CHINA | Why Transfer Pricing Risks Emerge in M&A?

Companies navigating China transfer pricing within an M&A can face a number of risks. Generally, risks emerge when integrating the target into the group framework.

In 2021, mergers and acquisitions (M&A) cases completed in China broke new historical heights, according to the data from the Ministry of Commerce in China. Successful M&A should encompass various elements of the business operations, including operations, strategy, culture, employee management, system, and so forth.

In the M&A process, Chief Finance Officers (‘CFO’) should consider optimising the transfer pricing (‘TP’) in the business value chain. Namely, enterprises should consider improving the integration efficiency and reducing the TP risk through identifying potential risks based on industry qualities and actual operating conditions and developing TP policies for the related party transactions.

Why Do TP Risks Emerge in M&A?

Commonly, M&A is utilised by enterprises to enhance competitiveness and accelerate development. Completing the M&A is the first step. Subsequent challenges will arise in integrating the acquired operations within the future group framework.

In the acquisition’s initial stage, certain factors will hinder the enterprise’s operational efficiency, including

  • the coexistence of different business entities and business departments of the Group;
  • varying transfer pricing structure models;
  • increased number of entities in the Group, expansion of the organisational structure; and
  • decentralised resource allocation.

Therefore, the Group should prioritise leveraging TP to optimise the value chain of the operational structure. And further enhance the group’s operations and taxes efficiency.

Equally, optimising the business value chain should include:

  • the group strategies;
  • the positioning of employees;
  • transaction arrangement; and
  • applying tax preferential policies.

For cross-border M&A, the TP scheme involves more complexities. Enterprises should consider international tax policies and implications on the value chain, such as U.S Tax Reform and the Two-Pillar Solution from OECD/G20. OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines) state that the centralisation of intangible assets, risks, and functions are always involved in M&A and the arm’s length principle is still applicable for all kinds of transactions. For value chain optimisation, enterprises should focus on the following points

Integration of Intangible Assets

Within the M&A, identifying the ownership of the intangible asset in legal and economic terms should be conducted first. If a related party transaction involves intangible assets, the enterprises should recognise the function of each contributor (group members), its corresponding rights, and risk. Then formulate an arm’s length transaction framework for such transaction.

According to the Announcement of the State Administration of Taxation on Issuing the Administrative Measures for Special Tax Audits and Adjustments and the Mutual Agreement Procedure (Announcement No.6) published by the State Administration of Taxation, enterprises are required to evaluate the contribution of each related parties in the group, including its development, value-added, maintenance, protection and application of the intangible assets transaction.

Enterprises should conduct a TP analysis to ensure the intangible assets transaction is applied with an arm’s length principle. Particularly, the analysis should consider any off-the-balance sheet intangible assets that hold essential economic value such as client relationships. Besides the cost approach, income approach, and market approach outlined in No.6 Announcement, enterprises can adopt other asset appraisal methods to meet the requirements of special cases.

Integration of Group Transfer Pricing Mode

In the integration process, enterprises should decide whether to apply a unified group TP policy. Generally, in determining a unified policy, the enterprise should evaluate the integration level and independence of each business operation, the feasibility of capital and human capital allocation, and the complexity of related party transactions in regard to the management cost.

Enterprises need to conduct new pricing arrangements under the arm’s length principle after the M&A. From the Group’s perspective, the arrangement should be reviewed based on whether the scope of service provided by headquarters has changed or whether the relevant supporting activity is recharged.

Improving Aggregate Taxation Efficiency

Optimising the value chain within the M&A enhances the operation’s efficiency and aggregates tax efficiency. For instance, where the target entity holds deductible loss, the Group can reallocate resources including the working capital, human capital, and business functions to optimise the business operations and leverage tax incentives.

In practice, enterprises obliged to achieve mandatory business performance commitments can maximise and leverage tax return policies. However, adjustments to the related party transaction policy may cause a TP tax risk. Therefore, the CFO should evaluate the applicability of local tax return policy within the integrated group business during the M&A procedure.


China transfer pricing plays a crucial financial function in the entire M&A process. Namely, the TP should be considered in each M&A stage including planning, execution, and post-M&A operation, to improve the efficiency of operations and tax policies.

In conclusion, integrating intangible assets and formulating transfer pricing policies should be evaluated from the Group perspective. Equally, CFOs should optimise the overall value chain by improving deductible loss by arranging the distribution of profits. By optimising the overall value chain post-M&A, enterprises could improve enterprise income tax and VAT, and lower the tax risk.

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