China: Tax Inspection Mechanism and Enterprises Reaction

published on December 27, 2017

With the State Council to implement the reduced political decentralization, improving the efficiency of law enforcement, the State Administration of Taxation ("SAT") changes approval procedure to filing or direct reporting procedure for a large number of taxation issues, which greatly facilitate the taxpayers. However, the release does not mean that the taxpayer's prior management responsibility to be alleviated, on the contrary, in some cases actually increased the tax-related risks. At the same time, the SAT also strengthens the post-management efforts, and gradually promotes tax inspection system to achieve the minimization of enforcement costs and the maximization of the effectiveness of law enforcement. Under this circumstance, companies should keep the latest information for tax inspection mode, and fully prepared for the possibility of tax inspections and actively make quick response.

• Relevant regulations and background

• Random Check Mechanism

• Key objects of tax inspection

• Possible items involved in the tax inspection

• Enterprises Reaction

Relevant regulations and background

In the past tax inspections, the selection of objects to be inspected was mixed with artificial factors, and the selection and approval process was circulated internally in the tax department, under which the determined objects are questioned to be not fair. In 2015, to deepen the reform of administrative system, speed up the transformation of government functions, and further reduce the political decentralization, the State Council issued the Notice on Promoting Random Inspection to Regulate In-process and Ex Post Supervision (Guo Fa [2015] No.29) to vigorously  promote the random inspection. In order to promote the random check of tax inspection and enhance the effectiveness of law enforcement, the SAT formulated the Implementing Proposal for Promoting Random Check of Tax Inspection (Shui Zong Fa [2015] No. 104). With the release of the Implementing Proposal, the selection of tax inspection objects is no longer "willful", but it is determined by random check.

Random Check Mechanism

The objects and contents of the random check are fulfillment of obligation of tax payment and withholding and other tax compliance, by taxpayers, withholding agents and other tax-related parties. All objects to be inspected must be chosen at random through a lottery from the list of tax inspection objects classification and list of abnormal tax inspection objects, unless those whose clues are apparently suspected of evading tax and falsely making out invoice tax and other taxation offences are directly filed for investigation.

Random check is divided into directional and non-directional inspection. Directional inspection is selected according to conditions like operational scale, tax risk level etc. and non-directional is selected without conditions, and then the objects to be inspected are chosed at random through a lottery. For random check objects, the tax inspection department can directly inspect them or ask them to perform self-check firstly and then carry out the inspection on key issues, or self-check and the inspection on key issues are carried out simultaneously.

Directional random in combination with non-directional inspection shall be adopted for key tax source enterprises. The proportion of random check is about 20% each year, and the check in principle shall be conducted every five years. For non-key tax source enterprises, the directional inspection is taken as main method and the non-directional inspection as assistance method, which proportion does not exceed about 3% each year. For non-enterprise taxpayers, non-directional inspection is adopted as main method, which proportion does not exceed 1% each year. The tax inspection object that has been randomly selected within 3 years is not included in the random check scope.

Key objects of tax inspection

Key objects of tax inspection random check may include:

• Key tax source enterprises;
• Enterprises with newly added or continuously enjoying preferential projects;
• Enterprises which most preferential treatment eroding the most of tax base (e.g. with huge accounting profits but very little tax payment);
• Projects with large risks (e.g. high and new technology enterprises, enterprises with a large number of research and development projects);
• Enterprises with related party transactions in huge amount and complex model and with abnormal profit level;
• Enterprises which VAT or CIT burden is lower than the industry average etc.

Possible items involved in the tax inspection

Tax related items are the focus of tax inspection including:

• Whether the tax benefits are eligible;
• Whether the pricing policy of related party transaction is according to arm's length principle;
• Common tax risk items in the daily business (all tax items including turnover tax, income tax and small tax);
• Tax treatment of special matters (e.g. special tax restructuring application, tax benefits application according to double tax treaty, tax treatment of relocation and acquisition, etc.);
• Enterprise loss compensation (including domestic and overseas income tax credit operation) etc.

Enterprises Reaction

Firstly, enterprises should pay attention to the changes of regulation in time and actively carry out self-check on a regular basis, to one by one check whether each tax-related items are in compliance with the laws. Mistakes should be corrected in time if found to avoid the risk of unnecessary tax burden. Secondly, enterprises should regulate finanical accouting treatement and commnunicate with tax authorities timely to ensure the correctness of tax treatment. Furthermore, enterprises should carefully prepare and keep tax information and relevant internal documents to deal with the tax inspection.