Latest development of APA in China - simplified procedures of unilateral APA.
The State Administration of Taxation (“STA”) has made a continuous effort to promote Advanced Pricing Arrangement (“APA”). On 26 July 2021, the STA issued STA Public Notice  No.24 (“Bulletin 24”), which sets forth simplified procedures for unilateral APA for enterprises that meet certain conditions. On 29 October 2021, it also published the China APA Annual Report (2020). The report shows that the STA signed record-high unilateral APAs and bilateral APAs in 2020.
APAs in China
APAs are arrangements between enterprises and tax authorities concerning the pricing principles and calculation methods for related party transactions. An APA is an important tool for multi-national enterprises (“MNEs”) to obtain transfer pricing and tax certainty for cross-border business operations. It is vital in reducing transfer pricing compliance costs and promoting cross-border investments and operations. A unilateral APA is an arrangement between one entity and the tax authority in which the entity is located. A multi-lateral APA, e.g., a bilateral APA, is the arrangement between the related entities and the relevant tax authorities in which the associated entities operate.
Relying on the APA framework set out in STA Public Notice  No.64 (“Bulletin 64”), the STA further simplified the procedures for unilateral APAs by issuing Bulletin 24 on 26 July 2021. Bulletin 24 became effective on 1 September 2021.
In recent years, the Chinese government has been working on deepening reform to delegate power, streamlining administration and improving the business environment. The Chinese tax authorities have launched relevant implementation measures and held a “Tax Convenience for the People” campaign.
Since the introduction of the APA program over 20 years ago, the number of unilateral APAs has been lower than expected by the Chinese tax authorities. Bulletin 24 reflects the increased flexibility the Chinese tax authorities have towards unilateral APAs. It is hoped that there will be a growing number of companies choosing to achieve tax certainty through unilateral APAs.
The simplified procedures
Bulletin 24 contains three phases in the APA process:
- Application evaluation;
- Negotiations and signing; and
- Monitoring and execution.
The procedures are much simplified from the normal APA process under Bulletin 64, which sets forth six phases, namely (i) pre-filing meeting, (ii) letter of intent, (iii) analyses and evaluation, (iv) formal filing, (v) negotiations and signing and (vi) monitoring and execution.
In addition, the simplified procedures set time limits for tax authorities on accepting APA applications and for negotiations and signing. The relevant tax authority must send a “Notice on Tax Matters” to the applicant within 90 days of receiving the application to inform the enterprise whether the application has been accepted. The tax authority must complete negotiations within six months of issuing the Notice of Tax Matters. Of course, any time the enterprise spends on preparing and submitting additional information required by the in-charge tax authority is not included in the time period noted above. In the event that there are no time delays in preparing and submitting information, the APA application under Bulletin 24 can be concluded within six to nine months. Consequently, not only the procedures are simplified, the time required is also shortened.
The three phases are summarized as follows:
Phase 1: Application evaluation
- The enterprise submits the application form.
- The tax authority would analyze and evaluate the information and conduct on-site interviews relating to the functions and risks undertaken by the enterprise.
- The tax authority must send a Notice of Tax Matters within 90 days of receiving the application to inform the enterprise whether the application is accepted and/or the reasons for rejection
Phase 2: Negotiations and signing
- The tax authority must negotiate with the enterprise regarding whether the related party transactions comply with the arm's length principle. The negotiations must be completed within six months.
- During the negotiations, the tax authority may request additional information and analysis to be provided by the enterprise. The time spent by the enterprise in gathering the additional information and the additional analysis is not considered in counting the six-month period.
Phase 3: Monitoring and execution
- During the execution of the APA, in case of any significant changes that would affect the APA, the APA would be terminated. If the enterprise desires another APA with the changed facts, it must re-apply in accordance with Bulletin 24.
Applicable conditions under Bulletin 24
According to Article 3 of Bulletin 24, the simplified procedures apply to enterprises with annual related party transactions exceeding RMB 40 million in each of the three years prior to the tax year in which the in-charge tax authority serves the Notice of Tax Matters to accept the unilateral APA application formally.
In addition to the RMB 40 million threshold, the enterprise must have met any one of the following three conditions:
- It has provided the tax authorities with contemporaneous documentation for the three years prior to the application of the simplified procedure, and such documentation complies with the requirements set out in Bulletin 42;
- It has executed an APA within the ten years before the application of the simplified procedure and has complied with the requirements of the APA; or
- Tax authorities audited it for special tax adjustments ten years before the application of the simplified procedure, and the tax authorities concluded the case.
Under any of the following circumstances, the in-charge tax authority may reject an application filed by an enterprise:
- The tax authority has already initiated a special tax adjustment investigation or other tax investigation on the enterprise, and the relevant tax investigation has not been closed;
- The enterprise fails to file its annual related party transaction disclosure forms as required by the relevant regulations and does not make corrections on time;
- The enterprise fails to prepare, maintain and provide contemporaneous documentation as required by the relevant regulations;
- The enterprise fails to provide relevant information required by Bulletin 24 or fails to provide additional and/or corrected information if the information initially provided does not meet the requirements of the tax authority; or
- The enterprise fails to cooperate with the tax authority in carrying out on-site functional and risk interviews.
For unilateral APAs, both the general procedures under Bulletin 64 and the simplified procedures under Bulletin 24 may apply. Therefore, if an application under simplified procedures is rejected or negotiations fail within the six-month period, the enterprise may apply for a unilateral or bilateral APA per Bulletin 64. However, for information that had already been submitted, it wouldn’t be necessary to re-submit.
Mazars’ thoughts - Key points to make simplified procedures successful
In the work plan issued in February 2021, the STA stated that it is necessary to complete within 2021, to simplify procedures for unilateral APAs. The simplified procedures help the local in-charge tax authority to handle more applications for unilateral APAs. It is also 4 Opinions of the State Taxation Administration on Carrying out the 2021 “I Do Practical Work for Taxpayers and Convenient Taxation Spring Breeze Actions” (Shuizongfa  No.14)
Therefore, tax authorities and enterprises must pay close attention to the simplified procedures and solve any issues during the negotiations and signing stage. Based on our view, these issues would include:
- Find the reasons for the discrepancies between the financial data and the pricing policy of related party transactions. Explain these reasons to the in-charge tax authority well during the submission. In particular, the fiscal years with low-profit margins should be analysed, and the reasons for the impact quantified should be explained to the in-charge tax authority.
- To the extent there should be adjustments for prior years from any benchmarking analysis, the enterprise could bring this to the attention of the in-charge tax authority. This would be the case when there was a historical fluctuation in profits.
- The role of enterprise in the group value chain, especially the role played by the China companies in research and development (“R&D”) and marketing, if any, must be clearly defined. In particular, the role must be explained and demonstrated during the functional on-site interviews. For example, R&D activities relating to the production process must be segregated from R&D activities relating to product development. These expenditures were often grouped into a single item called R&D expenses in the financial statements.
- There should be an analysis of the significant impact of unique factors during the COVID-19 pandemic on the enterprise's operation, with actual business data as evidence. For example, logistics costs could go up significantly during the COVID-19 pandemic. The enterprise should be able to illustrate the impact of the rise in logistics costs.
- As in all APAs, forecasting the enterprise's future operation is essential. The enterprise should perform a reasonable economic model, including the basis of the forecast and comparison with historical data.
 Public Notice of the State Taxation Administration on Matters Regarding Application of the Simplified Procedures for Unilateral Advance Pricing Arrangements (STA Public Notice  No.24)
 Public Notice on Matters Regarding Enhancing the Administration of Advanced Pricing Arrangements (STA Public Notice  No.64)
 Public Notice on Matters Regarding Refining the Filing of Related Party Transactions and Administration of Contemporaneous Transfer Pricing Documentation (STA Public Notice  No.42)
 Opinions of the State Taxation Administration on Carrying out the 2021 “I Do Practical Work for Taxpayers and Convenient Taxation Spring Breeze Actions” (Shuizongfa  No.14)