Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

China's tax man is coming for you

 China’s State Administration of Taxation (SAT) is desperate for money. This is quoted straight from the SAT’s Circular 114 published in September this year. “For the purposes of further strengthening tax administration and stopping leaks to increase tax revenue, and guaranteeing the accomplishment of this year's tax revenue increase targets, the State Administration of Taxation has formulated the Specific Measures on Further Strengthening Tax Administration.” These new measures are being combined with a much greater level of activity and scrutiny by the SAT.

Government spending has been outstripping falling tax receipts by some measure. The massive economic four trillion Renminbi stimulus package and an 8% fall in tax revenue in the first half of 2009 as a result of the downturn, as well as the Olympics and Shanghai Expo, are all putting serious strain on the nation’s finances. When we add the new full refund on VAT for exports of certain products and the payment in full for VAT refunds on fixed assets, rather than over the time assets take to depreciate, we see the full extent of the fiscal shortfall.

At the beginning of the year, the government called for an 8.2 percent increase in national tax collections in 2009. After the bumper tax collection of 2008, that target looks increasingly unlikely to be met. The tax man is under serious pressure to find new ways of increasing revenue, and foreign invested companies (FICs) are a prime and easy target.

Christopher Marquis, Partner at SJ Grand Financial and tax Advisory, tells me that foreign companies are exposed to greater tax liabilities than before. “The tax bureau is likely to come knocking at your door soon, so it’s vital to have everything in order and be constantly updated about new regulations.”

Areas under closer scrutiny and subject to change include the transfer of goods to companies outside of China at below market value. This is being carefully examined by tax bureaus because companies have in the past reduced tax by trading and selling goods to sister companies, under a system called “transfer pricing”.

Marquis tells me that “every company should prepare their documents on transfer pricing and regular benchmarking of goods and services should be conducted to ensure the company’s compliance with the regulations”.

The difficulty in conforming to China’s tax regime is exemplified by the new tax rules for mergers and acquisitions. These rules apply retrospectively from January 2008, rather than starting from publication, giving companies a real headache in working out the ramifications of the changes.

The regulations concerning the taxation of employees’ telecommunications and auto allowances, as well as termination compensation and non compulsory insurances have changed, meaning that tax is increasing on work-related benefits.

Previously the fees that company directors charged were given special tax treatment – that privilege has now been withdrawn. Now only “absent” directors still qualify for a special individual income tax treatment.

The SAT has initiated a special tax bureau to deal with multinational companies’ tax issues, but scrutiny is not only limited to large foreign companies - any kind of FIE is now subject to much more detailed appraisal of tax returns. Foreign companies have been punished for attempting to avoid tax through transfer pricing, with one client of a large accountancy firm already being subject to a considerable fine. But this new approach from the SAT has ramifications beyond simple tax avoidance. Marquis says “there have been instances where mistakes in tax returns that do not materially affect the amount of tax paid by the company have been punished severely, beyond what we would normally see for such a small infraction.”

Local tax bureaus in second tier cities have been instructed to examine FIEs in much greater detail; circulars have been issued that explicitly single out foreign companies as a source of greater revenue. Tax inspectors are being pressured to find mistakes and discover tax avoidance, which means that all tax returns are being closely looked at. Yet most of those new regulations often need to be explained to tax bureaus in those cities.

“Our advice to clients in this new and changing tax environment is that tax is now a business issue that goes beyond the finance department, and so education is vital for all managerial staff so that they operate in a way that does not create tax risk their employer’s China operations,” warns Marquis. ”We also suggest preparedness. Tax reforms in China are aimed at conforming to international standards, but changes can be rapid and unpredictable so, companies should be ready to adjust to a new tax environment. They should be ready to receive the tax man should he come calling.”