Group taxation is not permitted under the CIT law unless otherwise prescribed by the State Council.
All enterprises are required to conduct transactions with related parties on an arm’s-length basis. The Chinese tax authorities are empowered to make adjustments to transactions between related parties that are not conducted at arm’s length and result in the reduction of taxable income of the enterprise or its related parties using the following appropriate methods: comparable uncontrolled price method, resale price method, cost plus method, transactional net margin method, profit split method, and other methods (e.g. cost approach, market approach, income approach) that are consistent with the arm’s-length principle. In June 2016, the SAT issued a circular that imposed new transfer pricing compliance requirements in China, including annual reporting forms for related-party transactions (RPT forms), CbC reporting, and transfer pricing documentation, all of which contain substantial changes to the existing rules. Specifically, the transfer pricing documentation requirement has adopted a three-tiered approach, including a master file, local file, and special issue file.
The CIT law also contains transfer pricing provisions relating to cost sharing arrangements and advance pricing arrangements (APAs). In addition, it also contains a few tax avoidance rules, such as a CFC rule, a thin capitalisation rule, and general anti-avoidance rules (GAAR).
The CIT law has a thin capitalisation rule disallowing interest expense arising from excessive related-party loans. The safe harbour debt/equity ratio for enterprises in the financial industry is 5:1 and for enterprises in other industries is 2:1. However, if there is sufficient evidence to show that the financing arrangement is at arm’s length, these interests may still be fully deductible even if the ratios are exceeded.
Controlled foreign companies (CFCs)
Under the CFC rule, the undistributed profits of CFCs located in low-tax jurisdictions with an effective income tax rate of less than 12.5% may be taxed as a deemed distribution to the TRE shareholders. The Chinese tax authorities have published a list of countries (i.e. a 'white list') that they do not regard to be low-tax jurisdictions.