Contract scam cuts taxes on flat deals
Mainland statistics can be notoriously inaccurate. But when it comes to the property market, the wild disparity between official data and reality has less to do with Beijing fudging the numbers than a so-called 'yin yang' contract subterfuge designed to avoid taxes.
Real estate experts describe a widespread illegal practice between buyers and sellers that dramatically understates transaction prices.
It is a scheme that robs the government of revenues and yet one that officials are reluctant to crack down on for fear of spooking the property market.
In the middle of last month, Beijing released a report saying that home prices in 70 cities, including new and second-hand homes, rose 7.8 per cent year on year in December.
Despite what appeared to be a modest annual increase, policymakers were seriously concerned, voicing fears of a bubble in the property market. They tightened mortgage lending, increased the level of customer deposits that commercial lenders must keep on reserve with the central bank and cut preferential tax treatment on properties offered last year.
They had reason to be worried, likely knowing the official figures were wildly off-base.
In reality, property consultants said home prices in the secondary, or resale, markets of big cities such as Shanghai grew more than 60 per cent and Shenzhen 80 per cent last year because of high demand and strong liquidity.
'The existence of the yin yang contracts is the real reason behind' the disparity, said Zhang Jian, a lawyer at Dacheng Law Offices' Shenzhen branch who is experienced in dealing with legal disputes on the resale of homes.
'[The mainland government] does not deliberately understate the growth pace, but weak enforcement has led to decades of abuse.'
Yin yang contracts refer to the practice of sellers and buyers signing both a 'public' and a 'private' contract on the same second-hand property in order to evade taxes on gains from the sale.
The contract with the real sales price of the property is signed under the table and kept by both the buyer and the seller. They submit a fake document which states a much lower transaction value to the land bureau.
Industry players describe these two contracts as yin yang - the Chinese philosophy to explain the opposing forces of darkness and light.
Using yin yang contracts is a fairly easy process, arranged by property agents, said a Hong Kong fund manager who in December last year bought a 120 square metre second-hand unit in Futian for 1.8 million yuan (HK$2.05 million).
'I submitted the real contract to the bank for mortgage arrangement and reported to the land bureau with a contract, which was 1.1 million yuan, just 75 per cent of the 1.5 million yuan the seller paid a few years ago,' he said.
'It was all recommended by the agent,' the fund manager said.
The fund manager is happy to follow the agent's guidance. Home sellers on the mainland usually pass on all transaction costs - even taxes - to buyers. So buyers end up paying lower taxes.
Li Wenjie, the general manager at Centaline Property Agency's Beijing office, believes first-hand property transactions reported by developers are much more accurate.
First-hand property deals are homes bought directly from developers, while second-hand homes refers to resold properties.
Developers, especially those listed on stock exchanges, will not understate transaction prices as it would affect their revenue. Also, it is easier for the government to trace the real selling prices, Li said.
'But the whole process of reporting data and compiling data takes time, resulting in a few months' lag, and that cannot reflect the changing market conditions,' Li said.
In the secondary market, it is hard for the government to collect correct data because of the yin yang contracts, he said.
The widespread understatement of official growth rates was confirmed by another set of official figures on property sales revenues announced two weeks ago.
The National Bureau of Statistics reported 4.4 trillion yuan in property sales for last year, a 75.5 per cent year-on-year growth rate. But sales as measured by floor area, not price, expanded only 42.1 per cent, according to the bureau. That significant difference in growth rates suggests a big increase in property prices.
Under law, the resale of second-hand properties will be subject to personal income tax, which is levied at a rate of 20 per cent of the gain.
After paying personal income tax, sellers are also required to pay business tax of 5.5 per cent on the transaction gain if the sale occurs within two years of purchase.
However, sellers will pass on all the tax charges to buyers, who are also required to pay other costs, such as a stamp duty, a deed tax and bank service charges.
Excluding the business tax and personal income tax, the other costs account for about 4 per cent of the purchase price, Zhang said, adding that home-buying costs are high.
'The overall transaction costs will jump to 7 per cent [of the entire transaction price] in my case if I report a real transaction price,' said homebuyer Mr Chen, who bought a unit in Chaoyang district in Beijing two years ago.
Chen, who works for a firm in Hong Kong, said he reported to Beijing's land bureau that the transaction price was 800,000 yuan. The price he paid was 1.4 million yuan.
'Such tax-avoidance arrangements have long been practised. It is an open secret,' Xavier Wong, the director and head of research for property consultant Knight Frank's Greater China division, said.
In Shanghai, some buyers adopt another method to avoid taxes.
'For example, on a unit transacted at two million yuan, they will write a transaction value of 1.5 million yuan, plus a furnishing fee of 500,000 yuan, in the official contract to the government,' an industry source said. 'The tax department only levies taxes based on property values. No tax is levied on decorating and furnishing.'
The yin yang contract deception is well known among government officials.
Last month, Guangzhou said it would introduce a guideline under which the government will investigate property transactions where prices are 15 per cent lower than the government's valuation.
In 2007, Shenzhen said it would adopt property evaluation as a basis for charging the seller a 20 per cent tax on the profit made from the sale of the house.
The evaluation price takes into account indicators such as location and age of the property. The Bureau of State Land and Resources at that time said the policy would effectively solve the problem of the yin yang contract.
But Samuel Kong of Midland Realty's Shenzhen branch said enforcement was not actively imposed in the city's centres such as Lowu, Futian, Yantian and Nanshan. District governments adopted this system but the government valuation was lower than the market value, Kong said.
Zhang said enforcement was weak in many cities that had introduced such evaluation offices.
'The local governments have no incentive to implement the enforcement because an increase in personal income tax charges may hit property sales volume and the overall market sentiment,' he said. 'It will hit land sales. That will directly hit their revenues.'
Income tax on each deal increases, but total tax income will fall as overall sales volume declines because of weaker buying desire.
Wong said the malpractice has long existed in the market, but more accurate data reflecting the huge increases in prices could lead to a jump in overall economic data. And the central government may not want to see that.
Zhang said the yin yang contracts have resulted in rising legal disputes between buyers and sellers. Buyers sometimes insist that the contract reported to the government was the real one.
As a result, the case will be brought to court, and the transaction will be cancelled or sellers are required to pay tax from the sale.
'There are no tough penalties for people who report fake transaction figures to the government, and that encourages the malpractice,' Zhang said.
In a move to cool the market, the central government has ended the special tax break on property resales. Last year, a 5.5 per cent business tax on the capital gains from the transfer was imposed on those who sold their property within five years of purchase. But from January 1, that has been cut to two years.
But Zhang said buyers and sellers are not concerned with the changes.
'They are not supposed to make any gains under the yin yang contract practice,' he said.