Chinese Official Speaks to Human Cost of Location Savings

Those who work in the transfer pricing area are used to thinking in terms of technical analysis: applying one of the five OECD-sanctioned pricing methods, calculating a range of results from comparables, etc. So when Liao Tizhong, deputy director general of international taxation at China’s State Administration of Taxation, talked about the human cost of location savings during the Bloomberg BNA-Baker & McKenzie conference in Paris, those in the room seemed a little shocked.

Holding up a glass, he said, “In China, this glass costs $1.00. In the United States, maybe it is $10.00. Why? Because in China it does not include the price of pollution. It does not include the price of social security. It does not include the price of the injuries of the employees who make the glass. And the cost of the labor is much lower.”

That is why China's currency is relatively cheaper, Liao said. “People say that China is manipulating its currency. That is wrong. That means they do not understand the Chinese economy.”

Liao told the Paris conference, “I believe it's time for us to go back to the good old days when we believed that labor is the primary force that creates value.” The latest transfer pricing economics, he said, reward technology, institutional synergies, and legal infrastructure, but the people “who are actually working and suffering from their daily work get very little reward.”

The official saw China’s chapter of the U.N. Transfer Pricing Practical Manual for Developing Countries as the antidote to this problem.

Chapter 10.2 of the manual states that Chinese related parties must be appropriately remunerated for their “location-specific advantages”--unique economic and geographic factors that contribute to the profitability of Chinese taxpayers and their foreign parent companies. These unique factors include readily available migrant labor, low labor and infrastructure costs, first-mover advantages in certain industries, foreign exchange controls, and growing population and consumer demand for foreign and luxury products.

The China chapter also provides that Chinese related parties should be entitled to additional profit when they improve their foreign related party's original intangibles, including global brand names, technical know-how, and business processes.

India, in its U.N. manual chapter (10.3), takes a similar position. Both countries’ chapters represent a significant departure from the OECD guidelines, which critics say have always advanced the interests of developed rather than developing countries.

But that may change. The OECD has received a mandate from the G-20 to review transfer pricing and other international tax rules with the goal of helping governments respond to aggressive tax planning and profit shifting (BEPS) on the part of multinational corporations. In taking on the BEPS project, the OECD acknowledged that  corporate tax planning strategies have a “tendency to associate more profit with legal constructs and intangible rights and obligations, thus reducing the share of profits associated with substantive operations involving the interaction of people with one another.” Although tax planning strategies technically may be legal, the organization said, the overall effect is to erode the corporate tax base of many countries in a manner that is not intended by domestic policy.

The G-20 has asked the OECD to come up with an action plan on BEPS by July.

Molly Moses, Managing Editor, Transfer Pricing Report