If competition is fierce, one may experiment different solutions: price and cost reduction, wider distribution, more targeted advertising. But, the most effective one is breaking the law with a tax fraud. That gives you unexpected advantages.
VAT, value added tax, is an old tool for a old game in town. Either forging or selling VAT receipts is becoming increasingly popular in China. The tax is to be paid at every step of the production chain; it is also deductible by every buyer of the component up to the final products. Temptations to practice a tax evasion are hard to resist. Consequently, it is a big loss for State’s revenues.
Since its introduction in 1994, VAT (which may reach 17%) has been the biggest source for Government revenues, with a solid 27% of the total taxation. Even if is difficult to calculate the precise amount of VAT being evaded, according to some estimates, it could even equal the actual collection. Despite harsh punishment – death penalty for the most blatant violations – the illegal practice seems unstoppable, widely obvious also in the ordinary commercial transactions. This opacity is reinforced by Hong Kong’s status. Its investments in the mainland are considered as “foreign” and, as such, eligible for tax break.
This preferential treatment comes from an old political decision to attract FDI. Even if largely reconsidered, the disparity with the local companies still exists. One of the biggest tax shelter is the reduction of the VAT. So, some firms pretend to be from Hong Kong. They save tax money in the mainland – for example understating the export incomes or blowing purchasing costs – to then transfer excess funds to the former colony. There, the sum is disguised as foreign and goes back to China to meet tax incentives.
Since Hong Kong is the biggest investor in China (56% of more than $100billion in total in 2010) , it is easily understood the magnitude of this flow. Beijing’s authorities are very determined to tackle this “illicit game”. A wide anti-corruption campaign is being implemented and publicized. Its ambition is to stop a disease which may hurt not only the rule of the law but the economic structure as well.