China’s SAT Has Luxury Goods Manufacturers in Crosshairs

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

Luxury multinational groups operating in China face a daunting transfer pricing environment as the nation’s tax officials apply transfer pricing analyses that give foreign luxury goods subsidiaries in that country a bigger share of global group profits.

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 transactional net margin method (TNMM) allow companies too much control over where to place profits in a multinational group.

“Regarding profit splits, nobody has clarified how to address where the value is created, and how you value the value which has been created between the different companies in the group,” said Beatrice Deshayes-Van Wichelen, group tax director of LVMH, on March 27.

“Then it is hard to allocate value to any functions,” Deshayes-Van Wichelen told the Bloomberg BNA Baker & McKenzie LLP Paris conference.

Value Chain Reporting

China’s State Administration of Taxation has adopted a “special items” file for value chain reporting.

A multinational company 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.

As LVMH started work on its value chain analysis, the company found it “had lots of concerns,” Deshayes-Van Wichelen said. “We know our key value drivers, but how do you approach it with so many unanswered questions?”

LVMH

LVMH is the world’s largest luxury group.

Deshayes-Van Wichelen said LVMH faces a conundrum in providing a value chain analysis to the Chinese tax authorities and gave the example of an LVMH group company, Bulgari.

Bulgari is an Italian high-end jeweler that is an Italian brand, the LVMH tax official said. “So most of the value of the brand from our perspective is probably in Italy where the brand, design, the marketing, and some of the production of the main jewels” takes place.

Location Savings

Deshayes-Van Wichelen said Bulgari has wonderful stores in China “but there are lots of Chinese people who would rather buy something overseas than in China.” There are several reasons for this, the LVMH tax official explained. For example, when the pound decreased substantially this year, lots of Chinese went to the U.K. to buy less expensive luxury goods there. “But it has nothing to do with the company’s value chain.”

However, the Chinese tax authorities assert that luxury goods manufacturers are the beneficiaries of “location savings,” Deshayes-Van Wichelen said.

According to the SAT, China’s location savings for transfer pricing purposes include the world’s largest population and a middle class that has been growing exponentially during the past 20 years and has a big appetite for luxury goods. Other value drivers of China’s luxury goods industry include strong purchasing power and marketing activities encouraging people to consume those items.

The LVMH tax official asked if, in the case of Bulgari, that was a location saving advantage.

“I don’t think so,” she said.

To contact the reporter on this story: Kevin A. Bell in Washington at kbell@bna.com

To contact the editor responsible for this story: Molly Moses at mmoses@bna.com

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