The Complexity of Transfer Pricing for Intercompany Services

By Shirley Chu

Most Multinational Corporations (MNCs) charge intercompany service fees for services provided to other entities within the same company or business. In China,tax authorities regularly encounter inconsistencies in transfer pricing for intercompany services due to lack of access to necessary information due to opaque business structures, unclear rules under Enterprise Income Tax (EIT) laws, and difficulty determining whether selected transfer pricing methods for services comply with the arm’s length principle. Companies found guilty of these inconsistencies can be penalized by China’s tax authorities, making it essential to understand the country’s regulations connected to intercompany services.

Transfer pricing analysis of intra-group services

While China’s transfer pricing regulations make provisions for some intercompany services, guidance is limited to a select amount of company structures, and lacks a wider analysis for services provided by the Chinese subsidiaries of MNCs. Traditionally, tax authorities do not  classify fees charged for intercompany services by parent companies as deductible for CIT under EIT law.

OECD guidelines provide guidance on intragroup services from a transfer pricing perspective, which highlights two issues that should be observed. The first issue is determining whether intragroup services have been provided. A service is defined as an activity which provides an entity with economic or commercial value that enhances its commercial position. This can be determined by whether an independent enterprise would pay for an activity (service) provided by an outside entity, or if it could have sourced it internally. The second issue is determining whether services were charged under the arm’s length principle. OECD guidelines note that the CUP, or cost plus methods, are the most suitable for intercompany services. Once an appropriate base rate is determined, a percentage mark-up will typically be added to calculate the total value of the service charge.

China’s position on intercompany services

Guoshuifa [2008] No. 863 stipulates that intercompany service fees should be calculated by the arm’s length principle. Furthermore, the 2016 transfer pricing regulations specify that service-related payments should be categorized into a single line item as “service payments,” and that China’s tax authorities will examine the provider and recipient of services, their specific contents and necessity, method of conducting, as well as how both parties benefit from the services. Assessment of who benefits from the services is particularly important for taxpayers because tax authorities pay special attention to discerning service and royalty payments and the supporting documents disclosing this information.

About the Author

This article was originally published on China Briefing, a subsidiary of Dezan Shira & Associates. Since its establishment in 1992, Dezan Shira & Associates has been guiding foreign clients through Asia’s complex regulatory environment and assisting them with all aspects of legal, accounting, tax, internal control, HR, payroll and audit matters. As a full-service consultancy with operational offices across China, Hong Kong, India and emerging ASEAN, we are your reliable partner for business expansion in this region and beyond.

For inquiries, please email us at [email protected]. Further information about our firm can be found at: www.dezshira.com