Transfer Pricing and Cross-Border Inter-Company Transactions

China Briefing November 2011: Payment Arrangements & Transfer Pricing

Overview:

This article discusses the complexities of cross-border inter-company transactions in China, focusing on payment arrangements among headquarters (HQs), wholly foreign-owned enterprises (WFOEs), and clients. It addresses strategies for managing these transactions, including tax implications, regulatory compliance, and the documentation requirements necessary to ensure adherence to the arm's length principle.

Key Points:

1. Payment Arrangements:

   • Direct Sales: HQs often sell goods directly to Chinese clients, bypassing the WFOE due to various business reasons or limitations.
   • Export-then-Sale Model: More commonly, HQs export goods to a WFOE, which then sells them to the Chinese client. This model allows for input VAT and customs duties to be claimed by the WFOE.

2. Service Provision:

   • Client-Payment to WFOE: Chinese clients may prefer to pay the WFOE in RMB for services provided by the HQ, avoiding foreign currency transactions.
   • Remittance Conditions: For service fees, regular contracts between the WFOE and HQ are typically sufficient. Special registration might be required for technology imports.

3. Tax Implications:

   • Transfer Pricing Issues: Involvement of the WFOE in the import process can trigger transfer pricing concerns, especially when dealing with imported goods.
   • Duplicate Taxation: Service fees remitted through the WFOE to the HQ can lead to duplicate taxation, requiring careful management of tax obligations.

4. Documentation Requirements:

   • Contemporaneous Documentation: WFOEs must disclose related-party transactions, especially service fees, royalties, interest, etc., to the tax authorities annually.
   • Arm's Length Principle: All transactions between HQs and WFOEs must adhere to the arm's length principle to avoid tax adjustments during audits.

5. Accounting Treatment:

   • Separate Records: WFOEs should maintain separate records for revenue and costs related to service fees, despite potentially using an intercompany account for transfers.

Conclusion:

Managing cross-border transactions in China requires navigating intricate legal and tax frameworks, emphasizing the importance of thorough planning and compliance. Ensuring adherence to the arm's length principle and maintaining accurate documentation are crucial for avoiding penalties and ensuring tax efficiency.