China: The Balance Between The Tax Authorities And The Customs ---Another Important Consideration For Transfer Pricing Documentation

Last Updated: 5 June 2015
Article by Rose Zhou, Richard Bao and Julie Zhang

Since the release of The Administrative Measures of Special Taxation Adjustment, as Guoshuifa [2009] No. 2 ("Circular 2") by China State Administration of Taxation (the "SAT") in 2009, the preparation and submission of contemporaneous transfer pricing ("TP") documentation has been compulsory to many enterprises in China. As stipulated in Circular 2, Chinese enterprises who meet the requirements should submit contemporaneous TP documentation to the tax authorities on time. In this regard, many enterprises may naturally regard the submission of TP documentation as the reporting requirement by the tax authorities. But in recent years, not only the tax authorities lay more emphasis on TP documentation, but also the Customs keeps a close eye on it. Especially, for those enterprises who are involved in intercompany import transactions, the TP documentation submitted to the tax authorities has become an important channel for the Customs to understand their TP arrangements. Based on our observations, many enterprises involved in intercompany import transactions have been required by the Customs to submit the TP documentation that had already been submitted to the tax authorities.

Due to the fact that TP can affect not only the import duty but also the corporate income tax ("CIT"), both the tax authorities and the Customs give close attention and scrutiny to the TP arrangements of the enterprises. Whether the TP policy is correct will directly influence the duty, turnover tax, and CIT. From the perspective of the tax authorities, the lower the prices of imported goods are, the more the corporate profits/CIT will be. However, from the perspective of the Customs, they may collect lower duties due to the lower price of imported goods. Therefore, the tax authorities and the Customs are naturally inclined to be at odds with each other on the import pricing. As such, from the perspective of the enterprises, it is increasingly important for them to properly establish TP policies and balance their duty burdens and CIT burdens in order to avoid any investigations by the two authorities.

In practice, we witnessed that some enterprises engaged in import transactions obtain satisfactory profits in China and thus in their TP documentations, they spare no efforts in highlighting their financial performance as "much higher than the comparable profit range". In the view of these enterprises, the profit level which is "much higher than the comparable profit range" could prove to local tax authorities that the intercompany pricing is "more than acceptable" from China perspective. Nevertheless, when reviewing such TP documentation, the Customs will likely draw a conclusion that the functions, risks and assets of the enterprise do not deserve such a high profit level and thus query the rationality of the import price. In other words, the TP documentation which is originally used to prove it reasonable to the tax authorities conversely proves it unreasonable from the Custom's point of view. Therefore, in the process of preparing the TP documentation, it is not appropriate to exaggerate the high profit level of the enterprise. On the contrary, the enterprises should also take duties into account, so as to avoid the potential inquiries from the Customs due to any inadvertent and improper descriptions in the documentation.

In addition to the consideration on the TP documentation from the perspective of the Customs, enterprises who are required to submit the documentation should also be aware that as the New Year begins, the submission deadline of the 2013's documentation is approaching again. In the sixth year ever since the administration of the TP documentation, it is believed that the collection coverage of the documentation will be further widened and for those enterprises obligated to prepare the documentation, the inspection rate will continue to be 100%. The requirement for the submission deadline from the tax authorities will be more strictly followed. In addition, tax authorities have been increasingly experienced in reviewing the documentation. The officials will focus on not only the integrity but also the quality of the related party information disclosed. For example, tax authorities will discuss with the enterprises on the reasonability of the comparables in the benchmarking study as well as the reasonability of the special factors which are to explain the reasons leading to the unsatisfactory profit level. Thus, when preparing the TP documentation, it is recommended that the enterprises shall disclose the relevant information as stipulated in Circular 2 and pay more attention to the quality of the information disclosed in order to meet the requirements of the tax authorities.

In summary, the preparation of the TP documentation is of great importance to the enterprises with legal obligations. The enterprises should prepare the TP documentation deliberately and carefully since that the TP documentation has been no longer the simple document and information disclosure to meet the compliance; instead, it is an important approach to risk prevention as well as a vital means to prove the rationality of TP arrangements when facing the challenges from the tax authority and the Customs. It is essential for the enterprises to make a full consideration of the interests of both authorities so as to avoid the undeserved inquiry from any of the authorities due to the unintentional and inappropriate disclosure. Meanwhile, the preparation of the TP documentation could help the enterprises review their TP arrangements, identify potential TP risks as well as ways for improvement, in order to mitigate TP risks in China.

Originally published January, 2014.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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