Meaning
Procedural standards require that transactions between associated enterprises mirror the pricing found in an open market. This transfer pricing compliance is managed by the State Taxation Administration through a tiered reporting system based on the total value of intercompany trade. It forces companies to justify their internal pricing models to prevent the artificial shifting of profits to lower tax jurisdictions.
Documentation Tier
Companies exceeding specific transaction thresholds must prepare a local file and a country by country report. For transfer pricing compliance at the local level, the threshold for tangible goods transactions is 200 million yuan while for intangible assets and services it is 40 million yuan. Smaller entities are exempt from the formal documentation requirement but still must adhere to the arm’s length principle in their internal accounting.
The master file provides a global overview of the group’s business operations and supply chain structure to give local authorities context for the specific transactions occurring within the mainland.
Benchmarking Analysis
The local file must contain a study of comparable transactions between independent parties to prove that the company’s profit margins are reasonable. This analysis uses financial databases to find peer companies with similar functional profiles and risk levels. If the company’s performance falls outside the interquartile range of its peers, the tax bureau may initiate an adjustment to the taxable income.
Audit Scrutiny
Tax authorities use big data analytics to identify companies with persistent losses or fluctuating profit margins for detailed investigation. Transfer pricing compliance becomes a defensive shield during these audits because a well prepared local file shifts the burden of proof to the tax official. A failure to produce documentation within twenty days of a request results in strict penalties and a potential adjustment covering the previous ten years of operations.
