Chapter Six

Reporting Related Party Transactions in China

The Chinese government requires a taxpayer doing business in that country to report related party relationships to the State Administration of Taxation (SAT). The Chinese government developed these reporting forms pursuant to Corporate Income Tax Law Article 43. The SAT requires the taxpayer to submit nine specific documents to the tax authorities on an annual basis:

Form 1—Related Party Relationships
Form 2—Summary of Related Party Transactions
Form 3—Purchases and Sales
Form 4—Services
Form 5—Intangible Assets
Form 6—Fixed Assets
Form 7—Financing
Form 8—Outbound Investment
Form 9—Outbound Payments

Although the SAT requires extensive reporting of outbound investment and payments, the SAT fails to address the treatment of inbound investments and outbound payments. These forms, taken as a group, provide the SAT with data pertaining to transfer pricing, but certain forms, especially Form 8 and Form 9, have a broader purpose not necessarily connected with transfer pricing.

Enterprises that must submit the reporting forms to the SAT include foreign-based resident enterprises. The SAT imposes income taxes according to the taxpayer’s accounting books, which include nonresident enterprises that have permanent establishments in China. All of these enterprises are to attach and submit their reporting forms on an annual basis and pay corporate income taxes when they submit their annual reporting forms.

As a preliminary matter, the taxpayer must fill in its full name as reflected on the tax corporate certificate. The taxpayer is to fill in the taxpayer identification number, which is the number of the tax registration certificate number that the tax authorities have verified and issued. The enterprise is to use the company’s official stamp, including the taxpayer’s identification number. The enterprise is to provide the name of the legal representative, telephone number, and reporting date. The SAT must accept the enterprise’s report, reflecting the name of the in-charge tax authorities, the SAT stamp, the signature of the accepting officer, telephone number, and date of the SAT’s acceptance. The preparer and the legal representative must each sign and stamp each of the nine related party forms before sending these forms to the SAT.

FORM 1—RELATED PARTY RELATIONSHIPS

The taxpayer, in providing Form 1—Related Party Relationships, is to provide the SAT with this information:

  • Name of related party
  • Taxpayer identification number
  • Country/Region
  • Address
  • Legal representative
  • Type of related party relationship

The SAT provides the taxpayer with further explanations regarding these items. The taxpayer’s identification number is the number the taxpayer uses for tax filing in the country or region in which the related party is located. The country or region is the name of the country or region in which the related party is located. The address is the registered address of the related party’s actual operation and management, or the residence of the related individuals. The SAT provides the taxpayer with codes for eight separate categories, enumerated A through H, that create the related party relationship with the taxpayer. The taxpayer should fill in more than one relationship code if more than one code is applicable.

The SAT provides a broad array of shareholder relationships as being within the transfer pricing control provisions. The SAT enumerates eight specific related party relationships as discussed in the next sections.

Share Ownership

The SAT uses a 25% ownership threshold that is similar to section 6038A in the United States1 and similar to the 26% ownership threshold in India. The SAT views parties as being related in under the 25% ownership threshold if one party, directly or indirectly, owns 25% or more of the shares of the other party. The SAT views parties as being related in under the 25% ownership threshold if a third party owns 25% of shares of both the party at issue and the other party.

The party might indirectly own the shares of the other party through an intermediate party. This intermediate party relationship exists so long as the party owns 25% or more of the shares of the intermediate party. In that event, the taxpayer is to calculate the percentage of shares of the other party that is directly owned by the party at issue according to the percentage of shares of the other party that is directly owned by the intermediate party.

Loan Relationships

One party might establish control over the other party by providing an extensive loan relationship to the other party. The SAT excludes independent financial institutions from the loan relationship analysis and from the computations themselves. The SAT provides that a loan relationship constitutes a related party transaction if loans between one party to another party account for 50% or more of the party’s paid-in capital; or alternatively, 10% or more of the party’s total loans are guaranteed by another party.

Power of Appointment by Controlling the Board

The SAT views the retention of one party’s power to control the activities of another party as the presence of a related party relationship. The SAT enumerates four of these related party relationships:

1. The other party might appoint more than half of the senior management personnel of one party, including the board members or managers.
2. The other party might appoint at least one senior board member of one party who has the controlling power over the board.
3. The third party might appoint more than half of the senior management personnel of both parties, including the board members or managers.
4. The third party might appoint at least one senior board member of either party who has the controlling power over the board.

Taking Senior Management Positions

The SAT provides that one party’s control over the other party’s board indicates control over the other party. The SAT enumerates two of these related party relationships:

1. More than half of the senior management personnel from one party, including board members and managers, take senior management positions of the other party, including board members and managers.
2. At least one senior board member of one party who has the controlling power over the board takes the position of the senior board member of the other party.

Licensing Arrangements Indicate Related Party Relationships

The SAT provides that one party can control the other party because of its control through licensing arrangements. From the standpoint of ascertaining whether parties are related parties or whether the relationship is one of control, the issue becomes whether the production and business operations are determinative, or whether the activities could be carried out in a normal manner only with the licensee from the other party. The lack of choice determines control. Such intangibles include other intangibles, industrial property rights, and proprietary technology.

Control through Purchase and Sale Activities

The SAT provides that one party can control the other party through exercising its control through its purchase and sale activities. One party controls the purchase and sale activities during this control situation.

Offering and Receiving Services Activities

The SAT provides that one party’s service activity receives or offers are primarily controlled by the other party.

Catchall Relationships

One party might have effective control of the other party, whether through effective control of the production, operation, or transactions of the other party. Alternatively, both parties might have a shared interest due to another shared relationship. Such shared interest might include common activities not reaching the shareholder percentage stipulated but can arise from both parties’ shareholders enjoying generally the same economic interest or with a family or relative relationship enjoying generally the same economic interest.

FORM 2—SUMMARY OF RELATED PARTY TRANSACTIONS

As a preliminary inquiry, Form 2 questions whether:

1. The taxpayer has prepared contemporaneous documentation for the current year pursuant to relevant requirements.
2. The taxpayer is exempt from the contemporaneous documentation preparations for the current year.
3. The taxpayer has a cost sharing arrangement in place for the current year.

Form 2 requires the taxpayer to delineate four primary transaction categories:

  • Related party transactions
  • Overseas related party transactions
  • Domestic related party transactions
  • The total amount

The taxpayer is to provide amount and percentage for each such category. Form 2 then requires the taxpayer to delineate its activities into 11 specific activity categories:

1. Purchase of material (products)
2. Sale of material (products)
3. Services income
4. Services disbursement
5. Transfer in of intangibles
6. Transfer out of intangibles
7. Transfer in of fixed assets
8. Transfer out of fixed assets
9. Accrued interest income from financing
10. Accrued interest expense of financing
11. Others

Form 2 is a consolidation of the results from these five forms:

1. Form 3—Purchases and Sales
2. Form 4—Services
3. Form 5—Intangible Assets
4. Form 6—Fixed Assets
5. Form 7—Financing

Because Form 2 is a consolidation, we advise taxpayers to complete Forms 3 through Form 7 before completing Form 2. The interrelationship among the forms is explained next.

1. The columns for purchase of materials and products on Form 2 include these amounts:
a. The first column of purchase of materials and products in Form 2 is the first item of purchases and sales on Form 3.
b. The fourth column of purchases of materials and products in Form 2 is the fourth item of purchases and sales on Form 3.
c. The seventh column of purchase of materials and products in Form 2 is the seventh item of purchases and sales on Form 3.
2. The columns for sale of products and materials in Form 2 include these amounts:
a. The first column of sale of products and materials on Form 2 is the eighth item of purchases and sales on Form 3.
b. The fourth column of sale of products and materials in Form 2 is the eleventh item of purchases and sales on Form 3.
c. The seventh column of sale of products and materials on Form 2 is the fourteenth item of purchases and sales on Form 3.
3. The columns for services income on Form 2 include these amounts:
a. The first column of services income on Form 2 is the first item on the Services form, Form 4.
b. The fourth column of services income on Form 2 is the fourth item on the Services form, Form 4.
c. The seventh column of services income on Form 2 is the seventh item on the Services form, Form 4.
4. The columns for services disbursement on Form 2 include these amounts:
a. The first column of services disbursement on Form 2 is the eighth item on the Services form, Form 4.
b. The fourth column of services disbursement on Form 2 is the eleventh item on the Services form, Form 4.
c. The seventh column of services disbursement on Form 2 is the fourteenth item on the Services form, Form 4.
5. The columns for transfer in of intangible assets on Form 2 include these amounts:
a. The first column of the transfer in of intangible assets on Form 2 is the first column on the Intangible Assets form, Form 5.
b. The fourth column of the transfer in of intangible assets on Form 2 is the second column on the Intangible Assets form, Form 5.
c. The seventh column of the transfer in of intangible assets on Form 2 is the fourth column on the Intangible Assets form, Form 5.
6. The columns for transfer out of intangible assets on Form 2 include these amounts:
a. The first column of the transfer out of intangible assets on Form 2 is the sixth column on the Intangible Assets form, Form 5.
b. The fourth column of the transfer out of intangible assets on Form 2 is the seventh column on the Intangible Assets form, Form 5.
c. The seventh column of the transfer out of intangible assets on Form 2 is the ninth column on the Intangible Assets form, Form 5.
7. The columns for transfer in of fixed assets on Form 2 include these amounts:
a. The first column of the transfer in of fixed assets on Form 2 is the first column of the Fixed Asset form, Form 6.
b. The fourth column of the transfer in of fixed assets on Form 2 is the second column of the Fixed Asset form, Form 6.
c. The seventh column of the transfer in of fixed assets on Form 2 is the fourth column of the Fixed Asset form, Form 6.
8. The columns for transfer out of fixed assets on Form 2 include these amounts:
a. The first column of the transfer out of fixed assets on Form 2 is the first column of the Fixed Asset form, Form 6.
b. The fourth column of the transfer out of fixed assets on Form 2 is the second column of the Fixed Asset form, Form 6.
c. The seventh column of the transfer out of fixed assets on Form 2 is the ninth column of the Fixed Asset form, Form 6.
9. The columns for accrued interest income from financing and accrued interest expense from financing on Form 2 include these amounts:
a. The fourth column of accrued interest income from financing on Form 2 is the eighth column of the first total of the Financing form, Form 7.
b. The seventh column of accrued interest income from financing on Form 2 is the eighth column of the second total on the Financing form, Form 7.
c. The fourth column of accrued interest expense from financing on Form 2 is the seventh column of the first total of the Financing form, Form 7.
d. The seventh column of accrued interest expense from financing on Form 2 is the seventh column of the second total on the Financing form, Form 7.
10. The term “others” refers to amounts related to those activities other than to the activities just mentioned.

FORM 3—PURCHASES AND SALES

The SAT requires the taxpayer to delineate purchases and sales and to provide these amounts:

1. Total purchases and sales. The SAT seeks information concerning domestic and international activities and from related and unrelated activities. The SAT is seeking information as to the annual amount of purchases of tangible goods: raw materials, semifinished goods, materials (products) excluding fixed assets, construction materials, and low-value consumables. Import purchases, domestic purchases, export sales, and domestic sales are each divided between related activities and unrelated activities.
2. Overseas sales by export trade mode. The SAT seeks information concerning contract processing and other activities, whether the parties are related or unrelated. The taxpayer is to include the purchasing fees as contract purchasing.
3. Descriptions of overseas parties to which export sales account for more than 10% of total export sales and the relevant transactions. The taxpayer is to provide SAT with the name of the overseas related party, the country or region, the amount, the pricing methodology, and notes. This information is required for both related and unrelated parties. “Pricing methodology” refers to one of the following, and the taxpayer is to reflect the pricing method by number: (1) comparable uncontrolled price; (2) resale price method; (3) cost plus method; (4) transactional net margin method; (5) profit split method; other—taxpayer must explain in the notes column.
4. Descriptions of overseas parties to which payment for overseas purchases accounts for more than 10% of the total overseas purchases and the relevant transactions. The taxpayer is to provide SAT with the name of the overseas related party, the country or region, the amount, the pricing methodology, and notes. This information is required for both related and unrelated parties. Pricing methodology refers to one of the following, and the taxpayer is to reflect the pricing method by number: (1) comparable uncontrolled price; (2) resale price method; (3) cost plus method; (4) transactional net margin method; (5) profit split method; other—taxpayer must explain in the notes column.

FORM 4—SERVICES

The SAT requires the taxpayer to delineate services income and disbursement for services and to provide these amounts:

1. Total services transactions.
2. Description of overseas parties from which the overseas services income account occurs for more than 10% of the total services income and the respective transactions. The taxpayer must delineate between related parties and unrelated parties. The taxpayer need take into account the name of the overseas party, the country or region, the amount, the pricing methodology, and notes. Pricing methodology refers to one of the following, and the taxpayer is to reflect the pricing method by number: (1) comparable uncontrolled price; (2) resale price method; (3) cost plus method; (4) transactional net margin method; (5) profit split method; other—taxpayer must explain in the notes column.
3. Overseas parties to whom the overseas distribution account pertains to more than 10 percent of the total services disbursement and the respective transactions. The taxpayer must delineate between related parties and unrelated parties. The taxpayer need take into account the name of the overseas party, the country or region, the amount, the pricing methodology, and notes. Pricing methodology refers to one of the following, and the taxpayer is to reflect the pricing method by number: (1) comparable uncontrolled price; (2) resale price method; (3) cost plus method; (4) transactional net margin method; (5) profit split method; other—taxpayer must explain in the notes column.

Form 4 delineates services transactions between services income and disbursement for service. Form 4 also delineates services income activities between income from unrelated parties or income from related parties. Similarly, Form 4 delineates services disbursement activity between disbursements made to unrelated parties and disbursements made to related parties.

FORM 5—INTANGIBLE ASSETS

The SAT would have the taxpayer account for the transfers of intangible assets. Form 5 looks to the direction of the intangible asset transfer, the source of the intangible asset transfer, and the affiliated party nature of the intangible asset transfer:

  • The direction of the intangible asset transfer (i.e., whether the transfer is into China or whether the transfer is out of China)
  • The source of the intangible asset transfer (i.e., whether the transfer is from overseas sources or whether the transfer is from domestic sources)
  • The affiliated nature of the intangible asset transfer (i.e., whether the transfer is with a related party or whether the transfer is with an unrelated party)

The SAT’s three inquiries as to the transfers of intangible assets necessitate eight columns mathematically, 23. Then there are two total transaction amount columns, one column for transfer in, and one column for transfer out.

Form 5 requires the taxpayer to specify the nature of the intangible item, whether a “right for use” item or an “ownership” item. The right for use category is subdivided into land use rights, patent rights, nonpatented technology, trademarks, copyrights, and others. The ownership category is subdivided into patent rights, nonpatented technology, trademarks, copyrights, and others.

FORM 6—FIXED ASSETS

The SAT would have the taxpayer account for the transfers of fixed assets. Form 6 looks to the direction of the fixed asset transfer, the source of the fixed asset transfer, and the affiliated party nature of the fixed asset transfer:

  • The direction of the fixed asset transfer (i.e., whether the transfer is into China or whether the transfer is out of China)
  • The source of the fixed asset transfer (i.e., whether the transfer is from overseas sources or whether the transfer is from domestic sources)
  • The affiliated nature of the fixed asset transfer (i.e., whether the transfer is with a related party or whether the transfer is with an unrelated party)

The SAT’s three inquiries as to the transfers of fixed assets necessitate eight columns mathematically, 23. Then there are two total transaction amount columns, one column for transfer in, and one column for transfer out.

Form 6 requires the taxpayer to specify the nature of the intangible item, whether a “right for use” item or an “ownership” item. The right to use category is subdivided into buildings; aircraft, trains, ships, machines, and other equipment; equipment, tools, and furniture related to production and operation; transportation vehicles other than aircraft, trains, and ships; electronic equipment; and others. The ownership category is subdivided into buildings; aircraft, trains, ships, machines, and other equipment; equipment, tools, and furniture related to production and operation; transportation vehicles other than aircraft, trains, and ships; electronic equipment; and others.

FORM 7—FINANCING

The SAT requires the taxpayer to determine its debt/equity at the outset of preparing Form 7. This debt/equity ratio is the ratio of debt investment received from related parties from the enterprise divided by the equity received by the enterprise. The SAT requires the taxpayer to determine its debt/equity ratio on a monthly basis. The taxpayer is to determine its debt/equity amount in this way:

  • The annual sum of the monthly average debt invested amount from related parties is divided by
  • The annual sum of the monthly average equity amounts

The monthly average debt investment amount from related parties is determined in the following manner:

  • The book balance of debt investment from related parties determined at the beginning of the month, plus
  • The book balance of debt investment from related parties determined at the end of the month, dividing the sum of these amounts by two

The monthly average equity investment is determined in the following manner:

  • The book balance of the equity investment at the beginning of the month, plus
  • The book balance of the equity investment at the end the month, dividing the sum of these amounts by two

The SAT would have the taxpayer delineate overseas related party debt and domestic related party debt and then delineate between fixed-term financing and other debt. Form 7 requires the taxpayer to provide the SAT with this information:

  • Name of overseas related party/Name of domestic related party
  • Country or region, the location where the overseas related party is located
  • Currency, converted to RMB on the middle exchange rate for RMB on the last day of the taxable year
  • Financing-in amount
  • Financing-out amount
  • Interest rate, the annual interest rate for the financing
  • Financing start date and ending date
  • Accrued interest expense/interest payable, using accrual accounting, including capitalized interest
  • Accrued interest income/interest receivable, using accrual accounting
  • Name of guarantor
  • Guarantee fee
  • Guarantee fee rate

The SAT asks the taxpayer to fill in each fixed-term financing. The SAT asks that the taxpayer not fill in financing-in and financing-out in the same line.

FORM 8—OUTBOUND INVESTMENT

Form 8 is the longest of the nine related party transaction forms, comprising two pages. Form 8 is not a transfer pricing form per se, and the form addresses issues outside of the transfer pricing purview. Form 8 is applicable to PRC tax resident enterprises that own shares on an enterprise located in the foreign country or region. “Foreign enterprises” on this form applies to enterprises incorporated in Hong Kong SAR, Macau SAR, and Taiwan. Form 8 itself addresses nine specific facets:

1. Basic information pertaining to the investment enterprise
2. Basic information pertaining to the invested foreign enterprise
3. Tax rate pertaining to the invested foreign enterprise
4. Profit of the invested foreign enterprise
5. Tax payables of the invested foreign enterprise
6. Shareholders of the invested foreign enterprise
7. Profit and loss statement of the invested foreign enterprise
8. Balance sheet of the invested foreign enterprise
9. Dividend distributions of the invested foreign enterprise

1. Basic Information Pertaining to the Investment Enterprise

Form 8 requires the taxpayer to provide information as to the taxpayer’s name, its taxpayer identification number, its registered address, and its legal representative. The taxpayer is to fill out Part I on its own account, excluding the taxpayer’s investments.

2. Basic Information Pertaining to the Invested Foreign Enterprise

Form 8 requires the taxpayer to provide information to the SAT concerning the taxpayer’s investments. A taxpayer may need to fill out more than one Form 8 if the taxpayer has more than one foreign enterprise.

The taxpayer is to fill out this information:

  • Name of the company in which the investment enterprise makes the investment
  • Taxpayer identification number of the invested foreign enterprise
  • Registered address of the invested foreign enterprise
  • Invested foreign enterprise’s legal representative
  • Operations of the business
  • Date on which the business became established
  • Address of the legal representative
  • Scope of the business, the currency book amount
  • Exchange amount for the RMB (using middle rate in exchange rate for the recording currency used in the accounting books to RMB as of December 31 of the taxable year)
  • Start and end of the taxable year

In addition to these requests, the SAT asks the taxpayer for information as to total shares of invested foreign enterprises, asking about the total number of shares and the starting or ending date. Similarly, the SAT requests the taxpayer to provide information concerning:

  • Shares held by an investment enterprise in invested foreign enterprises, looking at the type of shares
  • Start or end date
  • Number of shares owned
  • Percentage of shares owned

Share types include common shares with voting rights, common shares without voting rights, preferred shares, and other equity capital of a similar nature.

3. Tax Rate Pertaining to the Invested Foreign Enterprise

The SAT seeks to differentiate invested foreign enterprises located in a non–low-tax country or region from invested foreign enterprises located in a low-tax country or region. The SAT itself delineates low-tax and non–low-tax countries or regions.

4. Profitability of the Invested Foreign Enterprise

The SAT seeks to delineate invested foreign enterprises with income exceeding RMB5 million from invested foreign enterprises with income not exceeding RMB5 million.

5. Effective Tax Rate

The SAT is seeking from the taxpayer the effective tax rate of the invested foreign enterprise. The taxpayer is to provide the SAT with this information for each invested foreign enterprise:

  • Taxable income
  • Income tax actually paid
  • Profit after income tax
  • Effective tax rate
  • Statutory income tax rate of the invested enterprise

6. Information as to All Shareholders of the Invested Foreign Enterprise

The taxpayer is to provide the name of the shareholder, its country or region, its taxpayer identification number, the type of shares, the start and end date, and the percentage of total shares.

7. Annual Profit and Loss Statement of the Invested Foreign Enterprise

The SAT requires the taxpayer to provide this information as to the profit and loss statement:

  • Revenues
  • Cost (of goods sold)
  • Gross profit
  • Dividend income
  • Interest income
  • Rent and royalty income
  • Income or loss from the transfer of property
  • Other income
  • Deductible compensating expenditures
  • Rent and royalty expenses
  • Interest payments
  • Depreciation
  • Taxes
  • Other deductible items

8. Balance Sheet of the Invested Foreign Enterprise

The SAT requires the taxpayer to provide these balance sheet data:

  • Assets or items comprising these assets:
    • Cash
    • Accounts receivable
    • Inventories
    • Other current assets
    • Loans to shareholders and other related parties
    • Investments in affiliates
    • Other investment affiliates
    • Other investments
    • Building and other depreciable property
    • Land
    • Intangible assets
    • Total assets
  • Liability items comprise:
    • Accounts payable
    • Other current liabilities
    • Loans from shareholders and other related parties
    • Other liabilities
    • Shares
    • Undistributed profits

9. Annual Dividend Distributions of the Invested Foreign Enterprise

The SAT requires the taxpayer to provide information as to distributable dividends from the year, dividends distributed during the year, and the distribution percentage.

FORM 9—OUTBOUND PAYMENTS

The SAT requires the taxpayer to provide this information for each activity:

  • Outbound payments for the current year
  • Outbound payments to overseas related persons (including amounts accrued and not paid)
  • Withholding income tax
  • Presence or absence of preferable tax treatment under the tax treaties

The enumerated payments include:

  • Dividends (to equity investors)
  • Interest (to debt investors)
  • Rents (pertaining to tangible assets)
  • Royalties (pertaining to patents, nonproprietary technology, trademark payments, copyrights, etc.)
  • Trademark payments
  • Technology license fees
  • Asset transfer expenses
  • Commissions (including third-party referrals for suppliers or customers, including handling and kickbacks)
  • Design fees (payments for architectural design, construction, system software, etc.)
  • Consulting fees
  • Training fees
  • Management services fees
  • Contractor fees
  • Construction and installation fees
  • Artistic and athletic performance fees
  • Certification or testing fees
  • Market development fees
  • After-sales service fees

NOTES

1. R. Feinschreiber, Transfer Pricing Handbook (3rd ed.) (New York: John Wiley & Sons, 2001), Chapters 54–66.

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