Tax assignment system

Prior to 1994, China’s tax assignment system was based on a combination of tax separation and revenue-sharing approaches. Under it, certain taxes were designated as central government revenue and a portion of revenue from other taxes as local government revenue with the remainder allocated to a pool of shared revenue. Most of the latter was apportioned according to complex formulas stipulated in fiscal contracts between the central and local authorities (IMF, 1994). It was believed that the combination of fiscal contracting arrangements and the influence of local governments on tax administration contributed significantly to the sharp decline in central government share of total revenue in the early 1990s as was shown in Table 1.

To increase both total revenue and the central government share, the government introduced a new intra-governmental revenue system in 1994. It abolished the complex contracting schemes and replaced them with a more transparent (and easier to administer) tax assignment arrangement for central and local governments. Among the major taxes, the central government was assigned all revenue from the consumption (excise) taxes, customs duties, and international trade-related tax on VAT and consumption taxes. Shared taxes include domestic VAT (75 percent central, 25 percent local), enterprise income tax (60 percent central, 40 percent local), and personal income tax (60 percent central, 40 percent local). All remaining taxes are allocated to local governments including, most importantly, the business turnover tax on services, social security contributions, and stamp duties on real estate transactions.

Substantive tax laws

Tax laws in the early 1990s suffered from a lack of equity (different treatment applicable to different types of taxpayers and transactions), inefficiency (rate structure encouraging some types of investment over others), and administrative complexity (many taxes, multiplicity of rates and bases). To address these problems, major taxes were comprehensively restructured on January 1, 1994 with further reforms introduced in subsequent years. Importantly, the tax policy reforms included a number of provisions that have facilitated tax administration.

The tax policy reforms in 1994 (and in subsequent years) greatly simplified the tax system by reducing the number of taxes and converting many fees to taxes. China’s 35 different taxes in the early 1990s were reduced to 18 today (including both central and local government taxes). This simplification has both lowered administrative costs for the SAT and reduced compliance costs for taxpayers.

For direct taxes, the previous domestic income taxes on enterprises with different forms of ownership were merged in 1994 into a uniform income tax for all domestic enterprises. They were later unified with the separate income tax for foreign-funded enterprises through the enactment of the 2008 Enterprise Income Tax Law. This law includes important administrative provisions: most importantly, a set of specific anti-avoidance provisions¹⁰ and a general anti-avoidance rule.¹¹ Taken together, the provisions are powerful tools for addressing international tax risks, though improvements are needed in some provisions to deal with emerging challenges from China’s international dealings.

Personal income taxes also underwent a major reform in 1994 with the enactment of a new law that applies to both Chinese and foreign nationals, thus replacing the previous separate personal income tax laws on Chinese taxpayers and foreigners. The current personal income tax law has preserved a number of important administrative provisions from the old law. These include imposing tax on individuals (instead of families), applying withholding regimes to many income categories, permitting few personal deductions, and restricting the requirements for filing a tax return.¹² These provisions greatly simplified tax administration and, by doing so, have reduced administrative and compliance costs. At the same time, the system’s highly schedular nature—where 11 different categories of income are subject to different rate schedules—continues to complicate administration and creates opportunities for taxpayers to evade tax by illicitly reclassifying income to lower taxed categories.

Indirect taxes also experienced major simplification in 1994 and thereafter. In 1994, a broad-based VAT—covering production, wholesale and retail trade, and imports—with only two rates and few exemptions replaced the previous VAT (with 12 rates) and product tax (with over 150 rates). In subsequent years, the VAT underwent further reforms including allowing the crediting of VAT paid on purchases of capital goods (2008) and gradually extending the VAT to selected services (beginning in 2012 and continuing through today), which had been previously taxed under a non-creditable turnover tax (the business tax). Excises and business taxes were also restructured and simplified in 1994 while about a dozen minor taxes were eliminated.

China’s VAT has been designed with its administrative requirements taken into account. In line with good international practice, the VAT provides relatively high registration thresholds to restrict the number of VAT registrants to a level consistent with the tax authorities’ administrative capacity.¹³ More unusual from an international perspective, the issuance of VAT invoices is subject to very tight control and checks by the SAT, and many exporters are entitled to receive a refund on their export sales at less than the statutory 17 percent rate. While both provisions reflect the government’s understandably high concern with VAT fraud, it is also important to recognize that their reportedly high compliance costs are negatively affecting the business environment.

Tax Collection Law

A third element in the legal framework for tax administration is the Law on the Administration of Tax Collection (commonly referred to as the Tax Collection Law) which was enacted in 1992. This law is critical to the operation of the tax system in that it provides the SAT with the legal authorities for administering the substantive tax laws (on VAT, enterprise income tax, and so on).

Prior to the Tax Collection Law’s enactment, tax administration was governed by various tax statutes, administrative orders, and regulations whose scope and legal standing were unclear. The weak and often undefined legal framework hampered tax administration in a number of ways as market reforms gained steam in the 1980s and 1990s:

• First, the inadequate enforcement powers left the tax system vulnerable to tax evasion, resulting in large revenue losses to the government.

• Second, the lack of clarity in the tax laws allowed local governments and tax officials to apply the laws arbitrarily—including by illicitly providing exemptions and other tax preferences to local enterprises—often at the expense of central government revenue (Phillips 1996).

• Third, tax officers were frequently subject to physical violence as they carried out their duties in an environment where many new taxpayers lacked knowledge of the tax laws and some aggressively resisted paying taxes.

• Finally, the absence of an administrative review process left taxpayers with little recourse for resolving disputes with tax officers.

To improve this situation, the Tax Collection Law was enacted to establish in a single law the common administrative provisions that apply to all of China’s substantive tax laws. Among other things, this law sets out broad provisions for each tax administration function (such as registration, record keeping, filing and payment of taxes, auditing, penalties, and appeals), vests the tax authorities with various enforcement powers, defines the rights and obligations of taxpayers, and provides dispute resolution mechanisms. The Tax Collection Law has helped significantly to clarify the legal foundation for tax administration, but requires updating to address emerging challenges to the tax system as discussed in Section V.

Tax collection responsibilities

Prior to the 1994 fiscal and tax reforms, the central government did not have strong control of the tax administration. Instead, the provincial tax bureaus and their subordinate tax offices were subject to a dual-reporting system. On the one hand, the tax bureau directors were accountable to the SAT for tax administration and tax policy implementation; on the other hand, these officials were appointed by, and dependent on local governments for budgetary support, staffing, and promotion policies (World Bank, 1990).

The absence of a strong national tax administration was a major factor in the decline in the central government share of revenue in the early 1990s. As mentioned in Section II, the influence of local governments on tax administration often gave priority to the collection of local taxes over central government taxes. The unclear legal framework for tax administration, which local governments could exploit to provide exemptions and other tax preferences to designated enterprises, exacerbated this tendency.

To deal with this problem, the government in 1994 created two separate tax agencies, in one of China’s most sweeping organizational reforms in tax administration:

• A National Tax Service, which collects central government taxes and most taxes shared by central and local governments.

• Local Tax Services, which collects local government taxes and some shared taxes, including the personal income tax, in each jurisdiction.

Figure 3 shows the current division of responsibilities among the SAT, local governments, the National Tax Service and the Local Tax Service. As can be seen, China’s tax administration comprises a five-tier organization consisting of (1) SAT headquarters, (2) provincial tax bureaus, (3) municipal tax bureaus (broken down into districts and other subordinate units), (4) county tax bureaus (outside of the municipalities) and district tax sub-bureaus (within the municipalities), and, (5) tax stations (also referred to as tax offices or branch offices). This same hierarchy applies to both the National Tax Service and the Local Tax Services.

View Full Size

Organizational Chart of China’s Tax Administration

Citation: IMF Working Papers 2016, 068; 10.5089/9781475523614.001.A001

• Download Figure
• Download figure as PowerPoint slide

According to this set up, SAT headquarters has direct (solid line) authority not only for overseeing the tax administration operations of the National Tax Service tax bureaus but also for appointing, promoting, and providing budgetary resources to the bureaus. It has also shared (dotted line) authority with local governments for overseeing the Local Tax Services tax bureaus. Under this arrangement, the SAT is responsible for monitoring and supporting the Local Tax Services’ operations while local governments are responsible for appointing and promoting officials as well as resourcing the offices.

The separation of collection responsibilities, as described above, was intended to tighten central control over national taxes. This was to be achieved by vesting the National Tax Service with full and exclusive authority over the collection of central government (and most shared) taxes. In this way, the scope for local governments to influence tax collection would be limited to local government taxes. Together with the new tax assignment system, the creation of separate national and local tax services has helped bring about the intended increase in the central government share of revenue that has been achieved since 1994 (see Figure 1).

Size and structure

A defining characteristic of China’s tax administration is its large size and geographic footprint: the SAT is the world’s largest tax agency by the number of staff and offices.¹⁴ Both its size and structure present major challenges to effective tax system management.

Size. The national and local tax services together comprise some 750,000 staff in more than 30,000 locations (Table 7). 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.

Table 7.

Number of Organizational Units and Staff by Level of Administration

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

Table 7.

Number of Organizational Units and Staff by Level of Administration

	Number of Organizational Units		Number of Staff
SAT headquarters	1		850
	National	Local	National	Local
Provincial-level	36	35	13,286	13,416
Municipal-level	353	332	63,580	60,777
Counties and districts	3,020	2,584	212,049	141,651
Tax stations	10,151	16,729	101,171	145,812

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

View Table

Table 7.

Number of Organizational Units and Staff by Level of Administration

	Number of Organizational Units		Number of Staff
SAT headquarters	1		850
	National	Local	National	Local
Provincial-level	36	35	13,286	13,416
Municipal-level	353	332	63,580	60,777
Counties and districts	3,020	2,584	212,049	141,651
Tax stations	10,151	16,729	101,171	145,812

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

Consistent administration 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 head office (IMF, 2015b), SAT headquarters has been allocated only about one-tenth of 1 percent of the organization’s staff (Table 7).¹⁵

While economies of scale generally allow the headquarters of large tax agencies to function effectively with a smaller proportion of staff than smaller tax agencies, a headquarters still needs a critical mass of staff to carry out its core functions regardless of the overall size of the organization. Lacking this, the SAT has had to adopt practical (but often less efficient and less uniform) approaches to managing the national tax system. For example, the SAT has frequently allowed the provincial tax bureaus to develop their own operational programs and then worked to achieve a consensus among provinces to adopt one of these programs as the national standard. This has resulted not only in duplication of design and investment but also in differences in administration across jurisdictions.

Structure. Each of the five tiers in the SAT organization, as depicted in Figure 3, have distinct functions. The SAT’s headquarters office is mainly responsible for designing and overseeing the implementation of national tax administration policies. It also has shared responsibility with the Ministry of Finance for formulating tax policy and drafting new tax legislation. The provincial, municipal, and county/district levels are primarily responsible for planning, monitoring, and supporting their subordinate offices. Most operational activities for tax administration (such as registering taxpayers, providing assistance, collecting tax returns, auditing taxpayers) take place at the grassroots level under the direction of the counties and districts. These grassroots units comprise specialized tax service halls, tax offices, inspection bureaus, and call centers.¹⁶

In carrying out its functions, SAT headquarters has adopted a hybrid organizational structure (Appendix 1). The provincial, municipal, county and district offices are organized largely in the same way. Under the SAT’s hybrid organization, staff is assigned to units based partly on tax type (e.g., goods and services, income tax, property tax), partly on type of taxpayer (e.g., large business), and partly on type of administrative function (e.g., audit and taxpayer services). This form of organization has given the SAT the capacity to design administrative programs and monitor the tax system from different lenses (such as tax, taxpayer, and administrative function), which is an important advantage in a highly dynamic environment like China. On the negative side, hybrid structures can lead to lack of coherence and overlapping responsibilities as highlighted in Section IV.

At the grassroots level (below the county and district bureaus), the SAT’s tax offices have undergone major changes in their organizational structure since 1994. Prior to that time, tax office staff were assigned a set of taxpayers for whom they were responsible for performing a range of tax administration functions, including: receiving and reviewing tax returns, responding to queries, auditing, and dealing with tax arrears. The inherent inefficiencies of this tax manager system, due to the lack of staff specialization, rendered it unsustainable in coping with the huge increase in the taxpayer population that resulted from the shift toward a market economy.

To achieve the administrative efficiencies needed to manage a growing taxpayer population, grassroots staff in many locations were reorganized into units based on tax administration function (such as processing tax returns, taxpayer services, and audit). This function-based organization allows tax officers to develop specialized skills in different administrative functions, which is crucial to achieving higher rates of productivity.

Today, most grassroots tax offices have adopted the function-based system, particularly in the more economically developed areas. Other tax offices, mainly in less economically developed locations, continue to use the tax manager approach because they have insufficient numbers of staff need to create specialized units or because it is felt that the low compliance levels in these locations requires a one-on-one relationship between tax officers and taxpayers. But even in these locations, improvements in the tax manager system have been made, including by rotating the assignment of taxpayers to tax officers.

One of the more recent and important organizational reforms has been the creation of the Large Business Department in 2008. The rationale for this reform was that by providing large businesses with a higher degree of scrutiny and a higher level of service in their tax affairs, the department would increase revenue collection and improve the investment climate.¹⁷ The department’s creation has helped advance both objectives: tax collections from large businesses have increased by 70 percent over the department’s first three years of operation ¹⁸ and large businesses, in a taxpayer satisfaction survey, have expressed a high degree of satisfaction with its services.¹⁹ Nevertheless, the Large Business Department’s full potential has not yet been realized due to its small size (at both headquarters and the field offices) and limited responsibilities as later in Section V.

Registration

The registration function records key background information on each taxpayer and the taxes that they are liable to pay. It also assigns a unique identification number to each individual and business registrant. Such numbers play a crucial role in tax administration, particularly in an automated environment, by linking a person’s tax-related information over time and across taxes as well as to other related and non-related persons.

In the early stages of China’s tax administration reforms, taxpayer registration was highly cumbersome and inefficient for both enterprises and individuals. Enterprises were required to register separately with at least four different agencies (1) the Administration for Industry and Commerce for business licensing and regulatory purposes, (2) the Quality and Technology Supervision Bureau, (3) the National Bureau of Statistics for statistical purposes, and (4) the SAT for tax purposes. Each followed different registration procedures and issued separate identification numbers. For individuals, different provinces (and jurisdictions within provinces) adopted different identification numbering schemes that applied both to self-employed persons with business income and individuals with wage and salary income. The creation of separate national and local tax services added further burdens because the two tax services used separate registration processes and, in some cases, different identification numbers.

Since 2004, the SAT has taken important steps to simplify tax registration with the issuance of the Administration Measures of Tax Registration instruction. Under this, both the national and local tax services have adopted a common business identification number based on the organization code issued by the Quality and Technology Supervision Bureau.²⁰ They have also adopted the national identification number, issued by the Ministry of Public Security, as the identifier for individual wage and salary earners. In addition, businesses now need to register for tax purposes only once with either a national or local tax bureau which have coordinated their registration activities. Together, these simplifications have streamlined administration and reduced the compliance costs for businesses.

Despite the progress in streamlining tax registration, enterprises continue to face the burden of registering their activities with separate government agencies. And the current practice of issuing separate business identification numbers to each of an enterprise’s branches complicates the development of a whole-of-enterprise picture of its tax affairs. For individuals, the registration system is hampered by duplicate numbers issued by the Ministry of Public Security and the absence of a common identification number for self-employed persons (including individual industrial and enterprise households). Further improvements in the registration system will be needed to address these weaknesses and strengthen the administration of the tax system as discussed in Section V.

Taxpayer services

In the early 1990s, the SAT provided taxpayers with a limited range of services and assistance with their tax affairs. Tax returns differed across jurisdictions, instructions often only repeated the complex language in the tax laws, and taxpayers had to visit the tax offices in person to fulfill many of their tax obligations and seek assistance. The absence of an effective taxpayer service program became increasingly problematic as the restructuring of the economy was accompanied by the creation of large numbers of new businesses many of which had little knowledge of their tax obligations and how to fulfill them.

This situation began to change in the mid-1990s when the SAT recognized taxpayer services to be a basic tax administration function and made their improvement a priority. Following the 2001 amendments to the Tax Collection Law—which established a legal obligation for the tax authorities to assist taxpayers with their tax affairs—the SAT has made a concerted effort to enhance its service offerings by improving face-to-face access; implementing electronic services (including electronic filing and electronic payment options); and creating telephone call centers.

Beginning in 1997 and continuing throughout the 2000s, the SAT invested substantially in creating a large network of taxpayer services halls throughout the country. These provided taxpayers with face-to-face assistance in registration, tax return filing, payment, invoice purchase and submission, and general tax law and procedural questions. In 2001, the SAT launched the tax service hotline (Hotline #12366) and created a network of call centers to answer taxpayers’ inquiries on tax procedures, tax law, and other questions. This new service channel has greatly facilitated compliance by allowing taxpayers to get assistance on tax matters without having to visit a tax office.

To raise the organizational focus for assisting taxpayers, the SAT in 2008 created a specialized Taxpayer Services Department at its headquarters and soon thereafter set up taxpayer service divisions at the provincial level and below. By the end of 2013, this top-down service organization comprised over 9,775 taxpayer services halls, 70,516 multi-function tax service counters, 70 provincial-level call centers, and 70 provincial, as well as some municipal, websites.²¹ The creation of a dedicated taxpayer services organization within the SAT has provided the organizational focal point needed to deliver an effective taxpayer services program.

In 2014, further technological improvements to the taxpayer services function were introduced with the development of a mobile tax application and the opening of official accounts on the two dominant social media sites (Weibo and WeChat). Through these sites, taxpayers can now receive tax information on a timelier and more convenient basis. Tax officials also use text messaging to provide a range of services such as reminders about upcoming tax deadlines and information on important tax matters. In 2013, the Chinese tax authorities had sent 86.4 million SMS messages to taxpayers.

In line with good international practice, the SAT has established a performance measurement system for its taxpayer services program. As part of it, the National Bureau of Statistics has been engaged since 2008 to conduct taxpayer satisfaction surveys every two years. The steady increase in the survey scores, as Section II shows, has revealed that the SAT’s service levels have been gradually improving over the last several years. In the last 20 years, it is clear that the SAT has evolved into an organization that gives the services function a high priority.

Filing tax returns and paying taxes

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-SOEs) 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. Once the tax return was accepted, the tax officer would prepare a payment form for the taxpayer to submit to the bank for processing.

As China’s economic restructuring proceeded, the inefficiencies of the administrative assessment system were found to be incompatible with a tax system in an increasingly market-oriented economy. In particular, the requirement for tax officers to either prepare tax returns for SOEs or review each return prepared by non-SOEs left the SAT struggling to keep up with the increasing workload that resulted from the rapid growth in the taxpayer population. In addition, the cursory reviews that tax officers performed on the tax returns were found to be insufficient at identifying the growing incidence and more complex forms of tax evasion. And the close one-on-one interactions between taxpayers and tax officers created opportunities for collusion.

To improve this situation, the SAT decided to replace the administrative assessment system with the modern self-assessment system by which taxpayers are now required to prepare their own tax returns and make their own payments without the direct involvement of tax officers. Under it, tax authorities accept tax returns at face-value, subject to ex-post arithmetic checks and selective audits based on risk-management principles.

Because it was felt that not all taxpayers had the capacity to self-assess their taxes, the SAT first piloted the new system with those taxpayers who could most easily adopt it (such as those with bank accounts) and then gradually extended self-assessment to additional categories of taxpayers. Today, the old administrative assessment system is limited to those self-employed persons who do not meet the criteria for establishing company accounts as stipulated in the Provisional Regulations for the Establishment of Company Accounts for Self-Employed Businesses. These taxpayers are subject to a simplified tax regime where the tax administration sets a fixed amount of tax to be paid at fixed periods based on the taxpayer’s location and scope of operations.

Consistent with good international practice, the SAT took a number of steps to facilitate the introduction of self-assessment. Tax returns were standardized, electronic filing and payment options were introduced, and a computer system was developed to process the tax returns and maintain the accounts of the amount of taxes paid and owed by each taxpayer. Crucially, the SAT made huge investments in improving its taxpayer service programs, as described previously, to enable taxpayers to self-file and self-pay their taxes.

The filing and payment reforms have led to a steady reduction in compliance costs for taxpayers and greater administrative efficiencies for the tax authorities. The number of tax payments that companies have to make each year was reduced from 35 in 2004 to 7 in 2013. Over the same period, the take-up rate for electronic filing increased from 40–50 percent of total tax filings to 80 percent on average across China and to 90 percent for some large cities, like Shanghai and Beijing (Mui, 2015).

As a result of the filing and payment improvements (and other reforms), the amount of time an average medium-sized company spends on tax matters was reduced from 832 hours in 2004 to 261 hours in 2013 (World Bank, 2015b), bringing China in line with the world average of 264 hours. This is still more than the average for Asian and Pacific countries (229 hours) and well above the levels achieved by leading tax agencies.²² These ratings suggest that while the SAT has made significant progress in reducing compliance costs in recent years, ample room remains for improvement.

Audit

Before the economic restructuring and emergence of the private sector, tax auditing was a fairly simple task. The taxpayer population was relatively small, which allowed the tax authorities to audit a large proportion of tax returns without requiring sophisticated systems for identifying high risk taxpayers. Similarly, audits focused on verifying that a small number of large SOEs had transferred revenue to the correct government accounts, which did not require strong auditing powers or robust audit methods. Auditing was made even easier because, in many cases, tax officers either assessed the amount of taxes for the taxpayer or provided detailed guidance on the assessment (Casanegra, 1992).

Tax auditing became much more challenging with the advent of a market-oriented economy and the introduction of a new tax regime. As was mentioned earlier, the restructuring of the economy and tax system was accompanied by a substantial increase in noncompliance by both SOEs and private businesses (JEN, 1993). The SAT’s audit program was ill-equipped to deal with noncompliance of this magnitude and needed to be considerably strengthened to protect the tax bases.

In response to this changing environment, the SAT introduced a number of reforms to modernize its audit program. These began with the enactment of the Tax Collection Law in 1992 which included provisions that vested tax authorities with broad audit powers. This reform was followed in 1997 by the creation of a national network of Inspection Bureaus (from headquarters down to the county and district levels) to examine serious violations of the tax laws. More recently, provincial tax bureaus have removed their inspection bureaus from the county levels (and below) and placed them at the municipal level (and above) to better concentrate their resources. They have also assigned large audit cases to higher level inspection bureaus (at the municipal and provincial levels).

These efforts have produced gradually improving audit results over the last 20 years. Evidence of the improvements can be seen in the sharp increase in the amount of taxes assessed by audits, which has increased from ¥41.9 billion in 2000 to ¥116.4 billion in 2010, and ¥185.6 billion in 2014. Further, the number of audit cases that have yielded ¥10 million or more in tax revenue has increased nearly eightfold since 2003 (Table 8). These results reflect improvements in the SAT’s audit strategy, including its audit selection systems and audit methods.

Table 8.

Number of Audits with Recovered Tax Revenue of ¥10 Million or More

Source: SAT Annual Report, 2014.

Table 8.

Number of Audits with Recovered Tax Revenue of ¥10 Million or More

	2003	2005	2010	2014
Number of cases	101	92	242	792

Source: SAT Annual Report, 2014.

View Table

Table 8.

Number of Audits with Recovered Tax Revenue of ¥10 Million or More

	2003	2005	2010	2014
Number of cases	101	92	242	792

Source: SAT Annual Report, 2014.

Notwithstanding these improvements, the SAT’s audit program still requires much further strengthening if it is to effectively deal with the increasingly complex forms of noncompliance in an increasingly complex economy. A standardized, risk-based system for selecting taxpayers for audit has not yet been developed (instead, different locations have developed their own audit selections systems), resulting in differentiated treatment of taxpayers in different locations. A detailed audit procedures manual has not been developed for auditors. Consequently, audits still tend to be conducted in a perfunctory manner; often focusing on a simple clerical verification of the company’s books and records. Such superficial audits rarely detect the issues that result in large losses of tax revenue. Critically, the audit function is split across a number of departments (Inspection Bureaus, Large Business Department, Income Tax Department, Indirect Tax Department, and the International Tax Department) resulting in the lack of a unified approach to examining taxpayers and an inefficient duplication of work.

Dispute resolution

In the early 1990s, the dispute resolution process was not governed by formal institutional arrangements and procedures. Where disputes arose, taxpayers would seek to resolve them mainly through informal discussions with the same tax officers within the tax administration whose acts were the subject of the dispute.

With the growth in the private sector and a growing incongruity of interests between taxpayers and the tax authorities, it became increasingly necessary to develop a more formalized dispute resolution system. Such a system is particularly important in China where the tax authorities tend to have more discretionary powers than their counterparts in OECD countries. This is the case, in part, because Chinese tax legislation tends to be broadly worded allowing the tax administration greater discretion in applying the law (Li, 1993).

An important step in formalizing the dispute resolution process was taken when the SAT issued the Rules of Administrative Review of Tax Matters in 1991. These rules were later extended and codified in the Tax Collection Law, and refined through subsequent amendments to the administrative review rules.²³ Together, the TCL and administrative review rules have created two formal mechanisms for resolving tax disputes: (1) tax administrative reconsideration within the tax authorities and (2) tax administrative litigation in the courts.

Under the administrative reconsideration, taxpayers are given 60 days to file an objection to a specific administrative act that was carried out by the tax authority. For disputes involving the assessment and payment of taxes, taxpayers are required to first seek to resolve the dispute through administrative review and, in doing so, fully pay the tax according to the decisions by the tax authorities before the administrative review may be heard. In such cases, taxpayers must exhaust the administrative review process and, importantly, satisfy the tax payment requirement, before appealing to a court.

The administrative reconsideration is conducted by the tax agency at one level above the tax agency whose action is the subject of the dispute.²⁴ The reconsideration process has been institutionalized within the SAT through the creation of administrative review organs in the tax office’s legal department at each level of administration. These are responsible for hearing administrative review cases as well as representing the tax authorities in any subsequent litigation before a court.

Under tax administration litigation, taxpayers can seek to resolve some types of tax dispute by appealing to a people’s court. To contest a prior tax administrative reconsideration decision, a taxpayer must file the appeal with an appropriate court within 15 days of the receipt of the decision. In those (limited) circumstances where a taxpayer can contest an administrative act without first completing an administrative reconsideration, an appeal must be filed within 3 months of the time of the administrative action that is the subject of the appeal that has been taken.

Despite the availability of a formal dispute resolution mechanism, Chinese taxpayers generally do not rely on administrative or judicial reviews to contest tax agencies’ actions as frequently as taxpayers in other countries. For example, in 2011 only 473 administrative reviews and 166 tax litigation cases were finalized. By comparison, there were much higher numbers of administrative and judicial reviews in the following OECD countries: 24,513 in Australia, 50,485 in Canada, 8,463 in Japan, 56,228 in the United Kingdom, and 142,553 in the United States in the same year (OECD, 2015a).

Several factors may account for the low number of formal tax disputes in China. These could include the perceived benefits in maintaining a non-adversarial relationship with the tax authorities, the perceived low probability of prevailing against the tax authorities in formal proceedings, and the burden of having to first pay a tax assessment before contesting it compared to the alternative of negotiating a smaller tax payment without the formal proceedings. Other relevant factors could be the extensive opportunities for taxpayers and tax officers to interact with each other—including both to reach an ex ante understanding on the application of the tax law or an ex post settlement of a dispute through bargaining—that is afforded by China’s highly decentralized tax administration (Cui, 2015).

To the extent that the low number of review cases may indicate that taxpayers lack confidence in the fairness and independence of the dispute resolution process, the SAT is exploring various measures to promote the rule of law, improve the process including by revising the Tax Collection Law as described in Section V.

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).²⁷ 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 last several years, Chinese businesses still spend more time in 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 (refer to Section III.D). 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 sharp increase in electronic commerce.

Regarding services, this sector is expected to continue to grab a growing share of the economy.²⁸ 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, 2015), many of whom 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 (HWIs) 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, it had yet to develop 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 the United States, United Kingdom, Japan, Germany, and France 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 on-line platform and charges a fee, arranges a sale of a good or service between a producer and consumer of a good or service.²⁹ The boom in e-commerce and new business models will confront the SAT with the challenges of identifying on-line 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 non-residents are taxed on income only from 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 (as shown in Table 6), the nature of the international tax risks that it faces is changing. 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,³⁰ and various aggressive tax planning schemes.³¹ 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.³² 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.

Organizational stresses

The SAT’s current organizational and staffing arrangements, which have evolved incrementally over the last 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 continues 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 its 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.

Along with the internal challenges the SAT could also leverage a number of opportunities to advance tax administration reform. Crucially, the stability in its leadership—particularly among its commissioners and deputy commissioners—has provided a continuity in reform leadership 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.

The SAT will need to take into account both its challenges and opportunities as it formulates a modernization strategy for the next five years, which we turn to in the next section.

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 (AIC). Most agencies are expected to adopt this new identifier by 2017.

Although the AIC will be the custodian of the taxpayer identification numbers, the SAT has a very strong interest in maintaining the integrity of the numbers 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 inter-agency 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 processes and identification numbers for self-employed and other natural persons into its reform plans. 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. ⁵¹

• 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 will 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

As mentioned in Section II, 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. As noted in Section IV.A, 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. ⁵² 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.⁵³ Perhaps the biggest gains could be made through technological improvements to the VAT computer system as described in Section V.H. In these and other areas, the SAT would benefit from consulting and co-designing the reforms with key external stakeholders, including industry associations, tax professionals 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 (who must prepare the annual statements) and the tax authorities (who must process large numbers of statements in setting the lump-sum assessment). These costs far outweigh the trivial amount of tax revenue 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 (PIT). Here, the SAT should seek to preserve, to the extent possible, the existing features of the PIT 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 (e.g., allowances based on the amount of mortgage payments, educational expenditures, 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 noncompliance.⁵⁴ 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.⁵⁵ 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:

• 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 differ 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 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, sometime 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 Tax Collection Law 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,⁵⁶ 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 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 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.⁵⁷ 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.

Human resources

Earlier human resource management (HRM) 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 HRM 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 800 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 30 provinces.

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).⁵⁸ Notwithstanding some of China’s unique features, the SAT’s staff allocation would not be expected to diverge too sharply from the 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, 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 HRM 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 as described in Section V.H. 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

As described in Section III.F, 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 1 and 2) to control VAT invoice fraud. Further information 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 assessing the 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 which is to replace the China Tax Administration Information System, as described earlier.

In creating a national data center, the SAT will need to take 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. As mentioned in Section III, 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 not only has the potential 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 (i.e., 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 high-speed 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.