Thursday 4 February 2010

Yin-yang contracts must be stamped out

The disclosure of fraudulent conduct often foreshadows the bursting of an asset bubble. If so, the revelation of widespread dodgy property transactions on the mainland designed to cheat the taxman may be a signal of worse news to come. So-called “yin-yang” contracts are a common but illegal practice to avoid paying taxes. Officials have long known about it, apparently, but have done little for fear of upsetting shaky market sentiment during the financial crisis. They may soon have to pay a much higher price for not cracking down on the practice.

1 comment:

Guanyu said...

Yin-yang contracts must be stamped out

LEADER
03 February 2010

The disclosure of fraudulent conduct often foreshadows the bursting of an asset bubble. If so, the revelation of widespread dodgy property transactions on the mainland designed to cheat the taxman may be a signal of worse news to come. So-called “yin-yang” contracts are a common but illegal practice to avoid paying taxes. Officials have long known about it, apparently, but have done little for fear of upsetting shaky market sentiment during the financial crisis. They may soon have to pay a much higher price for not cracking down on the practice.

In such a scam, a flat buyer and a seller agree to sign an under-the-table contract, which states the true value of their transaction. But they also produce another contract that understates the value for official registration. In doing so, the seller avoids paying the full capital gains levy, which is counted as part of personal income tax. The buyer has an incentive to go along because, on the mainland, most or all the costs of a property transaction are offloaded onto buyers, including the seller’s tax from any capital gain.

How widespread is the illegal practice? The scale of the problem may be gleaned from the wide discrepancies between official and unofficial estimates of price rises in major cities. Last month, a report released by Beijing estimated home prices in 70 cities rose just 7.8 per cent year on year in December. However, large property agencies with nationwide coverage believe price rises were closer to 60 or even 70 per cent last year, the result of tight supply and massive liquidity from Beijing’s stimulus programmes. Even people who take only a cursory interest in the mainland property market would know the agents’ estimates were much closer to the mark. Indeed, officials must know it, too. What else would account for the recent introduction of anti-bubble measures to rein in property speculation and cool an overheating market if prices rise less than a paltry 8 per cent?

The prevalence of “yin-yang” property transactions has created many problems, such as frequent disputes between sellers and buyers. More seriously, it distorts property prices and creates a potential black market.

Transaction prices become fictitious, and buyers cannot consult reliable official records to determine the fair value of a property. When “real” prices become what sellers and agents pull out of a hat, the conditions are ripe for a speculative market in which people no longer care about fair value, but only for offloading property onto “greater fools”.

To be sure, tougher monitoring guidelines have been introduced in many major cities. For example, officials are supposed to investigate when a recorded transaction price is more than 15 per cent below market rates. But enforcement has been uneven and sometimes lax. Many local governments have an incentive to keep up market sentiment to fetch higher prices in official land auctions. By cracking down, they may collect more taxes individually but less in total if transaction volumes fall.

The problem for Beijing is that a property market collapse would pose a serious threat to the nascent economic recovery, yet allowing a bigger bubble to brew will create an even greater danger. However, tolerating price distortions and illegal practices not only makes a mockery of the law; enforcement becomes even more difficult down the road.

Officials must act to stamp out already rampant yin-yang contracts before they go truly out of control.