Adjustment of Annual Tax Clearance of Enterprise Income Tax

According to the Enterprise Income Tax Law (hereinafter refers to “EITL”) it is mandatory to finish the annual EIT clearance within 5 months. From the viewpoint of our clients the Tax Bureau at the moment is commencing to conduct the annual EIT of 2011 step by step. Therefore, on basis of our careful observation of the process of the annual EIT clearance we would like to point out important adjustments as a reference and for implementation.

1) Adjustment of Revenue Recognition

According to income tax regulations revenue recognition is carried out on the general principles of the “accrual basis” or “substance over form”, therefore it is necessary to admit tax adjustments which are a result of the difference between tax law and accounting standards (or value-added tax clearance). For example: On receipt of a payment of CNY 300,000 (excluding tax) from a customer whereby a special VAT invoice is already issued (for value added tax) and on basis that the goods for this transaction have not been finished and are still awaiting transfer to the customer, the payment from that customer was already recognized as revenue. But due to the fact that the revenues in this case do not fulfill the basic regulations of revenue recognition of the income tax law it is necessary to decrease the revenues at the end of the tax year.

In addition, companies should look with care for what is “income which should not be taxed”, where is “tax exempted income” and where is “income which is not recognizable according to account standards and the tax income is at the same time seen as income from sales”. Income which should not be taxed and itself should not constitute taxable income and tax exempt income which itself already constitute taxable income and is a form of tax incentives.

Example: In 2011 a company received a subsidy for research and development of CNY 1 million from the Finance Authority. At year end of 2010 the company’s total expenses for research and development amounted to CNY 350,000. If the company would strictly follow the legal requirements and would handle these tow matters separately, the subsidy of CNY 1million received by the company for research and development would be, according to the rules of “income which should not be taxed”, reduce the revenues by CNY 1million. At the same time the special expense of CNY 350,000 should be not be deducted before tax, and therefore revenues would be increased by CNY 350,000.

2) Reduction of Expenses for Taxes

According to income tax regulations costs, expenses and taxes, which are actually incurred directly from production and from operations, should be deducted according to the “accrual basis”. That means only cost of the current period, no matter if payments were made, are recognized as expenses and cost of current period; in the case where payments were made in the current period, but the expenses do not belong to the current period, which are not recognized as expenses of the current period as the following examples illustrate:

It should be noted that the cost of goods sold whereby the official invoice has not been received
cannot be recognized as deductible cost of income tax in the year 2011 without the relevant official invoice. Therefore, the official invoice related to the cost should be obtained before the annual tax clearance for deduction.

Costs which are related to start-up costs, entertainment expenses, salary and wages, employee benefits, labor union funds, staff education expenses, advertising costs, business promotion expenses and commission fees, according to EITL standards and scope may be considered as extraordinary deductible expenses.

In addition in the case of purchased services from abroad while payment has not be made or if expenses for royalties have occurred it should be noted that it is very important “to withhold business tax” and/ or “to withhold income tax”. If a company does not withhold the applicable tax of the expenses related to the above matters, those expenses cannot be included as a deductible part for the year end 2011 tax settlement.

Taxes other than VAT and enterprise income tax that occurred during the fiscal year are deductible for s. It should be noted that the tax amount incurred from tax investigation can also be deducted within the annual tax deduction. But invoices issued on behalf of a third party or withhold on behalf of a third party cannot be assumed by the company.

3) Adjustment for Extraordinary Depreciation of Assets

An extraordinary write-down of assets due to an extraordinary loss should be reported according to the procedures and requirements to the tax authorities. Otherwise undeclared losses are not deductible. The deduction of the asset loss amount is divided into the actual loss of asset transfer (Hereinafter refers to “Actual generated loss”) and the statutory loss according to tax law (Hereinafter refers to “Statutory loss”). The actual generated loss should be included in the year end declaration for the deduction according to accounting standards. The statutory loss should be included in the year end declaration for the statement for the tax authorities. Additionally documentary evidence should be provided to prove that the asset loss has fulfilled the criteria for recognition according to tax law. Furthermore, the losses shall be booked according to accounting standards have been declared in the applicable annual deduction.

Please pay attention that the declared asset loss of an enterprise can also be divided into two forms: the declaration of an inventory list and a declaration of special items. For the asset losses of the declaration of the inventory list, the enterprise may use the classification and the summary of the computation from accounting. Then the summary of the inventory list will be send to the tax authorities. For the declaration of special items (extraordinary losses) the enterprise should file an application whereby an itemized list (or a list of cases) should be provided, together with a copy of accounting information and other related information about tax payments.

4) Non-operating Expenses Adjustment

Non-operating expenses basically include losses of non-current assets, losses due to the replacement of non-monetary assets, losses due to debt restructuring, charitable donations, extraordinary losses, losses from stocktaking, and losses due to monetary penalties. Payments of the enterprise for penalties on basis of the violation of laws and regulations are not deductible for income tax. Payments for general charitable donations can be deducted up to an amount equivalent to 12% of the annual profit according to financial statement law. For example, in November 2011 an enterprise received an approval from the local Board of Education to donate 50 computers to a school for the purpose of rural compulsory education. Each computer has a retail price of CNY 3,400. In 2011 the enterprises profit according to financial statement law amounted to CNY 1million (assuming no other tax adjustment matters). The actual donation amount = 50 x CNY 3,400 = CNY 170,000. The donation limit of this year = CNY 1,000,000 x 12% = CNY 120,000. Therefore an adjustment is needed whereby the taxable income is increased by CNY 50,000 (CNY 170,000 – CNY 120,000).

5) Adjustment of Reserves

Reserves (including reserves for bad debts) and reserves for other risks which are not included in the regulations of State Council for Finance and the tax authorities such as allowances for the reduction of assets, are not deductible. The current income tax law allows only companies in the finance, insurance, securities industries as well as small and medium sized credit guarantee institutions to set up provisions according to tax law for deduction purposes. Other provisions by companies are not allowed for tax purposes. If provisions have been set up they should be adjusted.

6) Adjustment of Assets

The assets of a company include fixed assets, biological assets, intangible assets, long-term prepaid expenses, investment property, inventories, etc. This group of assets is recorded at historical cost as tax base. Companies which hold assets and the asset value increases or decreases, only on the condition that the losses and gains on basis of laws and regulations issued by the State Council for Finance and tax authorities will be recognized. Other sources as tax base for assets are not recognized. Companies should be aware of differences between the valuation on basis of tax laws and financial statement laws. Thereby, accelerated depreciation of fixed assets policy and research and development expenses are special beneficial deductibility.

Our Understanding and Suggestions

After compilation of the final tax settlement for enterprise income tax, it is recommended that qualified personnel (such as your company’s auditors, tax advisers, etc.) verify relevant and necessary adjustments.

Ecovis Ruide has a team of professional tax advisers. We are able in behalf of your firm to compile and file the report of the annual tax settlement for enterprise income tax for the year 2011.

ECOVIS Ruide Certified Public Accountants Co., Ltd.
ECOVIS Ruide Investment Management Consulting Co., Ltd.
Unit 302, LJZ Fund Tower,
1528 Century Avenue, Pudong New District,
200122 Shanghai, P.R. China
Telephone:+86-21-6105 7333
Telefax: +86-21-6105 7330
Email: info@ecovis.cn