Reasonable salary and wage expenses include all cash and non-cash remunerations provided to employees, including wages, bonuses, allowances, subsidies, year-end extra salaries, and overtime wages.
Principles for determination of reasonable salaries and wages include:
- A sound staff compensation policy is established;
- Compensation is consistent with the benchmark level of the industry and the region;
- Compensation granted within a certain period is stable, and adjustment to compensation is consistent;
- The enterprise withholds IIT for the compensation in accordance with relevant laws and regulations; and
- Arrangement for compensation is neither for the purpose of tax decrease nor evasion.
In addition, a 100% super-deduction on the salaries expense paid to disabled persons is allowed.
Property insurance enterprise may deduct commission costs up to 15% of net premium revenue, while life and casualty insurance enterprise may deduct commission costs up to 10% of net premium revenue. Effective 1 January 2019, the expense deduction limit for insurance enterprises handling fees and commission expenses is increased to 18% of pre-tax premium income for all insurance companies, with the excess allowed to be carried forward.
Other enterprises are allowed to deduct commission costs up to 5% of the total income specified in service agreements or contracts with legally qualified brokerages or individuals.
The asset losses deductible for corporate income tax purpose shall be those incurred in production or operation activities and associated with taxable income generating process, such as the losses related to monetary capital, bad debt, loan, equity investment, stocktaking shortage, damage, disposal, or theft of fixed assets and inventory, and the losses caused by natural disasters, etc.
Assets for the purpose of taxation means assets owned by or under the control of a taxpayer for operation and management, including monetary assets such as cash, bank deposits, accounts receivable, and advance payments (including notes receivable, advances of all kinds, and current accounts between enterprises), non-monetary assets such as inventory, fixed assets, intangible assets, construction in progress, productive biological assets, as well as debt investments and equity investments.
Asset losses are categorized into two categories: actual asset losses and statutory asset losses. Actual asset losses refer to reasonable losses incurred in the course of the disposal and transfer of the above-mentioned assets; and statutory asset losses refer to the losses where the assets have not been disposed of or transferred yet.
A company may treat the unrecoverable receivables or prepayments as bad debt loss if one of the following conditions is met:
- The debtor is declared bankrupt, or closed, dissolved or terminated, or has its business license revoked or cancelled according to law, and its property is insufficient to pay off the debt;
- The debtor is deceased, or is declared missing or dead, and its property or heritage is insufficient to pay off the debt;
- The outstanding debt has been overdue for more than three years, and there is verified evidence which demonstrates that the debtor is unable to pay off the debt;
- The creditor has no recourse against the debtor by effect of a debt restructuring agreement or a court-approved bankruptcy reorganization plan of debtor;
- The debt is unrecoverable as a result of natural disasters, wars, or other force majeure; or
- Other conditions set by the financial or tax departments under the State Council.
Further to the above, taxpayers may calculate and deduct the following asset losses for corporate income tax purposes without the tax authorities’ approval:
- The assets losses resulted from sales, transfers, and disposal of fixed assets, productive biological assets, and inventory associated with the operation of an enterprise;
- The regular depreciation of inventory;
- The losses resulted from disposal of fixed assets of an enterprise that reaches or exceeds the life of use;
- The assets losses resulted from the natural death of productive biological assets of an enterprise that reach or exceed the life of use;
- The losses resulted from the transactions of bonds, stocks, funds, and financial derivative products through securities exchanges and inter-bank markets by an enterprise in accordance with relevant provisions; and
- Other assets losses that are not subject to the examination and approval by taxation authorities as confirmed by the State Administration of Taxation.
The accounts receivable of an enterprise overdue for more than three years which have been recognized from an accounting perspective can be treated as bad debt losses with an explanation letter and a special report.
Where the accounts receivable of an enterprise is overdue for more than 1 year and has been recognized as a loss from an accounting perspective, if the amount is no more than CNY 50,000 or 0.01% of the enterprise's annual gross income, it can be deducted as a bad debt loss with an explanation letter and a special report.
However, the deduction of the assets losses for corporate income tax purposes other than the above said losses are subject to examination and approval by the tax authorities.
To claim a deduction for the assets losses, the taxpayers are required to submit to the tax authorities the evidence which can substantiate that the losses are actually incurred, including external evidence and internal documents issued by the enterprises. External evidence includes the written documents with legal effect produced by judicial, administrative authorities or professional technical verification divisions, such as rulings of judicial authorities, bankruptcy and liquidation announcement, etc. The taxpayer with a sound accounting and internal control system may use its internal documents, such as accounting vouchers, stocktaking records, business contracts, etc., as supporting documents of the losses of certain assets.
For example, a company may treat the unrecoverable receivables or prepayments as bad debt loss with the following supporting documents:
- Contract, agreement, or description on relevant matters;
- Announcement of bankruptcy or liquidation issued by the people's court in case of the bankruptcy or liquidation of a debtor;
- Judgment or ruling of the court, or arbitral award of the arbitration agency, or the legal documents of the court ruling on termination (suspension) of the execution in case of a lawsuit;
- Certificates of cancellation or revocation of the debtor's business license issued by the Administrative Department of Industry and Commerce in case of termination of debtor's business;
- Certificates of death or missing of a debtor issued by the Public Security or any other relevant departments in case of the death or missing of the debtor;
- Debt restructuring agreement and description of the payment of taxes for debtor's income from such restructuring in case debt restructuring; and
- A description of the disasters sustained by the debtor and the declaration of the waiver of claims in chase of irrecoverable losses caused by force majeure such as natural disasters and war.
The taxpayer shall claim the deduction of the above asset losses for corporate income tax purposes during the annual corporate income tax return filing period with the submission of the relevant supporting documents to the tax authority for review.
For the following asset losses, taxpayers may claim deduction by submitting a combined list of losses to tax authorities, with relevant accounting records in place for possible future inspection:
- Losses incurred by selling or transferring non-monetary assets at a fair market value during the normal operation of an enterprise;
- Asset losses incurred by an enterprise due to normal inventory loss;
- Asset losses incurred by an enterprise due to normal abandonment and disposal of fixed assets reaching or exceeding the useful life;
- Asset losses incurred by an enterprise due to the normal death of productive biological assets reaching or exceeding the useful life; and
- Losses incurred by an enterprise due to trading of bonds, shares, futures, funds, and financial derivatives, etc. on an arm's length price through stock exchanges, etc.
Deduction of asset losses other than the above-mentioned shall be specifically applied for by submitting reports together with other supporting materials (e.g., copies of accounting records) to tax authorities.
Where asset losses incurred in previous years by a taxpayer have not been deducted in the year when the losses occurred, the taxpayer may give an explanation to the tax authority and make special declaration for deduction. Actual asset losses are permitted to be retroactively recognized and deducted in the year which the losses occurred, the time limit for the recognition of which shall be no more than five years, while some special actual asset losses may be appropriately extended upon the approval of the State Administration of Taxation. The statutory asset losses shall be deducted in the year when the losses are declared.
A super deduction of 150% of research and development (R&D) expenses incurred during the development of new technologies, new products, or new production techniques is allowed if the R&D expenses are capitalized as intangible assets, and 150% of actual costs are allowable for amortization purposes. This deduction is increased to 200% from 1 January 2022 for eligible SMEs. From 1 January 2018 to 31 December 2023, the super deduction is increased to 175% for all qualifying companies. Effective 1 January 2021, qualifying manufacturing enterprises can avail a higher deduction of 200% for R&D expenses or can amortize 200% of the cost of the intangible assets (see Sec. 10.4. for additional details).
China employs a social welfare system which includes, pension, medical insurance, unemployment insurance, work-related injury insurance, maternity insurance, and housing fund. These are required to be paid for by both employers and Chinese employees (by law, foreign individuals employed by Chinese entities are also required to participate in the social insurance scheme, although enforcement is inconsistent). Portions paid by employers are deductible.
Supplemental pension fund and medical insurance premiums paid by an enterprise for employees are deductible as long as the premiums do not exceed 5% of the total salaries paid to the employees, respectively.
Interest payments on loans from financial institutions, which are incurred during the course of production and business, are deductible. Interest payments on loans from non-financial institutions are deductible only to the extent that the interest rates do not exceed the rates of financial institutions for the same type of loan over the same period.
Interests on acquisition, construction, and production of fixed assets and intangible assets prior to the assets being put into use or inventories that will not reach estimated saleable condition until after more than 12 months, are not deductible and shall be added to the original value of the assets and depreciated over the expected life of the assets.
Interest expenses will be non-deductible to the extent it relates to related party debt that exceeds the following standard debt-to-equity investment ratios, unless that enterprise could provide relevant documents and prove the transaction activities are carried out at arm’s-length, or the actual tax liability is not higher than the related parties in China:
- 5:1 for financial institutions; and
- 2:1 for other enterprises
Debt investments refers to financing that an enterprise has directly or indirectly acquired from related parties, and the enterprise is required to repay the principal and make interest payment or financing that requires other compensation of an interest payment nature.
Debt investments indirectly acquired from related parties by an enterprise include:
- Debt investments made by related parties but through unrelated third parties;
- Debt investment made by unrelated third parties, with related parties providing guarantees and assuming joint and several liability; and
- Other debt investments having the nature of liabilities indirectly acquired from related parties.
Equity investments refer to investments which an enterprise received without being required to repay the principal and make interest payments, while investors have the proprietary rights of the net assets of the enterprise. The specified ratio is expected to be separately stipulated by the government authorities of the State Council in charge of finance and taxation.
Interest expenses (including any interest, guarantee expense, mortgage expense, and other expenses with the nature of interest actually paid by an enterprise for direct or indirect associated debt investments) not allowed to be deducted in calculating taxable income shall be calculated according to the following formula:
Interest expenses not allowed to be deducted = annual interest actually paid to all associated parties × (1 − (the standard ratio / associated debt-to-equity ratio))
The associated debt-to-equity ratio is the percentage of which debt investments from all of its associated parties divided by equity investments. Associated debt investments include debt investments for which associated parties provide security in various manners.
Interest payments on loans from individual shareholders or other individuals who are related parties to the taxpayer must meet the requirements for pre-tax deduction purposes.
Interest payments on loans from the non-related individuals should fulfill the following additional requirements for pre-tax deduction purpose:
- The loan transaction between the taxpayer and the non-related individual is true and not for an illegal purpose of raising money or other violation of laws and statutes; and
- The loan contract has been signed by the taxpayer and the non-related individual.
If the investors of a taxpayer fail to make the payable capital contribution within the specified time limit, the interests accrued from the external loans by the taxpayer, are not deductible.
Calculation period is introduced when calculating the above non-deductible interest. The period in which the capital actually received and the balance of the loan for each account remains the same within one calendar year is treated as one calculation period, and the formula is as follows:
Non-deductible loan interests in one calculating period = Amount of loan interests × unpaid registered capital / Loan amount
The total amount of the non-deductible loan interest of a taxpayer in one year shall be the sum of the non-deductible loan interests of each calculating period within the same year.
Interest paid between operational units within a non-financial enterprise is not deductible.
Effective 2021, in case of conversion of convertible bonds into equity investments, the issuing enterprise can claim a deduction for the interest paid on convertible bonds. When the bonds are converted to equity, any unpaid interest is also deemed to have been paid and is deductible.
Interest paid by resident enterprises to foreign investors relating to cross-border hybrid investments is generally deductible, subject to specified conditions. However, effective 2021, the interest paid will be considered as dividend and will not be deductible if:
- The resident enterprise is a related party to the foreign investor; and
- The investment income is treated as equity investment income, and no corporate income tax is levied in the jurisdiction where the foreign investor is located.
Foreign exchange losses incurred in currency transactions and foreign exchange losses as a result of the conversion of non-CNY assets and liabilities to CNY at the end of the tax year using the year-end middle spot rate can be deducted. However, any portion which has been recorded as the cost of assets or related to profit distribution to investors is not deductible.
Employee welfare expenses are deductible subject to a limit of 14% of the enterprise’s deductible wages and salaries.
Labour union dues incurred are deductible with a limit of 2% of the deductible wages and salaries.
Employee education expenses are deductible subject to 8% (increased from 2.5% effective from 1 January 2018) of the enterprise’s deductible wages and salaries for that tax year. Any excess is allowed to be carried forward to the following tax years for deduction.
Training expenses incurred by qualifying software manufacturing enterprises are allowed to be deducted on an actual basis.
Education and training expenses incurred by technological-advanced service enterprises are deductible subject to 8% of the enterprises' deductible wages and salaries for that tax year. Any excess is allowed to be carried forward to the following tax years for deduction.
Entertainment expenses incurred during the course of production or business operations may be deductible up to 60% of the actual amount expensed. However, this cannot exceed 0.5% of the sales revenue for the year.
Advertising and promotional expenses are deductible up to 15% of the sales revenue for the current tax year, unless the governing authorities of the State Council in charge of finance and taxation stipulate otherwise.
Effective from 1 January 2008, the deduction limit of the advertising and promotional expenses for cosmetic production enterprises, medicine production enterprises and beverage production (exclusive of liquor) enterprises is up to 30% of the sales revenue. Cosmetic trading enterprises may also enjoy the increased deduction limitation from 1 January 2011. Any excess is allowed to be carried forward to the following tax years for deduction within the deduction limit.
Effective 1 January 2021, an enterprise can either claim the deduction of the advertising and promotional expenses itself or allocate a portion or all of the expenses to a related enterprise under a cost-sharing agreement, up to the 30% limit mentioned above. The related enterprise to which the expenses are allocated is required to exclude the allocated expense amount in determining its own deduction limit for advertising and business promotion expenses.
Advertising and promotional expenses for tobacco companies are not deductible.
The increased deduction limit (i.e., 30%) applies until 31 December 2025 (previously until 31 December 2020).
Specific funds that have been set aside for environmental protection, eco-regeneration, and similar purposes in accordance with relevant laws and regulations are deductible. The deduction is now allowed if the use of the specific funds changes.
Insurance premiums for the following types of insurance are deductible:
- Personal safety insurance premium paid by enterprises for certain job categories;
- Property insurance; and
- Other deductible commercial insurance specified by relevant authorities.
The scope of other deductible commercial insurance types is yet to be specified, and in most cases it is difficult for enterprises to claim deductions for commercial insurance premiums paid for their investors or employees.
Rental payments under operating leases are deductible. Rental payments under finance leases should be capitalized into the costs of the fixed assets and depreciated. (CITIR, Art 47).
Reasonable worker protection expenses incurred by an enterprise are deductible.
Company formation expenses can be deducted on a lump sum basis in the year in which the enterprise commences business operations or amortized as a long-term prepaid expenditure.
Management fees paid by a foreign-invested enterprise to its associated enterprises overseas are generally not tax deductible. However, fees paid by the Chinese establishment or place of business of a foreign enterprise to its overseas head office in the course of production and business may be allowed for tax deduction subject to the approval of the Chinese tax authorities.
To qualify, the taxpayer must have supporting documents from its head office certifying the scope of the expenses involved, the total amount, and the basis and method of allocation.
An enterprise may claim qualified donations of up to 12% of its total annual profit before tax as deductible expenses. Qualified donations refer to the donations made by an enterprise through public interest social organizations or the People’s Government and their departments above county level, to be used in the activities for public interest. Effective 2021, freight, insurance, labor costs, and other related expenses incurred in the relation to donation of non-monetary assets (donations-in-kind) are also deductible.
Public interest social organizations refer to social organizations that concurrently satisfy the following conditions, such as foundations and charitable organizations:
- Legally incorporated, with legal person status;
- With a mission of development for public interest, not for profit making purposes;
- All assets and their associated earnings and appreciation belong to the legal person;
- Profits and operating surplus are mainly used in activities that support the established purposes of the organization;
- Upon termination, remaining assets do not belong to any individual or the profit-making organization;
- Not engaged in activities that are irrelevant to the purposes upon establishment;
- With complete financial accounting system;
- Donors do not participate in distribution activities of the public interest social organization in any form or manner; and
- Other conditions stipulated by the government authorities of the state council in charge of finance and taxation and with the departments in charge of civil affairs.