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Enhancing tax risk management function of large businesses enterprises
The Large Business Taxation Department ("LBTD") was established in the midst of 2008 during the internal restructuring of the State Administration of Taxation ("SAT"). The LBTD is established to manage and service large business enterprises' ("LBs") taxation. Branches of the LBTD are being set up at local-level tax bureaux. A list of 45 national level LBs to be directly administered by the LBTD ("the List") was released in December 2008. Subsequently the "Guidelines on Tax Risk Management of Large Business Enterprises" ("the Guidelines") was published on 5 May 2009.
In this News Flash, we will discuss the objectives and functions of the LBTD and the key points of the Guidelines and share our observations on the impact of the LBTD and the Guidelines to LBs.
Objectives and functions of the LBTD
The LBTD's main objective is to enhance taxpayers' tax compliance level and to minimise non-compliance through self-check and self-control. Through a management information platform established to connect LBs with the tax authorities, the LBTD will provide customised services to the LBs and at the same time exercise effective tax administration over sizable and cross-regional LBs. In the process, the LBTD makes reference to relevant international practice in respect of the combination of providing services and tax administration. The LBTD's main functions include: (Please refer to the official SAT website (Simplified Chinese version) for more detailed description on the objectives and functions of the LBTD)
Service
- To evaluate LBs' existing tax risk management function and guide them to improve it;
- To establish direct communication channel between tax authorities and LBs in response to the needs for transparency and certainty of tax rules and to address and coordinate any comments and suggestions raised by LBs;
- To resolve the tax issues of LBs arising from conflicts, uncertainties or inconsistencies between state policies and local practice through consultation; and
- To build "cross-level coordination working system" among tax bureaux at different levels, departments and regions to improve the efficiency in handling LBs' tax matters.
Administration
- To formulate working procedures and technical standards related to tax risk management function of LBs, e.g., the Guidelines that was recently promulgated;
- To set up and maintain the management information system for tax administration of LBs;
- To organize and undertake analysis of the composition of the LB's tax liabilities and assessment of the level of tax compliance;
- To organize and supervise regular examinations, anti-avoidance investigations and tax audits conducted by tax authorities at provincial and municipal levels; and
- To develop target investigation plans jointly with tax investigation department of the SAT based on the assessments and regular examination result; and to organize and coordinate the target investigation of the LBTD branches at provincial and municipal levels.
The List consists of 45 LBs which will be directly served and administered by the LBTD. However, the roles of LBTD will not replace the roles of the LBs' existing in-charge tax bureaux with regard to the day-to-day tax administration, settlement and allocation. Instead, the LBTD will focus on tax risk management, cross-regional tax matters and explanation of tax policies, etc.
We note that the LBs in the List are from nearly all of the most important business sectors in China, both economically and politically. These LBs are the leaders and representative players in their respective business sectors. LBs at provincial and municipal levels will be identified and enlisted in the coming months by LBTD branches. As such, the newly published Guidelines will not only be applicable to the 45 LBs in the List but also to those LBs to be identified.
Obviously the LBTD has analyzed the key features of LBs and is exploring a win-win approach through collaboration between the taxpayers and tax authorities in handling the tax risk management. For instance, the "directly-managed LBs approach" will provide a mechanism to focus on the needs of the LBs for transparency and certainty of tax rules and at the same time allow the LBs' existing in-charge tax bureaux to handling the day-to-day tax administration. To achieve consistency in serving the needs of these LBs, a "joint conference system" will be established internally among the tax authorities at different levels, departments and locations to address industry-specific inquiries and individual cases.
Highlights of the Guidelines
The objective of the Guidelines is to provide guidance to LBs on how to identify and control tax risks, improve tax compliance and avoid possible undesirable impact of non-compliance. The tax authorities will assess the effectiveness of the tax risk management of the LBs based on which different tax administration measures will be taken by the tax authorities.
The Guidelines are composed of 6 sections. The first section lays down the general principles of tax risk management, including its objectives and components of a tax risk management system. In this section it is clear that the Board of Directors should oversee the tax risk management function and participate in the decision for tax risk management.
The remaining five sections provide the guidance on the following:
- Composition of a tax risk management system, including personnel and their functions. Independence between these functions is an important element in a tax risk management system.
- Process in identifying and assessing tax risks and a list of major tax risk factors is provided in this section.
- Strategies and internal control system in handling tax risk identified.
- Management of tax information, including internal and external communication and maintenance of tax information databases for information and knowledge sharing.
- Monitoring and continuous improvement of tax risk management system, including appointment of professional organizations to assist in the evaluation of the LBs tax risk management function.
We believe that in drafting the Guidelines, the SAT has made references to the "Basic Rules for Enterprise Internal Control" ("Rules") issued by the Ministry of Finance and the "Circular of the State-owned Assets Supervision and Administration Commission of the State Council on the Publication and Distribution of the Guidelines for Comprehensive Risk Management of Central Enterprises" issued by the State-owned Assets Supervision and Administration Commission of the State Council. The Rules address the overall internal control while the newly published Guidelines focus on control of tax risks.
Approach of the LBTD
We understand that the sub-system to collect information on the LBs tax risk management has been established by the LBTD. A set of questionnaires has been sent to a number of LBs on the List. It contains more than 600 questions covering almost all aspects of an enterprise's daily operation. The questionnaires are designed to obtain information on whether the LB has a tax risk management function in place and if there is, how reliable or efficient it is. The current set of questionnaires applies to all industries. Industry-specific questionnaires are under preparation by the LBTD.
Based on the LB's self-inspection, the LBTD will assess the LB's likelihood for non-compliance, and the capability and the effectiveness of its tax risk management function. The exercise will allow the LBTD to group these LBs into different categories according to their overall tax risk level. Appropriate administrative measures will then be taken, namely the lower is the tax risk, the less stringent tax examination will be applied; conversely the higher is the tax risk, the more stringent tax audit may be applied. The most risky LBs will be subject to target investigations.
Through self-inspection and early identification of tax risks, it is expected to have a significant reduction in tax audit.
PwC's observations
Objective of the Guidelines
The issuance of the Guidelines signifies that the SAT has adopted a new concept and approach in tax administration, including:
- To raise the self-awareness of taxpayers of tax compliance and to minimize the need for tax inspections by the tax authorities. Taxpayers are encouraged to manage their tax risk proactively and to rectify any non-compliance rather than passively respond to tax inspections by the tax authorities.
- To analyse the reasons of non-compliance and exercise controls accordingly ex ante, rather than conducts tax inspections and impose penalty after the non-compliance. This is to detect tax revenues at source and to prevent the loss of tax revenues. This is not to undermine the involvement of the tax administration, but to extend the tax administration to the origins. Also shifting the focus to the early stage of tax administration cycle is expected to provide savings in resources for both taxpayers and tax authorities.
- Instead of sending tax officials to carry out tax inspections nationwide, tax administration can be carried out effectively through self compliance check by taxpayers and devote resources to target investigations for those who are identified as high risk taxpayers in the assessment.
Legal standing of the Guidelines
Although many countries' tax administration systems have similar departments serving and administering LBs, their functions and scope of work vary. In some countries, tax authorities have tax officials involved in the day-to-day tax compliance and risk control of taxpayers. Some others just announce their standards for tax risk assessment through their websites, carry out assessment of the tax risk of taxpayers and then work with the LBs to improve its tax risk management system, when necessary. There are also tax authorities in some countries adopting the "advanced ruling" system to confirm tax treatments in order to reduce the tax risks to both tax authorities and taxpayers.
It is imperative to note the unusual legal standing of the Guidelines in China. It is issued as guidance to LBs rather than as a mandatory regulation. One may question whether the LBs will take the Guidelines seriously and devote large amount of resources and time to establish a tax risk management system as proposed or to improve it if they have already had one. We understand that the Guidelines taking the form of guidance instead of regulation is because the SAT's intention is to provide service to the LBs rather than to impose another set of mandatory rules for them to follow. Moreover, given the diversity in LBs' scales, operations and locations, it would be impractical to have one set of rules to fit all of them in different businesses.
Impact of tax risk management to LBs
Turbulent economy, changes in tax policies and increasing complexity of the taxpayers' operations are all reasons for businesses to pay more attention to the management of overall risks. Tax risk management is an important component of overall risk management. Tax management is no longer merely a day-to-day administrative function; it plays a more important role in the strategic planning, significant business decision-making and risk-monitoring of a business. Good tax management will enhance the efficiency of an enterprise's business plans, achieve legitimate tax savings and lower tax risk exposures. On the contrary, paying no attention to tax risk issues at the initial stage of business planning may result in undesirable tax consequences which are not easily fixed later on, e.g., double taxation for a long period of time. Negligence of tax management in daily operations may result in errors and mistakes in tax computation, filing and documentation. These errors and mistakes will not only causes financial losses but even damage to the reputation of the enterprise. The Guidelines was issued at the right time to provide direction for enterprises to enhance their tax risk management and at the same time assist them to identify opportunities and to address challenges.
- Opportunities
Now LBs have the one-stop platform which allows them to communicate with the SAT's LBTD directly in resolving tax issues arising from inconsistency of the implementation of existing tax policies, cross-border transactions and other tax administration matters. At the same time, LBs also have the chance to be consulted on new tax regulations and policies before they are issued and to reflect any concerns they may have before the promulgation.
- Challenges
Because of the complexity in their cross-region or cross-border operations and productions and being the key taxpayers, LBs have always been the focus of Chinese tax authorities.
According to the Guidelines, where the LBs fail to establish and implement effective tax risk management function, the tax authorities may take "appropriate administrative measures". We believe that the "appropriate administrative measures" means classifying the tax risk levels of the LBs through assessment. It is apparent that tax audits, or even target investigations will be carried out on enterprises with high tax risks. From the SAT's perspective, when a taxpayer puts more emphasis and effort on its tax risk management, its tax compliance level should be higher, and accordingly its risk level lower. Conversely, when non-compliance is more likely to occur, more resources should be devoted for ex post tax audit in order to protect tax revenue collection.
- Proposed actions
It is advisable that enterprises should assess their existing tax risk management function based on the benchmarks set out in the Guidelines and take actions to improve it where necessary. Designated personnel should be appointed to liaise with the LBTDs of the SAT and of local-level tax bureaux on the developments of new tax policies and to solve any issues. Enterprises may consider the following aspects in assessing whether they have an overall effective tax risk management:
- Effective tax planning with commercial justification;
- Thorough consideration of tax factors in the daily operations;
- Accurate tax computation;
- Timely and complete tax filing; and
- Proper maintenance of tax records and documentation.
If enterprises need assistance in the process, they may engage professional organizations, not only for their tax expertise but also for their experience in the internal control systems, particularly in the tax risk management system and methodology. Some international accounting firms were invited by the SAT to make comments and suggestions during the drafting of the Guidelines. Their experience in assisting clients to establish or to improve their internal control systems in general and in dealing with tax departments similar to LBTD in other countries should be valuable.
It should be noted that tax risk management is an integral part of an enterprise's overall risk management function. It is not necessary to establish a separate internal control system solely for tax risks in order to comply with the Guidelines. Instead, tax risk management should be part of the existing internal control function in order for it to be effective.
Conclusion
Based on our observations, most LBs have already had tax risk management function as part of the overall internal control system. The issuance of the Guidelines and the LBTD's new approach in handling LBs are of no surprise to them. For sizable foreign investment enterprises ("FIEs"), due to their global internal control requirements, most of them should already have taken care of such tax function by their finance teams or even dedicated tax teams. The annual budgets of some of these FIEs on tax risk management are significant. Chinese private-owned enterprises have yet a lot to catch up with the international practice in this respect. State-owned enterprises also have the desire and tendency to improve their tax risk management functions.
As mentioned above, the Guidelines create a communication channel between the tax authorities and LBs. We believe this is the first step the SAT undertakes to raise the quality of the tax risk management and at the same time to improve the efficiency in tax administration. More details of implementation are expected to follow. We will closely monitor the development in this area and share with you.
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