Tax administration and compliance management: Steady progress follows reforms
China merged its previously separate state and local tax authority systems in 2018. This has provided a basis for improvements in tax administration and services, and required taxpayers to adapt. Michael Li, Tracey Zhang and Fang Wei explore the changes.
In last year's eighth edition of China – Looking Ahead the article Adding wings to a tiger: Data in tax enforcement in China looked at a number of significant changes in the structure and organisation of Chinese tax administration. Of particular importance was the merger of the thousands of local tax bureaus (LTBs) and state tax bureaus (STBs), which previously existed in parallel in each individual tax district within China. Another important development was the abolition of tax 'pre-approval' and 'recordal' requirements, as part of China's transition to a more self-assessment-based tax system; this was coupled with the issuance of detailed guidance on the on-file documentation taxpayers would need to keep in order to support their tax positions on audit.
This year we detail how the latest tax administration improvements have sought to build on the 2018 changes, and how enterprise in-house tax management practices have sought to keep pace.
The government's new priorities
Building on the STB-LTB merger in 2018, the national government has identified a number of new focus areas for further enhancing tax administration efficiency and taxpayer services. These interlink with the government's broader multi-year programme of reducing red tape and regulatory burdens and improving the overall Chinese business environment; for example, by reducing the time it takes to establish/liquidate companies, etc. This has already resulted in China's ranking in the World Bank's 2019 Doing Business report rising from 78th to 46th, out of 190 countries.
In the latest announcement, Premier Li Keqiang outlined a series of priorities in June 2019 that were subsequently set out in the official notice Guo Ban Fa  No. 39 (Circular 39). On the tax side, these interlink the Fang-Guan-Fu programme, translated as 'one service standard, one administrative procedure, and one rule for law enforcement'. It requires the State Taxation Administration (STA) and other government agencies to draft and implement detailed regulations to achieve the following, in many cases by the end of 2019:
Implementation a 'one-stop shop' process for new enterprise set-up. This is to cover the plethora of various licences and registrations needed for a new company, which previously required applications to multiple separate authorities. These include the business licence, company stamp, official tax invoice arrangements, tax control equipment, social security registration, housing funds registration, and others. The processes have already been consolidated to a certain degree, as noted in last year's chapter. The goal now is to complete the consolidation process. Pursuant to Circular 39, in September 2019 it was announced (in Guo Ban Fa  No. 89) that pilot reforms in this space in Beijing and Shanghai would be rolled out nationally.
Implementation of 'one-website' processing of enterprise de-registration, so that the process can be completed simultaneously with all the relevant agencies (tax, social security, commerce, customs, etc.).
Establishment of a national unified digital tax invoice platform to provide free e-invoice issuance service to taxpayers. E-invoicing is to be expanded from general tax invoices (for example, for CIT deductions) to special tax invoices (for VAT input credits) within a short timeframe. Building on Circular 39, in August improvements to the invoice management system were outlined in Shuizonghan  No. 223 and No. 243, with more to follow.
The launch of a national unified digital tax invoice platform is of particular importance. It helps to further reduce risk of invoice fraud (for example, fraudulent VAT input credits, CIT deductions and more), by allowing more effective cross-checking by the tax authorities. It also provides useful statistical data on economic performance to the government policymakers.
The platform also facilitates further integration of enterprise in-house tax management systems with tax authority invoicing systems. This could drive automation of output VAT special invoice issuance to customers, the verification of the input VAT special invoices received from vendors, and the integration of accounting systems/e-filing systems.
Post STB-LTB merger
We have observed developments in tax administration practices following last year's STB-LTB merger. In many cases, these constitute a continuation of new trends which had emerged in recent years.
In last year's chapter, a trend was noted whereby Tier 1 city (Beijing, Shanghai, Guangzhou, etc.) tax authorities had in many cases become more 'reasonable'. For taxpayer cases where complex commercial arrangements were in point (for instance, cross-border restructurings) the authorities appeared to being showing more commercial sophistication and sensitivity in deciding on the tax treatment. At the same time, it was noted that in lower tier cities the tax authorities were becoming more aggressive. This was driven by the greater pressure these cities were under to raise tax revenues and, in some cases, the grounds on which tax was imposed could be quite unreasonable.
Increasing 'reasonableness' amongst Tier 1 city tax authorities has been observed in a number of contexts:
Tier 1 tax authorities are becoming more open to listening to taxpayer and tax advisor interpretations of tax rules in complex cases – for instance, restructuring cases falling under the Announcement 7 indirect disposal rules. Tier 1 city authorities have been seen to adopt a certain degree of flexibility, such as where it is difficult to say whether the very strict literal terms of the Announcement 7 restructuring safe harbour have been met.
Some Tier 1 tax authorities have been seen to adopt reasonable approaches in seeking to understand and accommodate companies facing economic difficulties. This has particularly been seen to be the case in the context of the China-US trade frictions. An example is where companies restructure to deal with the economic challenges, and make taxable intragroup transfers of assets and entities for which valuations are required. In some cases, tax authorities in Tier 1 cities have been seen to accept valuations, put forward by taxpayers, which show future profit projections lower than current and historic levels. The economic stresses of the current era are being acknowledged by the authorities in a commercially sensitive way, and in a way that was less often seen in the past.
For treaty relief cases, there is a mixture of increased rigour of enforcement, coupled with an increasing degree of commercial sensitivity for treaty relief evaluations. In some Tier 1 cities, the authorities have taken a more open-minded view that was the case in the past. Rather than simply dismissing treaty relief applications out of hand where the overseas treaty claimant has limited personnel, the authorities have been seen to encourage taxpayers to set out their position why they thought relief was justified, in the context of the commercial arrangements supporting their specific business model.
Of course, there are still plenty of instances in which tax authorities in Tier 1 cities take harsh and unbending positions, but the overall trend is seen as positive. At the same time, a less favourable position is often seen in Tier 2 and 3 cities, whether in terms of services, coordination or administrative approach. For example, some Tier 2 and 3 city local tax authorities still heavily review the application for treaty relief, instead of implementing the current lighter record filing procedures. This is despite the changes made under STA Announcement 60 already being several years old.
Turning specifically to the effects of the STB-LTB merger, this is seen to have produced some positive results. We have noted efforts made by the merged tax authorities to cut red tape and improve services. In many cases they have achieved significant time improvements, and lessened documentation and procedural requirements, for new company setup, inter-district relocation of companies, record filings for tax relief, and liquidation/deregistration. We have also noted that tax bureaus are eager to burnish their credentials in the area of providing taxpayer services. For example, the Shenzhen tax authority is piloting a simplified APA application approach, and they are also working closely with local customs authorities to coordinate pricing for royalties paid in connection with goods imported.
The STB-LTB merger has also given rise to some drawbacks. We have noted that in some cases, there was a greater divergence of tax official opinions, on the tax treatment of similar issues, due to the differing backgrounds and understandings of former STB and LTB officials.
A further noted outcome of the STB-LTB merger process is that while the merger was underway last year, it had led to some disruption of normal activities, such as in relation to the review and audit of indirect transfers and cross-border service fee and royalty payments. Now that the new post-merger arrangements are more firmly in place, cross-border tax matters are being actively picked up on once more. There was also a backlog of transfer pricing (TP) audit cases left outstanding following the disruption of the LTB-STB merger period; some authorities are now rushing to wrap these up with reasonable adjustments, in line with the timelines for conclusion set under their key performance indicators (KPIs).
STA's tax technology strategy
The STA is setting its tax technology strategy for the next three to five years. According to the tax technology planning tender document, released by the STA in November 2018, strategic planning is focused on the following areas:
Integration and enhancement of tax app systems (both for desktop and mobile interfaces);
Data governance and use;
IT infrastructure and security;
Government information sharing and collaboration; and
New technology use and innovation.
As shown in the last bullet point, in addition to enhancing the national tax administration system, the Golden Tax III system, the STA is also eager to explore the use of new technologies. These include blockchain, cloud computing, big data, mobile internet, face/voice recognition and artificial intelligence. For many of these technologies, the STA is drawing on experience with pilot programmes by provincial tax authorities, such as the blockchain pilot in Shenzhen (see We need to talk about platforms: Ongoing tax challenges in China. In general, the STA takes an open approach to understanding potential applications for new technologies, and is engaging extensively with industry in refining its technology strategy.
Corporate tax management best practice
On the corporate side, large enterprise taxpayers are making significant efforts to upgrade their corporate tax management to match changes at tax authority level.
Many large enterprises in China are planning to institute more systematic corporate tax management frameworks. These give top management a clearer sense of priority areas for improvement, allowing them to set roadmaps and action plans and allocate sufficient resources for improvement over time. The frameworks encompass the enterprise tax management strategy, preferred and applicable corporate tax governance models, tax team structure, and tax management tools (for example, tax management measures, manuals and templates).
For large Chinese enterprises with overseas investments or operations, the China-based headquarters are increasingly keen to have tax management frameworks in place to govern their overseas businesses. Concerns have mounted in recent years over the lack of overseas tax expertise, insufficient focus on potential overseas tax exposures, and deficiencies in the timely collection of overseas tax information. Headquarters consequently see a need to fix guidance on the segregation of duties between headquarters and overseas entities, and on the prioritisation of tax matters or tax information for close headquarters attention. We have seen several large enterprises make this a research focus for 2019, and they have reached out to advisors for input on designing optimal overseas tax management frameworks.
On tax technology, ever more taxpayers have chosen to perform a tax IT planning and tax data governance review. They are increasingly aware of the challenges involved in tax management system integration with ERP and financial systems, and in the coordination of different tax management modules. They are determined that their tax technology investments should facilitate alignment with the STA's systems. They are also concerned that, in many cases, data inputs from upstream systems into the tax management system may not be ready in terms of quality and granularity. As these issues could significantly impair the degree of system automation that can be achieved, reviews and analyses are being prioritised before kicking off any system construction.
Looking ahead, we expect that these best practices in corporate tax governance and tax technology will be followed by ever more Chinese companies.
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Michael Li is based in the Shanghai office of KPMG China. Over the past 18 years, Michael has advised multinational enterprise clients on their tax and regulatory issues in China. His client portfolio includes real estate, logistics and manufacturing enterprises, and his focus areas include M&A, cross-border tax planning, IPO restructuring and outbound investment.
Michael is the tax technology leader of KPMG China. His team offers technology-enabled tax solutions to drive the tax performance of enterprises, including compliance automation, process optimisation, and data analytics. In addition, during 2012-2013, he was seconded to the KPMG US Los Angeles office with a global china practice role covering China-US investment.
Michael is a member of the China Registered Tax Agent and has a bachelor's degree in law from Shanghai International Studies University.
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Tracey Zhang has more than 21 years' tax advisory experience in the financial services industry. She is the financial services national tax lead partner at KPMG China, specialising in banking, insurance, real estate funds and leasing.
Tracey is also the lead partner for tax transformation for the northern region of KPMG China. She has been seconded to KPMG Holland to study the Dutch horizontal monitoring system and has established extensive knowledge and experience in tax risk control and tax technology. She has led professional teams in assisting a number of state-owned enterprises to establish or improve their tax risk control systems.
Senior manager, Tax
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Fang Wei has more than 10 years of experience in China corporate tax advisory.
She specialises in tax transformation services, assisting clients to improve their in-house tax functions for both domestic and overseas tax matters. She advises on the set-up of tax management frameworks, tax governance models, tax manuals, and tax IT management systems.