On April 30, 2009, the PRC Ministry of Finance (MOF) and State Administration of Taxation (SAT) jointly issued the Circular on Several Issues Regarding the Pre-Enterprise Income Tax Deduction of Financial Enterprises’ Loan Loss Reserves, which applies retroactively to January 1, 2008 and is effective through December 31, 2010.
Compared with the Administrative Measures for the Pre-Tax Deduction of Financial Enterprises’ Loan Loss Reserves issued by the SAT in June 2003, the Circular no longer allows financial enterprises to deduct, for enterprise income tax (EIT) purposes, the loan loss reserves provided for its non-loan assets. Non-loan assets include assets that are used to pay a debt, equity investments, national bond investments, dividend receivables, reserves paid to the central bank, creditors’ rights and equities that have been stripped, financial pay interest receivables, and central bank payments. The rationale behind this change is that financial enterprises do not bear risks or incur losses for these non-loan assets, and therefore should not be allowed to deduct them. As for consignment loans, the Measures do not allow a financial enterprise to deduct, for EIT purposes, the loan loss reserves provided for consignment loans, and the Circular remains unchanged in this regard.
The Circular governs policy banks, commercial banks, financial companies, urban and suburban credit unions and other financial enterprises that are allowed to conduct loan businesses in the PRC. Under the Circular, a financial enterprise may provide loan loss reserves for the following loan assets:
- loans (including mortgage loans, pledge loans and guaranty loans);
- bank card overdrafts, time discounts, credit advance payments (including advance payments made for a bank acceptance, letter of credit or guaranty), bills to purchase documentation for imports or exports, call loans to banks, and other risky assets with loan attributes;
- foreign loans that the financial enterprise onlends and is responsible for repaying (including loans of international financial institutions, foreign buyer credits, foreign government loans, untied loans of Japan Bank for International Cooperation, and mixed loans of foreign governments).
The Circular also reiterates the formula for calculating the current tax year’s loan loss reserves that may be pre-tax deducted, which amounts to 1 percent of the current year-end balance of qualified loan assets minus the balance of the loan loss reserves up to the end of the previous tax year that have been deducted for EIT purposes. If the above-mentioned amount is less than zero, the taxable income for the current year will increase. When a financial enterprise incurs qualified loan losses, the enterprise must first use loan loss reserves to offset the qualified loan losses. If loan loss reserves are insufficient to offset the qualified loan losses, then the remaining qualified loan losses can be deducted from the enterprise’s taxable income.
The policy change presented in this Circular will increase the tax base of the enterprise income tax. Since the Circular applies retroactively to January 1, 2008, financial enterprises’ EIT burden may be adversely affected by this Circular