What is the current legislation governing business transactions between affiliates?
Under the Income Tax Law of the PRC Concerning Foreign-invested Enterprises and Foreign Enterprises ("Foreign Enterprise Income Tax Law") promulgated in 1991, China adopts the internationally recognized "arm's-length rule" for transfer pricing. Accordingly, a subsidiary in China should be pricing the goods it sells to its parent company at the same fair level as if the parent company was an unrelated party. Similarly, the parent company must charge interest and royalties to its subsidiaries at rates it would offer to non-affiliates.
The Foreign Enterprise Income Tax Law and its detailed implementing rules allow China's tax authorities to make reasonable adjustments to prices and costs if they believe that a foreign enterprise has lightened its tax burden in China by failing to adhere to the arm's-length rule. If the Chinese subsidiary can only provide its local SAT office with information which shows that it is selling its goods to the parent company at unjustifiably deflated prices, the SAT officials have the right to apply the "comparable uncontrolled" method, "resale price" method, "cost plus" method or any other reasonable method to adjust the prices to an arm's-length standard for tax purposes. These methods will be familiar to companies whose business straddles two or more jurisdictions. The Chinese tax authorities may also effect appropriate adjustments to abnormally high or low interest rates or to non-existent or negligible royalty payments in affiliate transactions.
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