Introduction
Post-importation transfer pricing (“TP”) adjustments have always presented great challenge for multinational companies doing business in China due to the lack of formal nationwide mechanism which simultaneously addresses the tax, customs and foreign exchange administration requirements, in order to allow customs valuation adjustment to be made in response to a post-importation TP adjustment.
While a TP and customs aligned approach which was introduced in a pilot program in Shenzhen in 2022 allows retroactive TP adjustment to be made with respect to imported goods, the application of the pilot program is currently limited to companies registered in Shenzhen which have in place advanced pricing arrangements (“APAs”) with the China tax authority. As such, given the geographical limitation and the complexity involved in negotiating an APA, it is our understanding that the take up rate of the Shenzhen pilot program is so far limited.
A new practice adopted by China Customs piles on additional challenges for companies looking to implement TP adjustments.
Details of the development
Given that there is currently no nationwide mechanism which allows customs valuation adjustment to be made in response to post-importation TP adjustment, companies operating in China typically rely on the customs voluntary disclosure regime to report a customs valuation adjustment such that an investigation on the upward adjustment of import prices can be initiated by China Customs. In the past, this process typically ends with the issuance of a customs declaration form (“ 0110 CDF”) reflecting the difference in the import value of the goods resulting from the TP adjustment. With the 0110 CDF, the company will be required to pay the underpaid customs duty and import value added tax (“VAT”) associated with the adjustment and the form will also be used as supporting document for the company to make outward foreign exchange remittance to account for the increase in the intercompany sales price. 0110 CDF is a requisite supporting document under China’s foreign exchange control regime for outward remittance.
The issuance of the requisite 0110 CDF is typically coordinated between the Tariff Administrative Bureau (“TAB”) and the port level customs authorities. Starting late 2021, we observed increasing difficulty in obtaining the requisite 0110 CDF following any settlement with Customs on post-importation TP adjustment. We note that China Customs would now issue “9700 CDF”, which purpose is to claw back the shortfall in customs duty and import VAT paid. As this document represents only the claw back of underpaid customs duty and import VAT (and does not reflect changes in import prices), it is not an acceptable document to support an outward remittance of funds to implement the TP adjustment.
As of early 2023, it is our observation that TAB and the port level customs authorities will generally deny the issuance of the 0110 CDF, and issue 9700 CDF in response to a TP adjustment instead.
While there is no formal reasoning provided by the authorities, we understand that this change could be resulting from a heightened scrutiny by the General Administration of Customs of the practices of the subordinate customs departments/offices, including port level customs authorities. As the issuance of either 0110 CDF or 9700 CDF is not governed by law, TAB and port level authorities generally have full discretion in deciding which form is issued and there is unfortunately no formal legal recourse available to companies in the event that a 0110 CDF is denied.
Implications and next steps
In view of the above development, companies will find it even more difficult to execute TP adjustments moving forward, due to the foreign exchange remittance challenges.
While there is no clear solution for tackling this issue for now, companies operating in China with related party transactions which may potentially be affected by this development can consider the following approaches:
- Companies should check and align with TAB and local port authorities on their prevailing practices prior to making any TP adjustments.
- Given the increasing difficulty involved in making retrospective post-importation TP adjustments, companies should prioritize prospective adjustments while keeping in mind that substantial prospective adjustments resulting in significant fluctuation to import prices may attract China Customs’ scrutiny.
- Other intercompany arrangements, such as service fee and royalty payments can also be considered for aligning a company’s overall profitability with the benchmarks to manage TP compliance, but such approach should only be adopted upon review and analysis of the resulting customs implications.
- Companies should also proactively consider their customs valuation defense strategy, including adding a customs valuation addendum to their TP studies. Substantial deviation of a company’s actual profit from the target set based on its TP studies may potentially trigger scrutiny on the customs value of imported goods declared.
It is more important now than before for companies to ensure that their customs valuation approach with respect to their TP methodology can be substantiated and defended when necessary. Given the aforementioned development, where China Customs determines that an upward adjustment of the related party import prices is warranted, not only would the company be subject to additional customs liabilities, it would also be denied the corresponding benefit of “truing down” its profit which should result in a reduction of tax liability in China, as the outward remittance is unlikely to be supported.
We, together with our tax team, regularly advise clients from a wide range of industries in tackling the challenges of implementing post-importation transfer pricing adjustments in China, and we will be happy to provide further guidance on this issue, if required.
Frank Pan is a partner and Tina Li is an associate of FenXun Partners who is a premier Chinese law firm. FenXun established a Joint Operation Office with Baker McKenzie in China as Baker McKenzie FenXun which was approved by the Shanghai Justice Bureau in 2015.
