Since the Ministry of Finance made arrangements to carry out special inspections of accounting information for 77 pharmaceutical companies on May 23, tax issues in the pharmaceutical industry have become the focus of public attention. The document stipulates that local regulatory bureaus and finance departments (bureaus) should submit pharmaceutical enterprise inspection materials to the Ministry of Finance before August 30. Issues such as sales expenses, cost accounting, and income authenticity have become the focus of recent inspections of the pharmaceutical industry. Recently, Director Liu Tianyong of Hwuason was interviewed by China Tax News and expressed his professional opinions on the tax risks hidden in the "new developments" such as the large reduction of stock holdings and high financial expenses in the pharmaceutical industry.

There are many stocks to reduce, high financial costs, and large e-commerce retail scale...

"New developments" of pharmaceutical companies hide tax risks

Source: China Tax News Reporter: Qin Weiyingzhao August 23, 2019

The "new developments" of pharmaceutical companies, such as the frequent reduction of stock holdings, high financial costs and the gradual increase in the scale of e-commerce retail business, conceal tax risks and require pharmaceutical companies to pay more attention and strengthen management. When it comes to the upcoming August 30, many pharmaceutical companies are very nervous. In accordance with the relevant requirements of the Ministry of Finance, the inspection materials for the 2019 pharmaceutical industry accounting information quality inspection will be submitted to the Ministry of Finance before August 30. Reviewing sales expenses, revenue, and cost accounting has become the focus of pharmaceutical companies in recent times.

Reducing stock holdings: different tax calculation methods for different shareholders

According to statistics from Oriental Fortune Choice, from January 1, 2019 to August 20, 2019, more than 60 listed pharmaceutical and biological companies issued announcements on the reduction of holdings by major shareholders.

Reduction of holdings by major shareholders refers to the stock selling behavior of the listed company's major shareholders of tradable shares in compliance with the "Guiding Opinions on the Transfer of Existing Shares of Listed Companies on Lifting Sales Restrictions" and making timely information disclosures. Liu Tianyong, director of Hwuason Law Firm, analyzed that major shareholders generally reduce their holdings after the lifting of the ban. From the perspective of entities, major shareholders of listed pharmaceutical companies can be divided into three types: enterprises, partnerships and individuals. Different types of shareholders may reduce their shareholdings, and the tax treatment issues involved may be different. ​

According to Liu Tianyong, if the shareholder is an enterprise, when the restricted shares of the listed company are reduced after the ban is lifted, the investment income from the reduction should be calculated and the corporate income tax should be calculated and paid. If the shareholder is an individual, it is necessary to distinguish whether it is a restricted stock that is subject to personal income tax, or a shareholding reduction transfer that enjoys personal income tax exemption. If the stocks being reduced are restricted shares, the relevant provisions of the "Notice of the Ministry of Finance and the State Administration of Taxation on Issues Concerning the Collection of Personal Income Tax on Income from Individuals Transferring Restricted Shares of Listed Companies" (Caishui [2009] No. 167) and subsequent documents must be followed. Income from property transfer is subject to a 20% proportional tax rate to calculate and pay personal income tax. Individual transfers of restricted shares are carried out through a combination of securities company withholding and individual liquidation. ​

Hao Longhang, founder of Beijing Dali Shuishou Information Technology Co., Ltd., said that if the shareholder is a partnership, the types of partners need to be distinguished for processing. If the investor of the partnership is an individual, according to the provisions of the "Notice of the Ministry of Finance and the State Administration of Taxation on Income Tax Policies for Individual Partners of Venture Capital Enterprises" (Caishui [2019] No. 8), if the venture capital enterprise chooses a single fund for investment fund accounting, its other Individual partners can calculate and pay personal income tax at a tax rate of 20%; if they choose to calculate the annual income as a whole, their personal partners should calculate and pay personal income tax based on "business income" at an excess progressive tax rate of 5% to 35%. If the partners of a partnership are the entities paying corporate income tax, they must calculate and pay corporate income tax in accordance with regulations.

Hao Longhang reminded that no matter what type of shareholder they are, when a shareholding reduction occurs, they still need to calculate and pay value-added tax and surcharges based on the transfer difference, and pay stamp tax on securities transactions.

Financial expenses: can be deducted before tax only if they meet the regulations

The annual report of N Pharmaceutical Company, a listed pharmaceutical company, shows that at the end of the reporting period, the company's monetary fund balance was 2.265 billion yuan, the balance of short-term borrowings was 3.035 billion yuan, and the balance of other current liabilities was 3.168 billion yuan. Financial expenses this year were 348 million yuan, accounting for 131.82% of net profit. In response, the Shanghai Stock Exchange issued a letter of inquiry, requiring Company N to provide additional disclosures on the reasons and rationality of the higher financial expenses.

Financial expenses refer to the expenses incurred by an enterprise to raise funds required for production and operation, etc., mainly including net interest expenses, net exchange losses, financial institution fees and other expenses incurred in raising funds for production and operation, etc. In this regard, Han Xinyong, deputy director of finance and taxation of Sykes Biotechnology Co., Ltd., reminded that although the industry has generally focused on the issue of excessive sales expenses in the pharmaceutical industry in recent times, whether financial expenses are compliant and reasonable , whether the accounting is accurate should also attract the attention of pharmaceutical companies.

Hao Longhang said that in accordance with the provisions of the Enterprise Income Tax Law and its implementation regulations, the interest expenses incurred by non-financial enterprises in borrowing from financial enterprises, the issuance of bonds by enterprises upon approval, and the borrowings by non-financial enterprises from non-financial enterprises shall not exceed the amount incurred by financial enterprises in the same period. Interest expenses calculated on similar loan rates can basically be deducted before calculating corporate income tax. Accordingly, listed pharmaceutical companies with relatively high financial expenses must pay close attention to whether the borrowing interest rate complies with relevant regulations and obtain corresponding deduction certificates in compliance with regulations to determine the year at which the deduction is due. What companies need to pay attention to is whether the above-mentioned interest expenses are appropriately capitalized and expensed.

Liu Tianyong reminded that if the accounting treatment of financial expenses is inaccurate, the company is likely to face the risk of tax adjustment. For example, Company A, a listed pharmaceutical company, borrowed a loan from another company to build an office building and incurred reasonable borrowing costs. Before the building was completed, Company A included the borrowing costs incurred in the "financial expenses" account and made pre-tax expenditures accordingly. "Such an accounting treatment is obviously inappropriate." Liu Tianyong said.

Liu Tianyong analyzed that the "Accounting Standards for Business Enterprises" stipulate that the cost of self-constructing fixed assets consists of the necessary expenditures incurred before the asset reaches its intended usable state. The "Enterprise Income Tax Law" and its implementation regulations stipulate that for self-built fixed assets, the tax calculation basis shall be the expenditure incurred before completion and settlement. Reasonable borrowing costs incurred by an enterprise in its production and operation activities that do not require capitalization are allowed to be deducted. If an enterprise borrows money for the purchase and construction of fixed assets, intangible assets and inventories that take more than 12 months to reach the intended salable state, the reasonable borrowing costs incurred during the purchase and construction period of the relevant assets shall be included in the capital expenditures. The cost of the relevant assets shall be deducted before corporate income tax in accordance with regulations. ​

E-commerce retail: Only by paying taxes in accordance with the law can we develop better

Recently, listed pharmaceutical company T Company stated at its 2018 performance briefing that its pharmaceutical e-commerce subsidiary K Company’s sales revenue exceeded 2.1 billion yuan in 2018, accounting for 64% of T Company’s total sales revenue.

Han Xinyong said that nowadays, more and more pharmaceutical companies are developing e-commerce retail businesses by building their own platforms or cooperating with third-party platforms. For listed pharmaceutical companies, e-commerce retail, like offline sales, must adhere to the business philosophy of operating with integrity and paying taxes in accordance with the law. The E-Commerce Law, which came into effect on January 1, 2019, stipulates that e-commerce operators shall perform tax obligations in accordance with the law and enjoy tax benefits in accordance with the law. "Paying taxes in accordance with the law is crucial for listed pharmaceutical companies to carry out e-commerce retail." Han Xinyong said.

Liu Tianyong reminded that listed pharmaceutical companies develop e-commerce retail business through Internet platforms. Those who retail drugs on e-commerce retail platforms should conduct tax treatment in compliance with relevant regulations. However, judging from the cases he has come into contact with, some pharmaceutical e-commerce retail companies still have non-compliant tax treatment. For example, the names of goods recorded on the value-added tax invoices of some pharmaceutical e-commerce retail companies do not match the purchase and sale of goods; some pharmaceutical e-commerce retail companies do not proactively issue invoices if consumers do not ask for them; and some pharmaceutical e-commerce retail companies do not issue invoices to some customers. Cash rebates are provided, but tax treatment is based on sales discounts to offset sales. ​

Liu Tianyong said that almost every business transaction that occurs in the daily operations of listed pharmaceutical companies involves the collection and payment of taxes. These companies must pay attention to the compliance of tax treatment.