Editor's Note: Under China's VAT chain-based tax administration system, once an upstream company absconds, goes missing, or is characterized as having engaged in fraudulent invoicing, the risk readily propagates downstream along the invoice chain. Invoices obtained by downstream recipient companies are frequently classified as abnormal tax deduction vouchers or fraudulent invoices, triggering a cascade of consequences — including reversal of input VAT credits, disallowance of pre-tax deductions for corporate income tax, characterization as tax evasion, and even criminal prosecution. Drawing on current tax regulations and practical experience, this article analyzes the criteria for characterizing upstream absconding and fraudulent invoicing, the risk transmission mechanisms involved, and the primary tax risks faced by downstream companies. It also offers actionable compliance strategies for invoice recipient companies.

01 Lessons from the Tianjin CNY 1.2 Billion Fraudulent Invoicing Case: The Predicament of Downstream Companies

In April 2026, the First Inspection Bureau of the Tianjin Municipal Tax Authority under the State Taxation Administration announced a typical organized fraudulent invoicing case. Since 2024, a criminal gang led by a person surnamed Chen had, through illicit channels, purchased citizens' identity information and used those stolen identities to register 346 shell companies in bulk — including Tianjin XX Agricultural Technology Co., Ltd. — without any genuine business transactions taking place. In response to downstream companies' "invoice procurement demands," the gang issued 7,846 ordinary VAT invoices and charged a fee proportional to the face value of each invoice. The total amount of invoices involved reached CNY 1.2 billion.

During their investigation, tax inspectors discovered that the agricultural company's registered primary business was the promotion of "agricultural, forestry, animal husbandry, and fishery" technologies. Yet all 10 ordinary VAT invoices it issued in concentrated batches in May 2024 listed the items as "grain*oats" and "traditional Chinese medicinal materials*milk thistle." The company had no input VAT credit records whatsoever. Its highly conspicuous anomalies — such as "having sales but no purchases" and absconding immediately after issuing invoices in bulk — were unmistakable. Following a joint assessment and investigation by tax and public security authorities, the task force swiftly identified and arrested the actual controllers. In November 2025, the two principal offenders were convicted of the crime of issuing fraudulent invoices and sentenced to six and five years' imprisonment, respectively, with fines also imposed. Concurrently, the tax authorities initiated audits or formal investigations against 1,936 downstream invoice recipient companies implicated in the case.

The investigation pathway in this case vividly illustrates the typical pattern by which fraudulent invoicing risk propagates from upstream to downstream. Tax authorities use the Golden Tax System's big-data analytics to identify anomalous features in upstream companies — such as "having sales but no purchases" and the issuance of invoices in concentrated bursts — and, upon confirming that invoices are fraudulent, trace the invoice flow to compile a complete list of all recipient companies before initiating investigations company by company. Notably, the invoices involved in the Tianjin case were all ordinary VAT invoices rather than special VAT invoices, meaning that input VAT credit deduction was not at issue. Nevertheless, the risk to downstream companies — of losing pre-tax deductibility for corporate income tax purposes, being characterized as tax evaders, and facing potential criminal prosecution — is equally serious and must not be underestimated. For bona fide recipient companies that obtained invoices based on genuine transactions and had no knowledge of upstream fraudulent invoicing, the most pressing challenge today is how to demonstrate good-faith receipt during a tax audit, restore pre-tax deductibility, and avoid characterization as tax evasion or criminal liability.

02 Criteria for Characterizing Upstream Companies as Absconded/Missing or as Fraudulent Invoicers, and the Risk Transmission Mechanism

Under China's VAT chain-based tax administration system, tax violations by an upstream invoice issuer readily transmit downstream to the invoice recipient. To fully understand this risk transmission mechanism, one must first understand the criteria for characterizing a company as an "absconded (missing) company" or a "fraudulent invoicer," and the corresponding tax treatment rules.

According to the Announcement of the State Taxation Administration on Issues Concerning the Identification and Handling of VAT Special Invoices Issued by Absconded (Missing) Companies (STA Announcement [2016] No. 76), an absconded (missing) company is one that has failed to fulfill its tax obligations and has evaded oversight by the tax authorities. Specifically, if the tax authority is still unable to locate the company or its relevant personnel after conducting on-site investigations, telephone inquiries, checks on tax-related matters, and other administrative measures — or if only the company's agent for bookkeeping or tax filing can be reached but that person is unaware of and unable to contact the actual controller — the company may be characterized as an absconded (missing) company. Building on this foundation, the Announcement on the Administration of Abnormal VAT Input Tax Credit Vouchers and Related Matters (STA Announcement [2019] No. 38, hereinafter "Announcement No. 38") further clarifies that where an absconded (missing) company, during the period it was in operation, exhibits certain specified conditions, the VAT special invoices corresponding to the relevant period will be classified as abnormal VAT input tax credit vouchers.

The criteria for characterizing an entity as a fraudulent invoicer are more stringent than those for absconding or going missing. Under Article 21, Paragraph 2 of the Measures for the Administration of Invoices, fraudulent invoicing encompasses three scenarios: issuing invoices for others or for oneself that do not reflect actual business operations; having others issue invoices for oneself that do not reflect actual business operations; and facilitating the issuance by others of invoices that do not reflect actual business operations.

Once an upstream company is characterized as having absconded, gone missing, or engaged in fraudulent invoicing, risk along the VAT chain rapidly propagates downstream. With respect to VAT special invoices, those not yet claimed for input VAT credit are temporarily disallowed from being credited; those already credited are, unless otherwise provided, subject to full reversal of the input VAT credit. With respect to ordinary VAT invoices, while input VAT credit deduction is not directly at issue, downstream companies similarly face the risk of losing pre-tax deductibility for corporate income tax purposes, and in serious cases may even be characterized as tax evaders or held criminally liable.

In practice, some tax authorities take an overly simplistic approach, indiscriminately classifying all invoices obtained by downstream recipient companies from absconded or fraudulent invoicing companies as abnormal vouchers or fraudulent invoices, and requiring downstream companies to reverse input VAT credits or pay additional corporate income tax. This approach effectively expands the scope of abnormal vouchers and fraudulent invoices beyond what is warranted, thereby harming the legitimate rights and interests of downstream recipient companies. Taking the Tianjin case as an example, the 1,936 downstream recipient companies subject to investigation may span industries such as trading, services, and manufacturing. While the tax risks they face are highly similar in nature, their specific response strategies must be tailored to the characteristics of their respective industries and transaction patterns.

03 Four Major Tax Risks Arising from Upstream Company Absconding or Fraudulent Invoicing

Once an upstream company absconds, goes missing, or is characterized as a fraudulent invoicer, the downstream recipient companies will face tax risks across multiple dimensions. These can be examined from four perspectives: VAT, corporate income tax, characterization as tax evasion, and criminal liability.

(I) VAT Dimension: Reversal of Input VAT Credits and Applications for Verification

For downstream companies that have obtained VAT special invoices, the most immediate consequence of an upstream company absconding, going missing, or being characterized as a fraudulent invoicer is that the input VAT credits become non-deductible. Under Announcement No. 38, credits not yet claimed are temporarily disallowed; those already claimed are, unless otherwise provided, subject to full reversal. Regarding the ordinary VAT invoices involved in the Tianjin case, while reversal of input VAT is not directly relevant, general VAT taxpayers among the downstream companies that have obtained special invoices would equally be subject to the above rules.

It is particularly important to note that a tax authority's classification of a voucher as abnormal or as a fraudulent invoice does not automatically require the downstream company to unconditionally reverse its input VAT credits. The treatment must still be differentiated based on the genuine nature of the transaction and the subjective state of the invoice recipient. If the recipient company disputes the tax authority's classification, it should submit a verification application to the competent tax authority and simultaneously provide materials proving the genuine nature of the transaction. Specifically, trading companies may submit purchase and sales contracts, bank transfer records, cargo transportation documents, weighbridge tickets, and warehouse receipt/acceptance forms; service companies may submit service contracts, service delivery records, payment vouchers, and communication records; and manufacturing companies may submit procurement contracts, payment vouchers, raw materials receipt records, production usage records, and quality inspection reports.

Under the Operating Procedures for the Handling of Abnormal VAT Input Tax Credit Vouchers (Trial), recipient companies must submit a verification application along with supporting materials to the competent tax authority within 20 working days of receiving the Tax Matters Notice. If no application is submitted within the deadline, or if the materials submitted are insufficient to prove the genuine nature of the transaction, the tax authority will require the company to reverse its input VAT credits in accordance with the law. Downstream companies that receive notification of abnormal vouchers should therefore immediately initiate internal review procedures and organize supporting materials as quickly as possible, so as not to miss the deadline and forfeit their legal remedies.

It is also worth noting that companies with higher tax credit ratings enjoy certain procedural advantages. Under Announcement No. 38, companies with a Class A tax credit rating that have obtained abnormal vouchers and already claimed the corresponding input VAT credits may submit a verification application to the competent tax authority within 10 working days of receiving the tax authority's notice, during which period the input VAT reversal is temporarily suspended. This differentiated procedural arrangement further underscores the importance of tax credit management to a company's day-to-day operations.

(II) Corporate Income Tax Dimension: Fraudulent Invoices Do Not Automatically Preclude Pre-Tax Deductibility

At the corporate income tax level, many companies harbor a common misconception: once an upstream company is characterized as a fraudulent invoicer, the invoices obtained by the downstream company cannot be used for pre-tax deductions under corporate income tax. In reality, the concept of abnormal VAT vouchers or fraudulent invoices cannot be directly transposed to the assessment of pre-tax deduction vouchers under corporate income tax. Each tax type must be independently assessed according to its own applicable rules and cannot be conflated with others. Corporate income tax pre-tax deduction vouchers are governed by the Measures for the Administration of Pre-Tax Deduction Vouchers for Corporate Income Tax (STA Announcement [2018] No. 28, hereinafter "Announcement No. 28"), which require pre-tax deduction vouchers to satisfy the principles of authenticity, legality, and relevance, but do not automatically exclude abnormal VAT vouchers or fraudulent invoices from the scope of valid pre-tax deduction vouchers.

Furthermore, even where an invoice is classified as an abnormal voucher or a fraudulent invoice, Article 14 of Announcement No. 28 grants taxpayers the right to use alternative external supporting documents for deduction purposes. Under this provision, where — during the process of obtaining a replacement or re-issued invoice — a company is unable to do so due to special reasons such as the counterparty having been deregistered, dissolved, had its business license revoked by law, or been classified as a non-normal taxpayer by the tax authority, the company may still deduct the relevant expenditure for corporate income tax purposes upon substantiating the genuine nature of the expenditure with the following documentation: (i) evidence proving the reason for the inability to obtain a replacement or re-issued invoice (such as documents evidencing business deregistration, institutional dissolution, classification as non-normal taxpayer, or bankruptcy announcement); (ii) the contract or agreement relating to the relevant business activity; (iii) payment vouchers reflecting non-cash payment methods; (iv) evidence of cargo transportation; (v) internal vouchers for warehouse receipts and dispatches; and (vi) corporate accounting records and other materials. The first three categories of documents are mandatory.

The above provisions offer downstream companies an important basis for rebuttal. As long as a company can demonstrate that the transaction genuinely took place, it may still deduct the relevant expenditure for corporate income tax purposes on the basis of the above documentation — even if the upstream company has absconded, gone missing, or been characterized as a fraudulent invoicer, rendering it impossible to obtain a compliant replacement invoice. In practice, companies across various industries should proactively retain a complete and coherent chain of documentation capable of proving the genuine nature of their business transactions, tailored to their respective industry characteristics.

(III) Tax Evasion Characterization Dimension: Subjective Intent Is the Core Element

Beyond the reversal of input VAT credits and restrictions on corporate income tax deductions, characterization as tax evasion represents an even more serious administrative legal risk for downstream companies. Once so characterized, a company faces additional tax assessments, surcharges for late payment, and fines ranging from 50% to 500% of the amount of tax underpaid or unpaid. Article 63, Paragraph 1 of the Law on the Administration of Tax Collection provides that a taxpayer who falsifies, alters, conceals, or destroys account books or accounting vouchers without authorization, or who lists excess expenditures or omits or understates income in account books, or who refuses to file a return after being notified by the tax authority or files a false tax return, thereby failing to pay or underpaying the amount of tax due, shall be deemed to have committed tax evasion.

Accordingly, the constitution of tax evasion requires the simultaneous satisfaction of four elements: a qualified subject, a fault element, a conduct element, and a consequence element. In practice, the most frequently disputed element is the fault element — that is, whether the taxpayer had subjective intent. Both a textual reading of Article 63 of the Law on the Administration of Tax Collection and the spirit of relevant replies by the State Taxation Administration (see STA Letter [2016] No. 274 and STA Letter [2013] No. 196) inherently require subjective intent as a necessary precondition for a finding of tax evasion. Therefore, if a downstream company can demonstrate that it exercised reasonable due diligence in obtaining the invoices, was unaware and should not have been aware of the upstream company's fraudulent invoicing conduct, and had no subjective intent to knowingly use irregular invoices, the tax authority cannot characterize it as having committed tax evasion.

Returning to the Tianjin case, the 1,936 downstream recipient companies should be analyzed on a case-by-case basis. Companies that obtained invoices based on genuine transactions and had absolutely no knowledge of the upstream fraudulent invoicing should actively gather evidence to establish their status as good-faith recipients. Relevant evidence may include supplier due diligence records, business negotiation correspondence, documentation of the contract signing process, and records of actual delivery and use of goods or services, all with a view to rebutting the characterization of tax evasion.

(IV) Criminal Liability Dimension: The Boundary Between Good-Faith Receipt and Complicit Receipt

In cases involving upstream fraudulent invoicing, downstream companies' criminal liability risk varies significantly depending on their subjective state. If a downstream company obtained invoices based on genuine transactions, was unaware of the upstream fraudulent invoicing, and the description, quantity, and amount of goods or services stated on the invoices are substantially consistent with those of the actual transaction, the company qualifies as a good-faith recipient and does not constitute the crime of issuing fraudulent invoices or the crime of falsely issuing special VAT invoices. Even where the supplier and the issuer of the invoice are not the same entity, if this discrepancy was not caused by the downstream company, the company should not bear criminal liability. In such circumstances, the company's legal liability is primarily confined to the tax dimension — additional tax payment and late payment surcharges. Conversely, if a downstream company knowingly accepts and uses invoices it knows to be fraudulent — or even actively participates in the procurement of such invoices — it may face criminal prosecution for offenses involving fraudulent invoicing or tax evasion. In the Tianjin case, the principal offenders have already been duly convicted and sentenced. Downstream companies in which bad-faith invoice purchasers exist may similarly be subject to corresponding criminal liability.

Therefore, for downstream companies subject to investigation, the most pressing priority is to accurately assess their own subjective state and objective conduct during the transaction, and to formulate a corresponding response strategy accordingly. If the company is indeed a good-faith recipient, it should actively gather evidence and seek a favorable administrative resolution. If there is subjective fault, the company should engage a professional tax lawyer at the earliest opportunity, with the aim of resolving the dispute at the administrative stage and preventing the escalation of criminal liability risk that would follow a referral to the public security authorities.

04 Compliance Strategies for Downstream Companies in Responding to Risks Arising from Upstream Absconding or Fraudulent Invoicing

Faced with the series of tax risks triggered by upstream companies absconding, going missing, or being characterized as fraudulent invoicers, downstream companies should establish a systematic compliance response mechanism that integrates risk prevention and control throughout the entire process — from pre-transaction prevention, to mid-transaction management, to post-transaction remediation.

(I) Pre-Transaction Prevention: Building a Supplier Tax Compliance Review System

Downstream companies should establish a comprehensive supplier admittance and dynamic management mechanism to reduce, at the source, the risk of transmission arising from upstream companies' tax violations.

First, conduct thorough due diligence on suppliers prior to entering into a business relationship. Companies should use publicly available channels — such as the National Enterprise Credit Information Publicity System and official tax authority websites — to check suppliers' basic information and tax compliance status, with particular attention to whether a supplier has been classified as a non-normal taxpayer by the tax authority, whether it has any record of tax arrears, and whether it has been listed on the Register of Major Tax Violations and Dishonest Subjects. For bulk transactions or long-term suppliers, companies should further verify business registration information, shareholder backgrounds, and operating qualifications, and conduct a comprehensive assessment of the supplier's operational stability and tax compliance capability.

Second, continuously monitor the operational status of suppliers during the course of the business relationship. Changes in a supplier's operational status — such as frequent changes of legal representative, relocation of registered address, a sharp rise in litigation within a short period, or listing as a judgment debtor — are often important warning signals. Companies should establish a supplier risk early-warning mechanism, regularly review suppliers' tax credit status, and promptly assess and take responsive measures upon detecting any anomalies.

Third, strengthen invoice liability clauses in procurement contracts. It is advisable to include express contractual provisions stipulating that, where invoices obtained by the purchaser are classified as abnormal vouchers or fraudulent invoices due to reasons attributable to the supplier — resulting in the purchaser being required to pay additional taxes, surcharges, fines, or suffering other losses — the supplier shall bear full indemnification liability. The contract should also clearly set out the supplier's obligations to issue compliant invoices, cooperate with audits, and the consequences for breach of such obligations, thereby preserving an adequate contractual basis for any subsequent rights protection.

Fourth, standardize business processes to ensure that the contract flow, funds flow, goods flow (or service flow), and invoice flow are mutually corroborating and consistent with each other. All vouchers and supporting documents arising during a transaction should be promptly filed and retained to form a complete chain of business evidence.

(II) Mid-Transaction Response: Handling Procedures Upon Receipt of Notice of Abnormal Vouchers or Fraudulent Invoice Classification

Upon receiving notification from the tax authority regarding the classification of obtained invoices as abnormal vouchers or fraudulent invoices, downstream companies should take the following targeted responsive measures.

First, immediately conduct an internal self-review. Upon receiving a risk notification, the finance department should promptly verify the specific details of the abnormal vouchers or fraudulent invoices, cross-reference against original business documentation, and confirm the genuine nature of the transaction and the compliance of the invoice acquisition. At the same time, all new business dealings with the implicated supplier should be immediately suspended to prevent the risk from spreading further.

Second, comprehensively collect and organize evidentiary materials proving the genuine nature of the transaction. Evidence collection should focus on the core issue of transaction authenticity, with the emphasis tailored to the type of company and the nature of the business. All evidentiary materials should be mutually corroborating and form a complete, closed chain of evidence.

Third, take corresponding measures based on the type of invoice and the company's tax credit rating. With respect to VAT special invoices, companies with a Class A tax credit rating may submit a verification application to the competent tax authority within 10 working days of receiving the notice, during which period the reversal of input VAT credits is temporarily suspended. Companies with a Class B or lower tax credit rating generally need to first reverse the input VAT credits in their current period's return while simultaneously submitting a verification application promptly. With respect to ordinary VAT invoices, the primary focus should be on the corporate income tax dimension: companies should actively submit materials to the tax authority demonstrating the genuine nature of the transaction in order to seek restoration of pre-tax deductibility.

Fourth, proactively communicate and cooperate with the tax authority. Companies should take the initiative to explain the situation to the competent tax authority, submit materials proving the genuine nature of their business operations, and seek the tax authority's understanding and support. During the communication process, companies should avoid miscommunication or insufficient cooperation that could cause the tax authority to doubt the genuineness of the business, leading to referral of the case to the inspection department or even the public security authorities, thereby escalating the risk further. For cases involving a large number of invoices or significant amounts, companies are advised to promptly retain a professional tax lawyer to assist in formulating a communication strategy and preparing the relevant materials.

(III) Post-Transaction Remediation: Multi-Dimensional Rebuttal to Safeguard Legitimate Rights and Interests

If the tax authority ultimately issues a ruling or penalty decision unfavorable to the company, the company should mount a rebuttal from multiple dimensions and make full use of the legal remedies available to it.

On the VAT dimension, the core rebuttal argument is the genuine nature of the transaction. Companies should systematically organize evidentiary materials, submit verification applications to the tax authority, and strive to demonstrate that the transaction genuinely took place and that the invoices were obtained in a compliant manner. If the tax authority fails to complete the verification within the prescribed timeframe or if the conclusions drawn are inconsistent with the facts, the company may seek further relief through administrative reconsideration or administrative litigation.

On the corporate income tax dimension, companies should make full use of the provisions of Article 14 of Announcement No. 28. Even if it ultimately proves impossible to obtain a compliant replacement invoice, as long as the company can provide the mandatory documentation — including the contract, payment vouchers, and evidence proving the inability to obtain a replacement invoice — supplemented by ancillary evidence such as transportation documents, warehouse receipts, and service delivery records to prove that the expenditure was genuine and actually incurred, the deduction of such expenditure for corporate income tax purposes should be permitted.

In terms of the determination of tax evasion, enterprises shall focus their defense on the core element of subjective intent. It should be clarified that the burden of proof for the subjective intent of tax evasion is legally borne by the tax authority, and enterprises have no statutory obligation to prove their innocence. Enterprises may proactively collect and submit relevant evidence (such as supplier access review records and transaction communication records) to corroborate that they have fulfilled their reasonable duty of care in the transaction and had no actual knowledge of the tax violations committed by upstream enterprises, thereby undermining the factual and legal basis for the tax authority’s determination and precluding the establishment of a tax evasion finding.

On the criminal liability dimension, if there is a risk of referral to the public security authorities or if the case has already been so referred, companies should engage a professional tax lawyer at the earliest opportunity. Tax lawyers can help companies accurately assess the level of criminal risk, guide the collection and preservation of favorable evidence, and provide professional defense services at the public security investigation stage, the procuratorial review and prosecution stage, and the court trial stage, with the aim of securing a favorable outcome.