Pricing Intercompany Loans In China

Chair’s Commentary

China will continue to provide employment to treasurers for a long time to come. As always, cash pooling and cross-border intercompany loans are a good story: it is possible to do most things. But, as usual with China, there are complexities and unresolved issues.

The main topic of the call was how to price intercompany loans in, and from, China, especially when these are part of a cash pooling arrangement. The main concern here is tax, and participants are finding their tax departments are becoming more involved in this question. It is also clear that there is a move – and not just in China – for authorities to become more aggressive in requiring full arm’s length pricing. Taken to its extreme, this can require the application of an interest rate which takes into account the credit rating of each individual entity, and the separate application of a charge for any guarantees, either explicit or implied.

Historically, the Chinese tax authorities have not been aggressive in challenging transfer pricing methodologies. Several participants reported questions from the authorities, but no actions so far. Having said this, people are nervous because:

China has different regional tax authorities, each of whom has a tax revenue collection target. So they can challenge internal transfer pricing.

The bid/offer spread on deposits and loans in China is significant, so the question of how you split the difference is important.

China has general thin capitalisation rules (generally, debt is limited to twice equity): intercompany loans can fall foul of these.

Cross border intercompany loans are now quite common, as are structures where an internal cash pool is feeding into a cross border one. This means any inconsistency in pricing methodology can become more easily visible.

Against this background, some participants are adopting approaches which more closely follow market pricing. Many have used a simple 3% interest rate for many years – this has never been challenged. 

Bottom line: if you aren’t already close friends with your tax department, you soon will be!

For reference, I attach links to a couple of articles which discuss the question, but which leave room for interpretation:
CMS Law-Now: An overview on cash pooling in China
Deloitte tax@hand: PBOC reforms calculation of loan prime rate