On 12 April 20012, the State Administration of Taxation (“SAT”) issued the China 2010 APA Annual Report (“Report”) in bilingual , which is the second Annual Report subsequent to 2009 APA Annual Report. The Report introduces the Chinese APA program, its implementation procedures and development of APA practices, and offers statistics and analyses of China’s APA program for the period from 2005 through 2010.
As one of the few public reports in the Chinese transfer pricing and anti-tax avoidance administration, many descriptions in the Reports reveal the “hidden rules” of the Chinese transfer pricing administration.
- 1. Strictly administration procedures of transfer pricing / APA
APA is time-consuming and burdensome. According to the Report, the unilateral APAs are generally completed within 2 years, of which 53% is completed within 1 year, and 47% is completed within 1 to 2 years. The time to complete a bilateral APA is usually longer than the same of unilateral APA. The 56% of the bilateral APAs was completed within one year, 19% within 1 to 2 years and 19% within 2 to 3 years. The 6% of the APAs spend more than 3 years to complete. The above data shows that China is very prudent for the administration of transfer pricing/APA, and the whole control process is very stringent.
- 2. Basis for assessment and adjustment of related party transactions
Where the related party transactions in application year or pervious years are identical or similar with the same in the applicable years under APA, upon approval from the in-charge tax authority, the pricing principle and calculation approach determined under APA may also be applicable to the first mentioned related party transactions. The retroactive adjustment period is up to ten years before the application year.
- 3. Bilateral APA is still the priority of the SAT’s APA agenda
Nowadays, there are 35 accepted unilateral APA applications by Chinese tax authority, which are under examination and evaluation or under negotiation, while the accepted bilateral APA applications are 55. The bilateral APA accounts for more than 60% of the total accepted APA applications under examination and evaluation or under negotiation. In addition, as emphasized in the first section of the Report, Bilateral APAs can also provide the following additional advantages: (a) facilitate communication and collaboration among the competent tax authorities of different jurisdictions; and (b) help enterprises avoid transfer pricing adjustments as well as double taxation risks in two (for bilateral APA) or more (for multilateral APA) tax jurisdictions. Therefore, we anticipate that the SAT prefers to accept the bilateral APA application.
- 4. The geographic scope of the jurisdictions having APA with China shows a trend of “go from near to distance”
The bilateral APAs signed by China from 2005 to 2010 are mainly with Asia countries, accounting for 75% of the total bilateral APAs. According to the public materials available to us, the major countries concluded bilateral APAs with China include Japan, Korea and Singapore etc. The 19% of the bilateral APAs are with European countries and the country is Denmark. The bilateral APAs with North America account for 6% and the country is USA. Besides these, no any other bilateral APA is achieved. Therefore, in terms of the regions or the countries of the bilateral APA, the SAT may wish to accept some applications from other regions or countries beyond the jurisdiction with existing APA.
- 5. Interquartile method is simplified to bisection method
Firstly, the SAT expressly indicates that they will in practice give priority to APA applications made by the following types of enterprises: (a) enterprises which have provided sufficient and complete information, actively cooperate with the tax authority’s examination and evaluation, and proactively submit a reasonable APA proposal (the range of the interquartile is reasonable and the median is on a high level); (b) enterprises which have been investigated by the tax authorities for their transfer pricing policies.
Secondly, the Report makes it clear that, where the interquartile method is adopted in an APA and the actual profit level is lower than the median, the tax authority may not accept the enterprise’s APA renewal application.
The above situations indicates that the tax authority is inclined to accept the data above the median as the reasonable data range in transfer pricing/ related party transactions.
- 6. Preference to use the transfer pricing method
As disclosed in the Report, the transactional net margin method (“TNMM”) is the most commonly used transfer pricing method, being used in 42, or 64%, of signed APAs. The most commonly used profit level indicators are the Return on Sales ratio (used in 23 APAs) and the Full Cost Mark-up ratio (used in 19 APAs). Recently, the Chinese tax authorities have frequently used public data, which explains why the TNMM is the most commonly used method in the signed APAs. In addition, the TNMM is also used to determine the routine profit when applying a residual profit split method.
The second most popular transfer pricing method is the cost plus method, being used in 16 of the concluded APAs. The other transfer pricing methods are applied less frequently. The comparable uncontrolled price (CUP) method is used in 4 cases; the profit split method in 2 cases; and other methods in the other 2 signed APAs. As the CUP method requires a very high standard of comparability for application and the resale price method and profit split method require a heavy amount of information regarding the transaction and pricing, these methods tend to be applied less frequently in practice.
Meanwhile, the Reports mentioned that the Chinese tax authorities hope that enterprises will better cooperate with tax officers during the APA review and evaluation phase and provide sufficient information regarding transactions and prices so that the resale price method and the profit split method may be more frequently applied in the APA program.
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