China Fapiao: The Rules Have Changed

Earlier this week, China initiated a new fapiao (tax invoice) system.  A fapiao (发票) is both a receipt (i.e., proof of purchase) and a tax invoice (i.e., a way to determine the tax paid on a given transaction). Under the previous system, a buyer of goods or services in China simply had to provide its legally registered name (i.e., the name listed on its business license) to receive a valid fapiao from the seller. Abuse of the system was widespread; fapiaos were often inaccurate both in terms of amount and in the description of what was sold.

The new system imposes several additional rules, including the following:

1. The fapiao must specify the goods or services being provided.

2. The fapiao must bear a special fapiao chop from the seller.

3. The buyer must provide its tax identification code or unified social credit code.

4. Sellers/issuers of fapiao must link their internal fapiao data with the government to ensure that when the buyers/recipients of fapiao file their taxes, the amounts and the descriptions match up.

It’s hard to say with specificity to whom the new requirements are aimed at, in part because there are so many potential targets. But on a certain level, this new rule should be viewed as part of China’s escalating clampdown on capital flight and tax avoidance.

One of the major ways Chinese factory owners get money out of China is to create a Hong Kong shell company and then route all payments for manufacturing at the mainland China factories to that Hong Kong company. The Hong Kong dollar is not regulated in the same way as the Chinese renminbi, and once money is in a Hong Kong account, it can be moved offshore with relative ease. There’s nothing illegal about this process per se, so long as the payments in Hong Kong are declared as income by the Chinese factory that actually did the manufacturing. I’ll leave it as an exercise for the reader to guess how often that happens.

A variation of this scheme is overinvoicing of products imported into China from Hong Kong. For example, a shipment of goods valued at $100 would be invoiced at $1000. The Chinese company sends the full $1000 to Hong Kong, and the Hong Kong exporter deposits the difference (i.e., $900) in the Chinese factory owner’s Hong Kong bank account, less a service fee. Presto! $900 has been moved offshore. And the goods at issue have been transformed into grey market goods.

How will the new fapiao system affect foreign companies operating in China, especially WFOEs? For those already scrupulously following the rules, things shouldn’t change that much: a minor, but manageable increase in paperwork and logistics overhead. But WFOEs will need to be even more attentive when procuring or preparing fapiao. This puts more pressure on the general manager to oversee operations, especially staff who regularly deal with fapiaos (like sales agents). Easier said than done. It also puts more pressure on the parent company to appoint a general manager who is both (1) trustworthy and (2) understands that the parent company isn’t just giving lip service when it says it wants to follow the rules. And it puts more pressure on the entity handling the WFOE’s accounting and tax reporting. I don’t think that every WFOE needs to go out and hire a Big Four Accounting firm, but the WFOEs that have been doing it all themselves may want to rethink their strategy and hire an outside accounting firm. I know I would.