China’s tax agency recently clarified the corporate 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 Corporate Income Tax Guidelines Notice (STA Notice  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 at assessment” to “Collection at audit”;
- Tax treatment of the company’s collection of cultural goods and works of art; and
- The point in time when income is recorded after receiving government 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 actions and help businesses get through the year, the government has put in place support measures (MOF SAT communication  # 9), which allows funds and materials donated by companies to fight COVID-19 to be fully deducted before corporate income tax (CIT) is calculated.
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 this cost is the STA announcement  No. 17 clarifies that:
- 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 may 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 announcement  No. 17 clarifies the CIT treatment for converting 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 should declare and pay CIT in accordance with the law.
- 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 interest expense, which is part of the company’s financing costs, before tax.
If the bond holder converts the convertible bond and the accrued interest claims (unpaid interest in the case of 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  No. 41), if a hybrid system meets certain conditions, it can be treated as a debt investment (instead of an equity investment); This enables the investee to record interest expenses and deduct input tax.
To fill in tax loopholes omitted in the SAT message  No.41 implemented from 2013 onwards, the SAT announcement  No. 17 added two qualifying conditions. The additional conditions prevent hybrid investments from being considered as debt instruments in certain situations.
According to Notice No. 17, the interest that the domestic investee pays to the foreign investee should be considered a dividend (i.e. an equity investment instead of debt) when a hybrid investment meets the following two conditions (investment) 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.
Eventually, in some cases, taxpayers can move from collecting the CIT upon assessment to collecting the CIT upon auditing.
After the conversion, it is important to confirm 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 profit and loss and taxable income.
To avoid tax evasion, the STA notice  No. 17 clarifies how to confirm the value of assets for the purpose of tax collection.
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 specified in the invoice, in accordance with Notice No. 17.
In the event that an invoice for the purchase of assets cannot be presented, the amount contained in the sales contract (agreement), proof of payment, as well as accounting records and other documents can be used as the basis for tax collection.
Dealing with the depreciation and amortization of the asset
For an asset that was drawn down during the assessment period, after the company’s transfer 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 the STA announcement  No. 17, cultural relics and works of art acquired by the company and used for collecting, displaying, preserving and enhancing 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 on an accrual basis
According to the STA announcement  No. 17, if a company sells goods at market prices or performs labor and all or part of the government finance department in accordance with a certain proportion of the quantity or amount of goods sold or labor is paid by the company, the income is after the To record the period principle.
Capturing income on an actual basis
Aside from the foregoing, income for all types of government funding received by companies, such as financial grants, subsidies, tax rebates and indemnities, should be recognized in cash at the time the income is actually generated.
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