Editor's Note: The circumstances in which an upstream supplier absconds and becomes uncontactable, is listed as a non-normal taxpayer, or is characterized as having falsely issued invoices are frequently encountered in practice, and the resulting spillover of risk is becoming a real predicament for many downstream enterprises. Invoices that the recipient has already entered in its books and already used for deduction are determined by the tax authorities to be abnormal value-added tax deduction vouchers, and the recipient is consequently required to reverse the input tax amount or pay supplementary tax, among other measures. While such measures prevent the loss of state tax revenue, they nevertheless draw enterprises engaged in genuine transactions passively into tax-related risk. Why are invoices determined to be abnormal? Once such a determination is made, what rights does the recipient have, what risks does it face respectively with respect to value-added tax and enterprise income tax, and what measures should it take to reduce its losses? This article analyzes the foregoing questions.

I. The Rules Governing the Determination of Abnormal Vouchers

The legal basis for abnormal vouchers consists principally of the Announcement of the State Taxation Administration on Issues Concerning the Determination and Handling of Value-Added Tax Special Invoices Issued by Absconding (Uncontactable) Enterprises (State Taxation Administration Announcement No. 76 of 2016) and the Announcement of the State Taxation Administration on Matters Concerning the Administration of Abnormal Value-Added Tax Deduction Vouchers and the Like (State Taxation Administration Announcement No. 38 of 2019). Under Article 1 of Announcement No. 38, value-added tax special invoices falling within any of the following circumstances are included within the scope of abnormal vouchers: first, special invoices that have not been issued, or that have been issued but not uploaded, in special tax-control equipment lost or stolen by a taxpayer; second, special invoices in respect of which a non-normal taxpayer has neither filed a declaration with the tax authorities nor paid tax as required; third, special invoices found through the audit and cross-checking of the value-added tax invoice management system to involve a "comparison discrepancy", a "missing counterpart" or "voidance"; fourth, special invoices issued by a taxpayer that the big-data analysis of the State Taxation Administration or a provincial tax service finds to be suspected of false issuance or to involve circumstances such as failure to pay consumption tax as required; and fifth, invoices falling within the circumstance provided in Article 2, paragraph (1), item (1) of Announcement No. 76, namely, during the period in which an absconding (uncontactable) enterprise continued to operate — where a trading enterprise's purchases and sales of goods diverge seriously in the names of the goods; where a manufacturing enterprise has no actual production and processing capacity and has no entrusted processing, where its production energy consumption is seriously inconsistent with its sales, or where the goods it purchases cannot directly produce the goods it sells and there is no entrusted processing; and where it directly absconds and disappears without filing a tax declaration, or, although it files a declaration, files a false declaration by filling in the relevant columns of the value-added tax return so as to evade the examination and cross-checking of the tax authorities — the special invoices issued for the corresponding period.

In addition, Announcement No. 38 further expands the scope of abnormal vouchers, namely: where a general value-added tax taxpayer claims a deduction in respect of abnormal vouchers and the aggregate input tax amount of its abnormal vouchers accounts for 70% or more (inclusive) of all input tax on value-added tax special invoices for the same period and exceeds RMB 50,000 in the aggregate, the special invoices issued by that taxpayer for the corresponding period will likewise be included within the scope of abnormal vouchers, so that the risk of determination is transmitted downstream along the deduction chain; in order to avoid double counting, where abnormal vouchers have not yet been claimed for deduction by the taxpayer, have not yet been claimed for export tax refund, or have already had the input tax amount reversed, the input tax amount involved is not counted in the calculation of the above ratio and amount. Abnormal vouchers determined under the foregoing rules will trigger such consequences as a temporary bar on claiming a deduction, mandatory reversal of input tax in respect of amounts already deducted, suspension of the handling of export tax refunds or recovery of refunds already granted, and offsetting or supplementary payment of consumption tax.

II. The Rights of the Invoice Recipient After an Invoice Is Determined to Be Abnormal

Value-added tax is a typical indirect tax and chain tax. The computation of the tax takes the amount of value added as the tax base and operates on a link-by-link deduction basis; the deduction chain depends on lawful and valid deduction vouchers, so that deduction against vouchers has become the core of value-added tax collection and administration. The relationship of rights and obligations thereby formed is as follows: while the issuer enjoys the right to collect the tax-inclusive contract price, it bears not only the obligation to complete the act of issuing the invoice, but also an obligation as to result — to issue an invoice that is authentic and valid and may be lawfully deducted by the recipient — and it must truthfully declare and pay tax in respect of the transactions corresponding to the invoices it issues; the recipient, for its part, enjoys the right to obtain lawful deduction vouchers on the basis of genuine transactions and to deduct input tax, and bears the obligation to declare truthfully.

Under the tax laws, where an invoice obtained by the recipient is determined to be abnormal, the recipient enjoys three rights that it may assert. The first is the right to apply for verification: where it objects to the determination of the voucher as abnormal, the recipient may, within the prescribed period after receiving the Notice of Tax Matters, submit an application for verification together with such materials as the business contract, bank vouchers, and transport and warehousing certificates; where the tax authorities find no abnormality and the requirements for deduction are satisfied, further claiming of the deduction will be permitted. The verification work of the tax authorities is generally based on the authenticity of the business and proceeds along four dimensions: whether the declaration and the deduction are consistent; whether the contract, the funds, the goods and the invoice are consistent; whether the transaction subject to cross-regional assistance in investigation is genuine; and an on-site examination of the operating conditions and production capacity. The second is the substantive right to assert entitlement to deduction: under the Announcement of the State Taxation Administration on Issues Concerning the Issuance of Value-Added Tax Special Invoices by Taxpayers to External Parties (State Taxation Administration Announcement No. 39 of 2014), where the upstream issuer, although having falsely inflated its input tax, satisfies in respect of its outward issuance of invoices the conditions that it sold goods or provided taxable services, that it collected payment or obtained a voucher entitling it to demand payment, and that the contents of the invoice conform to reality, were lawfully obtained and were issued in its own name, the issuance is generally not characterized as false issuance, and the invoice obtained by the recipient may still serve as a deduction voucher. The third is the right to object as to scope: in respect of invoices obtained from a non-normal taxpayer, only the portion corresponding to its failure to declare to the tax authorities or to pay tax as required is abnormal, and it is inappropriate to determine all invoices of the same taxpayer as abnormal together.

In addition, the recipient should also clearly recognize its own obligations, namely to conduct genuine transactions with upstream enterprises, to obtain lawful vouchers, and to declare truthfully. Once it is established that the recipient, knowing that there was no genuine business, nevertheless obtained invoices, paid invoice-issuing fees, or cooperated in the return of funds, its status will change from that of a recipient in good faith to that of a participant in false issuance, and the liability it bears will accordingly also change. This is precisely an important reason why tax handling distinguishes good faith from bad faith.

III. Tax-Related Risks Arising from Abnormal Vouchers

At the value-added tax level, the first is the risk of reversal of input tax. In respect of abnormal vouchers already deducted, the input tax shall, unless otherwise provided, first be reversed in all cases, correspondingly increasing the tax payable for the current period or reducing the retained tax credit. Where export tax refunds are involved, the refunds must be reversed or recovered, and those engaged in the production of taxable consumer goods must also adjust their consumption tax deductions. The second is the risk of being characterized as tax evasion. The mere obtaining of an abnormal voucher does not necessarily constitute tax evasion; however, if the recipient acted with subjective intent, obtaining invoices and using them for deduction while knowing that there was no genuine business, such conduct may be characterized as tax evasion through the filing of a false tax declaration, and in addition to recovery of the tax and imposition of a late payment surcharge, the recipient will face a fine of 0.5 to 5 times the tax not paid or underpaid; where tax evasion is so characterized, the recovery of the tax is not subject to any limitation period, and the risk may further extend to criminal liability.

At the income tax level, the first is the risk of downward adjustment of costs. Pre-tax deduction requires that the voucher be authentic, lawful and related; in practice, the tax authorities in some regions treat expenditure corresponding to abnormal vouchers as non-deductible and require the enterprise to make a full tax increase adjustment. However, under the Administrative Measures for Pre-tax Deduction Vouchers of Enterprise Income Tax (State Taxation Administration Announcement No. 28 of 2018), the obtaining of an abnormal voucher does not by itself entail the loss of eligibility for deduction. Under Articles 13 and 14 of that Announcement, where an enterprise obtains non-compliant invoices or other non-compliant external vouchers, and the expenditure is genuine and has actually been incurred, it shall require the counterparty to reissue or replace the invoices or external vouchers; if the reissued or replaced vouchers comply with the provisions, they may serve as vouchers for pre-tax deduction. Where, in the course of reissuing or replacing invoices, the enterprise is unable to do so for special reasons such as the counterparty having been deregistered, dissolved, lawfully had its business license revoked, or determined by the tax authorities to be a non-normal taxpayer, it may rely on three indispensable materials — documentary proof of the reasons why reissuance or replacement is impossible, the contract or agreement relating to the relevant business activity, and the payment voucher evidencing a non-cash payment — supplemented by internal vouchers for the transport and the inbound and outbound storage of goods and by accounting records, and, upon verification of the authenticity of the expenditure, pre-tax deduction will be permitted. The second is the risk of being characterized as tax evasion. If the enterprise's purpose in obtaining abnormal vouchers was precisely to falsely include costs and fabricate transactions so as to secure pre-tax deduction, it may be characterized as tax evasion by overstating expenditure in its books and filing a false tax declaration, and will face corresponding penalties.

Moreover, the impact at the level of tax creditworthiness must not be overlooked either. A downgrade in creditworthiness will affect an enterprise's invoice acquisition, its entitlement to refunds and the convenience of its financing. For example, a taxpayer enjoying the value-added tax preference of refund upon collection will have that preferential treatment suspended for 36 months starting from the month following the issuance of the penalty decision.

IV. Tax Handling After Obtaining Abnormal Vouchers

Once an invoice obtained by the recipient is determined to be an abnormal voucher, the recipient may take measures in the following respects. First, strictly observe the procedural time limits and make good use of the right to verification. After receiving the Notice of Tax Matters, it should submit an application for verification within the prescribed time, submitting materials on whether the declaration and the deduction are consistent, whether the contract, the funds, the goods and the invoice are consistent, and whether the transaction is genuine. Second, seek a favorable characterization and narrow the scope of liability. Where there is a genuine transaction and the four flows are consistent, the recipient should actively assert that the invoice obtained is lawful, so as to retain the right to deduct. Where an invoice is determined to have been falsely issued, the recipient should seek a characterization of good-faith acquisition, the imposition of no late payment surcharge and no fine, and the narrowing of the scope of abnormal vouchers to the invoices corresponding to the failure to declare or to pay tax. Third, where compliant invoices can be reissued or replaced, promptly require the counterparty to reissue or replace them; where this is objectively impossible, provide the corresponding supporting materials as required and apply to the tax authorities for pre-tax deduction based on the actual facts. Fourth, proactively communicate and arrange payment. The recipient should communicate fully with the competent tax authorities regarding the basis for confirming the tax, the imposition of the late payment surcharge, and the payment deadline, and, where the conditions are met, apply in accordance with the rules for deferred or installment payment, so as to avoid secondary risks caused by financial stringency. Fifth, make good use of administrative remedies. Where it objects to a tax handling or penalty decision, it may seek relief through administrative reconsideration or administrative litigation. In addition, after paying supplementary tax and a late payment surcharge on account of obtaining abnormal vouchers, the recipient may seek recourse against the issuer through civil litigation, and there have already been cases in judicial practice in which a court ordered the issuer to compensate the recipient for tax losses.

V. Conclusion

The key to handling a recipient's obtaining of abnormal vouchers is to take the authenticity of the business as the foundation, to observe procedurally the verification time limit conferred by law, to seek substantively a favorable characterization of good-faith acquisition and compliant deduction, and, alongside tax remedies, to make concurrent use of such means as civil claims to seek recourse against the responsible parties, thereby minimizing the losses caused by abnormal vouchers.