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Remedies needed to combat tax evasion
By Wang Wu (China Business Weekly)
Updated: 2004-07-14 16:22

Fifty-five per cent of companies with investment from overseas reported losses in the statements about their operations in the Chinese mainland.

This phenomenon should have served as premonition for overseas entrepreneurs against more investment in China.

Facts, however, contradict this reasoning.

Foreign investment in China has never ceased. It even soared at an unbelievably high speed in recent years. For instance, in the first five months of this year, contracted foreign investment rocketed 50 per cent year-on-year and 17,359 new foreign-invested companies were set up, a rise of 14 per cent.

The State Administration of Taxation (SAT) explained the puzzling phenomenon. According to statistics provided by the administration, only one-third of the overseas-funded enterprises which claimed losses are really losing money; the rest are actually winning profits. In other words, two-thirds of them made faulty financial statements.

They lied because they wanted to avoid paying taxes. A loss-making company certainly does not have to pay the income tax.

SAT experts put the size of the dodged taxes at 30 billion yuan (US$3.7 billion) annually.

Tax avoidance is not necessarily illegal. In most cases, it is conducted in legal acts.

All enterprises try to maximize their profits through possible means, including tax avoidance. Nobody can blame them for this as long as it is done in a legal manner.

The problem is whether the taxation authorities are capable enough to ferret out the illegal elements in the methods adopted by the dodgers and whether our tax laws are tight enough to leave no loopholes.

One of the methods usually adopted by overseas-invested companies is "pricing transference." By this method, these companies buy raw materials and parts from their parent companies or business partners abroad at high prices and then export products to them at very low prices. "Loss-making" is thus created within the Chinese mainland, while the profit is "exported" to their businesses overseas.

Another method to avoid paying tax is to borrow more money from banks to increase the percentage of "loan capital" in the company's total capital asset because the interest to be paid to the bank is deducted from the tax-incurring income.

Companies in other countries also use these methods to avoid tax payment. Developed countries have stipulated laws against such acts of avoidance. Their tax authorities are experienced in dealing with various kinds of tax evasion and avoidance.

China has basically established a market economy system but has a lot to learn to cope with the new problems brought along by the market mechanism. How to avoid tax avoidance is such a subject.

In fact, China began to take moves to cope with "pricing transference" in the early 1990s. But the problem remains unsolved. There are at least two reasons for the failure.

First, China does not have enough skilled tax officials to conduct effective investigations into overseas companies, which enjoy rich experience in avoiding paying tax under market economy conditions.

Second, some local governments are reluctant to crack down on tax evasion because they worry that tighter taxation may scare foreign investors away. Attracting foreign investment to develop the local economy -- and thus adding weight to their political achievements -- is more important for local officials than protecting State revenue.

To educate these local officials to put national interests above theirs is probably more difficult than training qualified tax officials.

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