Since our publication of Transfer Pricing Audits in China (Palgrave Macmillan, 2007), over a decade of economic growth and the completion of a welter of spectacular and specific achievements in China have taken place. They have given the country a more vibrant, modern, and prosperous appearance, functionally improving facilities for those who travel there, as well as for the country’s innumerable citizens, including those new classes of citizens which have produced them or have prospered from their existence.
The economic growth of China has been riveted on the minds of consumers around the world. Most people are now conscious of the fact that myriads of tangible goods they are buying have the “Made in China” label on them. Ubiquitous Chinese goods are a testimony to the surging success of indigenous Chinese companies and the innumerable foreign-owned companies, which have transferred themselves to China to take advantage of the commercial opportunities it has offered.
Those alive to international news have in addition been impressed by the engineering triumphs in the city skylines, bridge building on motorways, over the rivers, and in the mountains of the country, as well as the continuing improvement of existing facilities and the ambitious initiatives in the ocean resources and usage of the Chinese coasts and islands. The development of its roads, railways, and airlines has made the access to the country and movement in it so much easier. In space exploration and military accomplishments, China has joined the leading powers. In scientific inquiry, it is active and often the leader in discovery and application in many fields of endeavor.
There was a time when the flow of enterprising international companies into China was intended to take advantage of a virgin market, cheap labor, and attractive government inducements to import new skills and knowledge, while contributing at the same time to the build-up of the economy to fulfill its huge potential.
That Chinese business environment has now fundamentally changed. More strict internal as well as global transfer pricing compliance requirements are demanded, as large numbers of Chinese companies carry the transfer of business the opposite way by investing overseas, while vast numbers of foreign companies continue to operate in China. Many of the latter have moved into exploiting the huge, growing domestic market, an objective that has taken precedence over their original preferences in using the economic advantages of low-cost labor and financial incentives for their export purposes.
A contrasting situation has developed in the rapidly increased reverse flow of Chinese-owned companies, many government backed, which have invested in other countries around the world, particularly in Africa, Europe, the Pacific, and the United States. Whereas the obligation was once placed on foreign companies investing in China to meet the regulations and laws of their adopted country, Chinese-owned companies have learned to face the same requirements expected in the countries they have chosen for their foreign investments.
The decade has seen the acclimatization of both sets of those companies, especially the foreign companies operating in China, which survived the vicissitudes of their foundation and initial years of establishment, by adjusting to the legislative and economic aspects of the regime operating in their adopted country.
The observance of transfer pricing regulations is a subject in point. Some companies which failed to comply with the expectations, and were unable to meet the penalties applying to them for non-compliance, have become bankrupt.
A majority of companies have formally observed the rules applying to transfer pricing of their assets into the country and their exports from it. Compliance has been accepted by the multinational companies, sometimes after a punishing record of original transgression. They were naturally first in line to be the subject of investigation for transfer pricing non-compliance.
Smaller companies have been more likely to ignore the compliance rules. After all, taxation enforcement relies on the unavoidable need to balance the number of companies to be surveyed with the number and quality of staff to manage it. With the passing of the years, the staff for enforcing compliance has been increased considerably, from low levels to a more competent delivery of routine inspection. There has been a considerable effort to catch up with the need by the Chinese taxation administration, from being swamped with new companies to dealing with a more stable situation.
Generally, a thorough sifting process is at work, but it has been difficult to mount the task necessary in a huge country, with such diversity as China, to a level of uniform cover. In some parts of China, the inspection and checks are more rigorous than in others. Companies would prefer to be in areas where their costs are lower and inducements are greater. They have a tantalizing choice among higher cost coastal areas and internal lower cost regions, but confusing inducements from the former to overcome their possible deterrence and the rival, competitive, and compensating offers of the latter.
Those trading in tangible assets are more vulnerable to the discovery of their miscalculations than those trading services or finances. The type of product is also a factor affecting a company’s ability and willingness to exhibit exact compliance. Many more products have become liable to justifiable transfer pricing controls for intercompany trading.
International practice has a pervasive influence on a particular national market. It is more difficult to determine the right criteria for arriving at an arm’s length price—the price charged to another unrelated company for the transfer of the same asset—if a company’s product is rare or unique, especially if it is first in the market. This observation, however, is more in sympathy with companies that accidently or through ignorance or incompetence fail to meet compliance standards. It still remains that companies still appear which deliberately use the opportunities to create greater profits by non-compliance.
Companies that comply with the rules on transfer pricing enjoy the acceptance of Chinese people and are being integrated comfortably in the national economy. They derive benefits of another kind, although they have forgone higher profits by fraudulent transfer pricing means. Being accepted has led to greater sales by a supportive community. In the way of their relentless search for competitive dominance, some or all companies, having their conduct curbed in one instance, will search for alternative means among the large number of variables they face in international trading to further their interests.
This book seeks to offer a second look specifically at transfer pricing in China. Its focus is on the successful implementation of the arm’s length principle, as it is practiced by a majority of companies in the transfer of their traded assets or imported products into China and their exports of goods or transfer of assets out of China, when they pass from and to a related company.
After an exploration of the concept of transfer pricing, and the methods used for testing the compliance requirements of the regulations, either when self-applied or after the imposition of corrective findings from audits by the State Administration of Taxation (SAT), business models in China are noted and legislative developments are reviewed, followed by a summary indication of the variable terms and conditions for different industries which exist in China.
Details of practices, which vary according to the data available, subject of interest, and whether the principal company is foreign or Chinese in multinational operations, both foreign and Chinese owned, form Part II of the text. The book is completed in Part III by reported research into the many factors which draw the attention of the authorities to a company’s transfer pricing policy, assessed for their relative importance by one hundred practicing tax officials currently in office, and finally the key points of future action which may be drawn.