Meaning
An administrative tax regulation issued by the State Taxation Administration establishes the compliance standards and audit procedures for related-party transactions and transfer pricing reporting. This Bulletin 64 governs the documentation requirements for multinational enterprises operating in China, defining the files they must maintain to prove that their intercompany transactions comply with the arm’s length principle. The regulation applies to all foreign-invested companies that exceed the specified annual transaction thresholds, and its jurisdiction stops applying when transactions fall below these limits or when the statutory limitation period for tax audits expires.
Compliance Obligations
Under this administrative directive, covered enterprises must prepare and submit three tiers of transfer pricing documentation, which consist of the master file, the local file, and the special file. The master file provides a high-level overview of the global business operations of the multinational group, including its organizational structure, intangible assets, and financing arrangements. The local file focuses on the specific operations of the Chinese subsidiary, detailing its management structure, business strategies, and intercompany transactions.
The special file is required for companies engaged in specific transactions, such as cost sharing agreements or thin capitalization. These files must be prepared in Chinese and made available to the tax authorities within a specified timeframe upon request. Failure to comply with these documentation requirements can result in severe penalties, including the adjustment of taxable income by the tax authorities and the imposition of interest on unpaid taxes.
Transfer Pricing Methods
The regulation dictates that companies must use appropriate transfer pricing methods to evaluate the arm’s length nature of their related-party transactions. These methods include the comparable uncontrolled price method, the resale price method, the cost-plus method, the transactional net margin method, and the profit split method. The choice of method must be justified by a detailed functional and risk analysis of the local entity, showing that the profits earned are commensurate with the functions performed and the risks assumed.
The tax authorities pay close attention to the allocation of risks, such as market risk, research and development risk, and inventory risk, which must be supported by the actual behavior of the parties rather than just the written contract. Benchmarking studies using comparable independent companies are often necessary to support the selected transfer pricing method and demonstrate that the profit margins are within an acceptable range.
Audit and Adjustments
The State Taxation Administration uses the documentation provided under this regulation to conduct risk assessments and select targets for transfer pricing audits. If the tax authorities find that the related-party transactions do not comply with the arm’s length principle, they can make transfer pricing adjustments to the taxable income of the Chinese subsidiary. These adjustments can lead to significant additional tax liabilities, interest charges, and the loss of preferential tax treatments, such as high and new technology enterprise status.
Taxpayers have the right to appeal the adjustments through administrative review or litigation, but the burden of proof rests on them to show that their transfer pricing was fair. This makes the preparation of robust documentation under the regulation a critical defense strategy for foreign-invested enterprises.
