Strategic response to reporting for tax inspection

In the era of tax information technology, tax inspections based on big data analysis are already quite common, while inspections arising from reporting are usually a lesser probability. But according to some firms, the frequency of inspections caused by tax reporting has increased significantly compared to previous years.

In this article, the author shares his experiences in dealing with such tax inspections.

Reporting sources

(1) Reported by internal employees. This frequent type of reporting is often provoked by disgruntled internal employees reporting tax violations to authorities with information they have due to dissatisfaction over promotions or adjustment of work positions and workplaces.

(2) Reported by professional whistleblowers for rewards. According to article 6 of the Interim Measures for Rewarding Taxpayers for Reporting Tax Violations, the maximum bonus for a whistleblower can be up to RMB100,000 (USD14,300) upon taxation authorities investigating and verifying tax violations, and collecting taxes according to the law.

(3) Reported by competitors. As an example, Zhejiang Semir Garment was reported for tax evasion before listing in 2011 by a departing employee, but the company chairman claimed a rival orchestrated the reporting. This type of reporting is very likely to occur in the pre-listing or listing period, which may lead to failure of the proposed listing and damaged reputation of the listed company.

(4) Reporting triggered by economic disputes. If an economic dispute cannot be resolved through normal and reasonable channels, tax reporting may be used as a means of relief and revenge.

(5) Reporting triggered by emotional disputes. As an example, a wife reported her husband and his company in real name to the Inspection Bureau of the State Taxation Bureau of Furong district in Changsha for alleged tax evasion, due to an emotional dispute.

(6) Reporting triggered by shareholder disputes. Disputes over shareholders’ interests, if not properly controlled and dealt with, may further increase a conflict, triggering the reporting of tax evasion by shareholders on one side.

Reporting strategies

Enterprises need to be highly aware of potential risks that may arise from tax reporting, so attention needs to be paid to the following aspects:

1. 1. Avoid blindly trusting tax authority relations. In a tax inspection due to reporting, it is often necessary to respond to the whistleblower’s case. Some enterprises make the mistake of thinking they only need to “handle” the tax authorities, so they can respond to the whistleblower that the reported company will be imposed a light penalty. Such an idea is very dangerous and may risk repeated reporting by whistleblowers, or even tax officials reported by association.
   2. Information submission should be prudent. Inspection of reported matters by tax authorities is usually more severe than inspections under other circumstances. For this reason, enterprises should actively co-operate with the authorities and submit requested material in a timely manner. However, enterprises should bear in mind that submitting inappropriate information may increase the scope of a tax inspection. Therefore, enterprises should conduct key inspections and risk assessments of information to be submitted to the tax authorities in advance.
   3. The policy logic should be understood accurately. In the process of responding to inspections, the characterisation of matters reported by the tax authorities should be analysed in terms of the applicability of tax policies. Owing to the complexity of tax policies and the pressure brought about by reporting, the tax authorities may to a certain extent adopt tax policies based on the protection of law enforcement officers, resulting in incomplete correct characterisation. For this reason, enterprises should carefully analyse the substance of the relevant business, accurately grasp the relevant tax policies, and communicate with the tax authorities with justification and evidence.
   4. Apply necessary tax inspection response skills. These skills usually include, but are not limited to, analysing the logic behind the reporting, possible sources of information reported, tax authority concerns, and resulting tax consequences.

Most of the information in tax reporting is highly accurate, and the reported enterprises basically need to pay back the tax after the inspection, resulting in bigger tax impact to shareholders and enterprises than from regular tax inspections.

For this reason it is prudent to take preventive measures to avoid or reduce tax risks arising from tax reporting.

(1) Precautions against tax reporting. Enterprises should take precautionary measures over matters that may trigger tax reporting in their daily management, such as reasonable internal personnel management, establishment of an information isolation mechanism, proper dispute resolution mechanism, and information disclosure review mechanism to avoid mishandling internal employee or economic disputes triggering tax reporting. For example, some companies have very rigorous information management, with strict rules on permission setting and outgoing emails, so that information can be kept within a controllable range as far as possible, greatly reducing the risk of information leakage. Also, in disputes with external parties, proper consideration should be given to whether the dispute itself has tax flaws, otherwise it could easily become leverage for tax reporting by another party.

(2) Improve tax compliance by introducing internal tax experts or hiring external consultants. To prevent the risk of tax reporting, enterprises need to conduct comprehensive tax compliance. According to the experience of some, internal finance personnel often misjudge the tax compliance of their enterprise, as they are used to understanding compliance only from a financial perspective. Without specialist tax experts within the enterprise, they overlook understanding compliance from a tax perspective. To reduce the risk of tax reporting and inspection, the ideal solutions are to recruit professional internal tax experts, as well as bring in external organisations to conduct specialised tax compliance checks, and tax consultants to improve tax compliance.

Duan Congjun is a senior consultant at Zhilin Law Firm