China, People's Republic of

Group taxation is not permitted under the CIT law unless otherwise prescribed by the State Council.

Transfer pricing

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 State Taxation Administration (STA) issued a circular that imposed new transfer pricing compliance requirements in China, including annual reporting forms for related-party transactions (RPT forms), country-by-country (CbC) reporting, and transfer pricing documentation, all of which contain substantial changes to the previous rules. Specifically, the transfer pricing documentation requirement has adopted a three-tiered approach, including a master file, local file, and special issue file (i.e. cost sharing agreement special issue file and thin capitalisation special issue file).

The STA also issued a revised circular on advance pricing arrangements (APAs) in October 2016, which provides process and requirements for an enterprise to apply for an APA as well as the situations where an APA application will be prioritised or declined.

The STA issued a circular in March 2017 to renew the Chinese rules on the procedures of transfer pricing investigation and mutual agreement procedures (MAPs). This circular empowers the Chinese tax authorities to collect financial information of overseas related parties under the transfer pricing audit for value chain purpose. In addition, this circular reiterates and reinforces the Chinese tax authorities’ focus on outbound related-party remittance, such as service fees and royalty payments (see Recent focus of Chinese tax authorities in the Tax administration section for details).

The CIT law also contains a few tax avoidance rules, such as a thin capitalisation rule (see below), a CFC rule (see below), and general anti-avoidance rules (GAAR) (see the Tax administration section).

Thin capitalisation

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 (e.g. a thin capitalisation special issue file) 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.