China: China Practice Alert Using Advance Pricing Agreements To Manage Transfer Pricing Risks

Last Updated: 2 October 2009
Article by Bernd-Uwe Stucken, Fang Liu, Andrew Lui, Matthias Mueller and Yun Wei

The global recession has put great pressure on revenue authorities worldwide. China is no exception. Recently China's State Administration of Taxation ("SAT") issued a number of circulars1 to strengthen the protection of tax revenues. It appears that tax audits on transfer pricing will be one of the main focuses of Chinese tax authorities in 2009. Tax audits could have a significant impact on enterprises' tax obligations2. We therefore consider it prudent for enterprises to seriously evaluate their transfer pricing risks and understand the solutions that can help manage such risks.

This alert analyzes how to mitigate transfer pricing risks by entering into an Advance Pricing Agreement ("APA") with the tax authorities.

What is an APA?

An APA is an agreement between a taxpayer and its competent tax authority to regulate the price of future transactions using agreed methods and principles. This price will be recognized as the arm's length price for a designated period.

The APA concept was introduced to China in 1998, and shortly after that the first unilateral APA was concluded. In 2009, China set up a comprehensive transfer pricing regime by issuing the Implementation Rules for Special Tax Adjustments ("STA Rules"). The STA Rules have replaced previous regulations governing APAs in China.

There are two types of APAs – unilateral and bi/multilateral - under the STA Rules. A unilateral APA is an agreement between a taxpayer and its local tax authority. Although simpler to implement than a bilateral/multilateral APA, it is not recognized by foreign tax authorities. This means that a Chinese subsidiary of a multinational company ("MNC") securing a unilateral APA for trade with one of the MNC's foreign subsidiaries risks being assessed if the relevant foreign tax authorities do not agree with the method of calculating the arm's length price. This could result in double taxation.

But bi/multilateral APAs do provide such coverage, though they require a longer application process that includes consultation/ negotiation and agreement between the relevant competent authorities. (See the flow chart attached.)

Advantages of an APA

Alternative Dispute Resolution Solution: Negotiating an APA with the tax authorities is a cooperative process, rather than an adversarial undertaking like a tax audit. The APA process enables taxpayers to build a rapport with the tax authorities, and enables the tax authorities to better understand the structure, business and functions of the taxpayers and their affiliates.

Certainty: The APA will cover related-party transactions for three to five continuous years starting from the year after the taxpayer submits a formal written APA application. An APA ensures that the taxpayer's arm's length transactions will be accepted by the tax authorities upfront, eliminating tax audit risks. Also, a bi/multilateral APA substantially reduces the possibility of future double taxation.

Rollback: Subject to the approval of the Chinese tax authorities, the pricing method in an APA can be utilized to resolve similar transfer pricing issues in years before it was executed.

Rollover: Subject to the approval of the Chinese tax authorities, a taxpayer may apply to renew its APA before it expires, if there has been no substantial change in the facts and conditions of the APA.

Threshold for an APA Application

Normally a taxpayer must satisfy all of the following conditions before it may apply for an APA negotiation with the relevant tax authorities:

  • Its annual related party transactions amount to more than RMB 40 million;
  • It has duly made related-party transaction filings; and
  • It has duly prepared, maintained and provided transfer pricing documentation materials.

APA Negotiation Process

A taxpayer has to go through six stages in the APA process:

  • Proposing an APA negotiation intention to the competent tax authority;
  • Entering preparatory meetings with the tax authorities and submitting required documents for discussion;
  • Submitting the formal APA application to the tax authorities;
  • Waiting for the tax authorities to review the APA application;
  • Negotiating the APA with the tax authorities;
  • Concluding the APA.

For a unilateral APA, all matters involved in the six stages are handled by the taxpayer and its local tax authority in charge; the exception is that the draft APA must be submitted to SAT for final approval before it may be formally signed by the taxpayer and the local tax authority. The process for a unilateral APA can normally be completed within 12 months.

A bilateral APA involves SAT at the inception of the process and the negotiation of the APA is largely between SAT and a relevant foreign tax authority. A flowchart of the bilateral APA process is attached for reference. For a bilateral APA, the length of the process is hard to estimate but SAT generally manages to complete it within 18 to 24 months.

Our Comments

In the past, unilateral APAs were more popular in China than bilateral APAs. To date, more than 200 unilateral APAs have been concluded while about nine bilateral APAs have been signed by SAT with foreign countries including Japan, US, Korea and Denmark, but no multilateral APA has been concluded yet. It appears that after the issuance of the STA Rules in 2009, SAT has made great efforts to promote bilateral APAs. According to SAT's report, it now has about 40 bilateral APA cases under the application process. SAT's commitment to the APAs demonstrates China's determination to enhance MNC confidence in the Chinese business environment at a time when SAT is bringing unprecedented challenges to taxpayers by enhancing the enforcement of anti-avoidance measures.

Based on currently-available information we have, we recommend that enterprises with the following characteristics consider an APA:

  • Chinese subsidiaries of MNCs engaging in business in the Chinese market that have been not seriously affected by the global economic downturn, such as fast food services, large-scale retailing, food and drinks production, automobile and spare parts production, infrastructure construction and related machinery production, pharmaceutical production, etc;
  • Chinese subsidiaries of MNCs that have made unique contributions to the group through the potential of China's market and its cost advantages;
  • Chinese subsidiaries of MNCs with significant related party transactions; particularly those who represent limited risk and functionality for overseas related parties (such as toll manufacturing, distribution and research) but who suffer losses or have seemingly unreasonable profit standards; and
  • Enterprises that have already been subject to transfer pricing audits


1 Guo Shui Fa [2009] No. 85, Guo Shui Han [2009] No. 188 and Guo Shui Han [2009] No. 363, etc.

2 Chinese tax authorities conducted anti-avoidance tax audits of 174 cases in 2008, netting the government additional tax revenue of RMB1.24 billion. (Source: the official website of SAT)

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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