China's tax agency recently clarified the corporate income tax assessment applicable to six items, including expenses related to COVID-19 charity donations, convertible bonds and cross-border hybrid investments. Businesses should note that the new policy will close some prevalent corporate tax loopholes.
On June 25, 2021, the State Taxation Administration (STA) published the announcement of corporate tax collection guidelines (STA Notice (2021) No. 17). The announcement, which will apply to tax filing and payment for tax year 2021 and future years, clarified the following treatment of corporate tax (CIT) for six items in China:
- Input tax deduction on expenses related to COVID-19 charity donations;
- Tax treatment when converting convertible bonds into equity investments;
- Tax treatment of cross-border hybrid investments;
- Tax treatment of assets after the changeover from “Collection upon assessment” to “Collection upon audit”;
- Tax treatment of the company's collection of cultural goods and works of art; and
- The time of recording income after receiving state payments.
This article explains the CIT treatment for the six items for reference by companies.
1. How to deduct expenses related to COVID-19 charity donation?
During the pandemic, some companies donated to aid COVID-19. To encourage such acts and help businesses get through the year, the government has put in place support measures (MOF SAT Announcement (2020) No. 9) that will enable company-donated funds and materials to fight COVID-19 Completely deduct corporation tax (CIT) from the calculation.
However, when corporate taxpayers make non-monetary asset donations, some of them incur transportation costs, insurance costs, handling fees, labor costs, and other related costs.
For these costs, STA Communication (2021) No. 17 clarifies the following:
- If the expenditure is included in the donation receipt issued by the state organs or non-profit social organizations, it can be deducted from the CIT as a donation expenditure for public welfare.
- If the above costs Not Included in this amount, they can be deducted before the CIT as related business expenses.
It should be noted that for general charitable donations, the deduction limit is within 12 percent of the company's gross annual profit and the excess can be carried over to the following three years. In principle, the same effort cannot be deducted repeatedly.
2. How is the conversion of convertible bonds into equity investments treated for tax purposes?
A convertible is a fixed-income corporate bond that pays interest but can be converted into a predetermined number of common stocks or shares.
The conversion of bonds into stocks can occur at certain times during the life of the bond and is usually at the discretion of the bondholder. A vanilla convertible bond gives the investor the choice of holding the bond to maturity or converting it into stocks.
The STA notification (2021) No. 17 clarifies the CIT treatment for the conversion of convertible bonds into equity investments:
CIT treatment for holders (purchasing companies) of convertible bonds
- If a bondholder earns interest income at an agreed rate during the holding period, the bondholder must declare and pay CIT in accordance with the statutory provisions.
- If a bondholder converts the bond into shares along with the accrued interest receivable, even the accrued interest receivable is not to be recorded as income in the bondholder's accounts, should it be recognized by the tax authorities as interest income for the current period and claimed for tax purposes. After conversion, the purchase price of the bond, the accrued interest receivable and the associated taxes and fees paid together form the acquisition costs of the investment.
CIT treatment for issuers (issuing companies) of convertible bonds
- If a bond issuer incurs interest expenses for convertible bonds, the costs can be deducted before CIT.
- If the issuer of the bond converts the bond into shares along with the unpaid interest, the unpaid interest is deemed to have been paid to the investor and may be deducted before the CIT.
In short, convertible bond issuers are allowed to deduct the interest expense, which is part of the company's financing costs, before tax.
If the bondholder converts the convertible bond and the accrued interest claims (unpaid interest for bond issuers) into shares, the interest is deemed to have been received by the investor and is therefore initially taken into account for bond issuers. Tax deduction.
3. How are cross-border hybrid investments treated for tax purposes?
Hybrid investments refer to investments that have two characteristics – equity and debt.
According to the STA Communication on issues related to the handling of CIT in hybrid investments by companies (STA Communication (2013) No. 41), if certain conditions are met, a hybrid investment can be treated as a debt investment (rather than an equity investment); In this way, the investee can record interest expenses and deduct input tax.
In order to fill tax loopholes that were left out in SAT Announcement (2013) No. 41, which was implemented from 2013, two restrictive conditions have been added in SAT Announcement (2021) No. 17. The additional conditions prevent hybrid investments from being considered as debt instruments in certain situations.
According to Notice No. 17, if a hybrid investment meets the following two conditions, the interest that the domestic investee pays to the foreign investee should be considered a dividend (i.e. an equity investment instead of debt) and cannot be deducted before CIT :
- Foreign affiliates and domestic affiliates are related parties; and
- The country (region) in which the foreign investee is based recognizes the investment income as investment income and does not levy a CIT on it.
4. What is the tax treatment of assets after the changeover from “Collection upon assessment” to “Collection upon audit”?
There are two methods of corporate tax collection in China:
- CIT collection based on auditing; or
- Survey of CIT based on assessment.
Most corporate taxpayers are subject to CIT on the basis of audit. However, for taxpayers who are exempt from accounting or whose accounting is confusing, the tax authorities will determine the percentage of their taxable income.
In some cases, taxpayers can eventually move from a CIT in assessment to a CIT in auditing.
After conversion, it is important to validate the value of the company's assets as this will affect the owner's equity, depreciation and amortization charges, which in turn will affect the company's profits and losses and its taxable income.
To avoid tax evasion, STA Notice (2021) No. 17 clarifies how to confirm the value of assets for tax collection purposes.
How to confirm the value of the asset
If a company can issue an invoice for the purchase of assets, the tax should be calculated based on the amount indicated in the invoice, in accordance with Notice No. 17.
If an asset purchase invoice cannot be submitted, the amount of tax levied in the asset purchase contract (agreement), the proof of payment, the accounting documents and other documents can be used as the basis.
Dealing with the depreciation and amortization of the asset
For an asset that was drawn down during the assessment period, after the company has transferred to the assessment after the audit on the basis of the depreciation years prescribed in tax law after deducting the years of use of the asset, the depreciation amount of the asset will continue to be calculated and for the remaining year before tax deducted.
5. What is the tax treatment of corporate collections of objects of art and culture?
Based on STA Communication (2021) No. 17, cultural relics and works of art acquired by the company and used for collecting, exhibiting, preserving and upgrading should be treated as fixed assets for tax purposes.
Therefore, accumulated depreciation during the holding period of cultural goods and works of art is not permitted for the input tax deduction.
6. When should income be recorded after receiving government payments?
Record the income in the appropriate period
Pursuant to STA Notice (2021) No. 17, a company sells goods or provides labor services at market prices and is paid in whole or in part by the government finance department in accordance with a certain percentage of the quantity or amount of goods sold or labor performed by the company to record the income according to the accrual principle.
Capturing income on an actual basis
Aside from the above circumstances, income for all types of government funding companies receive, such as financial subsidies, subsidies, tax refunds, and indemnities, should be recognized in cash – at the time the income is actually generated.
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