China Issues More Rigorous Advance Pricing Agreement Rules

China is requiring multinational groups to provide more information, including the location-specific advantages of their Chinese entities, when they apply for advance pricing agreements.

The State Administration of Taxation’s Public Notice 64, dated Oct. 11 and released Oct. 18, requires companies to provide the additional information to Chinese tax authorities at the pre-filing stage of both bilateral and unilateral APA requests.

In a unilateral APA, a multinational group and the Chinese tax authorities seek to reach an agreement on the appropriate transfer pricing method for the group’s related-party transactions for a period of three to five years. In a bilateral APA, the company reaches an agreement with two tax administrations–for example, with China’s State Administration and the U.S. Internal Revenue Service. The agreements, which are intended to cover future years but in some cases may be “rolled back” to cover past years, allow companies to avoid audits of their cross-border transactions.

“The new provisions significantly raise the threshold for formal APA applications,” Jeff Yuan of PricewaterhouseCoopers in Shanghai told Bloomberg BNA in an e-mail. “Enterprises must prepare their application package in accordance with the new requirements, especially to include analyses which China tax authorities pay special attention to, such as analysis of value chain and location-specific advantages.”

Chinese officials have argued in recent years that transfer pricing analyses must provide for adequate remuneration to the Chinese entity for characteristics unique to the local market, such as low labor and infrastructure costs and consumer demand for foreign and luxury products.

According to Public Notice 64, in addition to describing the Chinese entity’s location-specific advantages, the entity in its APA application must also describe at the pre-filing stage any market premium it earns because of its operation in the Chinese market, according to an unofficial English translation of Notice 64 by PricewaterhouseCoopers Consultants (Shenzhen) Ltd. Market conditions include industry development trends and the competitive environment.

The State Administration of Taxation’s new APA requirements are effective Dec. 1, 2016, and will replace guidance on the administration of APAs issued by the SAT in 2009. Companies whose APA applications haven’t been formally accepted before the effective date will also need to comply with the new rules.

The maximum retroactive period under the APA application is 10 years.

Pre-Filing Stage

Under Notice 42, the company during the pre-filing meeting must describe the allocation of functions and risks among the related parties covered under the APA, including the allocation bases used, entities involved, personnel, expenses and assets.

Notice 42 also requires the company to describe the business operations of the Chinese enterprise for the most recent three to five years and provide its contemporaneous transfer pricing documentation.

In addition, for bilateral applications, the company must provide the APA application sent to the other country’s competent authority and describe the transactions of related parties involved in the APA for the most recent three years. Finally, the company must disclose any international double taxation issues and explain them.

Value Chain Analysis

Yuan said Public Notice 64 “has moved the stage of analysis and evaluation ahead of the formal application stage.”

He pointed out that the new guidance requires enterprises to coordinate with tax authorities and adjust the proposed transfer pricing methods during the stage of analysis and evaluation, and the formal application will not be accepted until the two parties reach an agreement at this stage. This “may present challenges for the taxpayers and their related parties.”

Public Notice 64 requires the Chinese tax authorities to conduct an analysis of the draft APA application package after receiving the letter of intent from the enterprise. The tax authority will evaluate whether the application is consistent with the arm’s-length principle.

The tax authority’s functional and risk profile analysis will evaluate the functions performed and contributions made by the entity. Functions include production, logistics, sales, and research and development of intangibles. Risks include inventory risk, credit risk, foreign exchange risk and market risk borne by the enterprise and its related parties.

The value chain analysis will evaluate whether the company’s analysis of its supply chain is complete, and whether adequate consideration has been given to location-specific advantages including location savings and market premium.

Monitoring

Yuan said Public Notice 64 imposes more stringent requirements on the Chinese tax authorities to monitor the implementation of APAs and the enterprises’ actual operating results during the period covered by the APA. “For arrangements adopting the interquartile range, special attention shall be paid if the weighted average profitability of the enterprise during the implementation of the APA is below the median of the interquartile range.” The adjustment, if necessary, shall be made as early as possible to avoid any impediment to future renewal.

“Applying for bilateral China-US APAs is still viable option,” Yuan said. Companies will need to give more consideration to the information that needs to be disclosed and the analysis they will present to have the application accepted.