Tax evasion in China

Tax evasion remains a significant concern for governments worldwide, and China is no exception. To address this issue, the country has put in place legal mechanisms and systems to detect, penalize, and sometimes even offer an avenue for taxpayers to voluntarily correct their tax filings before facing severe penalties. This article outlines the legal definition of tax evasion in China, its consequences, how tax authorities detect violations, and the possibility of voluntary disclosure to mitigate penalties.

Definition of Tax Evasion and Detection

According to the Tax Collection Administration Law of the People's Republic of China (2022), tax evasion is defined as the deliberate act of taxpayers forging, altering, concealing, or arbitrarily destroying accounting records and vouchers, overstating expenses, or failing to report income. This also includes instances where taxpayers refuse to file returns or submit false tax returns after being notified by the tax authorities, resulting in the non-payment or underpayment of taxes owed. The law applies to both domestic tax residents and foreigners with tax obligations in China. The detection of tax evasion is increasingly facilitated by technological advancements. The Chinese tax authorities primarily rely on the Golden Tax Phase IV System (金税四期系统), a robust data analytics platform that compares invoices, bank transactions, contracts, and other relevant data points to identify discrepancies and signs of tax evasion.

Consequences of Tax Evasion

The consequences of tax evasion in China are severe and multi-faceted. Under Article 63 of the Tax Collection Administration Law, if tax evasion is detected, the tax authorities are empowered to recover the unpaid taxes, impose late fees, and levy fines ranging from 50% to five times the amount of unpaid taxes. If the violation constitutes a criminal act, the taxpayer may also face criminal prosecution in accordance with Chinese law, with potential imprisonment ranging from 3 to 7 years. Tax evasion thus poses not only financial risks but also potential legal ramifications, including criminal charges for repeated or large-scale violations.

How Tax Authorities Detect Tax Evasion

Tax authorities in China employ sophisticated tools to detect tax evasion. The Golden Tax Phase IV System plays a central role in this effort. By analyzing vast amounts of data such as invoices, bank transactions, and contracts, the system cross-references information to identify inconsistencies, anomalies, or deliberate omissions that may suggest tax evasion. This data-driven approach allows tax authorities to detect irregularities more efficiently and accurately than traditional methods. Additionally, since 2018, China has also been receiving automatic exchanges of financial account information (AEOI) from financial institutions in a vast number of countries, which helps uncover unreported offshore financial assets and income. 

Amending Tax Declarations: Voluntary Disclosure

One of the key provisions within China’s tax law allows taxpayers the opportunity to amend their declarations voluntarily before the tax authorities detect the violation. If taxpayers proactively come forward and pay the underpaid taxes before they are discovered by tax authorities, they generally face reduced penalties. In practice, taxpayers may only be required to pay a late fee, calculated at 0.05% of the underpaid tax amount per day of delay. However, once the tax authorities have issued a formal recovery notice, the opportunity for reduced penalties becomes more limited. In such cases, taxpayers who voluntarily pay the due taxes and late fees—while having already faced administrative penalties—may avoid criminal liability. This is contingent on the absence of prior criminal punishment for tax evasion or more than two administrative penalties within the past five years.

Conditions for Voluntary Disclosure of Tax Evasion

While the Tax Collection Administration Law does not explicitly provide a formal framework for voluntary disclosure, customs regulations outline specific conditions applicable to tax matters. Under these regulations, if voluntary disclosure occurs within six months of the tax underpayment, taxpayers may benefit from the waiver of late fees. If disclosure is made between six months and one year after the underpayment, and the underpaid taxes do not exceed 30% of the payable amount, taxpayers may be eligible for a reduction or waiver of late fees.

This framework offers an opportunity for taxpayers who have made honest mistakes or wish to correct past errors without facing the full extent of legal penalties. Additionally, in certain circumstances, Chinese authorities may implement grace periods for specific industries, allowing taxpayers to disclose non-compliance without facing sanctions. This regulatory flexibility encourages voluntary compliance and helps taxpayers resolve discrepancies.

Consequences of Voluntary Disclosure

As mentioned before, if the taxpayer voluntarily discloses tax evasion, the authorities may reduce or waive the penalties typically associated with tax evasion. However, it depends on the specific circumstances, including the severity of the noncompliance and whether the taxpayer has made a full disclosure. Criminal penalties may be waived, but this is not guaranteed. Voluntary disclosure allows taxpayers to correct their noncompliance without facing the full penalties that could result from being caught through an investigation. 

Too Late for Voluntary Disclosure

Naturally, voluntary disclosure is no longer possible when the authorities have initiated an audit or investigation into the taxpayer’s affairs. Once the taxpayer is under investigation or has been notified of an inspection, they typically cannot benefit from voluntary disclosure policies. 

Main Fields and Overseen Fields

Voluntary disclosure plays a major role in fields involving income tax, customs duties, and currency exchange control violations. Taxpayers with undeclared offshore assets or income, for example, may use voluntary disclosure schemes to correct their filings. Compliance with respect to offshore assets or income is often overseen as well. Additionally, failure to comply with currency exchange control rules may be overlooked. 

Suggestions for Taxpayers

For businesses and individuals in violation of tax laws, the best course of action is to stop illegal activities and take immediate steps to rectify the situation. Engaging professional advisors, such as tax consultants or legal experts, is critical to ensure the voluntary disclosure process is handled properly. A professional team can help navigate the complex regulatory landscape, assess potential risks, and determine the most effective strategy for minimizing penalties. Taxpayers should also consider proactively monitoring their tax compliance practices to avoid future violations and ensure adherence to all applicable laws and regulations.

In conclusion, while tax evasion carries significant legal consequences in China, voluntary disclosure offers an opportunity for taxpayers to correct mistakes with reduced penalties. By understanding the legal framework surrounding tax evasion, the detection mechanisms, and the conditions for voluntary disclosure, businesses can better protect themselves against the risks associated with tax non-compliance. Taking timely and informed action can safeguard both a company’s financial stability and its reputation.

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With nearly a decade of experience in accounting, Dream is a Partner at MSA. Her expertise lies in tax and HR, where she plays a key role helping clients navigate complex challenges. She also assists in other areas such as payroll compliance, corporate tax, and social security contributions.