Meaning
Accounting procedures for charging the cost of centralized functions to various subsidiaries follow strict transfer pricing guidelines. The intercompany service allocation ensures that the entity providing the support recovers its expenses along with a small profit margin. China requires that these charges reflect a genuine commercial benefit to the local subsidiary.
Distribution Logic
Group headquarters identify the total costs incurred for global functions like legal, finance, human resources and information technology. In the intercompany service allocation, the firm must select a driver that links the cost to the specific activity performed for the branch.
Deductibility Rule
State taxation authorities scrutinize outbound payments for management fees to prevent profit shifting. An intercompany service allocation must satisfy the benefit test, meaning the service would have been purchased from a third party or performed in-house if the affiliate had not provided it. Tax officials frequently challenge these allocations during annual audits if the documentation fails to show a clear link between the expense and the local revenue generation.
Expenses that provide no direct advantage to the China entity are disallowed for corporate income tax purposes. Local tax bureaus have the power to recharacterize these payments as dividends if the commercial substance is missing.
Transactional Proof
Documenting the flow of services requires contracts and detailed work logs. Within an intercompany service allocation, the taxpayer must provide evidence of the actual performance of the service. This evidence often includes emails and travel records of the personnel involved.
