The initial cost of real estate project development is high, and a large amount of capital investment is required for pre-development. Many enterprises' own funds are difficult to meet the demand for engineering construction, and due to the strict approval of loans by financial institutions, in order to ensure that the project is carried out normally, the enterprises are forced to broaden the source of funds through other financing channels. However, according to the rules of the current tax law, when handling the land value-added tax settlement, the interest expenses incurred are subject to different deduction methods depending on the circumstances. Taxpayers should effectively grasp the scope and conditions of interest expense deduction to ensure maximum enjoyment of deduction.

I. General Provisions on Deduction of Interest Expenses for Land Value Added Tax Clearance

(I) Current provisions on issues relating to deduction of interest expenses

According to Article 7(3) of the Implementation Rules of the Provisional Regulations on Land Value-added Tax, interest expenses belong to the finance costs in real estate development costs. In respect of the deduction of interest expenses, taxpayers may not be able to deduct interest expenses according to the actual expenses incurred, but should apply the standard deduction prescribed by the Tax Law as the case may be. The Circular of the State Administration of Taxation on Relevant Issues of Land Value-added Tax Settlement (Guo Shui Han [2010] No. 220) has made detailed provisions on this issue:

For one thing, if it is possible to calculate the apportionment according to the transferred real estate project and provide proof from financial institutions, the interest expenses are allowed to be deducted accordingly. Allow the deduction of real estate development costs for the sum of interest expenses and other real estate development costs calculated in accordance with the standards set forth in the tax law.

Secondly, if the interest expense cannot be calculated and apportioned according to the transferred real estate project or if the financial institution cannot provide the proof, the real estate development expense is calculated within 10% of the sum of the "amount paid for the acquisition of the land use right" and the "real estate development cost". The actual amount of interest expenses incurred is irrelevant.

The provincial people's government may make specific regulations on the percentage of deduction.

(II) Legal conditions for interest expenses to be deductible

By the State Taxation Letter [2010] No. 220 can be seen, the interest expense deduction should meet the following conditions:

First, it can be calculated and apportioned according to real estate projects; Notice of Guangzhou Local Taxation Bureau on Issuing Guidelines for Handling Relevant Issues of 2013 Land Value-added Tax Clearance Work (Sui Di Shui Letter [2013] No. 179) divides "accurate apportionment" and "reasonable apportionment", specifically, "accurate apportionment" and "reasonable apportionment", and "reasonable apportionment". "Specifically, "accurate apportionment" should meet the nominal and usage restrictions, i.e. the funds obtained in the name of any project must be used directly and wholly for the development of the project. This will make the flow of funds clear and avoid mixing with other funds such as own funds and inter-enterprise loan funds. "Reasonable apportionment" means adjusting the apportionment of loan funds among different development projects within the scope of an independent enterprise legal person, and "reasonable" requires that the funds be apportioned in accordance with the method of "different development projects occupying the amount and time of the loan". Reasonableness" requires that the allocation be made in accordance with the "amount and duration of loans occupied by different development projects" method.

The second is to be able to provide proof of financial institutions; on the one hand, the nature of the lending enterprise should be a financial institution; in practice, the tax authorities determine the nature of the enterprise usually based on the written certification materials submitted by the real estate enterprises in the land value-added tax clearance process, and the lending enterprise that meets the determination criteria should obtain the financial institution license issued by the relevant state regulatory authorities. Referring to Item (4) of Article 1 of the Circular of the State Administration of Taxation on Several Issues Concerning the Approved Collection of Enterprise Income Tax (Guo Shui Han [2009] No. 377), the financial enterprises include banks, credit unions, microfinance companies, insurance companies, securities companies, futures companies, trust and investment companies, financial asset management companies, financial leasing companies, guarantee companies, finance companies, pawnbrokers and so on. On the other hand, the "proof of financial institutions" that can be recognized includes the loan contracts, interest settlement documents or invoices signed between the taxpayer and financial institutions with loan qualifications.

Third, the interest rate does not exceed the commercial bank lending rate for the same period. Loans to non-commercial banks, financial institutions, commercial banks should be provided with similar proof of the same period of the loan interest rate. With reference to Article 1 of the Announcement of the State Administration of Taxation on Certain Issues of Enterprise Income Tax (Announcement No. 34 of 2011 by the State Administration of Taxation), the "interest rate for loans of the same kind for the same period of time" refers to the interest rate of loans provided by a financial enterprise under the conditions of the loan period, the amount of the loan, the guarantee for the loan as well as the enterprise's creditworthiness, etc., which are basically the same. It can be either the average interest rate of the same category in the same period announced by the financial enterprise or the actual interest rate of the loan provided by the financial enterprise to certain enterprises. If the amount exceeds the amount calculated on the basis of the commercial bank's interest rate for the same type of loan for the same period, it shall not be deducted.

II. Tax-related Risks of Interest Expense Deduction for Land Increase Tax from a Case Study

(I) Case: Real estate enterprises did not obtain invoices from financial institutions and interest expenses were not deductible.

Since its establishment, Company A of M City has been engaged in real estate development and business management. Due to the large investment in the early stage of project development and the strict restrictions on obtaining loans for the development of high-end real estate, Company A's sources of funds for the early stage of development expenses include trust company borrowings and advances on current accounts, with billions of dollars of interest expenses.

On January 17, 2023, the S District Tax Bureau completed the land value-added tax ("LVAT") clearance audit of Project X reported by Company A and issued a Notice on Tax Matters to Company A, which did not recognize the amount of deduction for interest expenses and required the payment of LVAT of RMB450 million.

(II) Tax risk of interest expense deduction

(1) Repeated deduction of interest expenses resulting in underpayment of land value-added tax

According to Item (4) of Article 3 of the Circular of the State Administration of Taxation on Relevant Issues Concerning Land Value-added Tax Clearance (Guo Shui Han [2010] No. 220), when land value-added tax is being cleared, the interest expenses that have been capitalized should be adjusted to the financial expenses to calculate the deduction. That is, when calculating the real estate development costs, the capitalized interest in the real estate development costs should be reduced first, which will be summed up with the interest expenses in the financial expenses, and then apply the calculation method stipulated in the document of Guo Shui Han [2010] No. 220 for tax treatment. In practice, if the taxpayer does not adjust the interest expenses included in the real estate development cost in the accounting to the financial expenses, it will lead to repeated deduction of interest expenses and underpayment of land value-added tax.

2. Inability to obtain the deduction vouchers may cause a surge in tax burden.

According to the current tax law, where financial institutions can not provide proof of interest expenses are not allowed to be deducted, but only in the "acquisition of land use rights paid for the amount" and "real estate development costs" within 10% of the sum of the amount of deduction. As the real estate development enterprises borrow more funds, the project development occupies a large amount of funds, coupled with the long development cycle of the project, interest expenses account for a larger proportion, whether the taxpayer pays a high interest to non-financial enterprises loans, through the deployment of funds between the affiliated enterprises to finance, or because of other reasons can not be obtained from financial institutions to prove that the actual deduction can not be deducted in accordance with the proportion of 10% deduction may not be covered The deduction of 10% may not be able to cover the actual interest expenses, thus creating the risk of a surge in tax burden.

3. Illegal deduction of interest expenses may constitute tax evasion

In practice, some real estate development enterprises have the problems of irregular deduction of costs and expenses, unreasonable division of cost objects and confusing deduction, which not only increase the difficulty of cost deduction, but also profoundly affect the authenticity of land value-added tax clearance. For the interest expenses that have been incurred, taxpayers should prove their authenticity, legality and relevance. If the taxpayers are unable to provide the evidence and materials that the interest expenses have really occurred, the corresponding funds have been directly and fully used for the construction of the projects according to the development of the projects and the development of the business, the interest expenses can be apportioned among the different real estate projects as well as the calculation and deduction ratio are in line with the standards stipulated in the tax law, etc., and the audit determines that the deduction is not If the audit determines that the deduction is not in compliance with the regulations, the taxpayer may be required to pay back taxes and late fees, and if it constitutes tax evasion, the taxpayer will be held administratively and criminally liable.

III. Lack of rationalization of the current legislation on the actual deduction of interest expenses

(I) Providing financial institutions' certificates is not a requirement for deduction, but only a collaborative obligation of taxpayers.

In the land value-added tax settlement, the tax authorities require the taxpayers to provide financial institutions' certificates for the purpose of verifying whether the interest expenses are really incurred and how much the expenses are, so as to confirm the amount of deduction of interest expenses. According to the logic of the principle of tax law, the tax authorities are responsible for investigating and determining the tax facts ex officio, and the verification of interest expenses is the responsibility of proof that should be fulfilled by the tax authorities. The taxpayer provides the financial institution's certificate to the tax authority to fulfill the obligation to help the taxpayer to identify the deduction items and confirm the tax basis, and the tax authority's burden of proof for whether the interest expenses can be deducted and how much can be deducted will not be changed because of whether the taxpayer provides the financial institution's certificate or not. If the financial institutions to provide proof as a taxpayer interest expense deduction of a formal requirement, in essence, the tax facts of the burden of proof shifted to the taxpayer, both obviously contrary to the principle of administration in accordance with the law of the law enforcement logic, but also with the tax collection and management of the legitimate rights and interests of taxpayers to protect the objectives of the inconsistent.

(II) Strictly limiting the actual deduction of interest expenses will affect the recovery of taxpayers' investment interests.

On the one hand, the current land tax clearance for real estate enterprises borrowing from financial institutions or non-financial institutions respectively stipulates the calculation method of interest deduction, but in essence, as long as the real estate enterprises return the borrowings and pay the interest according to the agreed interest rate, whether the corresponding expenditures can be deducted should be based on whether the funds are used for the development of the project and whether the additional payments made for the purpose of returning the borrowings constitute the interest or not. The current legislation has a significant impact on the deduction of interest only on the basis of the difference in the subject of the source of funds, which not only ignores the fact that the economic essence of interest expenses is to compensate for the time value of capital occupation, which has nothing to do with the subject of the funds, but also hinders the realization of tax fairness among taxpayers obtaining funds from different sources of financing.

On the other hand, the overly strict conditions for interest expense deduction affect the recovery of taxpayers' investment interests and are not in line with the requirement of substantive taxation. Due to the long development and construction period of real estate projects, interest expenses, as an important deduction item in the accounting of land value-added tax, often account for a relatively high percentage, and in some cases, if the deduction cannot be made in accordance with the actual conditions, it will have a greater impact on the level of tax liability of taxpayers, thus affecting the recovery of investment interests. And "standardize the order of land, real estate market transactions, and rationally regulate the land value-added gains" is only one of the purposes of the legislation of the land value-added tax, just as the "Tax Collection and Management Law" begins, "to protect the legitimate rights and interests of taxpayers" is also an important aspect of the land value-added tax collection and management.

(III) The actual expenditure of interest and the deduction of development cost limit are not reasonable.

First, the real estate credit regulation is tightening, some real estate enterprises to borrow from financial institutions, there are objective difficulties. Real estate industry is a capital-intensive industry, project development requires a large amount of capital investment, the enterprise's own funds and operation of the accumulated profit surplus is difficult to meet the demand for development, therefore, the ability to open up external financing channels for the survival and development of real estate development enterprises is crucial. The Notice of the People's Bank of China on Further Strengthening the Management of Real Estate Credit Business (Yinfa [2003] No. 121) points out that the management of real estate development loans should be strengthened and the direction of loans should be guided and standardized by appropriately restricting the issuance of loans for projects of large-size, large-area, high-grade commercial houses and villas. As a result, enterprises developing the aforementioned types of real estate have difficulties in borrowing from commercial banks. In order to alleviate the financing pressure, such enterprises urgently need to explore other financing methods in addition to continuing to seek support from traditional sources of funds in order to promote the development of project works. The enterprise's failure to obtain financial institutions to prove the existence of objective difficulties, without the intent to actively seek them, should not result in a derogation of the enterprise's deduction entitlement. Where a taxpayer objectively fails to obtain a financial institution's certificate (invoice) due to loopholes in the tax administration, financial or tax policies, etc., this should not have the consequence of making its tax liability for land tax increase abnormally heavy.

Secondly, under the current legislation, if a taxpayer cannot provide proof from a financial institution, the overall development costs are subject to a 10% limit on deductions, which, combined with the 5% limit on deductions for administrative expenses and selling expenses in the case of deduction on the basis of actual deductions, means that only 5% deduction for financial expenses is allowed, which is neither based on the supreme law nor on a realistic basis. Taxpayers obtaining loans from non-financial institutions are usually required to pay interest at a higher rate to compensate for the additional market risk borne by social capital under relatively liberal credit conditions. That is to say, taxpayers pay higher than the level of commercial bank interest rates for the same period of the same kind of loan is the result of market adjustment, rather than the existence of related transactions and other business arrangements that need to be adjusted for tax purposes, as long as the corresponding expenditures have the authenticity of the project project development and construction for the project has been assessed according to the real estate project, the taxpayers should be allowed to deduct the actual deduction.

Thirdly, the current legislation authorizes the provincial people's government to make specific provisions on the ratio of calculation of deduction, but the ratio of calculation of deduction affects the determination of the amount of deductions, which in turn affects the value-added amount as well as the confirmation of the basis of land value-added tax, while the basis of tax belongs to the category of tax legislation, and this authorization is not reasonable.

(IV) Summary: The actual deduction of interest expenses should pay more attention to the economic substance.

The purpose of land value-added tax settlement is to summarize the value-added amount generated by real estate enterprises due to project development and to calculate and determine their tax obligations, and whether the interest expenses, as one of the important deductions, can be accurately and reasonably deducted is linked to the tax payable by the taxpayers. From the standpoint of protecting taxpayers' rights and interests in reasonable deductions, the current legislation lacks reasonableness in strictly restricting the nature of the loan subject and the provision of financial institutions' certificates, and whether or not interest expenses can be deducted should focus on the use of funds and the nature of the expenditures.

IV. Suggestions to deal with the tax risk of interest expense deduction

(I) Combining tax factors and prudently addressing financing needs

The operation of real estate development enterprises is characterized by high leverage, high initial cost, long development cycle and inefficient capital recovery, etc. In order to solve the capital demand for project construction, it is normal for real estate enterprises to seek various financing channels to obtain funds. However, due to the current tax law on real estate enterprises to financial institutions and non-financial institutions borrowing respectively provided for different interest expense deduction methods, different calculation methods may lead to differences in interest expense deduction, and ultimately affect the level of tax burden on taxpayers. Therefore, in practice, real estate development enterprises should prudently choose the way of loan financing to solve the financing needs. If it is necessary to borrow from non-financial institutions, they should fully assess the impact of tax factors on the premise of preliminary business planning to avoid incurring tax risks or economic losses.

(II) Ensure the accuracy of accounting for interest expenses

On the one hand, real estate development enterprises should pay attention to the scope of interest expense deduction, and make it clear that the interest expense that can be deducted in accordance with the facts refers only to the interest expenses incurred during the development period that should be capitalized, and where the taxpayer fails to accurately account for the interest that should be capitalized for different development projects in accordance with the "Accounting Standards for Business Enterprises" or the "Accounting System for Business Enterprises", and is not able to calculate the apportionment of the interest expense according to the transfer of real estate projects, and is not able to Provide financial institutions to prove or commercial banks of the same type of interest level of the same period of time loans, shall not be deducted according to the facts;

On the other hand, real estate development enterprises should grasp the differences between land value-added tax settlement and accounting and enterprise income tax treatment, and pay attention to the interest portion allowed to be deducted for income tax which exceeds the loan period, and the interest with penalties, etc. are not allowed to be deducted in land value-added tax settlement. Borrowing costs incurred by taxpayers for the development of project works should be accurately and reasonably classified and centralized in accordance with the cost objects, and properly handled in compliance with the accounting standards and tax laws to prevent tax risks.

(III) Focus on the percentage of interest expenses and accurately grasp the conditions applicable to the calculation of deduction methods.

According to different methods of calculation and deduction, the results of interest expense deduction are different. Under normal circumstances, if the enterprise project development funds mainly from loan financing, the interest expense with the principal amount and the time of capital occupation shows a growing trend, the amount is large, should be as far as possible to obtain the loan certificate issued by the financial institutions, and strive for the actual deduction; if the enterprise project development mainly use their own funds, the interest expense accounted for a small proportion of the expenses should be deducted according to the proportion of 10% calculation. Enterprises should combine their own business development, accurately verify whether the interest expenses of multiple (period) projects are apportioned according to the project, whether to obtain legal and effective deduction certificates, whether the loan contract is standardized, whether the interest rate is in line with the regulations, etc., especially pay attention to the proportion of interest expenses, and strive for the application of favorable calculation and deduction methods in the liquidation process.