VAT invoice trafficking defies death and taxes

PUBLISHED : Tuesday, 04 January, 2011, 12:00am
UPDATED : Tuesday, 04 January, 2011, 12:00am

It's a crime punishable by death on the mainland yet some enterprising businessmen think ripping off the taxman is worth the risk.

To be precise, entrepreneurs have made a business out of trafficking invoices generated by the mainland's value-added tax (VAT). Since 1994, a sales tax of up to 17 per cent has been levied on the added value to a product, material or service at each stage of manufacturing or distribution.

The upshot is the VAT is now the single biggest source of revenue. In the first nine months of last year, tax authorities collected 1.5 trillion yuan (HK$1.76 trillion) from VAT - 27 per cent of the country's total tax intake.

VAT invoices are particularly important to companies operating in the mainland because they can be used to offset taxes.

It is unclear how much tax revenue is lost to the government each year through the fraudulent trading of VAT invoices but anecdotal evidence suggests the practice is widespread, relatively open and performed by what appear to be professional invoice traders. The office of this newspaper in Shanghai receives about 10 faxes a week from dealers offering to sell VAT and other types of invoices - at a discount. The offers do not disclose any names but usually provide a mobile-phone number. 'This can help your company to save at least 90 per cent taxation,' one recent faxed offer promised.

Robert Li, China tax partner at international accounting firm PricewaterhouseCoopers, said providers of fraudulent VAT invoices fell into two camps: unethical entrepreneurs who have forged invoices to sell; or owners of financially troubled companies seeking additional revenue by selling their own legitimately acquired VAT invoices.

Whatever the case, 'the practices are all illegal', Li said. The culprits would face 'harsh penalties' if they were caught.

Perpetrators risk at least a jail sentence, and even the death penalty if the case is deemed to have cause serious enough damage to the tax system. An intermediate court in Anhui province sentenced a businessman, Sun Zhanyun, to death in 2005 for faking VAT invoices, which he sold to other businesses, according to the Xinhua news agency.

Sun and his partners falsified VAT invoices worth 67 million yuan. Authorities recovered much of the tax owed, but Xinhua said the fraud ultimately cost the government 7.9 million yuan in foregone revenue.

The State Administration of Taxation had stepped up investigations of tax fraud and uncovered several cases involving very large amounts, according to a spokesman.

He added that details of the cases would be made public soon to demonstrate the government's resolve in cracking down on such illegal practices.

'VAT tax fraud has been curbed in the past few years due to intensified supervision and an upgraded technical system' that better tracks invoice issuance, the tax office spokesman said. 'It is now increasingly difficult for unethical businesses' to use the VAT regime to cheat the tax system.

Other countries, including Germany and France, impose VAT, but global accounting firms say the illicit trading in invoices in those countries is rare because of more advanced collection and monitoring.

'I would say China is the only market in the world that has rampant VAT tax trades,' said Steven Feng, a partner with accounting firm Deloitte, adding that he doubts the practice can be 'totally rooted out in the near future'.

One businessman's account of how he turned to trafficking in VAT invoices offers a peek into this underground scheme of tax dodging. The Shanghai-born businessman, who asked not to be identified, started a business assembling and selling personal computers in the late 1990s. He had several good years as mainlanders became more affluent and the rising popularity of the internet spurred the sale of PCs and computer parts.

Then his profit margins began to shrink because of cutthroat competition. Desperate for cash, he hit upon the idea of selling his own VAT invoices generated from buying computer parts from suppliers, ironically after being questioned by the tax authorities about why his business generated so many incoming VAT invoices from suppliers but so few outgoing invoices to customers.

According to the way the VAT works, participants are taxed all along the supply chain. Typically a business receives VAT invoices from suppliers, then when the finished product is sold, the business issues VAT invoices to the buyer of the finished product.

The invoices are printed, endorsed and distributed to corporate taxpayers by the authorities. The value of the VAT invoices issued by suppliers, in this case for the purchase of computer components, is measured against the value of the VAT invoices issued to customers who buy the finished product, in this case a PC. The difference between the two values is considered to be the value added, and therefore subject to 17 per cent tax.

When the Shanghai businessman buys components from a supplier, it generates a VAT invoice. Because he purchases computer parts in large lots, the value of each invoice can be worth tens of thousands of yuan.

But most of his customers are individuals who do not need VAT invoices because they are not useful in offsetting personal tax bills. The invoices are, however, very useful to companies generating big incomes that are subject to the 17 per cent value-added tax. And they can help reduce the amount of tax a company has to pay under the mainland's 25 per cent corporate tax rate by overstating its costs.

After comparing what he could earn by trafficking in VAT invoices with the paper-thin margins his computer-selling business was producing, the businessman decided he could make more selling - even at a discount - the 'extra' VAT invoices issued to him by suppliers that his customer
.s did not ask for. 'I sold 10,000 PCs while only 3,000 customers asked for the invoices,' the businessman said, 'so it was nothing wrong for me to issue another 7,000' to companies who wanted to pad their own accounts for tax purposes.

Meantime, he has started underreporting his actual PC sales, which gives him excess incoming VAT invoices from his suppliers to sell because it makes it look like he added less value to his finished products than he actually did. That, in turn, reduces the amount of VAT he owes the government.

An added bonus is that by underreporting his sales he also understates the amount of profit subject to the 25 per cent corporate tax rate. Plus, the businessman pockets 100 per cent of the income from the invoice sales because, obviously, the authorities are not supposed to know about his illicit sideline.

'All the good days have passed,' the businessman said about his teetering legitimate computer sales business. 'We can't survive without this diversification' into invoice trading, from which he said he expects to reap millions of yuan a year.

'Had it not been for the questioning from the tax authorities, I wouldn't have come up with this,' he said, adding that 'as long as no police knock at your door, you win'.

Income stream

VAT is the mainland's single biggest source of revenue

The sales tax levied on the added value to a product, material or service at each stage of the supply chain is: 17%

Taxing scheme

It is unclear how much revenue is lost through invoice trafficking

In the first nine months of last year, VAT amounted to 1.5 trillion yuan, or this percentage of the total tax intake: 27%

Risky Business

2001 Shanghai-based Fengxiang Trade found to have fabricated 12,000 VAT invoices to obtain rebates worth 100 million yuan.

2003 A Beijing court sentences Chen Xuejun to death for falsifying 2,800 VAT invoices to help businesses dodge 390 million yuan in taxes.

2004 A Henan court sentences Zhang Mi and Zhan Xizeng to death for faking 400 million yuan of invoices.

2005 Chen Zhourong sentenced to death for trading 1,700 false VAT invoices in Hangzhou. His business partner receives a suspended death sentence.

2009 An Anhui court sentences Sun Zhanyun to death for faking 67 million yuan worth of invoices.

2010 A Lanzhou court jails Li Ghuangjian for 15 years for selling