Page 7 - The South China Business Journal

authorities may make adjustments if they deem the methods, and making necessary allocations of
declared value to be inaccurate. the increased tariff costs.
The escalation of tariffs between China and the US Companies must be cautious not to overstep
may incentivize MNCs to adjust their transfer pricing regulatory boundaries, as signi昀椀cant deviations
policies to offset the import tariff burden. This is from market-based benchmarks or historical
primarily achieved by reducing the prices charged pricing norms can trigger scrutiny from tax
by the exporting subsidiaries for goods and services authorities. Any adjustments to intercompany
sold to af昀椀liated importing entities. However, while pricing should be supported by robust
this strategy can mitigate tariff-related costs, it has documentation and a clear economic rationale,
the secondary effect of increasing the pro昀椀t margin especially given the dual compliance challenges
of the importing entity, leading to higher income posed by both transfer pricing and customs
tax exposure in that entity’s jurisdiction. As the US valuation rules.
currently imposes a lower corporate income tax
rate than China (21 percent 昀氀at rate on resident Impact on comparabIlIty analysIs
companies to China’s 25 percent 昀氀at rate), this will
mostly be a concern for arrangements that increase The introduction of tariffs may distort pro昀椀t
the pro昀椀ts of the Chinese af昀椀liate (however, various margins, making it dif昀椀cult to rely on historical
preferential tax arrangements in both countries comparables due to 昀氀uctuations in their
could affect this dynamic). 昀椀nancial statements, as the tariffs impact
different competitor companies in varying
Such pricing adjustments often involve a trade-off ways. For instance, entities subject to tariffs will
between reduced customs duties and increased experience increased costs, which in turn can
corporate tax liabilities. The overall 昀椀nancial impact reduce their operating margins.
depends on a range of factors, including tariff In contrast, companies that are not exposed
rates, pro昀椀t margins, applicable income tax rates, to similar tariff burdens may show signi昀椀cantly
and the structure of the MNC’s supply chain. In higher pro昀椀tability, resulting in an apparent
practice, companies may weigh these competing discrepancy between the tested party
outcomes to assess the net economic effect of and the external comparables. Therefore,
modifying intercompany pricing in response to there may be fewer comparable companies
higher tariffs. available on databases than before. This can
lead to challenges in demonstrating that the
complIance wIth arm's length prIncIple intercompany pricing is consistent with arm’s
length principles.
Both China and the US adopt the arm’s length
principle to assess the legitimacy and fairness of ImplIcatIons for tp results
intercompany transfer prices. Mitigating TP risks
created by the increased cost of import tariffs, The tariffs may also impact TP results by
therefore, requires careful navigation to ensure altering a company’s pro昀椀tability. For instance,
compliance with transfer pricing regulations. This as tariffs increase the costs of goods sold
means taking care when transferring tariff costs, (COGS) for the importing af昀椀liate, it can reduce
making necessary changes to the operational its operating pro昀椀t unless transfer prices are
transaction models, being 昀氀exible in the face of adjusted or the costs are passed on to the
changes in customs valuation and transfer pricing consumer (where applicable). This means the

SOUTH CHINA BUSINESS JOURNAL 4