Tax audits and corporate compliance under phase four of ‘golden tax’ reform

In March 2021, the general office of the CPC Central Committee and the general office of the State Council issued the Opinions on Further Deepening the Reform of Tax Collection Administration, initiating the development of phase four of China’s Golden Tax System, a countrywide administration and monitoring system of tax collection. The plan sets 2025 as the target for its completion, marking a significant milestone in taxation reform.

Phase four of the Golden Tax System extends beyond monitoring corporate tax data to comprehensively overseeing business operations. This mandates companies to establish robust internal management systems, standardise financial processes and streamline operations, so enhancing overall corporate governance. With this, China’s tax administration has officially entered the era of big data supervision.

Key focus of tax audits

Invoicing. The principle of “inspecting invoices when investigating taxes, accounts and cases” has long been a cornerstone of tax enforcement. Following the reform of fully digitalised electronic invoices, tax authorities are now better equipped to detect and address illegal activities such as tax evasion through dual contracts, falsified costs and fraudulent invoicing.

Companies found engaging in such practices will not only be required to repay taxes but may also face fines and other administrative penalties. In severe cases, responsible individuals could be subject to criminal prosecution.

Tax burdens and profit margins. The development of “smart taxation” reflects a shift towards intelligent transformation, leveraging next-generation technologies such as big data and cloud computing to digitise tax administration and oversight. This enables tax authorities to accurately monitor industry-specific tax burden ratios.

Should a company’s tax burden and profit margins significantly deviate from industry norms or exhibit anomalies such as sustained losses despite ongoing operations and severe mismatches between revenue and costs, it will trigger risk alerts within tax authorities. Upon verification of violations such as concealing income, inflating costs and profit shifting, the company will face stringent tax investigations and penalties.

Corporate and individual taxes. As China has centralised the collection of social insurance contributions under its tax administration system, companies must ensure that their staff cost declarations for tax purposes strictly align with the taxable income reported for employees’ individual income tax.

Discrepancies in declarations, failure to pay social insurance during probation, fraudulent social insurance affiliations, or falsified employee records will expose businesses to penalties from labour inspection authorities, social security agencies and tax administrations.

Account registration. Leveraging improved data sharing between banks, foreign exchange regulators and customs, tax authorities can now consolidate tax, business registration and payment data to detect warning signs like non-local legal representatives, clusters of incorporations, multiple firms registered at the same address, and suspicious large transactions.

The Regulation on Fair Competition Review further tightens oversight of regional tax incentives, closing loopholes for firms using fake registrations or related-party transactions to evade taxes.

Measures of corporate compliance

Firstly, companies should rigorously strengthen their financial systems. This includes strict compliance with accounting laws and regulations, standardising accounting practices and enhancing invoice management to avoid fraudulent invoicing. A comprehensive internal control system, incorporating risk assessment and anti-fraud mechanisms, should be established.

Additionally, related-party transactions must adhere to the arm’s length principle, demonstrate legitimate business purposes, and be properly disclosed. Companies must also complete annual corporate income tax settlements and adjustments as required by tax laws, while conducting regular self-audits of their tax filings for the past five years (minimum three years) to promptly address any non-compliance.

Secondly, companies should leverage big data technologies to refine the management of cost invoices. Specifically, businesses should transition to fully digitalised electronic invoices, gradually phasing out paper-based ones.

By using the enterprise-facing features in phase four of the Golden Tax System, businesses can automate electronic invoice processing and establish real-time monitoring mechanisms to dynamically track invoice issuance and reimbursement, enabling prompt identification and resolution of anomalies.

Thirdly, companies should accurately apply tax policies in line with their specific circumstances.

• Pre-tax deductions. Deductible items of costs include annual wages accrued and paid to employees before the completion of annual tax settlement, severance payments allocated under company policies (upon actual disbursement), as well as employee benefits and training fees. For expenses, deductions include reasonable and non-capitalised borrowing costs incurred during business operations, interest paid to related parties, exchange losses, business entertainment expenses, advertising and promotional costs, and charitable donations, provided they meet the conditions and limits set by tax laws.
• VAT incentives and exemption for small-scale taxpayers. For example, those with monthly sales of RMB100,000 (USD13,700) or less are exempt from VAT until 2027.
• Business segregation. When restructuring business operations, companies should carefully evaluate whether the separated operations are essential components of the business, ensure that related-party transaction prices are fair, and verify consistency in business processes, payment flows and financial invoicing.
• Regional tax incentives. Companies are required to demonstrate genuine business activities, maintain a workforce proportionate to their operations, and provide a clear evidence trail of transactions. They should also ensure a legitimate registered address and physical premises, transparent fund flows, signed service contracts, valid commercial purposes, and fair pricing.
• Equity structuring. Companies can optimise tax planning systematically by aligning organisational and equity structures within the group.

In light of phase four of the Golden Tax System reform, businesses must adapt to policy trends and proactively navigate tax regulatory landscapes. They should also ensure compliance based on actual business operations, fortify overall competitiveness, and mitigate potential tax risks.

Li Weiming is a partner and Wu Jiayu is an associate at Blossom & Credit Law Firm