China: Is an Invoice Sufficient for CIT Pre-Deduction?

​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​published on 3 September 2024 | reading time approx. 3 minutes​

It is commonly understood that for companies operating in China, almost all deductible expenses for calculating taxable income for Corporate Income Tax (CIT) should be supported by an invoice. However, this does not mean that any expense accompanied by an invoice can be deducted pre-tax without compliance risk.

In 2020, the tax authority in Shandong Province, China, made CIT adjustment for an enterprise by excluding the deduction of hotel expenses, training expenses and meeting expenses supported by three general VAT invoices. They also imposed an administrative penalty on the company for obtaining false invoices without actual transactions. Because the company could not provide any associated supporting documents for its personnel's travel expenses, the tax authority concluded that the company did not incur the actual hotel, training or meeting expenses.

This case was disclosed on the official website of the tax authority, highlighting some practices that differ from the former common understanding. It was commonly understood that the supervision on general VAT invoices is usually not as strict as that of special VAT invoices. It was commonly observed that the tax authority may question the authenticity of the transaction behind a general VAT invoice, if the company that issued the invoice was identified by their in-charge tax authority as issuing false invoices without actual business transactions. Consequently, through internal information circulation within the tax authorities, companies that accept invoices issued by this company may face questions or investigations by their local tax authority.

However, in the case published by the Shandong tax authority, the tax authority determined the authenticity of three general VAT invoices by purely logical verification, i.e., from the incomplete chain of evidence. This indicates that the measures adopted by the tax authorities for tax administration and supervision are becoming more rigorous and detail-oriented. It can also be concluded from this case that companies with better internal controlling system and procedures may have lower tax compliance risks resulting from invoice managements.

In a sophisticated corporate internal control system, the incurrence of expenses for hotel, training, or meeting is often subject to pre-approval for budget control and post-approval for invoice management, both with sufficient purpose description and detailed support. For training and meetings that take place locally without requiring business trips, supporting documentation including training materials, training purposes, training results for each participant, or meeting invitations including purpose descriptions, meeting agendas, meeting minutes, meeting discussion results and decisions made, and meeting follow-up activities, etc., should be well-documented by the company for internal control purposes. Such documentation could also serve as strong supporting evidence in case the local tax authority questions the authenticity of the expenses incurred behind a single invoice. In addition to meeting expenses, business entertainment expenses and travel expenses are also the focus of tax authorities, and the companies should also pay attention to such expenses and fully prepare detailed supporting documents.

It is recommended that companies operating in China attach sufficient importance to setting up an internal controlling system and periodically review its effectiveness. If necessary, they should introduce a review procedure by a third-party advisor.