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Special value-added tax (VAT) invoices are issued by the state tax authorities to manage VAT collection and record VAT amounts on goods and services. Most importantly, they are used for tax deduction. In practice, taxpayers also issue fraudulent VAT invoices for various purposes, such as inflating performance, securing financing, obtaining loans and evading taxes.

But once found in violation of the criminal law, such acts can result in fines for convicted companies and prison sentences for an immediate supervisor and others responsible. Once a company is implicated in a criminal offence, regardless of the final verdict, its brand image, market influence and competitiveness also suffer significantly.

Therefore, it is crucial that companies enhance their ability to identify and respond to tax compliance risks by implementing compliance management in key tax-related areas to effectively prevent non-compliance and significantly contribute to the company¡¯s sustainable development.

Legal liability

Issuing false VAT invoices without the intent to fraudulently claim tax credits or without causing tax losses through deductions does not constitute the crime of issuing false VAT invoices.

However, according to article 35 of the Regulations on the Administration of Invoices, such acts may result in administrative penalties, including confiscation of illegal gains and fines by the tax authorities.

If the false invoicing is intended to fraudulently claim tax credits, under the Law on the Administration of Tax Collection and relevant tax regulations the offender shall pay the evaded taxes, late fees and fines.

Pursuant to article 11 of the Interpretation of Several Issues Concerning the Application of Law in Handling Criminal Cases of Jeopardising Collection and Administration of Taxes by the Supreme People¡¯s Court and the Supreme People¡¯s Procuratorate, false invoicing exceeding RMB100,000 (USD13,857) warrants the filing of a criminal case, and the offender shall be held criminally liable.

China¡¯s Criminal Law specifies four types of fraudulent issuance of special VAT invoices, namely: issuing fraudulent invoices for others; issuing fraudulent invoices for oneself; having others issue fraudulent invoices for oneself; and facilitating the issuance of fraudulent invoices for others.

The above-mentioned interpretation further details specific instances of false invoicing, including:

1. Issuing special VAT invoices without actual business transactions;
2. Issuing special VAT invoices for amounts exceeding the actual deductible business transactions;
3. Issuing special VAT invoices for non-deductible transactions by fabricating transaction entities, and
4. Illegally altering electronic information related to the special VAT invoices.

Among the four types of false invoicing, issuing fraudulent invoices for others is most closely related to the internal business mechanism of companies. For this reason, compliance recommendations are offered below primarily from the perspective of invoice issuers.

Compliance advice

In the exercise to improve their compliance mechanism, companies are advised to focus on the alignment of ¡°three flows¡±, the concept of which first appeared in the Notice of the State Administration of Taxation on Strengthening VAT Collection and Management.

As per the notice, when a taxpayer purchases goods or taxable services and pays transportation fees, the paying entity shall be consistent with the entity issuing the deductible voucher and that providing the services, otherwise the tax credits shall not be claimed.

Here the three flows refer to the flow of goods (services), flow of funds, and flow of invoices. While the flow of goods (services) involves the buyer and seller, flow of funds involves the payer and payee, and flow of invoices involves the recipient and issuer.

Generally, it is required that the buyer, payer and invoice recipient are consistent, and the same for the seller, payee and invoice issuer. Accordingly, tax authorities tend to initiate investigations into false invoicing by examining the consistency of three flows.

To ensure consistency in the three flows during commercial activities and invoicing, companies should establish and improve their comprehensive systems of contract, financial and tax management, as well as invoice management.

Additionally, a regular tax audit mechanism should be implemented to monitor the overall system¡¯s operation, helping to integrate the identification and assessment of tax risks into the company¡¯s business process and daily management. Based on the business operation, preventive measures should also be adopted against identified high-frequency risks.

Specific essentials

A company¡¯s contract management system should include: approval procedures before contract signing; a tracking and supervision system of the contract performance; and a contract storage protocol.

The financial system should focus on the payment process, requiring financial operators to review the underlying contracts, orders, receipts and other supporting documents, ensuring authenticity of the underlying transactions.

The invoice management system should stress the invoicing process, under which the invoice issuers are to verify information of both parties in the contract, logistics information of the sender and recipient, payer¡¯s information, and the receipt of funds.

In case of inconsistencies detected in the three flows, the responsible party should be required to provide additional material to prove the transaction¡¯s authenticity.

Additionally, companies should assign operators with financial and tax expertise to conduct comprehensive and regular reviews of the contract performance, delivery and receipt of goods, payment status, and issuance and receipt of invoices. This will help identify risks of false invoicing in a timely manner.

Ding Wen is an associate at Starrise Law Firm