Recently, a client saw a video online claiming that Document No. 158 of 2003 regarding shareholders borrowing from the company as deemed distribution does not include sole proprietorships and partnerships. Therefore, partners borrowing from their enterprises will not be deemed distribution and subject to individual income tax. If a loan agreement is signed with a non-partner, symbolically agreeing on some interest would be even safer. So, the client asked if this "planning" is reliable? Borrowing from their own companies is a common practice for bosses. I have compiled the consultation replies and, together with a case of tax inspection where non-shareholder loans were overdue and not repaid and were also regarded as dividends and taxes were recovered, I will explain the tax issues related to the relevant behaviors.

Administrative Counterpart: XX Concrete Co., Ltd.

Illegal Facts: Zeng Mou, the father of Zeng Mouhao, a shareholder of XX Concrete Co., Ltd., borrowed a total of 11,620,000 yuan from the company from June 2019 to January 2020 and has not repaid it for a long time. According to Article 2 of the "Notice of the Ministry of Finance and the State Administration of Taxation on Regulating the Collection and Management of Individual Income Tax for Individual Investors" (Cai Shui [2003] No. 158): "Regarding the handling of long-term non-repayment of loans from individual investors from their invested enterprises (excluding sole proprietorships and partnerships): If individual investors borrow from their invested enterprises (excluding sole proprietorships and partnerships) within a tax year, and neither repay the loan nor use it for the enterprise's production and operation after the end of the tax year, the unreturned loan may be regarded as the enterprise's dividend distribution to individual investors, and individual income tax shall be calculated and levied according to the 'interest, dividends, and bonus income' item." According to the regulations, Zeng Mou borrowed a total of 11,620,000 yuan from the company and has not repaid it for a long time, and individual income tax should be calculated and levied on the "interest, dividends, and bonus income" item. After inspection, it was found that the above-mentioned long-term outstanding loan was not declared for individual income tax.

Basis for Punishment:  Article 69 of the "Law of the People's Republic of China on the Administration of Tax Collection" stipulates that "If the withholding agent fails to withhold or collect tax that should have been withheld or collected, the tax authority shall recover the tax from the taxpayer, and impose a fine of more than 50% but less than 3 times the amount of tax that should have been withheld or collected on the withholding agent." According to the regulations, the individual income tax that XX Concrete Co., Ltd. should have withheld but did not withhold is 2,324,000.00 yuan (11,620,000×20%) 

Punishment Content: A fine of 50% of the tax payable but not withheld, amounting to 1,162,000.00 yuan (2,324,000.00×50%), is imposed on XX Concrete Co., Ltd. for the act of failing to withhold the tax.

Our country's tax law system includes many tax normative documents. Although it is very complex, the relevant regulations have their own formulation background and development history. An economic behavior may involve the provisions of several tax laws, regulations, rules and normative documents. To answer this consultation question from the client, we must first master the complete tax law context of individual income tax collection for individuals borrowing from enterprises.

We know that natural person loans generally do not involve tax matters, but there are exceptions, that is, deemed distribution. The original intention of the introduction of the tax policy on individual loans to enterprises as deemed distribution was to solve the problem of individual investors misappropriating enterprise funds, resulting in unfair distribution among high-income groups. As early as June 2001, the State Administration of Taxation formulated the "Notice on Further Strengthening the Collection and Management of Individual Income Tax for High-Income Earners" (Guo Shui Fa [2001] No. 57), requiring private companies to compulsorily distribute net profits that are not distributed in the accounts for more than 1 year to shareholders in proportion to their capital contributions, and levy individual income tax according to the "interest, dividends, and bonus income" item. This policy was a "powerful measure" under the background of increasing tax enforcement efforts against high-income earners at that time, but it only targeted private companies and indirectly deprived shareholders of the autonomy of distribution, which is increasingly deviating from the constantly improving "Company Law".

In July 2003, the Ministry of Finance and the State Administration of Taxation issued the "Notice on Regulating the Collection and Management of Individual Income Tax for Individual Investors" (Cai Shui [2003] No. 158), which abolished the provisions of mandatory distribution of net profits in Document No. 57 of 2001, and plugged the tax loopholes for individual investors to distribute from enterprises in disguised form and for investors of company-based enterprises to occupy enterprise funds for a long time in the name of loans by means of behavioral enumeration. This is the tax law basis that everyone is familiar with, the so-called "shareholders borrowing from the company that is not used for production and operation and is not returned after December 31 of the year is regarded as a dividend." In July 2005, the State Administration of Taxation issued the "Notice on Issuing the "Individual Income Tax Management Measures"" (Guo Shui Fa [2005] No. 120), which clarified that enterprises implementing individual income tax policies, that is, investors of sole proprietorships and partnerships, are also deemed to be distributed if they borrow from the enterprise under certain circumstances, and should pay taxes in accordance with laws and regulations, which also plugged the gap left by the tax normative document No. 158 of 2003.

In June 2008, the Ministry of Finance and the State Administration of Taxation jointly issued the "Reply of the Ministry of Finance and the State Administration of Taxation on the Issue of Individual Income Tax Collection for Enterprises Purchasing Houses or Other Properties for Individuals" (Cai Shui [2008] No. 83). In addition to emphasizing the circumstances in which investors obtain funds from enterprises as deemed distribution in Document No. 158 of 2003 and Document No. 120 of 2005, the scope was further expanded to relevant personnel of the enterprise, that is, it was clarified that enterprise employees other than investors should also be deemed to be distributed if they obtain funds from the enterprise, and the individual income tax items that should be applied after the deemed distribution of different subjects were stipulated. So far, the three currently effective tax normative documents constitute the tax law basis for the collection of individual income tax for individuals obtaining funds from enterprises.

After understanding the historical evolution of the formulation of the above documents, and then returning to the client's consultation, it is obvious that this online planning scheme is very unreliable. It can be said that "knowing one thing but not seeing the other, seeing the outside but not knowing the inside." Taking the tax inspection case in this article as an example, this case involves relatives of shareholders of a limited liability company. If it were relatives of partners of a partnership enterprise and the same behavior occurred, it is likely that only the violation of Article 2 of "Cai Shui [2003] No. 158" in the illegal facts section would be replaced with the violation of Item 4 of Article 35 of "Guo Shui Fa [2005] No. 120", and this "planning" behavior would be defined as tax evasion.

Of course, different subjects lead to different individual income tax rates, and the circumstances stipulated in the relevant tax law basis should also be met when applying different tax law basis. In addition, relevant evidence will also affect the judgment of the principle of substance over form. These factors are in the recognition of the economic behavior of individuals obtaining funds from enterprises. Is it just affecting the change in the "quantity" of the tax amount, or may it affect the "quality" of the recognition? I will elaborate on this in subsequent articles, so stay tuned.

Double publicity of credit information of Guangdong Provincial Taxation Bureau of the State Administration of Taxation: Administrative Penalty Decision Hui Shui Yi Ji Fa 〔2022〕No. 158

1. Notice of the Ministry of Finance and the State Administration of Taxation on Regulating the Collection and Management of Individual Income Tax for Individual Investors (Cai Shui 〔2003〕No. 158)

2. Notice of the State Administration of Taxation on Issuing the "Measures for the Administration of Individual Income Tax" (Guo Shui Fa [2005] No. 120)

3. Reply of the Ministry of Finance and the State Administration of Taxation on the Issue of Individual Income Tax Collection for Enterprises Purchasing Houses or Other Properties for Individuals (Cai Shui [2008] No. 83)