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Mr. Liu Tianyong and Mr. Jiang Zhenghe of Hwuason Law Firm expressed their opinions on the tax-related risks of pharmaceutical enterprises and published in China Tax Newspaper

April 23, 2024, 2:29 p.m.

For a long time, the pharmaceutical industry has had problems such as long drug research and development cycles, excessive research and development costs and sales expenses, and high pressure on and slow recovery of enterprise funds, and some pharmaceutical enterprises have been able to extract funds by means of false invoices in order to obtain profits. In addition, on July 10, 2023, the National Health Commission, together with several ministries and commissions, deployed a one-year centralized rectification of corruption in the national pharmaceutical field, which set off a storm of anti-corruption in the pharmaceutical industry and led to a number of cases of false invoicing and tax evasion. The pharmaceutical industry has been a key area of concern for HuaShui for a long time, and HuaShui has issued tax compliance reports on the pharmaceutical industry for many years in a row. Recently, Mr. Liu Tianyong and Mr. Jiang Zhenghe of Hwuason Law Firm commented on the common tax-related risks in the pharmaceutical industry and made suggestions on corporate compliance. The relevant content was published in China Tax Newspaper. The full text is as follows:

No real business support, high risk of false opening for pharmaceutical enterprises

According to the "Tax Compliance Report (2024) for Pharmaceutical Industry" recently released by Hwuason Law Firm, since the "14th Five-Year Plan", China's pharmaceutical industry has seen an average annual growth rate of 9.3% in its main business revenue and an average annual growth rate of 11.3% in its total profit, which has resulted in a sustained improvement in the scale and efficiency of the industry. However, while the pharmaceutical industry is developing at a high speed, the risk of false VAT invoicing cannot be ignored. Liu Tianyong, director of Hwuason Law Firm, said that pharmaceutical enterprises should firmly establish the awareness of tax risk prevention and control, improve the awareness of paying taxes in good faith according to the law, improve the degree of enterprise tax informatization, standardize the auditing and management of invoices and all kinds of vouchers, and prescribe tax compliance "prescriptions".

Common Risk Point 1: False Invoicing through Online Service Platforms

In May 2023, a case notified on the official website of the State Administration of Taxation (SAT) showed that a criminal gang controlled A Medical Technology Limited Liability Company, utilized the upstream Internet platform enterprises to fictionalize their business, and falsely issued 3,872 VAT special invoices with items such as information services and marketing fees to a number of pharmaceutical manufacturing enterprises, with a total amount of price and tax of 353 million yuan.

In practice, there are various possibilities for pharmaceutical online service platforms to be suspected of false invoicing: firstly, in order to seek benefits, they disregard the authenticity of business, forge supporting materials and take the initiative to cooperate with pharmaceutical enterprises to issue false invoices; secondly, they are subjected to collusion and fraud by pharmaceutical enterprises, consulting companies and service providers, and fail to audit the authenticity of business, which results in false invoicing to the outside world; thirdly, the pharmaceutical online service platforms provide corresponding services but lack relevant materials to prove the authenticity of business, and thus are recognized as the authenticity of business. Thirdly, the pharmaceutical online service platform provided corresponding services but lacked relevant materials to prove the authenticity of the business, which was recognized as false invoicing.

In this regard, Jiang Zhenghe, a partner of Hwuason Law Firm, suggests that after a similar situation occurs, the pharmaceutical enterprise, as the recipient of the invoice, should actively prepare the business and financial information to explain the authenticity of the business to the tax and public security. If the online service platform steals tax and makes false invoices by means of false enhancement, the enterprise can claim that the platform's inputs and outputs should be cut, because although the platform's inputs are false invoices, the services it provides to the downstream may be real, and the outputs may not necessarily constitute false invoices. If the business of the pharmaceutical enterprise is real and there is no subjective intention of false invoicing, it can claim that the invoices are obtained in good faith to avoid criminal risk, and on the other hand, it should prove that the business is real and the cost expenditure is legal, so as to fight for no adjustment of enterprise income tax.

Good faith acquisition is a civil law concept. According to tax laws and regulations, it can be recognized as good faith acquisition of falsely issued VAT invoices if the following four conditions are met: firstly, the purchaser and the seller have real business transactions; secondly, the seller uses special invoices of the province (autonomous regions, municipalities directly under the central government and municipalities with single-lined cities under the central government) in which the seller is located; and thirdly, the contents of the VAT invoices are in accordance with the real business, including the name of seller, seal, quantity of goods, amount, and the amount of VAT invoices, as well as the amount of VAT invoices, seal, quantity of goods, amount and tax amount, etc.; fourthly, there is no evidence that the purchaser knows that the special invoice provided by the seller is obtained by illegal means.

Common Risk Point 2: Invoicing and Bribery are Interlinked

In January 2023, Anhui Province released five typical cases of bribery offenses. Among them, Xiao Moumou, the legal person of Anhui B Minsheng Pharmaceutical Co. Ltd, was sentenced to 20 years in prison and fined 100,000 yuan for crimes such as false VAT invoicing. While serving his sentence, it was found that he had also committed the crime of bribery, having paid bribes totaling RMB 2,295,306,000 and USD 13,000 to 11 national public officials. For the crime of bribery, Xiao was sentenced to six years of imprisonment and a fine of 300,000 yuan.

The analysis of "Tax Compliance Report of Pharmaceutical Industry (2024)" pointed out that the relevant authorities regulate drugs and medical devices more strictly, and their sales require the endorsement of hospitals and other medical institutions. Pharmaceutical companies often give benefits to doctors and other relevant personnel in order to expand the sales of drugs, which breeds a breeding ground for bribery. In practice, pharmaceutical companies, medical representatives, etc. will choose to extract bribe funds through the way of false invoicing.

The "Guidelines for Prevention and Control of High Crime Risks in Enterprises" issued by the Jiangxi Provincial Higher People's Court points out that enterprises shall not purchase or falsely issue ordinary invoices at low prices, list more costs, reduce the amount of taxes paid by enterprises, such as income tax, or take advantage of the differences in the tax rates of different industries to evade taxes; they shall not purchase and falsely issue ordinary invoices to cover expenditures, and use them for bribery or transfer of benefits in business transactions. If a person who commits the above acts also commits the crimes of false invoicing and tax evasion, unit bribery, etc., he or she will be punished severely by choosing a felony according to the circumstances of his or her crime. From the publicly available cases, false invoicing and bribery in the pharmaceutical industry are often implicated in each other, and both those who choose one felony to be punished and those who are punished jointly with the crime of false invoicing and the crime of bribery will be sentenced to a higher term of imprisonment.

Wu Xiaohong, director of the Modern Fiscal Governance Research Center of Hefei University and director of the China Fiscal Law Research Society, reminded that in the next few years, the pharmaceutical industry is still likely to be a key industry for tax audits. The tax risk will always be high for pharmaceutical enterprises that have illegal behavior and intend to reduce their tax burden and make illegal profits. "Pharmaceutical enterprises should seize the time to self-check and self-correct the existence of false driving and bribery, comply with the response and resolve the risks that may be involved in criminal proceedings, strengthen internal control and compliance mechanism construction, and standardize their own behavior." Wu Xiaohong said.

Common Risk Point 3: False Invoicing of Agricultural Products Acquisition

In July 2023, the audit department, in auditing a social security project, through understanding the business characteristics of the pharmaceutical distribution industry, utilizing fiscal, tax, and industry and commerce related data for comparison, verifying the business flow, capital flow, and logistics of the enterprise, and on-site investigation of the identity of the selling farmers and the local Chinese medicine planting transactions, found that Pharmaceutical Company C fictionalized the business of acquisition of Chinese herbs and falsely issued agricultural product acquisition invoices of 1.68 billion yuan for offsetting input tax. At the same time, Pharmaceutical Company C also colluded with other pharmaceutical companies and falsely issued nearly 150 million yuan of VAT special invoices for other pharmaceutical companies by means of circular invoicing in the absence of real business, resulting in a serious loss of state tax.

Yang Feng, Chief of Goods and Services Tax Section of Bozhou Taxation Bureau of State Administration of Taxation, introduced that for the purpose of protecting and supporting the development of "Three Rural Areas" in China, buyers of agricultural products are allowed to issue purchase invoices to individual agricultural producers and calculate or approve the deduction of VAT input tax amount. Although agricultural producers are not required to pay VAT on the sale of self-produced agricultural products, the buyers can still deduct input tax with the purchase invoices of agricultural products. Some unscrupulous elements take advantage of this to increase the cost of the enterprise through false issuance of purchase invoices for agricultural products, so as to extract funds to bribe organizations in the downstream chain, such as pharmaceuticals, in order to expand the sales volume, or to achieve the unlawful purpose of underpayment of VAT and EIT by offsetting inputs through the false issuance of purchase invoices for agricultural products.

In the above case, Pharmaceutical Company C had no real goods transactions between purchase and sale, and had no obligation to pay VAT to the state. However, the falsely issued VAT invoices will be used by the recipient unit to offset tax without paying tax, thus leading to the loss of state tax. Yang Feng reminded that the determination of the crime of false invoicing should not ignore the substantive judgment on whether it causes tax loss. If Pharmaceutical Company C falsely issued VAT invoices for the purpose of inflating performance, not for the purpose of offsetting tax, and in essence did not cause loss of state tax, it does not constitute the crime of falsely issuing VAT invoices.

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