By Tony Dong and Daisy Duan   King & Wood Mallesons’ Taxation Group invoice plays an indispensable role in economic activity and business operations in China. It also plays an important role in tax scrutiny when tax authorities are collecting taxes and combating tax evasion. It is reported that in 2013, the tax authorities investigated 91,000 cases of selling or producing false invoices or the illegal issuing of invoices  and 130 million illegal invoices were uncovered. Invoice-related non-compliance is found frequently in certain industries such as real estate, construction and installation, medicine and medical equipment, power generation and supply, catering and entertainment, and the education or training industry. The tax authorities have identified 89,000 entities that have illegal invoices issues, and they are pursuing taxes of more than RMB 13.8 billion.

Based on the Administrative Measures of the People’s Republic of China on Invoices[1], drawing up or having drawn up invoices for oneself, or for others, or introducing others to issue invoices which are not in line with an actual operating business will constitute drawing up false invoices. In addition to administrative punishment, serious violation may result in criminal responsibility. Not surprisingly, most enterprises or individuals that receive false invoices clearly know that the invoices are false and they are being used to evade tax. Therefore, obtaining such invoices in “bad faith” will be investigated and punished. However, some buyers who receive invoices do have real transactions with sellers and the information stated in these invoices is consistent with actual transactions, and the buyers might not be aware that the invoices are illegally acquired or drawn up. Such taxpayers may still suffer losses or even be punished by tax authorities though they have acquired false invoices in “good faith”.

This article will discuss differences between the good and bad faith acquisition of falsely issued invoices, and the tax implications of acquiring falsely issued invoices in good faith as well as ways to avoid acquiring false invoices.

Distinguishing “good faith” and “bad faith”

Determination of the taxpayers’ good faith or bad faith when acquiring invoices will make a difference as to whether or not taxpayers will be subject to administrative punishment or even criminal liability. The crux of the matter is whether the enterprise as an invoice recipient subjectively knew that the invoice had been falsely issued. Because of the complexity of business transactions and different positions on tax collection, tax authorities and enterprises have plenty of scope for different arguments on tax liability and it is difficult to achieve a consensus.

To show “good faith”, a taxpayer who acquires invoices must not intend to evade tax nor fraudulently obtain export tax refunds, nor intend to achieve illegal benefits. Generally speaking, acquisition of falsely issued invoices in “good faith” must satisfy all the following conditions: (1) there must be a real transaction between the buyer and the seller; (2) the amount in the invoices issued to the buyer must be consistent with the sales amount; (3) the buyer must not be aware that the invoices are drawn up illegally, or issued by a third party.

Acquisition of falsely issued invoices in “bad faith” refers to circumstances where a taxpayer requests a counterparty to draw up false invoices lacking a real sales transaction, or a taxpayer knowingly accepting false invoices, or a taxpayer acquiring invoices from a third party during the transaction, and subsequently the taxpayer claiming a tax credit or pre-tax deduction from the tax authorities. The “bad faith” acquisition of false invoices must satisfy all of the following conditions: (1) there is no sales activity, or even if there is a sales activity the invoices are acquired from a third party; (2) the taxpayer has claimed the VAT credit or tax deduction before income tax; and (3) subjectively, the taxpayer is aware that the invoices are falsely issued.

In order to avoid being found liable for acquiring invoices in “bad faith”, a buyer needs to provide relevant documents to convince the tax authorities that it received the false invoices in “good faith”.

Tax impact of acquiring falsely issued invoices in good faith

For enterprises which carelessly acquire false invoices in “good faith”, tax consequences are different depending on the types of the false invoices and their functions (e.g. whether used as a credit against input VAT, an export VAT refund or a pre-tax deduction for income tax purpose). A brief introduction is set out below.

  •  VAT treatment for acquiring special VAT invoices in good faith

Tax treatment of taxpayers who acquire special VAT invoices in good faith are relatively clear[2]. To be specific:

–            Taxpayers who acquire special VAT invoices in good faith will not be treated as tax-evaders or of defrauding export tax refunds. However the input tax deduction or import tax refund will not be permitted and the tax deducted or refunded must be repaid by the buyer;

–            If taxpayers who acquire falsely issued special VAT invoices in good faith can replace them with lawful and valid special invoices then the input VAT credit can be deducted; if valid invoices could not be re-obtained then the taxpayer cannot deduct the input VAT and the deducted input VAT must be repaid.

–            Where the deducted tax credit has been legally repaid by a taxpayer which acquired the falsely issued special VAT invoice in good faith, then late payment interest will not be imposed on the taxpayer.

–            Taxpayers who have received administrative or criminal sanctions for false special VAT invoices will not be entitled to the preferential policy of obtaining VAT refunds at or after collection up to 36 months, and may be denied export tax refunds. However, taxpayers who acquire false special VAT invoices in good faith will not be subject to these punishments.

  •  Income tax treatment for acquiring invoices in good faith

Due to lack of explicit tax guidance, local tax authorities hold different opinions about whether the corresponding purchase costs indicated in false invoices (including special VAT invoices and other invoices) acquired by enterprises in good faith can be deducted before income tax. Currently, most tax authorities disallow the deduction of such costs before income tax and thus the income tax burden of enterprises is increased directly, however, many enterprises disagree with this tax treatment. The fundamental reason for the disagreement is due to a different opinion of the principle for deduction before income tax.

Prior to implementation of the Enterprise Income Tax Law (effective as of 1 January 2008), as required by relevant tax rules, the deduction filed by taxpayers had to be true and lawful with the lawful invoices as the basis for bookkeeping.  The tax authorities held that falsely issued invoices failed to satisfy the aforesaid “lawful” requirement, therefore no deduction before income tax could be allowed, however, it was normally recognized that if the buyer could re-acquire lawful and valid invoices from the seller, deduction before income tax would be allowed for the period when costs and expenditures were generated.

The Enterprise Income Tax Law and its implementation regulations stipulate that reasonable expenses that are relevant to the income were actually incurred and obtained by enterprises are allowed to be deducted from the taxable income. Compared with previous rules, the Enterprise Income Tax Law emphasizes the principle of actual occurrence, relevance and reasonableness instead of the legality of the vouchers for deduction. This creates discussion space about whether deduction of the false invoices acquired in good faith is allowed before income tax.

Since 2008, though certain local tax authorities still require in their enterprise income tax final settlement notices that falsely issued special VAT invoices or ordinary invoices acquired by enterprises in good faith cannot be treated as the evidence validating deductions before  income tax, we note that the ‘Administrative Measures on Pre-tax Deductions of Enterprise Income’ (Su Di Shui Gui [2011] No.13, effective as 1 Feb. 2012) issued by the Jiangsu local tax authority[3] has made a breakthrough in terms of vouchers for pre-tax deduction. More specifically,

–            Disqualified invoices are not to be the sole evidence for pre-tax deduction; contracts, expenditure receipts and other vouchers may be provided as well so as to prove the legality and authenticity of such expenditure;

–            For costs and expenditure actually incurred in the current year, if the enterprise cannot obtain valid vouchers in time, it can calculate taxes temporarily based on the accounting amount when paying provisional income tax quarterly. However, when the enterprise conducts its annual filing, valid vouchers for the costs and expenditures shall be supplemented;

–            Upon completion of the annual income tax filing, if the enterprise still cannot obtain lawful vouchers, but there is solid evidence to prove the authenticity of business expenditure and  the party obtaining the income has recorded such income in its books, then the relevant costs and expenditures of the buyer may be deducted before income tax.

We are of the view that Circular 13 properly demonstrates the principle of actual occurrence, relevance and reasonableness for the expenditure deduction as regulated in the Enterprise Income Tax Law. This ensures the proper administration of tax collection, and at the same time provides enterprises with their reasonable tax benefits in cases where they may fail to obtain lawful vouchers despite incurring actual and reasonable expenditure. This circular gives a basis on which enterprises acquiring falsely issued invoices in good faith may successfully argue for a deduction before income tax.

Tips for taxpayers

Based on the analysis above, enterprises which acquire falsely issued special VAT invoices cannot claim an input VAT credit unless lawful and valid invoices can be re-acquired from the seller. Furthermore, the tax authorities may disallow the deduction of the corresponding costs before income which results in unnecessary economic losses for enterprises.

In order to avoid obtaining falsely issued invoices, taxpayers should pay close attention to the authenticity of their suppliers’ sales activity, the legality of the source of invoices and the authenticity of invoices etc. Taxpayers can reduce risk by applying various effective precautionary measures which include:

–            Make sure transactions are real, watch the genuineness and consistency of the three elements in a transaction, i.e. the flow of goods, invoices and payments;

–            In addition to the quality and price factors, taking into account of the size, reputation and track records when selecting the suppliers to do business with;

–            Investigate the suppliers’ business scope, business scale, production capacity, enterprise qualifications and ownership of goods;

–            Request the suppliers’ tax registration certificate, application and general VAT payer certificate, invoice purchase book, delivery order, accounts of the receiving bank,  warehouse entry and books, so as to perform comprehensive cross-reference and verification;

–            Make the payment via bank accounts, request that the bank account information be consistent with the information specified on invoices;

–            Perform tax verification for the acquired invoices in a timely manner. Seek assistance from the tax authorities for suspicious invoices;

–            Maintain complete documentation, e.g. contracts, vouchers and accounting records to retain to sufficient evidence in case of the tax authority’s investigation.


[1] This circular was approved by the State Council on December 12, 1993, promulgated by the Order of the Ministry of Finance No.6 on December 23, 1993 and revised by the Decision of the State Council on Revising the Administrative Measures of the People’s Republic of China for Invoices on December 20, 2010.

[2] VAT treatment for taxpayers who acquire falsely issued special VAT voices in good faith are mainly based on Guo Shui Fa [2000] No. 187, Guo Shui Han[2007] No. 1240 and Cai Shui [2013] No. 112.

[3] Enterprises whose enterprise income tax is collected by Jiangsu Local Tax Authority shall apply this Measure.