In some lawsuits, specialized financial and tax issues are directly related to the outcome of the case. Once professional opinions are involved, their conclusions often become the focus of dispute between the parties. A case handled by the author originated from the 'Special Audit Report on Business Transactions' which did not recognize 'IOUs' as accounting entries. The enterprise, as an accounting entity, did not make income tax adjustments, but instead adjusted all labor costs that the parties had already reimbursed and recorded but had not obtained compliant invoices for, into a company receivable, treating the expenses involved in the 'IOUs' as 'suspense account' amounts, causing the parties to bear the debt again, thus triggering the dispute. This issue will discuss the content of 'IOUs' in judicial appraisal and auditing, combined with relevant regulations and judicial opinions, to discuss the author's views.

The so-called 'IOU' is a colloquial term, referring to a written note on white paper as a basis for payment. It is a concept relative to invoices, and its connotation refers to a written or recorded note or receipt in the name of an individual or unit, proving the occurrence of business and income and expenditure items, used as an original voucher in the absence of a formal invoice.

I. 'IOUs' Cannot Be Used to Offset Cash but Can Be Entered into Accounts

Many financial personnel confuse the concept of 'IOU offsetting cash' with 'IOU accounting entry', thus believing that IOU accounting entry is also prohibited by financial management. 'IOU offsetting cash' is a financial term, also known as IOU topping cash, which refers to the act of using notes and receipts issued in the name of individuals or units that do not comply with financial systems and accounting voucher procedures to replace cash in the treasury, which is equivalent to putting IOUs into the company's safe as cash. IOU offsetting cash makes the book cash balance higher than the actual cash on hand, resulting in inconsistencies between accounts and reality, which can easily leave room for relevant personnel to squander public funds, embezzle, misappropriate, and engage in malfeasance, which is a serious financial internal control defect and violates cash receipt and expenditure management regulations, and should be strictly prohibited.

"IOU offsetting cash" and "IOU accounting entry" are not the same thing. The former focuses on the cash management system, while the latter emphasizes the authenticity of the original vouchers in the accounting records. For example, if you borrow 10,000 yuan in cash from your company, find some day laborers, pay them, and get receipts, returning these IOUs is considered repayment. Even if you spend this 10,000 yuan yourself and create a receipt to return, the company's cash account may appear balanced, but without a physical cash count, you won't realize that 10,000 yuan in cash is missing. This is called IOU offsetting cash. On the other hand, if you can't obtain a formal invoice and use a receipt from the other party for reimbursement, the finance department verifies it and records this 10,000 yuan IOU as a cost or expense, while simultaneously writing off your 10,000 yuan loan in the books, with a corresponding decrease of 10,000 yuan in the cash balance. This is called IOU accounting entry.

The statement that 'IOUs' cannot be entered into accounts comes from the confusion of the concept of 'IOU offsetting cash' on the one hand, and from concerns about the defects and risks of 'IOUs' in proving the authenticity of business. According to Article 14, Paragraph 3 of the Accounting Law of the People's Republic of China, accounting institutions and accounting personnel must review the original vouchers in accordance with the provisions of the state's unified accounting system, and have the right to refuse to accept untrue and illegal original vouchers, and report to the person in charge of the unit. After all, in addition to having a pair of discerning eyes, financial personnel must also have enough aura to resist pressure to identify the authenticity of the economic business behind the 'IOU'. In order to avoid the responsibility of auditing the authenticity and legality of the original vouchers, it is no wonder that many financial personnel refuse to accept 'IOUs'.

The most basic work of enterprise finance is to truthfully record the various economic transactions of the enterprise. When an economic transaction occurs, accounting treatment must be carried out. According to Article 16 of the Enterprise Accounting Standards—Basic Standards: An enterprise shall conduct accounting recognition, measurement, and reporting in accordance with the economic substance of the transaction or event, and shall not only base it on the legal form of the transaction or event. Accounting is always based on accounting standards and accounting systems. Accounting standards have never stated that accounts cannot be entered or reimbursed without invoices. Therefore, the 'IOUs' mentioned above can of course be used as proof of economic transactions after review.

II. 'IOU' Accounting Entry Is Indeed a Tax Obstacle

What is okay in accounting may not be suitable in tax law. In the case where 'governance by numbers' has not been fully realized, the status of invoices in tax management is still difficult to shake. If an enterprise can obtain an invoice, if it uses an 'IOU' instead of an invoice to enter the account, it can conceal this part of the income without declaring tax, resulting in the loss of state tax revenue. Abuse of 'IOUs' will inevitably endanger the order of tax collection and management.

Therefore, according to tax laws, 'IOUs' face substantial obstacles in value-added tax (VAT) deductions and corporate income tax final settlement (including partnerships, sole proprietorships, and individual businesses' individual income tax final settlement). Let's first consider the VAT aspect. VAT is a chain tax. If you are a link in the chain, as a general taxpayer, you theoretically only incur a capital cost related to the value-added portion of the differential tax and do not actually bear the VAT burden. However, if you cannot obtain input deduction vouchers that comply with tax laws, your role changes from a temporary participant in the VAT chain to the final consumer. Consequently, the VAT burden that could have been passed on to the next party becomes your cost and expense, inevitably reducing corporate profits. Currently, VAT deduction vouchers include, in addition to VAT special invoices, unified motor vehicle sales invoices, customs import VAT special payment receipts, VAT withholding tax payment certificates, agricultural product sales invoices, agricultural product purchase invoices, toll VAT electronic general invoices, bridge and gate toll invoices, domestic passenger transport service VAT electronic general invoices, air transport electronic ticket itineraries with passenger identity information, train tickets with passenger identity information, and other passenger tickets (e.g., road and waterway) with passenger identity information.

Some people say that 'IOUs' will definitely not pass the value-added tax declaration system, and if they cannot deduct value-added tax, they will be treated as cost expenses. In fact, tax laws do not even leave you a chance to take a step back and treat them as cost expenses. Looking at corporate income tax again, Article 9 of the State Administration of Taxation's Measures for the Management of Pre-tax Deduction Vouchers for Enterprise Income Tax (State Administration of Taxation Announcement No. 28 of 2018, hereinafter referred to as Announcement No. 28) stipulates that if an enterprise's expenditure items incurred in China belong to value-added tax taxable items, and the other party is a value-added tax taxpayer who has completed tax registration, its expenditure shall be based on invoices (including invoices issued by tax authorities on its behalf in accordance with regulations) as pre-tax deduction vouchers. This article tells everyone that basically activities involving transactions (except for small and sporadic businesses) cannot be deducted from income tax as cost expenses if invoices cannot be obtained.

Value-added tax is deducted based on invoices (deduction vouchers), and income tax is deducted based on invoices (other deduction vouchers stipulated by tax laws). Tax laws are so strict that even if a business actually occurs, if you cannot obtain an invoice or compliant voucher, in addition to not being able to deduct value-added tax, you are not allowed to deduct it as a cost expense. If you want it, go to a place with invoices to buy it, and get at least a general invoice if you can't get a special invoice. It is no wonder that many financial personnel do not dare to enter 'IOUs' into accounts when they encounter them. The questioning of the legality of 'IOUs' actually comes from the thinking of tax laws. However, we must recognize that tax laws do not allow 'IOUs' to be deducted before tax, but they do not prohibit 'IOUs' from being entered into accounts. No one will stop you if you are willing to pay more taxes, but it is illegal to use 'IOUs' for tax declaration.

3. "IOUs" Entering into Accounts Has Room for Rectification in Taxation

Some "IOUs" genuinely cannot obtain invoices or vouchers recognized by tax law, so honestly pay taxes. However, for some business transactions where "IOUs" actually occurred, there is still room for rectification in taxation.

Regarding VAT, if you later obtain a special VAT invoice or deduction voucher from the upstream supplier of the real transaction, you can use it for deduction in the month it is obtained. There is theoretically no time limit for reissuing, but the VAT rate should be the original one. According to Article 2 of the "Announcement of the State Taxation Administration on Relevant Matters Concerning Deepening VAT Reform" (State Taxation Administration Announcement No. 14 of 2019), if a taxpayer needs to reissue a VAT invoice for a VAT taxable sales act for which a VAT invoice was not issued before the VAT rate adjustment, it shall be reissued at the original applicable tax rate.

In terms of corporate income tax, "Announcement No. 28" clarifies the remedial measures for pre-tax deduction of "IOUs" and other illegal vouchers. First, before the final settlement, if the other party reissues or exchanges invoices or other external vouchers, they can be deducted before tax; if the other party cancels, is identified as an abnormal household by the tax authority, or other special reasons make it impossible to reissue or exchange, with special reason certification materials, business contracts, non-cash payment vouchers, warehousing vouchers, accounting records, etc., they can be deducted before tax. Second, after the final settlement, if the tax authority informs them to reissue or exchange compliant invoices or other external vouchers within 60 days, they can be deducted; if special reasons of the other party make it impossible to reissue or exchange, relevant materials that can prove the authenticity of their expenditures according to Article 14 of these measures shall be provided within 60 days from the date of notification by the tax authority, and they can be deducted. Third, if they are not notified by the tax authority after the final settlement, and invoices or other external vouchers that should have been obtained in previous years have not been obtained, and the corresponding expenditures have not been deducted before tax, the corresponding expenditures can be retroactively deducted before tax in subsequent years, but the retroactive period shall not exceed five years.

Returning to the case handled by the author, the purpose of this "Special Audit" is to verify the unit's business dealings, rather than to evaluate the company's tax declaration. In the absence of other evidence to prove that the economic business is not genuine, the audit report should not deny the economic business behind the "IOU" due to tax illegality. "IOU" entry emphasizes the recognition of the authenticity of economic business, and does not stick to the external form of "IOU". Even the agency-issued invoice recognized by the unit also belongs to "IOU". Although tax is illegal and even suspected of false issuance, taxation and finance cannot be confused. It cannot be concluded that the relevant economic business did not occur. For enterprises that initially accepted "IOU" entry and are responsible for the custody of accounting vouchers, if they now want to deny the authenticity of the economic business behind the "IOU", and also prove that they recognized the "IOU" due to involuntary reasons such as being deceived or coerced, they should bear a higher burden of proof. It is by no means possible to get away with a sentence that the finance department did not understand the business or the original vouchers were missing.

4. Relevant Judicial Opinions

When evaluating the substance of an economic business, the negative thinking of tax law on "IOUs" should not be used as the standard for judging the authenticity of the economic business, nor should the formal elements listed in the administrative norms be used as the standard for judging the authenticity of the economic business. The following cases show that the people's court has adhered to this attitude in the judgment.
 

On December 4, 2018, the plaintiff, Wang, accidentally lost the outpatient prescription fee receipt and the patient expense details form. Therefore, he went to Tonghua Central Hospital to photocopy the outpatient prescription fee receipt and the patient expense details form. The defendant, Tonghua County Social Medical Insurance Administration, refused to reimburse on the grounds that the photocopy was invalid according to the document regulations. Therefore, the plaintiff filed an administrative lawsuit, requesting the people's court to order the defendant to perform its statutory duties and reimburse the corresponding medical expenses in proportion as required.

The people's court held that: Article 19 of Chapter 5 of the "Notice on Issuing the Implementation Rules for the City-level Overall Planning of Urban Basic Medical Insurance in Tonghua City (Trial)" provided by the defendant stipulates that "After the end of medical treatment, carry valid original medical expense receipts (photocopies are invalid), photocopies of inpatient medical records, expense lists, diagnosis certificates, and "Referral and Transfer Approval Form" and other relevant materials to the handling agency for reimbursement." This clause is the necessary material for the parties under normal circumstances, but if the original receipt is lost, how to remedy it, the document does not stipulate. The court believes that if the document does not stipulate, relevant laws and regulations should be referred to. According to Article 55 (5) of the "Accounting Basic Work Specification" issued by the Ministry of Finance, "If the original voucher obtained from an external unit is lost, a certificate with the official seal of the original issuing unit shall be obtained, and the number, amount and content of the original voucher shall be indicated. It can only be used as an original voucher after being approved by the person in charge of the accounting agency, the accounting supervisor and the person in charge of the unit." The plaintiff accidentally lost the original medical expense receipt and immediately went to Tonghua Central Hospital to photocopy the plaintiff's outpatient charge special receipt and the patient expense details form, and Tonghua Central Hospital issued a statement of the situation and affixed the official seal, which fully complied with the above regulations. At the same time, it provided a photocopy of the outpatient prescription and the Bank of China consumption receipt, which can form a chain of evidence sufficient to prove that the plaintiff purchased medicine at Tonghua Central Hospital due to illness and incurred corresponding medical expenses. Therefore, the defendant was ordered to pay the medical expenses that the plaintiff should be reimbursed immediately from the date of entry into force of this judgment.
 

In the next issue, let's talk about the topic of tax judicial appraisal, so stay tuned.

"Wang Moukai v. Tonghua County Social Security Bureau Administrative Judgment on Disapproval of Administrative Decision" (2018) Ji 0521 Xingchu No. 43