Meaning
Ancillary tax correction following a primary adjustment that treats the excess profit not received or paid as a deemed dividend, loan, or capital contribution. This measure ensures that the actual cash position of the company matches the revised tax position after a transfer pricing audit. The secondary transfer pricing adjustment addresses the fact that even if the tax is paid on the adjusted profit, the physical money may still be in the wrong jurisdiction.
In the People Republic of China, this often takes the form of a deemed dividend, which triggers an additional withholding tax. The goal is to discourage companies from shifting profits offshore by making the total cost of an adjustment very high. This secondary layer of taxation applies after the primary corporate income tax adjustment has been finalized and the tax has been paid.
Adjustment Consequence
Implementation of this rule changes the character of the cash remaining with the foreign affiliate. The secondary transfer pricing adjustment treats the amount of the primary adjustment as if it were a distribution of profit to the parent company. For instance, if a Chinese subsidiary paid one million dollars too much for raw materials, that million is now seen as a dividend.
This means the company must pay the ten percent dividend withholding tax on that amount, in addition to the twenty-five percent corporate income tax on the denied expense. This effectively creates a double hit to the company’s finances. The tax authority will issue a notice requiring the company to register this deemed dividend and settle the tax within a short period.
This process is a significant deterrent against aggressive transfer pricing because it makes the financial penalties much more severe.
Cash Repatriation
Mitigation of the secondary tax is sometimes possible if the company agrees to bring the excess money back into China. The secondary transfer pricing adjustment can be avoided or reversed if the foreign affiliate returns the cash that was the subject of the primary adjustment. This repatriation must be done through formal banking channels and must be documented with the tax and foreign exchange authorities.
If the money is returned within a specified timeframe, typically ninety days, the tax bureau may agree not to treat the amount as a dividend. This allows the company to restore its balance sheet to what it would have been if the transactions had been at arm length from the start. However, this process can be complicated by foreign exchange controls and the tax laws of the country where the money was held.
Withholding Obligation
Responsibility for the additional tax falls on the Chinese entity as the withholding agent for the foreign shareholder. The secondary transfer pricing adjustment creates a legal debt to the state that must be settled regardless of whether a physical dividend was ever declared. The company must use its own funds to pay this tax if the foreign parent does not remit the amount.
Failure to pay this withholding tax leads to further penalties and can affect the company’s ability to send out future legitimate dividends. This rule ensures that the total tax paid to the Chinese government reflects the full economic impact of the mispricing. It is a critical component of the anti avoidance framework used by the State Taxation Administration.
Multinational groups must consider this secondary risk when setting their global pricing policies, as the total cost of a Chinese tax audit can be much higher than in other jurisdictions.
