If you had told me ten years ago that I would some day be writing on transfer pricing, I would never have believed it. Heck, if you had told me ten years ago that I would one day be writing on transfer pricing, I might have considered going into a different field. Even three years ago I would have just laughed.
I am not laughing right now and believe me when I tell you that I am writing this post only because I deem it absolutely necessary. Too many companies are missing the boat when it comes to transfer pricing and by doing so they are costing themselves a lot of money.
So to minimize my pain, I am going to get right down to business by listing the three things you need to know about transfer pricing as related to your China business. Spoiler alert: If you are just buying product from or selling product to China, you can (mercifully) leave now; this post relates only to those who are actually doing business in China.
1. Definition of Transfer Pricing. Wikipedia very nicely defines transfer pricing as follows:
Transfer pricing refers to the pricing of contributions (assets, tangible and intangible, services, and funds) transferred within an organization. For example, goods from the production division may be sold to the marketing division, or goods from a parent company may be sold to a foreign subsidiary. Since the prices are set within an organisation (i.e., controlled), the typical market mechanisms that establish prices for such transactions between third parties may not apply. The choice of the transfer price will affect the allocation of the total profit among the parts of the company. This is a major concern for fiscal authorities who worry that multi-national entities may set transfer prices on cross-border transactions to reduce taxable profits in their jurisdiction. This has led to the rise of transfer pricing regulations and enforcement, making transfer pricing a major tax compliance issue for multi-national companies.
Transfer pricing comes into play in China for transactions between related companies. KMPG provides a good definition of what constitutes a related or associated company in China:
Twenty-five percent ownership, be it direct or indirect ownership, or control. This applies whether one party owns another or two parties are owned by a third party. The formula for calculating indirect shareholding percentage has been changed: 25 percent ownership is now counted as 100 percent when multiplying the shareholding percentages of each level of indirect shareholdings. Other criteria including loans, control of management, or other types of control can also be taken into account.
2. Why Transfer Pricing Matters. NOW. I could write pages and pages as to why it is imperative that you deal with transfer pricing now and why these issues have come to the fore all of a sudden in China. But I won’t. What I will tell you is that China has over the last year or so been cracking down on transfer pricing and that crackdown just keeps accelerating. China is striving to increase its tax revenues (that’s a given) and transfer pricing is a great way for it to do so by tapping foreigners for money.
3. What Must You Do About China Transfer Pricing. NOW. Again, I could write pages and pages on this. But I won’t. I will just say that if you have or will have a related Chinese entity you should look at your prices between your foreign entity and your Chinese entity because if those prices are not reasonable enough to get past the Chinese tax authorities, you will likely be facing serious problems. Just a few examples. If your Chinese entity (let’s say it’s a WFOE) is buying $1 widgets from the home entity back in the United States or England or wherever and paying $50 for those widgets so that the profits from sales will go to the United States or England and not to China, the Chinese tax authorities will probably step in and re-calculate your Chinese taxes as though you paid $1 for the widgets. You also face penalties. On the flip side, if your Chinese entity’s profits is only $10,000 from making $100 million in product for the home entity, the Chinese tax authorities will probably impute much higher profits (than the $10,000) to your Chinese entity. It will then tax the Chinese entity on the imputed profits and you will be facing potential penalties as well.
But the main thing you need to know about transfer pricing in China (or anywhere) is that it is very complicated and the rules relating to it and the levels of enforcement seem to be perpetually toughening. So if you are doing business with a related or associated company in China, you should be working with accountants experienced with China’s transfer pricing laws and you should be doing so before you have a problem.
If you wish to learn more about China transfer pricing, I urge you to read any or all of the following reports from the Big Four: Deloitte, Ernst & Young KMPG, PwC.
What do you think?
