Written by: Ye Bill, Sun Xing, Yu Yue, Jin Baihe, Ding Ying 

KWM Compliance & Regulatory Group



While large-scale special administrative inspection on royalty payments had not been completed, the PRC customs (“the Customs”) launched a new round of investigation early this year, with an increasing focus on the effects of special relations between buyers and sellers (“Special Relation”) on the determination of dutiable value of imports. The transfer pricing investigation pays close attention to luxury, medicine and mechanical equipment industries. Up to now, many enterprises have received oral or written notices from the Customs requesting explanations on whether and how Special Relation would impact their import price.

In fact, it has been a headache for multinational enterprises to determine how Special Relation impacts their import price. On the one hand, the question is closely related to both customs and tax (transfer pricing); on the other hand, the question is one of a reasonableness test. Furthermore, there is an inherent conflict between the Customs supervision and tax supervision as the authorities have different foci. The Customs pays attention to the import price of each shipment – the higher the import price, the greater the VAT and tariff collected on import. By contrast, the tax authority concerns more on related party transactions and overall profit level – the higher the import price, the lower the local importer’s gross profit earned and income tax paid. In addition, some transactions may incur costs of economic double taxation due to the possible overlap of tax supervision in PRC.

As such, in determining import price and organizing import transaction structure, enterprises often face a two-side dilemma resulted from the conflict between the Customs supervision and the tax supervision. It poses a great challenge to enterprises’ compliance management. The issue is complicated in nature. Solely considering the pressure from supervision of one side may not only weaken the reasonableness of the overall transaction and price arrangement, but also bring additional risks of supervision of the other side.

To solve the two-side dilemma, internally, it requires solid teamwork among financial, tax, customs, legal and business departments of an enterprise as well as effective communication between the local importer and its overseas headquarter. Externally, professional advice, review and analysis which take into account the compliance requirements of both customs and tax sides can make significant contributions. By formulating an overall transfer pricing policy and specific transaction plans from a comprehensive perspective, the enterprise can have a better chance to meet the requirements of both the Customs supervision and the tax supervision.

This article addresses twelve key questions related to import price. Based on our years of practice experience on import-price-related legal, customs and tax issues, those questions are commonly and heavily discussed in dealing with import-price-related disputes with the Customs and tax authorities. We hope that this article can assist multinational enterprises in responding to the new round investigation more efficiently and effectively. We also hope to offer enterprises a practical guide to designing and improving import pricing strategies for future transactions.

Question 1: Why does the Customs focus on Special Relation in determining import price?

Generally speaking, Special Relation influences the fairness of the transacted price of imports. Such effect usually gives rise to significant tax consequences.

Normally, the Customs examines and determines the dutiable value of imports based on the transacted price. This is a principle set forth in the Customs Law of the People’s Republic of China (海关法) (“Customs Law”), the Regulations of the People’s Republic of China on Import and Export Duties (进出口关税条例) (“Regulations”), and the Measures of the Customs of the People’s Republic of China for the Determination of the Customs Value of Imported and Exported Goods (海关审定进出口货物完税价格办法) (“Measures”). However, if a transacted price does not meet relevant requirements and is considered unreasonable, the Customs would negotiate with the taxpayers on the dutiable value of their imports. Special Relation between the buyers and the sellers is one of the key factors that affect the Customs’ judgment on reasonableness of the transacted price.

Yet, it is not taken for granted that the transacted price concluded between parties with Special Relation is unreasonable in nature. If an enterprise can prove that regardless of the Special Relation the transacted price is reasonable or is consistent with general commercial practice, it can still be used as the dutiable value.

The Customs’ attention to Special Relation’s influence on import prices shares the same idea with the tax authority’s concern on transfer pricing or fairness of pricing in related party transactions in the past decade. Unlike the Customs, the tax authority largely focuses on the overall transfer pricing policy in related party transactions, including not only imports and exports of goods, but also deals of services, intangible assets, capitals and equity. The Customs mainly concentrates on goods transactions; and only in rare cases, due to its unique price valuation system, the Customs may also examine intangible-assets-related imports and service transactions.

Question 2: If an enterprise has included royalty payment in the dutiable value and paid taxes accordingly, is examination on Special Relation’s impact on transacted price still required?

Royalty payment is one of the common items subject to adjustments in assessing the transacted price. Royalty payment is included in the dutiable value on the condition that the transacted price itself is reasonable. But if the buyer and seller have Special Relation that may influence the transacted price of imports, the transacted price is considered not reasonable, and is subject to adjustment pursuant to the Customs’ valuation methods (see Questions 4 and 5 for details). If this is the case, no adjustment on the inclusive items of the transacted price is required.

In fact, during the large-scale special administrative inspection, many enterprises have reported their transacted price, included royalty payments in the dutiable value and paid taxes accordingly. In the new round of investigation, enterprises can likely argue that by allowing them to include royalty payment in the dutiable value, the Customs has confirmed reasonableness of the transacted price, and the dutiable value is adjusted based on the transacted price. However, whether this argument can adequately support a conclusion that Special Relation did not unreasonably affect the price of imports remains to be further discussed.

Question 3: If Special Relation is present, is it possible to prove that the transacted price is reasonable and can be used as the dutiable value?

Yes, it is possible, but normally not easy.

According to Article 17 of the Measures, if the transacted price can be proved to be similar to the transacted price of identical or similar goods, chargeback price and computed price, the transacted price is deemed reasonable. However, this rule is strictly applied. In case of any doubts from the Customs, it is often difficult for the enterprises to collect and provide applicable supporting evidence and data (see Question 5 for details). In addition, the general commercial practice and sales environment test provided in Article 18 of the Measures is in nature a reasonableness test but lacks clear application guidelines. Thus, in practice, it is hard for the enterprises to prove reasonableness of the transacted price relying on the test.

Question 4: If an enterprise fails to prove or the Customs does not agree on the reasonableness of the transacted price, how will dutiable value be determined?

According to the Regulations and the Measures, if the transacted price is not in compliance with applicable rules, after investigating on background information and negotiating with the taxpayer, the Customs will determine the dutiable value of the import goods with reference to, and in order of, (i) the transacted price of identical goods, (ii) transacted price of similar goods, (iii) chargeback price or computed price, or (iv) other reasonable price.

Question 5: What are the major similarities and differences between the Customs’ valuation methods and transfer pricing methods?

The Customs’ valuation methods are very similar to the transfer pricing methods, but they are not exactly the same.

  • The valuation method relying on the transacted price of identical or similar goods is similar to the comparable uncontrolled price method under transfer pricing. In measuring comparability, the Customs focuses on the differences in commercial level, import quantity, transaction time, and transportation method, etc.; while the transfer pricing method examines transaction features, contract terms, economic background and business strategies, etc. Enterprises that have undertaken transfer pricing analysis may have already known this, except for commodity, capital or certain other types of transactions, the comparable uncontrolled price method is often difficult to be applied in practice due to its strict application conditions and restrictions on comparable data selection, especially for such industries as luxury, medicine and machinery equipment whose import goods usually consist of unique characteristics with no publicly available data for external reference . For the same reason, it is also difficult for the Customs to use the aforementioned valuation methods. If an enterprise applies both buy-sell model and commission model, it may obtain internal reference through imports of identical or similar goods. But whether the internal reference can be used is yet to be further discussed (see Question 8 for details).
  • The chargeback price valuation method shares similar ideas with the resale price method used in transfer pricing. Both of them calculate import price reversely by analyzing the profit level of the importers. The resale price method used in transfer pricing is transaction-based, requiring high level of comparability and cautious inspection on function, risk and asset of the parties, and differences in relevant contract terms. Therefore, due to the unavailability of comparable data, the resale price method is not used in most enterprises’ transfer pricing analysis. The chargeback price valuation method used by the Customs also has strict requirements on comparability, transaction time, trade modes, etc., when applied to import goods. Its application is thus limited.
  • The computed price valuation method is similar to the cost-plus method used in transfer pricing. Both of them mainly calculate import prices by analyzing the profit level of the manufacturers. Similar to the resale price method, the cost-plus method is also a transaction-based transfer pricing method with high requirements on comparability and applying numerous conditions in analysis. It should be noted that the computed price valuation method requires financial data of overseas manufacturers. Since many foreign multinational enterprises show apprehension in providing overseas data. It restricts the practical application of the method.
  • Regarding other reasonable price valuation methods, there is currently no clear convention in the Customs Law. Based on our previous experience in cases concerning import price valuation, the valuation method proposed by the Customs is usually similar to the transfer pricing method, but coupled with its own understanding in the enterprises’ business operations. Pursuant to precedents, most enterprises adopt the transactional net margin method in assessing the reasonableness of their transfer price. Thus, this method is commonly used during communication with the Customs. Nonetheless, due to the different or even conflicting foci between transfer pricing analysis and Customs’ valuation analysis, enterprises should be cautious in applying other reasonable price valuation methods.

Question 6: Would it be helpful to submit the contemporaneous documentation of transfer pricing and other relevant documents to the Customs in order to explain reasonableness of the import price?

Difficult to say.

Since contemporaneous documentation of transfer pricing contains detailed disclosure of and comparability analysis on the enterprises’ business operations, it is a commonly used document that the Customs would refer to during price valuation. As a result, before submitting any contemporaneous documentation, it is essential for the enterprises to carry out a basic risk analysis and review the documents from the perspective of the Customs.

The first issue is to take a position. The contemporaneous documentation usually draw a conclusion that the enterprise’s related party transaction is at arm’s length arguing its profit level is higher than the median of comparable enterprises. However, this might be right the basis for the Customs to adjust import price. Higher profit level normally means the import procurement price is lower than comparable enterprises. From the Customs’ standpoint, it means the enterprise have underestimated import price in order to maintain profits. Thus, the conclusions and statements contained in the contemporaneous documentation are the first crucial element to be examined in deciding whether the documents can be submitted.

Even if the contemporaneous documentation contains a neutral conclusion, enterprises are advised to pay attention to matters listed below before its submission:

  • to carefully assess the comparability of comparable enterprises from the perspective of the Customs, paying extra attention to the comparability of products, countries and time, etc.;
  • to estimate gross margin of comparable enterprises and compare with own situation to avoid falling into an unfavorable situation; note that contemporaneous documentation usually only addresses the net profit margin;
  • to review chapters on functional risk analysis, value chain analysis and special factor analysis (if any) in the contemporaneous documentation as such analysis likely offers further insights into the comparability between an enterprise and its comparable enterprises.

If in review of the contemporaneous documentation, an enterprise discovers significant differences between the comparable enterprises and itself. Especially when the gross profits of the comparable enterprises likely will pose an adverse impact on justifying reasonableness of the enterprise’s own gross profits, it is advised to prepare relevant supporting analysis and explanations in advance, or to make necessary adjustments on existing comparable data taking into account product features, transactional conditions, functional risks and other relevant factors.

If an enterprise also has an internal transfer pricing guideline or has applied for an advance pricing arrangement (“APA”), it may review chapters on functional risks, transactional conditions, trade environment and economic analysis in the transfer pricing analysis. During communication with the Customs, the enterprise can reasonably use the above information to form a complete analysis.

In addition, most transfer pricing reports focus on the overall operational and financial situation of an enterprise, while the Customs pays more attention to the gross margin of particular import goods. On top of the transfer pricing report, the enterprise may refine analysis on product and business to enhance its communication with the Customs in terms of relevance and pertinence.

Question 7: If the gross profit of an enterprise is higher than industrial average, does it mean that its import price has been influenced by Special Relation?

This is not always the case, but reasonable proof is required.

For the sake of efficiency, in this new round of investigation the Customs tests whether an enterprise with high gross profits (in comparison with industrial average) have significantly low import price. This is also why many enterprises receive oral or written notices from the Customs. However, the business and transactional situation of each enterprise is different. Some Chinese trade subsidiaries of multinational enterprises may only perform simple sales liaison function, or simple retail distribution function. Some may participate in large-scale marketing and sales activities in the Chinese market. The different roles taken by those trade subsidiaries lead to different financial performance, especially in terms of their gross profit levels. Thus, reviewing all enterprises uniformly with the industrial average, without regard to their particular roles and function, would neglect each individual enterprise’s special business features. To solve this problem, the enterprises need to collect and organize a complete chain of evidence internally to prove their roles and functions, and to prove the root cause of high gross profits. But it poses great challenges for enterprises.

Question 8: Is it required to explain to the Customs the impact of local intangible assets on an enterprise’s gross profit?

Yes, but it is usually not easy.

One of the major reasons why an enterprise has high gross profits is that it participates in creating local intangible assets and shares part of the profits. Especially in the luxury and pharmaceutical industries, benefiting from fast growth of the Chinese market, many Chinese trade subsidiaries have engaged in a large number of marketing and sales activities in the Chinese market so as to widen customer base, increase market share and obtain favorable sales prices. During this process, Chinese trade subsidiaries contribute to cultivating and investing in the market, thus share part of the profits when their products generate additional or residual values. This is consistent with the ideas that the Chinese tax authority has been advocating in recent years – values shall be allocated to place of creation and Chinese market premiums.

Nonetheless, multinational enterprises have to balance the regulatory pressure from both the Customs and tax authority. If an enterprise owns local intangible assets, it is of some assistance in justifying high gross profit of its Chinese trading subsidiary to the Customs. At the same time, the enterprise needs to evaluate the boundary it sets for its intangible assets: whether they constitute unconventional major intangible assets and whether they will increase the tax authority’s expectation on the enterprise’s future profits. If the enterprise takes different “positions” in communications with the tax authority and the Customs, while the Customs can request information from the tax authority with reference to its regulatory rules, the enterprise may fall into an extremely passive position.

In terms of quantity, it is also practically hard to determine the effects of intangible assets on gross profits. A simple solution is to conduct detailed analysis of the marketing functions of comparable enterprises. A more appropriate approach is to carry out a comprehensive quantitative analysis of the value contribution of intangible assets relying on transitional profit split method or other complex transfer pricing methods.

Question 9: If a Chinese trade company adopts both buy-sale model and commission model, will it be more difficult to prove the reasonableness of import price under a Special Relation?

Yes, it may increase the difficulty.

When a Chinese trade company has both buy-sale model (i.e. importing goods under a Special Relation) and commission model (i.e. an overseas manufacturer directly selling goods to a domestic third-party with assistance of the Chinese trade company), it naturally obtains contemporaneous import prices of identical or similar goods. In most cases, the import price under a Special Relation is lower than import price between two third parties.

However, it is yet to be determined if the import price under a Special Relation would be significantly low. With regards to functional risk analysis, Chinese trade subsidiaries likely assist multinational enterprises in conducting many marketing activities in China, while third-party traders mostly only undertake simple distribution work. Apparently, their gross profit cannot be simply compared due to the different functions taken, thus, import prices cannot be simply compared. Nonetheless, in practice, relying on the potential comparability of import prices, the Customs imposes great challenge and supervision pressure. To deal with the pressure, enterprises may explain the differences in terms of commercial levels and import quantities. They may also submit solid functional risk analysis and other supporting materials to further justify their explanations.

Please note that, if an enterprise merges the two pricing models together in its internal management which leads to difficulties in distinguishing personnel and expenses, etc., and the enterprise does not keep relevant supporting materials, it should prepare and sort out the relevant materials in advance. Otherwise, it will likely fall into a disadvantageous position when being questioned by the Customs.

Question 10: If the Customs decides an enterprise needs to pay outstanding taxes for imports under a Special Relation, how will this decision influence the enterprise’s tax treatments subsequently?

The outstanding taxes required for imports under Special Relations normally include tariff and import related VAT, which are calculated collectively based on a certain period of time. Tariff cost is the real cost for enterprises. Import VAT is normally creditable by enterprises, though it still imposes realistic cash pressure.

Once an enterprise and the Customs reach an agreement on payment of outstanding taxes on imports under Special Relation, it will be applied to the Customs’ supervision on the enterprise’s imports in subsequent years. This is consistent with the principle of subsequent self-adjustment in transfer pricing audit. Although there is no clear legal basis for this “application”, most enterprises will cooperate on the grounds of compliance and efficiency. As a result, when assessing the cost of adjustment, enterprises should not focus only on the specific time period subject to adjustment, but also consider possible financial impacts on subsequent years in a comprehensive way. Moreover, enterprises should consider reassessing and analyzing the reasonableness of the import prices under Special Relations in order to properly reduce the impacts on subsequent years.

It should be noted that if the tax authority does not agree with additional tariff paid due to the Customs’ adjustment on import price, although the enterprise may not need to perform corresponding financial adjustments to increase the procurement or sales costs, the tax authority may deny the enterprise’s pre-tax deductions for income tax purpose, which brings additional tax expenses.

Question 11: If the tax authority determines the gross or net margin of an enterprise is lower than industrial average and adjust down the import price, how can the enterprise respond to the Customs?

If the tax authority determines the gross or net margin of an enterprise is relevantly low and not in compliance with the arm’s length principle under transfer pricing, many enterprises bother about how to make adjustment correspondingly so as to reduce risks of the Customs supervision. Approaches that the enterprise may take include but not limited to:

  • to adjust import price. It may be the most convenient method in practice. But in adopting this method, the enterprise must assess the corresponding risks of the Customs supervision and likely effects on the import price before and after adjustment.
  • to adjust service charge and other non-trade fees. In this case, the enterprise needs to pay attention to the reasonableness and consistency of its transfer pricing policy as well as VAT expenses.
  • to adjust special transfer pricing adjustment payments. This method relies on the enterprise’s functional risk analysis, which is a more reasonable method. The enterprises need to pay attention to communications with the Administration of Foreign Exchange and tax authority, to facilitate the implementation of the adjustment plans.

Question 12: How to break the deadlock and strike a balance between adjustment plans, time costs and enterprises’ interests?

Discussion with the Customs on the dutiable price of imports under Special Relation is itself a discussion of reasonableness without a strict black-and-white standard. The discussion process can be time consuming. During the process, due to the conflict of interests and different understanding of reasonableness, the parties may encounter a deadlock and struggle in finding a balance. Enterprises want to maximize protection of their own interests, at the same time, manage time and cost injection. To solve this issue, our suggestions include:

  • to conduct internal analysis from both Custom and transfer pricing perspectives as soon as possible, evaluate risk exposures, set up expectations and bottom lines.
  • to develop a communication strategy to take a leading position, including own proposals and responses to the Customs.
  • to pay attention to procedural rules, unless necessary, try to avoid adjustments made by self adjustments. Note that under formal procedures, the Customs values the fairness of the process and result as well as risks of law enforcement. Enterprises shall also reserve their right to legal remedies. However, legal remedies will not be applicable in the case of self adjustment since it is a voluntary reporting by the enterprises.
  • to seek legal remedies if the result is significantly disadvantageous to the enterprise, balancing between insistence and compromise. Note that legal remedies like the administrative reconsideration/review path are not antagonistic. The gold is to aid enterprises in protecting their interests through proper administrative procedures, and at the same time to reduce the pressure of the administrative organs in law enforcement.


Both Customs supervision and tax supervision focus on the effects of Special Relation on import price. Given the conflicting positions of the two authorities, it is hard for enterprises to meet both requirements. In dealing with the complex challenge of the Customs’ new round of investigation on Special Relation’s effects on transacted prices, enterprises should undertake adequate internal preparation, conduct comprehensive evaluation, estimate possible risks and formulate corresponding strategies. By carrying out comprehensive analysis from multiple perspectives including legal, financial and tax, enterprises can have a better change to fulfil the supervision requirements of both the Customs and tax authority. Most importantly, not only for this new round of investigation, it is also crucial for enterprises to develop solid and comprehensive optimization strategies to effectively manage and reduce risks of the Customs and taxation supervision in a long run.