China’s transfer pricing administration began in the 1980s, with significant developments in the 1990s and 2000s. The Corporate Income Tax Law (CITL) and its Implementation Regulations CITLIR, Public Notice 6, and Public Notice 42 form the basis of China’s transfer pricing legal regime, largely following the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (The OECD TP guidelines).
Arm’s Length Principle
China’s income tax treaties typically include Article 9 on associated enterprises, similar to the OECD and U.N. model tax treaties, reinforcing the arm’s-length principle. While the OECD Guidelines do not have legal authority in China, they influence Chinese transfer pricing policies. China stepped up and worked hard to help modify OECD transfer pricing guidelines while working through BEPS.
The arm’s-length principle (also called the “independent transaction principle”) requires transactions between related parties to be priced as if they were between independent, unrelated parties. Chinese tax authorities use this principle to assess whether transfer pricing is fair and make adjustments if necessary. China’s income tax treaties and OECD Guidelines also align with this principle.
Related Party Definition
A related party refers to any enterprise, organization, or individual connected to a company through direct or indirect control of funds or operations, common control by a third party, or other substantial relationships. The legislation further explains that parties will be considered to share a relationship when:
- A related-party relationship exists if one party directly or indirectly owns 25% or more of the shares of the other party, or if a third party owns 25% or more of the shares of both parties. Constructive ownership rules apply for calculating this threshold.
- If common share ownership does not meet the 25% threshold, a related-party relationship may still exist if debt between the parties accounts for 50% or more of a party’s total paid-up capital, or if 10% or more of a party’s debt is guaranteed by the other party.
- A related-party relationship is present if one party’s business operations depend on the other party’s patents, trademarks, or other intellectual property, even if common share ownership does not meet the 25% threshold.
- A related-party relationship is established if one party controls the business operations of the other, such as through the purchase of materials or provision of services, without meeting the 25% ownership threshold.
- More than half of the board members or senior management of one party being appointed by the other party, or having overlapping personnel, indicates a related-party relationship.
- Spouses, lineal relatives, or individuals under custodianship/family maintenance relationships having any of the above relationships with different parties can establish a related-party relationship.
- Other substantial common interests between two parties can also define a related-party relationship.
- Ownership by the state or board appointments by state asset departments are excluded from related-party determinations.
Transfer Pricing Methods
Chinese tax authorities use reasonable methods to adjust prices in related-party transactions to ensure they follow the arm’s-length principle. These methods are largely based on OECD Guidelines but have some unique applications in China.
The methods that can be used to determine the arm’s length price in China are:
- Comparable Uncontrolled Price Method
- Resale Price Method
- Cost Plus Method
- Transactional Net Margin Method
- Profit Split Method
Unlike the OECD Guidelines, China does not mandate the selection of the “best” transfer pricing method; instead, companies can apply any reasonable method. The TP rules offer general recommendations on the appropriate use of each method. For the Transactional Net Margin Method (TNMM), Chinese tax authorities typically favor calculations based on operating margin or markup on total costs.
Additional Methods for Valuation
Besides the five main transfer pricing methods, China also allows these valuation methods:
- Cost Method – Values assets based on the cost of replacing them.
- Market Method – Compares asset values to recent transactions of similar assets.
- Income Method – Uses future earnings projections to determine asset value (commonly used for shares and intangible property).
Comparability Analysis
In China, the jurisdiction follows the guidance on comparability analysis outlined in Chapter III of the TPG, as specified in Public Notice No.6. During transfer pricing investigations, tax authorities are required to conduct comparability analysis within the TPG framework. There is no preference for domestic comparables over foreign comparables. Additionally, the tax administration is permitted to use both public and secret comparables for transfer pricing assessment purposes.
Documentation Requirements
Transfer pricing documentation requirements in China are based on the three-tiered approach set forth by the OECD. This requires multinational groups to submit the following documentation to the Chinese tax authorities:
- Master file;
- Local file; and
- Country-by-Country (CbC) report.
Most Chinese taxpayers must maintain a master file in Chinese, with requirements largely consistent with BEPS standards. However, local file requirements are more detailed, including value chain analysis, related-party disclosures, and outbound investment details. In addition to the master and local files, companies may need to prepare “special files” if they are involved in cost-sharing agreements or exceed certain debt-to-equity ratios. Companies must also submit extensive related-party transaction reports as part of their annual tax filings, sometimes requiring up to 22 forms, even if their transactions do not meet the local file documentation thresholds.
Country-by-Country Reporting
Under Country by Country Reporting (CbCR) in China, if any group of companies with parent company in China combined revenue tops RMB 5.5 billion for the last fiscal year, then that group of multinational enterprises has to file the report. This certification process ensures transparency and accountability both to China and to other countries as well. The report must be submitted with the tax return, but an extension may be requested if needed. If a Chinese company is designated as a “surrogate parent” by its group, it can file the report on behalf of the entire multinational group. The report includes detailed financial and operational data on each group entity, consistent with BEPS standards. China exchanges these reports with other tax jurisdictions under international agreements. While there is no mandatory local filing requirement, Chinese tax authorities may request the report during tax investigations if they cannot obtain it through information-sharing mechanisms.
Advance Pricing Agreements (APA) and Mutual Agreement Program (MAP)
Advance Pricing Agreements (APA)
China’s Advance Pricing Agreement (APA) program, governed by Public Notice 64 since December 1, 2016, allows enterprises to reach agreements with tax authorities on transfer pricing methodologies for future related-party transactions. APAs can be unilateral, bilateral, or multilateral.
To apply, a company must have had related-party transactions exceeding RMB 40 million annually for the past three years. The APA process includes six steps: pre-filing meeting, intention discussion, analysis and evaluation, formal application, negotiation and conclusion, and execution monitoring.
Tax authorities prioritize applications based on factors such as the completeness of documentation, tax credit ratings, cooperation with authorities, and past compliance history. China’s State Tax Administration (STA) also exchanges information on unilateral APAs with other tax jurisdictions under treaty obligations. The program emphasizes value chain analysis, location-specific advantages (LSAs), and compliance with interquartile range standards, favoring results at or above the median. If an APA is violated or the taxpayer’s circumstances change significantly, it may be terminated or renegotiated.
Mutual Agreement Program (MAP)
The Mutual Agreement Procedure (MAP) allows taxpayers to avoid double taxation by seeking adjustments when one party in a related-party transaction faces a transfer pricing adjustment. If the counterparty is in a treaty country with China, the tax authorities can negotiate with the other country’s tax authorities under the MAP in the tax treaty. China’s MAP process, effective from May 1, 2017, involves taxpayers applying to initiate MAP by submitting an application, and the Chinese tax authorities may also initiate MAP upon request from a foreign tax authority. The process typically involves meetings between tax authorities, without taxpayer participation, to resolve disputes. If everyone agrees, then the tax authority will send an announcement with details about any changes in taxes that need to be made. When it comes to applying for MAP, taxpayers need to make sure that all the taxes, interest, and penalties are paid first. If there is an agreement, further taxes owed or refunds due will be processed accordingly, but no interest is paid on refunds.
Approach to Transfer Pricing Audits
The State Tax Administration (STA) uses a sophisticated monitoring system to track multinational profits and identify potential audit targets based on annual tax returns and related-party transaction (RPT) forms. Companies are more likely to be audited if they have large or complex related-party transactions, report low, fluctuating, or below-industry profits, engage in transactions with low-tax jurisdictions, or fail to comply with transfer pricing disclosure rules. If selected for an audit, companies must provide the required documents, with investigations conducted by at least two tax officials and based on extensive data collection.
Penalties
Taxpayers in China can face penalties for not complying with transfer pricing documentation and reporting requirements. Failure to file transfer pricing disclosure forms with tax returns can result in fines between RMB 2,000 and RMB 10,000. If a taxpayer does not maintain or provide necessary accounting records upon request, fines range from RMB 2,000 to RMB 10,000, and in severe cases, up to RMB 50,000.
There are no direct penalties for transfer pricing adjustments, but if a taxpayer fails to submit the required documentation, a 5% interest surcharge applies. To avoid this, companies have to provide transfer pricing documentation within 30 days of when a tax authority asks for it. The banks charge interest on amounts owed for unpaid taxes through the People’s Bank of China’s lending rate.
Taxation at a Glance
China follows a socialist legal system that is based on civil law principles, but it also has its unique features. The foundation of today’s legal system was solidified in the ’80s as part of China’s efforts to modernize, and from the start, it has thrived and kept moving fast. It’s important to remember that mainland China deals with its taxes and has different legal rules entirely from Hong Kong and Macau which have their tax systems separate. Hong and Macau are essentially autonomous jurisdictions with special laws. Today, both foreign and local businesses are generally subject to the same tax laws, with tax incentives now aimed at promoting industries like high technology and sustainable development.
The official name of the Chinese tax authority is the State Taxation Administration of China.
The table below provides a summary of the main taxation rates related to businesses:
Tax Type | Tax Rate |
Corporate Tax | 25% |
VAT | 6 %, 9%, 13% |
Withholding tax on dividends to non-residents | 10% |
Withholding tax on interest to non-residents | 10% |
Withholding tax on royalties to non-residents | 10% |
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