There are two issues need to clarify: one is the division of the set-up period and operation period; and the other issue is when to deduct the entrainment, advertising and promotional expenses incurred in the set up period for tax purposes.

Caishui 2012 No. 27 clearly defines that the operation period starts from the enterprise business license registration date.

According to Article 43 and 44 of the Enterprise Income Tax Law Implementation Rules, entertainment expenses incurred by an enterprise are deductible to the extent of 60% of the expense incurred, but up to 0.5% of sales revenue of the current year; advertising and promotional expenses are deductible up to 15% of the sales revenue of the current year. These are only applicable to the expenses incurred during the enterprise operation period and differ from those expenses incurred during the set up period, which were mentioned in the Announcement of SAT 2012 No.15.

There are two principles for the tax deduction of the entertainment, advertising and promotional expenses in the set- up period: firstly the deductibility is not limited by the 0.5% or 15% of the sales revenue of the current year as there shall be no sales revenue in the set-up period, and secondly these expenses can only be tax deductible when the enterprise starts its operation.

Example

Company A started to set up in year 2010 and incurred RMB 550,000 during the set up period, including entertainment expenses of RMB 100,000, advertising and promotional expenses of RMB150, 000 and other expenses of RMB 50,000. Company obtained its business license on 1 January 2013. In year 2013, the company achieved sales revenue of RMB10 million, and incurred entertainment expenses of RMB 80,000, advertising and promotional expenses of RMB400, 000. What are the tax deductible entertainment expenses, advertising and promotional expenses in year 2013?

Answer

• Tax deductible entertainment expenses in year 2013
  Deductible entertainment expenses incurred in the set up period:
  RMB 100,00060% = RMB 60,000
  Deductible entertainment expenses incurred in 2013:
  Lower of RMB 10,000,000 * 0.5% and RMB 80,00060% = RMB 48,000
  Total tax deductible entertainment expenses in year 2013:
  RMB 60,000+48,000=RMB108, 000

• Tax deductible advertising and promotional expenses in year 2013
  Deductible advertising and promotional expenses incurred in the set up period: RMB150, 000
  Deductible advertising and promotional expenses incurred in 2013
  Lower of RMB 400,000 and RMB 10,000,000 * 15% = RMB1, 500,000 = RMB 400,000
  Total tax deductible advertising and promotional expenses in year 2013:
  RMB 150,000 + 400,000 = RMB 550,000