At the beginning of 2019, enterprises have entered the time period of 2018 yearly final settlement of income tax. With the national tax supervision becomes tightened, how to determine the amount of enterprise income tax declaration according to the latest laws and regulations and avoid the occurrence of tax evasion has become the focus of enterprise tax accounting declaration personnel (hereinafter referred to as enterprise tax personnel). On the basis of Enterprise Income Tax Law of the People's Republic of China (revised in 2018) (hereinafter referred to as “Enterprise Income Tax Law”) and Regulation on the Implementation of the Enterprise Income Tax Law of the People’s Republic of China (hereinafter referred to as “Implementation Regulation of Enterprise Income Tax Law”), enterprises and other organizations that have income within the territory of the People’s Republic of China are taxpayers of enterprise income tax, and they shall pay enterprise income tax in accordance with the provisions of the Enterprise Income Tax Law, which are not applicable to proprietorship and partnership. Although the laws and regulations have clear definition of the taxpayer, in practice, there are often serious operating risks which might be defined as tax evasion and lead to administrative or criminal penalties to enterprises for reason that the enterprise tax personnel cannot accurately identify the pre-tax deduction items.
This article makes a brief risk analysis of organization start-up costs, which seems to be simple but easy to be ignored, for the reference of enterprise tax personnel.
Organization start-up costs, the so-called organization costs, refer to the expenses incurred for the establishment of an enterprise, which shall be recorded into the enterprises’ organization expense account (account), whether and when these expenses can bring income, and how much income they can bring to the enterprise in
the future cannot be estimated. The cost is incurred before the enterprise formally runs business, which includes but not limited to all sorts of registration fee, cost of raising funds, office cost, lease cost, renovation cost, labor cost for preparatory work, training cost and travel expense, the amortization, abandonment and damage of enterprise assets, , advertisement cost, business entertainment expense, and other cost for preparatory work.
【Practical Problems】How is the organization start-up costs incurred during the preparation period, whether it still can be used on accountant processing organization cost course after the enterprises formally run business. The following are relative regulations.
It’s prescribed in Article 9 of Notice of the State Administration of Taxation on Several Issues regarding the Linkup between Matters Related to the Enterprise Income Tax (Letter No. 98 [2009] of the State Administration of Taxation) about organization start-up costs that “In the new tax law, if the organization (starting-load) costs are not clearly listed as long-term deferred expenses , an enterprise may deduct the expenses in a lump sum in the current year on the day when it begins to operate, or it may handle the expenses in accordance with the provisions of the new tax law on long-term deferred expenses. But it shall not be changed once decided. The unamortized organization start-up costs of an enterprise in the year prior to the implementation of the new tax law may also be disposed of in accordance with the above provisions.” Moreover, in line with the provisions of Article 13, Section (4) of the new tax law (issued in 2007) and the provisions of Article 70 of the Regulations on the Implementation of Enterprise Income Tax Law on “other expenditures that shall be accounted as long-term deferred expenses”, enterprises can amortize its organization start-up costs in no less than three years since the commencement of its business (the current month; If there is an organization cost before the current month, then the next month)
It’s clearly ruled in the regulations above; however, what are the legal risks?
The legal risks hinted hereinafter:
Firstly, no deduction may be made before tax where the law expressly prohibits the expense from being listed as expenditure before tax.
- Expenses incurred in the acquisition of various assets: transportation expenses, installation expenses, insurance premiums paid in the purchase and construction of fixed assets and intangible assets, labor expenses incurred in the purchase and construction of such assets, and expenditures on fixed assets and intangible assets related to training of staff and workers, etc., shall not be included in the organization start-up costs.
- Expenses to be borne by the investors: due diligence expenses, travel expenses, consulting fees, entertainment expenses, interest on fund raising and other expenses incurred by the investors for the preparation of the enterprise.
- During the preparation for the establishment of a Chinese-Foreign Joint Venture, the entertainment expenses incurred in the negotiations with foreign investors shall not be included in the enterprise's organization start-up costs, but shall be borne by the inviting enterprise. Fees paid for depositing foreign currency cash in a bank shall be borne by the investor.
Secondly, the preparation period shall be determined in accordance with laws and regulations
Enterprises established according to the Chinese laws and administrative regulations is granted business license after the implementation of “five certificates in one” in 2018, the preparatory period of the enterprise will end. The preparatory period for an enterprise that does not require industrial and commercial registration shall end from the date on which it obtains the approval of the competent authorities and departments/institutions for its business operation. After the enterprise runs business, the organization start-up costs subject can no longer be listed as the new debit amount. However, the adjustment of errors of account, VAT input tax adjustment and adjustment of amount difference arising from the receipt of invoices for items during the preparatory period after commencement of business and other expenses that can be clearly identified as costs incurred during the preparation period shall be excluded。
Thirdly, invoices illegally obtained shall not be reimbursed for the preparation expenses.
Since the preparatory period is long, the enterprise usually has large amount of organization start-up costs which include the amount of spending on all kinds of sporadic expenditure in small amount but of high frequency or in large quantity. organization start-up costsand invoices of which can’t be received before the industrial and commercial and tax registration has been finished.(After replacing business tax with VAT, enterprises must provide the tax number of the taxpayer when requesting the VAT invoice, and before the completion of tax registration, the enterprise does not have a tax number. If the invoicing unit requires that the tax number must be provided, the enterprise cannot obtain the current VAT invoice). Besides, illegal invoices obtained during the preparation period due to delayed reimbursement, personnel replacement and other reasons resulting in the loss of invoices shall not be included in the organization start-up costs. “Illegal” here means the “violation of invoice management laws and regulations, resulting in enterprises not paying, paying less or defrauding tax and other illegal acts, such as buying fake invoices, issuing false invoices, etc.”.
Violation of the above regulations may lead to adverse consequences: the enterprise will not only pay an overdue tax, but also will be fined by the tax authorities. Once it constitutes a crime, the enterprise and/or individuals (unit head, financial personnel) will also be investigated into the criminal responsibility. Relative tax-related crimes include tax evasion (The Criminal Law No. 201, The Criminal Law Amendment VII), offense of resisting taxes (The Criminal Law No.202), evading tax arrears (The Criminal Law No.203), defrauding an export tax refund (The Criminal Law No.204 Section 1), illegally purchasing special VAT invoices, purchasing forged VAT invoices (The Criminal Law No.208) and possession of forged invoices (The Criminal Law No.210 item 3), etc.
In view of the above risks, the author suggests:
- For those uncertain items, it’s better to consult the tax administrators, external auditors and other enterprises in the same industry that are in charge of the enterprise. If there is still doubt, it is better not to deduct before tax;
- Pre-tax expenditures that are explicitly prohibited in the Enterprise Income Tax Law, administrative regulations and normative documents, shall not be deducted in pre-tax, enterprises cannot afford to take chances;
- The enterprise shall, at the time of annual final settlement, correct the false declaration items within the year by itself.
- Before the tax inspection, the enterprise shall conduct internal self-inspection. If any error is found, it shall immediately make a supplementary
- Deal with tax-related issues with the help of external professionals in the day-to-day operations, such as hiring external auditors, perennial legal consultants, etc.
