Navigating Chinese Transfer Pricing Recharacterizations and Secondary Adjustments
Chinese transfer pricing recharacterizations reclassify intercompany cash flows into non-deductible deemed dividends unless secondary adjustments return excess funds.
Double Taxation Treaty Article 9
Meaning
International agreements use a specific provision to govern the adjustment of profits between associated enterprises when commercial or financial conditions differ from those between independent firms. Most bilateral agreements signed by China include double taxation treaty article 9.
Allocation Authority
Revenue officials apply this rule to increase the taxable income of a domestic subsidiary if transfer prices were set artificially low. Because double taxation treaty article 9 defines the relationship between parent and subsidiary, it establishes the legal right to ignore the contract price in favor of an arm length value. This power extends to any arrangement that reduces the total tax paid in China.
Mutual Agreement
Relief from the resulting double taxation requires a formal coordination process between the two national tax authorities involved. Taxpayers invoke the second paragraph of double taxation treaty article 9 to request a correlative adjustment in the other jurisdiction. This procedure aims to prevent the same income from being taxed twice by different states.
Jurisdictional Conflict
Disagreements often arise when one country identifies a profit shift that the other country views as a legitimate cost. While double taxation treaty article 9 provides the framework for resolution, it does not guarantee that the two governments will reach a consensus. The resulting deadlock leaves the taxpayer with higher costs and no immediate legal remedy.