Meaning
Regulatory requirements issued by the State Taxation Administration mandate the filing of detailed transfer pricing documentation including master files and local files for enterprises with cross border transactions. The circular 42 defines the thresholds and contents for these reports to ensure that multinational companies are paying the appropriate amount of tax in the country. It governs the disclosure of related party transactions, the selection of benchmarking methods and the description of the value chain.
This regulation applies to any company exceeding certain annual transaction amounts or those with significant intangible asset transfers. The boundary of the requirement is set by the total value of related party imports, exports or service fees within a single fiscal year.
Disclosure Threshold
Mandatory reporting is triggered when the total amount of related party transactions exceeds the limits set by the tax authority. Under circular 42, an enterprise must prepare a local file if the annual amount of tangible asset transfers is above 200 million yuan. For other types of transactions like service fees or intangible asset transfers, the threshold is 40 million yuan.
These figures are calculated based on the accounting records of the local entity and do not include transactions with unrelated third parties. Companies below these limits are still required to maintain basic records of their intercompany pricing but do not have to submit the full documentation set.
Master File
Global operations of the parent company and its subsidiaries must be described in a centralized document that provides context for the local transactions. The circular 42 requires the master file to explain the overall business strategy, the locations of key research centers and the allocation of profits across the entire group. This document helps local tax officials understand the role of the Chinese entity within the global value chain.
It must be prepared in Chinese and submitted within ninety days of the parent company filing its own report. The file serves to highlight inconsistencies between the local tax filings and the global profit distribution of the multinational group.
Local Impact
Specific analysis of the transactions involving the Chinese subsidiary forms the core of the local file and determines the tax risk of the entity. The circular 42 mandates a detailed functional and risk analysis for the local company to justify the margins earned on its operations. Auditors use this data to compare the company with local competitors and identify potential profit shifting.
If the margins are found to be lower than the industry average, the tax bureau may launch a full transfer pricing audit. The consequence of a failed audit is a retrospective tax adjustment plus interest on the underpaid amount. This pressure forces companies to carefully document their pricing policies and ensure they are based on market realities.
The reporting cycle is annual and must be completed by June 30 of the following year. By enforcing these rules, the state ensures that the local economy receives its fair share of tax revenue from international trade and technology transfers.
