Regulations Governing Assessment of Profit-Seeking Enterprise Income Tax on Non-Arm's-Length Transfer Pricing
The Cost Plus Method set forth in the Regulations shall refer to the situation where the Arm's-length Price of the Controlled Transaction would be the price computed by multiplying the profit-seeking enterprise’s cost of purchasing from Unrelated Parties or producing the transferred assets by the rate of markup on cost rate, realized in comparable Uncontrolled Transactions. The formula is set forth below:
Arm's-length price = Cost of purchasing from Unrelated Parties or actual production cost for self-manufactured products × (1 + Rate of Markup on cost realized in a comparable Uncontrolled Transaction)
Rate of Markup on cost = Gross profit / Purchase cost or actual production cost for self-manufactured products
The " rate of markup on cost realized in a comparable Uncontrolled Transaction" set forth in the preceding Paragraph shall refer to the rate of markup on cost earned by a profit-seeking enterprise undertaking Controlled Transactions from sales of Tangible Assets of the same category, either purchased from Unrelated Parties or self-manufactured to Unrelated Parties. If the “markup on cost rate realized in a comparable Uncontrolled Transaction” is not available, the markup on cost rate can be determined based on the markup on cost rate earned by other profit-seeking enterprises, with similar functions, risks and contractual terms, engaging in the sale of Tangible Assets of the same category, either purchased from Unrelated Parties or self-manufactured.
In order to evaluate the applicability of the Cost Plus Method, the factors described in Paragraph 1 of Article 8 shall be considered, particularly the following factors that may affect the markup on cost rate:
1. Function performed, such as manufacturing and process engineering skills or complexity of installation, and testing function.
2. Risks assumed, such as market risk and foreign currency risks.
3. Contractual terms, such as scope and terms of warranties provided, sales or purchase volume, credit terms and delivery terms.
4. Whether or not Intangible Assets are involved in the transaction.
5. Cost structures, such as the age of machinery and equipments.
6. Business experience, such as whether the business is in a start-up or mature phase.
7. Management efficiency.
8. Consistency in accounting practices, such as the evaluation method of costs and inventory.
If there are any differences of the factors prescribed in the preceding Paragraph between the profit-seeking enterprise and its Controlled Transactions and the comparables, appropriate adjustments are to be made to eliminate the impacts on the markup on cost rate with respect to the Uncontrolled Transaction. In the event that the impacts of such differences on the rate are unable to be eliminated by appropriate adjustments, other Arm's-length Methods as set forth hereunder shall apply.
The foregoing 4 Paragraphs shall apply to the rendering of services or use of funds.