Editor's Note: In June 2026, the Inspection Bureau of the Hami Municipal Tax Service served by public notice a Decision on Tax Treatment (Hami Tax Inspection Treatment [2026] No. 21) and a Decision Not to Impose a Tax Administrative Penalty (Hami Tax Inspection No-Penalty [2026] No. 3). The logistics company involved had obtained falsely issued special VAT invoices and claimed input VAT credits. Its VAT and urban maintenance and construction tax underpayments were characterized as tax evasion, but no penalty was imposed because the five-year limitation period for penalties had expired. As for enterprise income tax, because the company's books and records were missing and an audit-based determination was impossible, the Inspection Bureau assessed the tax payable by estimation; it neither characterized the matter as tax evasion nor imposed a fine. Taking this case as its starting point, this article analyzes why tax assessed by estimation should not serve as the basis for either a finding of tax evasion or the calculation of a penalty. It also discusses the separate application of the tax recovery period and the limitation period for penalties, as well as the availability of tax incentives for small low-profit enterprises under assessment by estimation, with a view to providing guidance to relevant market participants.

01 Case Overview

In August 2025, the Inspection Bureau of the Hami Municipal Tax Service opened a tax inspection into Company A, a logistics company, for the period from January 1, 2018 to December 31, 2019. The investigation found that, between January 2018 and March 2019, Company A obtained 19 special VAT invoices issued by Building Materials Company B by paying invoicing fees, even though no genuine purchase or sale transactions existed between the two companies. The total invoiced amount, including tax, exceeded RMB 10.97 million, and Company A claimed input VAT credits for all of the invoices. With respect to VAT and related surcharges, the Inspection Bureau determined that the 19 invoices had been falsely issued and therefore could not serve as lawful and valid VAT deduction vouchers. Company A was required to reverse the input VAT credits already claimed, pay more than RMB 1.01 million in VAT, and make corresponding payments of urban maintenance and construction tax, education surcharge, and local education surcharge.

With respect to enterprise income tax, Company A submitted neither books and accounting records nor original materials proving the authenticity of the transactions, making its costs and expenses impossible to verify. The Inspection Bureau therefore assessed the tax payable by estimation pursuant to Article 35 of the Tax Collection and Administration Law. As to the assessment method, Article 47(2) of the Detailed Rules for the Implementation of the Tax Collection and Administration Law was applied, and the assessment was based on the operating revenue declared by Company A itself. As to the taxable income rate, the Inspection Bureau referred to the Measures for the Assessment and Collection of Enterprise Income Tax (for Trial Implementation) (SAT Document [2008] No. 30). Because Company A's principal business was transportation, the applicable range for the transportation industry was 7% to 15%. Citing Company A's failure to cooperate with the inspection and enforcement cases investigated in previous years, the Inspection Bureau applied the upper rate of 15%, determining taxable income of more than RMB 6.46 million for 2018 and more than RMB 2.28 million for 2019. After making the assessment, the Inspection Bureau reviewed the company's eligibility as a small low-profit enterprise on a year-by-year basis. The company was denied the incentive for 2018 because its taxable income exceeded the applicable threshold, but was granted the reduction for 2019 because it satisfied the relevant conditions. The additional enterprise income tax payable for the two years totaled more than RMB 1.73 million, including more than RMB 1.58 million for 2018 and more than RMB 150,000 for 2019.

As to characterization and penalties, the Inspection Bureau concluded that Company A had made false tax filings by claiming input VAT credits on the basis of falsely issued special VAT invoices, resulting in underpayments of VAT and urban maintenance and construction tax. This fell within the definition of tax evasion under Article 63 of the Tax Collection and Administration Law, and recovery of the unpaid tax was therefore not subject to any time limit. A fine of between 50% and five times the underpaid tax would ordinarily have been imposed. However, because more than five years had elapsed between the end of the violation and its discovery, no administrative penalty was imposed under Article 86 of the Tax Collection and Administration Law. The enterprise income tax matter was not characterized as tax evasion and was therefore subject to a five-year recovery period. The more than RMB 1.58 million payable for 2018 was not recovered because more than five years had elapsed between the filing and payment deadline and the discovery of the suspected circular flow of funds associated with the invoices. The more than RMB 150,000 payable for 2019 was recovered, but no fine was calculated on the basis of the amount assessed by estimation.

Notably, the Inspection Bureau neither characterized the enterprise income tax assessed by estimation as tax evasion nor used the assessed amount as the penalty base. The tax-law reasoning underlying this approach is examined below.

02 Tax Assessed by Estimation Should Not Be Used as the Basis for Finding Tax Evasion or Calculating a Penalty

(1) Tax Assessed by Estimation Is a Legally Constructed Presumption, Not a Verified Amount of Underpaid Tax

Assessment by estimation is a method of tax collection authorized by Article 35 of the Tax Collection and Administration Law. It applies in statutory circumstances such as where a taxpayer's books are incomplete or its records are so deficient that an audit cannot be conducted. The purpose of the system is to secure the timely collection of state revenue and prevent tax losses when an audit-based determination is impossible. In essence, under conditions of information asymmetry, the tax authority uses statutory methods to estimate and presume the amount of tax payable, rather than precisely reconstructing the objective facts. In this case, the Inspection Bureau applied a taxable income rate to estimate taxable income precisely because Company A refused to provide books and records and its costs and expenses could not be verified. From the outset, therefore, the amount assessed was not a verified amount of underpaid tax.

More fundamentally, enterprise income tax is calculated on the basis of taxable income, which requires consideration of total revenue, non-taxable revenue, tax-exempt revenue, and all allowable deductions. Even if the transactions recorded on the invoices in question did not exist, it does not follow that Company A incurred no genuine and reasonable costs in generating its operating revenue. Expenditures on fuel, labor, vehicle depreciation, road and bridge tolls, and transportation subcontracting are objectively unavoidable for a logistics and transportation enterprise. Once missing books and records make it impossible to verify these costs item by item, the true amount of taxable income can no longer be calculated. If the tax authority itself acknowledges that it cannot ascertain the actual costs and expenses, it likewise cannot determine the exact amount of tax underpaid. The figures disclosed in the decision itself confirm the presumptive nature of the assessment. With the same declared revenue, applying a taxable income rate of 7% rather than 15% would produce an additional tax amount differing by more than a factor of two. The amount assessed therefore depends directly on the selected assessment method and taxable income rate.

(2) Both a Finding of Tax Evasion and a Multiplier-Based Fine Require the Amount of Underpaid Tax to Be Verified

Tax evasion as defined in Article 63 of the Tax Collection and Administration Law comprises four elements: the taxpayer, fault, conduct, and result. The result element requires a consequence of failing to pay or underpaying tax. At the same time, the penalty for tax evasion is calculated on the amount of unpaid or underpaid tax, with a fine ranging from 50% to five times that amount. The exact amount of underpaid tax is therefore both the factual foundation for characterizing the conduct as tax evasion and the direct basis for calculating the fine; in both respects, the amount must be proven. Tax assessed by estimation lacks precisely this degree of certainty. If it is used to establish tax evasion, the result element rests on a presumption. If it is used to calculate a fine, the amount of the fine will fluctuate with the chosen taxable income rate, leaving the penalty without a definite factual basis.

(3) Imposing a Penalty Based on Tax Assessed by Estimation Violates the Statutory Evidentiary Standard for Administrative Penalties

Article 40 of the Administrative Penalty Law provides: "Where a citizen, legal person, or other organization has committed an act in violation of administrative order and shall be subject to an administrative penalty according to law, the administrative organ must ascertain the facts; where the facts of the violation are unclear or the evidence is insufficient, no administrative penalty shall be imposed." Accordingly, one prerequisite for an administrative authority to impose a penalty is that the relevant facts have been clearly established. Where the facts of the violation are unclear or the evidence is insufficient, no administrative penalty may be imposed, even if the administrative counterparty has engaged in unlawful conduct. Allowing an amount assessed by estimation to serve as the penalty base would create a contradiction. On the one hand, the tax authority acknowledges that it cannot ascertain the taxpayer's actual operating data and can only presume the tax payable through methods such as a taxable income rate. On the other hand, it treats that presumptive amount as conclusive proof of the taxpayer's tax underpayment and imposes a penalty on that basis. This effectively forces an uncertain presumption into the administrative-penalty framework. It is inconsistent with the statutory requirements that the facts be clear and the evidence conclusive, and it also conflicts with the principle of proportionality between the violation and the penalty. A tax authority may therefore recover tax on the basis of an estimated assessment, but the amount so assessed cannot be used either to determine the amount of tax evaded or to calculate a multiplier-based fine. The Inspection Bureau's decision not to characterize the enterprise income tax assessed by estimation as tax evasion and not to impose a penalty is consistent with this reasoning.

03 Separate Application of the Tax Recovery Period and the Limitation Period for Administrative Penalties

Another notable feature of the case is the Inspection Bureau's separate treatment of the tax recovery period and the limitation period for penalties. Although more than five years had elapsed in each instance, the VAT and urban maintenance and construction tax were recovered without a penalty, whereas the enterprise income tax for 2018 was not recovered at all. The difference results from the distinct functions, commencement rules, and objects of application of the two regimes.

(1) The Tax Recovery Period Determines Whether the Tax May Still Be Recovered

Under Article 52 of the Tax Collection and Administration Law and Articles 82 and 83 of its Detailed Rules for Implementation, the tax recovery period has three tiers. Where an underpayment results from the tax authority's own responsibility, the recovery period is three years and no late-payment surcharge may be imposed. Where it results from a taxpayer's calculation error or similar mistake, the period is three years, extended to five years if the cumulative amount exceeds RMB 100,000. For tax evasion, refusal to pay tax, or tax fraud, recovery is not subject to a time limit. The recovery period begins on the date when the taxpayer should have paid but failed to pay, or underpaid, the tax - that is, when the filing and payment deadline expires. In this case, the enterprise income tax matter was not characterized as tax evasion and was therefore subject to a five-year recovery period. The annual filing and payment deadline for 2018 expired on May 31, 2019. More than five years had passed by the time the violation was discovered, so the additional tax for that year was not recovered. The corresponding deadline for 2019 expired on May 31, 2020, and fewer than five years had elapsed when the matter came to light, so the additional tax was recovered. By contrast, because the VAT and urban maintenance and construction tax underpayments were characterized as tax evasion, their recovery was not time-barred.

It should be noted that the endpoint used to determine whether the recovery period has expired is the time when the tax authority "discovers" the violation, rather than the date on which it formally opens the case or issues a tax treatment decision. The Inspection Bureau opened the case in August 2025. However, based on the fact that it declined to recover the 2018 enterprise income tax but recovered the 2019 amount, the discovery date can be inferred to have fallen between June 2024 and May 2025. The Inspection Bureau most likely received an investigation-assistance lead at that time from the case involving Company B's false issuance of invoices, and only later formally opened the case.

(2) The Limitation Period for Penalties Determines Whether the Violation May Still Be Punished

Under Article 86 of the Tax Collection and Administration Law, no administrative penalty may be imposed for a violation of tax laws or administrative regulations if the violation is not discovered within five years. The limitation period begins on the date the violation occurs; where the conduct is continuous or continuing, it begins when the conduct ends. Company A's conduct of obtaining falsely issued invoices and claiming input VAT credits ended in the first half of 2019. More than five years had passed by the time the conduct was discovered. Accordingly, although the VAT and urban maintenance and construction tax underpayments were characterized as tax evasion and the taxes were recovered, no fine was imposed. Thus, tax evasion that is recoverable without a time limit is not punishable without a time limit. Characterizing conduct as tax evasion only removes the limitation on tax recovery; it does not extend the limitation period for penalties. Because defenses based on the tax recovery period and those based on the limitation period for penalties differ in their governing rules and commencement dates, taxpayers undergoing a tax inspection should distinguish between the two and raise targeted defenses at the appropriate time.

04 Application of the Taxable Income Rate and Tax Incentives under Assessment by Estimation

(1) Applying the Highest Taxable Income Rate Is Open to Question

In selecting the assessment method, the Inspection Bureau ruled out, one by one, both comparison with the tax burdens of similar taxpayers in the same industry and estimation based on consumption or usage. It ultimately assessed the tax on the basis of operating revenue. Its decision to apply the upper taxable income rate of 15%, however, warrants scrutiny. The purpose of the taxable income rate range in SAT Document [2008] No. 30 is to bring the assessed result as close as possible to the taxpayer's actual profitability. Neither of the two reasons given by the Inspection Bureau for choosing the upper limit is fully persuasive. First, "failure to cooperate with the inspection" is plainly punitive in character. Assessment by estimation is a method of tax collection, not a means of punishment; using a harsher assessment to achieve a punitive effect indirectly contradicts the preceding conclusion that tax assessed by estimation should not serve as the penalty base. Second, the Inspection Bureau offered no explanation of how "cases investigated in previous years" were connected to Company A's actual profitability. Moreover, according to Company A's declared figures, its gross profit margin for 2019, after excluding the amount corresponding to the falsely issued invoices, was only 6.71%, far below the 15% taxable income rate. For enterprises in similar circumstances, this indicates meaningful room to contest the rate selected. An enterprise may submit materials reflecting its cost structure and profitability, including historical profit levels, vehicle and fuel expenditures, labor costs, its business model, and operating conditions in the same industry, and may make representations and defenses regarding the appropriate taxable income rate.

(2) Assessment by Estimation Does Not Preclude Tax Incentives; Small Low-Profit Enterprise Status Should Be Reviewed Annually

After assessing taxable income, the Inspection Bureau did not simply apply a uniform tax treatment. Instead, it reviewed on a year-by-year basis whether the company qualified as a small low-profit enterprise. The assessed taxable income for 2018 exceeded RMB 6.46 million and was above the applicable threshold, so the incentive was denied. For 2019, the assessed taxable income was more than RMB 2.28 million, the company had three employees, and its total assets exceeded RMB 1.04 million; it therefore met the conditions and received the statutory reduction. Article 1 of the Announcement of the State Taxation Administration on Issues Concerning the Implementation of Inclusive Enterprise Income Tax Reduction and Exemption Policies for Small Low-Profit Enterprises (STA Announcement [2019] No. 2), which applied to the years at issue, expressly provided that small low-profit enterprises could enjoy the enterprise income tax incentive regardless of whether they paid enterprise income tax on an audit basis or under assessment by estimation. Although that announcement has since been replaced as the incentive regime evolved, the same position has been maintained. Article 1 of the currently effective Announcement of the State Taxation Administration on Administrative Matters Concerning the Implementation of Enterprise Income Tax Incentives for Small Low-Profit Enterprises (STA Announcement [2023] No. 6) contains the same rule. Assessment by estimation and tax incentives are therefore not mutually exclusive, and the existence of a tax violation does not automatically deprive an enterprise of tax benefits to which it is legally entitled. The Inspection Bureau's year-by-year review and full application of the available incentives should be commended. Conversely, taxpayers should proactively verify during a tax inspection whether the tax authority has overlooked any incentives applicable to them, so as to avoid losing substantive benefits merely because of procedural passivity.

Conclusion: In this case, the Inspection Bureau did not characterize the enterprise income tax assessed by estimation as tax evasion and did not use the assessed amount as the penalty base. This approach provides important guidance for similar cases. When facing a tax inspection, an enterprise should take the inspection seriously and respond proactively. It should fully exercise its rights to make representations and defenses and to request a hearing, and should present targeted arguments concerning the underlying business facts, the assessment method, the probative value of the evidence, and procedural legality. Where necessary, the enterprise should promptly engage professional tax counsel and, as the case progresses, pursue administrative reconsideration, administrative litigation, or other remedies in accordance with law, with a view to securing a more favorable outcome through professional assistance.