In the annual corporate income tax reconciliation process, what financial professionals fear most is receiving a notice from the tax authorities about a special tax adjustment interview. This is because such adjustments typically involve large tax amounts and can retroactively adjust tax periods for a long time. This article will use a case study to explore transfer pricing, a common issue in special tax adjustments.

Case Study:

Company A, an electronic component manufacturer, has sold its core products to its overseas affiliate, Company B. The unit cost of the product is 80 yuan, and Company A sells it to Company B for 90 yuan, while the average market price at the time is 120 yuan. Because the pricing is significantly lower than the market level, Company A's profits are greatly reduced. In 2025, the tax authorities, through monitoring data, discover that Company A's sales profit margin has been consistently below the level of comparable companies for nearly 10 years. After calculation based on the median value, the company is found to owe nearly 10 million yuan in back taxes. The authorities then issue a Tax Matters Notification Letter, demanding that Company A conduct a self-assessment to ensure its related-party transaction sales profit margin meets the average standard for comparable companies, the so-called Transfer Pricing.

Does Low Pricing Inevitably Lead to Back Taxes?

In practice, Transfer Pricing for related-party transactions by multinational enterprises must follow the arm's-length principle and the relevant transactions must have a reasonable business purpose. The key to determining whether a company meets these requirements lies in the comparable information between related-party transactions and transactions between independent enterprises. According to Article 14, Clause 4 of the "Announcement of the State Administration of Taxation on Improving Related-Party Transaction Reporting and Concurrent Documentation Management" (State Administration of Taxation Announcement [2016] No. 42), "factors considered in comparability analysis include the characteristics of the assets or services transacted, the functions, risks, and assets of the parties involved in the transaction, contractual terms, economic circumstances, and business strategies."

In this case, further investigation reveals that the core business of the overseas affiliate, Company B, covers R&D, procurement, manufacturing, marketing, and sales. The core functions of overall R&D, procurement, marketing, and distribution are undertaken by Company B, and the related costs are also fully paid by Company B. Company A is only responsible for product manufacturing and bears limited production, inventory, and exchange rate risks. Therefore, its profit return level is relatively limited. If companies with inconsistent functions and risk profiles are used as comparable subjects for Company A, the analysis data is highly likely to be distorted.

What Measures Can Companies Take to Avoid Special Tax Adjustments by Tax Authorities?