China's transfer pricing system has developed significantly in recent years. The key points are: 1) China established its transfer pricing legal framework in 1991 and strengthened the laws in 2007, adopting the arm's length principle. 2) Transfer pricing audits were initially focused on tangible goods but now include intangibles, services, and equity shares. Guidelines were issued in 2009 and audit cases have increased annually. 3) Bilateral and multilateral APAs have been signed to provide certainty, with the first report issued in 2010. A "three in one" anti-avoidance system was created involving administration, services, and investigation. 4) Special considerations for Chinese factors include location savings, market premium,

1. China’s transfer pricing system
Zhang Ying
State Administration of Taxation of
People’s Republic of China

2. Introduction
With the integration of China’s economy into
the world, more and more MNEs have
entered into the Chinese market.
At the same time, outbound investments byAt the same time, outbound investments by
Chinese domestic company have been
exponentially growing.
Consequently, transfer pricing has been
becoming a more and more pressing issue
for Chinese tax authority.

3. Outline
The development of China’s transfer pricing
legal framework
The development of China’s transfer pricing
practicepractice
Special considerations on Chinese factors
Development trend of China’s transfer
pricing system

4. The development of China’s
transfer pricing legal system
On July 1 1991, the Income Tax Law for Foreign
Investment Enterprises and Foreign Enterprises
( known as “the FEIT Law”) and its implementing
rules came into force.
FEIT law adopts arm’s length principle as the
basis for china’s transfer pricing system and tax
authorities are authorized to adjusted a Foreign
Investment Enterprise and Foreign Enterprise’s
taxable income where it has been reduced as a
result of non-arm’s length prices.

5. The development of China’s
transfer pricing legal system
In 2007, China promulgated Corporate Income
Tax law (“CIT”) and its implementing rules ,which
have been in force since Jan 1, 2008.
The new CIT mergers the Enterprise Income Tax
Law (which previously applied to domesticLaw (which previously applied to domestic
enterprises) and the Foreign Enterprise Income
Tax Law (which previously applied to foreign
enterprises).

6. The development of China’s
transfer pricing legal system
In the new CIT law and its implementation
rule, Chapter 6 “special tax adjustment” is
aimed at regulating transfer pricing issues.aimed at regulating transfer pricing issues.

7. The cornerstone of
“special tax adjustment” Chapter
Arm’s length principle
The CIT Law provides the arm’s length
principle standard as the guiding principle
for related party transactions, andfor related party transactions, and
empowers the tax authority to adjust a
taxpayer’s taxable income if the taxpayers
fails to comply with the arm’s length
principle in dealing with related parties.

8. The scope of
“Special Tax Adjustment ”chapter
Transfer pricing
Advance pricing agreement
Cost sharing arrangement
Annual disclosure of related transactions and
contemporaneous documentation
Annual disclosure of related transactions and
contemporaneous documentation
Controlled foreign enterprises
Thin capitalization
General tax avoidance
Special interest Levy

9. Law Regulations Rulings
The current legal framework
Corporate
Income Tax Law
Tax collection
and
administration
law
Implementation
rules of CIT
Implementation
rules of Tax
Collection and
Administration
law
Detailed rules
and circulars for
tax laws and
regulations

10. The development of
China’s transfer pricing practice
The first case was initiated in 1986
In the early years, transfer pricing audits are
mainly focused on transfer of tangible good.
In recent years, audit targets have beenIn recent years, audit targets have been
broadened with transfer of intangible good,
services, equity shares as well as tangible
goods.

11. Practical guidance for
transfer pricing auditors
Circular Guoshuifa [2009] No 2, “The
implementation measures of Special Taxation
Adjustment”, which is a detailed transfer pricing
audit directive.audit directive.

12. Investigation cases
closed in recent years
2006 2007 2008 2009 2010 2011
Number of
adjustments
177 174 152 167 178 207
adjustments
Average adjustment
(RMB millions)
3.84 5.75 8.16 12.51 14.5 11.8
Approximate total
adjustment (RMB
millions)
458 680 1,000 1,240 2,089 2,581

13. APA annual report
In December 2010, SAT issued the first ever
annul report on APA in China for 2009,
which initiated China’s annual APA reporting
system.system.

14. Number of APA
Signed in recent years
Year Unilateral APAs Bilateral APAs Multilateral APAs Total
2005 13 1 0 14
2006 10 0 0 10
2007 7 3 0 10
2008 6 1 0 7
2009 5 7 0 12
2010 4 4 0 8
Total 45 16 0 61

15. The creation of “three in one ”
anti-tax avoidance system
In order to optimize the limited transfer pricing
audit resources and achieved the goal of “both
prevention and investigation”, SAT created a
“three in one” anti-avoidance administrative“three in one” anti-avoidance administrative
system which includes administration, service
and investigation.

16. Administration
Rely on mechanism such as mandatory
related-party transaction reporting, examination
of contemporaneous documentation and follow-
up measures to encourage taxpayer to perform
a self-examination and self-correction of theira self-examination and self-correction of their
transfer pricing policies.
In order to minimize transfer pricing risks from
the beginning.

17. Service
APA: provide certainty for taxpayers on its
transfer pricing policy
Map: create a channel for taxpayer to resolve
disputes and minimize the risk of doubledisputes and minimize the risk of double
taxation

18. Investigation
Strengthening investigation on MNS with huge
amount of related transactions and
unreasonable transfer pricing policies
Joint investigationJoint investigation

19. Standardized working procedure
In order to run the transfer pricing
administration in a more efficient and effective
manner and with a high degree of consistency
and transparency, all transfer pricing casesand transparency, all transfer pricing cases
must be reported to the SAT for final review
and assessment after they have been
examined by different tax authorities at various
levels.

20. The weakness in
applying OECD guideline
Difficult to find perfect comparables due to the
limited amount of Chinese listed companies in
china and lack of information sharing
mechanism among different administrationmechanism among different administration
authorities and different regions.
Difficult to make reasonable adjustment
between Chinese companies and comparables
located oversees.

21. The ways to
overcome the weakness
Besides searching for desirable comparable
for tested party, we tend to analyze the profit
of the tested party in the context of whole
supply chain.supply chain.
By doing so, we want to rationalize the
appropriateness of allocation of Chinese
company’s profit in the whole supply chain
of MNEs, unaffected by their related position.

22. The ways to
overcome the weakness
Therefore, we need to focus on the value
drives with unique Chinese characteristics
which contributes to the residual profit of the
whole supply chain.whole supply chain.

23. Special consideration
on Chinese factors
Location saving
Market premium
Unpaid pollution

24. Location Saving
Lower cost of labor
Better infrastructure and logisticsBetter infrastructure and logistics

25. Location Saving
More importantly, location saving is reflected in
the unique contribution made by low-paid
Chinese engineers and technicians who
improve and refine the technology provided byimprove and refine the technology provided by
the associated company and fostered
incomparable intangibles which cater to the
needs of customers.

26. Market premium
Huge population
Exponential growth of Chinese middle classExponential growth of Chinese middle class

27. Environmental cost
High emission of pollution by MNC
As a manufacturer, the cost of manufacturing isAs a manufacturer, the cost of manufacturing is
more than what is recorded on the book.

28. Taking the car manufacturing
as an example
10, 33010, 33010, 33010, 330
13, 76013, 76013, 76013, 760 13, 70013, 70013, 70013, 700
10000100001000010000
12000120001200012000
14000140001400014000
t
h
o
u
s
a
n
d
c
a
r
s
t
h
o
u
s
a
n
d
c
a
r
s
t
h
o
u
s
a
n
d
c
a
r
s
t
h
o
u
s
a
n
d
c
a
r
s
Chi na paseenger car sal esChi na paseenger car sal esChi na paseenger car sal esChi na paseenger car sal es
754754754754
5, 6005, 6005, 6005, 600
0000
2000200020002000
4000400040004000
6000600060006000
8000800080008000
10000100001000010000
u
n
i
t
u
n
i
t
u
n
i
t
u
n
i
t
::::
t
h
o
u
s
a
n
d
c
a
r
s
t
h
o
u
s
a
n
d
c
a
r
s
t
h
o
u
s
a
n
d
c
a
r
s
t
h
o
u
s
a
n
d
c
a
r
s
2001200120012001 2008200820082008 2009200920092009 2010201020102010 2011201120112011

29. Are we simply contract
manufacturers?
In the MNEs’ supply chain, Chinese companies
are usually characterized as contract
manufactures.
However, concerned with the unique factorsHowever, concerned with the unique factors
with Chinese characteristics, should we be
rewarded simply as contract manufacturer?

30. Issues we concern
Royal t i es pai d t o f or ei gn compani es( uni t : USmi l l i ons)
10, 300 11, 100
13, 000
14, 700
10, 000
12, 000
14, 000
16, 000
18, 000
6, 006
8, 200
10, 300
0
2, 000
4, 000
6, 000
8, 000
10, 000
2006 2007 2008 2009 2010 2011

31. Issues we concern
Is technology the most important value drivers
of the profit of the company?
Do we really need it?
How much contribution does the technologyHow much contribution does the technology
make to the profit of the supply chain?
How about the local R&D value?

32. Issues we concern
Huge amount of meticulous fees paid by
Chinese companies to their associated
companies.
If the Chinese companies are characterizedIf the Chinese companies are characterized
only as contract manufactures, do we really
need so many sophisticated services?

33. Solution
More frequent use of Profit split method or
hybrid methods to test whether or not the result
reflects the reasonable allocation of profit ofreflects the reasonable allocation of profit of
whole supply chain

34. Development trend of
transfer pricing system
Further refining the anti-avoidance legal
framework

35. Development trend of
transfer pricing system
Expanding the database
Greater cooperation in the area of exchange
of information with other administration
authorities.authorities.
Creation of a national database which allows
for the sharing of tax filing information among
tax authorities in different regions.

36. Development trend of
transfer pricing system
More efforts will be put on prevention of tax
avoidance.
Engaging in more bilateral APAs to reduce the
uncertainties for taxpayers.uncertainties for taxpayers.
Encouraging the use of MAP to resolve transfer
pricing controversy

37. Development trend of
transfer pricing system
Expanding the target of audit from Enterprises with
foreign investment or Foreign enterprises to domestic
enterprises which made outbound investment.
Expanding the focus from manufacturing operations to
intangible assets, financial transactions, corporateintangible assets, financial transactions, corporate
restructuring and special services.
Expanding the enforcement measures from transfer
pricing and APA to cost sharing arrangement (CAS),
Controlled Foreign Company (CFC) rule, Thin
Capitalization rule and General Tax Avoidance rule
(GAAR).

38. Talents development plan
Deployment of a national expert committee
Intensive training for experienced and newly
recruited transfer pricing auditor.

39. Thank youThank you