At an event held by the Suzhou Committee, which is part of the American Chamber of Commerce in Shanghai, held on Tuesday November 17, James Zhou of Deloitte and Cheng Chi of KPMG discussed the recent trends in transfer pricing audits in China.

Despite the number of transfer pricing audits in China falling from 257 in 2006 to 174 in 2008, the amount of taxable income adjusted has risen from ¥5.88 billion ($861 million) to ¥15.7 billion in the same period.

The Chinese tax authority is coordinating industry-focused audits in those industries less affected by the economic crisis. For instance, enterprises engaged in financing for infrastructure, tyre manufacturing, pharmaceutical manufacturing and franchise restaurants.

“Loss making companies with single functions and limited risk do not only include manufacturers,” said Chi. “The idea is that enterprises with limited risk and single functions should not make losses.”

In China, the statute of limitation for transfer pricing audits is 10 years and the audit itself can last for five years. There are interest and potential interest penalties associated with transfer pricing adjustments and companies have a maximum of 30 days to submit the information required by the tax authorities. The actual audit process is carried out by the local tax authorities unless it is a national audit.

For companies that have been audited and received an adjustment, there are strict rules on what to do next.

“You must pay tax, interest and penalties within the prescribed period after the final adjustment notice. Administrative appeal is not a real viable option and filing a law suit may also not be an option,” said Zhou.

Arranging an advance pricing agreement may be an option, given the risk of there being an audit without a feasible appeal mechanism. It is also possible for companies to go to the competent authorities (CA) and apply for help under the mutual assistance procedure, companies must do this within three years after the adjustment is issued.

For companies that are being audited, Zhou has some advice. “You must understand which stage the audit is at and adopt corresponding strategies. Do not underestimate the anti-avoidance officials and be persistent and do not give up easily.”

Chi also urges corporates not to sit back. “The best practice approach is to proactively manage the risks. You must understand the risk and exposures and be prepared for risks and technical discussions. You must look for ways to mitigate your risk.”