Implementation rule regarding transfer pricing documentation requires enterprises to disclose extensive details about their related party transactions and structures. The release of state taxation administration circular 2016 no 42 brought Chinese regulations in line with the global standards developed by the organization for economic cooperation and development. it mandates a three tiered approach to documentation, consisting of a master file, a local file, and a country by country report. Any Chinese company that engages in related party transactions above certain thresholds must prepare these files annually to demonstrate that their pricing is at arm’s length.
The circular is a powerful tool for the tax authorities to identify profit shifting and to prepare for transfer pricing audits. It focuses on the functional analysis of the business and the economic substance of the arrangements. By requiring this information, the state ensures that it can capture the correct amount of tax from the activities of multinational groups.
Overview of the global business operations of a multinational group is the purpose of this part of the documentation. Under state taxation administration circular 2016 no 42, the master file must be prepared by any company that has a cross border related party transaction and belongs to a group that already prepares such a file. It includes information about the group’s legal structure, its global supply chain, and its intellectual property strategy.
The tax authorities use this file to understand how the Chinese subsidiary fits into the overall business model. They look for information about where the value is created and how the profits are distributed across the world. The file must also describe the group’s financial and tax positions in different countries.
This level of transparency makes it much harder for companies to hide their profits in low-tax jurisdictions.
Detailed analysis of the specific transactions between the Chinese entity and its foreign affiliates is the most important part of the filing. State taxation administration circular 2016 no 42 sets a threshold of two hundred million renminbi for the purchase and sale of goods, and forty million renminbi for services and intangibles. If a company exceeds these limits, it must prepare a local file that provides a functional and risk analysis of its activities.
This includes a dempe analysis for intellectual property and a benchmark study of comparable companies in the same industry. The local file must justify the transfer pricing method used and show that the results are consistent with the market. The tax bureau reviews these files to identify potential audit targets.
A well prepared local file can reduce the risk of a long and expensive investigation.
Deadlines for submitting these documents are strictly enforced to ensure timely monitoring of tax risks. According to state taxation administration circular 2016 no 42, the master file must be completed within twelve months of the end of the group’s fiscal year. The local file has a shorter deadline, requiring completion by June 30 of the following year.
Companies do not have to submit these files automatically but must provide them to the tax bureau within ten days of a request. The country by country report, which provides a snapshot of the group’s global taxes and profits, must be filed annually by the ultimate parent company or a designated entity. Failure to comply with these rules can lead to significant fines and a lower credit rating for the company.
The circular ensures that the tax authorities have the information they need to protect the national tax base. It is the most comprehensive transfer pricing regulation in China.
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