Documenting Direct Economic Benefit and Cost Allocation Methods under Bulletin 6
Chinese subsidiaries deducting parent service fees require direct economic benefit logs, cost pool transparency, and arm-length allocation keys under Bulletin 6.
Intercompany Contracts
Meaning
Legal instruments formalize the transfer of goods, services, or intangibles between related entities within a corporate group. In the context of Chinese compliance, intercompany contracts provide the foundational evidence for the pricing of transactions and the allocation of risks between a parent and its subsidiary. These documents are essential for satisfying the requirements of the state taxation administration regarding transfer pricing.
They define the rights and obligations of each party and establish the commercial logic for the payments made across borders. This alignment between legal form and economic reality is the primary defense against double taxation in the event of a government investigation.
Statutory Compliance
Local regulations require that these agreements are contemporaneous and reflect the actual behavior of the parties involved. When intercompany contracts lack specificity regarding the scope of services or the basis for the fee, the tax bureau may disregard them during an audit. The contract must be signed before the transaction occurs or at the start of the fiscal year to be considered valid for tax purposes.
Price Justification
The financial terms included in the document must align with the results of a benchmarking study. If the prices in the intercompany contracts deviate from the market average for similar functions, the taxpayer must provide a detailed explanation for the difference. Adjustments to the pricing are often required if the functional profile of the entity changes due to a restructuring or a shift in the supply chain.
Operational Enforcement
Auditors check the actual execution of the contract against the written terms to ensure that the risk allocation is genuine. If intercompany contracts state that the subsidiary bears no market risk but the entity consistently records losses due to market fluctuations, the tax authorities will likely challenge the arrangement. The final determination of tax liability rests on the economic substance of the relationship rather than the legal form of the contract alone.