In 2012, the Chinese tax authorities conducted tax investigations on 191,000 taxpayers and collected back taxes of RMB121 billion ($19.7 billion).
This is the fourth year in a row that the Chinese tax authorities have collected back taxes from tax investigations with the amount in excess of RMB100 billion.
To avoid becoming a candidate for tax investigation, it is imperative that taxpayers are able to handle tax disputes effectively.
International Tax Review (ITR): How can multinationals operating in China reduce the risk of becoming involved in a tax dispute with the State Administration of Taxation (SAT)?
Vincent Pang (VP) (pictured): The key in reducing the risk of tax disputes is to ensure compliance with the Chinese tax law by accurately reporting tax information. Taxpayers should have qualified tax staff in handling tax-related matters and have sound tax internal control systems in place to ensure the accuracy of tax reporting.
Taxpayers should seek external professional assistance if the competency is not adequate. In addition, the tax staff should establish good relationships with the tax official in charge to allow him/her to discuss tax treatment on issues where the tax law does not provide clear guidance.
As most tax returns in China are now submitted electronically, there is an increasing trend that the Chinese tax authorities are utilising analytical tools to conduct desktop reviews on taxpayers’ tax data. The analytical tools are able to spot abnormalities and focus on areas such as whether tax rules have been followed, fluctuation of tax liabilities compared to prior periods, effective tax costs compared to other taxpayers in similar industries, consistency of tax information with those submitted to other government authorities, and others.
Hence, taxpayers must fully understand the taxation status of the company and be prepared for potential enquiries raised by the tax authorities. Also, taxpayers must ensure that all financial information submitted to different government authorities is consistent.
Large group taxpayers may consider entering into tax compliance agreements (TCA) with the tax authorities which can reduce the overall risk of tax disputes. A TCA is a legal agreement entered into between taxpayers and the tax authorities which lays out the responsibilities of the tax authority and the taxpayer, such as, the tax authority must respond to the taxpayer’s enquiries with a more definitive response and the taxpayer must make timely disclosures to the tax authority on significant tax matters.
ITR: What options do taxpayers in China have to resolve disputes with the authorities other than litigation? What are the positives and negatives of these options?
VP: Even if the taxpayer has a very competent tax team, there may still be tax disputes with tax authorities as there are ambiguities in the current Chinese tax law which are open to interpretations.
If challenged, it is advisable that taxpayers respond to the tax authorities’ request promptly but with thorough preparation. Taxpayers should fully understand the cause of the enquiries and prepare adequate documentation to defend challenges.
In general, the first stage would be to hold a discussion with tax officials to put forward the defence. If the dispute cannot be resolved and the taxpayer believes there is technical ground to support its case, the taxpayer should approach the Policy and Regulation Division (PRD) at the tax authority in charge or at the provincial level tax authority to get their buy-in.
If so, the official at PRD may be able to influence the tax official in charge and allow the taxpayer to receive a more desirable result. The advantage of approaching PRD under such arrangement is that it is less formal which is more acceptable by the tax official in charge since it is important to maintain a good relationship with tax officials in China to ensure receiving continued support.
Also, the officials at the PRD are generally more technical-oriented and do not have tax revenue targets. Therefore, they are more open for technical discussion on tax matters in an unbiased manner.
If unsuccessful, taxpayers still have other options, including seeking legal assistance from PRD or even filing a formal appeal with PRD for administration reconsideration. Taxpayers should be very positive on the technical grounds of the tax matter involved before taking these steps as the tax officials in charge generally feel offended and it may ruin relationships with them.
ITR: Are you seeing any trends in the Chinese tax authorities’ approach to large taxpayers?
VP: The Chinese tax authorities are facing increased revenue targets and resource constraints. Therefore, we notice that there is an increasing trend of adopting tax assessment methodology with the use of analytical tools in identifying taxpayers which may have potential tax issues which can significantly reduce the demand on manpower.
Through the use of analytical tools, the tax authorities are able to identify different types of abnormalities rather than focus on certain types of tax disputes. By analysing the tax information in the tax return, the tax authority is able to identify whether the depreciation period is accurately applied, the non-deductible expenses are accurately calculated and others.
In addition to comparing the tax burden of the taxpayer with the prior periods, we have also noticed an increasing trend of the tax authority comparing tax burden and even other financial indicators of taxpayers in similar industries, such as, the ratio of transportation expense to revenue, gross profit and others.
Once the analytical tools have identified certain taxpayers that may have potential issues, the tax authorities would request the taxpayers to provide supporting documents to explain and clear their queries.
If the taxpayer is not able to provide satisfactory supporting documentation, then the tax authority may initiate further investigation on the taxpayers. As such, it is imperative to understand the enquiry from the tax authority and provide strong support that can defend against the tax authorities’ challenges.
ITR: What do you think Chinese taxpayers can expect from China‘s tax authorities in the future?
VP: The Chinese tax authorities will likely focus on the development of the tax assessment system to enhance the level of information technology to be used in identifying taxpayers with potential issues on all types of taxes as well as transfer pricing issues.
The tax assessment system will have industry capability whereby there will be special focus on taxpayers in different industries during the assessment.
Also, the tax authority will develop an internal database to allow the sharing of tax information including major or complex tax audit cases or controversial cases, among all tax authorities including both state and local tax bureaus.
The existing tax dispute resolution system will likely remain the same. However, the Chinese tax authority has established the Large Business Enterprise Division to better serve large corporations.
The Large Business Enterprise Division and its branches will provide large corporations with a channel to discuss complex tax issues with the tax authority and obtain feedback which could apply to all companies within the group nationwide.
This would result in a reduction of tax dispute risks for the large corporations. Also, the Large Business Enterprise would allow the conduct of tax audits in a more coordinated manner.
The tax authority also set up a system allowing small and medium taxpayers to file complaints at the tax service hotline over the phone if they believe they have not been fairly treated by the tax authority.
As this is relatively new, its effect is yet to be seen. However, it shows that the Chinese tax authority is trying to reposition itself to allow more communication and better service for taxpayers.
