Tax-evading businesses beware: the Inland Revenue Department is drawing a bead on sloppy bookkeeping, suspect tax-planning arrangements, and companies that pay too little and too late. And its aim is improving all the time. In the assessment year to March this year, for example, the Field Audit Group's special unit handling audits on tax avoidance unearthed an average of $13 million in understated profits for each case it completed. That is a big jump from the unit's first six months, from October 1995 to March 1996, when it found an average of $3.2 million in understated profits per case. Obviously, IRD investigators are getting better at fingering the worst corporate deadbeats. 'They're getting more buck for their bang,' said Philip Hung Wan-tak, a senior manager of tax services at accounting firm PricewaterhouseCoopers. Catching tax dodgers is becoming an increasingly urgent task because, as the Financial Secretary, Donald Tsang Yam-kuen, pointed out last week, Hong Kong's tax base is shrinking. About 80 per cent of profit-tax revenue comes from only 5 per cent of all taxable business entities. And as the revenue base shifts from land-related sources - 31.7 per cent of profit-tax revenue comes from the property sector - the need to diversify the tax base will increase. 'The situation is serious,' Mr Tsang said. 'We have to look at broadening our tax base to find other stable sources of revenue.' One way to increase revenue, without introducing new taxes, is to step up compliance. And a prime time for the tax man to check compliance is when a company lists on a public stock exchange. In fact, the Field Audit Group's tax-avoidance unit was set up, at least in part, to unmask tax-planning arrangements put in place in tandem with public offerings, according to Mr Hung, who worked in the IRD's Investigation Unit in the late 1980s. Section 61A of the Inland Revenue Ordinance nullifies the tax benefit of any transaction whose 'sole or dominant' purpose is to reduce or avoid taxes, but companies have been quick to realise that listing arrangements can provide an alternative 'dominant' purpose and so serve as cover for underlying tax-planning arrangements. Not surprisingly, the IRD has got wise to this practice. 'The IRD said: 'If we look at the [company's listing] prospectus, then we'll know exactly what the [tax-planning] arrangement is',' Mr Hung explained. So as more companies list their shares - five have begun trading on the Growth Enterprise Market since its launch on November 25 - they also tip their tax-planning hand, and Hong Kong's tax authorities stand ready to pounce on any cheats among them. The IRD is beefing up its staff of sleuths, doubling its tax-avoidance unit in October by adding a second team. An even bigger change will occur in April, when all 23 teams in the Field Audit Group and the Investigation Unit - and the total of 199 professional staff working in them - are merged into a single entity in the Investigation Unit. Currently, the Field Audit Group, with its two anti-avoidance teams and eight regular field-audit teams, is administered separately as part of the IRD's Headquarters Unit. The Investigation Unit has 13 teams, of which two focus on prosecutions. Alice Lau Mak Yee-ming, acting deputy commissioner, says the new, consolidated arrangement will foster efficiency and flexibility. 'If we think more investigations are warranted, then we might move a few audit cases into the investigation unit,' she said. 'If there is a very blatant case that has the potential for prosecution, then we will take it up with the prosecution team.' This represents a significant shift in practice because the Field Audit Group and the Investigation Unit have divergent histories and investigative styles. The Investigation Unit is the older of the two, having been established in 1976. It goes after complicated cases, and its investigations can be lengthy, usually at least six months but sometimes as long as five years. Interviews, which can take in anyone from the taxpayer's relatives to his banker, are usually conducted at the IRD's own offices. Cases come to the Investigation Unit via referrals from inside the IRD or other governmental departments. Informers figure heavily, too - with tip-offs typically coming from angry spouses, jilted girl-friends or boyfriends, and disgruntled employees. The Field Audit Group dates from 1991 and was launched as part of a plan to boost voluntary compliance ahead of the introduction of self-assessment. Under self-assessment, taxpayers figure their own tax liability and enclose a cheque with their return. This has long been the practice in the United States and has recently been introduced in Britain, but it is still just a glimmer in the tax commissioner's eye in Hong Kong. Self-assessment was expected to liberate IRD staff from having to make simple checks on many returns, allowing them instead to focus on more-detailed checks on fewer returns. Investigations undertaken by the Field Audit Team originate from the taxpayer's own submissions and tend to be shorter than the Investigation Unit's cases, running anywhere from two weeks to three years. Interviews are often done on the taxpayer's own premises - thus the term field audit - and can include anyone from the lowest clerk to the person flogging Ferraris to members of the board. The Field Audit Group was originally expected to target taxpayers at random; however, it soon became apparent that flagging specific practices could boost the hit rate tremendously. By narrowing its focus, the Field Audit Group manages to find 'discrepancies' on more than 90 per cent of the returns it investigates. The IRD hopes that by putting the Investigation Unit and the Field Audit Group under the same administrative roof, it will be able to capitalise on the strengths of both investigative styles and save money at the same time. The 91 professional staff in the Field Audit Group each pulled in an average of $11.8 million in back taxes and penalties last year, outpacing their 108 colleagues in the Investigation Unit, who each brought in an average of $9.9 million. By making it possible to shift cases more easily from one unit to the other, the IRD can hope to boost its return on costs. Where does that leave companies considering whether to list their shares? Like every other Hong Kong taxpayer, they face a more efficiently staffed overseer. Unlike every other taxpayer, however, they also face greater disclosure. Remember, the IRD reads prospectuses just as carefully as potential investors do. Things that might have gone unremarked in a private company - such as founder shares that automatically entitle a particular shareholder to a percentage of profits, or related-party transactions that operate on a wink and a handshake rather than solid documentation - simply will not fly when the time comes to go public. Sometimes it is enough to call in the lawyers and tax advisers to draw up clearly written inter-company agreements. Sometimes it is enough to do a voluntary tax filing to eliminate a ticking time bomb from the company's books. But sometimes the only solution is to wind up the old company and start over. 'When it's a private company, people may be less concerned about the outcome [of a challenge by the tax authorities] because ultimately it only affects the small group of private proprietors of the company,' said David Smith, a tax partner at accounting firm KPMG. 'But if you've got a public company and you've got a huge [tax] exposure, it's going to affect a whole lot of outside shareholders.' One situation that crops up with small and medium-sized companies in Hong Kong that have manufacturing operations on the mainland is the improper use of offshore companies, typically incorporated in the British Virgin Islands, to shift profits out of both the Hong Kong and mainland tax nets. Tax authorities on both sides of the border are making this strategy more difficult, however. Related-party transactions with companies based in tax havens are just as likely to set off alarms in the Field Audit Group as they are in its mainland counterpart. Florence Yip Chiu Kwai-fong, a tax partner at Arthur Andersen, said tax authorities in Shenzhen were now assigning grades to corporate taxpayers. Companies with low grades could expect an on-site visit every year, while those with good grades would be spared two years out of three. A listed company would be especially subject to scrutiny. 'When a company is listed, it is very high profile,' she warned. 'And sooner or later, it will attract the tax authorities' attention in both jurisdictions.' Company managers who are making arrangements to list their organisations should also use the occasion as an opportunity to take care of their personal financial arrangements. 'Before their companies are listed, they should structure their family wealth as well,' Ms Yip said. 'It's an opportune time to do trust planning or family-wealth planning.'