Meaning
A transfer pricing method establishes the arm’s length price of intercompany services by adding a predetermined markup to the total direct and indirect costs incurred by the service provider. In the Chinese tax environment, the State Administration of Taxation frequently mandates the full cost plus margin approach for domestic subsidiaries acting as contract manufacturers or shared service centers. This ensures that the local entity receives a stable profit that covers all operating costs plus an appropriate return.
Tax audits routinely review the cost base to ensure that no expenses are excluded from the markup calculation.
Expense Calculation
Operating expenses and overheads are pooled together to form the cost base that is subject to the agreed markup. Under Chinese administrative practice, the full cost plus margin calculation must include both direct labor and indirect administrative costs like rent and depreciation. Local tax officers scrutinize the allocation keys used to distribute regional management expenses to the Chinese entity.
If the cost pool is found to be understated, the tax authority will recalculate the transfer price and assess additional corporate income tax.
Markup Standard
Benchmark studies of independent service providers determine the appropriate profit percentage applied to the accumulated costs. Under the rules of Bulletin 6, the State Administration of Taxation evaluates the selected markup against the profit margins of local peers in similar industries. A markup ranging from five to ten percent is common for routine support services.
Higher percentages are demanded if the local entity performs complex engineering or logistical tasks.
Transfer Risk
Multinational groups must maintain comprehensive documentation that justifies the inclusion or exclusion of specific cost categories. Inconsistencies between the global policy and local ledgers will trigger automated tax alerts during regional reviews.
