Chapter 3. Strengthening Tax Administration
Author: Mr. John D Brondolo and ZHANG Zhiyong
Language:
English
Keywords:
BOOK; government; China; pension; rate; local government; tax administration; value-added tax; information system; tax agency; SAT headquarters; Compliance costs; Tax law; Tax collection; Global; Asia and Pacific
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Abstract

China’s tax administration has improved substantially over the past two decades in the face of major changes in the economy and the tax system (see Chapter 2). This has contributed importantly to a doubling of the tax-to-GDP ratio and the significant reduction in taxpayers’ compliance costs since the mid-1990s. As the State Administration of Taxation (SAT) formulates its modernization plan for 2016–20, this chapter examines the results and impacts of previous tax administration reforms, and identifies areas where further reforms are needed to sustain revenue collection and reduce compliance costs over the next five years.

China’s tax administration has improved substantially over the past two decades in the face of major changes in the economy and the tax system (see Chapter 2). This has contributed importantly to a doubling of the tax-to-GDP ratio and the significant reduction in taxpayers’ compliance costs since the mid-1990s. As the State Administration of Taxation (SAT) formulates its modernization plan for 2016–20, this chapter examines the results and impacts of previous tax administration reforms, and identifies areas where further reforms are needed to sustain revenue collection and reduce compliance costs over the next five years.

During the early 1990s, China’s tax administration was ill-suited to and performed poorly at collecting taxes from an increasingly market-oriented economy. The tax system included some 35 different taxes, many of which accounted for little revenue. A single tax agency collected both national and local taxes, with complex intragovernmental revenue-sharing arrangements. The tax authorities’ powers were set out in various statutes and circulars whose legal standing were not clearly established. Most tax administration functions were performed manually and required laborious checking procedures. Tax evasion and taxpayers’ compliance costs were very high, and the tax yield had fallen to below 10 percent of GDP.

Since the early 1990s, China has made great progress in creating a modern tax administration. The system now comprises 18 taxes with clear apportionment of revenue between central and local governments. Separate national and local tax authorities have been created to collect central and local government taxes, and the revenue-sharing arrangements have been made more transparent. The tax authorities’ powers and taxpayers’ rights have been codified in a tax procedures law, and many tax administration procedures have been automated based on a standardized computer system. These changes have helped to reduce tax evasion and compliance costs, and contributed to raising the tax yield to nearly 20 percent of GDP.

Today, China’s tax administration finds itself at a new crossroads. The economy is again undergoing significant restructuring, major changes to the tax laws are currently underway, and the relatively easy gains from previous tax administration reforms have been largely reaped. At this juncture, it is useful to ask whether further improvements in tax administration are needed and, if so, what should be the priority areas for reform.

The next section summarizes the background to and impacts of China’s tax administration reforms over the past 20 years. The chapter then describes the main features of China’s tax administration today and how they have evolved since the early 1990s. It assesses the challenges now facing China’s tax system in the following section, and the penultimate section suggests a number of reforms for the SAT to consider in formulating its new five-year modernization strategy. Lessons from SAT’s reform experience conclude the chapter.

Background

In the late 1970s, China embarked on a bold journey toward a market-oriented economy by opening up trade and investment with the rest of the world and restructuring the domestic economy. Mandatory planning was relaxed, market forces and the non-state sector were allowed to play a greater role in the economy, and the institutions for conducting macroeconomic policy were transformed. These reforms have contributed significantly to the massive structural transformation and rapid economic growth since the early 1980s (IMF 1993).

As the economic reforms unfolded, it became increasingly clear to policymakers that the existing tax system was incompatible with the requirements of an economy that relied increasingly on the market for the allocation of resources and would require a substantial overhaul. Similarly, it was also recognized that tax administration required fundamental changes if it were to effectively secure tax revenue from a new tax system in an increasingly market-oriented economy.

The need to modernize tax administration was made even more urgent by worrisome declines in both the tax-to-GDP ratio and the central government’s share of total revenue during the early to mid-1990s. As can be seen in Table 3.1, the tax yield dropped by about 5½ percent of GDP during the period 1990–96, while the central government revenue share declined by nearly 12 percentage points from 1990–93.

Table 3.1.

State Budget Tax Revenue to GDP and Share of Total Revenue 1990–96

(Percent)

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Source: China Statistical Yearbook 2014; and IMF staff calculations.Note: Tax revenue comprises both central and local government taxes. Central government revenue and total revenue include both tax and nontax revenue.

The decline in the tax-to-GDP ratio can be traced to three main factors: (1) structural economic factors involving shifts in the different components of GDP, (2) discretionary changes in tax policy, and (3) changes in tax administration effectiveness. Although it is difficult to disentangle their relative importance, a 1997 IMF technical assistance mission found that these factors contributed to the decline in China’s tax yield during the early to mid-1990s.1 The impact of weak tax administration, which is the main concern of this chapter, was manifested through a growing incidence of tax evasion and the SAT’s difficulties in controlling it. Some studies estimated that up to 30 percent of state-owned enterprises, 60 percent of joint ventures, 80 percent of private enterprises, and 100 percent of individual street vendors failed to comply with their tax obligations in the mid-1990s (Yu 1997).2

As for central government finances, the decline in its share of revenue during the early 1990s has been attributed mainly to the former intragovernmental revenue-sharing arrangements.3 However, weak tax administration—in the form of loose central control over local tax offices—was also seen to have contributed to the decline. Prior to 1994, local governments played a major role in financing and directing the operations of the tax offices. As such, local authorities had strong incentive to concentrate revenue collection on local tax bases and shift the tax bases from those that had to be shared with the central government to those over which they had greater control (IMF 1994).

It was in this highly challenging environment of rising noncompliance and declining tax yields that the Chinese authorities launched a major tax administration modernization program in the mid-1990s as an integral part of a broader fiscal and tax reform program. The overriding objective for the tax administration reforms was to achieve sustainable increases in tax revenue by improving taxpayers’ compliance with the tax laws. This objective was to be achieved by replacing the previous form of tax administration with new approaches that were better suited to the rapidly changing economy and tax system.

The modernization program began in 1994 with the splitting of the tax agency into two separate organizations: the National Tax Service (to collect central and most shared taxes) and Local Tax Services (to collect local government taxes and some shared taxes). Once the collection responsibilities for the various taxes were established, the focus of the reforms then shifted to designing and implementing new organizational arrangements, tax administration processes, and information systems.4 These reforms have continued, at varying intensity, through today.

Since the introduction of the tax administration reforms, both the tax-to-GDP ratio and the central government share of total revenue have increased sharply. As shown in Figure 3.1, the tax-to-GDP ratio, after steadily declining in the early 1990s, increased by nearly 10 percentage points of GDP through the early 2010s, reaching 19.4 percent of GDP in 2013. Similarly, the central government share of revenue, which had fallen to 22 percent of total revenue in 1993 (Table 3.1), more than doubled by 1995 and has averaged about 50 percent of total revenue since then (Figure 3.1).

Figure 3.1
Figure 3.1

State Budget Tax Revenue to GDP and Share of Total Revenues (1990-2014)

(Percent)

Sources: China Statistical Yearbook (various years); and IMF staff calculations.Note: Tax revenue comprises both central and local government taxes.

The steady increase in the tax-to-GDP ratio since the mid-late 1990s resulted from changes in the same three factors that accounted for the decline in the tax yield during the early 1990s: structural economic shifts, tax policy changes, and tax administration factors. While structural shifts in the economy5 and tax policy changes6 had important positive impacts, tax administration improvements also played a major role.7 A 2007 IMF technical assistance mission estimated that the value-added tax (VAT) compliance ratio had increased from about 39 percent of potential VAT revenue in 1997 to 56 percent in 2005 (Figure 3.2).8

Figure 3.2.
Figure 3.2.

Value-Added Tax Compliance Ratio

(Percent)

Source: IMF staff calculations.Note: left scale: VAT actual and potential revenue as percent of GDP; right scale: VAT efficiency ratio in percent.

The tax yield, after steadily increasing for nearly two decades, posted its first decline in 2014, dropping to 18.7 percent of GDP as the economy slowed. Taxpayer compliance can be expected to come under pressure if the economy continues to grow slower than in past years. Maintaining compliance in the face of slower growth is one of the key challenges facing the SAT in the period ahead.

In addition to boosting tax revenue, there is also evidence that tax administration reform has reduced business compliance costs and improved taxpayers’ perceptions about the tax system, particularly in recent years. Regarding the former, the amount of time that medium-sized Chinese companies spend on tax matters has been reduced from 832 hours in 2004 to 261 hours in 2013 (World Bank 2015).9 Concerning the latter, taxpayer perception surveys conducted by the National Bureau of Statistics since 2008 indicate a steady increase in taxpayer satisfaction with the tax system (Table 3.2).

Table 3.2.

Taxpayer Satisfaction Ratings

(Percent)

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Source: National Bureau of Statistics, State Administration of Taxation.Note: LTS = local tax services, NTS = National Tax Service.

To the extent that the decrease in time spent on complying with the tax laws and increase in taxpayer satisfaction represent a reduction in compliance costs, it can be inferred that the tax administration reforms have had a positive impact on the business climate. Achieving further compliance cost reductions, as a vehicle for promoting economic growth, is another major challenge for the SAT in the period ahead.

Tax Administration Today

To set the stage for assessing the current challenges facing the State Administration of Taxation and for identifying future reform priorities, this section describes key features of tax administration today and how they’ve evolved over the past two decades.

Policy and Legal Framework

For many years, tax administration in China had been governed by various tax statutes, orders, and regulations whose scope and legal standing were unclear. This situation has been significantly improved by the enactment of the Law on the Administration of Tax Collection (henceforth, the Tax Collection Law) in 1992 and the continuous refinement of the substantive tax laws over the past two decades. These laws and their related regulations provide the policy and legal foundation for China’s tax administration today.

The Tax Collection Law establishes the common administrative provisions that apply to all of China’s substantive tax laws (on VAT, enterprise income tax, and so on). These include the key rules for each tax administration function (such as registration, filing and payment of taxes, auditing, and so on), SAT’s enforcement powers and penalty provisions, taxpayers’ rights and obligations, and dispute resolution procedures.

The substantive tax laws provide the administrative authorities that are specific to each of China’s 18 taxes. Among these, the Enterprise Income Tax Law is particularly important for tax administration by including both general10 and specific11 anti-avoidance provisions. Such provisions are essential for dealing with aggressive tax planning and tax avoidance schemes.

While the Tax Collection Law and the substantive tax laws vest the SAT with powerful tax administration tools, both require updating to deal with emerging challenges to China’s tax system. In updating the laws, it is essential to achieve a balance between SAT’s enforcement powers and the rights of taxpayers.

Taxpayer Population

China’s taxpayer population has undergone significant changes over the past two decades with major implications for tax administration. Most profoundly, the total number of registered taxpayers with business income nearly tripled since 2000 (Table 3.3). To meet the resulting increase in workload, the SAT has introduced major changes to its core tax administration processes and information systems over the past 20 years, as described below.

Table 3.3.

Number of Registered Taxpayers (National Tax System)

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Source: State Administration of Taxation.Note: … = not available.

A second important change has involved transformations in the forms of enterprise ownership (Table 3.4). During 2000–10 the numbers of private enterprises increased tenfold and enterprises from outside the mainland nearly tripled, while the state-owned enterprises (including collectives and cooperatives) declined substantially. With the growth in the private sector, the SAT has had to design new strategies and enhance the skills of its tax officers to ensure the compliance of a large number of private enterprises that respond to market incentives rather than incentives created by an economic plan.

Table 3.4.

Number of Registered Industrial Enterprises

(Annual revenue over RMB5 million)

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Source: National Bureau of Statistics, China Statistical Yearbook (2001, 2011).Note: Data are not presented after 2010 because the 2011 change in the enterprises covered (to those with annual revenue of more than RMB20 million as compared to RMB5 million before 2011) makes comparisons to earlier years misleading.

Organization

China’s tax administration consists of two separate tax agencies: (1) a National Tax Service, which collects central government taxes and most taxes shared by central and local governments and (2) Local Tax Services, which collect local government taxes and some shared taxes.

As shown in Annex 3.1, the two tax services are organized into five levels of administration comprising SAT headquarters, provincial, municipal, and county/ district offices, and tax stations. Under this setup, SAT headquarters has direct (solid line) authority for overseeing the operations of the National Tax Service as well as appointing and promoting its staff, and funding its budgets. SAT also shared (dotted line) authority with local governments for Local Tax Services. Accordingly, SAT is responsible for monitoring and supporting the Local Tax Services operational activities while local governments are responsible for appointing and promoting staff, and funding their budgets.

The national and local tax services collectively comprise some 750,000 staff in more than 30,000 locations (Table 3.5). A tax administration of this size faces enormous difficulties in designing and consistently applying its operational programs, human resource management policies, computer systems, and other activities. This is made even more difficult by the very small size of SAT headquarters relative to the rest of the organization. Whereas many effective tax agencies commonly assign 3–10 percent of staff to their head office (IMF 2015), SAT headquarters has been allocated only about one-tenth of 1 percent of the organization’s staff.

Table 3.5.

Number of Organizational Units and Staff by Level of Administration

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Source: State Administration of Taxation (as of December 31, 2014).

Tax Administration Processes

Prior to the mid-1990s, China had relied on an administrative assessment system for assessing, filing, and paying taxes. Under it, tax officers would help SOEs prepare their paper-based tax returns and tax payment forms. Other (non-SOE) taxpayers were required to file their tax returns and supporting documents at the tax office where a tax officer reviewed them in the taxpayer’s presence. The inefficiencies of administrative assessment rendered it incompatible with a tax system in an increasingly market-oriented economy, with an increasing workload from a rapidly growing taxpayer population. It was also ineffective at redressing the rampant noncompliance that had contributed significantly to the decline in China’s tax-to-GDP ratio during the early 1990s.

To improve compliance and increase administrative efficiency, the SAT replaced the administrative assessment system with self-assessment. Under it, taxpayers now prepare their own tax returns and make their own payments without the direct involvement of tax officers, subject to selective audits. To support self-assessment, SAT has continuously streamlined tax filing and payment procedures, enhanced taxpayer services and strengthened its enforcement programs.

The continuous improvements to SAT’s core tax administration processes over the past 20 years have contributed importantly to the impressive gains made in taxpayer compliance, tax collection, and reducing business compliance costs as described previously. Achieving further gains in these areas will require enhancing the administrative processes to deal with the new challenges to the tax system.

Human Resources

The SAT has also made strong progress in strengthening its human resources over the past two decades. To enhance the skills of its existing workforce, the SAT’s tax training academies (in 36 provinces and municipalities) provide induction and technical training to tax officers while its three national tax academies (in Changsha, Dalian, and Yangzhou) provide training to senior officials in selected topics (such as transfer pricing). To enhance the quality of new staff, the SAT has built up its cadre of university-trained officers: whereas in 1992 less than 5 percent of staff had university degrees, this proportion had increased to 60 percent in 2014.

While the SAT has succeeded in building an increasingly capable workforce, it has had less success at strengthening other important elements of its human resource management regime. In particular, the SAT’s position classification, staff evaluation, and promotion/salary policies have, until very recently, remained largely unchanged and tied to government-wide civil service regulations. Progress in these areas will be crucial to raising the productivity and ethical standing of the SAT workforce in the future. At the same time, SAT’s skills enhancement program must provide managers and officers with the requisite skills to implement the agency’s key reform priorities and deal with emerging challenges.

Information Systems

The SAT has evolved from a tax agency whose operations were based mainly on low-productivity, manual processes to one that relies increasingly on modern technologies and systems. It has reached this state by having made major investments over many years in its two backbone information systems: (1) the China Tax Administration Information System (CTAIS) and (2) the Golden Tax Project (GTP).

CTAIS is the SAT’s core tax administration information system whose nationwide implementation was a major achievement for China’s tax administration. The system provides automated support for the core tax administration functions (registration, tax returns and payment processing, taxpayer accounts, and others) for the main central government taxes and shared taxes. It also provides a platform for the tax administration to coordinate its activities with banks (on tax payments) and the national treasury. The system was first developed in 1999 and is now deployed at all tax offices across the country.

GTP is a specialized computer system for detecting and dealing with VAT invoice fraud, which has plagued China’s tax administration for many years. It consists of four subsystems: (1) an invoice generation system in which VAT taxpayers use SAT proprietary software and hardware to generate invoices that include a numerical cipher, (2) an invoice certification system that permits taxpayers to claim a VAT input credit only after the SAT has authenticated their purchase invoices by decrypting the ciphers, (3) a cross-checking system that compares sales invoices (submitted by sellers) to purchase invoices (submitted by buyers) and forwards mismatches for investigation, and (4) an investigation system that coordinates follow-up actions on potentially fraudulent invoices (Winn and Zhang 2013).

CTAIS and the Golden Tax Project have provided vital pillars for improving the effectiveness and efficiency of tax administration. The government has recognized their important contributions to increasing revenue performance.12 The SAT is currently implementing the GTP Phase 3 to replace CTAIS and, in doing so, provide automated support for all taxes (both central and local), include a broader set of tax administration applications (including risk management), and, crucially, tie together the provincial-level databases into a national network of taxpayer information. The successful deployment of this system13 and further improvements to the VAT system will be crucial to the effective administration of the tax system in the future.

Emerging Challenges and Opportunities

The SAT faces significant challenges in ensuring the health of the tax system over the next five years. These take two broad forms: (1) external challenges that emanate from the SAT’s operating environment and (2) internal challenges from within the SAT itself. There are also a number of opportunities that the SAT could exploit to enhance its operations. Identifying both the challenges and opportunities, as described in this section, is a key first step in setting the SAT’s future reform priorities as described in the next section.

External

The SAT is operating in an increasingly complex external environment. Key challenges include slowing economic growth, structural shifts in the economy, and China’s continuing integration into the global economy—all of which present heightened risks of lost revenue from noncompliance by taxpayers. Further challenges include the implementation of an ambitious tax reform agenda and the need to promote the business climate by reducing the compliance costs of the tax system.

Slower Economic Growth

China’s slowing economy, from double digit to single digit growth under the so-called new normal, could have significant implications for tax administration. The economic slowdown can be expected to reduce the rapid growth in tax revenue that had been achieved in previous years. The revenue decline is not a concern in itself to the extent it reflects the normal operation of automatic stabilizers, but would pose a problem for tax administration if it causes a decline in taxpayer compliance. The latter can occur because economic stress creates incentives for distressed taxpayers to use tax evasion as an alternative form of finance for their operations and a means to avoid bankruptcy (Brondolo 2009; CASE 2013).14 Compliance declines can be expected to differ across industries in line with their relative declines in economic activity. From this perspective, the SAT will need to give special attention to those industries most impacted by the slowdown such as industrial commodities (for example, steel, real estate, and mining).

The economic slowdown will also make it more important than ever to ensure that the tax administration avoids unnecessarily impeding the business climate. Although the SAT has taken many steps to reduce compliance costs over the past several years, Chinese businesses still spend more time dealing with tax matters than taxpayers from comparator countries in the Asia Pacific region and far more time than taxpayers in countries with high-performing tax agencies. A substantial portion of these costs is associated with the administration of the VAT: in 2006, more than 40 percent of the costs incurred by Chinese taxpayers in meeting their tax obligations were attributed to handling VAT special invoices (Xu 2006).

Structural Changes in the Economy

Structural shifts in the economy can also be expected to pose additional challenges for the SAT in the coming five years. Three of the more significant shifts involve the increasing contribution of the services sector, the growing volume of cross-provincial transactions, and a sharp increase in electronic commerce.

Regarding services, this sector is expected to continue to grab a growing share of the economy.15 This trend will present two particularly significant challenges to tax collection. First, the services sector in China comprises larger numbers of small and unincorporated businesses, as compared to the industry sector (Rosen and Bao 2015), many of which have low rates of tax compliance. Second, the expected growth in the financial services industry and the introduction of new financial products will raise complex tax issues that will require increasing attention to ensure their correct tax treatment.

The increase in cross-provincial transactions presents further challenges to tax administration. Large businesses and high-wealth individuals in China are increasingly carrying out economic activities in multiple provinces. This increase in cross-provincial transactions is in contrast with the SAT’s decentralized tax administration—with little exchange of information among the provincial tax bureaus—and points to the need for a more national approach to administering highly mobile taxpayers.

China’s rapid growth in electronic commerce (e-commerce) presents a third, major structural shift in the economy and a growing challenge to tax administration. In 2000 China had yet to develop any significant e-commerce applications and had only 2.1 million Internet users. By the end of 2013, Chinese Internet users reached approximately 600 million and e-commerce growth had topped 70 percent annually from 2009 to 2012. By 2020, China’s e-commerce market is forecasted to be larger than those of France, Germany, Japan, United Kingdom, and the United States combined (KPMG 2014).

The growth in e-commerce has been accompanied by the development of new business models, which commonly feature a third-party facilitator who operates an online platform, arranges a sale of a good or service between a producer and consumer of a good or service, and charges a fee.16 The boom in e-commerce and new business models will confront the SAT with the challenges of identifying online transactions, determining the nature and value of the transactions, and establishing the taxable persons.

Globalization

China has a worldwide income tax system under which its residents—both corporations and individuals—are taxed on income from sources both within China and outside China (with credit for taxes paid on foreign income) and nonresidents are taxed on income only from sources within China. Since the country opened up its economy to trade and investment with the rest of the world in the late 1970s, the Chinese tax system has faced the risk of cross-border tax avoidance and evasion. As mainly a capital-importing country until recent years, the international tax risks have centered on guarding against offshore profit shifting by foreign-funded enterprises that invested in China. These included such risks as transfer pricing, thin capitalization, and indirect transfer of Chinese assets.

With China having now become an increasingly capital-exporting country, the nature of the international tax risks that it faces is changing.17 While transfer pricing continues to be a central issue, the SAT must now be concerned not only with transfer pricing practices of foreign enterprises in China but also those practices of Chinese-owned subsidiaries in other jurisdictions. Other emerging international risks include cross-border restructuring of Chinese businesses (such as acquiring foreign companies and corporate inversions), deferred recognition of income by Chinese companies from their foreign subsidiaries in low-tax jurisdictions, unreported overseas income and assets by Chinese residents,18 and various aggressive tax planning schemes.19 The SAT will need to adapt its international compliance programs, in cooperation with other jurisdictions, to deal with these and other similar risks.

New Tax Legislation

The government’s tax reform agenda presents additional challenges for the SAT. Over the next five years, major reforms are planned for six taxes: value-added tax, excise tax, resource tax, environment protection tax, property tax, and individual income tax. Such an ambitious reform program will require a major implementation effort by the SAT: taxpayers (especially individuals) will need to be educated in their new obligations, new administrative systems and procedures will need to ensure taxpayers comply with their obligations, and tax officers will require training in applying the new legislation and compliance procedures.

Along with the external challenges, there are also a number of opportunities emanating from the tax system’s external environment that the SAT could exploit to strengthen tax administration over the coming years. Most importantly, the Communist Party of China’s Central Committee Leadership Group to Comprehensively Deepen Reform has given high-level political support for tax administration reform when it passed on October 13, 2015, the Plan to Deepen Reform of the National and Local Tax Administration System.

Internationally, the growing cooperation among countries in exchanging tax information, both through bilateral and multilateral arrangements, provides the SAT with new opportunities for tackling cross-border tax evasion.

Internal

The increasingly complex environment facing the tax system will put pressures on the SAT’s internal administrative capacity. Potential vulnerabilities include the SAT’s organizational structure, staff skills, and information systems. The SAT will need to strengthen its capacity in each of these areas to deal with the emerging challenges that it faces.

Organizational Stresses

The SAT’s current organizational and staffing arrangements, which have evolved incrementally over the past two decades, have a number of stress points that present risks to the agency’s capacity to deal with emerging challenges and implement its modernization strategy. These organizational stresses are manifested in four main areas:

  • The small size of SAT headquarters hinders its capacity to design and implement national and international compliance strategies precisely at a time when Chinese taxpayers are increasingly engaging in cross-provincial and overseas taxable activities.

  • The very large network of tax offices—while facilitating close support and monitoring of taxpayers—is costly to maintain and presents serious difficulties in managing, ensuring uniform administration, and avoiding collusion.

  • The creation of separate national and local tax services—although providing a dedicated organizational focus for collecting national and local taxes, respectively—has had the disadvantages of high budgetary costs for the government (from maintaining two separate agencies) and additional compliance costs for taxpayers (who must deal with two separate agencies in carrying out their tax obligations).

  • The SAT’s hybrid organizational structure—where staff are organized into units based partly on tax type, partly on type of taxpayer, and partly on tax administration function—has resulted in fragmentation of administrative responsibilities across the organization. This fragmentation is particularly pronounced and harmful in the areas of auditing and large taxpayer administration.

In addressing the above stress points, it is important to recognize that organizational restructuring is always very challenging, particularly for a large tax agency like the SAT. This suggests that priority should be given to implementing those organizational and staffing changes that are most critical to the successful delivery of the SAT’s modernization strategy.

Achieving Greater Uniformity in Administration

The effective operation of a national market economy is influenced by the extent to which the tax system is applied in a uniform manner across the country. Notwithstanding the progress that the SAT has achieved over the past two decades in harmonizing its tax administration practices across China, there continue to be differences in the way the tax laws are applied from province to province and city to city.

To some extent, inconsistencies in administration and service delivery are inevitable in a very large country with a decentralized tax agency and weak communications, particularly where the tax agency has a very small headquarters as is presently the case in China. Nevertheless, such inconsistencies can be harmful to the economy by distorting competition across (and within) jurisdictions and industries. They can also raise serious questions in the eyes of taxpayers about the fairness of the tax system if tax laws are applied differently in different locations. With the government seeking to promote the business environment and the rule of law, it is increasingly important for the SAT to achieve greater standardization and consistency in the application of the tax laws.

Critical Skills Gaps

Ultimately, the SAT’s capacity to effectively administer the tax system depends on the skills of its managers and staff. While it has steadily strengthened the quality of its workforce over many years, significant skill gaps remain in some important areas, particularly among auditors. Future reform initiatives, such as planned amendments to the Tax Collection Law and other changes in tax legislation, will create further demands for skills enhancement.

In this situation, the SAT needs to identify its key skill gaps and formulate a comprehensive strategy for closing them. Importantly, these efforts need to be directed not only at strengthening the SAT’s technical skills but also at improving the capacities of its senior executives and managers. To achieve the best results, the SAT will need to adopt a broad range of skills enhancement approaches and technologies.

Weaknesses in Information Systems

Tax administration is an inherently information-intensive activity where appropriate data and well-designed analytics are critical to the effective administration of the tax system. While the SAT has made great strides in deploying a standardized information system across a large network of tax offices, it has not yet fully realized the potential benefits of information technology. Key weaknesses include the lack of national databases of taxpayer information, the absence of third-party information, and the high compliance costs that some of the SAT’s computer systems impose on taxpayers.

In addressing these internal challenges, the SAT could also leverage a number of opportunities to advance tax administration reform. The stability in its leader-ship—particularly among its commissioners and deputy commissioners—has provided a continuity in reform management that is crucial for implementing medium-term reforms. In addition, various ongoing tax administration reforms—to the SAT’s legal framework, administrative processes, and computer systems—provide a strong foundation for future modernization. Crucially, the Chinese leadership has explicitly given its political support to the SAT’s modernization strategy as described in the next section.

Future Reform Priorities

Tax administration reform has an important role to play in supporting the government’s economic reform agenda under the 13th Five-Year Plan (2016–20) by mobilizing adequate revenue to pay for high-priority public sector expenditure and helping to promote the business climate. To contribute to these objectives, this section suggests measures that the SAT may consider incorporating into its tax administration modernization strategy for the next five years.

State Administration of Taxation’s Modernization Program

The importance of tax administration reform has been recognized at the highest level of the Chinese government. The 13th Five-Year Plan has reinforced the earlier call by the Third Plenum of the 18th Central Committee on the need to strengthen the collection of national and local taxes.20 The SAT has translated the government’s high-level policy goals into a more detailed Blueprint for Deepening the Reform of Tax Administration.

The blueprint sets four overarching objectives for tax administration reform: (1) reduce tax collection cost and compliance burdens, (2) increase the efficiency of tax administration, (3) strengthen the awareness of tax compliance, and (4) improve taxpayer satisfaction. These four objectives are underpinned by 31 initiatives that are grouped under six headings.21 Importantly, this reform agenda has been endorsed by the highest levels of the Chinese government.22

By early 2016, the SAT intends to develop a five-year action plan for implementing the blueprint in a step-by-step manner by 2020. In this context, the balance of this section provides guidance on a number of key reform initiatives that the SAT may consider in formulating its action plan.

Amending the Tax Collection Law

The Tax Collection Law (TCL) is crucial to the operation of China’s tax system as it sets out the common administrative provisions that apply to all of its substantive tax laws. Updating the TCL, which has had only minor amendments since its enactment in 1992, is a key prerequisite for strengthening tax administration by ensuring the SAT has the legal authorities needed to implement its modernization strategy and deal with emerging challenges.

In amending the TCL, the government should ensure that the revisions achieve an appropriate balance between the powers of the tax authorities and the rights of taxpayers. The former would provide the SAT with the powers needed to safeguard tax revenue while the latter would help promote the investment environment by providing businesses with greater protections and certainty on the tax treatment of their transactions.

Several amendments are needed to strengthen the SAT’s enforcement powers. First, the amendments need to make clear that the TCL is not limited to enterprises, as is currently the case with some key provisions, but also applies broadly to all taxpayers. Second, the law needs to require private sector third parties—including financial institutions and other income payers23—to provide the SAT with tax-related information as well as facilitate the SAT’s receipt of tax information from other government agencies.24 Third, the SAT’s arrears collection powers need to be enhanced, including by vesting the organization with the power to impose a tax lien on the property of tax debtors, require third parties who owe money to (or hold money on behalf of) a tax debtor to pay some portion of the monies owed (or held) to the SAT in satisfaction of the tax debt, and extend the length of time for eligible tax debtors to pay their arrears installments.

Other amendments are needed to enhance taxpayers’ protections. Importantly, the provisions governing the confidentiality of taxpayer information need to be strengthened, taxpayers should be provided with a comprehensive set of procedural protections, and clear guidelines issued on how tax bureaus should apply the law’s penalty provisions.25 The current requirement for taxpayers to pay 100 percent of a disputed tax assessment before they can file an administrative review should be eliminated26 and replaced by a provision that requires taxpayers to pay only some percentage of the disputed tax liability. In addition, the SAT should have the power to provide taxpayers, upon request, with a binding ruling on how the tax law applies to a particular transaction. Finally, steps need to be taken to ensure that the SAT’s administrative review organ has greater independence from the rest of the organization (as described in the next section).

The SAT and Ministry of Finance in November 2014 jointly submitted draft amendments to the TCL to the State Council. During 2015, the SAT coordinated with the Legislative Affairs Office of the State Council in reviewing and addressing comments received from a wide cross section of society, held expert panel discussions, and did further research on improving the TCL. It is expected that the amendments will be enacted during 2017, which will be crucial for keeping the SAT’s modernization program on track.

Aligning the Organizational Modernization Strategy

The successful implementation of the SAT’s modernization strategy depends critically on ensuring that its organizational structure is aligned with and supportive of the modernization strategy. In this connection, the SAT would benefit from rationalizing its current organizational structure, strengthening headquarters, consolidating the large network of tax stations, and establishing effective organizational arrangements for administering large businesses and high-wealth individuals.

Over the past 20 years, the SAT’s organizational structure has evolved in an ad hoc manner with new departments created to deal with emerging priorities. For example, in 2008 the SAT created a new Taxpayer Services Department and Large Business Department with a view to improving its taxpayer services programs and strengthening the administration of large enterprise groups. A consequence of the organization’s ad hoc evolution is that the administrative responsibilities have become increasingly fragmented across the SAT’s departments. The formulation of the SAT’s modernization strategy provides both an opportunity and a need for the SAT to review its existing organizational arrangements, with a view to achieving greater coherence and efficiency.

As a starting point, the SAT needs to identify the key aims of its modernization strategy and then ensure that they are appropriately reflected in its organizational structure. For example, if the strategy is intended to provide more customized administration to different taxpayer segments—large businesses, medium businesses, small businesses, and high-wealth individuals—then the organizational structure should provide a clear accountability for each key taxpayer segment. Similarly, if the strategy seeks to better protect taxpayers’ rights then it would be important to ensure that the SAT’s administrative review function is organized in a way that provides it with a high degree of independence from the rest of the SAT.

A second organizational imperative is to clarify the division of responsibilities for the main tax administration functions. On this issue, it is essential to eliminate the current fragmentation of administrative functions that currently exists across the SAT. This is particularly important for the audit function where several departments are authorized to conduct examinations.27 Similarly, the administration of national and local taxes needs to be better coordinated—for example, by setting up joint tax service halls, co-locating the service counters in the public service centers of local governments, or establishing liaison counters in the tax service halls of the national and local tax bureaus—to achieve greater efficiencies in administration and reduce compliance burdens for taxpayers.

The extremely small size of the SAT’s headquarters relative to its overall staff is a third organizational issue that needs to be addressed. The small headquarters creates a huge impediment to designing, monitoring, and supporting national tax administration programs as well as ensuring their consistent application. While these shortcomings were not a major problem when the economy and tax system were highly provincial-centric, the need for a larger and stronger headquarters has become more important as both have become increasingly national and international in scope. The best solution to this problem would be to gradually increase the number of headquarters staff over time. A second-best approach would be to designate certain municipalities as “centers of excellence” that, under the supervision of SAT headquarters, would be responsible for designing and implementing various national programs.

Along with strengthening headquarters, there is also a need to consolidate the more than 10,000 grassroots’ tax stations. While this wide office network provides convenience for taxpayers and allows close monitoring by tax offices, these advantages come at the cost of huge administrative inefficiencies (because the small tax stations are not conducive to specialization), difficulties in ensuring consistent administration, and risks of collusion (due to close contacts between taxpayers and tax officers).28 With the growing capacity of the SAT’s telephone contact centers and its electronic services, substantial efficiencies could be gained without significant losses in convenience and monitoring by consolidating smaller tax stations into larger ones, particularly in urban areas.

An additional organizational issue is the need to strengthen the administration of two critical taxpayer segments: large businesses and high-wealth individuals. Both of these segments account for a large share of tax revenue,29 have growing volumes of cross-provincial and overseas transactions, and deal with some of the more complex provisions in the tax laws. For these reasons, a strong organizational focus with a national span of control is required to manage their compliance.

For large businesses, the SAT took an important step toward strengthening administration with the creation of the Large Business Department in 2008. Despite this important reform, the department’s potential for safeguarding revenue and promoting the business climate has not yet been fully exploited because the department does not have full administrative authority over large businesses but instead shares its authorities with other SAT departments. This situation could be improved by expanding the Large Business Department headquarters’ authority in overseeing the provincial Large Business Departments.30 It would also help to vest the department with exclusive responsibility for auditing and issuing tax assessments to large businesses31 and to increase substantially the number of staff assigned to the department’s headquarters, provincial, and municipal departments.

For high-wealth individuals, the SAT has not yet created a special organizational focal point for this important group of taxpayers. Despite their increasingly national and international scope of activities, wealthy individuals are currently administered separately by each local tax office where they receive income. Consequently, the SAT cannot easily monitor their tax activities across provinces and overseas. This weakness could be addressed by creating a specialized high-wealth individuals’ unit similar to that of (and, possibly, incorporated within) the Large Business Department.32 This unit would be responsible for a range of tax administration functions for high-wealth individuals, including taxpayer services, risk assessment, and audit. It would comprise a centralized high-wealth individuals unit at SAT headquarters to oversee, coordinate, and provide technical support to high-wealth individuals units at the provincial or municipal levels.

Extending the SAT’s National and International Reach

China’s large size, diversity, and intragovernmental revenue-sharing regime has necessarily led to a decentralized system of tax administration. Under this system, taxpayers are administered separately in each province where they earn income, with insufficient coordination across provinces or, in some cases, even within provinces. This decentralized, provincial-centric approach is becoming increasingly incompatible with the growing number of enterprises and individuals with taxable activities that stretch across provincial borders and overseas.

On the domestic front, protecting China’s tax bases in the face of increasing cross-provincial transactions will require the adoption of a more national approach to tax administration.33 Such an approach depends on, among other things, three important preconditions: (1) a nationally standardized tax identification number, (2) a centralized database of taxpayer and third party information, and (3) effective organizational arrangements for coordinating the cross-provincial (and overseas) administration of taxpayers.

A nationally standardized taxpayer identification number is crucial to the creation of a national tax administration by tying together individuals’ and businesses’ tax-related information across locations as well as over time and in relation to other taxpayers. Recognizing this, the SAT is adopting a new identification number for enterprises as part of a whole-of-government reform to business registration. Similar effort will be needed to strengthen the identification system for individual taxpayers.

A second important precondition involves the creation of centralized mas2017-01-04ter-files34 of taxpayer and third-party information. Since it is not feasible, under current conditions, to immediately create such centralized information depositories for all enterprises and individuals, priority should be given to those taxpayers who are most likely to have cross-provincial and overseas income. Accordingly, the creation of national master-files should begin with large enterprises and high-wealth individuals since these persons tend to carry out more taxable activities in multiple locations than other persons.

A third prerequisite is to establish proper organizational arrangements for coordinating the administration of large enterprises and high-wealth individuals across different locations. As mentioned earlier, coordination could be improved by leveraging the SAT’s Large Business Tax Department and by creating a new, high-wealth individuals unit at headquarters and the provincial/ municipal levels.

On the international front, China’s large and growing volume (and complexity) of international transactions poses substantial risks to tax collection through cross-border base erosion and profit shifting (BEPS) by businesses and individuals. In addressing the international tax risks posed by businesses, a key priority involves implementing the package of 15 measures in the BEPS action plan that has been developed by the OECD and G20 countries (OECD 2015a). This will require introducing changes to China’s domestic legislation and the SAT’s administrative practices as well as tax treaty provisions. In making these changes, the SAT will give particular attention to the following BEPS measures:

  • Improve the transfer pricing rules—which govern the valuation of transactions within a multinational enterprise group—to better align the apportionment of profits across the entities in the group with the economic activities that generate the profits. This will require revisions to the SAT’s Implementation Measures of Special Tax Adjustments (Circular No. 2).

  • Introduce a country-by-country reporting regime that will require China-based parents of large multinational enterprise groups to file with the SAT an annual report containing tax-related information for each jurisdiction in which the groups do business and for the SAT to share this information with other tax agencies. Implementing this regime will require revising Circular No. 2 (referred to above) and signing the Country-by-Country Multilateral Competent Authority Agreement.

  • Incorporate anti-abuse provisions into China’s tax treaties with other countries. These will include adopting a new definition of permanent establishment (PE)—the existence of which entitles a country to tax the profits of a foreign enterprise—to prevent the artificial avoidance of PE status, for example, by replacing distributors with commissionaire arrangements. The SAT intends to introduce these changes through both bilateral renegotiations of China’s tax treaties and the adoption of a new multilateral instrument.

  • Improve the operation of the mutual agreement procedure (MAP), which is a mechanism that tax agencies use to resolve tax treaty-related disputes (typically involving double taxation) between taxpayers and tax agencies. The SAT will strengthen its capacity in this area by allocating additional resources—including personnel, funding, and training—to its MAP function.

In addition to above international issues, the SAT will also need to pay greater attention to the tax risks associated with the increasing overseas investments by Chinese enterprises, including those involving income shifting to foreign subsidiaries in low-tax jurisdictions, improper deferral of Chinese tax by claiming that income generated by their foreign subsidiaries is not subject to current taxation in China under China’s rules on controlled foreign corporations, improper claiming of foreign tax credits, and avoidance of Chinese tax by repatriating cash from controlled foreign corporations without recognizing dividend income. Controlling these risks will require changes in China’s tax legislation and strengthening the SAT’s international compliance programs.

In mitigating international tax risks posed by individuals, a crucial task will be to implement the multilateral and bilateral exchange of information agreements that China has entered into with other jurisdictions.35 These agreements require, among other things, foreign financial institutions to report to the SAT information and assets held by Chinese taxpayers (and Chinese financial institutions to report the same information on foreign taxpayers to foreign tax agencies). Putting these agreements into operation will require, among other things, translating their reporting and due diligence requirements into domestic law, creating the administrative and information technology infrastructure needed to collect and exchange information, and establishment of confidentiality safeguards on the use of the information.

Expanding the Use of Compliance Risk Management

Over the next five years, China’s tax system will face a range of new and complex compliance risks. Some risks, such as those discussed in this chapter, have already been identified; other risks not presently known may arise in the future. To safeguard revenue in an environment fraught with many complex risks, the SAT needs to fully develop a compliance risk management approach to tax administration.

In essence, compliance risk management provides a systematic approach to identifying and ranking the major tax compliance risks, developing a comprehensive set of treatments for mitigating the risks, and establishing a set of indicators to assess the treatments’ impact on the risks identified. Leading tax agencies typically develop compliance management strategies at three levels:

  • Tax level, by identifying the most material compliance risks facing each major tax (irrespective of market segment or industry)

  • Segment level, by identifying the major compliance risks that are prevalent to relatively homogenous groups of taxpayers (such as large, medium-sized, and small businesses, and high-wealth individuals) and, in some cases, for important industries within those segments

  • Taxpayer level, by evaluating the risk posture of individual enterprises and persons.

In recent years, the SAT has taken important first steps toward developing a risk management approach to tax administration. Beginning with the large taxpayer segment, the SAT has piloted the development of compliance management strategies at the taxpayer level.36 This assigns each taxpayer into one of three risk categories—high, medium, and low—and then applies different treatments depending on their risk level. Building on this, the SAT issued the SAT Opinion Concerning the Strengthening of Tax Risk Management Work in September 2014. This is intended to standardize tax risk management nationally by establishing uniform approaches for risk identification, rating and ranking risks, risk treatments, and evaluation and feedback.

In the period ahead, it will be important for the SAT to extend its risk management approach, beyond assessing the risks of individual taxpayers, to identifying and dealing with major compliance risks at the tax level and taxpayer segment level. In doing so, a separate compliance management strategy should be developed for each major tax (such as individual income, enterprise income, value-added) and major taxpayer segments within each tax (such as large taxpayers, high-wealth individuals, and small businesses). As an example, Annex 3.2 provides a high-level illustration of a compliance management strategy for a taxpayer segment (in this case, medium-sized businesses) that the IMF assisted in developing for another country’s tax agency.

To ensure appropriate headquarters direction and oversight, it would be useful to assign a senior headquarters official with the responsibility for designing and overseeing the implementation of each compliance management strategy.37 To facilitate coordination among the provincial tax bureaus, the SAT could establish a national compliance management steering committee, chaired by headquarters and including the tax heads of selected provinces, to approve the compliance strategies and coordinate cross-provincial activities (such as cross-provincial audits). To avoid conflicts and duplication of work, it would also be important for all departments to adopt a common risk management framework, which should be applied in a coordinated manner to cover all of the SAT’s compliance improvement activities (such as taxpayer services, audit, arrears collection, proposed legislative changes, and so on).

Enhancing Core Tax Administration Processes

The SAT’s core tax administration processes—including those involving registration, taxpayer services, audit, arrears collection, and dispute resolution—need to be enhanced to deal with emerging tax compliance risks and to exploit the new legal authorities that the SAT is expected to be granted under the planned amendments to the Tax Collection Law. It is also important to ensure that the administrative processes—and, hence, the tax laws—are applied in a more uniform matter across China than is currently the case so as to achieve a level playing field among taxpayers and to avoid distorting economic activities.

To this end, the SAT intends to upgrade its core tax administration processes in two stages by first standardizing the processes around the SAT’s current best practices and then by introducing a new set of innovative practices. The first stage was completed with the nationwide implementation of the National Tax Administration Standards (version 1.0) on May 1, 2015.38 The second stage will be guided by the National Tax Administration Standards (version 2.0), which is to be introduced over the next several years beginning with pilots at the national level in Jiangsu and local level in Henan provinces. In designing the new practices, the SAT could consider some of the suggestions that follow.

Registration

To reduce business compliance costs and facilitate exchange of information among government agencies, the government is adopting a whole-of-government approach to enterprise registration. Under it, four government agencies—the SAT, National Bureau of Statistics, Administration for Industry and Commerce, and the Quality and Technology Supervision Bureau—will adopt a single business identifier and a one-stop registration process based on the new 18-digit Uniform Social Credit Code. The new business identifier is to be issued by the Administration of Industry and Commerce. Most agencies are expected to adopt this new identifier by 2017.

Although the Administration of Industry and Commerce will be the custodian of the business identification numbers, the SAT has a very strong interest in maintaining the integrity of the identifiers given their importance in tax administration. To this end, appropriate governance arrangements need to be put in place to ensure that the SAT has a role in deciding on critical issues concerning the design, operation, and ongoing maintenance of the national identification numbering system. One possibility would be to create an interagency steering committee that would be responsible for reviewing and approving the system’s strategic direction, its key operational features, and infrastructure decisions. The SAT should have membership on and an important role in this steering committee.

For individuals, the SAT has not yet incorporated into its reform plans improvements in the registration process and identification numbers for self-employed and other natural persons. With the expected reform of the personal income tax and property tax as well as the tax information exchange initiatives that China is contemplating with other tax jurisdictions, it is imperative to strengthen the taxpayer identification system for individuals. This will require arrangements for introducing a nationally standardized identifier for self-employed persons (including individual industrial and commercial households), identifying and eliminating duplicate identification numbers for natural persons, and developing a centralized taxpayer register for individuals. These arrangements could usefully begin with high-wealth individuals—due to their extensive cross-provincial and international dealings—and gradually expanded to additional categories of individual taxpayers.

Taxpayer Services

Consistent with the government’s objective of reducing taxpayers’ compliance costs and promoting the business climate, the SAT has launched its “Spring Breeze Project.” This initiative has been designed to streamline frontline tax administration procedures, delegate decision-making authority to lower levels in the organization, and improve services for taxpayers—all with a view toward making it easier, faster, and cheaper for taxpayers to fulfill their tax obligations. In implementing the project, further gains in service delivery could be achieved by the following:

  • Benchmarking the SAT service offerings against those of leading tax agencies. Here, leading tax agencies have achieved substantial benefits by expanding the types of queries that can be handled by the telephone contact centers, making greater use of email and text messaging in taxpayer service delivery, introducing online applications (such as electronic registration, request to pay a tax debt in installments), and creating individualized taxpayer portals that allow businesses and individuals to have access to and self-manage their personal tax information and history.39

  • Migrating taxpayer assistance from relatively costly and burdensome in-person visits at tax offices to (less costly and more convenient) use of call centers and websites. This would require enhancing the range of online and phone services provided by the SAT as described above. Adopting a more centralized approach to service delivery would allow the SAT to achieve potentially large gains in administrative efficiency by reducing the large number of small tax offices whose main function is to provide basic services to taxpayers.

  • Preparing taxpayers for the anticipated changes to the business, individual income, and property taxes. The latter two reforms could add to the tax rolls large numbers of new taxpayers many of whom have little previous experience in paying taxes. A dedicated taxpayer services program will be needed to help these new taxpayers to understand and fulfill their new tax obligations.

Filing and Payment

The SAT has made good progress in reducing the time and effort in complying with the tax laws. Nevertheless, Chinese businesses still spend more time on tax matters than those in some regional competitor countries and far more time than in leading tax agencies. To promote the investment climate, additional measures are needed to further reduce these costs.

One important area for reducing compliance costs involves the VAT. The VAT is estimated to account for about 40 percent of business tax compliance costs. The high costs occur because the VAT administration in China requires more documentation, more reporting, more steps in the process, and more involvement of tax officers than in most other countries.

A number of actions could be taken to reduce these high compliance costs. A large amount of paperwork could be eliminated by simplifying the VAT return and its data requirements.40 Further cost reductions could be achieved by better aligning the SAT’s rules with commercial practices on the timing for crediting VAT paid on inputs.41 Perhaps the biggest gains could be made through technological improvements to the VAT computer system. In these and other areas, the SAT would benefit from consulting and co-designing the reforms with key external stakeholders, including industry associations, tax professional bodies, and software vendors.

A second promising area for compliance cost reduction is to further simplify the taxation of very small (micro) businesses. While the personal income tax law currently includes a simplified lump-sum payment regime for small businesses, many of its cost-reducing benefits have been eroded by requiring each small business to prepare an annual statement that the tax authorities use to determine the value of the lump-sum payments. This requirement adds substantially to the compliance costs of small businesses (that must prepare the annual statements) and the tax authorities (that must process large numbers of statements in setting the lump-sum assessment). These costs far outweigh the trivial amount of tax revenue that these small businesses pay—both individually and collectively—and thereby undermine the very purpose of a simplified regime.

To reduce the costs of the lump-sum regime, all micro-businesses could be subject to the same lump-sum payment regardless of their actual amount of sales or industry. This arrangement would eliminate the need for these businesses to file an annual statement and tax authorities to process the statements. Eligibility for the regime would be limited to very small businesses with sales below some very low threshold. Under this regime, the lump-sum payment(s) could be linked to and made a requirement for the issuance of an annual business license. While applying the same lump-sum tax to all micro taxpayers, as proposed here, would result in some inequities, this cost would be the price for greatly simplifying the system and, thereby, reducing its compliance and administrative costs.

As important as it is to reduce existing compliance costs, it is equally important to avoid increasing the cost of compliance from new reforms. This would be particularly important in reforming the personal income tax. Here, the SAT should seek to preserve, to the extent possible, the existing features of the personal income tax that help to minimize compliance costs for taxpayers and administrative costs for the SAT. These include maximizing the withholding of tax at source, minimizing the number of persons who are required to file tax returns, limiting deductions to those that can be easily incorporated into the withholding regime, and avoiding the introduction of expenditure-based tax allowances (such as allowances based on the amount of mortgage payments, educational expenditure, and charitable contributions).

Audit

To date, the SAT has relied heavily on cross-matching tax invoices between sellers and purchasers as the main vehicle for identifying and dealing with non-compliance. While invoice cross-matching appears to have helped bring under control the previous rampant incidence of fraudulent VAT invoices, it has been far less successful at mitigating other forms of underreporting that have plagued the VAT.42 Nor will the cross-matching of VAT invoices, by itself, mitigate underreporting of tax due for other taxes such as the corporate and personal income tax.

Reducing tax underreporting and safeguarding revenue will require the SAT to considerably strengthen its audit program beyond cross-checking invoices. Priority areas for enhancing audit capacity should include the following:

  • Making greater use of analytical methods. The growing amount of data that is becoming available to the SAT—and the additional amounts of third-party information that may become available with the planned amendments to the Tax Collection Law—provides a rich repository of information for developing analytical methods to detect emerging compliance risks and the taxpayers who pose such risks.

  • Improving basic audit methods. This will require auditors to be trained in and provided tools to examine the entire operations of a business, identify material issues and inconsistencies in the taxpayer’s accounts, and probe until these issues are resolved. As a starting point, the SAT should develop a nationally standardized audit manual setting out the methods for auditing each of the main tax types.

  • Adopting limited-scope audits. The SAT’s audit program currently relies on comprehensive audits covering multiple taxes, tax periods, and tax issues. Broader audit coverage could be achieved by making greater use of limited-scope audits covering one (or a few) taxes and tax issues.

  • Developing industry specialization. Like in other countries, revenue risks in China vary across industries due to differences in their contributions to tax revenue, relevant provisions in the tax laws, and compliance patterns. For this reason, the SAT’s audit program needs greater industry specialization, including by developing industry-specific audit technique guides and methods.

  • Introducing coordinated audits for large enterprises and high-wealth individuals. Given their complex and increasingly national (and international) scope of operations, the SAT will need to adopt a coordinated, cross-provincial approach to auditing these two taxpayer segments. It will also require the SAT to strengthen its international compliance programs in relation to outbound investment by Chinese residents.

Arrears Collection

International experience has demonstrated that tax arrears tend to increase, sometimes sharply, in countries that experience a significant slowdown in economic growth. In such situations, tax agencies need sufficiently strong powers, on the one hand, to recover tax arrears and, on the other hand, provide those viable businesses with good compliance histories appropriate breathing space to pay their tax debts. With China’s rapid economic growth slowing, it will be important to strengthen the SAT’s arrears collection powers and the administrative procedures for applying these powers.

In this context, the planned amendments to the TCL are crucial. These are expected to vest the SAT with the authority to allow taxpayers to pay their tax arrears over an extended period of time and to impose a tax lien on a tax debtor’s real property. In addition, the TCL should authorize the SAT to issue a default assessment against those taxpayers who fail to file a tax return. Key issues in each of these areas include the following:

  • Installment arrangements. The draft amendments to the TCL would extend the period taxpayers could pay tax arrears from three monthly installments (under the current law) to 12 monthly installments. Implementing this new provision would require the SAT to (1) develop administrative policy on the terms and conditions for granting an installment arrangement and design the administrative guidance for applying the policy, (2) prescribe the type of information that a taxpayer must provide to the SAT to support a request for an installment arrangement, (3) train collection officers in evaluating requests for an installment arrangement,43 and (4) set the level of management approval required to accept an installment request.

  • Tax liens. A lien is a legal encumbrance on an asset owned by a tax debtor that allows for the recovery of monies if the asset is disposed of. The lien is also a necessary legal step before an asset can be seized and sold to satisfy a debt. Implementing this provision would require the SAT to (1) develop administrative policy and guidance on when and how a tax lien may be imposed (and removed), including whether the lien may be imposed on an administrative basis or must first require certification of the debt by a court; (2) determine the types of property that may be subject to the lien; (3) train collection officers in identifying and locating properties on which the lien may be imposed, and the procedures for imposing (and removing) the lien; (4) determine the notification procedures and forms for imposing a lien; and (5) decide the level of management approval required before a lien may be imposed.

  • Default assessments. When a taxpayer fails to file a tax return, many tax agencies are authorized to use any reasonable method for determining the amount of tax owed by the taxpayer. In doing so, some tax agencies are allowed to use a previous period’s tax liability (plus an uplift factor) to establish the tax liability for the current tax period. Such a default assessment has the advantage of more quickly establishing the tax liability and thereby accelerating its collection than by auditing the taxpayer. Moreover, the issuance of a default assessment does not prevent the tax agency from eventually auditing a delinquent taxpayer if it is believed that the actual tax liability could exceed the default assessment.

Dispute Resolution

A well-designed system for minimizing disputes between taxpayers and the tax authorities, and for resolving disputes when they arise, is an essential element of an effective tax administration. Such a system can also help promote the business climate by reducing taxpayers’ compliance costs in their dealings with the tax agency. To this end, a number of measures could be considered for improving the SAT’s dispute resolution system:

  • As a first step, the SAT could reduce the potential for tax disputes by converting more of its informal guidance into formal regulations and providing greater detail in the regulations. Traditionally, the SAT has been lower-than-average issuer of formal regulations compared to other ministries and agencies (Cui forthcoming). By publishing more regulations—following public consultation—with greater detail the SAT could provide both taxpayers and tax officers with a clearer and more reliable basis for applying the tax laws, thereby promoting the rule of law and reducing the scope for disputes.

  • The draft amendments to the Tax Collection Law provide for the establishment of a private advance ruling regime. Such a regime allows taxpayers to request from the SAT a written ruling on how the tax laws apply to a particular fact pattern described by the taxpayer. Experience in other administrations—and feedback from stakeholders within China—indicate that such a service would be very popular by providing taxpayers with greater certainty on the application of the tax laws prior to making an important investment decision. Implementing this provision will require the SAT to design administrative guidelines and procedures governing its application.

  • No matter how clearly the tax regulations are publicized and how widely advance rulings are made available, disputes on the correct application of tax laws are inevitable. Therefore, ensuring the community’s confidence in the fairness of the tax system requires, among other things, an administrative review mechanism that is perceived to be fair and independent. This could be facilitated by creating within the SAT a network of administrative review units that report vertically to a higher-level administrative review unit instead of to the head of a higher-level tax bureau as is the existing arrangement.44 Although the current statutory framework for administrative reviews, which applies to all ministries, may limit the opportunities for reform in this area, the SAT may have scope to pilot in a few locations a quasi-independent review organ along the lines described here.

Strengthening Human Resources and Information Technology

Human Resources

Earlier human resource management reforms equipped tax officers with the skills required to deal with the most pressing challenges to the tax system in previous periods. Addressing the emerging challenges to the tax system will require further human resource management reforms. To this end, the SAT needs to formulate a comprehensive human resources management strategy to right-size the workforce, enhance staff skills, and improve the incentives for staff to achieve high levels of productivity and ethical behavior.

Right-sizing the workforce entails ensuring sufficient numbers of staff are allocated to the different levels of the organization and across administrative functions. One priority in this area should be to increase the size of the headquarters’ staff. With only 850 officials, headquarters is far too small to effectively carry out its functions—including designing national policies and programs, monitoring the operations of the tax offices, and providing guidance to the tax offices—in an organization comprising some 750,000 tax officers spread across 36 provincial-level tax bureaus.

Another right-sizing priority is to ensure sufficient numbers of tax officers are allocated to each tax administration function. Here, the SAT could usefully benchmark its staff allocation against the norms in other tax jurisdictions. In this connection, OECD tax agencies allocate, on average, 36 percent of their staff to verification activities (including audit), 27 percent to account management (including taxpayer services), 11 percent to tax arrears collection, 9 percent to other tax operations, and 17 percent to support and other activities (including 3 percent to human resources management).45 Notwithstanding some of China’s unique features, the SAT’s staff allocation would not be expected to diverge too sharply from international averages. Where it does, the SAT should carefully analyze the factors accounting for the divergence to determine whether they are justified or require correction.

Concerning staff skills, the SAT needs a strategy for identifying and prioritizing those areas for skills and knowledge enhancement. Such a strategy should begin with an evaluation of current skills levels against future requirements and then provide a plan for filling identified gaps. This approach is needed not only to enhance the capacity of SAT staff at dealing with current challenges, but also to prepare staff for implementing key reforms in the SAT’s modernization strategy.

In implementing its skills enhancement program, SAT headquarters should play a greater role in establishing the training priorities and standardizing course curricula, for which in the past the provincial training academies have been given wide discretion. In delivering training, the SAT could usefully exploit modern training technologies—including e-learning—to extend training opportunities to more staff.

In addition to right-sizing and enhancing the skills of its workforce, the SAT’s human resource management reforms also need to strengthen its performance management policies. Here, the SAT’s recent Digital HR initiative holds great promise. Under this pilot project, organizational units and individual staff members are now evaluated on the basis of a broader set of performance measures than just the revenue target. To create incentives for staff to achieve greater productivity and more integrity, the new performance evaluation system needs to be linked more closely to remuneration increases and promotions, and the pilot project should be implemented throughout the SAT.

Information Technology

The SAT has made impressive progress over the last 20 years in developing a standardized information system (China Tax Administration Information System) to support core tax administration functions and a specialized system (Golden Tax Project Phases 1 and 2) to control VAT invoice fraud. Further improvements will need to be made to the SAT’s information systems—including to its data stores, analytical tools, and technologies—in order to safeguard revenue and reduce compliance costs.

Although the China Tax Administration Information System has been deployed at all provincial and municipal levels, these subnational computer networks have not yet been tied together at the national level to create centralized databases of tax information. Consequently, the SAT cannot easily compile the type of national data that is crucial for evaluating the performance of its operational programs and field offices, conducting data mining and risk analysis, and tracking taxpayers’ activities across provinces and with related entities. To address these shortcomings, it will be essential for the SAT to create a national data center (or centers) of tax-related information as envisaged in the Golden Tax Project 3 that is to replace the China Tax Administration Information System, as described earlier.

In creating a national data center, the SAT will need to make decisions on a wide range of technological and non-technological issues. These include the number of data centers and their geographic and organizational placement, the types of hardware and software to acquire, the types of information to be collected, and the applications for processing the information and using it to detect noncompliance. Two prerequisites for data centers are the existence of a national taxpayer identification numbering system and robust legal authorities for the SAT to collect third-party information, both of which were described earlier.

Other information technology challenges concern the SAT’s specialized system for VAT administration. This system has been designed to certify and cross-match invoices between purchasers and sellers to detect fraudulent invoices. Although the SAT views the VAT system as having contributed significantly to the increases in VAT collections, it should also be recognized that the system imposes very high compliance costs on taxpayers. In addition to simplifying the information reporting requirements of the VAT return itself, two technological improvements could help reduce the VAT’s compliance costs.

First, the VAT system software should be designed to automatically extract the VAT information required by the SAT from companies’ internal accounting systems. As it stands now, businesses spend substantial time and resources in printing invoices, manually extracting information from their internal systems, and transmitting/receiving transactions-level data with the SAT. The costs associated with these tasks could be eliminated or, at least, greatly reduced by better aligning the SAT’s computer systems to the accounting systems used by businesses. This points to the importance of the SAT working in closer cooperation with other stakeholders—including tax professionals’ bodies, industry associations, and software vendors—in developing new versions of the VAT software.

Second, steps should be taken to facilitate the introduction of electronic invoicing (e-invoicing). International experience has shown that e-invoicing has the potential not only to substantially reduce businesses’ compliance costs with the tax system, but also to expedite commercial transactions and increase business competitiveness (Toro 2007). At this time, the SAT is at an early stage in deploying an e-invoicing system. To move this initiative forward, the authorities will need to establish a legal mechanism for authenticating electronic invoices (that is, an electronic signature) as well as establish a robust technological platform to operate the system. Such a platform will require major investments in software development and hardware, including highspeed Internet connection, wide-area communication networks with high transmission capacity, and robust applications and database servers. As in the case of the VAT system software, the SAT could achieve many benefits by developing the e-invoicing system in close cooperation with external stakeholders in the tax system.

Building a Modern Performance Measurement System

Traditionally, the SAT has relied on the annual tax collection target as a key measure for evaluating the performance of its tax offices. This measure has had the advantages of the close link to the government’s key fiscal objectives (mobilizing tax revenue) and its relative ease of measurement.

Despite its advantages, over-reliance on the collection target for measuring performance can have significant (negative) unintended consequences by creating perverse incentives for tax officers to take inappropriate actions to achieve their target.46 Not only does this risk undermining taxpayers’ confidence in the fairness and integrity of the tax system, but it can also have a negative impact on the economy by interfering with the operation of automatic stabilizers. That is, when the economy slows down and, as a consequence, tax receipts fall behind the collection target, tax officers will tend to intensify their actions to achieve the target. Such actions could put further pressure on businesses and worsen an economic downturn.

For this reason, the SAT should adopt a more balanced set of measures than the tax collection target for evaluating the performance of its tax offices. These measures could include targets for (1) tax administration results (with quantitative and quality measures for each tax administration function), (2) taxpayer satisfaction (typically measured by independent surveys), and (3) tax officer engagement (also commonly measured by a survey). The targets can be set at the organizational level (provinces, municipalities, districts, and so on) and then cascaded down to managers and tax officers as part of their individual performance evaluation.

Given its long history and well-entrenched use, the tax collection target is likely to remain a key performance measure for the SAT. To lessen its disadvantages, it would be important to supplement the collection target with a broader set of measures as described above. This would be facilitated by the nationwide deployment of the Golden Tax Project 3 computer system—which will give the SAT the capacity to compile national data on key tax administration operations—and the national implementation of the Digital HR pilot project as described earlier in this section.

Conclusions

China’s tax administration has reached an important juncture. Over the past 20 years, the SAT has successfully transformed its operations to administer a new tax system in an increasingly market-oriented economy. As China embarks on its 13th Five-Year Plan, the SAT once again needs to adapt itself to deal with a new and challenging environment.

The SAT’s capacity to mobilize tax revenue is facing growing challenges. The slowdown and structural changes in the economy are reducing the growth of China’s tax bases and creating incentives (and new opportunities) for tax avoidance and evasion. Further revenue pressure can be expected as Chinese businesses and individuals increase their overseas investments, creating additional scope for noncompliance.

In addition to safeguarding revenue, the slowing economy makes it more important than ever for the SAT to help promote the business climate by reducing business compliance costs. It also heightens the importance of creating a more even playing field across sectors and locations through more uniform tax administration.

While addressing the mounting challenges to the existing tax system, at the same time the SAT will need to implement the government’s ambitious tax reform agenda. This will require a major effort to train tax officers and educate taxpayers in applying the changes to the tax laws.

The above-mentioned challenges create a new and complex environment for tax administration much like the situation that confronted the SAT in the early 1990s. To effectively address these challenges, the SAT will need to implement a comprehensive modernization strategy just as it did 20 years ago. Key reforms priorities could include the following:

  • The Tax Collection Law should be amended to expand the SAT’s enforcement authorities and enhance taxpayers’ protections. Enforcement authorities should expand the SAT’s ability to access tax-related information from third parties and to recover tax arrears. Taxpayer protections should be enhanced by strengthening the confidentiality of taxpayer information, providing greater procedural protections to taxpayers, introducing an advance rulings regime, and eliminating the current requirement for taxpayers to pay 100 percent of a tax assessment before filing an administrative review.

  • The SAT’s organizational structure should be aligned with and supportive of its modernization strategy. This would entail increasing the size of headquarters, eliminating the current fragmentation of administrative responsibilities across different departments, consolidating the large network of grassroots tax offices, strengthening the organizational arrangements for large taxpayers and high-wealth individuals, and creating a more independent administrative review organ within the SAT.

  • Comprehensive compliance risk management strategies should be developed—for each major tax, each taxpayer segment, and individual taxpayers—to identify, rank, and mitigate the main risks to the tax system. These should give priority to mitigating the compliance risks associated with large businesses and high-wealth individuals, the growth of the services sector (including electronic commerce), international tax issues, and increasing tax arrears that could result from the slowing economy.

  • Core tax administration processes need to be strengthened and standardized. The SAT’s audit and arrears collection programs require strengthening while the information reporting requirements for the value-added tax and the tax assessment procedures for micro businesses should be simplified. In addition, a system needs to be established for monitoring tax offices’ adherence to the new national standards for the core administrative processes.

  • The SAT’s computer systems need to be both strengthened and made easier for taxpayers to use. Priority areas for strengthening include creating nationally centralized databases of taxpayer information (beginning with large enterprise groups and high-wealth individuals) and exchanging data with third parties. Simplifying ease of use should focus on reducing business compliance costs of the value-added tax computer system.

  • In the human resources area, key priorities should be to substantially increase the number of staff assigned to headquarters, ensure that appropriate numbers of staff are allocated to each tax administration function, align the SAT’s training programs with the requirements of its modernization strategy, and introduce human resource management policies that create incentives for staff to achieve higher productivity and greater integrity.

The initiatives suggested above represent an ambitious reform agenda that needs to be carefully managed. In doing so, the SAT can draw upon the lessons it has learned in reform management over the past two decades. These confirm the following good practices:

  • Strong and stable leadership is crucial to medium-term institution building. The stability in the SAT’s leadership has facilitated business continuity, coherence of direction, and effective reform management. These advantages need to be preserved.

  • In designing new tax legislation, due consideration needs to be given to the SAT’s administrative capacity and taxpayers’ compliance abilities. The planned amendments to the personal income tax, for example, should minimize the number of taxpayers required to file tax returns, maximize the withholding of tax at source, and limit deductions to those that can be easily incorporated into the withholding regime.

  • Implementing major tax administration reforms requires sustained efforts over a prolonged period. Such efforts are best guided by a medium-term strategic plan that clearly sets out the reforms’ goals and objectives, key initiatives, broad timetable, and measures of success.

  • Piloting major reforms prior to their national implementation has been an integral part of the SAT’s reform management. This approach has provided the SAT with many benefits—including minimizing risk, developing consensus, and providing opportunities for learning-by-doing—and should be continued.

  • The SAT has benefited substantially from technical cooperation with other tax agencies and international institutions. While international practices can provide useful reference points for reform, they need to be adjusted to the local conditions in China and implemented with these conditions in mind.

Annex 3.1. Organizational Chart of China’s Tax Administration

Annex 3.2. Illustrative Compliance Management Strategy for Small Businesses

article image
Source: IMF technical assistance report.Note: CIT = corporate income tax; EXC = excise tax; PIT = personal income tax; ROY= rest of the year; VAT = value-added tax; WHT = withholding tax.

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A longer version of the chapter can be found in “Tax Administration Reform in China: Achievements, Challenges, and Reform Priorities” (Brondolo and Zhang 2016). It benefited from insights and support provided by Jun Wang, Michael Keen, Juan Toro, Peter Barrand, Carlos Silvani, Raphael Lam, Alfred Schipke, Jian Fan, Tizhong Liao, Daoshu Wang, Yungen Gao, Wei Wang, Wei Cui, Yukang Wang, Li Liao, and Francisco González-Cos. The authors would like to acknowledge the efforts of many SAT officials, both active and retired, at modernizing China’s tax administration over previous decades.

1

Structural factors mainly involved: (1) the decreasing share of profits from (relatively highly taxed) state-owned enterprises (SOEs) to (more lightly taxed) non-SOEs; (2) a relative shift in value-added from goods to services, with the former having higher effective tax rates than the latter; and (3) an increase in the trade surplus, which reduced the tax base as exports are excluded (with some exceptions) from the value-added tax (VAT) base. Discretionary changes in tax policy involved: (1) transitional refunds that were provided to domestic enterprises and foreign-funded enterprises (in accordance with guarantees that their indirect tax burdens would not increase) when the new VAT was introduced in 1994, and (2) various tax incentives that were given to enterprises.

2

Rampant tax evasion and weak tax administration were also widely reported in the Chinese media in the late 1980s and early 1990s, including Xinhua General Overseas News Services (1988).

3

Prior to the 1994 revenue-sharing reforms, local governments were permitted to keep revenue above a stipulated amount. Under this arrangement, the amounts that local governments were to remit to the central government could be reduced by, for example, investing in local industries, offering tax exemptions, or placing resources in extrabudgetary funds that did not have to be shared with the center (Ahmad 2011).

4

These reforms were initially introduced in four pilot cities, then expanded to an additional 14 cities, and ultimately implemented on a national basis by the end of 2003.

5

Structural factors center on the increasing share of the relatively highly taxed industry and service sectors (including construction and real estate) and the declining share of the lightly taxed agricultural sector (OECD 2013).

6

Important tax policy changes included the 1994 expansion of the VAT base and the introduction of a new consumption (excise) tax (Lin 2009).

7

These include reports by OECD (2013), Lin (2009), and World Bank (2003).

8

The VAT compliance ratio is defined here as the ratio of actual VAT collections to an estimate of potential collections if taxpayers had fully complied with the provisions of the VAT law.

9

By comparison, the world average is 264 hours and the average for Asian and Pacific countries is 229 hours. Some countries have achieved lower times, for example: Australia (105 hours), Canada (131 hours), Denmark (25 hours), Singapore (82 hours), United Kingdom (94 hours), and the United States (175 hours). See World Bank 2015.

10

In December 2014, the SAT issued the Administrative Measures for the General Anti-Avoidance Rules (Trial). Under these rules, Chinese tax authorities are authorized to counter transactions deemed to have no commercial purpose other than avoiding tax by re-characterizing the transaction and denying the tax benefits. To avoid its abuse, the tax authorities may not initiate an anti-avoidance investigation until it is approved by the SAT headquarters; headquarters must also approve the final decision of an investigation.

11

Chapter VI of the Enterprise Income Tax law establishes the arm’s length principle for valuing related party transactions, the requirement for taxpayers to report related party transactions to the tax authorities, and the tax authorities’ power to adjust a taxpayer’s taxable income if the taxpayer fails to comply with the arm’s length principle.

12

Former SAT Commissioner Mr. Renqing Jin reported at a tax conference on information systems in August 2002 that the incidence of fraud-related activities was greatly reduced since the GTP2 system was fully introduced in mid-2001. For example, the detection rate of fraud-related invoices decreased from 8.51 percent in February 2001 to 0.06 percent in mid-2002.

13

GTP Phase 3 is scheduled to be deployed at all tax offices by the end of 2016.

14

Recent experience, in Western countries and China alike, provides evidence that taxpayer compliance tends to worsen in an economic and tight credit conditions. During the global financial crisis, noncompliance with the value-added tax increased in nearly all European Union countries and tended to worsen most where the output contraction was greatest (IMF 2015). In China, a study of close to 190,000 Chinese industrial firms (Cai and Liu 2009) found that corporate income tax evasion is negatively correlated with access to credit.

15

The State Council’s Development Research Center forecasts the service sector share of GDP to increase from its 2011–15 average of 47.6 percent to an average of 51.6 percent during 2016–20, while its share of employment is expected to increase from 42.0 percent to 47.6 percent over the same period (World Bank and Development Research Center of the State Council 2012).

16

In China, the new business models include both consumer-to-consumer transactions (such as the Taobao company) and business-to-consumer transactions (such as Alibaba, JD, and Tmall companies). In addition to selling goods, the new business models also deal in services such as “ride-sourcing” where a third-party facilitator arranges for a fee a driver who uses his/her car to transport passengers for a fare (such as Uber and Didi Kuaidi companies). For further information see Consulate General of the Kingdom of the Netherlands in Guangzhou (2015).

17

China’s stock of outbound direct foreign investment increased from 1.1 percent of GDP in 1990 to 6.6 percent of GDP in 2013 (UNCTAD 2015).

18

The underreporting can take a wide range of forms from individuals not reporting overseas financial income to Chinese tour operators that fail to report income earned from their overseas tours.

19

For example, the United States, which also operates a worldwide tax system, has encountered aggressive tax planning schemes that sought to repatriate overseas profits to the United States without causing a U.S. taxable event. This can be done by various schemes including by arranging for the foreign subsidiary of a U.S. company to purchase the stock of its U.S. parent, as part of a triangular reorganization, instead of paying the parent an outright dividend that would be subject to U.S. income tax (IRS 2006).

20

See The Significance of and Guiding Thoughts on Deepening the Reform Comprehensively as adopted at the Third Plenary Session of the 18th Central Committee of the Communist Party of China on November 12, 2013. Also refer to the Plan to Deepen the Fiscal Reform issued by the CPC Politburo on June 30, 2014.

21

The six headings are (1) streamline the division of responsibilities for tax collection and administration, (2) innovative tax service payment mechanism, (3) transform the tax collection and administration approaches, (4) proactively participate in international cooperation on tax matters, (5) optimization on the tax organizational structure, and (6) establish a joint governance mechanism for tax administration.

22

The blueprint has been approved by the Central Committee of the Communist Party of China’s (CCCPC) Leading Group of Deepening Reform and promulgated by the General Office of the CCCPC and the General Office of the State Council.

23

The tax laws in some countries vest the tax agency with the authority to require certain persons in highly noncompliant industries to report information to the tax agency on their payments to other persons in the industry. For example, some countries require general contractors in the construction industry to report to the tax agency payments to their subcontractors.

24

In other countries, the implementation arrangements for exchanging information with other government agencies is commonly set out in a memorandum of understanding between the agencies.

25

The procedural protections could include, for example, establishing standards and timelines for the tax authorities to issue notices to taxpayers and decide on an administrative review.

26

Interest should accrue in favor of the tax agency on the percentage of the tax liability not paid by the taxpayer and in favor of the taxpayer on the amount of the tax liability paid to the tax agency, depending on the outcome of the dispute.

27

Responsibility for the audit function could be allocated as follows: (1) the tax bureaus should examine individuals, small businesses, and medium-sized businesses; (2) the Large Business Department should examine large businesses; and (3) the Inspection Bureaus should investigate serious violations of the tax laws, including those involving fraud and evasion.

28

See IMF 2015 for a description of the disadvantages of too large a network of local tax offices and the potential benefits from streamlined office networks.

29

The SAT estimates that the largest 45 large enterprise groups account for about 22 percent of the SAT’s tax collection while another 300–400 enterprise groups are estimated to account for an additional 20 percent of SAT revenue. In 2012 the top 10 percent of households accounted for about 50 percent of market income and a somewhat lower share of personal income taxes (based on data from the National Bureau of Statistics of China and China Household Finance Survey).

30

An intermediate step may be to arrange for the Large Business Tax Departments in a small number of large municipalities to fall under the direct management of the headquarters’ Large Business Tax Department in the same way that some the large enterprise groups in Beijing are administered.

31

Ideally, the municipal-level Large Business Tax Departments would be designated as a “bureau” in which case they would operate as a separate tax office (with a broad set of administrative authorities for large businesses) instead of one of several “departments” within a municipal tax bureau (with lesser authorities) as is currently the case.

32

Because high-wealth individuals often have significant ownership stakes in large businesses, some tax agencies place their high-wealth individuals unit within the large business department.

33

The need for a national approach to tax administration will be further amplified by the authorities’ plans to reform the personal income tax by replacing the current schedular system (where different income categories are taxed under separate schedules) with a more comprehensive system (where some income categories—including those earned in different provinces—are aggregated and taxed under a common schedule).

34

A taxpayer “master-file” refers to a database of tax-related accounts information for each taxpayer (type of taxes that they are liable to pay, frequency of filing and payment, amounts of tax paid and owed, assessment of additional tax, interest, penalties, and so on).

35

China signed the Multi-lateral Convention on Mutual Administrative Assistance in Tax Matters on August 23, 2013, and on December 16, 2015, ratified the Multi-lateral Competent Authority Agreement on automatic exchange of information. China also entered into an agreement in substance to the bilateral exchange information with the United States in relation to the United States Foreign Tax Account Compliance Act on June 26, 2014.

36

In addition to large businesses, the SAT is piloting the development of risk management strategies for other taxpayer segments in Jiangsu and Henan provinces.

37

For example, for each major compliance risk, the Australian Taxation Office assigns a senior executive as the “risk owner” with overall responsibility for overseeing the management of a particular risk and another senior official as its “risk manager” with responsibility for the risk’s day-to-day management in terms of coordinating the rating of the risk, developing the risk mitigation strategy, formulating operational plans for implementing the risk mitigation strategy, and monitoring the strategy’s impact on bringing the risk under control.

38

These standards unified the processes for 612 tax administration matters under 11 major categories, 152 subcategories, and 1,087 forms and certificates.

39

Refer to OECD 2010 for relevant benchmarks.

40

For example, Chinese taxpayers may need to file up to two VAT returns (the main return and export refund return) and more than 10 appendices with up to 800 data fields every month—which imposes far greater compliance costs than most other VAT countries, including China’s regional competitors. See Ernst and Young (n.d.) for a further description of the complexities of China’s VAT and opportunities for reducing compliance costs.

41

Under current arrangements, a taxpayer is not able to claim an input VAT credit unless it has actually received the VAT paper invoice and has had the invoice formally verified by the tax authorities. Hence, an unverified input VAT invoice cannot be credited on a taxpayer’s VAT tax return even though it has most likely been booked in the taxpayer’s accounting system. This disconnect in timing between a taxpayer’s accounting system and the SAT’s VAT system results in large variances that require businesses to undertake substantial manual interventions to adjust (Ernst and Young n.d.).

42

Examples include failing to charge VAT on final sales to consumers, failing to submit VAT tax returns and pay VAT despite issuing VAT invoices, improperly classifying a taxable transaction as exempt, improperly charging VAT at a lower rate, sham invoices for transactions that have not taken place (including sham invoices issued by bankrupt companies in collusion with taxpayers claiming credit on the basis of these invoices), incorrectly deducting VAT input tax from exempt sales, and structuring transactions to gain a tax advantage in a way that was not intended in the law (aggressive tax planning).

43

The evaluation should include an ability to pay analysis, which is a detailed assessment of the taxpayer’s current and future capacity to pay or borrow funds based in part on the financial statement prepared by the taxpayer.

44

Administrative reviews are currently heard by an administrative review organ at one level within the SAT organization above that where the dispute has arisen, Although this arrangement provides some degree of independence, it still creates a perception of bias in favor of the tax authorities since the administrative review organ reports to the head of a (higher-level) tax bureau who has an interest in achieving a collection target and thereby in sustaining lower-level decisions, particularly in those cases involving substantial amounts of tax revenue.

46

For example, by encouraging auditors to issue inflated audit assessments when tax collections are falling behind the target or encouraging taxpayers to incur tax arrears in current periods (which can be paid in subsequent periods) when collections are exceeding targets.

Other IMF Content

Other Publishers Content

Cover Modernizing China
Modernizing China
Investing in Soft Infrastructure
Author: Mr. Waikei R Lam, Mr. Markus Rodlauer, and Mr. Alfred Schipke
ISBN:
9781513539942
Publication Date:
14 Jan 2017
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781513539942.071
Pages:
388

State Budget Tax Revenue to GDP and Share of Total Revenues (1990-2014)

(Percent)

Value-Added Tax Compliance Ratio

(Percent)