Filing Mutual Agreement Requests under PRC Tax Treaties
Filing mutual agreement requests under PRC tax treaties requires submitting a dossier to the State Taxation Administration within three years of assessment.
Secondary Adjustment Deemed Dividends
Meaning
Transfer pricing consequences involve the reclassification of a primary tax adjustment into a constructive transaction to reflect the actual flow of funds between related parties. Secondary adjustment deemed dividends serves to tax the economic benefit that remains with a foreign affiliate after a primary transfer pricing adjustment is made. It governs the treatment of the “excess” profit that was shifted out of the domestic entity as a dividend payment.
The adjustment stops applying if the foreign affiliate repatriates the funds to the domestic entity within a specified period. It requires the application of withholding tax on the amount deemed to be a dividend. This mechanism ensures that the tax outcome matches the underlying economic reality of the transaction.
Successful implementation prevents companies from avoiding dividend withholding tax through artificial pricing.
Adjustment Logic
Rationale for this procedure is that any profit shifted to a foreign parent without a commercial basis is effectively a distribution of earnings. Under secondary adjustment deemed dividends, the State Taxation Administration first makes a primary adjustment to increase the taxable income of the domestic subsidiary. This primary adjustment fixes the corporate income tax liability but does not change the fact that the cash is still held by the foreign parent.
To address this, the tax bureau treats the amount of the primary adjustment as if it were a dividend paid by the subsidiary to the parent. This deemed transaction then triggers a withholding tax liability, usually at a rate of ten percent unless reduced by a treaty. This two-step process ensures that both the profit and the distribution are properly taxed in the source country.
Repatriation Option
Taxpayers may avoid the secondary adjustment by choosing to have the foreign affiliate return the excess funds to the domestic entity. Under secondary adjustment deemed dividends, the State Taxation Administration allows a window of time for this “repatriation” to occur. If the funds are returned, the deemed dividend is cancelled and the withholding tax is not applied.
This option is often preferred by companies that want to maintain their cash balance in the domestic entity or avoid the complexity of a secondary adjustment. The repatriation must be clearly documented and the funds must be transferred through a bank with the correct transaction code. This provides a way for the company to correct the pricing error and restore its financial position.
If the funds are not returned, the secondary adjustment becomes final and the tax must be paid immediately.
Procedural Limit
Administrative boundaries for these adjustments are set by the domestic tax laws of the involved countries and the mutual agreement procedures in tax treaties. Under secondary adjustment deemed dividends, a conflict may arise if the foreign country does not recognize the deemed dividend for tax credit purposes. This can lead to double taxation, where the same amount is taxed as a dividend in China and as regular income in the home country.
To resolve this, the taxpayer can request a mutual agreement procedure under the relevant tax treaty. The two authorities then negotiate to find a consistent treatment for both the primary and the secondary adjustments. However, not all treaties cover secondary adjustments, and the legal position in some jurisdictions remains unclear.
This boundary highlights the importance of aligning transfer pricing policies with international standards to minimize the risk of complex tax disputes.