Need to Know – Tax Evasion in China

The definition of tax evasion and penalties under China's tax law have aroused heated discussion among taxpayers after the trial and exposure of a Chinese television actress's tax evasion case. A full understanding of the tax compliance requirements of the Chinese tax law and the careful and truthful filing of tax returns are essential for both companies and individuals with taxable income.

Under the current tax law, for taxpayers who evade taxes, the tax authorities will seek the payment of the unpaid or underpaid taxes and late payment penalty (usually 0.05 percent per day of tax), and concurrently impose a fine not less than 50 percent of and not more than five times the amount of taxes unpaid or underpaid. For cases that constitute crimes, criminal liabilities shall be investigated according to the law. The penalty for tax evasion under Chinese criminal law is that if a taxpayer files false tax returns by cheating or concealing or fails to file tax declaration, and the amount of evaded taxes is relatively large and accounts for more than 10 percent of payable taxes, the taxpayer shall be sentenced to fixed-term imprisonment of less than three years or criminal detention and shall be fined. If the amount is huge and accounts for more than 30 percent of payable taxes, the taxpayer shall be sentenced to fixed-term imprisonment of more than three years and less than seven years and shall be fined.

It is worth noting that although the tax obligation of tax evasion lies in the taxpayer, both the tax law and the criminal law currently will punish the withholding agents according to above provisions, who have intentional omission or participation in tax evasion. Furthermore, if the enterprise constitutes the crime of tax evasion in the criminal law, in addition to the enterprise to bear the fine, the directly responsible person in charge and directly responsible personnel are punished by referring to the above provisions. In most cases, these personnel may involve the general manager, chief financial officer or manager, and the handling finance accountant.

In addition, the Chinese Tax Law stipulates that the direct person in charge will not be investigated for criminal liability if the person is able to pay the tax, late fees and fines in a timely manner after the tax authorities issuing the notice of recovery. For example, in the case of tax evasion by the actress, although it is a huge amount of tax, the criminal responsibility was not investigated after the payable taxes, late fees and fines were paid within in a certain period after the recovery notice was issued. However, according to several recent well-known celebrity tax evasion cases, the tax bureau can directly enforce the penalty according to the maximum 5 times of the fine for the huge amount of tax evasion.

The Chinese tax law also has clear provisions on the time limit for retroactive tax returns. For underpaid taxes due to the responsibility of the tax authority, the tax authority may require the overdue payment within three years but shall not impose a late fee. If a taxpayer intentionally fails to pay tax, the tax authority may recover the tax payment and overdue fine within three years (which can be extended to five years). To the subjective and intentional evasion of taxes can be pursued indefinitely. In addition, for transfer pricing adjustments and other general anti-avoidance matters, the tax authorities will be able to recover taxes and impose penalty interest for 10 years.

Our Observation

In daily operation, taxpayers often pay less taxes because they are not familiar with the provisions of the tax law and financial system, or they are careless. These cases have essential difference to tax evasion as mentioned above, as without subjective intent or malicious. For this type of underpaid taxes, companies usually only have to pay the taxes and late fees. However, in practice, repeated non-subjective tax underpayment may also cause the alarm of the golden tax system and the attention of the tax bureau, and increase the possibility of tax inspection. Therefore, the compliance of tax declaration by the financial and tax departments must be paid attention to.

In addition, in some cases, enterprises find tax evasion behavior in the past caused by historical reasons, but do not correct the wrong behavior timely, which may also constitute the crime of tax evasion.

In the case that the legal representative or some of the board members of foreign-invested enterprises are senior executives based in the headquarters, they are usually not aware of the tax evasion activities of the management of the Chinese subsidiaries because most of these senior executives are not involved in the operation of the company. In this case, the possibility of being identified as the direct responsible person or being required to bear criminal responsibility in China is very small.

In recent years, the Chinese tax authorities has cracked down hard the tax evasion behavior. No matter by what means, such as setting up shell companies, accepting false invoices, cashing out by booking more costs and less income, itemizing false personnel expenses. Tax may be indefinitely pursued for these tax evasion due to subjective intent, and will bring huge risks to the business operating and responsible person.