Many rich Chinese are business-owners who make millions a year. They have several methods to evade taxes. First, from the business level:
1. “Forget” to book certain revenues.
In most cases, these private businesses have two sets of books, one to show the Tax Authority, the other – the true book – is hided in the owner’s closet. The one for the Tax Authority may not record all the revenues from the company’s business transactions.
2. Book expenses that the company does not have.
The company can purchase invoices/receipts from numerous so-called “Financial Advisory” firms. These fake invoices/receipts can be prepared for all kinds of expense accounts: from equipment, supplies, medical expenditures, services…anything you would like them to be. How much these fake invoices/receipts are sold for? For a percentage of its face value. For example, a fake invoice/receipt for supplies for $600,000 is sold for 5% of face value, which is $600,000×5% = $30,000. The company pays $30,000 to obtain this invoice/receipt, and then books $600,000 in supplies expense in its books. Say the Company’s net profit for one transaction is $1,000,000, after booking this fake expense item, the company’s net profit becomes $1,000,000 – $600,000 = $400,000. The higher the denomination of the invoices/receipts, the lower rates they can be sold for, e.g., a $900,000 invoice may be sold for only 4%, and so on. In a lot of cases, business transactions with $1,000,000 in profit can be slashed to only $100,000 in profit after booking several such fake invoices.
One may wonder why the Tax Authority in China does not effectively catch these evading activities? That’s because there are so many of them! The names on the fake invoices/receipts are usually fly-by-night companies that have addresses in other far-away provinces and are hard to pin-point. Further, in many places of China, transactions are not conducted by credit card, check, or wire transfer, they are done in cash, so it’s difficult to trace.
Second, from the individual level:
The salaries reported by these business owners are meager compared to what they actually earn. Most of what are paid to them by their companies are absorbed by the companies’ books as expenses like: business development fees, travel allowances, rental expenses (that is, the owner rents a piece of old crap equipment to the company which in turn pays the owner a huge rental expense), advertising expenses (that is, the owner puts a logo in his car or his notebook, and the company pays him an “advertising fee” for doing it), etc. After all the expenses booked, what are recorded as salaries can be tiny. For instance, a business owner would take $100,000 in cash from the company each month, but only report $3,000 as salary and pay just $60 in individual income taxes.
How about capital gain taxes? When rich Chinese individuals invest in stocks, options, etc, they tend to settle their financial positions in overseas tax-heaven such as Hong Kong. That way the capital gain taxes in China are avoided.
Then, one may ask, if there are so many ways for rich Chinese to evade taxes, how can China’s tax revenue be sufficient? China has a national budget surplus every year in recent years. How can this be achieved? The reason is that the majority of China’s tax revenue is not coming from individual income taxes or privately-owned entities’ taxes; they are from large state-owned enterprises.
These state-owned enterprises function like bureaucracies, they dominate major industries of national significance, such as air transportation, rail transportation, large-scale construction, mining, oil, shipping, important equipment manufacturing, banking, etc. They have the resources to play the big games, hire the best minds, obtain the largest financing, and manipulate the market when necessary. Their CEOs are not private owners. Instead, the heads of the state-owned enterprises are appointed by the government. What they pursue is not just money, what they want the most is “power”. In a society like China, money sometimes cannot buy certain things. However, once one has “power”, one can have a lot of privileges. For example, a “powerful” person can let all the passengers on a commercial airplane wait for him or simply stop the whole flight just because he has “connections”; a “powerful” person can order the traffic police to hold all the cars from other directions to wait for his car to pass because he can get the police officer fired if the police officer does not obey him; a “powerful” person can influence the court system, the education system, etc., for his own or his relatives’ benefits.
These state-owned enterprises are important contributors to China’s tax revenue. There is no incentive for the CEOs of these state-owned enterprises to evade taxes. They don’t own the companies themselves anyway. Instead, they are in these positions for a number of years and hope that they can be promoted to something more powerful later. The more taxes these enterprises can pay to the Tax Agency, the greater performance the stewards of state-owned enterprises can score in the eyes of their government supervisors. Thus, one can understand why China can collect adequate tax revenue each year when a lot of rich small-business owners rampantly evade taxes.