Tax holidays in China end, transfer pricing documentation starts

Many Australian companies with business interests in China are underprepared for looming changes to transfer pricing tax being introduced by the Chinese government.

Australian companies have taken advantage of the tax breaks available for foreign investors as China opened its borders for trade in the past decade, with trade between the two countries reaching $57.5 billion last year.

Now the tax holiday is over. Following years of offering tax incentives for Australian companies investing in China, the China State Administration of Taxation (‘China SAT’) has issued draft transfer pricing rules. The new draft approach is expected to become final and take full effect by 31 December 2008 and means that:

• By 31 May 2009 all tax payers in China, including Australian businesses operating in China, must assess if their China company has more than approx $4.5 million of transactions with non China related parties. If they do, then the draft requires the subsidiary to create and hold “simplified transfer pricing documentation”. If the related party transactions are greater than approx $22 million then “full” documentation is required. The draft suggests how the documentation should be put together. In its simple form, it is expected to be similar to what the ATO suggests in Australia – the full documentation however may require more than what is drafted in Australia. The transfer pricing documentation relates to the previous tax year (effective from 1 Jan to 31 Dec 2008), and is required to be prepared at the time of annual tax return filing.
• Transfer pricing documentation must be completed in Chinese (Mandarin). Companies will have 15 days to comply with providing a transfer pricing document when required, or face potential transfer pricing audits (China SAT assumes companies will have prepared the statement in advance).
• If a transfer pricing adjustment is conducted during a transfer pricing audit, the taxpayer will be fined an interest payment, plus a 5% penalty. The 5% penalty can be exempted if a proper documentation study has been prepared and provided.

These draft changes are relatively unknown outside China and have the potential to catch out a lot of foreign investors in China who have manufacturing subsidiaries supplying product to related companies in the group. Australian businesses operating in China need to act on this now. From a business perspective this is as much about risk management and business continuity as it is about tax compliance.

Many Australian companies have been less than sympathetic in preparing transfer pricing documentation in Australia to protect their own operations from future Australian Taxation Office penalties. In Australia there has been a tendency to take the risk of ‘doing nothing /’wait and see’. Transfer pricing documentation is “suggested” by the ATO not mandated so the cost of preparing it is deferred by many companies until the ATO asks. The ATO is normally happy to give an extension greater than three weeks while the document is put together with an advisor. Penalties apply if the document is prepared when asked for rather than at the time of tax return preparation, if the ATO makes an adjustment.

The biggest danger is that the Chinese approach will be very different with less sympathy to reduce potential penalties. A proactive approach is recommended. Using the “wait and see” approach is an unwise strategy.

Grant Thornton has a team of accredited transfer pricing professionals who can help your business be prepared for the new Chinese transfer pricing rules. Contact us for assistance.

Alternatively, phone Chris Bowman directly

T +61 02 8297 2400