China’s Corporate Tax Audit Considerations

January 15, 2010 Posted by China Briefing Reading Time: 4 minutes

Jan. 15 – Corporate tax considerations are an important part of any company’s annual tax reconciliation and year-end account closings. Here we take a brief look at some important expenses and deductions enterprises can file for as well as some of the regulations for branch office CIT filing.

Advertising expense and business promotional expenses
Qualified advertising expense and business promotion expenses are allowed to be deductible of up to 15 percent of the sales (business) income of that year unless otherwise prescribed by the in-charge finance and tax departments of the State Council. Any excess amount is allowed to be carried forward and deductible in the following year.

Business entertainment expenses
For business entertainment expenses which is incurred by an enterprise and related to its production and business operation activities, only 60 percent of the incurred amount should be deductible but the maximum deduction amount shall not exceed 0.5 percent of the sales (business) income of the year.

Donation
Charitable donations incurred by an enterprise are allowed to be deductible up to 12 percent of the total annual accounting profit.

Commercial insurance expenses
Premiums for commercial insurance policies paid by the enterprise for its investors or employee are not deductible except for premiums for personal safety insurance paid by an enterprise pursuant to the state’s relevant regulations for its workers conducting special types of production work and premiums paid for other commercial insurance policies that may be deductible pursuant to the rules prescribed by the in-charge finance and tax departments of the State Council.

Sponsorship expenses
Sponsorship expenses are not deductible if they are of a non-advertising nature and not relevant to business operation.

Staff education expenses
Expenditures for staff education that is incurred by an enterprise are allowed to be deducted up to 2.5 percent of total wages and salaries. Any excess amount is allowed to be carried forward to future years.

Provisions
Provisions are generally not deductible.

Reserve fund
These are deductible for special funds that are appropriate for use in protecting environment, pursuant to the relevant laws and administrative regulations. Once usage of the aforesaid special funds changes, it shall not be deductible.

Management fees
Management fees paid between enterprises, rental and royalty fees paid between business units, and interest paid between business units of a non-bank enterprise are not deductible.

Interest expense of debt from related party
There are two articles in new CIT law that relate to interest expenses deduction for debt from related parties. They are summarized as follows:
1) Interest expenses on borrowing from non-financial enterprises by a non-financial enterprise, the excess part above the amount calculated by reference to the interest rate of similar loan with the same term as provided by financial institutions shall not be deductible
2) Interest expenses which exceed certain debt/equity ratio shall not be deducted while calculating taxable income. The ratio is 5:1 for financial enterprises; and 2:1 for other enterprise (Circular Caishui 2008 No. 121 defines the ratio)

According to Circular No. 121:

If supporting documents for related party transaction are not available or the effective CIT rate is above the tax rate of related party within territory of China, only the interest fulfilling the above mentioned criteria shall be deductible
If the supporting documents for related party transaction are available or the effective CIT rate is not above the tax rate of related party within territory of China, then interest expenses can be deductible despite the ratio limitation

Which enterprises need to comply with branch CIT filing regulations?
Resident enterprises that have branches located in different provinces, autonomous regions, or central government or administrated city need to comply with branch CIT filing regulations.

If a department has an independent manufacturing function and operating income and employee remuneration and assets can be separated from the management department, it can be deemed as a branch and perform the provisional branch CIT filing.

Units that do not need to be included

Third-tier branches that are supervised by second-tier branches
Branches recognized as small and thin profit enterprises in the previous year
New branches and de-registered branches
Second-tier branches without stand-alone manufacturing capacities, no turn over tax and that perform auxiliary services

Headquarters and branches are in locations with different CIT rates
Headquarters shall calculate the total taxable income for the enterprise first, among which 50 percent shall be filed by the headquarters and 50 percent shall be allocated among the branches. Different CIT rates will then apply to the taxable income for headquarters and branches respectively.

CIT to be pre-paid by a branch at local level
CIT to be pre-paid by a branch at local level shall be calculated using 50 percent of the CIT payable of the enterprise times the allocation ratio for the branch.

Allocation ratio for branches
Three factors are used in calculating allocation ratio for branch CIT provisional filing: revenue, salary and assets. For the initial six months, the figure for three factors shall be generated from the year before last year. For example, to calculate the branch CIT filing amount for January to June 2009, the figure in year 2007 is used. While for last six months, the figures for three factors shall be generated from last year, i.e. 2008 in above sample. Three percentages apply to three factors respectively as 35 percent, 35 percent and 30 percent.

Should the headquarters be deemed as a “virtual branch” and be included in calculation of allocation ratio?
In certain regions of China, headquarters are included in the calculation of the allocation ratio for branch CIT. Therefore, the total revenue, salary and assets amount not only include the branches but also figures from headquarters as it has been deemed as “one virtual branch.”

However, this treatment depends on the view of the tax bureau in-charge of the headquarters, as in some regions, the headquarters is excluded and “all branches” mentioned in the formula does not include it.

Annual tax filing
The headquarters shall perform the annual tax filing (CIT reconciliation); branches are not allowed to perform CIT reconciliation. If there are any over-paid or under-paid taxes during the year, the headquarters shall deal with the tax refund or additional tax liabilities.

Dezan Shira & Associates‘ regional staff include qualified tax inspectors who have the right to enter into dialogue with the local tax bureau to negotiate and discuss pertinent audit issues. Should you require advice or assistance with corporate audit in China, please contact Sabrina Zhang, the national tax partner for Dezan Shira & Associates at tax@dezshira.com.

This article originally appeared in the January issue of China Briefing, “Preparing for Annual Audits in China.”