China ’ s Prevention and Solution to the Risk of MSE ’ s Tax Compliance

1. China’s Prevention and Solution to the Risk of MSE’s TaxCompliance Mr. Li Linjun Director-General Department of Tax and Information Technology Administration State Administration of Taxation(SAT) People’s Republic of China Feb. 2010

2. China’s prevention and solution to the risk of MSE’s tax compliance • 1. Basic concept of China’s MSE • 2. Main risks of the tax administration on MSEs • 3. Main strategies to solve the risks of MSEs’ tax compliance

3. China’s prevention and solution to the risk of MSE’s tax compliance • 1. Basic concept of China’s MSE • According to the “Interim Regulations on Standards of MSEs” issued in 2003,China’s MSE mainly refers to: • An industrial enterprise with less than 2000 employees, or an annual sales of less than 300 million Yuan, or a total asset amount of less than 400 million Yuan; an enterprise in construction industry with less than 300 employees, or an annual sales of less than 300 million Yuan, or a total asset amount of less than 400 million Yuan; an enterprise in wholesale or retail industry with less than 500 employees, or an annual sales of less than 150 million Yuan; an enterprise in transportation industry or provides postal services with less than 3000 employees, or an annual sales of less than 300 million Yuan; an enterprise provides accommodation or catering services with less than 800 employees, or an annual sales of less than 150 million Yuan.

4. China’s prevention and solution to the risk of MSE’s tax compliance • From the perspective of taxation, presently in China about 16 million eligible MSEs, including around 11 million self-employed, are under tax administration, accounting for about 70% of all registered enterprise taxpayers, the number of which is over 23 million as by the end of 2009.

5. China’s prevention and solution to the risk of MSE’s tax compliance • 2. Main risks of the tax administration on MSEs • Insufficient information about their income, information asymmetry, and low compliance • Limited tax administrative resource, comparing to the large number of MSEs • Lack of legal system requiring third-party information be provided to revenue authority in a systematic, comprehensive and clear manner; lack of strict laws or regulations on controlling cash transactions, and a matching personal credit rating system is not in place

6. China’s prevention and solution to the risk of MSE’s tax compliance • 3. Main strategies to solve the risks of MSE’s compliance • MSE’s high risk nature • SAT’s Goal: voluntary compliance of MSEs • Methods: optimized taxpayer services strengthened administration

7. China’s prevention and solution to the risk of MSE’s tax compliance • (1)Optimize the tax services for MSEs • Preferential tax polices • Supporting MSEs is a national policy • Article 17 of “MSEs Promotion Law” Encourages venture funds to invest in MSEs through preferential tax policies • Article 23in “MSEs Promotion Law” Encourages the establishment and development of MSEs through preferential tax policies

8. China’s prevention and solution to the risk of MSE’s tax compliance • Other tax incentives

9. China’s prevention and solution to the risk of MSE’s tax compliance • Better communication with MSE taxpayers and enhanced services • Visits, symposiums and so on • Seeking opinions providing guidance and help

10. China’s prevention and solution to the risk of MSE’s tax compliance • (C) Reduce MSEs’ compliance cost • Tax awareness campaign • Waive tax registration fee in some population • Simplified procedure • Free consultative service through a national unified tax service hotline (12366).

11. China’s prevention and solution to the risk of MSE’s tax compliance • (D) Diversified payment methods • Payment through telephone, mail, internet and bank • simplified or unified tax collection period • Automated payment transfer from taxpayer’s bank account

12. China’s prevention and solution to the risk of MSE’s tax compliance • (2) strengthen risk management on tax compliance of MSEs • Categorized administration and collection method • (a) Collection-on-self-filing and collection-on-verificationon MSEs.

13. China’s prevention and solution to the risk of MSE’s tax compliance • (b) tax payable generated by computers • (c) commissioned collection on self-employed

14. China’s prevention and solution to the risk of MSE’s tax compliance • (B) Enhance the gathering and sharing of tax-relevant information • Key information: tax registration, declaration, invoice issuing, financial accounting, consumption of energy resources (e.g. coal gas, fuel oil, water, and electricity), consumption of raw materials, bank account opening and banking transactions.

15. China’s prevention and solution to the risk of MSE’s tax compliance • Third party information • Legislation • IT application

16. China’s prevention and solution to the risk of MSE’s tax compliance • (C) Conduct tax assessment on MSEs • China’s tax assessment is similar to the tax auditing which is being widely practiced in OECD countries. • What is tax assessment?

17. China’s prevention and solution to the risk of MSE’s tax compliance • The usual method: • Factor identification • Sequencing and rating of risk factors • Handle the high-risk taxpayers • Investigation and punishment

18. China’s prevention and solution to the risk of MSE’s tax compliance • General coverage: less than 10% of all enterprises annually. • A case-study

19. Result of Estimation Result of Estimation Result of Estimation Result of Estimation Risk Indicator A: VAT Burden Rate 31% lower than industrial pre- warning rate; Profit-margin Rate 36% lower than industrial average. Degree of Indicator D 20 points Degree in Total 78 points Degree of Indicator B 30 points Degree of Indicator A 15 points Degree of Indicator C 13 points Risk Indicator B: Quarterly Freight Expenditure as Deduction, 57% of Sales in corresponding period; VAT Burden Rate 28% lower than Historical Level. Risk indicator C: Percentage of Expenditure 33% higher than industrial average. Key Risks Risk Level Risk Indicator D: Issued-on-Behalf Invoices of Expenditure on Office Supplies, 0.47 million Yuan. A casestudy on Risk Management of Company A Analysis & Identification of Risk Processing of Risk Administration Outcome of Risk-administration Degree Sequence of Risk Estimation of Risk Degree • Through the tax-administrator’s portfolio of measures such as issuing risk-reminder letters to the taxpayer, investigating in the invoices on main expenditure, conducting professional assessment and so forth, Company A made a supplementary payment of 1.76 million Yuan as the tax payable, plus 32 thousand Yuan as the fine for overdue tax payment. Its VAT burden rate raised from 2.31% to 3.47%, which is 0.1% higher than the industrial average, and the profit-margin rate raised from 5.84% to 9.8%, which is 0.7% higher than the industrial average. Result of Estimation Risk Level Four Abnormal Burden Rate Abnormal Profit-margin Rate Abnormal Expense Rate Abnormal Invoices Accepted 1

20. Conclusion Thank you for your attention!