Meaning
Transfer pricing methodologies often incorporate regional economic factors to reflect the cost benefits of manufacturing in lower cost regions. A location savings adjustment allocates these cost advantages between the foreign parent and the domestic subsidiary. The State Taxation Administration utilizes this concept to capture the economic surplus generated by cheaper labor and materials in China.
Economic Analysis
Quantifying the cost savings realized from local operations involves comparing domestic production expenses with those in a benchmark country. In calculating a location savings adjustment, analysts examine wages and material expenses to determine the net savings. This analysis must also account for any offsetting disadvantages such as higher transportation costs or lower productivity, providing a complete picture of the regional economic benefit.
Administrative Position
Chinese tax authorities actively assert that the benefits of local cost efficiencies should remain within the domestic entity. The application of a location savings adjustment prevents multinational enterprises from shifting these savings to overseas jurisdictions through artificial pricing. Tax authorities during audits will evaluate whether the domestic subsidiary is being adequately compensated for its regional advantages.
Contractual Allocation
Intercompany agreements must specify how regional cost advantages are divided among the participating entities. To justify a location savings adjustment, companies must document the division of functions and risks within the group to support their pricing models.
