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Business> Legal-Ease
UPDATED: December 29, 2006 NO.1 JAN.4, 2007
The Annual Audit (II)
There are a number of areas where you need to take particular care and where there are some differences between Chinese and Western accounting practice

Audit items often queried by Chinese independent auditors

There are a number of areas where you need to take particular care and where there are some differences between Chinese and Western accounting practice. These are guidelines only as every business is different.

Adjustments for foreign-related payment income

If the foreign company has paid any overseas insurance for their expat employees, it should be noted that this is not tax deductible unless it is recorded as a salary payment and with individual income tax paid. Foreign sourced income should be provided for by providing evidence of foreign taxes paid with the relevant foreign documentation. Otherwise, foreign taxes may be accrued by the FIE.

Related party transactions

If your FIE had any transactions with related parties, you must make sure that these were at arms length and with adequate documentation to substantiate the charges/income, so that the results were not materially affected by related party transactions that were not in the ordinary course of business. Pay particular attention to transfer pricing issues. Tax officials reserve the right to adjust transfer prices, interest charged by related parties based on market prices or even based on prescribed profit margin.

Withholding obligations

If the FIE made or accrued in its costs or expenses any payments, such as rental (including office and expat housing), royalty charges, interest, services or management fees for services performed in China by foreigners (individuals or organizations), pursuant to related contracts and agreement, the relevant withholding obligation should be provided for on an accrual basis. This means 10 percent withholding enterprise income tax and 5 percent business tax apply (the tax rate might be different according to each individual case).

Input VAT

The tax bureau must verify the value-added tax (VAT) invoices within 90 days of the invoicing date, otherwise they cannot be deducted. Furthermore, if you have any unusual loss of inventory, then the VAT input related to the inventory previously credited has to be reversed in the period when the loss is recognized.

Export VAT

For FIEs, export VAT refunds for the year should be reconciled with the tax bureaus within three months of the end of the year. FIEs should register all export receivables for the previous year with the bureau.

Stamp duty

Although not a material issue with much cost, FIEs should not forget to pay stamp duty on all books, records and applicable contracts. Fines for non-compliance outweigh the dutiable value.

General accounting treatments on significant audit areas

Trade debtors

Generally speaking, China's GAAP (Generally Accepted Accounting Principles) rules allow enterprises to make a bad debt provision without any percentage limitation. However, there may be tax implications for such debts as well.

Long-term debt investments

Long-term debt investments of FIEs should be recorded at cost and based on the actual payments. Any interest should be accrued based on the face value of the investments and applicable interest rate, and recorded in the amount of "other receivables." The premium or discount on acquisition of the investment needs to be amortized over the holding period under either the straight-line method or the effective interest rate method. Long-term investments that mature within one year need to be reclassified as short-term debt investments.

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