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What may Trigger Tax Audits? Sharing on Recent Tax Audit Cases

Chinese tax authorities recently strengthened the tax collection efforts, in the face of diminishing fiscal revenues caused by stagnation of the economy. And they also intensified the tax audits when they spotted suspicious transactions from the tax filing system.

In this article, we will share with you the cases that may arouse tax authorities attention and trigger tax audits, so that you can perform a self-check of your accounting books and tax returns to stay safe on your tax exposure.

1. Share Transfer

It is known to all that gains from share transfer(capital gain) are taxable: individual shareholders should pay 20% personal income tax for the gains, and the corporate shareholder should consolidate these gains with the annual profit to pay corporate income tax. In order to evade the taxes arising from the share transfer, it was common practice previously to set the share transfer price as $0, $1, or the amount of paid-in capital of the company (target company) whose shares are transferred even if the target company operates as a profit-making business.

However, according to Public Notice [2014] No. 67 The Measures for the Administration of Personal Income Tax on Share Transfer, the price for transferring the shares of a target company being less than the companys net asset value is deemed as the transfer price being significantly lower than fair value.In this case, the tax authority has the right to adjust the transfer price to the fair value.

Some companies may manipulate the accounting by deferring the revenue recognition or accrue a large amount of expenses right before the share transfer so as to artificially reduce the net assets of the company and set the transfer price as low as possible. Unfortunately, it does not work under the tax bureaus scrutiny, who is very experienced in detecting such tricks by analyzing the financial statements submittedin the tax system. The monthly Profit and Loss Account before and after the month of share transfer are compared, any large fluctuation in revenue, margin, and profit level will be spotted and challenged by the tax authorities.

Starting from 20th December 2022, individual shareholders must complete the personal income tax filing for share transfer transactions before the shareholder information is updated with the tax bureau. And therefore, it is unlikely for the individual shareholders to set a low transfer price and avoid paying income tax. For corporate shareholders and share transfer activities that happened before 20thDecember 2022, we noted that the tax authorities are checking the data in the tax system for the past 3 years (from 2021 to 2023) and contacting the taxpayers one by one in case they spot suspicious transactions (i.e. the transfer price is much lower than the companys net assets or the profit for the month of share transfer is significantly lower than the month before and/or after the transfer).

2. Thin-profit companies

According to the tax rules, thin-profit companies can enjoy the beneficial corporate income tax rate of 5% while the normal tax rate is 25%. To be qualified as a thin-profit company, the total assets should be no more than RMB50M, the No. of employees should be no more than 300, and the annual profit should be no more than RMB3M.

We recently encountered a tax audit case that a companys annual profit is RMB2.98M. The tax bureau suspected that the company was manipulatingthe policy of thin-profit company by fabricating the profit just RMB20K less than the threshold. The company was asked to submit the sales and purchase contracts, the revenue / cost recognition policy, fapiao for various expenses to justify that the revenue, cost and expenses were booked in the correct period and in accordance with the tax rules.

3. Large amount of service fee paid to a third party

In the past few decades, the most commonly used method of tax evasion is to pay a third party a large amount of service fee to shift the profit from one company to another. The company that gets the service fee is usually controlled by the same person as the company paying the service fee, which isregistered in a low-tax region. By doing so, the taxpayer can get the profit without paying normal taxes. However, the risk of this kind of tax arrangement” is that the service fee transactions are not real, and it may be deemed by the tax authorities as falsely issuance of Value Added Tax fapiao which is a felony in China.

As the abovementioned method is widely used, the tax authorities are paying much attention to such transactions. From our experiences, a single payment of service fee greater than RMB500K and/or accumulated annual service fee greater than RMB1M would be challenged by the tax authority. The taxpayeris required to justify the nature of the service fee and provide the evidence validating the services delivery (i.e. email communication, chat record, deliverables and etc.).

4. The balance in the owners bank account and the personal income tax paid not matching with the sales volume of the company

The Golden Tax System Phase IV incorporates the bank data (including the business accounts and the personal accounts of the owners and senior management) into the system which enables the tax authority to cross check the revenue of a taxpayer against the personal income tax paid by the owner or senior management as well as their personal bank balance. Any unreasonable discrepancies (i.e. large amount of revenue vs. very little income tax paid but big amount in personal bank accounts) may trigger the tax audit. It happens frequently in the e-commerce industry where the tax bureau can obtain the Gross Merchandise Volume (GMV) data easily from the e-commerce platform.

We could foresee that the tax administration and collection endeavors will be increasingly strengthened.and companies should be more cautious in dealing with any tax related issues. If you are uncertain of any risks associated with tax planning or encounter any tax problems, please feel free to contact us.


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We are a boutique accounting and consulting firm servicing international businesses operating in China. We offers book keeping and business advisory service. We also help our clients select and implement SAAS business applications
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