On 4 December 2013, Jiaxing Daily reported that the Jiashan State Tax Bureau (“JSTB”) in Zhejiang province made a transfer pricing adjustment in domestic transactions between a local electronics manufacturing company (the “Company”) and its parent company in Shanghai (the “Parent”)1. The Company is subject to the general enterprise income tax (“EIT”) rate of 25 percent, while the Parent is a high and new technology enterprise which is subject to a reduced rate of 15 percent.
According to the report, JSTB discovered that the Company sold goods (solely) to the Parent for RMB236 million, which resulted in RMB11.62 million losses for the Company. JSTB determined that the transactions between the Company and the Parent were not arm’s length and made a transfer pricing adjustment of at least RMB11.62 million to the Company’s taxable income.
In practice, transfer pricing adjustments in transactions between domestic related parties are uncommon. However, under Chinese transfer pricing rules, transactions between domestic related parties are also subject to transfer pricing adjustments if these transactions would reduce the country’s overall tax revenue2.
As showed in this case, transactions between domestic related parties with different effective EIT rate will be subject to transfer pricing adjustment risk. In this case, profits are shifted from the Company to the Parent which is subject to a lower EIT rate of 15 percent.
This case also shows that companies in a loss position, in practice, are more likely subject to transfer pricing investigations by PRC tax authorities.