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Oct 2007
In the past, most of the Chinese transfer pricing ("TP") audits focused on tangible good transactions, in particular those relating to manufacturing operations. Intangible transactions have not been a major focus. However, the State Administration of Taxation ("SAT") have recently commenced a nation-wide tax audit exercise focusing primarily on royalty payments made by Chinese companies to overseas affiliates. These companies are generally from retailing and consumption goods and services industries.
In particular, we have noted a number of tax audit cases which have involved investigations into royalty payments which the Chinese tax authorities perceive to be too high. In one case, the Chinese tax authorities considered that the royalty paid by the taxpayer in China to its overseas affiliated entity was too high, resulting in an unduly high expense incurred on the books of the Chinese taxpayer company. The authorities made a TP adjustment to disallow a substantial part of the royalty payments. Notably, the SAT consider that an intangible attached to a royalty payment should generate a material benefit for Chinese licensee and as such, that licensee should not be in a loss making position or be earning only thin profits.
The Chinese TP regulations also provide that business tax and withholding income tax paid on royalties, albeit disallowed for income tax deductions under a TP adjustment, will not be refunded. Therefore, there is an exposure of double taxation within China.
Multinational corporations should therefore approach the transfer pricing of intangibles in China in the same careful and planned manner that they should approach it in any other developed tax jurisdictions. Intangible arrangements should be structured according to commercial business needs, whereby the benefits of the use of the intangible are clearly recognised and measured. An arm's length compensation should be paid to the owner to reflect this value. The arrangement should be properly documented following Chinese TP regulations. Additionally, an commercial agreement should be in place which clearly assign ownership, risks and rewards. |
