SHANGHAI – In June of last year, news broke that China’s official import and export totals had been grossly inflated via invoice fraud, with actual estimates half those of official figures. In response, the State Administration of Foreign Exchange (SAFE) promptly began cracking down on fake and falsely issued invoices and initiated tighter oversight, especially in China’s special trade zones, reputed to be hotbeds of such activity. Invoice falsification not only distorts China’s international trade figures, it can also result in tax losses to companies unknowingly victimized.
Falsified invoices are issued by suppliers for a number of reasons, most commonly to disguise transfers for the gain of illicit profit. While the supplier stands to benefit, when the recipient exporter goes to submit the falsified invoice for an export VAT credit they are held accountable for the missing amount.
Chinese law forbids an individual or institution from creating inaccurate invoices for oneself or others, however, it is recognized that companies may unknowingly accept a fake invoice (described in relevant provisions as accepting in “good faith”). The conditions of good faith require that the accepting party did not intend to reap any illegal benefits from the transaction, and that:
- An actual transaction between buyer and seller has taken place;
- The amount of the invoice issued to the buyer conforms to the sales amount; and
- The buyer was unaware of the invoice being drawn up illegally, or issued by a third party.
Conversely, accepting an invoice in bad faith means having claimed a tax credit with one or more of the above conditions left unfulfilled.
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Even a false invoice accepted in good faith, however, can have legal and administrative consequences for a tax refund applicant. Generally, invoices submitted for VAT returns and discovered to be false will not be punished beyond requiring the taxpayer to compensate for the credit amount; with respect to income tax returns, however, the situation is considerably more complex, where owing to variation between local tax authorities, false invoices accepted in good faith are commonly de facto refused eligibility for deduction. In both cases, tax credits may be reclaimed if the taxpayer is able to replace a falsely issued invoice with a legitimate one.
For foreign companies operating in China, the best defense against being saddled with falsely issued VAT invoices is to maintain high standards of diligence in all transactions. Making a regular practice of running due diligence checks on business partners in China can go a long way toward minimizing risk. Companies should also strive to maintain as much documentation as possible of their business transactions and avoid dealing with suppliers who are hesitant or refuse to provide access to their records.
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