China: Tax issues on receiving falsely issued invoices in 'good faith'

Last Updated: 9 March 2014
Article by Tony Dong and Daisy Duan

The invoice plays an indispensable role in economic activity and business operations in China. It also plays an important role in tax scrutiny when tax authorities are collecting taxes and combating tax evasion. It is reported that in 2013, the tax authorities investigated 91,000 cases of selling or producing false invoices or the illegal issuing of invoices and 130 million illegal invoices were uncovered. Invoice-related non-compliance is found frequently in certain industries such as real estate, construction and installation, medicine and medical equipment, power generation and supply, catering and entertainment, and the education or training industry. The tax authorities have identified 89,000 entities that have illegal invoices issues, and they are pursuing taxes of more than RMB 13.8 billion.

Based on the Administrative Measures of the People's Republic of China on Invoices 1, drawing up or having drawn up invoices for oneself, or for others, or introducing others to issue invoices which are not in line with an actual operating business will constitute drawing up false invoices. In addition to administrative punishment, serious violation may result in criminal responsibility. Not surprisingly, most enterprises or individuals that receive false invoices clearly know that the invoices are false and they are being used to evade tax. Therefore, obtaining such invoices in "bad faith" will be investigated and punished. However, some buyers who receive invoices do have real transactions with sellers and the information stated in these invoices is consistent with actual transactions, and the buyers might not be aware that the invoices are illegally acquired or drawn up. Such taxpayers may still suffer losses or even be punished by tax authorities though they have acquired false invoices in "good faith".

This article will discuss differences between the good and bad faith acquisition of falsely issued invoices, and the tax implications of acquiring falsely issued invoices in good faith as well as ways to avoid acquiring false invoices.

Distinguishing "good faith" and "bad faith"

Determination of the taxpayers' good faith or bad faith when acquiring invoices will make a difference as to whether or not taxpayers will be subject to administrative punishment or even criminal liability. The crux of the matter is whether the enterprise as an invoice recipient subjectively knew that the invoice had been falsely issued. Because of the complexity of business transactions and different positions on tax collection, tax authorities and enterprises have plenty of scope for different arguments on tax liability and it is difficult to achieve a consensus.

To show "good faith", a taxpayer who acquires invoices must not intend to evade tax nor fraudulently obtain export tax refunds, nor intend to achieve illegal benefits. Generally speaking, acquisition of falsely issued invoices in "good faith" must satisfy all the following conditions: (1) there must be a real transaction between the buyer and the seller; (2) the amount in the invoices issued to the buyer must be consistent with the sales amount; (3) the buyer must not be aware that the invoices are drawn up illegally, or issued by a third party.

Acquisition of falsely issued invoices in "bad faith" refers to circumstances where a taxpayer requests a counterparty to draw up false invoices lacking a real sales transaction, or a taxpayer knowingly accepting false invoices, or a taxpayer acquiring invoices from a third party during the transaction, and subsequently the taxpayer claiming a tax credit or pre-tax deduction from the tax authorities. The "bad faith" acquisition of false invoices must satisfy all of the following conditions: (1) there is no sales activity, or even if there is a sales activity the invoices are acquired from a third party; (2) the taxpayer has claimed the VAT credit or tax deduction before income tax; and (3) subjectively, the taxpayer is aware that the invoices are falsely issued.

In order to avoid being found liable for acquiring invoices in "bad faith", a buyer needs to provide relevant documents to convince the tax authorities that it received the false invoices in "good faith".

Tax impact of acquiring falsely issued invoices in good faith

For enterprises which carelessly acquire false invoices in "good faith", tax consequences are different depending on the types of the false invoices and their functions (e.g. whether used as a credit against input VAT, an export VAT refund or a pre-tax deduction for income tax purpose). A brief introduction is set out below.

  • VAT treatment for acquiring special VAT invoices in good faith
  • Tax treatment of taxpayers who acquire special VAT invoices in good faith are relatively clear 2. To be specific:

    • Taxpayers who acquire special VAT invoices in good faith will not be treated as tax-evaders or of defrauding export tax refunds. However the input tax deduction or import tax refund will not be permitted and the tax deducted or refunded must be repaid by the buyer;
    • If taxpayers who acquire falsely issued special VAT invoices in good faith can replace them with lawful and valid special invoices then the input VAT credit can be deducted; if valid invoices could not be re-obtained then the taxpayer cannot deduct the input VAT and the deducted input VAT must be repaid.
    • Where the deducted tax credit has been legally repaid by a taxpayer which acquired the falsely issued special VAT invoice in good faith, then late payment interest will not be imposed on the taxpayer.
    • Taxpayers who have received administrative or criminal sanctions for false special VAT invoices will not be entitled to the preferential policy of obtaining VAT refunds at or after collection up to 36 months, and may be denied export tax refunds. However, taxpayers who acquire false special VAT invoices in good faith will not be subject to these punishments.
  • Income tax treatment for acquiring invoices in good faith

Due to lack of explicit tax guidance, local tax authorities hold different opinions about whether the corresponding purchase costs indicated in false invoices (including special VAT invoices and other invoices) acquired by enterprises in good faith can be deducted before income tax. Currently, most tax authorities disallow the deduction of such costs before income tax and thus the income tax burden of enterprises is increased directly, however, many enterprises disagree with this tax treatment. The fundamental reason for the disagreement is due to a different opinion of the principle for deduction before income tax.

Prior to implementation of the Enterprise Income Tax Law (effective as of 1 January 2008), as required by relevant tax rules, the deduction filed by taxpayers had to be true and lawful with the lawful invoices as the basis for bookkeeping. The tax authorities held that falsely issued invoices failed to satisfy the aforesaid "lawful" requirement, therefore no deduction before income tax could be allowed, however, it was normally recognized that if the buyer could re-acquire lawful and valid invoices from the seller, deduction before income tax would be allowed for the period when costs and expenditures were generated.

The Enterprise Income Tax Law and its implementation regulations stipulate that reasonable expenses that are relevant to the income were actually incurred and obtained by enterprises are allowed to be deducted from the taxable income. Compared with previous rules, the Enterprise Income Tax Law emphasizes the principle of actual occurrence, relevance and reasonableness instead of the legality of the vouchers for deduction. This creates discussion space about whether deduction of the false invoices acquired in good faith is allowed before income tax.

Since 2008, though certain local tax authorities still require in their enterprise income tax final settlement notices that falsely issued special VAT invoices or ordinary invoices acquired by enterprises in good faith cannot be treated as the evidence validating deductions before income tax, we note that the 'Administrative Measures on Pre-tax Deductions of Enterprise Income' (Su Di Shui Gui [2011] No.13, effective as 1 Feb. 2012) issued by the Jiangsu local tax authority 3 has made a breakthrough in terms of vouchers for pre-tax deduction. More specifically,

  • Disqualified invoices are not to be the sole evidence for pre-tax deduction; contracts, expenditure receipts and other vouchers may be provided as well so as to prove the legality and authenticity of such expenditure;
  • For costs and expenditure actually incurred in the current year, if the enterprise cannot obtain valid vouchers in time, it can calculate taxes temporarily based on the accounting amount when paying provisional income tax quarterly. However, when the enterprise conducts its annual filing, valid vouchers for the costs and expenditures shall be supplemented;
  • Upon completion of the annual income tax filing, if the enterprise still cannot obtain lawful vouchers, but there is solid evidence to prove the authenticity of business expenditure and the party obtaining the income has recorded such income in its books, then the relevant costs and expenditures of the buyer may be deducted before income tax.

We are of the view that Circular 13 properly demonstrates the principle of actual occurrence, relevance and reasonableness for the expenditure deduction as regulated in the Enterprise Income Tax Law. This ensures the proper administration of tax collection, and at the same time provides enterprises with their reasonable tax benefits in cases where they may fail to obtain lawful vouchers despite incurring actual and reasonable expenditure. This circular gives a basis on which enterprises acquiring falsely issued invoices in good faith may successfully argue for a deduction before income tax.

Tips for taxpayers

Based on the analysis above, enterprises which acquire falsely issued special VAT invoices cannot claim an input VAT credit unless lawful and valid invoices can be re-acquired from the seller. Furthermore, the tax authorities may disallow the deduction of the corresponding costs before income which results in unnecessary economic losses for enterprises.

In order to avoid obtaining falsely issued invoices, taxpayers should pay close attention to the authenticity of their suppliers' sales activity, the legality of the source of invoices and the authenticity of invoices etc. Taxpayers can reduce risk by applying various effective precautionary measures which include:

  • Make sure transactions are real, watch the genuineness and consistency of the three elements in a transaction, i.e. the flow of goods, invoices and payments;
  • In addition to the quality and price factors, taking into account of the size, reputation and track records when selecting the suppliers to do business with;
  • Investigate the suppliers' business scope, business scale, production capacity, enterprise qualifications and ownership of goods;
  • Request the suppliers' tax registration certificate, application and general VAT payer certificate, invoice purchase book, delivery order, accounts of the receiving bank, warehouse entry and books, so as to perform comprehensive cross-reference and verification;
  • Make the payment via bank accounts, request that the bank account information be consistent with the information specified on invoices;
  • Perform tax verification for the acquired invoices in a timely manner. Seek assistance from the tax authorities for suspicious invoices;
  • Maintain complete documentation, e.g. contracts, vouchers and accounting records to retain to sufficient evidence in case of the tax authority's investigation.

Footnotes

1This circular was approved by the State Council on December 12, 1993, promulgated by the Order of the Ministry of Finance No.6 on December 23, 1993 and revised by the Decision of the State Council on Revising the Administrative Measures of the People's Republic of China for Invoices on December 20, 2010.

2VAT treatment for taxpayers who acquire falsely issued special VAT voices in good faith are mainly based on Guo Shui Fa [2000] No. 187, Guo Shui Han[2007] No. 1240 and Cai Shui [2013] No. 112.

3Enterprises whose enterprise income tax is collected by Jiangsu Local Tax Authority shall apply this Measure.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions