Transfer pricing documentation, required by the State Administration of Taxation (SAT), is due to be submitted by companies that are part of an international group by the end of December.

The requirement stems from a circular (Guo Shui Han [2009] No. 363) issued by the SAT on 6 July. Circular 363 should be read in conjunction with another SAT document, Guo Shui Fa [2009] No. 2, which was issued on 9 January. According to Cecilia Lee, a partner at PricewaterhouseCoopers in Hong Kong, Circular 363 sets out the SAT’s view that “entities in China established by multinational companies, that have limited functions and risks, should not bear the market risk associated with the financial crisis, and as such should not make losses and should continue to make a return in line with their functional profile”.

Circular 363 goes on to say that any such entities that do incur losses are required to prepare and submit transfer pricing documentation, regardless of the size of any transfer pricing transactions they have entered into. According to PricewaterhouseCoopers, this documentation must be submitted by 31 December.

The documentation should be prepared in accordance with guidance contained in chapter 3 of Guo Shui Fa [2009] No. 2. Broadly speaking, chapter 3 includes 26 elements under the categories of organizational structure, description of business operations, description of related party transactions, comparability analysis, and selection and application of transfer pricing method. According to Lee, PricewaterhouseCoopers would “expect any such documentation also to include a special factor analysis to support or justify the China entity’s loss position”.

In a group which includes companies both in the PRC and offshore, transfer pricing offers scope for reducing the group’s overall tax liability. Items sold intra-group to a Chinese company may, for example, be over-priced in order to reduce the PRC entity’s profitability, by effectively moving money to an overseas jurisdiction where it may attract a lower tax rate.

More generally, China’s transfer pricing regulations state that companies must prepare contemporaneous transfer pricing documentation if their related party transactions exceed certain thresholds. These thresholds are an annual amount of related party sales and purchases exceeding RMB200 million, or an annual amount of other related party transactions (such as interest, service fees and royalties) exceeding RMB40 million. Documentation relating to such transactions that took place in 2008 must be prepared by 31 December 2009, but unless a company is caught by Circular 363 the documentation does not need to be submitted to the SAT.