China Tax Administration Guide (5) - Business Dealings between Associated Enterprises

5.1 In business transactions between an enterprise with foreign investment or the establishments or sites set up in China by a foreign enterprise for production or business operations, and its associated enterprise, the payment or receipt of charges or fees shall be made in the same way as the payment or receipt of charges or fees in business transactions between independent enterprises. Where the payment or receipt of charges or fees is not made in the same way as business transactions between independent enterprises and results in a reduction of taxable income, the taxation authorities have the right to make reasonable adjustments.

(ZHU XI LING [45] 1991.4.9)

5.2 ′Associated enterprises′ refers to companies, enterprises and other economic organizations that have any of the following relationships with other enterprises:

A.relationships of existing direct or indirect ownership of, or control over, such matters as finance, business operations or purchases and sales;

B.direct or indirect ownership of, or control over, such enterprises and another, by a third party;

C.any other relationship involving association for reciprocal interests.

(GUO WU YUAN LING [85] 1991.6.30)

5.2.1 The ′direct or indirect ownership or control regarding capital, operation, purchase and sales′, ′directly or indirectly owned or controlled by a third party′, and the ′relationships based on other interests′ mainly consist of the following relationships between an enterprise with foreign investment or a foreign enterprise (hereinafter referred to as ′enterprise′) and another company, another enterprise or another economic organization (hereinafter referred to as ′another enterprise′):

a.the share held by one side (enterprise ) reaches 25% or more of the total share of the other side (enterprise);

b.the share owned or controlled by a third party either directly or indirectly reaches 25% or more of the total share of both enterprises;

c.the loan capital of an enterprise from another enterprise accounts for 50% or more of the equity capital, or 10% of the total loan capital of an enterprise is secured by another enterprise.

d.in an enterprise, over half of the higher executives such as directors or managers, or a managing director are appointed by another enterprise;

e.the production and operation of an enterprise may go on normally only with the chartered right supplied by another enterprise (including industrial property rights and know-how, etc.).

f.the raw materials, components and parts (including prices and terms of exchange) etc., purchased by an enterprise for production and operation are controlled or supplied by another enterprise;

g.the products of an enterprise or the sale of goods (including prices and terms of exchange) are controlled by another enterprise;

h.the relationships regarding other benefits (including family, relative relationship) which have actual control over the enterprise¡¦s production, operation and transactions.

(GUO SHUI FA [237] 1992.10.29)

5.3 ′Business transactions between independent enterprises′ refers to business dealings carried out between unassociated and unrelated enterprises, on the basis of arm¡¦s length prices and common business practices.

Enterprises have a duty to provide the local taxation authorities with relevant materials such as standard prices and charges for business dealings between associated enterprises.

(GUO WU YUAN LING [85] 1991.6.30)

5.4 Taxation on business dealings between associated enterprises

5.4.1 Where prices in purchases and sales transactions between an enterprise and its associated enterprises are not based on independent business dealings, adjustments may be made thereto by the local taxation authorities according to the following sequence of methods of determination:

A.based on prices of the same or similar business activities between independent enterprises;

B.based on the level of profits obtained from resale at unassociated and unrelated third party prices;

C.based on costs plus reasonable expenses and a reasonable profit margin;

D.based on any other appropriate method.

(GUO WU YUAN LING [85] 1991.6.30)

5.4.2 Where interest paid or received for financing between an enterprise and an associated enterprise exceeds or is lower than that which would be agreed upon by two unassociated and unrelated parties, or where the rate of interest exceeds or is lower than the normal rate of interest in similar business, adjustments may be made by the local taxation authorities with reference to normal rates of interest.

(GUO WU YUAN LING [85] 1991.6.30)

5.4.3 Where labour service fees are paid or received by an enterprise for provision of labour services to an associated enterprise and are not based on business dealings between independent enterprises, adjustments may be made by the local taxation authorities according to the normal standard fees for similar labour services.

(GUO WU YUAN LING [85] 1991.6.30)

5.4.4 Where the valuation, receipt or payment of usage fees between one enterprise and an associated enterprise for the provision of labour services is not based on business dealings between independent enterprises, adjustments may be made by the local taxation authorities according to the amounts that would be agreed to by unassociated and unrelated parties.

(GUO WU YUAN LING [85] 1991.6.30)

5.4.5 The modification of the pricing of assets transferred by the enterprise in the normal way shall be limited to the taxable income of the tax year in which auditing and investigation are carried out. The auditing, investigation and modification, generally, shall be carried out within 3 years starting from the year following the above tax year. If the modification involves the annual income occurring in previous years, it may be made in the previous years, but the earliest year for the modification to begin shall not be earlier than 10 years

(GUO SHUI FA [237] 1992.10.29)

5.4.6 The excess part obtained by the associated enterprise over that to be obtained by the independent enterprise shall be regarded as allocated dividends, for which tax exemption stipulated in Article 19 in the Tax Law shall not be granted if the enterprise does not make corresponding accounting adjustments for the modified taxable income from the pricing of the assets transferred. The modification of the already paid withholding Income Tax is not allowed if the income obtained by the associated side is from interest or royalties.

(GUO SHUI FA [237] 1992.10.29)

5.4.7 If the enterprise has complaints on the modification of the pricing of the assets transferred, it shall first pay tax at the time and as determined by the local taxation authorities, then apply for reconsideration or a judicial hearing according to the provisions of Article 26 in the Tax Law, it shall also present the materials on standard prices and expenses. The taxation authorities shall not make a reconsideration if the enterprise fails to present the materials or if the presented materials are not complete within the period when the request for reconsideration is carried out.

(GUO SHUI FA [237] 1992.10.29)

5.5 Management fees paid by an enterprise to an associated enterprise may not be itemized as expenses.

(GUO WU YUAN LING [85] 1991.6.30)