Transfer Pricing Documentation in China: Common Pitfalls and Best Practices

Preparing compliant transfer pricing documentation in China remains a complex task for multinational companies. From incomplete investment disclosures to vague pricing methodologies, many firms fall short of the expectations set by China’s transfer pricing rules. This article highlights the most frequent issues and explains how to avoid them using practical, regulator-aligned approaches.

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Under China’s transfer pricing documentation rules, enterprises engaging in related-party transactions must prepare and maintain contemporaneous documentation in the year following the transaction. This documentation includes the master file, local file, and special issue file, as required by the State Taxation Administration (STA).

Among these, the local file and special issue file must be completed no later than June 30 of the year following the related-party transaction year. In other words, for transactions that occurred in 2024, the documentation must be ready by June 30, 2025.

As the deadline nears, businesses should take proactive steps to assess their compliance obligations. In Part II of our two-part article series, we cover:

• Common pitfalls in preparing transfer pricing documentation
• Transfer pricing documentation best practices

Foreign-invested enterprises and domestic companies alike should not underestimate the importance of proper transfer pricing compliance, particularly amid tightening enforcement and growing scrutiny from China’s tax authorities.

Common pitfalls in preparing transfer pricing documentation

Despite growing awareness of transfer pricing compliance obligations, many enterprises continue to face recurring issues when preparing documentation. Below we list several common risk points that can trigger audit concerns or penalties if not properly addressed:

• Incomplete disclosure of required information: China’s transfer pricing regulation clearly specifies the content that must be disclosed in the master file, local file, and special issue file. However, some companies omit required sections or fail to provide the level of detail prescribed by the regulations.
• Inconsistencies across documents and data sources: It is not uncommon for disclosures in the master file and local file to contradict each other, or for financial data in the local file to differ from that submitted in tax returns or financial statements. Such discrepancies can raise red flags for auditors and undermine the credibility of the entire documentation set.
• Outdated content not reflecting current business conditions: Some enterprises continue to recycle past years’ documentation without incorporating key updates—such as changes in shareholding structure, management organization, or the external business environment—leading to an inaccurate portrayal of the taxpayer’s situation.
• Superficial disclosures that downplay key risks: Transfer pricing documentation is intended to demonstrate compliance with the arm’s length principle through thorough industry, value chain, and functional risk analysis. Yet, many enterprises focus solely on basic company profiles, omitting meaningful discussion of transaction substance, value contribution, or risk-bearing arrangements.
• Lack of proper formalization and source attribution: In some cases, the documentation is not drafted in Chinese or fails to indicate the sources of cited information. Other formal issues include missing company chops, absence of signatures from the legal representative (or authorized signatory), and failure to disclose intermediary involvement or attach their credentials if a third party assisted in preparation.

To ensure compliance and reduce transfer pricing risks, companies should treat documentation as a strategic exercise, not a routine filing, and allocate sufficient internal and external resources to its preparation and timely maintenance.

Transfer pricing documentation best practices

To ensure compliance and support effective risk management, companies should adopt practical, detailed, and policy-aligned approaches when preparing local files and special issue documentation. The following best practices can help enterprises improve the quality and defensibility of their transfer pricing files.

Local file preparation

Enterprise information

When preparing the local file, special attention should be paid to how enterprise information is presented. Key recommendations include:

• Use charts to present internal functions: Functional departments, their responsibilities, and employee headcounts should be clearly laid out using visual charts. This information must be consistent with Section 200 of the G000000 Associated Declaration Form (Report on Enterprise Information), and aligned with the company’s functional and risk profile as well as value chain analysis.
  If the company has not prepared a master file, it is also advisable to use a chart to present the shareholding structure—up to the ultimate parent entity—clearly indicating shareholding ratios and jurisdictions of registration.
• Disclose both organizational and management structures: In addition to the basic organizational chart, companies should provide details of the management structure, including reporting lines and the physical locations of supervisory personnel. This can be shown in table format, listing the office location, primary responsibilities, reporting relationships, and associated group entities for each senior executive and department head.
• Describe core business activities with up-to-date industry context: The file should include accurate descriptions of the company’s business sectors, key products, and main value drivers. Industry developments and relevant policy updates must reflect the actual conditions during the reporting year. Major competitors should be identified based on realistic market data.
• Disaggregate financial data by business line: Instead of only reporting aggregate financials, companies should break down revenue, costs, expenses, and profits by product or business type. For contract processing operations, declared values should be based on annual customs import-export prices.
• Disclose restructuring and intangible asset transactions that impact the company: Any corporate restructuring or transfer of intangibles that involves or affects the enterprise must be described in detail, including its influence on the entity’s structure, operating model, profitability, value chain contributions, and risk profiles. It is also important to assess group-level restructuring or intangible transfers that, although not directly involving the company, have significant implications for its operations or positioning—these are often overlooked in practice.

Related party information

Accurate disclosure of associated parties is a critical component of the local file in transfer pricing documentation. According to China’s transfer pricing rules, the local file should include details of:

• All related parties with direct or indirect shareholding relationships with the enterprise.
• All related parties that engaged in transactions with the enterprise during the reporting year.

In practice, companies should address the following key points:

• Properly determine related parties under current rules: Enterprises must determine whether a party qualifies as an associated party based on Article 2 of the STA Announcement [2016] No. 42. Special attention should be paid to the expanded definition of control under Article 9 of STA Announcement [2021] No. 69. A party that can control the activities of another and enjoy returns through contracts or other arrangements is deemed to have a substantive associated relationship, even in the absence of direct equity links.
• Understand the scope difference between local files and declaration forms: The scope of disclosure in the local file differs from that of Form G101000 (Associated Relationship Table). While Form G101000 requires only the basic information of related parties involved in transactions during the reporting year, the local file must disclose all related parties with equity, regardless of whether they engaged in transactions that year.
  Moreover, for each related party, the local file should provide detailed information on applicable income tax types, tax rates, and preferential tax treatments, if any.
• Disclose changes in related party relationships: If there are changes in related party relationships during the year, such as additions or removals of associated parties, these changes must be clearly described. Companies should report the name and jurisdiction of each newly added or removed related party, the nature of the relationship change, the reason for the change, and the date it occurred.

Value chain analysis

As stipulated under Article 12 of the STA Announcement [2016] No. 42, companies are required to include a detailed value chain analysis in the local file. This section should demonstrate how value is created, allocated, and captured within the multinational group, helping to substantiate that the transfer pricing arrangement aligns with the arm’s-length principle.

In practice, companies should pay particular attention to the following:

• Clearly illustrate business flow, logistics, and cash flow within the group: Enterprises should present the flow of goods, services, and capital in a structured and visual format, such as diagrams or tables, to clarify the roles of all entities involved.
  • Business flow: Identify each participant (including the reporting entity), specify their role within the value chain, and indicate the ownership and usage rights of intangible and tangible assets at each stage.
  • Logistics: Distinguish between domestic and international flows and disclose any involvement with bonded zones or special customs supervision areas.
  • Capital flow: Identify entities involved in intra-group funding activities and disclose the contributors and users of any group treasury or cash pooling arrangements. Companies should also attach the most recent financial statements of all relevant participants in the value chain.
• Disclose the impact of location-specific factors: When geographical elements, such as local market advantages, workforce quality, regulatory regimes, or government incentives, contribute significantly to value creation, companies must quantify and attribute these contributions accordingly. This can involve comparative analysis of the functions performed and risks assumed by different entities operating in distinct locations.
• Fully explain global profit allocation principles and outcomes
  Enterprises must disclose both the principle (that is, the standard used to allocate group profits across the global value chain) and the results (that is, the actual profit allocation). If profit is allocated based on functional and risk profiles, companies should quantify these aspects for each value chain participant and explain the basis and logic behind the quantification. If profit is distributed according to arm’s-length benchmarks (such as comparable profit margins), companies should clearly outline the method for determining the benchmark, the data sources used, and how this translates into the final allocation of profits across the value chain.

By conducting and presenting value chain analysis thoroughly and objectively, companies can provide a robust defense for their transfer pricing positions and reduce the risk of tax authority challenges.

Outbound investment information

Some companies tend to overlook or intentionally withhold information about their outbound investments in the local file. However, under the STA Announcement [2016] No. 42, if an enterprise engaged in outbound investment during the reporting year, it is required to disclose relevant basic information, project overviews, and operating data.

In practice, companies should ensure that the following aspects are properly addressed:

• Outbound investment projects include not only new investments made during the year but also those that remained active or were disposed of during the year. Both directly and indirectly held investments fall within the disclosure scope.
• When presenting an overview of outbound investment projects, the enterprise should disclose a complete equity structure, indicate shareholding percentages, and provide details such as the number of personnel in relevant departments and their respective responsibilities.
• Operating data for each outbound project must include annual revenue, costs, expenses, and tax-related information. This includes the applicable categories of income tax, preferential tax policies granted by local authorities, actual tax burden, any tax credits or exemptions, treaty benefits under double tax agreements, and any other relevant operational data that should be disclosed.

Related-party equity transfers

According to STA Announcement [2016] No.42, companies that engage in related-party equity transfers during the reporting year must disclose details such as the transaction overview, the transferred equity interest, and other related information. Failure to do so may obscure transfer pricing risks associated with internal restructurings.

In practice, enterprises should ensure the following:

• Related-party equity transfers include direct or indirect transfers of equity interests between the company and its related parties, whether occurring domestically or overseas. They also cover changes in shareholders resulting from corporate restructurings.
• When disclosing the transaction overview, the company should state the commercial purpose of the transfer. If the transaction requires approval from internal or external authorities (e.g., via contracts or agreements), the relevant approval documents should also be included.
• If the equity transfer involves payment in the form of non-monetary assets, valuation reports or other evidence of fair market value must be provided.
• Any due diligence reports or asset valuation reports related to the equity transfer should be attached as appendices.

Related-party services

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Under the STA Announcement [2017] No.6, the tax authority may initiate special tax adjustments for related-party service transactions that do not comply with the arm’s length principle. Inadequate documentation of the nature and pricing of such services increases the risk of transfer pricing challenges.

Companies should ensure that their local file includes a robust explanation addressing whether the services are beneficial and whether the pricing is at arm’s length. Specifically:

• The pricing methodology must be clearly stated. For instance, if the cost-plus method is used, the file should specify the exact markup percentage rather than a vague reference to “a certain markup”.
• The financial impact on both parties to the transaction should be assessed, with a focus on demonstrating the direct or indirect economic benefits received by the service recipient.
• If service costs can be allocated by recipient and by project, the documentation should disclose detailed costs accordingly. If costs cannot be separately allocated, the file must explain the allocation standard and ratio used, along with a breakdown of how the transfer price was determined based on those allocations.
• If the company or its group engages in similar service transactions with unrelated parties, the documentation should compare these with the related party services. Any significant differences in pricing principles or transaction outcomes should be reasonably explained with reference to service contracts or other supporting evidence.

Comparability analysis

The STA Announcement [2016] No.42 provides detailed requirements for the comparability analysis section of the local file. To enhance the credibility and defensibility of transfer pricing positions, companies are advised to adopt the following best practices:

Comprehensively disclose comparability factors: While many companies adequately describe the characteristics of the transaction and the functions, assets, and risks of the parties involved, other key factors—such as contractual terms, economic circumstances, and business strategies—are often insufficiently addressed. Companies should:

• Provide a complete summary of contractual terms, including payment methods and conditions, delivery terms, value-added service arrangements, amendment and renewal rights, and termination clauses.
• Offer relevant economic context, such as market share, consumer purchasing power, availability of substitutes, government regulations, cost efficiencies, and location-specific advantages or premiums.
• Describe business strategies, including innovation and development plans, diversification efforts, synergy benefits, risk management approaches, and market penetration strategies.

Ensure transparency in the selection of comparables: A well-documented screening process not only supports the reliability of comparability conclusions but also facilitates review by tax authorities. Companies should:

• Identify the data sources used for searches.
• Present a step-by-step account of how comparables were screened and excluded.
• Specify the industry classification codes, keywords, and geographic scope used in the database.
• Define quantitative filters, such as data completeness, independence, continuous loss periods, R&D intensity, SG&A benchmarks, and revenue thresholds.
• Clarify qualitative criteria, including the rationale, screening standards, and selection methods applied.

Comparable companies should be functionally similar to the tested party. Where there are significant differences in functions performed, risks assumed, or assets used, the reliability of the analysis may be undermined.

Disclose and justify comparable data: For the selected comparables, companies should:

• Where applicable, provide a side-by-side comparison of internal and external uncontrolled transaction prices for the same or similar products or services.
• List the name, jurisdiction, industry classification code, independence indicators, and financial metrics of each comparable company for the tested year.
• Present a summary of quartile values and compare the tested party’s financial results against these benchmarks within the same table.
• Identify and adjust for any material differences in data scope, contractual terms, economic environments, or strategic positions, and provide a clear explanation of the adjustments made and their justification.

By taking a structured, transparent, and comprehensive approach to comparability analysis, companies can enhance the defensibility of their transfer pricing documentation and reduce the risk of tax controversy.

Transfer pricing method selection

In accordance with STA Announcement [2016] No. 42 and the detailed provisions in STA Announcement [2017] No.6, enterprises are required to provide a comprehensive explanation of the transfer pricing method selected and its application. Insufficient disclosures, such as failing to explain the selection rationale, omitting profitability analysis, or not assessing compliance with the arm’s length principle, can expose the company to significant tax risk.

To ensure robust documentation, companies should consider the following best practices:

Clearly explain tested party selection: The enterprise should specify the rationale for selecting the tested party. As a general principle, the party performing simpler functions and assuming lower risks should be chosen. This helps ensure greater reliability in applying the selected method and enhances the comparability of financial outcomes.

Substantiate the method selection with detailed analysis: A methodical justification for the chosen transfer pricing method should be provided. Enterprises are encouraged to:

• Evaluate each of the transfer pricing methods specified in current regulations (e.g., CUP, resale price, cost plus, TNMM, profit split), including their applicability to the controlled transaction.
• Compare the functional and risk profile of the enterprise with that of comparables.
• Select the most appropriate method based on the results of the comparability analysis.
• Support the chosen method with data on the group’s overall profitability, and clearly state the tested party’s contribution to that profitability (both in absolute terms and as a percentage of group profit).

Disclose key metrics and calculations: Where the method involves the use of comparable uncontrolled transactions or profit-level indicators, the enterprise should:

• Specify the exact financial indicators used (e.g., operating margin, return on assets).
• Provide the formulae applied to calculate these metrics.
• Clarify the definitions and scope of the financial indicators to ensure consistency and replicability.

Provide reasoning when actual profit falls below benchmarks: When applying a quartile range to assess arm’s length outcomes (such as in TNMM):

• If the enterprise’s actual profit level falls below the median of the interquartile range, the reasons must be clearly analyzed and documented.
• If adjustments are made to address material differences, the basis, items, and methodology for these adjustments should be thoroughly explained.

Conclude on arm’s length compliance: The local file should synthesize key elements—including the nature of related-party transactions, functional and risk analysis, selection of comparables, transfer pricing method, and financial results—to assess whether the actual transfer prices or profit levels are consistent with the arm’s length principle. This conclusion is critical to demonstrate the integrity of the enterprise’s transfer pricing arrangements.

Special issue file preparation

Cost contribution arrangements: Ensuring complete disclosure of special issue documentation

According to Article 16 of the STA Announcement [2016] No. 42, enterprises that enter into cost contribution arrangements (CCAs) must prepare a special issue file that includes detailed disclosures. In practice, however, incomplete documentation is common. Enterprises should also pay close attention to additional requirements set out in the Implementation Measures for Special Tax Adjustments (Trial) (Guo Shui Fa [2009] No. 2, or “Circular 2”), which remain highly relevant in managing CCAs.

To ensure compliance and reduce tax risk, enterprises should adopt the following best practices when preparing CCA-related documentation:

Maintain documentation annually, not only in the signing year: The special issue documentation for a CCA must be prepared not only in the year the agreement is signed but also updated annually during its execution. Financial information and other disclosures should reflect the actual data for each fiscal year and align with the information submitted in the “Cost Contribution Agreement” section of the annual related-party transaction reporting form.

Disclose all required elements in full: Enterprises must fully disclose all nine categories of information required under the regulations, including a copy of the signed CCA and details such as:

• Objectives of the arrangement.
• Identity and roles of all participants.
• Allocation of expected benefits.
• Cost allocation methods.
• Basis for participation shares.
• Methods for handling entry/exit of participants.
• Accounting and valuation principles used.

Enterprises should check disclosures against the regulatory checklist to ensure completeness.

Explain benefit allocation and alignment with the arm’s length principle: Documentation must demonstrate that the allocation of payments by non-participants for the use of results is consistent with the arm’s length principle and reflects a reasonable cost-benefit relationship. This helps justify the economic substance of the arrangement to tax authorities.

Address changes in participation and early termination: If a CCA has been executed and has resulted in the creation of intangible assets, any change in participants or early termination must be handled in accordance with the arm’s length principle. The corresponding adjustments and rationale should be clearly disclosed in the documentation.

Adjust for imbalances in benefit sharing: Where the actual benefit derived by a participant is not proportionate to the costs allocated to it, compensating adjustments must be made. The basis, calculation method, and implementation of these adjustments should be clearly explained in the documentation to ensure transparency and support defensibility under audit.

Capital weakening: ensuring comprehensive disclosure in special issue documentation

Article 17 of the STA Announcement [2016] No.42 requires enterprises to prepare a special issue file addressing capital weakening. However, incomplete disclosures are common in practice. Capital weakening refers to situations where the ratio of debt-like investments from related parties to equity investments exceeds regulatory thresholds. The special issue documentation on capital weakening primarily supports demonstrating that related-party debt investments—covering amounts, interest rates, terms, financing conditions, and debt-to-equity ratios—are consistent with the arm’s length principle. Additional detailed rules on capital weakening management are set forth in Circular 2.

Enterprises should adopt the following best practices to ensure full and compliant disclosure:

• Disclose all required items thoroughly: The documentation must include analysis of at least 11 key aspects, such as the enterprise’s debt servicing and borrowing capacity. Enterprises are advised to systematically review the regulatory checklist and disclose all relevant information comprehensively.
• Describe market conditions at the time of financing: Disclose prevailing market factors that necessitated additional financing, for example, increased demand for main products or rising raw material costs. Such contextual information helps justify the financing decision and terms.
• Disclose any financing restrictions or conditions: Fully disclose whether financing was subject to any restrictive covenants, such as guarantees, collateral requirements, or other security interests.
• Benchmark with non-related party financing: Provide an overview of typical financing arrangements between unrelated parties under similar conditions, including comparable interest rate levels for equivalent amounts and terms.
• Detail collateral provided for related-party debt investments: Disclose specifics of any collateral securing the related-party debt, including descriptions, book values, and fair market values of pledged assets.
• Disclose any third-party guarantees: If third parties guarantee the related-party loans, disclose whether the guarantors are related to the enterprise, any guarantee fees charged, and the basic terms of the guarantee agreements.
• Compare financing terms with financial institutions: Provide information on interest rates and conditions offered by financial institutions for similar loans in the same period, accompanied by comparative analysis against the enterprise’s related-party financing.

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