Interpretation of Bulletin 42 issued by China’s State Administration of Taxation

      On July 13, China’s State Administration of Taxation (SAT) published Bulletin 42, which replaced its current transfer pricing documentation rules, and has made a series changes to multinational entities’ transfer pricing compliance obligations. In contrast with the 2015 Draft, the Bulletin 42 modified some terms and further explicated the requirements for reporting enterprises.
 
     The Bulletin 42 focuses on the Related-party Transactions and Contemporaneous Documentation. Different and specific thresholds are provided for each type of file, and the contents required include many additions on top of the requirements of BEPS Action Plan 13. (1)
 
     Related-Party Transaction Reporting: According to the new transfer pricing regulations, the number of related-party filing forms increased from nine to 22, including information disclosures with respect to the Country-by-Country (CBC) Report. Additionally, the CBC Report form must be filed in accordance with the information disclosure requirement stipulated by Action 13 of BEPS. 
 
     Contemporaneous Documentation: The regulations’ three-tiered framework for contemporaneous documentation consists of master files, local files, and special files. Enterprises are required to finish preparing their contemporaneous documentation before May 31 of the following year and must submit documentation within 20 days of a request by the tax authorities. (2)
 
     Multi-national enterprises (MNEs) play an increasingly important role in global trade, accounting for 10% of world gross domestic product (GDP) in 2007. It is estimated that more than 60% of international trade is intra-group trade – that is, it occurs within the same organization or group of companies. (3) The compliance burden faced by multi-national corporations (MNCs) operating in numerous tax jurisdictions can be onerous. This is perhaps most significant in the area of international transfer pricing, the means by which companies allocate profits, and therefore taxing rights, between jurisdictions. (4)
 
     The announcement shows a trend toward a tougher business environment for MNEs doing international trade in China. It is worth noting that SAT, together with the tax authorities of Canada and India, has signed the Agreement on Multilateral Competent Authorities for the Transfer Pricing Country Report, which guaranteed to automate the exchange of country reports prepared by multinational conglomerates. At the same time, the United States, Japan, and many other developed countries are also working on or have published their respective country reports on the domestic provisions. This shows that MNEs will face more workload and challenges such as stricter supervision, higher information transparency, and more stringent compliance requirements. Specifically, MNEs need to provide complex information involving communication with related parties overseas and maintain consistency with global transfer pricing disclosure.
 
     Bulletin 42 represents a breakthrough for the SAT in implementing the Base Erosion and Profit Shifting (BEPS) action plan launched by OECD in China, which requires more transparent disclosure of contemporaneous documentation (Ex: full analysis of value chains and related transactions). The increasingly extensive and mature exchange of information among tax authorities in various countries around the world will help the SAT be better prepared when conducting risk assessments for taxpayers, executing transfer pricing arrangements, and participating in global anti-tax avoidance actions. The issuance of Bulletin 42 signals the beginning of a new chapter for China’s transfer pricing practice and is in accordance with international standards, which brings Chinese transfer pricing in line with the BEPS developments occurring at the OECD and across many tax jurisdictions globally. 
 
     Transfer pricing is an enormous challenge globally, but the challenge is acuter in developing countries. The complexity of the transfer pricing system, combined with a lack of capacity and expertise in developing countries, leaves the latter open to abuse. Emerging economies, such as China, have realized the significance of transfer pricing in their globalized economies, as well as challenges caused by transfer pricing worldwide, and have begun to sharpen the skills and build administration structures to implement comprehensive rules in accordance with the arm’s length principle. They have the same goal as OECD countries, and they take transfer pricing rules based on the arm’s length principle as an important defensive method to protect their tax revenue and a critical step in creating a healthy business environment for international trade and investment.  
 
     Tax authorities in developing countries who wish to implement transfer pricing legislation may focus on the most common types of transactions and sectors in their economy first––for instance, the exploitation of natural resources, manufacturing, or service activities. Enforcement objectives should be realistic, given the available capacity, and compliance requirements should be made reasonable for taxpayers in light of the size of the cross-broad trade. So-called “safe harbors” are sometimes used to simplify compliance by small taxpayers, or to deal with small and less complex transactions carried out by multinational enterprises.(5) It is difficult to apply the arm’s length principle in practice and most OECD countries started modestly and built their transfer pricing regulations and rules gradually over years. They are still in the process of improving them.
 
     Since the controversial nature of transfer pricing in the regional and global scope, it is necessary for countries to work together on an equal footing and develop commonly shared principles to help countries control excess transfers of tax revenue abroad while lowering the risk of double taxation of these profits at the same time. This is what the arm’s length principle is for. Bulletin 42 brings China’s documentation rules up to speed with what is happening at the OECD level and global implementation of BEPS. With more and more developing countries applying it, international trade and investment would be more transparent and exchange of information among jurisdictions for tax purposes would be promoted. This is a key to building a sound and reliable international tax system for all as well as a stronger, healthier and fairer world economy. 

(1) Chan, Daniel. Li, Windson. “China makes major changes to transfer pricing documentation and country-by-country reporting requirements.” LEXOLOGY. 22 June, 2016.
 
(2) Chu, Shirley. “China Introduces Sweeping New Transfer Pricing Rules.” China business review. 19 September, 2016. 
 
(3) UNCTAD, World Investment Report: Transnational Corporations, Extractive Industries and Development, 2007.
 
(4) UNCTAD, Transfer Pricing, UNCTAD series on issues in international investment agreements, 1999, www.unctad.org/en/docs/psiteiitd11v1.en.pdf
 
(5) Silberztein, Caroline. ”Transfer pricing: A challenge for developing countries” OECD Observer. 5 October, 2016
 
(6) https://www.federalregister.gov/articles/2016/06/30/2016-15482/country-by-country-reporting.

​
Image: © Skypixel | Dreamstime.com - Business in China challenge