Taxable Income

As with presumably all income tax systems, in China an enterprise’s taxable income is the balance of it income after deducting any allowable deductions as well as ignoring any tax-free or tax-exempt income (see Article 5 of the EITL). Article of the EIT Regulations provides that in calculating an enterprise’s income, the accrual method of accounting should be used as opposed to the cash basis. 

Under Article 6, an enterprises taxable income expressly includes:

1. income from the sale of goods;
2. income from the provision of labor services;
3. income from the transaction of property;
4. dividend, bonus and other equity investment proceeds;
5. income from interests;
6. income from rentals;
7. income from royalties;
8. income from accepted donations; and
9. other incomes. 

Income, under Article 6, also includes non-monetary forms of income. In such cases, the income shall be determined according to the arms-length value (Article 13 of the EIT Regulations). It is important to points 3 and 4 above. China does not have a separate capital gains system but the EITL does tax realized capital gains. In such cases, the taxable income is the difference between the cost base (which includes purchase price, the relevant taxes and  surcharges paid, and other expenses directly attributable to enabling asset realize the predetermined purpose of use) and the value of the consideration received on realization.

Allowable and Non-Allowable Deductions

Under Article 8 of the EITL, “reasonable disbursements” that are actually incurred and which have an actual connection with the business operations of an enterprise are deductible. “Reasonable disbursements” means expenses that are in line with the rule of production and business operations (Article 27 of the EIT Regulations). Under Article 28 of the EIT Regulations a distinction is made between revenue and capital expenses. Revenue expenses are deducted on the current accounts whereas capital accounts are either deducted by instalment or factored into the capital costs and not deductible. The depreciation of fixed and intangible assets is deductible.

There are various limitations on the general allowability of deductions. For example, Article 43 of the EIT Regulations provides that expenses for business entertainment may only be deducted to the lesser 60% of the amount incurred. This is further limited in that the amount cannot exceed 5% of the enterprise’s sales revenue for that year.  A further example is that under Article 44 of the EIT Regulations, qualified expenses for advertising and publicity incurred by an enterprise are only deductible to the amount of 15% of the enterprise’s sales revenue for that year, although any excess amount may be carried forward to future years.

Various expenses are wholly disallowed, including dividend, bonus and other equity investment proceeds paid to the investors, late fees for taxes and sponsorship disbursements. One of the more important disallowed deductions, in accordance with Article 49 of the EIT Regulations, is expenses for management fees paid by one enterprise to another.