On Friday 8 May, a session of the ISEG Research Seminars will take place from 13.00 to 14.00. The guest speaker will be Tanya Tang.
The ISEG Research Seminars are held every week on Wednesdays, with the participation of professors from ISEG, as well as from other Portuguese and international educational institutions.
Title
Get My Money Back: The VAT Distortion and Related-Party Transactions in China
Abstract
Excess input VAT over output VAT cannot be refunded in China, creating a significant financial burden for businesses. Using a confidential National Tax Survey Database, we examine how firms manage their VAT payments to minimize cash lockup. We find that firms with substantial input VAT credit carryovers (IVCC) increase output credits through related-party transactions (RPTs). This effect is more pronounced among financially constrained firms, particularly when the related parties are subsidiaries of listed firms and when these related parties are capable of absorbing the additional output credits generated by increased purchases from listed firms. We further find that IVCC-induced RPTs negatively affect the gross margins of related parties, suggesting inflated transfer pricing. Following China's implementation of partial refund of IVCC in 2018, RPTs declined notably across the pilot industries. These findings provide empirical evidence of a mechanism for VAT non-compliance and distortion.
