By Peter Kung
&
Bolivia Cheung

The tax environment in the PRC is very different from what it was a few years ago. Apart from the ever-changing tax and duty law, the PRC tax and customs officials have tightened the administration of the law and the collection of the tax and the duty. These changes have contributed to a very strong growth in tax revenue during the past five years. While the annual GDP growth rate was about 8.5 per cent over the five years, the annual growth rate in tax revenue in the same period was approximately 15 per cent. The ratio of tax revenue to GDP has therefore been rising steadily from 10.2 per cent in 1995 to approximately 14 per cent in 2000.

The implementation of the nationwide anti-smuggling campaign in late 1998 also resulted in a 78 per cent growth of import taxes (i.e. customs duty and import VAT) collected by customs in 1999. This exceptionally strong growth rate has continued, with the collection of import taxes increasing nearly 30 per cent in the first six months of this year over the amount collected in the same period last year.

This article examines some of the key initiatives of the PRC authorities concerning the collection of taxes and duties.

A More Modernised Legal Environment
The PRC Government is clearly trying to establish a modernised legal environment to administer the collection of taxes. For example, the Administrative Penalty Law requires government authorities to follow all the legal procedures before imposing penalties, and the authorities cannot impose a penalty which exceeds the maximum amount under the relevant laws promulgated by the National People’s Congress.

In accordance with the Administrative Penalty Law, taxpayers have the right to request a hearing before the final penalty notice is issued by the tax authorities. Interestingly, out of the 1,764 appeals concerning tax administration issues last year, nearly two-thirds were won by taxpayers. Failure to follow the legal procedures before issuing penalty notices and failure to produce sufficient evidence to support the challenge to the taxpayers were the main reasons the tax authorities lost these cases.

More Focus on Tax Evasion Cases
The State Council submitted the draft amendment to the Tax Administration Law in August this year for review by the Standing Committee of the Ninth National People’s Congress. The draft amendment includes the introduction of a minimum penalty for tax evasion. According to the proposal, the penalty for tax evasion is going to range from 50 per cent to 500 per cent of the amount of tax evaded.

A taxpayer is deemed to have committed an act of tax evasion under Article 40 of the Tax Administration Law if he "forges or alters information, conceals information or destroys account books or account vouchers without authorisation, records an excess amount of expenditure or fails to record an insufficient amount of income in account books or uses other means to falsify tax declarations and this results in non-payment or underpayment of tax."

The State Administration of Taxation has issued a number of notices to further interpret this article, including a recent notice that stated that "claiming a tax deduction of bad debt expenses, loss of scrap assets or loss due to a natural disaster without prior approval of the tax authorities" would also be considered tax evasion. Taxpayers should watch out!

Current Tax Administration Law labels tax evasion a criminal offence if the amount evaded is over 10 per cent of the tax payable and over RMB10,000. In July this year, a Hong Kong resident who has engaged in VAT frauds was sentenced to death, subject to a two-year suspension. While more than 70 PRC citizens who committed VAT fraud have been sentenced to death, this is the first one that involves a Hong Kong resident in a PRC tax case.

Golden Tax Project and Golden Customs Project
The "Golden Tax Project" began in 1994. The idea is to use a nationwide computer network to match input tax claims made by taxpayers against the corresponding output tax filed by the issuer of the VAT invoice to which the input tax claim relates. On completion of the Golden Tax Project, taxpayers and tax officials are able to verify the VAT invoices received via their own "anti-fraud invoicing control machines" while the tax authorities can monitor all the VAT invoices issued by VAT general taxpayers in the PRC.

PRC customs are in the process of implementing the Golden Customs Project, which aims to facilitate online import and export declarations via the computer network. The databases generated by this project will also be available to other PRC authorities. For example, the State Administration of Foreign Exchange can use the customs information to verify payments of foreign currency from the PRC in relation to imports.

The Golden Tax Project together with the Golden Customs Project are the means to tackle smuggling and tax frauds. The ultimate goal is to link the computer systems of various authorities such as tax, customs, banks, foreign exchange and trade.

More Transfer Price Audits
Thirty-four of the 36 provincial or municipal level tax authorities have established their own transfer price audit teams and there are about 200 transfer pricing specialists within the PRC tax authority network. Transfer price audits have already made their mark by successfully helping the tax authorities increase their tax revenue by collecting an extra RMB120 million in 1998 alone.

A lot of multinational corporations are considering entering advance pricing agreements in the PRC in order to avoid possible transfer pricing challenges and the tax authorities have already approved a few, hinting at the possible emergence of a growing trend in future.

Conclusion
Foreign investment enterprises and expatriates in the PRC are now working in a much tougher tax environment than before. Foreign investors are recommended to keep abreast of the constant changes to the PRC regulations, review their internal control of tax compliance matters and consider whether current controls need to be revised. Whilst there will still be a lot of grey areas in the PRC tax context and therefore room for taxpayers to negotiate a better tax filing position with the tax authorities, these negotiations must be supported by sound legal arguments.