## _wp1668 ## Source details **Canonical URL:** [_wp1668](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp1668.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp1668.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp1668.pdf.json) --- ### Introduction and aggregate outcomes - China’s tax administration improved substantially since the mid-1990s, contributing to a doubling of the tax-to-GDP ratio and a significant reduction in taxpayers’ compliance costs. - Reform objective (mid-1990s onward): achieve sustainable increases in tax revenue by improving taxpayers’ compliance with the tax laws. - Major institutional reform in 1994: split of the single tax agency into a national tax service and local tax services; subsequent focus on organizational arrangements, tax administration processes, and information systems. - Modernization plan under preparation for 2016–20 in response to economic restructuring and major tax law changes. - Key aggregate statistics: - Tax-to-GDP ratio: 1990 15.1; 1991 13.7; 1992 12.2; 1993 12.0; 1994 10.6; 1995 9.9; 1996 9.7. - Tax-to-GDP ratio rose to 19.4 percent of GDP in 2013; declined to 18.7 percent of GDP in 2014. - Central government share of revenue averaged about 50 percent of total revenue since the mid-1990s. - VAT compliance ratio estimated: about 39 percent of potential VAT revenue in 1997 to 56 percent in 2005. - Taxpayer satisfaction survey scores (Percent): 2008 NTS 76.2, LTS 77.7; 2010 NTS 79.1, LTS 79.2; 2012 NTS 79.8, LTS 79.7; 2014 NTS 82.6, LTS 81.5; 2015 NTS 82.8, LTS 81.2. - Average time taxpayers spend on tax matters reduced by over two-thirds since 2004. ### Policy, legal framework, and substantive tax law reforms - Three main components: the tax assignment system; substantive tax laws and regulations; the Tax Collection Law. - Tax assignment (post-1994): - Central: consumption (excise) taxes, customs duties, international trade-related VAT and consumption taxes. - Shared: domestic VAT 75 percent central/25 percent local; enterprise income tax 60 percent central/40 percent local; personal income tax 60 percent central/40 percent local. - Remaining taxes allocated to local governments (including business turnover tax on services, social security contributions, stamp duties on real estate transactions). - Substantive law reforms: - Number of taxes reduced from 35 in the early 1990s to 18. - Enterprise Income Tax Law (2008): unified domestic and foreign-funded enterprise income taxes; includes specific anti-avoidance provisions and a general anti-avoidance rule. - Personal Income Tax Law (1994 retained features): tax imposed on individuals (not families); withholding regimes applied; few personal deductions; restricted filing requirements. ### Transfer pricing, anti-avoidance, and reporting - Chapter VI of the Enterprise Income Tax law establishes the arm’s length principle for related party transactions; requires reporting and allows tax authority adjustment of taxable income for noncompliance. - December 2014 Administrative Measures for the General Anti-Avoidance Rules (Trial): - SAT authorized to re-characterize transactions lacking commercial purpose other than avoiding tax. - Anti-avoidance investigations and final decisions require approval by SAT headquarters. - Filing threshold for individuals: individuals with annual income greater than ¥120,000, more than one job, income not subject to withholding, or overseas income must file a tax return. ### Indirect tax reforms and VAT design - 1994: broad-based VAT replaced previous VAT (12 rates) and product tax (over 150 rates) with only two rates and few exemptions. - Subsequent VAT changes: - 2008: crediting of VAT on capital goods. - 2012 onward: gradual extension of VAT to selected services, replacing the non-creditable business tax. - Administrative design and thresholds: - VAT registration thresholds: ¥800,000 for goods; ¥500,000 for services. - VAT invoice issuance tightly controlled by SAT. - Many exporters entitled to refunds on export sales at less than the statutory 17 percent rate. - Trade-off: tight invoice controls reduce fraud but impose high compliance costs. ### Registration, taxpayer services, filing, and self-assessment - Registration improvements: - Common business identification number since 2004; national ID used for wage earners. - SAT business identification number: 15 digit code (first 9 numbers from Quality and Technology Supervision Bureau identification; other 6 numbers administrative region code). - Remaining weaknesses: multiple agency registrations, branches with separate IDs, no common ID for self-employed persons. - Taxpayer services (as of end-2013 statistics and 2014 outreach): - Over 9,775 taxpayer services halls; 70,516 multi-function tax service counters; 70 provincial-level call centers; 70 provincial and some municipal websites. - 2013 outreach: 86.4 million SMS messages sent; about 93 million pamphlets/guides/questionnaires distributed; 28.8 million hotline inquiries answered; advice/publicity to 1.1 million central taxpayers and 1.3 million local taxpayers on 2.5 million occasions. - 2014: mobile tax application and official accounts on Weibo and WeChat introduced. - Filing and payment reforms and outcomes: - Introduction of self-assessment, standardized tax returns, electronic filing and payment, and a computer system to process returns and maintain taxpayer accounts. - Number of tax payments companies must make each year reduced from 35 in 2004 to 7 in 2013. - Electronic filing take-up rose from 40–50 percent to 80 percent on average and to 90 percent for some large cities. - Average time medium-sized company spends on tax matters: 832 hours in 2004 to 261 hours in 2013; world average 264 hours; Asian and Pacific average 229 hours; examples: Australia 105 hours, Canada 131 hours, Denmark 25 hours, Singapore 82 hours, United Kingdom 94 hours, United States 175 hours. ### Audit performance, gaps, and dispute resolution - Audit evolution and outcomes: - Taxes assessed by audits: ¥41.9 billion in 2000; ¥116.4 billion in 2010; ¥185.6 billion in 2014. - Number of audit cases yielding ¥10 million or more: 2003 101; 2005 92; 2010 242; 2014 792. - Remaining audit weaknesses: - No standardized nationwide risk-based selection system; lack of a detailed audit procedures manual; audits often superficial and clerical. - Fragmentation of audit function across multiple departments leading to duplication. - Dispute resolution mechanics and metrics: - Administrative reconsideration: taxpayers have 60 days to file an objection; must generally pay tax before review; to appeal reconsideration decision to court file within 15 days. - In limited cases appeal without prior reconsideration must be filed within 3 months. - Low utilization in 2011: 473 administrative reviews and 166 tax litigation cases finalized (comparators: Australia 24,513; Canada 50,485; Japan 8,463; United Kingdom 56,228; United States 142,553). - SAT exploring measures to promote rule of law and improve dispute resolution, including revising the Tax Collection Law. ### Organizational structure, size, and large taxpayer administration - Five-tier organization: (1) SAT headquarters, (2) provincial tax bureaus, (3) municipal tax bureaus, (4) county tax bureaus and district tax sub-bureaus, (5) tax stations. - National and local tax services together: some 750,000 staff in more than 30,000 locations. - Staff by level (as of December 31, 2014): - SAT headquarters: Organizational Units 1; Staff 850. - Provincial-level: National Organizational Units 36; Local Organizational Units 35; National Staff 13,286; Local Staff 13,416. - Municipal-level: National Organizational Units 353; Local Organizational Units 332; National Staff 63,580; Local Staff 60,777. - Counties and districts: National Organizational Units 3,020; Local Organizational Units 2,584; National Staff 212,049; Local Staff 141,651. - Tax stations: National Organizational Units 10,151; Local Organizational Units 16,729; National Staff 101,171; Local Staff 145,812. - SAT headquarters staff share is about one-tenth of 1 percent of the organization’s staff. - Large Business Department (LBD) (established 2008): - Taxes paid by the 45 large enterprise groups under direct supervision of LBD headquarters increased from ¥1.980 trillion in 2010 to ¥2.790 trillion in 2013. - Tax collections from large businesses increased by 70 percent over the department’s first three years. - LBD remains small in headquarters and field offices, limiting full potential. - Recommended large taxpayer/HWI actions: - Expand LBD authority, vest exclusive audit/assessment responsibility for large businesses, substantially increase staff at headquarters, provincial, and municipal LBDs. - Create a specialized HWIs unit with centralized oversight; in 2012 the top 10 percent of households accounted for about 50 percent of market income. - SAT estimates: largest 45 enterprise groups account for about 22 percent of SAT’s tax collection; another 300–400 enterprise groups account for an additional 20 percent. ### Human resources, training, and performance - HR evolution and metrics: - 1992: over 500,000 tax administration personnel; less than one in twenty were college graduates. - University degree share of tax officials: 1995 4.8; 2000 12.1; 2005 38.9; 2010 53.3; 2014 59.6. - Training institutions: provincial tax academies in 36 provinces; three national tax academies in Changsha, Dalian, and Yangzhou. - Remaining HR issues: - Position classification, evaluation, promotion/salary policies tied to civil service regulations until recently. - Headquarters under-sized (about 800 officials); need to increase headquarters staff and right-size workforce. - Recommended benchmarking staff allocation to OECD averages: 36 percent verification (including audit), 27 percent account management (including taxpayer services), 11 percent arrears collection, 9 percent other tax operations, 17 percent support/other (including 3 percent HR). ### Information systems, Golden Tax Project, and data strategy - Major systems: - China Tax Administration Information System (CTAIS): developed 1999; supports registration, returns, payments, taxpayer accounts, bank and treasury coordination. - Golden Tax Project (GTP) Phases 1 and 2: VAT invoice fraud detection and control; nationwide by July 2001. - Reported GTP effect: detection rate of fraud-related invoices decreased from 8.51 percent in February 2001 to 0.06 percent in mid-2002 (reported by former SAT Commissioner Mr. Jin Renqing in August 2002). - GTP Phase 3 (GTP3): - Will replace CTAIS and provide automated support for all taxes; include risk management and tie provincial databases into a national network. - Piloted in 6 provinces in 2013; scheduled for national deployment by end of 2016. - GTP3 applications sets: (1) Tax collection; (2) Administration; (3) Analytical support; (4) External information. - Box — VAT invoice cross-matching (GTP Phases 1 and 2) key elements: - Issuing VAT invoices: proprietary software and integrated circuit card (“black box”); 84-digit or 108-digit cipher printed on invoices; monthly black box data upload required. - Certifying VAT invoices: purchasers scan and transmit invoices; cipher decrypted and matched for input VAT credit certification. - Cross-checking: seller and purchaser copies compared; mismatches forwarded to investigation subsystem. - Coordinating investigations: SAT manages nationwide investigations for fraudulent/invalid invoices. - IT priorities and recommendations: - Create national data center(s) and centralized master-files for enterprises and individuals, prioritize large enterprises and HWIs. - Legal authority needed to collect third-party information. - Improve VAT software to automatically extract VAT data from companies’ accounting systems and facilitate e-invoicing with electronic signature and robust infrastructure. ### Emerging external risks and sectoral trends - External environment challenges: - Slowing economic growth (double digit to single digit “new normal”) risks reduced revenue growth and potential compliance declines. - Structural shifts: rising services sector, cross-provincial transactions, and sharp increase in e-commerce. - Globalization: evolving international tax risks as China shifts from capital importer to capital exporter. - Concrete data points: - Sectoral GDP shares (percent): 1990 Primary 27.1 Secondary 41.3 Tertiary 31.5; 1995 Primary 20.0 Secondary 47.2 Tertiary 32.9; 2000 Primary 15.1 Secondary 45.9 Tertiary 39.0; 2005 Primary 12.5 Secondary 47.4 Tertiary 40.5; 2010 Primary 10.1 Secondary 46.7 Tertiary 43.2; 2013 Primary 10.0 Secondary 43.9 Tertiary 46.1. - Trade and FDI (percent of GDP): 1990 Exports 15.0 Imports 13.7 FDI inbound stock 5.1 FDI outbound stock 1.1; 1995 Exports 20.5 Imports 18.1 FDI inbound stock 13.4 FDI outbound stock 2.3; 2000 Exports 20.8 Imports 18.7 FDI inbound stock 16.2 FDI outbound stock 2.3; 2005 Exports 33.7 Imports 29.2 FDI inbound stock 11.9 FDI outbound stock 2.3; 2010 Exports 26.2 Imports 20.6 FDI inbound stock 9.9 FDI outbound stock 5.3; 2013 Exports 24.1 Imports 20.6 FDI inbound stock 10.1 FDI outbound stock 6.6. - Internet and e-commerce: internet users grew from 2.1 million in 2000 to approximately 600 million by end-2013; e-commerce growth topped 70 percent annually from 2009 to 2012; forecast by 2020 that China’s e-commerce market will be larger than United States, United Kingdom, Japan, Germany, and France combined (KPMG, 2014). - Cross-border tax risks: - Vulnerabilities: intra-firm transactions at non-arm’s length, legislative mismatches, unreported overseas income, other schemes. - SAT responses: transfer pricing rules, anti-avoidance provisions, creation of international tax divisions, special audit programs. ### Internal vulnerabilities and capacity gaps - Organizational stresses: - Very small SAT headquarters (about 800 staff) constrains national/international strategy design and implementation. - Large, costly, decentralized network of tax offices with collusion risk and inconsistent administration. - Fragmentation by tax type, taxpayer type, and function causing inefficiencies (notably in audit and large taxpayer administration). - Uniformity and legal consistency: - Persistent differences in law application across provinces and cities; need for greater standardization. - Skills gaps: - Significant auditor skill gaps; need comprehensive training strategy and targeted capacity building. - Information system weaknesses: - Lack of national taxpayer databases and third-party information; high compliance costs from some SAT systems. ### SAT modernization program, reform priorities, and recommended measures - SAT six broad objectives (Wang, 2015): 1. a fully-developed tax law system; 2. a sound tax administration system; 3. a high-quality and convenient service system; 4. a rigorous tax collection system; 5. a robust information technology system; 6. an efficient organizational system. - Amendments to the Tax Collection Law (TCL) — enforcement and taxpayer protections: - Enforcement-strengthening measures recommended: - Apply TCL broadly to all taxpayers. - Require private third parties (including financial institutions) to provide tax-related information. - Enhance arrears collection powers: impose tax liens, require third parties to pay monies owed to tax debtors to SAT, extend installment payment periods. - Taxpayer protection measures recommended: - Strengthen confidentiality provisions. - Provide comprehensive procedural protections and clear penalty guidelines. - Eliminate requirement to pay 100 percent of disputed assessment before administrative review; replace with paying a percentage of disputed liability (interest accruing appropriately). - Grant SAT authority to provide binding rulings; increase independence of administrative review organ. - Status: SAT and Ministry of Finance jointly submitted draft TCL amendments to State Council in November 2014; coordinated review during 2015; expected enactment during 2016. - Organizational alignment: - Rationalize structure, strengthen headquarters, consolidate tax stations (over 10,000 grassroots tax stations), ensure clear accountability for taxpayer segments. - Options to strengthen headquarters: increase headquarters staff or designate “centers of excellence” supervised by SAT. - National and international reach: - Domestic prerequisites: nationally standardized tax identification number; centralized master-files for taxpayers and third-party information; effective cross-provincial/overseas administrative arrangements. - International priorities: implement OECD/G20 BEPS package; improve transfer pricing rules (revise Circular No.2); introduce country-by-country reporting; incorporate anti-abuse treaty provisions and new PE definitions; enhance MAP operations; translate exchange of information obligations into domestic law and build IT infrastructure. - International instruments and dates cited: China signed the Multi-lateral Convention on Mutual Administrative Assistance in Tax Matters on August 23, 2013; ratified the Multi-lateral Competent Authority Agreement on automatic exchange of information on December 16, 2015; entered into an agreement in substance relating to FATCA with the United States on June 26, 2014. - Compliance risk management expansion: - Typical three-level approach: tax level, segment level, taxpayer level. - SAT actions: piloted taxpayer-level compliance management for large taxpayers; issued SAT Opinion Concerning the Strengthening of Tax Risk Management Work in September 2014. - Recommendation: extend risk management to major taxes and taxpayer segments including HWIs and small businesses. ### Operational reforms and sequencing (implementation guidance) - Two-stage process to enhance core processes: - Stage 1: standardize processes with National Tax Administration Standards (version 1.0) implemented May 1, 2015 (unified 612 tax administration matters; 11 major categories; 152 subcategories; 1,087 forms and certificates). - Stage 2: introduce innovative practices under National Tax Administration Standards (version 2.0) with pilots in Jiangsu and Henan. - Filing, VAT simplification, and micro-business taxation: - VAT accounts for about 40 percent of business tax compliance costs. - Simplify VAT returns and data requirements; align timing rules for input VAT credit; pursue VAT IT improvements; co-design reforms with industry and software vendors. - Simplify taxation of very small (micro) businesses via lump-sum payment linked to annual business license and limited eligibility. - Preserve low compliance-cost features in PIT reform: maximize withholding, minimize filers, limit deductions that require filing. - Audit strengthening: - Broaden audit beyond invoice cross-matching; develop analytical methods, standardized audit manual, limited scope audits, industry specialization, coordinated cross-provincial audits for large enterprises and HWIs, and stronger international compliance for outbound investments. - Arrears collection implementation steps (linked to TCL amendments): - Installment arrangements: extend from three monthly installments to 12 monthly installments; develop guidance, evaluative tools, training, approval levels. - Tax liens: develop policy/guidance on imposition/removal, types of property, notification procedures, training, approval levels. - Default assessments: authorize reasonable default methods (e.g., previous period liability plus uplift) to accelerate collection while preserving audit rights. - Dispute resolution reforms: - Convert informal guidance into formal regulations following public consultation. - Implement private advance ruling regime per draft TCL amendments. - Create more independent administrative review mechanisms—consider vertically reporting review units or pilot quasi-independent review organs. - Human resources actions: - Comprehensive HR strategy to right-size workforce, increase headquarters to ~800+ officials benchmarked against needs, reallocate staff across functions, standardize training, exploit e-learning, and link performance to remuneration/promotions via Digital HR piloting. - Performance measurement: - Move beyond revenue-target centrism; adopt balanced measures including tax administration results, taxpayer satisfaction (independent surveys), and tax officer engagement. - Use GTP3 and Digital HR for national data compilation and cascade balanced targets. ### Appendix — Illustrative compliance management strategy for small businesses (segment profile and measures) - Segment definition: businesses with sales below VAT registration threshold, excluding those eligible for patent or benchmark regime. - Revenue (Tax Type — Revenue (billions)): - PIT 27.52; CIT 5.24; VAT 7.43; ROY 0.12; EXC 0.014; WHT 5.73; Other 7.12; Total 53.17. - Share: revenue from this segment represents about 1.9% of total tax collections. - Number/type of taxpayers: around 50,000 legal entities; almost 150,000 Sole Traders. - Priority risks: registration Medium; filing Medium; underreporting Medium; payment Medium (almost 80% of arrears cases are small, representing only about 5% of debt by value). - Risk treatments: - Facilitating compliance: simplified registration/filing/payment; “Right from the Start” assistance; free bookkeeping tools; early intervention calls/visits; partnerships with SME incubators. - Dealing with noncompliance: comprehensive audits for highest risk, hidden economy campaign, limited scope risk-based audits, small business benchmarks, income verification program, outbound calls for small arrears, voluntary disclosure initiative with concessional penalties. - Capacity development priorities: optimize e-tax, streamline processes, ensure risk management supports compliance strategy, staff training in technical and service skills, channel management, alliances with tax profession and other agencies, integrate compliance strategies into operational plans. *Source: IMF working paper excerpt (text as provided).* ### References ............................................................................................................. ### _wp1668 - References ### Introduction - China’s tax administration has improved substantially since the mid-1990s, contributing to a doubling of the tax-to-GDP ratio and a significant reduction in taxpayers’ compliance costs. - Reform objective (mid-1990s onward): achieve sustainable increases in tax revenue by improving taxpayers’ compliance with the tax laws. - Major institutional reform in 1994: split of the single tax agency into a national tax service and local tax services; subsequent focus on organizational arrangements, tax administration processes, and information systems. - Current context: economy undergoing significant restructuring, major changes to tax laws under way, and relatively easy gains from previous reforms largely reaped — prompting a new modernization plan for 2016–20. ### Background: fiscal and compliance outcomes - Tax Revenue-to-GDP Ratio (Percent) for 1990–1996: - 1990: 15.1 - 1991: 13.7 - 1992: 12.2 - 1993: 12.0 - 1994: 10.6 - 1995: 9.9 - 1996: 9.7 - Central Government Revenue-to-Total Revenue Ratio (Percent) for 1990–1996: - 1990: 33.8 - 1991: 29.8 - 1992: 28.1 - 1993: 22.0 - 1994: 55.7 - 1995: 52.2 - 1996: 49.4 - Mid-1990s noncompliance estimates (Yu, 1997): - up to 30 percent of state-owned enterprises failed to comply with tax obligations - 60 percent of joint ventures failed to comply - 80 percent of private enterprises failed to comply - 100 percent of individual street vendors failed to comply - VAT compliance ratio: estimated increase from about 39 percent of potential VAT revenue in 1997 to 56 percent in 2005. - Aggregate outcomes since reforms: - Tax-to-GDP ratio rose to 19.4 percent of GDP in 2013 (after an increase of nearly 10 percentage points through the early 2010s). - Tax-to-GDP ratio declined to 18.7 percent of GDP in 2014 as the economy slowed. - Central government share of revenue increased sharply after 1994 and has averaged about 50 percent of total revenue since the mid-1990s. - Taxpayer perceptions and compliance costs: - Taxpayer satisfaction survey scores (Percent): - 2008: NTS 76.2, LTS 77.7 - 2010: NTS 79.1, LTS 79.2 - 2012: NTS 79.8, LTS 79.7 - 2014: NTS 82.6, LTS 81.5 - 2015: NTS 82.8, LTS 81.2 - Average time taxpayers spend on tax matters has been reduced by over two-thirds since 2004. ### China’s tax administration today — policy and legal framework - Three main components of the policy and legal framework: - the tax assignment system; - the substantive tax laws and associated regulations; - the Tax Collection Law. - Tax assignment arrangements (post-1994): - central government assigned all revenue from consumption (excise) taxes, customs duties, and international trade-related tax on VAT and consumption taxes; - shared taxes include: - domestic VAT: 75 percent central, 25 percent local; - enterprise income tax: 60 percent central, 40 percent local; - personal income tax: 60 percent central, 40 percent local; - all remaining taxes allocated to local governments (including business turnover tax on services, social security contributions, and stamp duties on real estate transactions). - Substantive tax law reforms: - Simplification: number of taxes reduced from 35 in the early 1990s to 18 today (including both central and local government taxes). - Enterprise Income Tax Law (2008): - unified domestic and foreign-funded enterprise income taxes; - includes a set of specific anti-avoidance provisions and a general anti-avoidance rule — powerful tools for addressing international tax risks, though some provisions require improvement for emerging international challenges. - Personal Income Tax Law (1994 and retained features): - tax imposed on individuals (not families); - withholding regimes applied to many income categories; - few personal deductions permitted; - restricted filing requirements — features that greatly simplified tax administration. ### Key reform milestones and implementation notes - 1994 reforms: - split tax agency into national and local tax authorities; - introduced new intra-governmental revenue system, abolishing complex fiscal contracting schemes; - expanded VAT base and introduced a new consumption (excise) tax. - Phased roll-out: initial pilot in four cities, expanded to 14 additional cities, national implementation completed by the end of 2003. - Drivers of changes in tax yield since the 1990s: structural economic shifts, tax policy changes, and tax administration improvements — all contributing to the rise in the tax-to-GDP ratio. *Source: China Statistical Yearbook; State Administration of Taxation; IMF staff calculations.* ### Chapter VI of the Enterprise Income Tax law establishes the arm’s length principle for valuing related party transaction ### _wp1668 - Chapter VI of the Enterprise Income Tax law establishes the arm’s length principle for valuing related party transaction ### Transfer pricing, anti-avoidance, and reporting requirements - Chapter VI establishes: - the arm’s length principle for valuing related party transactions; - the requirement for taxpayers to report related party transactions to the tax authorities; - the tax authorities’ power to adjust a taxpayer’s taxable income if the taxpayer failed to comply with the arm’s length principle. - In December 2014, the SAT issued the Administrative Measures for the General Anti-Avoidance Rules (Trial): - Chinese tax authorities are authorized to counter transactions deemed to have no commercial purpose other than avoiding tax by re-characterizing the transaction and denying the tax benefits. - To avoid abuse, the tax authorities may not initiate an anti-avoidance investigation until it is approved by the SAT headquarters; headquarters must also approve the final decision of an investigation. - Filing threshold for individuals: - Only individuals with annual income greater than ¥120,000, more than one job, income that is not subject to withholding, or overseas income need to file a tax return. ### Indirect tax reforms and VAT design - 1994 reforms: - A broad-based VAT—covering production, wholesale and retail trade, and imports—with only two rates and few exemptions replaced the previous VAT (with 12 rates) and product tax (with over 150 rates). - Subsequent VAT reforms: - Crediting of VAT paid on purchases of capital goods (2008). - Gradual extension of VAT to selected services (beginning in 2012 and continuing through today), replacing the non-creditable business tax. - Administrative design choices: - VAT provides relatively high registration thresholds to restrict registrants consistent with administrative capacity. - Thresholds: ¥800,000 (about $125,000) for goods and ¥500,000 (about $79,000) for services. - VAT invoice issuance is subject to very tight control and checks by the SAT. - Many exporters are entitled to receive a refund on their export sales at less than the statutory 17 percent rate. - Trade-offs noted: - Tight controls and refund practices reflect concern with VAT fraud but reportedly impose high compliance costs that negatively affect the business environment. ### Tax Collection Law and administrative powers - The Law on the Administration of Tax Collection (Tax Collection Law), enacted in 1992: - Provides SAT with legal authorities for administering substantive tax laws. - Sets out broad provisions for registration, record keeping, filing and payment, auditing, penalties, and appeals. - Vests enforcement powers, defines taxpayer rights and obligations, and provides dispute resolution mechanisms. - Pre-law problems the Tax Collection Law addressed: - Vulnerability to tax evasion due to inadequate enforcement powers. - Arbitrary application of tax laws by local governments and tax officials, including illicit exemptions. - Physical violence against tax officers. - Absence of administrative review process for taxpayers. ### Taxpayer population growth and composition - Rapid increase in registered taxpayers with business income: - Table 3: Number of Registered Taxpayers (National Tax System) - 2000: 11,840,000 total - 2005: 14,730,000 total; 4,990,000 Enterprises; 9,710,000 Self-Employed; 30,000 Other - 2009: 19,090,000 total; 7,200,000 Enterprises; 11,890,000 Self-Employed - 2010: 19,070,000 total; 7,440,000 Enterprises; 11,610,000 Self-Employed; 20,000 Other - 2011: 20,670,000 total; 8,310,000 Enterprises; 12,330,000 Self-Employed; 30,000 Other - 2012: 23,370,000 total; 9,480,000 Enterprises; 13,860,000 Self-Employed; 30,000 Other - 2013: 26,790,000 total; 11,270,000 Enterprises; 15,470,000 Self-Employed; 50,000 Other - 2014: 30,760,000 total; 13,740,000 Enterprises; 16,950,000 Self-Employed; 70,000 Other - Changing ownership forms among registered industrial enterprises (annual revenue over ¥5 million): - Table 4: Number of Registered Industrial Enterprises - 2000 Total: 162,855; Domestic Funded: 134,440; State-owned enterprises: 42,426; Collectively-owned enterprises: 37,841; Cooperative enterprises: 10,852; Private enterprises: 22,128; Other: 74,682; Enterprises with Funds from Hong Kong SAR, Macao, Taiwan, Province of China: 16,490; Foreign Funded: 11,955 - 2010 Total: 452,872; Domestic Funded: 378,872; State-owned enterprises: 8,726; Collectively-owned enterprises: 9,166; Cooperative enterprises: 4,481; Private enterprises: 273,259; Other: 80,344; Enterprises with Funds from Hong Kong SAR, Macao, Taiwan, Province of China: 34,069; Foreign Funded: 39,976 - Note: data not presented after 2010 because the definition changed in 2011 (threshold raised from ¥5 million to ¥20 million). - Sectoral GDP shares (Table 5: Shares of Gross Domestic Product by Economic Sector, percent): - 1990: Primary 27.1; Secondary 41.3; Tertiary 31.5; Total 100 - 1995: Primary 20.0; Secondary 47.2; Tertiary 32.9; Total 100 - 2000: Primary 15.1; Secondary 45.9; Tertiary 39.0; Total 100 - 2005: Primary 12.5; Secondary 47.4; Tertiary 40.5; Total 100 - 2010: Primary 10.1; Secondary 46.7; Tertiary 43.2; Total 100 - 2013: Primary 10.0; Secondary 43.9; Tertiary 46.1; Total 100 - Trade and FDI (Table 6, percent of GDP): - 1990: Exports/GDP 15.0; Imports/GDP 13.7; FDI Inbound Stock/GDP 5.1; FDI Outbound Stock/GDP 1.1 - 1995: Exports/GDP 20.5; Imports/GDP 18.1; FDI Inbound Stock/GDP 13.4; FDI Outbound Stock/GDP 2.3 - 2000: Exports/GDP 20.8; Imports/GDP 18.7; FDI Inbound Stock/GDP 16.2; FDI Outbound Stock/GDP 2.3 - 2005: Exports/GDP 33.7; Imports/GDP 29.2; FDI Inbound Stock/GDP 11.9; FDI Outbound Stock/GDP 2.3 - 2010: Exports/GDP 26.2; Imports/GDP 20.6; FDI Inbound Stock/GDP 9.9; FDI Outbound Stock/GDP 5.3 - 2013: Exports/GDP 24.1; Imports/GDP 20.6; FDI Inbound Stock/GDP 10.1; FDI Outbound Stock/GDP 6.6 ### Cross-border tax risks and SAT responses - Integration into the global economy increased risks: - Vulnerabilities to cross-border tax avoidance and tax evasion through intra-firm transactions at non-arm’s length prices, exploitation of legislative mismatches, unreported overseas income, and other schemes. - SAT mitigation measures: - Legislative changes (transfer pricing rules and anti-avoidance provisions). - Organizational changes (creation of international tax divisions). - Administrative programs (special audit programs focusing on international tax issues). ### Organizational structure, size, and large taxpayer administration - Organizational design: - Five-tier organization: (1) SAT headquarters, (2) provincial tax bureaus, (3) municipal tax bureaus, (4) county tax bureaus and district tax sub-bureaus, (5) tax stations (branch offices). - Separation created in 1994: National Tax Service (central taxes) and Local Tax Services (local taxes and some shared taxes). - SAT headquarters has direct authority over National Tax Service and shared authority (with local governments) over Local Tax Services. - Size and staffing: - National and local tax services together comprise some 750,000 staff in more than 30,000 locations. - Table 7: Number of Organizational Units and Staff by Level of Administration (as of December 31, 2014) - SAT headquarters: Number of Organizational Units 1; Number of Staff 850 - Provincial-level: National Organizational Units 36; Local Organizational Units 35; National Staff 13,286; Local Staff 13,416 - Municipal-level: National Organizational Units 353; Local Organizational Units 332; National Staff 63,580; Local Staff 60,777 - Counties and districts: National Organizational Units 3,020; Local Organizational Units 2,584; National Staff 212,049; Local Staff 141,651 - Tax stations: National Organizational Units 10,151; Local Organizational Units 16,729; National Staff 101,171; Local Staff 145,812 - SAT headquarters staff share is about one-tenth of 1 percent of the organization’s staff. - Large Business Department (LBD) established in 2008: - Taxes paid by the 45 large enterprise groups under direct supervision of LBD headquarters increased from ¥1.980 trillion in 2010 to ¥2.790 trillion in 2013. - Tax collections from large businesses increased by 70 percent over the department’s first three years of operation. - LBD remains small in both headquarters and field offices, limiting full potential despite high taxpayer satisfaction. ### Registration, taxpayer services, and filing processes - Registration improvements: - Since 2004, adoption of a common business identification number based on the organization code issued by the Quality and Technology Supervision Bureau. - Adoption of the national identification number (issued by the Ministry of Public Security) as the identifier for individual wage and salary earners. - The SAT business identification number is a 15 digit code: first 9 numbers is the identification number issued by the Quality and Technology Supervision Bureau and the other 6 numbers are an administrative region code. - Remaining weaknesses: enterprises still register with multiple government agencies; branches receive separate business identification numbers; absence of a common identification number for self-employed persons. - Taxpayer services expansion: - By end-2013: over 9,775 taxpayer services halls; 70,516 multi-function tax service counters; 70 provincial-level call centers; and 70 provincial, as well as some municipal, websites. - Technological outreach: mobile tax application and official accounts on Weibo and WeChat introduced in 2014. - In 2013, the Chinese tax authorities sent 86.4 million SMS messages to taxpayers. - In 2013, SAT distributed about 93 million pamphlets, guides, and questionnaires; answered 28.8 million hotline inquiries; and provided other advice and publicity on 2.5 million occasions to 1.1 million central taxpayers and 1.3 million local taxpayers. - Performance measurement: National Bureau of Statistics conducts taxpayer satisfaction surveys every two years; survey results show steady improvement. - Shift from administrative assessment to self-assessment: - Self-assessment: taxpayers prepare their own tax returns and payments; tax authorities accept returns at face value subject to ex-post arithmetic checks and selective audits based on risk-management principles. - Administrative assessment remains for self-employed persons who do not meet criteria for establishing company accounts and are subject to a simplified tax regime with fixed amounts based on location and scope of operations. *Source: _wp1668 - Chapter VI of the Enterprise Income Tax law establishes the arm’s length principle for valuing related party transaction* ### introduction of self-assessment. Tax returns were standardized, electronic filing and payment ### _wp1668 - introduction of self-assessment. Tax returns were standardized, electronic filing and payment ### Filing and payment reforms - Key changes: - Introduction of self-assessment. - Standardized tax returns. - Electronic filing and payment options introduced. - A computer system developed to process tax returns and maintain taxpayer accounts. - Substantial investments in taxpayer service programs to enable taxpayers to self-file and self-pay. - Outcomes and statistics: - Number of tax payments companies must make each year reduced from 35 in 2004 to 7 in 2013. - Electronic filing take-up rate rose from 40–50 percent of total tax filings to 80 percent on average across China and to 90 percent for some large cities, like Shanghai and Beijing (Mui, 2015). - Average time a medium-sized company spends on tax matters reduced from 832 hours in 2004 to 261 hours in 2013 (World Bank, 2015b), aligning China with the world average of 264 hours. - Comparative benchmarks: Asian and Pacific average 229 hours; examples: Australia (105 hours), Canada (131 hours), Denmark (25 hours), Singapore (82 hours), United Kingdom (94 hours), United States (175 hours) (World Bank, 2015). ### Audit: evolution, results, and remaining gaps - Historical context: - Pre-restructuring auditing was simple due to a small taxpayer population and large SOEs; tax officers often assessed taxes or provided detailed guidance (Casanegra, 1992). - Market-oriented reforms increased noncompliance among SOEs and private businesses (JEN, 1993), requiring stronger audit capacity. - Institutional reforms: - Tax Collection Law enacted in 1992, vesting tax authorities with broad audit powers. - 1997 creation of a national network of Inspection Bureaus (from headquarters down to county and district levels). - More recent concentration of inspection bureaus at municipal and provincial levels; assignment of large audit cases to higher-level bureaus. - Audit performance and metrics: - Taxes assessed by audits increased from ¥41.9 billion in 2000 to ¥116.4 billion in 2010, and ¥185.6 billion in 2014. - Number of audit cases yielding ¥10 million or more in tax revenue: - 2003: 101 - 2005: 92 - 2010: 242 - 2014: 792 - Source: SAT Annual Report, 2014. - Persistent weaknesses: - No standardized, nationwide risk-based system for selecting taxpayers for audit; different locations have developed their own selection systems, causing differentiated taxpayer treatment. - Lack of a detailed audit procedures manual; audits often focus on clerical verification of books and records and tend to be superficial. - Audit function fragmented across Inspection Bureaus, Large Business Department, Income Tax Department, Indirect Tax Department, and International Tax Department, resulting in lack of unified approach and inefficient duplication. ### Dispute resolution - Historical evolution: - Early 1990s: disputes resolved informally through discussions with the same tax officers whose acts were in dispute. - Need for formalized processes rose with private sector growth and broader discretionary powers of tax authorities (Li, 1993). - Formal mechanisms established: - Rules of Administrative Review of Tax Matters issued in 1991; later extended and codified in the Tax Collection Law (TCL) and refined via subsequent amendments and new rules in 2010. - Two formal mechanisms: 1. Tax administrative reconsideration within the tax authorities. 2. Tax administrative litigation in the courts. - Procedures and time limits: - Under administrative reconsideration, taxpayers have 60 days to file an objection to a specific administrative act. - For disputes involving assessment and payment of taxes, taxpayers must first seek administrative review and fully pay the tax according to the tax authorities’ decisions before the administrative review may be heard; taxpayers must exhaust administrative review and satisfy the tax payment requirement before appealing to a court. - Administrative reconsideration is conducted by the tax agency one level above the agency whose action is disputed. - To contest an administrative reconsideration decision in court, a taxpayer must file within 15 days of receipt of the decision. - In limited cases where a taxpayer can contest an administrative act without first completing administrative reconsideration, an appeal must be filed within 3 months of the administrative action. - Patterns of use and possible causes of low utilization: - In 2011, only 473 administrative reviews and 166 tax litigation cases were finalized in China. - Comparative numbers in 2011 (OECD, 2015a): Australia 24,513; Canada 50,485; Japan 8,463; United Kingdom 56,228; United States 142,553. - Potential explanations for low use of formal dispute mechanisms: - Perceived benefits of maintaining a non-adversarial relationship with tax authorities. - Perceived low probability of prevailing in formal proceedings. - Burden of first paying tax assessments before contesting them versus negotiating smaller payments informally. - Extensive opportunities for ex ante understanding or ex post settlement via bargaining in China’s highly decentralized tax administration (Cui, 2015). - Reform intent: - SAT exploring measures to promote the rule of law and improve the dispute resolution process, including revising the Tax Collection Law (see Section V). ### Human resources - Baseline and strategy: - 1992: over 500,000 tax administration personnel; less than one in twenty were college graduates; few had tax, accounting, or related backgrounds. - Two-track workforce strategy: 1. Short-term: enhance skills of existing staff via vocational training, teaming new recruits with experienced staff, and on-the-job training. 2. Long-term: recruit new staff with stronger educational backgrounds. - Training institutions and programs: - Beginning in 2000, provincial tax offices took over training, setting up specialized tax training academies in 36 provinces and municipalities. - Three national tax academies created in Changsha, Dalian, and Yangzhou to provide targeted training to senior officials (e.g., transfer pricing). - Educational attainment progress: - Percentage of tax officials with a university degree: - 1995: 4.8 - 2000: 12.1 - 2005: 38.9 - 2010: 53.3 - 2014: 59.6 - Source: State Administration of Taxation. - Remaining HR management issues: - Position classification, staff evaluation, and promotion/salary policies remained largely tied to government-wide civil service regulations until very recently. - Progress in these HR areas is crucial to raising productivity and ethical standing. ### Information systems and the Golden Tax Project - Context and rationale: - Early 1990s: tax administration largely paper-based and manual, causing low productivity, errors, disputes, compliance costs, and opportunities for collusion. - Mid-1990s onward: major investments in information technology to automate core functions. - Major systems developed: - China Tax Administration Information System (CTAIS): - Core tax administration information system providing automated support for registration, tax returns and payment processing, taxpayer accounts, and coordination with banks and the national treasury. - First developed in 1999 and deployed at all tax offices nationwide. - Golden Tax Project (GTP), Phases 1 and 2: - Specialized computer system to detect and deal with VAT invoice fraud. - Controls issuance of invoices, authenticates invoices via encoded information, and cross-matches seller and purchaser invoices. - Reported effect: detection rate of fraud-related invoices decreased from 8.51 percent in February 2001 to 0.06 percent in mid-2002 (reported by former SAT Commissioner Mr. Jin Renqing at a tax conference in August 2002). - GTP Phase 3 (GTP3): - Will replace CTAIS and provide automated support for all taxes (both central and local). - Will include a broader set of tax administration applications including risk management. - Will tie together provincial-level taxpayer databases into a national network. - Piloted in 6 provinces in 2013 and scheduled to be deployed nationally by the end of 2016. - GTP3 will include four sets of applications: 1. Tax collection (registration, filing, payment, accounts management). 2. Administration (financial management, human resources, internal audit). 3. Analytical support (compliance risk management, performance measurement and reporting, policy analysis, statistical analysis). 4. External information (information exchange with other government and non-governmental entities). ### Box — Inside China’s VAT Invoice Cross-Matching System (Golden Tax Project Phases 1 and 2) - Purpose: - Automated control of VAT invoice issuance and detection of potentially fraudulent invoices; implemented nationwide by July 2001 (GTP Phase 2). - Four sub-systems: 1. Issuing VAT invoices: - Taxpayers obtain proprietary software and hardware (an integrated circuit card, the “black box”). - When sellers issue a VAT invoice, the software generates an 84-digit or 108-digit numerical cipher based on invoice data. - The cipher plus invoice number, taxable amount, VAT payable amount, issue date, and industry classification code number are printed on the invoice. - Invoice information stored in the system as invoices are issued. - VAT taxpayers required to upload monthly black box data to local tax offices when filing monthly VAT returns; data used by cross-checking and inspection systems. 2. Certifying VAT invoices: - Purchasers must apply to have invoice authenticity certified to claim input VAT credit. - Taxpayers scan paper invoices and transmit electronic files to the certifying subsystem. - The 84-digit cipher is decrypted and compared to unencrypted invoice data; matching data yields certification for input VAT credit. 3. Cross-checking and inspecting VAT invoices: - System compares issuer-submitted invoice copies (sellers) with purchaser-submitted copies (purchasers claiming input VAT credit). - Matching data triggers no action; mismatches forward the purchaser’s invoice to the investigation subsystem. - Cross-checking and investigation conducted at central government and provincial levels to expedite processing. 4. Coordinating investigations: - Investigation subsystem coordinates further inquiry when discrepancies are detected. *Source: _wp1668 - introduction of self-assessment. Tax returns were standardized, electronic filing and payment* ### 4. Coordinating investigations. If a VAT invoice is identified as fraudulent or otherwise invalid, it is sent to ### _wp1668 - 4. Coordinating investigations. If a VAT invoice is identified as fraudulent or otherwise invalid, it is sent to ### Coordinating investigations: VAT invoice handling - If a VAT invoice is identified as fraudulent or otherwise invalid, it is sent to the subsystem for the coordination of investigations run by the SAT. - The SAT manages a nationwide system for investigating VAT invoice fraud. - Source: This box is based mainly on Winn and A. Zhang (2013). ### IV. EMERGING CHALLENGES AND OPPORTUNITIES — overview - The SAT faces significant challenges in ensuring the health of the tax system over the next five years. - Challenges take two broad forms: - (1) external challenges that emanate from the SAT’s operating environment; and - (2) internal challenges from within the SAT itself. - There are also a number of opportunities that the SAT could exploit to enhance its operations. - Identifying both the challenges and opportunities is a key first step in setting the SAT’s future reform priorities. ### A. External — key risks and themes - The SAT will operate in an increasingly complex external environment. - Key challenges include: - slowing economic growth, - structural shifts in the economy, and - China’s continuing integration into the global economy. - These factors present heightened risks of lost revenue from noncompliance by taxpayers. - Further challenges include: - the implementation of an ambitious tax reform agenda, and - the need to promote the business climate by reducing the compliance costs of the tax system. ### Slower economic growth — implications for tax administration - China’s slowing economy, from double digit to single digit growth under the so-called new normal, could have significant implications for tax administration. - The economic slowdown can be expected to reduce the rapid growth in tax revenue that had been achieved in previous years. - The revenue decline is not a concern in itself to the extent it reflects the normal operation of automatic stabilizers, but would pose a problem for tax administration if it causes a decline in taxpayer compliance. - Economic stress creates incentives for distressed taxpayers to use tax evasion as an alternative form of finance for their operations and a means to avoid bankruptcy (Brondolo, 2009, CASE, 2013).27 - Compliance declines can be expected to differ across industries in line with their relative declines in economic activity. - The SAT will need to give special attention to industries most impacted by the slowdown such as industrial commodities (for example, steel), real estate, and mining. - The economic slowdown will make it more important than ever to ensure that the tax administration avoids unnecessarily impeding the business climate. - Although the SAT has taken many steps to reduce compliance costs over the last several years, Chinese businesses still spend more time dealing with tax matters than taxpayers from comparator countries in the Asia Pacific region and far more time than taxpayers in countries with high performing tax agencies (refer to Section III.D). - A substantial portion of these costs is associated with the administration of the VAT: - in 2006, more than 40 percent of the costs incurred by Chinese taxpayers in meeting their tax obligations were attributed to handling VAT special invoices (Xu, 2006). - Recent experience, in Western countries and China alike, provides evidence that taxpayer compliance tends to worsen in an economic and tight credit conditions. During the global financial crisis, noncompliance with the value-added tax increased in almost all European Union countries and tended to worsen most where the output contraction was greatest (IMF, 2015b). - In China, a study of close to 190,000 Chinese industrial firms (Cai and Liu, 2009) found that corporate income tax evasion is negatively correlated with access to credit. ### Structural changes in the economy — implications - Structural shifts expected to pose additional challenges for the SAT in the coming five years include: - the increasing contribution of the services sector, - the growing volume of cross-provincial transactions, and - sharp increase in electronic commerce. - Regarding services: - this sector is expected to continue to grab a growing share of the economy.28 - This trend presents two significant challenges to tax collection: - the services sector comprises larger numbers of small and unincorporated businesses, many of whom have low rates of tax compliance (Rosen, 2015). - the expected growth in the financial services industry and the [text ends mid-sentence in source]. *Source: IMF working paper excerpt (text as provided).* ### introduction of new financial products will raise complex tax issues that will require ### introduction of new financial products will raise complex tax issues that will require ### Major external challenges to tax administration - Cross-provincial transactions and taxpayer mobility - Large businesses and high-wealth individuals (HWIs) increasingly carry out economic activities in multiple provinces, contrasting with the SAT’s decentralized tax administration and little exchange of information among provincial tax bureaus. - Need for a more national approach to administering highly mobile taxpayers. - Rapid growth of electronic commerce (e-commerce) - In 2000, China had 2.1 million internet users. - By the end of 2013, Chinese internet users reached approximately 600 million. - E-commerce growth topped 70 percent annually from 2009 to 2012. - By 2020, China’s e-commerce market is forecasted to be larger than those of the United States, United Kingdom, Japan, Germany, and France combined (KPMG, 2014). - New business models commonly feature a third party facilitator operating an on-line platform that charges a fee and arranges a sale between producer and consumer, raising challenges of identifying on-line transactions, determining nature and value of transactions, and establishing taxable persons. - Globalization and changing international tax risks - China operates a worldwide income tax system: residents taxed on domestic and foreign-source income (with credit for taxes paid on foreign income); non-residents taxed on China-source income only. - As China shifts from a capital importing to an increasingly capital exporting country, international tax risks evolve: - Transfer pricing remains central and now includes Chinese-owned subsidiaries in other jurisdictions. - Emerging risks include cross-border restructuring (acquisitions, corporate inversions), deferred recognition of income by Chinese companies from foreign subsidiaries in low tax jurisdictions, unreported overseas income and assets by Chinese residents, and aggressive tax planning schemes. - The SAT must adapt international compliance programs in cooperation with other jurisdictions. - Structural reform environment and opportunities - The State Council’s Development Research Center forecasts the service sector share of GDP to increase from its 2011–15 average of 47.6 percent to an average of 51.6 percent during 2016–20; share of employment expected to increase from 42.0 percent to 47.6 percent over the same period (World Bank, 2012). - High-level political support: Communist Party of China’s Central Committee Leadership Group to Comprehensively Deepen Reform passed the Plan to Deepen Reform of the National and Local Tax Administration System on October 13, 2015. - Growing international cooperation on exchange of tax information provides opportunities for tackling cross-border tax evasion. ### Internal vulnerabilities and capacity gaps within the SAT - Organizational stresses - Small size of SAT headquarters hinders capacity to design and implement national and international compliance strategies. - Very large network of tax offices is costly, difficult to manage, hard to ensure uniform administration, and presents collusion risks. - Separate national and local tax services increase government budgetary costs and taxpayer compliance costs. - Hybrid organizational structure (by tax type, taxpayer type, and function) has fragmented administrative responsibilities—especially harmful in auditing and large taxpayer administration. - Organizational restructuring should prioritize changes critical to delivering the SAT’s modernization strategy. - Uniformity in administration - Despite progress, differences persist in tax law application across provinces and cities, risking distorted competition and perceptions of unfairness. - Greater standardization and consistency are increasingly important for promoting the business environment and rule of law. - Critical skills gaps - Significant skill gaps remain, particularly among auditors. - Planned reforms (e.g., amendments to the Tax Collection Law) will create further demands for skills enhancement. - Need for a comprehensive strategy to close skill gaps, targeting technical skills and senior executive/manager capacities and using diverse training approaches and technologies. - Weaknesses in information systems - Key weaknesses: lack of national databases of taxpayer information, absence of third party information, and high compliance costs imposed by some SAT computer systems. - Opportunity: stability in SAT leadership and ongoing reforms to legal framework, administrative processes, and computer systems provide a foundation for modernization. ### Future reform priorities and recommended measures - SAT Modernization Program and strategic objectives - SAT’s six broad objectives (Wang, 2015): 1. a fully-developed tax law system; 2. a sound tax administration system; 3. a high-quality and convenient service system; 4. a rigorous tax collection system; 5. a robust information technology system; 6. an efficient organizational system. - By early 2016, SAT intends to develop a five-year action plan to modernize tax administration step-by-step by 2020. - Amending the Tax Collection Law (TCL) - Rationale: TCL (enacted 1992 with only minor amendments) must be updated to provide authorities needed for modernization while protecting taxpayer rights. - Enforcement-strengthening amendments recommended: - Ensure TCL applies broadly to all taxpayers, not just enterprises. - Require private sector third parties (including financial institutions and other income payers) to provide tax-related information to the SAT and facilitate information receipt from other government agencies. - Enhance arrears collection powers: power to impose tax liens, require third parties to pay monies owed to tax debtors to the SAT, and extend eligible taxpayers’ installment payment periods. - Taxpayer protection enhancements recommended: - Strengthen confidentiality provisions for taxpayer information. - Provide comprehensive procedural protections and clear guidelines for penalty application. - Eliminate requirement to pay 100 percent of disputed tax assessment before filing administrative review; replace with requirement to pay a percentage of disputed liability (with interest accruing to the agency or taxpayer as appropriate). - Grant SAT authority to provide binding rulings on tax law application upon taxpayer request. - Increase independence of SAT’s administrative review organ (discussed in Section V.F). - Status: SAT and Ministry of Finance jointly submitted draft amendments to the TCL to the State Council in November 2014; coordinated review during 2015; expected enactment during 2016. - Aligning organizational structure to the modernization strategy - Rationalize organizational structure, strengthen headquarters, consolidate the large network of tax stations, and establish effective arrangements for administering large businesses and HWIs. - Address fragmentation from ad hoc departmental creation (e.g., 2008 Taxpayer Services Department and Large Business Department) by ensuring clear accountability for taxpayer segments and better coordination of functions (notably audit). - Options to strengthen headquarters: - Gradually increase number of headquarters staff, or - Designate certain municipalities as “centers of excellence” supervised by SAT headquarters to design and implement national programs. - Consolidate over 10,000 grassroots tax stations to gain efficiencies, leveraging telephone contact centers and electronic services, particularly in urban areas. - Strengthen administration of large businesses and HWIs: - Large businesses: expand Large Business Department (LBD) authority, vest exclusive responsibility for auditing and issuing tax assessments to large businesses, and substantially increase staff at headquarters, provincial, and municipal LBDs. - SAT estimates: the largest 45 large enterprise groups account for about 22 percent of SAT’s tax collection; another 300–400 enterprise groups account for an additional 20 percent of SAT revenue. - High-wealth individuals: create a specialized HWIs unit (possibly within the LBD) with centralized oversight at SAT headquarters and provincial/municipal units responsible for taxpayer services, risk assessment, and audit. - In 2012, the top 10 percent of households accounted for about 50 percent of market income. - Extending SAT’s national and international reach - Domestic prerequisites for a national approach: 1. a nationally standardized tax identification number for enterprises and strengthened identification for individual taxpayers; 2. centralized master-files of taxpayer and third party information, prioritized for large enterprises and HWIs; 3. effective organizational arrangements for coordinating cross-provincial and overseas administration (leveraging LBD and a HWIs unit). - International actions to address BEPS and other cross-border risks: - Implement the OECD/G20 BEPS 15-measure package, requiring changes to domestic legislation, SAT administrative practices, and tax treaties. - Priorities include: - Improve transfer pricing rules (revise Implementation Measures of Special Tax Adjustments — Circular No.2). - Introduce country-by-country (CbC) reporting: require China-based parents of large multinational enterprise groups to file annual reports and enable SAT information sharing (revise Circular No.2 and sign the CbC-MCAA). - Incorporate anti-abuse provisions into tax treaties, adopt a new definition of permanent establishment (PE), pursue bilateral renegotiations and a multilateral instrument. - Improve Mutual Agreement Procedure (MAP) operations by allocating additional resources (personnel, funding, training). - Address tax risks from overseas investments by Chinese enterprises (under-reporting of foreign income, excessive deductions, repatriation avoidance) through legislative changes and strengthened international compliance programs. - Implement multilateral and bilateral exchange of information agreements: - Translate reporting/due diligence requirements into domestic law, build administrative and IT infrastructure for information collection and exchange, and establish confidentiality safeguards. - China signed the Multi-lateral Convention on Mutual Administrative Assistance in Tax Matters on August 23, 2013; ratified the Multi-lateral Competent Authority Agreement on automatic exchange of information on December 16, 2015; entered into an agreement in substance relating to FATCA with the United States on June 26, 2014. - Expanding the use of compliance risk management - Necessity: address known and emergent complex compliance risks through a systematic compliance risk management approach. - Typical three-level approach: - Tax level: identify material compliance risks for each major tax. - Segment level: identify prevalent compliance risks for homogeneous taxpayer groups (large, medium, small businesses; HWIs) and industries. - Taxpayer level: evaluate risk posture of individual enterprises and persons. - SAT progress and next steps: - Piloted taxpayer-level compliance management for large taxpayers, assigning risk categories: high, medium, low, and applying differential treatments. - Issued SAT Opinion Concerning the Strengthening of Tax Risk Management Work in September 2014 to standardize national approaches for risk identification, rating, treatments, and evaluation. - Recommendation: extend risk management beyond individual taxpayer assessment to develop separate compliance management strategies for each major tax (e.g., individual income, enterprise income, value-added) and for major taxpayer segments (large taxpayers, HWIs, small businesses). *Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp1668.pdf* ### Appendix 2 provides an illustrative template of a compliance management strategy for a ### _wp1668 - Appendix 2 provides an illustrative template of a compliance management strategy for a ### Compliance management coordination and governance - Assign a senior headquarters official responsibility for designing and overseeing implementation of each compliance management strategy. - Establish a national compliance management steering committee, chaired by headquarters and including the tax heads of selected provinces, to approve compliance strategies and coordinate cross-provincial activities (e.g., cross-provincial audits). - All departments should adopt a common risk management framework applied in a coordinated manner across SAT compliance improvement activities (taxpayer services, audit, arrears collection, proposed legislative changes, etc.). - Example from an external jurisdiction: for each major compliance risk, the Australian Taxation Office assigns a “risk owner” (senior executive) and a “risk manager” (senior official for day-to-day management). ### Enhancing core tax administration processes — two-stage upgrade - Stage 1: Standardize processes around SAT’s current best practices; completed with nationwide implementation of the National Tax Administration Standards (version 1.0) on May 1, 2015. - Note: These standards unified processes for 612 tax administration matters under 11 major categories, 152 subcategories, and 1,087 forms and certificates. - Stage 2: Introduce innovative practices guided by National Tax Administration Standards (version 2.0) to be introduced over the next several years beginning with pilots at the national level in Jiangsu and local level in Henan. ### Registration - Whole-of-government enterprise registration using a single business identifier and a one-stop registration process based on the new 18 digit Uniform Social Credit Code. - Administration of Industry and Commerce (AIC) will issue the new business identifier; most agencies expected to adopt it by 2017. - SAT should secure governance arrangements to ensure a role in design, operation, and maintenance of the national identification numbering system, e.g., via an inter-agency steering committee with SAT membership. - Individuals: SAT has not yet incorporated improvements for self-employed and natural persons; reforms needed for a nationally standardized identifier for self-employed persons, elimination of duplicate identification numbers for natural persons, and development of a centralized taxpayer register for individuals. - Suggested sequencing: begin with high-wealth individuals due to cross-provincial and international dealings and gradually expand. ### Taxpayer services - Continue and deepen the “Spring Breeze Project” to streamline frontline procedures, delegate decision-making, and improve services. - Further service delivery gains: - Benchmark SAT services against leading tax agencies (expand call center query types, greater use of email/text messaging, introduce online applications, and individualized taxpayer portals). - Migrate assistance from in-person visits to call centers and websites; centralize services to reduce the number of small tax offices. - Prepare taxpayers for anticipated changes to business, individual income, and property taxes via a dedicated taxpayer services program to support many new taxpayers. ### Filing and payment — reducing compliance costs - VAT estimated to account for about 40 percent of business tax compliance costs. - Compliance complexity examples: - Taxpayers may need to file up to two VAT returns (the main return and export refund Return) and more than 10 appendices with up to 800 data fields every month. - Suggested actions to reduce VAT compliance costs: - Simplify the VAT return and its data requirements. - Better align SAT rules with commercial practices on timing for crediting VAT paid on inputs. - Pursue technological improvements to the VAT computer system (see Section V.H). - Co-design reforms with industry associations, tax professional bodies, and software vendors. - Simplify taxation of very small (micro) businesses: - Make all micro-businesses subject to the same lump-sum payment regardless of sales or industry; limit eligibility to very small businesses with sales below some very low threshold. - Link lump-sum payment to issuance of an annual business license. - Preserve low compliance-cost features in PIT reform: - Maximize withholding at source, minimize number of persons required to file returns, limit deductions to those easily incorporated into withholding, and avoid expenditure-based allowances. ### Audit — broaden beyond invoice cross-matching - Invoice cross-matching has been effective against fraudulent VAT invoices but less successful at mitigating other forms of underreporting and will not, by itself, address underreporting for corporate and personal income tax. - Priority areas for strengthening audit capacity: - Make greater use of analytical methods leveraging growing data and planned third party information under amendments to the Tax Collection Law. - Improve basic audit methods; develop a nationally standardized audit manual for main tax types. - Adopt limited scope audits (focused on one or a few taxes/issues) alongside comprehensive audits. - Develop industry specialization, including industry-specific audit technique guides. - Introduce coordinated audits for large enterprises and high-wealth individuals with a cross-provincial approach and strengthen international compliance programs related to outbound investment by Chinese residents. ### Arrears collection — new powers and administrative procedures - Economic slowdown tends to increase tax arrears; SAT needs strong powers to recover arrears and provide viable businesses with breathing space. - Planned Tax Collection Law (TCL) amendments expected to: - Allow taxpayers to pay tax arrears over extended periods. - Authorize SAT to impose a tax lien on a tax debtor’s real property. - Authorize SAT to issue default assessments against taxpayers who fail to file returns. - Key implementation issues and required administrative steps: - Installment arrangements: - Draft amendments would extend installment period from three monthly installments to 12 monthly installments. - SAT must develop policy/guidance, define supporting information required, train collection officers in evaluating requests (including ability to pay analyses), and set approval levels. - Tax liens: - Develop administrative policy/guidance on imposition/removal of liens, types of property subject to liens, train officers to identify/locate properties, set notification procedures and forms, and define management approval levels. - Default assessments: - Authorize use of reasonable methods (e.g., use previous period’s liability plus uplift) to establish tax liability and accelerate collection while preserving audit rights. ### Dispute resolution - Improve dispute prevention and resolution to reduce compliance costs and increase fairness: - Convert more informal guidance into formal regulations with greater detail and follow public consultation to provide clearer application of tax laws. - Implement a private advance ruling regime as provided in draft TCL amendments; requires administrative guidelines and procedures. - Create administrative review mechanisms perceived as fair and independent: - Consider a network of administrative review units reporting vertically to a higher level administrative review unit rather than to the head of a higher level tax bureau. - Pilot quasi-independent review organs in selected locations where statutory framework permits. ### Human resources (HR) — right-sizing, skills, and incentives - SAT needs a comprehensive human resources management strategy to right-size workforce, enhance skills, and improve incentives for productivity and ethical behavior. - Right-sizing priorities: - Increase size of headquarters; headquarters currently has only 800 officials. - SAT comprises some 750,000 tax officers spread across 30 provinces. - Ensure appropriate staff allocation across functions; benchmark against other jurisdictions. - OECD averages for staff allocation: 36 percent to verification activities (including audit), 27 percent to account management (including taxpayer services), 11 percent to tax arrears collection, 9 percent to other tax operations, and 17 percent to support and other activities (including 3 percent to human resources management). - Skills strategy: - Evaluate current skills against future requirements; prioritize and fill skill gaps. - SAT headquarters should set training priorities and standardize curricula; exploit modern training technologies including e-learning. - Performance management: - Expand evaluation beyond revenue targets. The Digital HR pilot project evaluates units and staff on a broader set of performance measures; link performance evaluations more closely to remuneration and promotions and implement the pilot nationwide. ### Information technology — centralized data and VAT system improvements - Create national data center(s) of tax-related information (Golden Tax Project 3 will replace China Tax Administration Information System) to enable national data compilation for program evaluation, data mining, risk analysis, and cross-provincial taxpayer tracking. - Prerequisites for data centers: national taxpayer identification system and robust legal authority to collect third party information. - VAT system challenges and technological improvements: - Current VAT system imposes high compliance costs through manual extraction and transmission of transaction-level data. - Improve VAT software to automatically extract required VAT information from companies’ internal accounting systems to reduce manual interventions. - Facilitate e-invoicing adoption: - Establish legal mechanism for electronic invoice authentication (electronic signature). - Develop robust technological platform requiring major investments in software, hardware, high-speed Internet, wide area communication networks, and robust applications/database servers. - Co-develop systems with tax professionals’ bodies, industry associations, and software vendors. ### Performance measurement — move beyond revenue-target centrism - Over-reliance on annual tax collection target creates perverse incentives and can exacerbate economic downturns. - Adopt a balanced set of measures in addition to the collection target: - Tax administration results (quantitative and quality measures for each function). - Taxpayer satisfaction (measured by independent surveys). - Tax officer engagement (measured by survey). - Use Golden Tax Project 3 and Digital HR nationwide deployment to compile national data and implement balanced measurement and cascade targets down to managers and individuals. ### Conclusions — reform priorities and implementation guidance - Key reform priorities: - Amend the Tax Collection Law to expand SAT enforcement authorities (access to third party tax-related information, arrears recovery) and enhance taxpayer protections (confidentiality, procedural protections, advance rulings, eliminate 100 percent payment before administrative review). - Align SAT organizational structure with modernization strategy: increase headquarters size; eliminate fragmentation; consolidate grassroots tax offices; strengthen large taxpayer and high-wealth individual arrangements; create more independent administrative review organ. - Develop comprehensive compliance risk management strategies for each major tax, taxpayer segment, and individuals, prioritizing large businesses, high-wealth individuals, services sector growth (including e-commerce), international tax issues, and rising arrears. - Strengthen and standardize core processes: audits and arrears collection; simplify VAT reporting and micro-business assessment procedures; monitor adherence to national standards. - Strengthen SAT computer systems and make them easier for taxpayers to use: centralized taxpayer databases (start with large enterprise groups and high-wealth individuals), data exchanges with third parties, and reduce VAT system compliance costs. - Human resources: substantially increase headquarters staff; ensure appropriate staff allocation by function; realign training with modernization needs; introduce HR policies that incentivize productivity and integrity. - Implementation guidance and good practices: - Preserve strong and stable leadership to sustain medium-term institution building. - Design new tax legislation mindful of SAT administrative capacity and taxpayer compliance abilities (e.g., PIT reform should minimize filers and maximize withholding). - Use medium-term strategic plans to guide sustained reform efforts with clear goals, initiatives, timetables, and success measures. - Pilot major reforms prior to national implementation to minimize risk and enable learning-by-doing. - Continue technical cooperation with other tax agencies and international institutions while adapting international practices to local conditions. *Source: IMF staff report content from the provided PDF chapter/section.* ### Appendix 1. State Administration of Taxation Headquarters Organizational Structure ### Appendix 1. State Administration of Taxation Headquarters Organizational Structure ### Strategy Overview - Objective: Support business development and encourage voluntary compliance for small businesses through better access to professional services and bookkeeping tools. - Approach: Strategies guided by risk profiling and strengthened intelligence. Risk treatments are designed to be preventative, low cost, and project based. ### Segment Profile - Definition: - Businesses with sales below the VAT registration threshold, excluding those eligible for the patent or benchmark regime - Amount/type of tax revenue (Tax Type — Revenue ( billions)): - PIT 27.52 - CIT 5.24 - VAT 7.43 - ROY 0.12 - EXC 0.014 - WHT 5.73 - Other 7.12 - Total 53.17 - Share: - Revenue from this segment represents about 1.9% of total tax collections - Number/type of taxpayers: - Mostly sole traders, limited liability companies and partnerships. - Around 50,000 legal entities; almost 150,000 Sole Traders, with varying levels of business/financial skills. - Number/type of tax returns: - SB have multiple tax obligations and entities are required to file quarterly. Most do not require audit certification. - Key industries: - Wholesale & retail, Construction, Manufacturing, and Professional services. ### Priority Risks (high, medium, low) - Registration risk: Medium - Some are unregistered others not registered for all Taxes. - Filing risk: Medium - SBs are prone to drop out of the system due to complexity or cash flow problems. Some drop out because of competition from unregistered businesses. - Under reporting risk: Medium - Both deliberate and inadvertent underreporting occurs. Low business acumen results in errors and the informal economy sees deliberate omissions. - Payment risk: Medium - Cash flow pressures are prevalent and payment default is common. Almost 80% of arrears cases are small, representing only about 5% of debt by value. ### Risk Treatments (Measures) - Measures for facilitating compliance: - Simplified registration, filing and payment processes to reduce errors. - New business assistance program (“Right from the Start” approach). - Easily accessible MTA advice tailored to the needs of SBs and delivered through multiple channels. - Improved accessibility to professional advice in partnership with SME Incubators. - Free electronic and paper-based bookkeeping tools. - Early intervention calls, visits and letters to prevent errors from occurring. - Closer working relationships with State Registration Department. - Measures for dealing with noncompliance: - Comprehensive audits for highest risk cases. - Hidden economy campaign. - Limited scope risk based audits. - Use of small business benchmarks for prevention and detection. - Income verification program. - Outbound telephone calls for small arrears cases. - Voluntary disclosure initiative with concessional penalty imposition. - Measures for simplifying tax policy design: - Small Businesses will be taxed under a simplified regime (based on turnover or cash-flow) with simple tax returns & no requirement to submit financial statements. ### Compliance Indicators and Workflows - Compliance Indicators (examples): - Registration: % increase in registration; % Reduction in lost registrants - Filing: % increase in on time filing - Reporting: % incease in audit strike rates; % of audit acts sustained on dispute - Payment: % reduction in arrears; % increase in collections of Audit Acts - Number of: - Assistance products - Voluntary Disclosures - Registration Checks - Outbound calls - Pre-filing letters - Workflows (activity counts): - Number of: - Advisory Visits - Limited Scope Audits - Comprehensive Audits - Debt Collection Actions ### Capacity Development - Information Systems, Data Management & Analytics: - Fully implement self-assessment and optimize e-tax. - Streamline registration, filing and payment processes. - Ensure Risk Management supports compliance strategy (rather than driving them). - Staff Development: - General and functional management, Technical, Industry specialization, Service and Communication skills training. - Administrative Tools and Procedures: - Develop Channel management strategy, optimize call center and web services. - Design a new business program. - Build alliances with the Tax Profession and other agencies servicing SB. - Management and Organization: - Integrate compliance strategies into operational plans. - Appoint a senior headquarters official to oversee development of small business compliance strategy. *Source: Appendix 2. Illustrative Compliance Management Strategy for Small Businesses.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp1668.pdf_