[ By Edward Ma, Dezan Shira & Associates ]

?There are two distinct classes of men…those who pay taxes and those who receive and live upon taxes? Thomas Paine, American Revolutionary thinker.

All foreign invested enterprises in China are required to prepare annual financial statements, including balance sheets and income statements for their annual Chinese audit. Such accounts must be in accordance with the Chinese accounting standards for business enterprises ? there are now no differences between standards for domestic and foreign enterprises.

Foreign invested enterprises (FIEs), including their legally responsible persons, must take full responsibility for the truthfulness, legitimacy and completeness of these financial statements. These documents must be completed ahead of the submission of consolidated accounts for tax purposes by the end of April every year, for the financial calendar year ending the previous December 31.

These statements will be used for computing the FIEs taxable and distributable profit. Accordingly, an annual audit by a firm of certified public accountants registered in the PRC is required under Chinese law.

There are a number of areas where you need to take particular care and where there are some differences between Chinese and Western accounting practice.

These are guidelines only as every business is different.

Tax items often queried by Chinese independent auditors

Adjustments for foreign related payment income
If the foreign company has paid overseas insurance for their expatriate employees, it should be noted that this is not tax deductible unless it is recorded as a salary payment and with IIT paid. Foreign-sourced income should be provided for by providing evidence of foreign taxes paid with the relevant foreign documentation.

Related party transactions and transfer pricing
If the FIE had any transactions with related parties, then they must make sure that these were at arm?s length and with adequate documentation to substantiate the charges/income, so that the results were not materially affected by related party transactions that were not in the ordinary course of business. Pay particular attention to transfer pricing issues. Tax officials reserve the right to adjust transfer prices, interest charged by related parties based on market prices or even based on the prescribed profit margin. Transfer pricing should not be used as a mechanism to reduce the amount of profit retained in China. If this is abused and discovered, the tax bureau will regard it as tax evasion and the penalties and repercussions can be severe.

Withholding obligations
If the FIE made or accrued in its costs or expenses any payments, such as rental (including office and expatriate housing), royalty charges, interest, services or management fees for services performed in China by foreigners (individuals or organizations), pursuant to related contracts and agreement, the relevant withholding obligation should be provided for on an accrual basis. This means 10 percent withholding enterprise income tax and five percent business tax apply. These charges shall be accompanied by substantial evidence ? otherwise they are not deductible. All the above debts in foreign currency also need to be registered with SAFE prior to approval for remittance.

Input VAT
The VAT invoice must be verified by the tax bureau within 90 days as from the invoicing date, otherwise it cannot be deducted. Furthermore, if you have any unusual loss of inventory, then the VAT input related to the inventory previously credited has to be reversed in the period when the loss is recognized.

Export VAT
Export VAT refunds for the year should be reconciled with the tax bureaus within three months of the end of the year. FIEs should register all export receivables of the previous year with the bureau. Failure to do so may result in the export sales being deemed as domestic transactions, subject to output VAT if the payment for export sales is not received and related documents are not presented within the deadline.

Stamp Duty
Although not a material issue with much cost, FIEs should not forget to pay stamp duty on all books, records and applicable contracts. Fines for non-compliance outweigh the dutiable value.

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