3. DEDUCTIBLE EXPENSES
All expenses can be classified into revenue or capital nature. The capital nature expenses can only be deducted through depreciation and amortization over a number of years specified by the tax authority. The general rules is that revenue expenses incurred in the course of carrying on the business, such as cost of goods sold. taxes on sales, non-operational gains/losses, selling expenses, administrative expenses and financial expense. They are deductible in computing taxable income. They include:
3.1 Cost of goods sold
It includes manufacturing cost, transportation cost, consumption tax, custom duty, resource tax and non-deductible value added tax. The valuation method of issuing goods can be first-in-first-out, weighted average, moving average, standard cost or retails sales method. The taxpayer can choose any one of the methods and it should be consistently applied. Any change in the valuation method should be approved by the tax authority.
3.2 Taxes on sales
It includes consumption tax, business tax, resource tax, custom duty, education surcharge, city maintenance and development tax.
3.3 Non-operational loss
It includes investment loss, loss on the disposal of fixed assets and intangible assets.
3.4 Selling expenses
It includes advertising, transportation of finished goods to the buyers, agency fee, packaging, exhibition fee, insurance, the traveling expenses, wages and salaries of sales department
3.5 Administrative expenses
It includes the amortization of intangible assets and pre-operating expenses, depreciation of office furniture and fixture, provision or write off of bad debts, stamp duty, audit fee, legal fee, research and development expenses, social security payment, entertainment, staff training, wages and salaries of administrative development, expense of board of directors meeting and investors¡¯ meeting.
@A company calculates the provision of bad debts, the collectable debtor balance is RMB5,000,000, collectable bill balance is RMB400,000, receipt in advance balance is RMB200,000 at the end of the year. Calculate the allowable deduction of the provision of bad debts for the year.
The collectable debts include the amount of collectable bills at the end of the year, so the allowable deduction of the provision of bad debts to the taxable income for the year (5,000,000 + 400,000) x 5% RMB27,000
3.6 Financial expense
It included the net interest expense, exchange gain or loss, bank charges and other financial handling charge.
For interest, the maximum allowable amount is the loan with interest rate not higher than the rate offered by the commercial banks for the same length of loan period and the similar degree of risk.
Some special cases for paying attention:
The interest for borrowing money to invest should be capitalized into the cost of investment.
If the money borrowed from the related company is more than 50% of the taxpayer’s registered capital, the interest in relation to the excess portion is not deductible.
For property developer, the interest incurred before the completion of the property should be capitalized as the cost of development.
Interest incurred during the pre-operation period should be capitalized as pre-operation expense.
3.7 Wages and salaries
The allowable wages and salaries is RMB 800 per month per person. There is a 20% upward for some developed areas. It includes the basic wages, bonus, allowance and overtimes. For an approved software enterprises, the full amount of actual wages and salaries payment are deductible.
3.8 Staff benefits
The provisions for trade union fund and workers education fund that are equivalent to 2% and 1.5% of the total allowable wages and salaries respectively are tax allowable. The deductible amount for staff welfare is the actual amount incurred. The staff welfare refers to the recurring staff welfare e.g. medical expense. It is tax allowable for all the contribution paid to the compulsory social security funds according to the relevant rules, e.g. retirement fund, unemployment fund, etc.
3.9 Entertainment expense
The maximum allowable is the lower of the actual amount and the amount per the following table. All the excess are not allowable and cannot be carried forward.
a An enterprise's annual sales income is RMB55,000,000, sales discount is RMB300,000, sales returns RMB100,000, other business income RMB 1,500,000, and how much is deductible amount for the year.
(55,000,000 + 1,500,000-300,000- 100,000) x 3% + 30,000 = RMB 198,300 (note 1)
3.10 The actual write off of fixed assets or current assets is allowable after the tax bureau's approval. However it should be noted that the input VAT associated with the inventory written off should be deductible under income tax but not to be set off the output VAT.
3.11 If the taxpayer can provide the documents issued by the headquarter concerning the scope, the basis and the method of allocation of the central administrative expenses, the share of headquarters¡¯ administrative expenses is tax allowable after the approval from the tax bureau. The maximum deductible is 2 % of the total income.
3.12 Research and development (R&D) expenses for new product / new technology / new method. It includes the research staffs¡¯ wages and salaries, depreciation of machinery, material cost, designing fee, etc. and is tax allowable. For nationalized and collectively owned enterprise, if the current R&D expenses is more than 10% of the last year's figure, it is 150% of the current year’s R&D that can be tax deductible. However, the extra 50% deduction is not allowed for the enterprises suffering losses during the current year. If after the extra 50% deduction, there is a loss suffering for the year, the net loss cannot be carried forward.
3.13 The expenses for transfer of fixed assets are allowable.

Annual turnover (in RMB) Allowable % (Fast addition factor)
The portion equal or below 15 million 0.5% (0)
The portion exceeding 15 million 0.3%(RMB3O,000)

3.14 Advertisement expense
Advertisement that used for the business operation can be classified into two types:
(a) Advertisement expense through the media:
The maximum allowable limit of 2 % of turnover (8% for the industries of pharmaceutics, food, home electric appliance, telecommunication, software development, integral circus, property development, sport and culture, etc.) is generally allowed and the exceeding part can be carried forward without time limit. The taxpayer may apply to the State Administration of Taxation for the higher percentage of deduction.
The advertisement expense incurred by enterprise in white wine industry is non tax deductible. To encourage the high technology industry, the advertisement expenses incurred in the first 5 years after the establishment of the enterprise in the industry of soft development, integral circus, Internet, venture capital can be fully deducted without limitation. After the first 5 years, the above rule of 8% applies.
To be deductible, the advertisement should be:
produced by the unit approved by the Commercial and Industrial Bureau.
paid and the legitimate invoice thereof is obtained.
conducted through the media.
(An white wine production collectively owned enterprise has RMB 18,000,000 turnover in the year of 2001, cost of sales RMB7,000,000, sales tax and surcharge are RMB5,000,000, all other costs RMB4,500,000. The costs above include RMB900,000 for research and development expenses for new product (the current R&D expenses is 20% more than last year’s), and advertisement expense of white wine RMB600,000. Calculate the income tax payable for the enterprise.
The current R&D expenses is more than 10% of the last year’s, therefore 150% of the current year’s R&D can be tax deductible. Advertisement expense of white wine cannot be deducted before tax. So, the taxable income for the year = 18,000,000 - 7,000,000-5,000,000- 4,500,000 -(900,000 x 50%) + 600,000 = RMB 1,650,000, the tax payable for the year = 1,650,000 x 33% = RMB544,500
(b) For others not satisfying all the above condition, it should be classified as promotion expenses.
Advertisement expenses not conducted through the media or promotion expenses The maximum limit is 0.5% of turnover and the exceeding part is neither deductible nor carried forward.
@An industrial enterprise had income RMB38,000,000 for the first year, advertisement expense RMB 1,000,000 and promotion expense RMB400,000. The income in second year was RMB42,000,000, advertisement expense RMB800,000 and promotion expense RMB200,000. Calculate the allowable deduction for advertisement expense and promotion expense for the second year.
It had RMB 1,000,000 of advertisement expense in the first year, the allowable deduction limit = 38,000,000 x 2% = RMB76O,000. The exceeding part of RMB24O,000 cannot be deducted in first year but can be carried forward without time limit. For promotion expense RMB400,000, the allowable limit = 38,000,000 x 5% = RMB 190,000, the exceeding part ofRMB21O,000 is neither deductible nor carried forward.
In the second year, it had RMB 800,000 of advertisement expense, the allowable deduction limit = 42,000,000 x 2% = RMB84O,000. The unused portion of RMB4O,000 can be deducted by using the brought forward RMB24O,000 from the first year. The allowable deduction for the advertisement expense for the second year = 800,000 + 40,000 = RMB84O,000; for promotion expense RMB200,000, allowable deduction = 42,000,000 x 5% = RMB2 10,000, the unused portion cannot be deducted, so the allowable deduction for promotion expense is RMB200,000. Therefore, the total amount of allowable deduction for advertisement expense and promotion expense for the second year = 840,000 + 200,000 = RMB 1,040,000
3.15 Purchase of domestic made machinery
The enterprises can claim back 40% of the cost for purchase of domestic made machinery that used in the upgraded technology projects approved by the government if the income tax is higher than the preceding year.
If the deductible cannot be fully be used up in the current year, the exceeding portion can be used in the following next 5 years if the income tax of each year in next 5 years is higher than that of immediate preceding year.
For an example, enterprise purchased qualified machinery in year 2 for RMB 200, 000 and the income tax of that year is RMB 100, 000. The income tax for year 1, year 3 and year 4 are RMB 80,000, 90,000 and 160,000 respectively. The allowable amount = 200,000 x 40% = RMB8O, 000
3.16 Sponsorship to unrelated research institutes
The sponsorship to unrelated institutes is allowable with full amount but if it results in a loss, the loss cannot be carried forward. The unrelated institutes refer to the approved institutes and the results of the research are not exclusively to the donor.
3.17 Traveling, conference and board of directors meeting

Income tax Additional Used up Final income tax
Year 1 80,000 -- -- 80,000
Year 2 100,000 20,000 20,000 80,000
Year 3 90,000 10,000 10,000 80,000
Year4 160,000 80,000 50,000 110,000

The reasonable amount of above cost with supporting can be fully deducted.
3.18 Commission
The commission paid must be legitimate with supporting. The payee must have the right to provide service within his business scope and if the payee is an individual, h cannot be the employee of the taxpayer and the amount is limited to 5% of the service amount.
3.19 Membership fee
Membership fee paid to the approved trade union, association and academic club is
allowable.
3. 20 Bad debt provision
The allowable general bad debt provision is limited to 0.5% of the year-end balance of accounts receivable. The actual bad debt incurred is allowable upon approval.