Foreign ventures dodging tax through paper losses

PUBLISHED : Monday, 04 November, 2002, 12:00am
UPDATED : Monday, 04 November, 2002, 12:00am

Thousands of foreign-invested ventures in China evade tax by reporting false losses, transfer pricing, inflating their production costs and under-reporting the price of their final product, an official newspaper said yesterday.

At the end of last year, China had approved 380,000 foreign-invested companies, of which nearly 250,000 had started operating, with an actual investment of US$370 billion.

The China Business Times quoted official figures as showing that, between 1988 and 1993, 35 to 40 per cent of these firms reported losing money, with the figure rising in 1993 and 1994 to between 50 and 60 per cent. From 1996 to 2000 the figure was 60 to 65 per cent.

It quoted the chief of the anti tax-evasion division of the National Tax Bureau as saying that, while some ventures actually lost money, a substantial number used transfer pricing and artificial methods to record a paper loss and transfer their profits offshore.

The most common method, accounting for 60 per cent of all types of tax evasion, was inflating the cost of production equipment, raw materials, components and labour and under-reporting the cost of the final product, to reduce the profit or leave no profit at all.

Another method was to create a loss by importing into China less capital than promised and to rely for working capital on high-interest loans from companies abroad that are related to the venture and paying them interest on the money, as a way to direct the profit abroad.

According to conventional economics, if a company loses money, it should shut down. But a third of the foreign-invested ventures had reported losing more and more - but kept expanding the scale of their business here.

One of the biggest sources of foreign investment into China, especially in the Pearl River delta, is the Virgin Islands.

Many of these firms are based in Taiwan and go there to avoid inspection from their own government and to avoid taxes in China.

Other ways to avoid tax are to turn a joint venture into a wholly owned company, in which staff of only one firm are reading the accounts, and paying everything in cash, popular with family firms and small companies.

A major factor facilitating evasion is China's lax regulatory and enforcement system for tax collection, which lags far behind such jurisdictions as the United States, Japan and Hong Kong.

Regulation is complicated by overlapping and often conflicting departments and local governments who want to retain foreign investors and do not want to move against them.

The collectors too are handicapped by poor enforcement procedures and lack of evidence, unless it is volunteered by a member of the public.