http://www.scmp.com/article/734767/if-tax-fraud-national-sport-hong-kong-chinas-stadium Value-added tax fraud is booming in China. As Ren Wei explains on the front page of today's Business Post, a thriving industry has grown up around diddling the VAT man, with mainland businesses buying and selling illicit VAT invoices in order to minimise their tax payments and maximise their profits. The scale of the racket is enormous. According to one recent estimate, more VAT revenue is lost to fraud than is actually collected by the government. Considering that VAT is now Beijing's biggest single source of tax income, that's a swindle of gargantuan proportions. The scam is so big, you could even say VAT fraud is China's national sport. But cheating the mainland taxman isn't solely a domestic game. Indeed, if VAT fraud is really the national sport, then Hong Kong, not the Bird's Nest in Beijing, is China's true national stadium. The fiddle works because of the favourable treatment that foreign-invested companies enjoy on the mainland. Although the authorities have been working hard to eliminate foreigners' tax breaks over recent years - Beijing unified the corporate income tax regime in 2008 and began collecting urban maintenance and education taxes from foreign companies just last month - when it comes to VAT, the playing field is still tilted heavily in favour of foreign-invested companies. To encourage inward investment, local governments offer foreign companies a wide range of VAT exemptions and rebates. Some allow foreign-invested enterprises to import capital goods VAT-free. Others give rebates to foreign companies buying locally-made machinery. High technology companies in Shenzhen, for example, can enjoy VAT rebates of up to 50 per cent. That's a significant advantage. According to a study by Hung-Gay Fung, Jot Yau and Gaiyan Zhang in the January edition of the Journal of International Business Studies, the average mainland-funded business pays an effective VAT rate equal to 8 per cent of its sales revenues. In contrast, the average foreign-invested enterprise pays an effective rate of just 3 per cent. That makes it well worthwhile to be classed as a foreign-invested enterprise. Of course, many business executives don't want to bring in real foreign investors, with all their tedious insistence on transparency, compliance and honest accounting. That would be far too much hassle. Happily for them, there is a convenient way around the problem. Mainland companies simply understate the export revenues they declare to the authorities, allowing them to retain money offshore. Alternatively, they overstate the cost of the goods they import. Either way, they accumulate a pot of money offshore, usually in Hong Kong. The two charts below from Fung and his co-authors give an idea of the size of fiddle.

1. GROUP OF HANEY HONG
KONG TAX REVIEWS
If tax fraud is the national sport Hong Kong is
China's stadium

2. Value-added tax fraud is booming in China. As Ren Wei explains on the front page
of today's Business Post, a thriving industry has grown up around diddling the VAT
man, with mainland businesses buying and selling illicit VAT invoices in order to
minimise their tax payments and maximise their profits.
The scale of the racket is enormous. According to one recent estimate, more VAT
revenue is lost to fraud than is actually collected by the government. Considering
that VAT is now Beijing's biggest single source of tax income, that's a swindle of
gargantuan proportions.
The scam is so big, you could even say VAT fraud is China's national sport. But
cheating the mainland taxman isn't solely a domestic game. Indeed, if VAT fraud is
really the national sport, then Hong Kong, not the Bird's Nest in Beijing, is China's
true national stadium.
The fiddle works because of the favourable treatment that foreign-invested
companies enjoy on the mainland. Although the authorities have been working hard
to eliminate foreigners' tax breaks over recent years - Beijing unified the corporate
income tax regime in 2008 and began collecting urban maintenance and education
taxes from foreign companies just last month - when it comes to VAT, the playing
field is still tilted heavily in favour of foreign-invested companies.

3. To encourage inward investment, local governments offer foreign companies a wide
range of VAT exemptions and rebates. Some allow foreign-invested enterprises to
import capital goods VAT-free. Others give rebates to foreign companies buying
locally-made machinery. High technology companies in Shenzhen, for example, can
enjoy VAT rebates of up to 50 per cent.
That's a significant advantage. According to a study by Hung-Gay Fung, Jot Yau
and Gaiyan Zhang in the January edition of the Journal of International Business
Studies, the average mainland-funded business pays an effective VAT rate equal to
8 per cent of its sales revenues. In contrast, the average foreign-invested enterprise
pays an effective rate of just 3 per cent. That makes it well worthwhile to be classed
as a foreign-invested enterprise.
Of course, many business executives don't want to bring in real foreign investors,
with all their tedious insistence on transparency, compliance and honest accounting.
That would be far too much hassle.
Happily for them, there is a convenient way around the problem. Mainland
companies simply understate the export revenues they declare to the authorities,
allowing them to retain money offshore. Alternatively, they overstate the cost of the
goods they import. Either way, they accumulate a pot of money offshore, usually in
Hong Kong.

4. The two charts below from Fung and his co-authors give an idea of the size of
fiddle. Correcting for trans-shipments, the first shows the mainland's exports to
Hong Kong as declared to the authorities, compared with Hong Kong's actual
imports from the mainland. The second chart shows the difference between China's
official imports from Hong Kong and Hong Kong's actual exports to the mainland.
Between 2000 and 2004, the combined cumulative gap came to some US$180
billion.
The money didn't stay in Hong Kong. Most of it was immediately channelled back
into the mainland in the guise of foreign direct investment, allowing the recipient
companies - now classed as foreign-invested enterprises - to enjoy a host of
benefits including lower land fees, favourable trade tariffs and, of course, that hefty
VAT advantage.
Tax fraud isn't the only motivation for round-tripping cash in this way. By
understating their export revenues (or overstating their import bills), booking the
proceeds offshore and then channelling them back to the mainland as inward
investment, managers at state-owned companies are effectively siphoning off state
assets into their own pockets. Not surprisingly, state companies are reckoned to be
the biggest offenders when it comes to misreporting trade figures.

5. Despite repeated attempts to crack down on the scam, the fraud continues
unabated. Over the first 10 months of last year, the mainland attracted US$82 billion
in foreign direct investment. Of that, US$45.7 billion - almost 56 per cent - came
from Hong Kong. Some of that was genuine investment.
But according to one estimate, as much as US$33 billion consisted of Chinese
money illicitly round-tripped through Hong Kong back into the mainland to exploit
VAT breaks.
So although Hong Kong may be suffering doubts about its future as China's premier
financial centre, its position as the mainland's pre-eminent tax fraud facilitator is
clearly unchallenged.
Source: http://www.scmp.com/article/734767/if-tax-fraud-national-sport-hong-
kong-chinas-stadium