Editor's note: Capital financing is crucial to the normal operation of enterprises, in order to improve the efficiency of capital utilization, reduce financing costs, the situation of capital borrowing between related enterprises is more common, some groups of companies also through the establishment of capital pools to enhance the liquidity of internal funds, minimize the cost of external borrowing. From a tax perspective, the borrowing behavior between enterprises involves the recognition of interest income of one party and the cost of the other party, in order to prevent the use of capital borrowing between related parties for profit transfer, illegal cost deduction, the tax authorities are usually based on the principle of deemed sales or arm's length principle of the capital borrowing between related parties to make adjustments, and some enterprises have "one in and one out of a borrowing mode between related parties". Some enterprises have the improper understanding that "the lending mode between related parties does not involve tax obligations, and the gratuitous lending without obtaining actual income is not subject to tax", which leads to the consequences of paying back taxes, charging late fees and even characterizing tax evasion. This paper analyzes the pre-tax deduction of interest cost under interest-free lending between related parties and compensated lending and the tax risk of individual shareholder's borrowing from practical cases and puts forward preventive and responsive suggestions for readers' reference.

Risk 1: Non-declaration of tax on interest-free borrowing between related companies, and the tax bureau's demand for additional tax payment, late payment charges and even tax evasion.

(I) Case: tax-related risks of interest-free lending among affiliated companies.

Case 1: The group company borrowed money without interest through the capital pool, and paid nearly 40 million yuan in back taxes and late payment fees.

Group company A is a high-tech enterprise, M and N are its subsidiaries, and B is a related enterprise of A. In order to reduce the financing cost of A company, it is necessary for the group company to pay the tax on the borrowing of funds at interest. In order to reduce the financing cost of affiliated enterprises, Company A set up a capital pool for capital operation, and centralized the funds of its subsidiaries and affiliated enterprises to the account of its head office, which was used for market operation and purchased financial products to benefit from, and at the same time, by virtue of its goodwill, it issued commercial bills of exchange to its affiliated enterprises through a number of banks, and before the expiration of a batch of commercial bills of exchange, Company A continued to issue new commercial bills of exchange, and requested the company to which the bills of exchange were issued to repay the previous bills of exchange by discounting them. tranche of bills of exchange.From May 2019 to May 2023, Enterprise A successively issued commercial bills of exchange totaling $6,138 million to Company M, Company N and Company B. The IRS found that Enterprise A had issued commercial bills of exchange totaling $6,138 million to Company M, Company N and Company B. Upon inspection, the tax department found that Company B was not a unit within the group, and that both the capital injection by Company B into the capital pool of Enterprise A and the provision of gratuitous funds by Enterprise A to Company B should be taxed as if they were sales, and the interest income between Company A and its affiliates had not been actually paid, and no income had been recognized and declared for tax purposes in accordance with the interest rates of similar loans for the same period. Under the counseling of the tax department, Company A paid VAT and its surcharges, enterprise income tax, stamp duty and other taxes and late fees of RMB 38,728,700; Company B paid VAT and its surcharges, enterprise income tax, stamp duty and other taxes and late fees of RMB 4,849,000 on its own.

Case 2: Providing interest-free loans to affiliated companies without declaring and paying VAT, characterized as tax evasion and imposed a fine

During the production and operation period from May 2016 to December 2022, an enterprise borrowed 1.9 million yuan to an individual, Zheng Moumou, without interest, and 3.6 million yuan to an affiliated company, Certain Industrial Company Limited, without declaring the payment of VAT for deemed loan services in accordance with the regulations, resulting in the underpayment of value-added tax (VAT) of 90,283 yuan, urban maintenance and construction tax (UMCT) of 6,319.80 yuan, and surcharge on education fees of 2,708.47 yuan, In February 2024, the Audit Bureau characterized the enterprise's failure to declare and pay tax as tax evasion and imposed a fine of 50% of the stolen VAT and urban maintenance and construction tax.

(II) Clarifying the definition of "unit within an enterprise group" and focusing on the VAT obligation of interest-free loans and credits

According to the Notice on the Comprehensive Pilot Program of Business Tax to Value-added Tax (Cai Shui [2016] No. 36), the provision of capital borrowing services by enterprises to other units belongs to the lending services under the financial services tax item, and for the provision of services without compensation and not for public welfare, nor for the public, it shall be treated as a sale for the payment of value-added tax. Therefore, the gratuitous lending of funds between related enterprises shall be treated as sales and subject to VAT.

Exceptionally, according to the Circular of the Ministry of Finance and the State Administration of Taxation on Clarifying the Policies on Exemption from VAT for Nursing Care Institutions and Other Policies (Cai Shui [2019] No. 20, hereinafter referred to as "Circular No. 20"), from February 1, 2019 to December 31, 2020 (which has been extended to December 31, 2027), the VAT payable on loans of funds between units (including enterprise groups) of enterprise groups shall be deemed to be sales. (including enterprise groups) shall be exempted from VAT on the gratuitous lending of funds between units (including enterprise groups). What is a "unit within an enterprise group"?

The current tax policy does not provide for "units within an enterprise group", and the Measures for the Administration of Enterprise Group Finance Companies, which came into effect on November 13, 2022, stipulates that "an enterprise group refers to a group of companies registered according to the law within the territory of China, which is organized by a group charter with capital as the link, parent and subsidiary companies as the main body, and the group's constitution as the common code of conduct, and which consists of a group of companies with the capital of the group as the main body. Group charter as a common code of conduct, by the parent company, subsidiaries, shareholding companies and other members of the enterprise or organization jointly composed of the enterprise legal entity". In practice, the tax department usually identifies enterprise groups mainly through the following criteria: first, enterprise groups approved and registered by the market supervision department; second, after the "Decision of the State Council on Cancellation of a Batch of Administrative Permits and Other Matters" (Guo Fa [2018] No. 28) cancels the approval of the registration of enterprise groups, the parent company of the enterprise group, in accordance with the requirements of the market supervision department, will make the name of the enterprise group and information of the members of the group known to the public through the national Enterprise Credit Information Disclosure System to the society of the enterprise group. Therefore, if the associated enterprises intend to apply the preferential policy of VAT exemption for interest-free borrowing, they should pay attention to whether they meet the definition of "unit within an enterprise group", and if they meet the conditions, they should make additional public announcements on the information disclosure system in a timely manner, so as to avoid the risk of paying back taxes and charging late payment fees.

(III) Can interest-free lending of funds between related enterprises be characterized as tax evasion without income?

The loan of funds between group companies usually takes the form of gratuitous, due to the lack of actual income, some enterprises ignored the tax issues, leading to the risk of tax reimbursement and late charges or even the characterization of tax evasion. In fact, from the point of view of enterprise income tax, one of the related parties will recognize the interest income, and the other party will charge the cost according to the regulations, which will not result in the loss of tax in the case that the actual tax burden of both related parties is the same; and in terms of value-added tax (VAT), one of the related parties, not belonging to the exempted situation of the enterprises within the group, shall pay VAT on the interest income, and the tax authorities will ask the enterprises to make up for the payment in accordance with the deemed sales.

In the case of gratuitous lending of funds by related enterprises, the tax authorities may adjust the related transaction according to the market fair interest rate from the perspective of special tax adjustment and require the lender of the funds to make up for the payment of EIT and add interest, which does not involve the recovery of VAT and the characterization of tax evasion; and from the perspective of general tax inspection procedure, the tax authorities may require the lender of the funds to pay VAT from the perspective of "deemed sales" of EIT and VAT. The tax authorities may start from the perspective of "deemed sales" of enterprise income tax and value-added tax, and consider that the lender of funds has the behavior of providing services without compensation, which should be regarded as sales, and require the enterprise to pay the value-added tax and enterprise income tax and charge late fees, or even characterize the tax evasion and impose a fine as in the previous case two. Although there is no provision specifying that the domestic related transactions are not applicable to special tax adjustment, according to the author's observation, the current practice for domestic related transactions are less likely to start the special tax adjustment procedure, the tax authorities generally use the "deemed sales" and refer to the principle of arm's-length transactions to require enterprises to make tax adjustments.

In practice, for the related-party fund borrowing and lending transactions in line with the VAT exemption of No.20, the enterprises can claim that "the transactions between related parties in the territory with the same actual tax burden, as long as the transactions do not directly or indirectly lead to the reduction of the overall tax revenue of the country, in principle, no special tax adjustment" as the reason for the tax inspections. In principle, no special tax adjustment shall be made", so as not to adjust the enterprise income tax and impose late payment fees, and the transaction shall not be characterized as tax evasion because it has not caused any tax loss; for the cases that do not comply with the circumstances of VAT exemption, the related enterprises shall pay attention to the VAT tax obligation when they carry out the interest-free lending of funds and guard against the risks of tax reimbursement, late payment fees or even the risk of being characterized as tax evasion.

Risk 2: Excessive deduction of interest expenses on loans by related enterprises, risk of paying additional tax and late payment fees

(I) Under what conditions can interest expenses of associated enterprises be deducted?

The Regulations for the Implementation of the Enterprise Income Tax Law provide for a limit on the pre-tax deduction of interest expenses, and the interest expenses incurred by enterprises in business activities (among non-financial enterprises) not exceeding the interest rate of the same type of loans in the same period of time of the financial enterprises are allowed to be deducted before tax, i.e., "interest rate limitation". In order to prevent related enterprises from violating the pre-tax deduction of interest expenses and transferring profits, the "Enterprise Income Tax Law" and the "Notice on Relevant Tax Policy Issues Concerning Pre-tax Deduction Standards for Interest Expenses of Related Parties of Enterprises" (Cai Shui [2008] No. 121, hereinafter referred to as "No. 121") further restrict the percentage of pre-tax deduction of interest expenses for related enterprises, and "the percentage of pre-tax deduction of interest expenses for related parties of enterprises". The ratio of pre-tax deduction for interest expenses of affiliated enterprises is further restricted by the Circular on the Tax Policy Issues Relating to the Standard for Taxation of Interest Expenses of Affiliated Enterprises (Cai Shui [2008] No. 121), which states that "interest expenses incurred by an enterprise in respect of a ratio of creditor investments to equity investments received from its affiliates in excess of the prescribed standard shall not be deducted in calculating its taxable income", i.e., the "principal restriction". For the non-financial enterprises, the ratio is 2:1, and for the pre-tax deduction in excess of the interest rate and principal limit, the enterprises will face the risk of paying additional tax and late payment fees, and even be held liable for tax evasion on the grounds of "over-listing of expenditures".

But at the same time, based on the principle of truthfulness, relevance and reasonableness of pre-tax deduction for enterprise income tax, No.121 stipulates that interest expenses of related enterprises are allowed to be deducted according to the actual situation, "If an enterprise can provide relevant information in accordance with the relevant provisions of the Tax Law and its implementing regulations and prove that the relevant transaction activities are in line with the principle of independent transaction; or if the actual tax burden of the enterprise is not higher than that of the domestic related party, its actual payment will be deducted according to the actual situation. domestic related parties, its actual interest expenses paid to domestic related parties shall be allowed to be deducted when calculating taxable income", i.e., attention should be paid to the principle of independent transaction and the actual tax burden between related parties.

In compliance with the proof of independent transaction principle, the related enterprises need to provide relevant information to confirm the reasonable commercial purpose of its capital lending and interest expenses, such as interest payments to the related party can provide its use of the borrowing obtained for the operation of the cash flow materials, pay attention to its own whether there are a large number of related receivables, or other receivables not yet received, accrued income not yet accrued to the enterprise losses and other behaviors. As for the actual tax burden, there is a view that in the case where the nominal tax rates of both parties to the transaction are the same and one party does not have any tax deduction or favor, the actual tax burden is the same; while there is a view that whether one party to the transaction has any unrecovered losses should also be considered. In the author's view, under the premise of safeguarding the overall tax revenue of the country not to be lost, judging "the same actual tax burden" according to the conditions of the same nominal tax rate and no unilateral tax concessions is conducive to reducing the enforcement costs of the tax authorities, and helping to maintain the stability of the connected transactions and improve the efficiency of the market operation.

(II) the new company law to reduce the registered capital of the company, the related party interest expenses pre-tax deduction should pay attention to the changes in the debt to capital ratio

The new Company Law, which will come into force on July 1 this year, makes it clear that "all shareholders' contributions shall be paid in full by the shareholders in accordance with the provisions of the articles of association within five years from the date of incorporation of the company", which applies to newly established companies and stock companies. For enterprises with capital reduction plans, they should pay attention to the changes in the debt-to-capital ratio of the affiliated enterprises after the capital reduction. For example, Company A originally accepted the equity investment of Company B, an affiliated enterprise, amounting to RMB 20 million, and under the debt-to-capital ratio of 2:1, the pre-tax deduction of interest expenses on borrowings from Company A to Company B is limited to RMB 40 million; if Company A carries out a capital reduction and the amount of the equity investment of Company B is reduced to RMB 10 million, then the corresponding deductible principal amount will be reduced to RMB 1 million, and the corresponding deductible principal amount will be reduced to RMB 1.5 million. million yuan, the corresponding deductible principal limit changes to 20 million yuan.

Risk 3: Shareholders borrowing from the company should pay attention to the return period to prevent the risk of tax reimbursement for the distribution of deemed dividends and bonuses

(I) Case: shareholder borrowing as deemed dividend distribution, the enterprise was penalized for failing to withhold and pay tax on its behalf

Company A lent its own funds of RMB193,363,636 to its individual shareholders, Huang and Yang, for free during the period from 2019 to 2020 without recognizing the interest income from the deemed sales calculation, resulting in underpayment of value-added tax (VAT) and surtax. Huang Mou and Yang Mou did not return the loan at the end of the tax year, and the loan was not used for the production and operation of Company A. The unreturned loan at the end of the tax year should be regarded as dividend distribution by Company A to Huang Mou and Yang Mou, and individual income tax was levied in accordance with the item of "Interest, Dividend and Bonus Income". The tax authorities for company A should be deducted without deduction of Huangmou, Yangmou's personal income tax behavior to be deducted without deduction of 50% of the tax fine.

(II) How to prevent the tax-related risks of shareholders' loans?

In order to combat the behavior of shareholders in the form of borrowing to cover the distribution of profits to evade the payment of individual income tax, the Circular on Regulating the Administration of Individual Income Tax Collection of Individual Investors (Cai Shui [2003] No. 158, hereinafter referred to as "No. 158") stipulates that shareholders' borrowing is regarded as distribution of profits. "If an individual investor borrows money from an enterprise (other than a sole proprietorship or partnership) in which he has invested during the taxable year, and neither returns it nor uses it for the production and operation of the enterprise after the end of the taxable year, the unreturned borrowings may be regarded as dividend distribution from the enterprise to the individual investor and be taxed as individual income in accordance with the item of 'Income from Interest, Dividends, and Bonus Dividends'. Income from Interest, Dividends and Dividends' shall be taxed under the item of 'Income from Interest, Dividends and Dividends'."

The application of Article 158 in practice is quite controversial, one is whether the scope of "individual investor" regulated by it includes the family members of the shareholders. In practice, there are cases where individual shareholders obtain loans from the company in the name of their family members, and some tax authorities expand the scope of "individual investor" to include the family members of the shareholders. Some tax authorities expand the scope of "individual investor" and consider that if the family members of the shareholders borrow money from the company, which is not used for the production and operation of the company and is not returned before the end of the taxable year, it shall be regarded as the distribution of dividends and bonuses to the shareholders, and the individual income tax shall be levied on the shareholders. Secondly, "tax year" refers to the statutory tax year (from January 1 to December 31 of the Gregorian calendar) or the time span of "one year", "State Administration of Taxation on the issuance of <Methods for Administration of Individual Income Tax> Notice" (State Taxation [2005] No. 120) stipulates that "the tax year" shall be the year of tax payment. No. 120) stipulates that "individual investors shall strengthen the management of borrowing from their investment enterprises, and shall be taxed in strict accordance with relevant regulations for borrowings with a term of more than one year that have not been used for the production and operation of the enterprises", which adjusts the concept of "tax year" to the term of "one year", and the time span of "one year". "One year", but in practice there are still tax authorities in accordance with the statutory tax year, for individual shareholders borrowing at the end of the year, from the following year there is a greater risk of paying back taxes.

The author suggests that shareholders, whether in their personal name or in the name of a family member from the company to obtain loans, should pay attention to the borrowing period, try to avoid borrowing across the year; at the same time, if the shareholders borrowed money for the company's production and operation, should also retain relevant materials to prove the use of funds, such as relevant purchase and sales contracts, warehouse receipts, travel documents, and so on. Enterprises should also pay attention to the borrowing period of shareholders, make timely tax adjustments and fulfill the withholding obligations.

(III) Can shareholders who return the borrowed funds after the end of the tax year request a refund of the paid tax?

In practice, the shareholders borrowed from the company at the end of the tax year has not been returned, according to the law to pay personal income tax, but in the subsequent tax year and return the borrowed money can apply for a refund of tax disputes, the caliber of the law enforcement around the controversy, such as the "Hebei Provincial Bureau of Local Taxation on the Qinhuangdao Municipal Bureau of individual investor borrowing the collection of personal income tax on the issue of the request for instructions" (Ji Di Shui letter 〔2013〕 No. 68) clearly that "the personal income tax already levied in accordance with 'interest, dividend and bonus' shall be refunded or deducted from the personal income tax payable in the future if an individual investor returns a loan of more than one year obtained from the enterprise in which he invested"; while some places make the opposite provision, arguing that it shall not be refunded. provisions that no refund shall be made, such as the Announcement of the Guangxi Zhuang Autonomous Region Taxation Bureau on Clarifying Certain Issues on Individual Income Tax (Announcement of the Guangxi Zhuang Autonomous Region Taxation Bureau of the State Administration of Taxation No. 9 of 2018), which clarifies that "the individual income tax levied by an individual investor of an enterprise, a member of the investor's family, or other persons of the enterprise who borrows money from the enterprise across the year, although the borrowing, after the tax has been imposed has been returned, the tax obligation of the act has already occurred and the tax levied will not be refunded".

In the author's opinion, from the perspective of substantive taxation principle, the taxation of income tax is based on the income obtained by the taxpayers, the shareholders returned the loans and actually did not obtain the income, and the taxation basis of individual income tax based on deemed profit distribution has been lost, and the non-refund of the tax paid by the shareholders on their acquisition of the loans as deemed distribution of profits will result in the mismatch between the shareholders' tax obligations and their income obtained, which is not in line with the principle of quantitative taxation and tax fairness, therefore, in this case, the tax obligation will not be refunded. Therefore, under such circumstances, the shareholders should have the right to request for tax refund, and the tax authorities should refund the tax or allow it to be deducted from the personal income tax payable in the future.