On 24 January 2014, China Taxation News2 reported that the Shaanxi
Provincial State Tax Bureau (“SPSTB”) made a transfer pricing adjustment
to a domestic business transfer and collected RMB22 million in enterprise
income tax (“EIT”) and interest.
According to the report, a foreign invested enterprise (“FIE”) in Xi’an
transferred part of its business at book value to another FIE as part of
an arrangement between the two FIE’s foreign corporate shareholders.
During the investigation, the SPSTB found that the transferor’s sales
revenue had been increasing steadily since it started operation. However,
when the SPSTB used the discounted cash method (income method) to
review the transfer price, it found that the transfer price was eight times
lower than the arm’s length price would have been. Therefore, the SPSTB
made a transfer pricing adjustment.
Most multinationals have long realized the difficulties and risks in
transferring companies through share deals at the original investment
cost or book value. However, most companies are less familiar with the
TP risks in transferring a business as a going concern through an asset
deal. Indeed, those TP risks have increased in recent years as some tax
authorities have started to challenge asset transfers at cost when the
business is transferred as a whole. Those tax authorities believe that the
value of the business should be determined by the income method rather
than the asset method when a business is transferred as a going concern,
regardless of whether the transfer occurs through a share deal or an
asset deal. Therefore, asset transfers at cost between related parties
might trigger a TP audit if the business is transferred as a going concern.
The Xi’an case serves as a wake up call to multinational companies doing
business restructuring in China. Their business/asset transfers in China
may be subject to transfer pricing adjustments if the transfer price is at
book value rather than fair market value. Moreover, they should be aware
that the PRC tax authorities may use the income method to determine the
arm’s length price of the business/asset transfer.