with the country;
  •  the parent company failed to file with its home country; or
  •  the country's exchange mechanism fails.

Yuan said that if the ultimate parent company of a multinational group is a Chinese tax resident and the information may be relevant to national security, then part or all of the country-by-country report can be deemed exempt from filing.

September 2015 Draft

Chamberlain noted that the July 12 circular, as expected, covers only documentation requirements.

Unlike the September 2015 discussion draft, the final circular doesn't cover substantive matters, including transfer pricing methods and thin capitalization rules, Chamberlain said.

“These will be covered by a subsequent circular—or circulars—of unknown timing,” he said.

The SAT's draft circular reflected many of China's positions on base erosion and profit shifting.

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

Notice 42, in Chinese, is at

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