Meaning
Transfer pricing regulations issued by the State Taxation Administration establish the procedures for special tax investigations and adjustments of related party transactions. Bulletin 2017 no 6 governs the documentation, monitoring and audit of pricing between associated enterprises to prevent profit shifting. It states the methodologies for determining an arm’s length price and the criteria for selecting audit targets.
The rule stops applying to transactions that are covered by an existing advance pricing agreement or those that fall below the materiality threshold. It requires companies to maintain a master file and a local file if their annual transaction volume exceeds certain limits. This circular provides the primary tool for the State Taxation Administration to protect the national tax base.
Successful implementation ensures that cross-border profits are taxed where the value is actually created.
Investigation Mechanism
Selection of targets for a transfer pricing audit is based on risk analysis and data from related party filings. Under bulletin 2017 no 6, companies that report persistent losses while expanding their operations or those with significant transactions in low tax jurisdictions are prioritized. The tax bureau issues a formal notice of investigation and requests the taxpayer to provide their contemporaneous documentation.
This documentation must explain the functions performed, assets used and risks assumed by each party. The bureau then compares these results with benchmarks from independent companies in similar industries. If the taxpayer’s pricing does not meet the arm’s length standard, the bureau proposes an adjustment.
This process is often lengthy and requires extensive negotiation between the taxpayer and the authorities.
Adjustment Procedure
Calculation of the tax adjustment follows the specific methods outlined in the regulation, such as the comparable uncontrolled price or the transactional net margin method. Under bulletin 2017 no 6, the tax bureau selects the most appropriate method based on the availability of data and the nature of the transaction. The adjustment involves restating the taxable income and calculating the additional tax due.
Interest is charged on the back taxes, often at a rate higher than the standard bank lending rate. The taxpayer has the right to present a defense and provide additional evidence to support their pricing. If an agreement cannot be reached, the bureau issues a formal tax assessment notice.
The taxpayer can then appeal the decision through the administrative or judicial systems.
Compliance Boundary
Mandatory documentation requirements apply to all enterprises that exceed the transaction thresholds set by the State Taxation Administration. Under bulletin 2017 no 6, the local file must be completed by June 30 of the year following the transactions. Failure to prepare or submit this file results in penalties and a higher risk of a full tax investigation.
The threshold for the local file is 200 million yuan for tangible goods and 40 million yuan for intangible or service transactions. For companies with a very high volume of related party dealings, a master file describing the global operations of the group is also required. These boundaries ensure that the compliance burden is proportional to the size and risk of the enterprise.
Small and medium businesses are generally exempt from the most rigorous documentation rules. The final responsibility for the accuracy of the transfer pricing filings rests with the corporate management.
