On April 16, 2009, China’s State Administration of Taxation (SAT) issued the Circular on Certain Issues Regarding Strengthening the Follow-up Supervision of Transfer Pricing to aid local tax authorities in the crackdown on transfer pricing.
The Circular is a continuation of Chapter 5 of the recently published Pilot Implementation Measures for Special Tax Adjustments a topic in our last issue of China Update), issued by SAT on January 8, 2009. To be consistent with the PRC Law on Enterprise Income Tax (New EIT Law) and its implementation rules, effective since January 1, 2008, the Measures were retroactively applied to the same date. Thus, 2008 was the first year that formalized transfer pricing regulations were implemented under the New EIT Law. However, the Measures lacked certain details on how local tax authorities should apply these regulations to supervise and audit enterprises. Consequently, SAT issued the Circular to parse the Measures and further guide local tax authorities in dealing with transfer pricing.
According to Chapter 5 of the Measures, if local tax authorities find that an enterprise’s related party transactions do not comply with the arm’s length principle, they will devise a Transfer Pricing Adjustment Plan, and issue a Special Tax Audit Adjustment Notice to the enterprise. The enterprise must pay the tax and interest due within the specified period in accordance with the Special Tax Audit Adjustment Notice.
To ensure future compliance, Chapter 5 of the Measures prescribes that if the tax authorities make a transfer pricing adjustment to an enterprise’s taxable income, then that enterprise will be subject to a five-year supervision period starting from the year after the most recent year in which the enterprise’s taxable income was adjusted (Follow-up Supervision Period). The Circular reiterates this provision, and orders local tax authorities to monitor enterprises involved in transfer pricing adjustment cases closed after January 1, 2008. Under the Circular, during the Follow-up Supervision Period, enterprises must submit contemporaneous documentation to the competent tax authority before December 31, 2009 if the transfer pricing adjustment occurred in 2008, or before June 20 of each subsequent year if the transfer pricing adjustment occurred in or after 2009. The Circular further emphasizes that local tax authorities should excise due diligence in analyzing and assessing enterprises’ transactions.
In addition, the Circular encourages local tax authorities to establish a sound mechanism for the follow-up supervision of enterprises that engaged in transfer pricing. With respect to enterprises subject to follow-up supervision that wish to adopt an advance pricing arrangement, another special tax adjustment method that allows enterprises to seek approval from local tax authorities before determining a transfer price in their related party transactions, local tax authorities should strictly implement the effective Transfer Pricing Adjustment Plan before any such advance transfer pricing arrangement is finalized.
The issuance of the Circular reflects the government’s efforts to further standardize the implementation of rules and regulations on transfer pricing, and to ensure full and accurate tax collection.