In recent years, entities have been trying to avoid taxes by splitting up their businesses. But with the deepening implementation of “data-driven tax governance”, compliance risks have risen sharply. Tax authorities now use big data to cross-check tax filings against bank records, employment data, social security contribution records, and more. They can quickly spot red flags like “multiple business licenses at one address,” “abnormally low output tax,” or “employees’ social security contributions not matching the filing entity.” Splitting up a business to avoid taxes no longer goes undetected.
Generally speaking, there are three common non-compliant methods for business splitting:
1. Shell entity operations: The actual controller registers multiple entities, sole proprietorships or individually-owned businesses, etc., but they share the same office, equipment, and staff, operating as a single integrated entity. In practice, salespeople’s contracts and social security contributions are rotated and adjusted among these different affiliated entities, but their actual work, clients, and business still stay the same. Their performance reviews and pay are still controlled by the actual controller. The affiliated entities just report wage costs on paper, creating the illusion that each one hires and accounts independently.
2. Threshold manipulation: When annual sales get close to the 5 million yuan threshold for general VAT taxpayers, the controller switches to a new entity to continue the business and stay a small-scale taxpayer. Or one big contract is broken into several smaller ones, each handled by a different small-scale entity, so each one can use the small-scale tax rate or enjoy preferential policies like VAT exemption on monthly sales under 100,000 yuan.
3. Off-book income operations: Only one bank account is reported to the tax authorities. Most revenue goes through unreported or personal accounts, and only the amount within the tax-free threshold gets reported. Combined with entity splitting, this forms a full chain for hiding income.
From a legal perspective, splitting income for the purpose of improperly enjoying tax preferences is tax evasion under Article 63 of the Tax Administration Law. The consequences are back taxes, late-payment surcharges, and fines of 50% to five times the amount of tax underpaid or evaded. In serious cases, the entity will be placed on the tax violation “blacklist,” facing joint sanctions from multiple government departments and significant damage to the business’s reputation.
Tax law doesn’t prohibit business splitting based on legitimate commercial purposes. But after splitting, each entity needs to be truly independent in terms of people, assets, finances, and business operations. When tax authorities check whether the split has a legitimate business purpose, they look at things like whether each entity can operate on its own, whether staffing and finances are separate, and whether the business transactions are real. If the entities are highly or entirely commingled in terms of people, finance, and business locations, and lack independent business substance, it could be seen as using a legal setup to hide an illegal purpose. That means tax adjustments and penalties. In this era of “data-driven tax governance,” entities should think carefully about whether their business splitting is compliant, so they don’t cross the legal line just to save on taxes.
By Jing Zhang, Financial Controller