Foreign Firms In China Accused Of Tax Evasion

by Mary Swire, Tax-News.com, Hong Kong

04 November 2002

According to the China Business Times, almost two thirds of foreign firms in China report trading losses, and the National Tax Bureau believes that in many cases, companies are using transfer pricing and other 'artifical' techniques to reduce taxable income.

Leaving aside the fact one man's legitimate tax planning is another man's tax evasion, it has become an article of faith among the Chinese hierarchy, which is struggling to raise tax collections to finance booming government expenditure, that rich individual taxpayers and corporates are extensively abusing the tax system. This latest article lends some statistical support to that view.

The newspaper says that 380,000 companies with foreign investment have been registered, of which nearly 250,000 have started operating, with an total investment of US$370 billion. Official figures show that while 35 to 40% of such companies reported losses between 1988 and 1993, this proportion had risen to 60 to 65% between 1996 and 2000.

The leading source of 'foreign' investment is said to be the Virgin Islands; but it is well known, at least among the offshore community, that the surge in corporate registrations of IBCs in the BVI in the last five years was largely fuelled by Chinese and Hong Kong flight capital. So much of this 'FDI' may in reality be undocumented Chinese profit being tax-efficiently recycled into the economy. Of course, the authorities won't see it that way.

Although tax collection in China is superficially on a roll, with overall tax revenues up 11% on the previous year in the 8 month period to the end of August, and income tax receipts up by 24% over the comparable period last year, the Chinese government is spending the money more quickly than it can collect it, and is facing a ballooning fiscal deficit as it pours resources into under-developed areas.

However, a recent report from Deloitte Touche says that the authorities face an uphill struggle to crack down on tax dodgers due to the mainland's preference for dealing in cash. "Many business transactions are conducted in cash instead of through banks because of the tight controls on foreign exchange," said Kaiser Kwan, a tax partner with the Field Audit and Tax Investigation Team.

Mr Kwan says that in an attempt to deal with this problem, China has established a computer database which enables comparisons between different companies in the same industry, pinpointing for investigation those that are paying unusually low amounts of tax.

In March, China announced an overhaul of its income tax system aimed at centralising control over its revenue sources and bringing the tax regime closer to international practices, but even with all the changes now in place, the tax system probably needs fundamental reform. The Far Eastern Economic Review observed that: 'China is clearly growing nervous about taxes and for good reason. The government needs a stable source of revenue to keep a lid on stresses racking the economy - from layoffs to bad loans to pension liabilities. If left untended, these fissures in the economic system could bring China's remarkable record of economic growth to an abrupt halt.'

Individual income tax in China is paid on a scale rising to to a maximum of 45 per cent, while enterprise income tax is 33 per cent for local companies and 15 per cent for foreign firms. There have been persistent hints that the Government is planning to level up the regime for foreign and local companies after its WTO entry.

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