With the export business in the doldrums, enterprises are increasingly turning to formal exports to claim export tax refund benefits – meaning goods do not leave China, but simply take advantage of deemed export policy on entering and exiting special customs supervision zones (SCSZs), such as comprehensive bonded zones. This article analyses the risks involved.

Case 1: A and B are domestic companies outside the SCSZs. Goods are transferred from company A to a storage enterprise inside the zone, and then onward to company B. Export tax refunds are achieved in this “one-day trip into SCSZs”, and the capital flows through an offshore company with settlement in foreign currency. Declared prices of this deemed export and import are exactly the same.

Case 2: Two companies, A and B, both outside the SCSZs, entered into a contract where company A exports goods to storage enterprises in a comprehensive bonded zone, then transfers via SCSZs to a public bonded warehouse, where company B declares the import. The prices of several customs declarations are all the same. Note: this case involved an additional SCSZ.

Neither of these operations are compliant, because the identities of the purchasers do not meet the conditions of a deemed export.

Article 1(2)(ii) of the Notice of the Ministry of Finance and the State Administration of Taxation on VAT and Consumption Tax Policies for Exported Goods and Labour Services stipulates that among exported goods and services to which the VAT refund (exemption) policy applies, goods entering the SCSZs approved by the state through customs declaration and being sold to entities or individuals inside the SCSZs, or outside China by the exporting enterprise, are deemed as exported goods.

The SCSZs include export processing zones, bonded logistics parks, bonded port zones, comprehensive bonded zones, the Zhuhai-Macau cross-border industrial zone (Zhuhai Park), and the China-Khorgos international centre for border co-operation (supporting area for the Chinese side).

Article 5 of the Announcement of the State Administration of Taxation on Issues Concerning Value-Added Tax and Consumption Tax on Exported Goods and Labour Services stipulates that goods that export enterprises have declared to enter an SCSZ and sold to entities or individuals inside SCSZs or outside the country, with settlement in renminbi, can be declared for an export tax refund (exemption). The renminbi receipt can be provided as proof when receipt of foreign exchange is required by the relevant regulations.

But the companies in both cases only fulfilled one condition of a deemed export, i.e., the goods entered the comprehensive bonded zone to complete the formal export. They did not fulfil another condition – that of “sold to entities or individuals inside SCSZs or outside the country” – since both parties were domestic companies outside the SCSZs.

Transfer of ownership of goods must occur on entering an SCSZ, rather than just delivering goods to a logistics company in the comprehensive bonded zone for storage and then selling them to an out-of-area company. Therefore, regardless of the flow of goods, the two companies are not eligible for export tax refunds.

A one-day trip into SCSZs is a supply chain issue that seems to fall under the jurisdiction of customs. But in reality, the entry and exit from the zone is only a means to get export tax refunds. Therefore, legality must comply with both the general administration of customs and the state administration of taxation regulations.

There are clear prohibitions on one-day trips for listed industrial raw materials into SCSZs, violations of which may constitute an illegal act of fraudulent tax refunds. Although many customs officers are dubious about such behaviour, the basis of any breach is not very clear to them since it may violate regulatory requirements of the fiscal and taxation authorities. It is therefore necessary to refer to the relevant regulations.

Article 3 of the Notice of the Ministry of Finance, General Administration of Customs and State Administration of Taxation on the Application of Tax Refund Policies for Domestically Purchased Materials Entering Export Processing Zones and other SCSZs stipulates that raw materials purchased domestically by manufacturers in SCSZs that comply with provisions of article 2 of the notice shall not be resold to non-manufacturing enterprises in the zones (such as storage and logistics, trading and other enterprises), directly exported, or exited from the zones in bond without substantial processing.

Any violation shall be dealt with as tax fraud and tax evasion under the relevant provisions. If the raw materials entitled to tax refunds leave the zones without substantial processing and are sold to the domestic market, all import taxes shall be levied in accordance with the rules.

Article 4 of the notice stipulates that raw materials purchased by non-manufacturing enterprises (such as bonded logistics, warehousing and trading enterprises) in the zones that meet the requirements of article 2 are not eligible for the tax refund (exemption) policy.

In practice, there are more violations of articles 3 and 4. Either the manufacturers in SCSZs will exit raw materials without substantial processing in bond, or the raw materials are only sold to non-manufacturing enterprises – such as bonded logistics, warehousing and trading in SCSZs – and then exit the zones in bond.

The operation, which seems to be closed-loop, either violates the rule that raw materials cannot be resold without substantial processing, or violates the general rule that ownership must be transferred, i.e., the goods must be sold to enterprises in the comprehensive bonded zone, rather than just entering the zone for storage.

The situation where listed raw materials enter the zone without any substantial processing and exit in a different SCSZ after receiving a tax refund does not meet the conditions for a deemed export and should not be entitled to a tax refund (exemption).

The legality of the prevailing situation is not always guaranteed. Customs, finance and tax officials should be aware of something potentially fishy in the situation to prevent tax evasion and better fulfil their regulatory obligations.