The Chinese government is pushing ahead with its social credit project, which evaluates the trustworthiness of every citizen and company using a points system. The aim is to record, evaluate, reward or sanction desired and undesirable behavior.
Already in 2014, the Chinese coastal city Rongcheng in Shandong Province launched a first test of the social credit system, and by 2020 all government databases together with some private databases are to be merged. Besides combating undesirable social behavior and educating citizens to be more honest and engaged, social activities, tax evasion or white-collar crime will also be more closely monitored.(You can read in our article what the new system means for a foreign business in China)
The Chinese State Council has set a framework for taxpayers, where the tax credit system will contribute a part to optimize the future social credit system. The State Administration of Taxation (SAT) has adopted two measures to create incentives for honest taxpayers and fines for dishonest taxpayers. This “two measures” tax system is considered to play an important role in the implementation of the social credit system and is seen as the backbone of the project. The tax system will improve its evaluation criteria, shorten the evaluation period, publish specific cases and conduct tests on the efficiency of reward and punishments.
Mechanisms of the Social Credit System
According to the SAT, the taxpayer credit system will use several indicators to evaluate taxpayers, raise and, if applicable, lower the score of taxpayers.
The evaluation is based on three main sources:
1. Information about the taxpayer’s history, such as previous tax returns, creditworthiness and other tax deductions.
2. Internal information from tax authorities on tax returns, tax payments, Fapiaos or other tax instruments, as well as tax account information and tax controls
3. External information including “credit records” from other authorities, which also check the creditworthiness
Based on a percentage point system, the taxpayer finds himself rated from Grade A to Grade D, which correspond to the following percentage points.
Grade A: Over 90 points
Grade B: Between 70-90 points
Grade C: Between 40-70 points
Grade D: Below 40 points
In April each year, the tax authorities will evaluate the performance of the previous year. If a taxpayer is not satisfied with his rating, he can apply for a new rating.
What impact does a Grade have on my business
In practice, the grade has a direct impact on the business and tax risk. Grade A taxpayers will be published on a list, given a higher quota of “Special VAT Fapiaos” and will receive active support from tax authorities for collecting and writing off Fapiaos. (Read also our article on the new rules for Fapiaos).
On grade B you get a normal treatment, while at grade C, you will be monitored more stringent and more evidence are needed.
When a company reaches grade D, it is rigorously checked for misconduct and will have to expect more surveillance while using fapiaos, applying for export discounts or general taxation. In addition, harsher fines are imposed on misconduct and other authorities are informed about the grade. Therefore the company must expect restrictions on the following projects: investment and financing, access to state-owned land, import and export, exit and entry, registration of a new company and general projects preceded by state approval.
The new administrative measures also specify in which cases grade D can be awarded directly. These include, but are not limited to, tax evasion, counterfeiting of Fapiaos, failure to make payments, late payments, obstruction of tax inspections, and withholding or falsifying relevant material in the tax return.
Even though the restrictions on the D taxpayers sound tough, being blacklisted is even worse. The exact criteria of the blacklist were finished at the end of 2013 and address serious tax offenses, such as repeated or severe tax evasion, tax fraud or counterfeiting of Fapiaos.
If there is a serious tax offense, the offender’s name will be published immediately. The publication will include the name of the company, the taxpayer’s registration number, address, nature of the offenses, and the amount of the administrative penalties.
Additionally, the blacklist also publishes the name, gender, and ID number of the company’s legal representative and financial staff, as well as the information of the agencies and their employees, who are responsible for tax matters.
The lists are published by local and municipal tax authorities via internet, newspapers, radio, television, social media, and press conferences. Each company will remain on the blacklist for at least two years after publication.
In order to ensure fair treatment, several authorities together and the Communist Party can also intervene at any point in time.
Implementation of the reward and punishment system
The incentives for honest taxpayers and sanctions against dishonest taxpayers are the core mechanism of the tax credit system. The two measures rely hereby above all on public supervision and the reward and motivation for honest taxpayers as well as increased restrictions and penalties against dishonest taxpayers. A general awareness shall be created that any behavior has its consequences and that taxpayers are motivated to comply with the tax rules.
An important prerequisite for the implementation of the system is the cooperation mechanism that has been established between the various tax authorities and other authorities. The aim is to build a more effective control system through differentiated responsibilities and a lively exchange of information. For example, companies, where the entry or exit of legal representatives caused by tax offenses are denied, are reported to appropriate authorities. To support the tax credit system, authorities from the industry, commerce or customs from various regions work together.
Advice from our ECOVIS Beijing tax consultants
The new tax credit system will not only tighten controls but also increase penalties. Being Grade C, D or even blacklisted, can easily cause long-term harm to your business or yourself, as all information and sanctions are made public.
Foreign businesses should be especially cautious since offenses often happen rather out of ignorance and negligence than on purpose. Insufficient knowledge about the correct handling of Fapiaos, mistakes regarding accounting or wrong tax returns can become an unintended but serious problem for a company in China. If you want to avoid this, you should get professional help as early as possible.
ECOVIS Beijing is a Sino-German consultancy focusing on accounting, audit, tax, legal, and FDI advisory. For more information or questions on late payments in China or our tax services, please contact email@example.com
With contribution by Tjun Long Mok
Richard Hoffmann is a partner at ECOVIS Beijing China. Richard obtained an honors degree in law and worked in Germany, the United States, and China for various prestigious law firms prior to joining ECOVIS. In addition to being a member of the board of ECOVIS International, he is Supervisor for the China business of a respected German company and shares his extensive knowledge to students by teaching commercial law in China at SRH Hochschule Heidelberg. He has published more than fifty articles in international magazines, frequently speaks at high profile events in China and abroad and is often invited as a legal expert by international TV stations. Contact: firstname.lastname@example.org
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