China clamps down on refiners’ windfall tax evasion

Chinese tax authorities are clamping down on non-payment of the country's windfall tax by independent refiners, potentially raising costs for a sector that has been one of the main drivers of crude demand.

Provincial governments in the independent heartland of Shandong, as well as refining-heavy Liaoning and Zhejiang, have issued notices this month calling on refiners to pay the tax, which is linked to the "floor price" system that has protected refiners' profits and helped sustain run rates amid the Covid-19 downturn.

The windfall tax has been in place since 2016, when top economic planning agency the NDRC suspended retail fuel price adjustments whenever a basket of crude prices falls below $40/bl. Taxation authorities then imposed the windfall tax on the additional profits that are earned from the difference between crude and fuel prices. The tax is paid into a special reserve fund to be used for emissions reductions, improving oil products quality and oil sector safety measures.

The windfall tax was applied to gasoline and diesel sales in April-June this year, when the floor price mechanism was triggered after crude prices collapsed. Tax payments averaged 741 yuan/t ($12.38/bl) on gasoline sales and Yn676/t or $11.29/bl on diesel sales in the period, according to Argus calculations based on a data sheet provided by the taxation bureau.

But the windfall tax has not been strongly enforced since it was introduced, particularly in the less-regulated independent refining sector. State-controlled refiners have received tax demands, and paid, but independents and private-sector refiners have not — likely because of the practical difficulty in collecting the levy, which depends on self-declaration of sales volumes.

The government now appears to be more serious about pursuing the tax payments. Notices have been published in Shandong, Zhejiang, Liaoning, Hubei, Henan, Hainan, Xinjiang, Tianjin, Jilin, Heilongjiang and Inner Mongolia, requiring refiners to declare their windfall tax liabilities by the end of February 2021 at the latest.

But the language in the notices suggests the declarations will be voluntary rather than mandatory, leaving it unclear how strong enforcement will be. And the self-declaration mechanism, together with the common practice of disguising gasoline and diesel as other oil or petrochemical products that are eligible for lower tax rates, further complicates the collection process.

The government centralized the tax collection process in 2018, requiring local authorities to collect tax payments on behalf of the central government to help secure payments into the stabilization fund. But that change did not lead to a big increase in tax payments, and officials at independent refiners said this week they are still waiting to see what impact the new crackdown will have.

China's big state-controlled refiners have already been including the windfall tax in their balance sheets. PetroChina and Sinopec expect to be subject to Yn13bn and Yn11.7bn of windfall tax respectively in April-June, according to their half-year result briefings. PetroChina's refinery and petrochemical operations made a loss of Yn10.5bn in January-June, while Sinopec's refining segment slumped to a loss of Yn31.7bn in the period.

New private-sector refiners Rongsheng and Hengli did not make any mention of the windfall tax in their half-year results. Each refinery is likely to have paid Yn0.5bn-1bn in April-June, investment bank CICC estimates.