GEO Investing

As part the due diligence process of understanding quality issues in the China Hybrid space, the GeoTeam retained the independent services of an attorney familiar with PRC law.  We asked him to contact different agencies in China, including the SAIC as well as other attorneys before writing the following letter to us.

Re: Annual Inspection and Annual Income Tax Filing Process in China

In China, there is an annual inspection done by the Statement Administration for Industry and Commerce (“SAIC”) for every registered company.  For the companies owned by Chinese individuals and/or entities (Variable Interest Equity ownership structures), except listed companies and/or some special companies, the companies need to file their financial reports to AIC for accomplishing the annual inspection and the audit of the financial statement is not required.

For the annual income tax filing in the taxation bureau, which is in the beginning of the next financial year, if a company owned by Chinese individuals and/or entities has a big loss (negative net income) in the last financial year and/or claim the rights to make up for losses in the next several financial years, the financial statement with a big loss (negative net income) shall be audited for the purpose of taxation by an independent CPA firm.  If a company only has a small loss (usually the line between big loss and small loss shall be RMB 100,000 and/or RMB 50,000 and the number of the line depends on the different requirements of different taxation bureaus) and does not claim the rights to make up for losses in the next several financial years, the financial statement is not required to be audited.  Accordingly, this company does not pay any income tax.  If a company owned by Chinese individual and/or entities has a positive net income, the company shall pay the income tax based on the standard income tax rate, which is twenty-five percent (25%) of the net income in the last financial year.  Such a financial statement with a positive net income is not required to be audited.

For the foreign invested companies, including Sino-foreign joint venture enterprises and wholly foreign owned enterprises, the annual financial report submitted to the AIC is required to be audited by an independent CPA firm.  The same report will also be filed to the taxation bureau and several other government authorizations, such as State Administration for Foreign Exchange, for the issues of foreign exchange administration and others.  If a company has a negative income in the audited financial report, the company does not pay income tax and the company may claim the rights to make up for losses in the next several financial years.  If the companies have positive net incomes, the companies shall pay income tax based on the standard income tax rate, which is 25% of the net income in the last financial year.

In the real life, for the purpose of avoiding income tax, some companies in China claim that there is a loss (negative net income) in the last financial year.  For the companies owned by Chinese individuals and/or entities, they may claim a small loss (for example, a loss lower than RMB 50,000 and/or RMB 100,000) but not claim to make up for losses in the next several financial years. Therefore, the financial report in the last financial year is not required to be audited by an independent CPA firms.  For the foreign invested enterprises, they may purchase a forged audited financial report which states a loss from a small CPA firm to avoid the possible income tax.

Chinese government controls the possible taxation fraud through the taxation inspection which conducts by the taxation bureau.  For conducting the taxation inspection, the taxation bureau may inspect and review the financial statement and materials of the companies in details from time to time.  However, as the taxation bureau only has limited number of officers and resources.  It is impossible for the taxation bureau to inspect the financial statements and materials of all companies in each financial year.  At the same time, the AIC does not review the financial statements and materials of a company, except in some administrative investigation process.

If a company with a forged financial report (whether it is audited or not) is chosen for taxation inspection and the fraud is found out by the taxation bureau, this company may be fined and be required to make up the tax which the company shall pay.  The responsible people within the company may also bear the criminal and/or administrative liability. However, to one specific company, as the chance for the taxation inspection is very low, the fine is also comparatively low and criminal liability is not always applied in the real life, some companies dare to take this risk to make a forged financial report for avoiding the income tax.  At the same time, there are also seldom cases that CPA firms which provided forged audit reports are fined and/or bear criminal and/or administrative liability in these situations.

In practice, for the taxation purpose, each company has a specific taxation officer which is the taxation officer to cover the district which the company lies in.  The officer in the company usually an accountant, directly deals with the taxation officer to file the taxation monthly through on line system and/or personally.  At the beginning of the next financial year, the annual income tax filing of the last financial year will also be reported to the same taxation officer.  After each monthly (annually for the income tax) payment of tax (VAT, business tax, personal income tax and company income tax, etc.), the taxation officer will issue a taxation certificate to the accountant to state the amount and types of tax paid on behalf of the taxation bureau.  This taxation information (including the amount of the tax) is not open to any third party except the court, prosecutor and/or police for the reasons of litigation and/or criminal/administrative investigation.

NOTE: This opinion letter is wholly based on the current effective laws and regulations of P.R. China, and the real annual inspection and income tax filing practice in China.  In different cities and/or provinces of P.R. China, the practice of annual inspection and income tax filing might be slightly different from this opinion letter.  Furthermore, this opinion letter is only for Geoinvesting LLC to understand the process of annual inspection and income tax filing in P.R. China.  This opinion letter shall not be regarded as a formal legal opinion letter based on the laws and regulations of P.R. China.


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