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Understanding transfer pricing in China.

Regulations, methods, and best practices.
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Understanding transfer pricing in China

Transfer pricing involves setting prices for transactions between related companies and is closely monitored in China to prevent tax avoidance. China’s regulations, aligned with international standards, require transactions to follow the arm’s length principle.

This article provides a brief overview of China’s transfer pricing rules, essential compliance requirements, and practical strategies for minimising risks and penalties. Businesses must understand and adhere to these regulations to ensure smooth operations and avoid financial penalties.

What is transfer pricing?

Transfer pricing, the practice of setting prices for transactions between related companies, is inherently complex. Several factors influence these prices, making establishing a single, universally accepted method difficult. This complexity attracts the attention of tax authorities, particularly China’s tax bureau, which has recently intensified its scrutiny.

Traditionally, transfer pricing involves companies in high-tax countries strategically lowering the price of goods, services, or intangible assets sold to affiliates in low-tax countries. Conversely, companies in low-tax countries inflate prices when selling to affiliates in high-tax jurisdictions. This strategy shifts profits from high-tax environments to low-tax ones, minimising the overall tax burden.

Overview of transfer pricing regulations in China

Transfer pricing in China is governed by Article 13 of the Income Tax Law for Foreign Investment Enterprises and Foreign Enterprises and Article 24 of the Law Concerning the Administration of Tax Collection. This legislation was first introduced in 1991 when China attempted to attract as many Foreign-Invested Enterprises (FIE) as possible. The regulations have been further tightened through the SAT, which issued a series of rulings (Guoshuifa).

Through these regulations, the PRC government has adopted international practices to govern transfer pricing based on comparable uncontrolled transaction principles, such as the OECD and US methodologies. Using these as guides, Chinese regulations stipulate that inter-company transactions and transactions between ‘associated entities’ should be priced using arm’s length principles.

The test of association between entities is based on control and ownership. Essentially, entities are considered associated if they fall into any of the following:


  • Not less than 25% shareholding
  • A provision of loans which accounts for not less than 50% of the owner’s capital.
  • A provision of a guarantee on loans accounting for not less than 10% of the company’s total loans


  • The legal representative or not less than half of the directors or executive management are appointed by another organisation.
  • The business operations depend on the provision of proprietary technology of another enterprise.
  • Another enterprise controls the purchase of raw materials or components or the sales of products.

Once entities are regarded as being associated, the firm must classify all related inter-entity transactions and account for them according to the arm’s length transaction principle. This applies to tangible assets, intangible assets and inter-company service transactions.

Key provisions and regulations, role of State Administration of Taxation (SAT)

According to Article 41 of the Tax Law, in cases where business transactions between an enterprise and its affiliated parties do not adhere to the principle of independent transactions and result in a reduction of taxable income or taxable amount for either the enterprise or its affiliated parties, the tax authorities have the authority to make necessary adjustments using reasonable methods.

It can be inferred that the key to transfer pricing risk lies in reducing income or taxable amounts for oneself or affiliated parties, resulting in a loss of national tax revenue.

To address this risk, the tax authorities employ a three-step approach to transfer pricing management:

  1. In the first step, the enterprise must submit documentation related to its affiliated transactions.
  2. The tax authorities meticulously analyse the submitted documentation to determine whether there are any risks of tax avoidance through affiliated transactions.
  3. During the third step, the tax authorities thoroughly investigate if a company is identified as posing a risk. If it is confirmed that underpayment of taxes has occurred due to transfer pricing, the company must make the necessary tax payment and any applicable interest.

According to Article 43 of the “Tax Law,” when an enterprise submits its annual corporate income tax declaration to the tax authorities, it must include a yearly report on affiliated business transactions.

Furthermore, Announcement No. 42 stipulates the specific information and documentation that enterprises should provide and provides guidelines for preparing the documentation. Announcement No. 6 outlines the approach taken by the tax bureau to analyse transfer pricing risks and conduct investigations on taxpayers.

Transfer pricing methods in China

According to legislation, tangible assets must be priced based on a transaction basis using one of three methods:

Comparable uncontrolled price method (CUPM)

The price is determined according to comparable transactions between unrelated parties. It could be based on a market price or an internal price based on the price paid or charged to independent third parties.

Resale price method (RPM)

Gross profit margin is determined according to the appropriate profit if it were an independent business. This is based on the functions performed, the assets used, and the risks the reseller assumes.

Cost-plus method (CPM)

The price is based on a markup comparable to a similar transaction with an independent seller.

However, given the difficulty in sourcing reliable public data in China, the tax authorities also consider other methods to price transactions as appropriate. These use a profit-based approach, where the price is determined based upon performance measures of a comparable company and industry, and include:

Comparable profits method

The price is based on profit measures from uncontrolled taxpayers engaging in similar business activities.

Profit split method (PSM)

The price is based upon the allocation of group profits by relative contribution to the combined profits.

Global profit allocation (GPA)

The price is based on a yardstick formula to allocate the group profits, such as costs, turnover, capital, etc.

Intangible assets

No method is specified but must be based upon agreeable charges between unrelated parties.


These should be charged at standard rates (i.e., at arm’s length), as with unrelated parties, where no influence can be exerted over the price.

The idea behind using the arm’s length transaction principle is that it provides parity of tax treatment for FIEs and local enterprises. Whilst China is conforming with WTO requirements to open its market and lower barriers to entry for foreign firms, it would only appear reasonable that it also assists in providing a more level playing field for its burgeoning domestic corporations.

Transactional net margin method (TNMM)

TNMM is particularly useful in China where comparables for transaction prices or gross margins are not available, which can be a common issue in China due to market opacity. This method compares the net profit margin relative to an appropriate base (like costs, sales or assets) that a taxpayer realises from a controlled transaction to that of comparable independent enterprises. Its adaptability makes it suitable for varied business operations in China, helping companies comply with regulatory demands by simplifying the analysis and focusing on overall business profitability.

Given the increased scrutiny by Chinese tax authorities and their focus on ensuring that all transactions comply with the arms’ length principle, employing TNMM can help align inter-company pricing strategies with regulatory expectations, which minimises transfer pricing risks and potential adjustments during an audit.

Challenges and risks in transfer pricing

Base erosion and profit shifting (BEPS)

BEPS (Base Erosion and Profit Shifting) refers to multinational enterprises exploiting deficiencies in international tax rules, differences in national tax systems, and loopholes in tax administration. They aim to minimise their global tax burdens, sometimes even achieving double non-taxation, thus eroding the tax bases of different countries. From a macro perspective, BEPS represents a significant tax compliance risk that multinational enterprises should pay close attention to when conducting cross-border operations.

In response to this challenge, on August 27, 2013, China signed the Multilateral Convention on Mutual Administrative Assistance in Tax Matters (referred to as the “Convention”), becoming the 56th signatory of the Convention. To effectively implement the outcomes of BEPS, China’s tax authorities have also revised existing policies in conjunction with new international tax rules. They have modified relevant regulations in areas such as related-party reporting, investigation and adjustment, advance pricing arrangements, and mutual agreement procedures. These revisions have led to the establishment of a new regulatory framework that aligns with international standards and aims to combat tax avoidance.

Transfer pricing audits and penalties

China’s tax environment is undergoing a significant shift. New legislation empowers more local governments to collect taxes while provinces offer varying tax breaks. The central government, meanwhile, cracks down on foreign-invested enterprises perceived to be avoiding paying their fair share.

Before companies embark on tax reduction strategies like inter-country profit shifting or fund repatriation, they must define their overarching global tax objectives. Then, they can develop localised tactics that align with these broader goals.

In China, the taxation authorities must audit:

  1. Companies which report losses for more than two consecutive periods
  2. Enterprises showing fluctuating profits.
  3. Enterprises showing profits lower than industry standards.
  4. Enterprises having transactions with affiliated companies in tax havens.

Given that the holding companies of most foreign companies’ China operations come from various tax havens (e.g., BVI, Cayman Islands) or Hong Kong S.A.R., which allows tax-free status for holding entities, the SAT will have many audits to perform in the coming years. However, they are well on their way, having trained over 1,000 employees for transfer pricing audits alone.

Improper transfer pricing practices can have severe consequences. One example of this risk is when a local company in China has been using transfer pricing to repatriate management fees for several years, only to be audited by authorities who decide that costs are not deductible for tax purposes. The company suddenly faced a significant tax bill, interest payments, and, even more importantly, penalties of up to five times the under-reported amount.

Best practices for minimising transfer pricing risk in China

Preparation is key

China’s stricter tax laws demand active transfer pricing risk management from all companies. This includes ensuring transactions comply with tax regulations and preparing data to demonstrate arm’s length pricing. Companies must also develop a deep understanding of their operations, functions, and assets to analyse related party transactions effectively.

Proactive preparation and planning are the best ways for FIEs to minimise their risk of a transfer pricing adjustment. Assuming that you will be audited at some point is always the safest way to play the tax game.

Preparing Advance Pricing Agreements (APAs)

To be proactive, organisations should prepare an Advance Pricing Agreement(APA) stipulating their dealings with associated entities to present to the taxation authorities for sign-off. This APA can be given to cover future dealings and past transactions. It also allows organisations to plead their case if there is a legitimate reason that their transfer pricing costs differ from industry norms, thus avoiding unnecessary scrutiny at later stages.

Tightening internal controls and financial systems

Similarly, companies should take the opportunity to upgrade and tighten their internal controls and financial systems. Whilst incorrect transfer pricing may be unintentional, the government will most likely take the stringent approach and classify such errors as intentional misreporting.

Maintaining documentation

Maintaining up-to-date documentation is crucial for all foreign companies in China, requiring annual audits and related party disclosures. Even if a full transfer pricing report isn’t mandatory, companies should evaluate their transfer pricing policy and potential risks regardless of size.

Additionally, they must ensure functions performed in China justify related party transactions and choose a transfer pricing methodology with a supporting comparable analysis. By presenting authorities with a clear audit trail and information (preferably in Chinese), companies can avoid an otherwise arduous experience.

Understanding the law

Finally, companies operating in China or dealing with Chinese entities must fully understand the law and its implications for their organisation. Ignorance is no excuse for illegal transfer pricing policies, and the SAT will certainly not understand companies that claim they did not realise.

Effective transfer pricing strategies

The documentation and submission of the transfer pricing report

According to Article 43 of the Announcement of the Corporate Income Tax Law of the Republic of China, the enterprise will attach the annual related party business dealings report for all business dealings between the enterprise and its associated parties when filing the annual corporate income tax returns.

Where the tax authorities conduct investigations into the party business dealings, the enterprise, the related parties and other enterprises related to the related party business dealing under investigation will provide the relevant information according to the provisions.

According to Article 10 of the Announcement of the State Administration of Taxation on Matters Relating to Improved Administration of Related Party Declarations and Contemporaneous Documentation, an enterprise shall, according to the provisions of Article 114 of the Implementation Regulations for the Enterprise Income Tax Law, prepare the contemporaneous documentation for its related party transactions for the tax year and following the requirements of the tax authorities.

Other documentation includes entity files, local files and special matter files.

Entity filesLocal files
Qualified enterprises
  • Cross-border party transactions occurred in the year, and the enterprise confirmed that the ultimate holding enterprise belongs to and has consolidated the enterprise’s financial statements and prepared the entity files.
  • The total amount of party transactions in the year exceeds RMB 1 billion.
  • The amount of the transfer of ownership of tangible assets (for processing of supplied materials, calculated following Customs declaration prices in the year) exceeds RMB 200 million.
  • The amount of the transfer of financial assets exceeds RMB 100 million
  • The amount of the transfer of ownership of intangible assets exceeds RMB 100 million.
  • The total amount of other related party transactions assets exceeds RMB 40 million.
DocumentsThe amount of the transfer of financial assets discloses the general information of the global business of the enterprise group to which the ultimate holding enterprise belongs and shall include the following contents:

  • Organisation structure
  • Business of an enterprise group
  • Intangible assets
  • Financing activities
  • Financial and tax situation
The local files shall disclose detailed information about the enterprise related to the party transactions and shall include the following contents:

  • Enterprise profile
  • Related party relationship
  • Related party transactions
  • Comparability analysis
  • Selection and use of the transfer pricing method


To effectively navigate China’s transfer pricing environment, companies must prioritise three key areas: strict compliance with evolving regulations, robust documentation of all intercompany transactions, and adherence to the arm’s length principle. By proactively implementing best practices and staying informed about regulatory updates, businesses can minimise tax risks and ensure fair taxation for their China operations.

How Acclime can help

Remember, transfer pricing is an estimation, not an exact science. Justification and a well-defined methodology are essential for defending against tax investigations. Acclime has English-speaking professionals who have assisted companies in evaluating their transfer pricing reports, reviewing their documentation, and identifying tax risks or potential issues. You can contact us to discuss your business transfer pricing reports or other concerns.

Contact our teams for expert support and further information about accounting & tax requirements in China to ensure you are compliant in the market.

Christophe Marquis, Director, Shanghai,
Mei Qian, Accounting Services Director,
Emily Shi, Partner,

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