When Assessed Taxation is Reversed to Audit-Based Collection: Protecting Legitimate Rights When Facing Tax Deficiencies, Late Fees, and Penalties

Editor's Note: China's tax collection and administration adopts a model where audit-based collection is the principle and assessed taxation is the exception. The primary theoretical and practical rationale is to strive for consistency between the taxes collected by the tax authorities and the economic substance of the enterprise. Assessed taxation, as a simplified administration method, offers high efficiency and is particularly applicable in specific scenarios and industries. However, it has also led to cases of tax evasion. In recent years, with increased intensity in tax supervision, cases where prior assessed taxation is subsequently adjusted retroactively are not uncommon. Taxpayers face risks including being required to pay back taxes, late payment fees, and even having their actions classified as tax evasion resulting in penalties. Under what circumstances might assessed status be denied? What measures can taxpayers take to protect their legitimate rights after the denial of assessed status? This article will provide a brief analysis.

I. Case Studies: Various Scenarios Where Assessed Status Was Denied

(I) Case 1: Denial of Assessed Status for Partnership Enterprise Investor Due to Questionable Business Purpose

In March 2025, a limited partnership invested in by natural person Gao was found to have engaged in artificial abuse of the assessed taxation policy for tax avoidance during its existence in 2020. The core suspicions were: First, the enterprise, acting as an employee for 26 employees, possessed considerable scale and bookkeeping capability but failed to set up account books as required. Second, its business substance was merely the transfer of clear listed company shares, which completely the statutory condition for assessment of "chaotic accounts making audit difficult". Third, to qualify for assessed taxation, the enterprise relocated to a tax haven and changed its business scope to obtain assessed status, but had no substantive operations, no office expenses, employee salaries, or other reasonable business purposes, and was quickly deregistered after completing the share transfer. Accordingly, the tax authorities determined its actions constituted artificially creating conditions to misapply the policy and required it to self-inspect and pay back taxes.

(II) Case 2: Denial of Assessed Status and Characterization as Tax Evasion Due to Non-compliance with Statutory Conditions for Assessed Taxation

In July 2018, an enterprise obtained a "Notice of Tax Matters" from its competent tax authority approving its corporate income tax to be levied on an assessed basis at a deemed profit rate of 4%. However, upon inspection, the tax authorities found that the enterprise's account records and accounting remained sound from 2016 to 2019, it could accurately calculate profits, its financial data was continuous across years, and it had implemented audit-based collection in 2016, 2017, and 2019. Accordingly, the tax authorities concluded that the enterprise had obtained assessed status in 2018 under false pretenses by concealing material facts, despite not meeting the statutory criteria for assessment that year. Ultimately, the tax authorities revoked its 2018 assessed treatment, recovered the tax deficiency, characterized its false declaration as tax evasion, and imposed a fine of 48.29 million yuan.

(III) Case 3: Internet Influencer Required to Switch to Audit-Based Collection After Incorrectly Applying Assessed Taxation

From 2021 to 2023, internet influencer Zhang, using his registered individual business as the entity, cooperated with live streaming platforms and accumulated income of 13 million yuan. The economic development zone where he was located, to attract tax sources, allowed him to pay individual income tax on this income at an assessed rate of 0.4%. However, subsequent supervision by the tax authorities that according to national regulations targeting the online live streaming industry, relevant entities must adopt the audit-based collection method and are not permitted to use assessed taxation. The regional policy relied upon by Zhang was invalid because it conflicted with mandatory national regulations. His assessed tax declarations for three consecutive years were wholly negated, facing the risk of being required to switch to audit-based collection and pay the tax difference.

II. Under What Circumstances Might Assessed Status Be Denied?

Based on the typical cases in Part I and combined with tax policy and administration practice, the main scenarios where assessed taxation status can be denied can be summarized into the following three categories.

(I) Non-compliance with Statutory Conditions for Assessed Taxation, Losing the Basis for Assessment

The application of assessed taxation has strict statutory prerequisites. Article 35 of the "Tax Collection and Administration Law" clarifies several scenarios for assessment (see table below). Among them, the most common basis is item 4, i.e., "account books have been set up, but the accounts are in disorder or the cost data, income vouchers, and expense vouchers are incomplete, making audit difficult." If the taxpayer substantially and continuously maintains sound accounting capabilities, the basis for assessed taxation ceases to exist.

As in the aforementioned cases, the tax authorities, by retrieving and comparing the taxpayer's financial data over multiple consecutive years, discovered that its account books were sound, accounting was accurate, and data across periods were logically consistent, thereby proving it fully possessed audit capability in the years assessed. In such cases, the tax authorities have the right to retroactively revoke its assessed status and require it to pay the tax difference based on audit-based collection. Furthermore, if the taxpayer concealed its sound accounting capability when applying for assessment, this becomes key evidence for the tax authorities to characterize the false declaration as tax evasion, subsequently facing risks of back taxes, late fees, and penalties.

(II) Lack of Reasonable Business Purpose, Constituting Artificial Abuse

The core of this scenario is that the taxpayer does not apply assessed taxation due to genuine management difficulties but uses it as a tax planning tool, artificially creating conditions that do not conform to the business substance. In addition to Article 35 of the "Tax Collection and Administration Law," tax authorities in practice often invoke the "substance over form" principle and the general anti-avoidance concept embodied in Article 8 of the "Individual Income Tax Law" and the "Enterprise Income Tax Law," emphasizing that tax collection must reflect the true substance of economic activities and negate artificial arrangements lacking a reasonable business purpose.

During review, the tax authorities focus on business substance, organizational form, and the authenticity of business activities. Taking the Gao partnership case as an example, the platform itself possessed sound bookkeeping capability and clear business content, yet changed its business scope and conducted no substantive operations to obtain assessed treatment, aiming to use the assessed taxation policy to reduce the tax burden on share transfer gains. Simultaneously, the tax authorities will verify the existence of genuine business traces such as real office premises, staff salaries, and utility expenses. A lack of these basic elements can lead to classification as a "shell" corporate structure without substantive business activities.

Once identified as artificial abuse of tax policy, the taxpayer will not only have their assessed status revoked, but their act of obtaining tax benefits through false declaration may also be further characterized as tax evasion, consequently facing administrative fines of 0.5 to 5 times the tax involved.

(III) Blurred Definition of Business Substance: Confusion Between Business Income and Labor Remuneration

In tax practice, the blurred boundary between business income and labor remuneration has become a high-frequency area for subsequent disputes regarding assessed taxation. In subsequent administration, tax authorities have the right to re-examine and determine the economic substance of the taxpayer's business, potentially overturning prior determinations based on superficial form. The core distinction lies in the substantive characteristics of the economic activity:

Business Income typically manifests as organized, continuous for-profit activities, possessing stable business premises, capital investment, personnel allocation, and cost expenditures, with the operator bearing profits and losses and undertaking business risks. For example, the income of an individual business with a fixed location, employees, and providing services externally over the long term aligns more with the substance of business income.

Labor Remuneration focuses on labor services provided independently by an individual, often characterized by project-based, temporary features. The service provider relies primarily on personal skills rather than business assets, does not bear business risk, and their income is directly linked to the completion of the service.

In practice, the line between the two types of income is often difficult to draw simply. If the tax authorities, upon review, determine that the taxpayer is essentially "an independent contractor undertaking specific project-based labor services" rather than operating as a "continuously operating business entity," they may negate the prior treatment of applying "Business Income" under assessed taxation. Instead, they may require the taxpayer to reclassify income as "Labor Remuneration" and pay the corresponding tax difference. Due to significant differences in calculation methods, deduction standards, and applicable tax rates between the two types of income, such adjustments often lead to a substantial increase in the taxpayer's actual tax burden.

III. After Denial of Assessed Status, What Key Defense Points Should Taxpayers Focus On?

(I) Actively Communicate with Tax Authorities Regarding the Nature of Income

If assessed status is denied due to the nature of income, the taxpayer can present arguments based on the differences between Business Income and Labor Remuneration. The core argument should focus on the following aspects: First, present the business license of the individual business or sole proprietorship enterprise to prove its legal status as an operating entity. Second, use customer contracts, project records, promotional materials, etc., to demonstrate that it conducts business externally continuously in its own name, rather than temporarily accepting instructions and management from a specific entity. Third, provide evidence such as premises lease contracts, equipment purchase vouchers, employee salary records, etc., to prove it has invested in operational assets and independently bears business risks. Finally, even if imperfect, existing bank statements, payment/receipt records, etc., should be provided to reflect the independence and continuity of financial activities.

(II) Post-Tax Recovery Calculation Method: Strive for Application of Assessed Taxation

Denial of prior assessed status does not necessarily preclude the application of subsequent assessment. If the taxpayer's actual situation meets the circumstances listed in items (2) to (6) of Article 35 of the "Tax Collection and Administration Law" (e.g., missing account books, incomplete materials), the taxpayer should proactively advocate for the tax authorities to use the assessed taxation method during the tax recovery stage. This is to avoid facing more unfavorable outcomes under audit-based collection when unable to provide complete cost vouchers.

(III) Denial of Assessed Status Should Be Judged from a Substantive Level

In practice, some local tax authorities overcorrect, denying assessment in a "one-size-fits-all" manner, leading to taxpayer-tax authority disputes. We believe that handling such issues should be based on facts and law, while considering historical and industry-specific circumstances. For enterprises that should applicable assessed taxation according to relevant regulations, consideration should not be limited to whether their cost and account book materials are "sound" in form, but should judge from a substantive level whether they possess the objective basis for audit-based collection, rather than imposing audit-based collection on enterprises. For example, for entities like individual businesses and sole proprietorship enterprises not covered by the "Measures for the Administration of Pre-tax Deduction Vouchers for Enterprise Income Tax," subjecting them to audit-based collection and requiring them to provide invoices and other payment vouchers lacks legal basis and does not align with administration reality and historical practice.

(IV) Factual Determinations of Assessed Taxation Already Made Should Not Be Overturned Without Due Process

The principle of protection of legitimate expectations in administrative law requires that administrative organs shall not arbitrarily revoke or change their effective administrative decisions already made. Taxpayers, based on the assessed taxation method approved by the tax authorities, form stable tax expectations and arrange their business activities accordingly. If the taxpayer, without employing any deceptive means, made tax declarations based on trust in the tax authority's prior effective assessment decision, then the inspection bureau should not overturn the prior effective administrative decision without going through sufficient investigation, evidence collection, and fulfilling necessary notification procedures. This is to maintain the credibility of tax enforcement and the stable expectations of taxpayers.

(V) Underpayment of Tax Arising from Adjustments to the Collection Method Should Not Be Deemed Tax Evasion

Underpayment of tax resulting from adjustments to the collection method is an objective consequence of changes in the application of tax policy or adjustments in tax authority determinations, rather than being caused by the taxpayer implementing tax evasion. It should not be characterized as tax evasion.

First, from the perspective of behavioral and subjective elements, in cases of underpayment due to adjustments in the collection method: Subjectively, the taxpayer is acting based on trust in the collection method previously approved by the tax authorities and declaring taxes accordingly, lacking the intent to deceive or conceal. Behaviorally, the taxpayer did not implement the tax evasion specified in Article 63, Paragraph 1 of the "Tax Collection and Administration Law." The underpayment of tax is a difference in calculation results arising from the subsequent change in the prerequisite condition – the shift from "Assessed Taxation" to "Audit-Based Collection" by the tax authorities – rather than a direct reduction of the tax payable through illegal means.

Second, from the perspective of causality, the underpayment results from policy adjustment, not from the taxpayer's illegal acts. The characterization of tax evasion requires a direct causal relationship between the "illegal act" and the "underpayment of tax." In this scenario, the taxpayer's declaration itself was permitted under the rules; their behavior and the result lack the causal chain required for tax evasion.

Third, as mentioned above, from the perspective of the principle of protection of legitimate expectations, taxpayers should be treated fairly. If, after the fact, not only is the collection method adjusted and taxes recovered, but the actions during that period are also characterized as tax evasion and penalties imposed, it seriously damages the taxpayer's legitimate expectations and violates fairness and justice.

Therefore, for underpayment of tax caused by adjustments to the collection method, the correct handling path is for the tax authorities to change the collection method and recover the tax difference according to law. Unless it can be simultaneously proven that the taxpayer, when applying the original assessed taxation method, already had committed fraudulent illegal acts listed in Article 63 of the "Tax Collection and Administration Law," their actions should not be characterized as "tax evasion" and penalized.

(VI) Taxes Exceeding the Recovery Period Should No Longer Be Pursued

According to the "Reply of the State Administration of Taxation on the Recovery Time Limit for Undeclared Tax" (Guo Shui Han [2009] No. 326): The circumstance where a taxpayer fails to file a tax return, resulting in non-payment or underpayment of tax payable, as stipulated in Article 64, Paragraph 2 of the Tax Collection and Administration Law, does not constitute tax evasion, tax resistance, or tax fraud. Its recovery period follows the spirit of Article 52 of the Tax Collection and Administration Law, generally three years, and under special circumstances, can be extended to five years. From this, it can be concluded that when an internet influencer falls under the circumstances of Article 64, Paragraph 2, and there is no tax evasion, resistance, fraud, or arrears, the tax authorities' recovery of taxes is subject to a maximum five-year recovery period limit. We believe that if the taxpayer's erroneous application of the assessed taxation policy is discovered after more than five years, and there is no tax evasion, resistance, fraud, or arrears, even if it results in non-payment or underpayment of tax, the tax authorities should not pursue recovery.

IV. Summary

In practice, tax authorities focus on reviewing the substantive operations and continuous compliance status of taxpayers. When discovering that taxpayers do not meet statutory assessment conditions, lack reasonable business purpose, etc., approved assessed taxation status faces the risk of adjustment. For taxpayers, the key lies in having a clear understanding of their own business substance and tax regulations beforehand, avoiding over-reliance on assessed taxation. If faced with denial of status afterwards, they should seek compliant resolution paths from multiple dimensions such as arguing business substance, tax calculation methods, and procedural rights, actively communicate with tax authorities, and protect their legitimate rights according to law. Against the backdrop of continuously improving tax supervision methods, taxpayers enhancing their own financial standardization and tax compliance level is the fundamental safeguard against potential tax risks.