Sep 2009
The Chinese State Administration of Taxation ("SAT") hosted its most important national training session of 2009 for over 100 transfer pricing officials across the country this week. The focus of the training was the pharmaceutical industry.
We as well as several multinational companies in the pharmaceutical industry participated in a multilateral dialogue which featured an in-depth review of the global operations and value chain of pharmaceutical multinationals. Industry representatives highlighted the high investment, high risk, and high return nature of the industry, and discussed functions specific to China operations such as manufacturing and distribution.
SAT officials were keen to understand the overall supply chain in the industry and how much profit should be retained by local subsidiaries for the functions they performed. They also questioned whether the cost plus method was always appropriate for formulation, local packaging and distribution functions currently most often performed by Chinese subsidiaries.
In addition, various transfer pricing issues with facets unique to the pharmaceutical industry were explored, including sales and marketing services, contract research and development ("R&D") and licensing of intangibles. With the multinational pharmaceutical companies rapidly evolving to perform increasingly sophisticated functions, extensive discussions focused on the creation of non-routine intangibles, legal vs. economic ownership, as well as transfer pricing methodology for licensing arrangements. The SAT was focusing on understanding whether local subsidiaries are creating intellectual property ("IP") relating to sales and marketing and contract R&D.
PwC observations
Garry Stone, our global transfer pricing leader led the discussion, together with Spencer Chong and other partners from our China and US practices.
Garry Stone emphasised that Chinese tax authorities are following suit of their global counterparts and are moving towards more sophisticated transfer pricing enforcement including focussing on specific industries.
Following the training, it is likely that multinational pharmaceutical companies will receive close scrutiny from tax authorities in relation to the areas highlighted above. Some local tax authorities had already started making inquiries of pharmaceutical companies in their jurisdictions prior to the training.
PwC recommendations
We recommend taxpayers in this industry revisit their transfer pricing policies to ensure their functions and risks profiles are aligned with the compensation they earn in China. Documentation to support taxpayer's transfer pricing position will be a key element at the inquiry stage. In particular, documentation should cover the nature of the local functions and whether there is any IP generated by these functions in China.
Taxpayers should also prepare to enter into in-depth communication and exchange of ideas on their business model and transfer pricing policies with tax authorities.
