Evasion a taxing problem
By Chen Yao (China Business weekly)
Updated: 2004-11-25 10:30

China's taxation authorities are stepping up efforts to enforce transfer-pricing rules, as transfer pricing -- a common means of tax evasion used by multinational corporations -- is becoming rampant across the nation.

On November 10, the State Administration of Taxation (SAT) issued the second version of the implementation rules for transactions between related enterprises. The regulations are meant to resolve transfer-pricing disputes by clearly identifying transactions between companies that have close relations.

Earlier this month, a survey team organized by Guangzhou's municipal government released a report on smuggling and tax evasion by foreign-funded companies in Guangdong Province, a coastal province that is one of China's richest regions.

The team investigated 9,465 foreign-funded enterprises in the province, and determined tax evasion through transfer pricing, or other illegal means, existed, to some degree, in almost all of the entities.

"Almost 90 per cent of the foreign enterprises are making money under the table. Some of their businesses involve smuggling. But, most commonly, they use transfer pricing to dodge tax payments," Huang Zhaoming, head of the team and leader of the municipal government's anti-smuggling department, said in a telephone interview.

These findings, despite being limited by their regional aspects, paint a daunting picture that "tax evasion could be even more serious in other parts of the country," he said.

This might be due to the fact other provinces have not established enforcement teams as efficient as Guangdong's, he added.

The survey is widely regarded to be the most comprehensive conducted in China to date. It is expected to have a significant impact on the municipal government's policies aimed at cracking down on tax-evasion.

The report is being sent to top officials in Guangzhou's government. It is not available to the public.

"The government is considering more proactive actions to crack down on tax evasion by multinational companies through transfer pricing," Huang said.

Narrowly defined, transfer pricing refers to the allocation of costs between units of a large multinational company for goods or services supplied. Accounting techniques employed in transfer pricing allow income to be shifted to countries with the lowest taxation rates.

"Many foreign-funded companies choose to register their businesses offshore in tax havens, such as, the Cayman Islands and the British Virgin Islands, while operating in China," said Zhang Wenchun, a taxation professor with the China Financial Policy Research Centre affiliated with the Renmin University of China.

"This has, however, made it hard for China's taxation authorities to track down transactions within these companies, let alone enforce laws."

Many foreign-funded enterprises are shifting income from their business operations in China to their overseas parents, which reduces profits in China so they can avoid paying taxes, he said.

Tax evasion by multinational companies costs China more than 30 billion yuan (US$3.6 billion) in lost tax revenues annually, Su Xiaolu, head of SAT's anti-tax avoidance department, said.

Su's estimate was recently quoted, extensively, by Chinese media.

It has been estimated transfer pricing accounts for nearly 60 per cent of the tax-evasion cases involving multination firms.

SAT does not have an official figure available, Zhang Peisen, a taxation specialist with SAT's research institute, said.

Research by the World Bank in 1995 estimated the Chinese Government was losing 50 billion yuan (US$6 billion) in tax income through such tax-evasion measures by foreign-funded companies.

"Even in the United States, where taxation enforcement is supposed to be more stringent and efficient, the government's losses due to tax evasion could reach US$35 billion annually," Zhang said.

"In emerging markets such as China, the situation is bleak, as loopholes widely exist in taxation laws and administration."

Of 494,025 enterprises nationwide that registered with local tax bureaux as foreign-funded entities, nearly half have posted losses, indicate Ministry of Commerce statistics.

Many of those loss-making enterprises have deliberately avoided paying taxes by manipulating their accounting books, said Zhang Bin, a research fellow, specializing in taxation, with the Institute of Finance and Trade Economics under the Chinese Academy of Social Sciences.

But foreign-funded companies will experience crackdowns on the increase of transfer pricing and other tax avoidance means, as the central government plans to launch a nationwide campaign aimed at boosting tax revenues, Zhang said.

Last year, SAT introduced a new regulation that extended the period of transfer-pricing review by tax officials to three years, or even 10 years under special circumstances.

Cases involving inter-total transactions in excess of US$12,000, or companies located in a tax haven, will fall into such a category.

Last June, SAT promulgated anti-tax evasion measures, and launched investigations into transfer pricing.

"The government now requires taxpayers to present accounting information to tax inspectors before they search for fraud," Zhang said.

Under the promulgated transfer-pricing rules, the burden of proof is on the company rather than China's tax authorities. Foreign enterprises must ensure they record and maintain all documentation in case they are audited.

The so-called advance-pricing agreement (APA) rules will require foreign enterprises to determine ahead of transactions the transfer prices for specific goods or services supplied.

Although tax evasion by foreign companies through transfer pricing started as early as the 1980s in China, the introduction of related regulations did not occur until 1991, when the income tax law for foreign enterprises was drafted.

However, the problem of transfer pricing remain unsolved, due in part to the inadequacy of anti-tax avoidance officials.

Currently, there are fewer than 300 anti-tax avoidance officials throughout China. They conduct about 6,000 audits every year, indicates a recent report by Deloitte Touche Tohmatsu.

These officials' knowledge and experience in transfer pricing varies considerably.

While some have substantial investigation and auditing expertise, the majority have only a basic understanding of transfer pricing, the report said.

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