Newsletter
Update and Observation on Transfer Pricing
On December 28, 2020, the Ministry of Finance promulgated the amended Regulations Governing Assessment of Profit-Seeking Enterprise Income Tax on Non-Arm’s-Length Transfer Pricing (the “Transfer Pricing Assessment Rules”). This key changes under this round of amendment include an updated definition of “intangible asset” that expand the scope thereof beyond registered assets, new valuation methods and additional rules on profit allocation. The filing of the 2020 business income tax return will be subject to the amended Transfer Pricing Assessment Rules.
The purpose of this amendment is to align the Transfer Pricing Assessment Rules with the relevant international norms and practices. To this end, the amendments were made by referencing the recommendations and guidelines on intangible assets and the relevant transfer pricing published in 2015 by the Organization for Economic Cooperation and Development (OECD) in its Base Erosion and Profit Shifting (BEPS) Actions 8-10: Aligning Transfer Pricing Outcomes with Value Creation.
Looking ahead, we anticipate that the issue of transfer pricing will continue to be a hot topic in 2021 and the profit allocation and transactions of intangible assets within group companies will come under closer scrutiny in the future, thereby increasing the potential tax risks attached thereto. The key amendments are summarized and explained below.
Periodic Assessment on Whether the Allocation of Profits from Related Party Transactions is Consistent with the Substantive Economic Activities
If the allocation of profits is consistent with the local production value, local tax authorities generally do not take issue in terms of transfer pricing. However, if a multinational enterprise takes advantage of information opacity and taxation parity between different jurisdictions to allocate the profits to related parties in regions or countries with lower tax rates to circumvent the tax of its home country and the country of production, the enterprise will face increased tax risks in its home country as well as the country of production.
In the past, when performing risk analysis, profit-seeking enterprises and tax authorities tend to rely too heavily on written contracts or documents for guidance while ignoring the real-world risk exposures relating to the performance of the contracts by the parties to the transaction. Therefore, the amended Transfer Pricing Assessment Rules identifies the steps that must be taken when conducting a risk assessment on a specific transaction as well as the criteria for determining the risk bearing capacity and management capability of the parties to the transaction, and stipulates that the transfer pricing reports must include a risk analysis performed in accordance with such steps and criteria.
l Steps of Risk Assessment and Analysis: focusing on the substantive economic activities of the parties to a transaction and whether they have proper capacities for risk bearing and management.
l Criteria for Determining Risk Bearing Capacity and Management: When determining the risk bearing capacity of the parties to a transaction, it is necessary to consider whether they are apt to weather an unfavorable outcome from the risks in question and whether they have the financial capability to mitigate such risks. As for risk management capability, it is necessary to evaluate the parties’ actual abilities to control and mitigate risks. If the assertions in written contracts and documents differ from the findings from the assessments conducted based on the foregoing principles in terms of the parties’ actual ability and financial capabilities to assume the risks, such risk shall be reattributed to the party that actually has the financial capability to bear the risks, and transaction in question shall be repriced and the party concerned shall be reasonably compensated.
Update on the Definition of “Intangible Assets”
An intangible asset is defined as a right with property value, such as a business right or a copyright, that can be owned or controlled for use in business activities and for which the use or transfer of the asset between non-related parties would result in corresponding compensations.
The profit allocation of intangible assets must be analyzed in terms of the function, risk and use of assets for development, enhancement, maintenance, protection and utilization of the asset, and risk assessment and analysis must be conducted in accordance with the steps and criteria mentioned above, and the process and results of such assessment and analysis must be disclosed in the transfer pricing reports, and the appropriateness of the profit allocation between the group companies must be examined.
“Income Approach” Included as Arm’s Length Transaction Method
The “income approach” identified in Guidance Note No. 7 Valuation of Intangible Assets published by the Accounting Research and Development Foundation has been included as one of the arm’s length transaction methods.
Conclusion
Anti-avoidance of taxes has been the consensus of the international community, and transfer pricing audits have become the focus of governments in various jurisdictions. In recent years, the tax authorities in India, Malaysia, Thailand and Vietnam have all introduced the three-tier transfer pricing rules, targeting companies with losses and fluctuating surpluses in their transfer pricing schemes. Therefore, it is advisable for all multinational enterprises to examine whether their overall capabilities and allocations of risks are comparable to their profit outcomes in order to mitigate the relevant tax risks.
For multinationals that have already completed their transfer pricing reports, they may consider entering into an advance pricing agreement the National Taxation Bureau and negotiating the terms affecting the transaction, the pricing methods and other factors thereunder. An advance pricing agreement is valid for three to five years, and can be extended for another three to five years upon the expiration thereof. Therefore, corporations with an advance pricing assistance with the National Taxation Bureau can enjoy up to 10 years of freedom from transfer pricing audits and savings in compliance costs for the preparation of transfer pricing reports.