1.1. The tax system refers to a set of tax laws and tax management measures, including tax codes, regulations and detailed implementation rules, tax administration system, and collection and administration measures, etc. The tax system serves as legal basis and working rules for the state to impose tax on taxable entities and individuals. China 's current tax system was set up after the 1994 tax reform designed to meet the needs of the market economic system through overall reform of industrial and commercial taxation system. The guiding ideology of the reform was to: unify tax laws, to make the tax burden equitable, to streamline tax systems to divide power rationally, straighten out distribution relationship and to guarantee revenues so as to establish a tax system suited to the need of socialist market economy. The following five principles were followed by the reform:
1.3.1. The turnover tax system is established according to fair, neutral, transparent and universal principles with VAT as its mainstay and consumption tax and business tax supplementary. VAT is generally levied on production, wholesale, retail and imported goods. Consumption tax is imposed on a small number of selected consumer goods after levying VAT. Business tax is levied on services and the tertiary industry exempt from VAT. All-round introduction of VAT is the focus of the turnover tax reform. After the new VAT the rate is significantly simplified; 17% serves as the basic VAT rate; with a tax rate of 13% on sales or imports of grain, edible vegetable oil, coal gas and natural gas; 6% on small-scale taxpayers engaged in selling goods or taxable services, o% on export goods.
1.3.2. There is significant improvement in the tax computation method of and collection and administration system, namely, a system of extra-pricing computation and collection method and deducting tax amounts indicated in invoices, and classifying taxpayers into ordinary ones and small-scale ones of which the former is subject to computation method of output tax minus input tax with special VAT invoice, while the latter pay VAT according to specified rate for the sake of computation, without deducting input tax. The reformed turnover taxes apply to both domestic and foreign enterprises, but have abolished the Combined Industrial and Commercial Tax originally levied on foreign investment and foreign enterprises.
1.3.1. The reform involved both enterprise income tax and individual income tax. Prior to the reform, state-owned enterprises, collective enterprises and private enterprises followed different tax system. After the reform, these three types of enterprises and joint-stock enterprises comply with a unified income tax system with a tax rate of 33%, like foreign investment and foreign enterprises. The new enterprise income tax system has helped standardise items and criteria of expenditure before paying enterprise income tax, stabilise tax base, abolish the method of repaying loans before paying tax, and make before-tax deductible items comply with tax legislation, leading to establishing standardised and legalised distribution relationships between the state and enterprises.
1.3.2. Individual income tax was reformed to establish a unified individual income tax system, generally applicable to domestic citizens and foreigners in which the original individual income tax, individual income adjustment tax and income tax of urban and rural individual industrial households are combined. The reformed individual income tax stipulates that a monthly deduction of 800 yuan shall be allowed for expenses and that income from wages and salaries is subject to 9 grades of progressive tax rates ranging from 5% to 45%. This reflects fully the legislation principle of adjusting individual income gaps, namely, levying more tax on higher-income earners, levying less or no tax on middle and low-income earners.
1.4.1. Land appreciation tax is levied to standardise of land and real estate market trading order and to rationally adjust land appreciation income. It is a tax category subject to four grades of progressive tax rates ranging from 30% to 60%, levied on the appreciation amount calculated by deducting cost expenses from the income from the transfer of state-owned land use rights and buildings on the ground. Resource tax was reformed to expand its collection scope and improve computation and collection methods; that is, as for units and individuals engaged in the exploitation of crude oil, natural gas, coal, metal ores and non-metal ores or production of salt within the territory of the People's Republic of China, tax payable for resource tax shall be computed in accordance with the assessable volume and of prescribed tax rate; urban and rural maintenance and construction tax category. In addition, other small tax categories were subject to adjustment, cancellation on combination with appropriate adjustment being made to tax rate or tax amount.
1.4.2. After the reform, tax categories in the Chinese industrial and commercial tax system have decreased from 32 to 20, leading to the simplification of tax system. The 20 tax categories can be classified into the following 5 major types according to nature and features of taxable objects:
| Tax Category | Turnover Tax | Income Tax | Resource Tax |
Property & Behaviour Tax |
|
| Total | VAT | ||||
| Percentage | 75.26% | 51.23% | 16.05% | 1.51% | 7 18%, |
1.4.3. In 1995 China carried out significant reform in and adjustment to its tariff policies by reducing dramatically the general level of tariffs from 36 to 23 per cent on one hand and collecting tariffs and import taxes on imported equipment and raw materials on the other hand. As a result, China's tariffs will conform to the demands of the socialist market economic system and common international practices, helping China participate in international competition and economic co-operation in a more open manner and promoting the development of the national economy.
1.5.1. To establish a tax payment and reporting system to promote residents' awareness of paying tax, the agency introduced a tax agency system which is expected to be an indispensable link between the tax collection and administration system. It will establish a system of restraints among taxpayers, agents and tax authorities to establish a strict tax inspection system. It will also form a new tax collection and administration pattern consisting of reporting, agency and inspection; to speed up the computerisation of tax collection and administration and establish a sound and effective tax monitoring network to modernise tax collection and administration system. This will fundamentally improve tax collection and administration level and guarantee the implementation of the new tax law.
1.6.1. In order to keep pace with demands of the government financial management system and tax-sharing system, China's tax authorities were separated into two types of authorities, namely the State Tax Administration and the Local Tax Authority. The former is responsible for collecting central taxes, central-local sharing taxes. The latter collects local taxes.
1.6.2. On the basis of the system reform, China introduced government financial management system of tax-sharing system in 1994 on the basis of dividing responsibilities among the central government and local governments. The scope of their respective expenditures was divided, with different tax categories classified into central fixed revenues, central- local sharing revenues, local fixed revenues. The main principle of the classification was: to safeguard the state interest, to make the tax category necessary to carry out macro control of central taxes; to make the tax category directly related to economic development as central-local sharing taxes; to make the tax category fit for collection and administration by local governments as local taxes.
1.6.3. Central fixed revenues rnainly include tariffs, consumption tax, central enterprise income tax, income tax on local banks and foreign- funded banks as well as non-banking financial institutions, refund of taxes for export by enterprises engaging in foreign trade. Local fixed revenues mainly include business tax, local enterprise income tax, urban and township land use tax, fixed assets investment orientation regulation tax, city maintenance and construction tax, slaughter tax, agricultural tax, cultivated land occupation tax, contract tax, land appreciation tax etc. Revenues shared by the central government and local governments include VAT, resource tax with 75 per cent of VAT as central revenues and 25 per cent as local revenues. Resource tax is classified according to different types of resources with taxes levied on most resources as local revenues and offshore oil resource tax as central revenues.
2.1. Tax audit in China refers to audit by state audit institutions on the authenticity, legality and efficiency of the implementation of tax plans and state tax codes as well as tax collection and administration. Falling into public finance audit, tax audit is a specialised audit with relative independence. Tax audit is enhanced to expose and reflect problems existing in the implementation of state tax policies and tax collection and administration by tax authorities at various levels, to safeguard strict compliance with state policies and codes and prevent the drainage of state tax revenues. In the meantime, tax audit urges the tax authorities to improve tax policies and systems to ensure the smooth operation of various tax systems and the healthy development of socialist market economy. As an important component of public finance audit, tax audit can be characterised by its audit objects, scope, basis and priorities.
2.2.1. Objects of Tax Audit According to the Audit law of the People's Republic of China audit institutions shall conduct auditing supervision on the budget implementation, management and utilisation of extra-budgetary funds by various departments of governments at and below their levels as well as the final accounts thereof. As tax audit is an important component of public finance audit, its main auditing objects are governments and state tax collection and administrative institutions at different levels. State tax collecting and administrative institutions include central and local public finance and tax authorities and customhouses.
2.2.2. Scope of Tax Audit Regarding the time span, tax audit usually covers the tax collection and administration in the previous year. However, it may be extended to issues in other prior years if the issues were material. Viewing from departments in charge of tax collection and administration, tax audit involves industrial and commercial taxes collected by tax authorities, agricultural taxes by public financial departments and customs duties by customhouses. The industrial and commercial taxes can be further broken down into state taxes collected by the central tax authorities, taxes jointly collected by the central and local tax authorities and those by the local tax bureaus.
2.2.3. Concerning the levels of tax collection, audit is carried out respectively on the central, central-local sharing and local taxes. With regard to the classification of taxes, tax audit is performed mainly on five types of taxes, including turnover tax, income tax, resource tax, property tax and behaviour tax. Considering auditing items of tax collection and administration, tax audit covers tax collection, reduction, exemption and collection administration (inspection and control), as well as the financial revenues and expenditures of tax collection bureaus. Tax audit also covers issues concerning tax authorities and government departments held as directly responsible for tax collection and administration. As for taxpayers, irrespective of entities or individuals, issues regarding their responsibilities are beyond the scope of tax audit and subject to other special audits.
2.2.4 Basis of Tax Audit
2.2 .4.1. The basis of tax audit includes the following contents:
2.2.4.2. Tax laws enacted by the National People's Congress;
2.2.4.3. Rules and regulations concerning public finance and tax, formulated by the state council;
2.2.4.4. Financial and tax policies systems and measures adopted by the Ministry of Finance and the state Administration of Taxation;
2.2.4.5. Local tax regulations and rules made in line with unified state laws, regulations and policies, by local governments and financial and tax departments within their jurisdiction.
2.2.4.6. Pursuant to the above laws, regulations and policies, tax audit is conducted to identify practices and local provisions not in compliance with state tax laws and regulations, and help audited organisations or localities correct those non-compliant cases, with a view to promoting the implementation of state macro-economic policies and the co-ordinated development of local economies.
3.1.1. The tax plan is an important component part of the state budget and a significant basis for examining and evaluating the performance of financial and tax departments and the customs. The audit of the state tax plan implementation is essentially the audit of the state financial revenues and budget implementation. In tax auditing, auditors make comparisons between the actual and planned targets to see if the planned quantity and progress of tax collection have been achieved and also between the tax increase and the growth of the economy to ascertain whether the two match well and, if not, to identify the causes by thorough analysis. Auditors examine measures that tax departments and customhouses have adopted for the execution of their annual plans with the purpose of discovering problems in the implementation of their plans. The auditors urge tax collecting agencies to organise the collection of tax revenues well so as to ensure the complete execution of the state budget of financial revenues.
3.2.1. In China only the central authorities have the power to enact tax laws. All local areas (with the exception of autonomous regions of national minorities) must execute unified central tax laws, regulations and policies.
3.2.2. However, in recent years, some local authorities have changed state tax policies and lowered tax requirements etc. for meeting the needs of developing the local economy. Therefore, audit should be conducted on the implementation of state tax laws and policies by different localities in order to maintain the unanimity thereof.
3.2.3. The audit involves the following two aspects:
3.2.3.1. Examining cases of non-compliance with state tax laws and policies by local governments, financial and tax departments and customs in making local tax regulations and policies;
3.2.3.2. Checking, through the extended audit of key tax payers, the implementation of state laws, regulations and policies by local tax collection agencies in tax collection, reduction and exemption, paying special attention to cases of abusing authority and violating regulations.
3.3.1. Tax reduction and exemption embody state preferential tax treatment for certain industries and enterprises in line with state tax ' policies. Before the introduction of the tax reform in 1994, provisions of tax laws concerning tax reduction and exemption were not well defined and requirements of their implementation were not strictly followed in some areas, resulting in great losses of tax revenues. Rigorous restrictions on tax reduction and exemption have been laid down in the tax system. But owing to the impact of past practices, cases of tax reduction and exemption in violation of competent state regulations recur. In tax auditing, focus should be put on the approval formalities and procedures of each tax reduction or exemption adopted by tax agencies, and the truthfulness and appropriateness of the return for the tax reduction or exemption submitted by enterprise by means of extended auditing, to ascertain the compliance of the return within the tax reduction and exemption framework so as to standardising thereof.
3.4.1. In 1992 the law of the People's Republic of China concerning Tax Administration and Tax Collection was promulgated with provision on tax administration, collection and inspection, and legal liabilities. In tax audit, auditors should examine if activities of tax administration and collection performed by relevant authorities at different level are strictly in conformity with competent tax laws and regulations for the purpose of:
3.5.1. Auditors conduct audit of tax drawing and refunding for the purpose of assuring the authenticity and compliance of tax refund with relevant state policies, and the safety and integrity of state tax revenues by examining:
3.6.1. In auditing the financial revenues and expenditures of tax authorities, auditors should examine the sources and utilisation of funds of tax authorities so as to identify such malpractice as using tax refund to make up for deficiency of their administrative funds; transferring or diverting for other purposes financial funds and cases of losses and wastes, and help authorities strengthen their internal controls, and management, and raise work efficiency and quality.
4.1. According to provisions of the Audit Law of the Chinese People's Republic, audit institutions have, in audit of public finance since 1995, audited the budget implementation and final accounts of governments both at their own and lower levels. As an important component of audit of public finance, tax audit also adopts the two basic organisational forms, i.e. audit of tax collection and administration of tax authorities by audit institutions, as a component of the audit of the budget implementation of governments at and below the levels of the audit institutions.
4.2. For instance, the National audit Office (CNAO), the SAI of China, in its audit of public finance, shall make an annual plan and its implementation program for audits of central and central-local sharing taxes collected by the State Administration of Taxation and customs duties by the Customs General Administration. CNAO takes charge of issuing audit notifications to auditees and assigning audit tasks to its departments and 16 regional offices, and organising field audit and handling audit cases in a unified manner. CNAO shall also make audit plans and their implementation programs for audits of tax collection and administration of local tax bureaus and organise the conduct of audits while arranging audits of the budget implementation and final accounts of governments at the provincial level.
4.3. Likewise, audit institutions at the provincial, prefecture and country levels shall arrange audits of tax collection and administration of audit bureaus at and below their levels, in line with the annual requirements of audit institutions at higher levels and governments at their own levels.
4.4. At present, the coverage of tax audits with auditees and audit institutions at the same levels has reached 100% and that of audits conducted by audit institutions at higher levels amounts to 30%. This approach helps audit institutions exercise supervision and provide guidance to audit institutions below their levels. It is also conducive to reducing duplication of audits and lessening burdens on auditees.
5.1. According to the Audit Law of People's Republic of China, and Provisional Regulations Concerning the Auditing Supervision on the Implementation of the Central Budget promulgated by the State Council, the reporting procedure of tax audit includes the following steps:
5.2. In the annual audit of the implementation of the central budget, CNAO shall form several audit teams to conduct audit of central and central-local sharing taxes collected by the State Administration of Taxation and customs by the Customs General Administration. After the completion of an audit, each audit team shall submit an audit report on audit results to CNAO. Pursuant to the audit procedure stipulated by the Audit Law, the audit team shall solicit opinions of the auditee before the submission. The auditee shall, within ten days from the date of receiving the audit report, send written comments to the audit team or the audit institution.
5.3. The audit report of tax audit generally contains three aspects: A. an evaluation of the implementation of state tax policies, status of tax collection and administration and execution of the tax plan by the auditee; B. main instances of non compliance in tax collection and audit conclusions and their basis; and C. opinions and recommendations on strengthening tax collection and administration of problems in tax policies and tax collection and administration.
5.4. The Public finance audit Department of CNAO which is in charge of tax audit shall, on the basis of analysing and summarising audit reports submitted to CNAO by the audit teams, make a comprehensive report on the audit of the State Administration of Taxation and Customs General Administration. The comprehensive report contains the statistics and classification of main non-compliance instances discovered through auditing, and opinions and recommendations on strengthening tax collection and administration and improvement of tax policies.
5.5. Key audit findings on the State Administration of Taxation and the Customs General Administration shall be included in the audit report on audits of the central budget implementation and of other financial revenues and expenditures.
5.6. In line with the arrangement of the Standing Committee of the National People's Congress and as entrusted by the State Council, CNAO shall draft, on behalf of the State Council, the audit work report on the audits of the central budget implementation and of other financial revenues and expenditures, to be submitted to the Standing Committee of NPC.
5.7. Audit institution have certain powers of discretion in tax audits as they do in other types of audits. CNAO shall draw audit conclusions, make audit decisions and recommendations or deal with tax cases in violation of State laws and regulations, in accordance with such state laws and regulations as the Audit Law, the Regulations on Administrative Sanctions, the Budget Law and the Law Concerning Tax Administration and Tax Collection and other relevant laws and regulations.
5.8. The basic principle of handling irregularities in tax collection discovered through auditing is as follows: all cases in violation of competent state tax laws, regulations and policies should be dealt with according to the law, such as tax reduction, exemption, evasion, refund and deficient or overdue payment of tax payable in violation of state unified tax laws, regulations and policies. Non-compliant instances affecting the central revenues should be corrected by turning over the deficient amount of tax revenues to the national treasury by the local tax bureaus or other authorities concerned. Alternatively the Ministry of Finance may deduct at the end of the year the deficient amount from that part of central-local shared tax revenues due to the local tax bureaus responsible for non-compliant instances.
5.9. As to those directly responsible for noncompliant cases, notices of criticism against them shall be circulated. If a case is a serious one, investigation shall be conducted to fix legal responsibility on the responsible person. After audit opinions, audit conclusion or decisions are issued, CNAO shall brief the State Administration of Taxation and the Customs General Administration on the audit results so that they will be well informed and help with the implementation of audit recommendations or audit decisions. In addition, CNAO and its regional offices shall make periodical supervision and inspection on the implementation of audit recommendations or decisions with the purpose of assuring the latter's execution.
6.1. Three years have past since the introduction of the tax system reform. Viewed from the development trend, the change of the form and modernisation of the means of tax collection and administration have confronted tax audit with new challenges, of which the most outstanding is that the means of tax audit lag far behind those of tax collection and administration. Taking the taxation system headed by the State Tax Administration, for example, the new form of tax collection and administration is based on tax returns and relies on the computer network; taxes are collected in a concentrated way and inspection is conducted on key link of taxation.
6.2. In a few years' time nation-wide computer supervision and control networks will be gradually set up at the levels of the State Administration of Taxation, province, municipality and country. By 1997 computer systems of tax bureaus in 30%-50% of urban districts of cities, countries and developed coastal townships will be connected to computer networks. By 2000 computer systems of tax authorities in developed coastal areas and urban districts of big and medium-sized cities will be connected to computer networks among themselves and with banks, customhouses and industrial and commercial departments. Tax bureaus in interior and rural areas will begin to use computers before 2000.
6.3. At present, tax audit in China is performed manually in the main. Among auditors engaged in audit of public finance, only a few auditors are proficient at computer techniques and still fewer at both tax auditing and computer techniques, who fall far short of requirements against the background of modernised means of tax collection and administration. Therefore, the audit community in China is well aware of the urgency of the issue and have formulated a preliminary program for accelerating the computerisation process of tax audit. This would have the following contents: laying down a basis for computerisation of tax audit by urging parties concerned to install a certain number of necessary computers and other related equipment through various channels; strengthening development and research of application software for tax audit; and speeding up the training of auditors in the knowledge of the computer discipline with a view to suiting the needs of modernised means of tax collection and administration.