Editor’s Note: Since the beginning of 2025, both national ministries and provincial/municipal authorities have reiterated efforts to deepen the governance of tax-related irregularities in investment promotion and support the construction of a unified national market. Against this backdrop, regulatory scrutiny over tax issues related to fiscal subsidies will become more stringent and detailed this year. Recent cases show that, in addition to full refunds of subsidies due to invalid eligibility, improper handling of fiscal subsidies for VAT or corporate income tax (CIT) purposes may lead to allegations of tax evasion. This article analyzes emerging tax risks related to fiscal subsidies through case studies.

1. Current Trends: Risks of Tax Reimbursement, Late Fees, or Tax Evasion Due to Improper Handling of Fiscal Subsidies

If fiscal subsidies received by enterprises meet the four conditions outlined in Circular of the Ministry of Finance and the State Administration of Taxation on the Corporate Income Tax Treatment of Special-Purpose Fiscal Funds* (Cai Shui [2011] No. 70, hereinafter “Circular 70”):  

1. The funds are obtained from fiscal departments or other government bodies at or above the county level;  

2. The enterprise can provide documentation specifying the designated use of the funds;  

3. The fiscal department or fund-allocating government body has established dedicated management rules or requirements for the funds;  

4. The enterprise maintains separate accounting for the funds and related expenditures,  

then the subsidies may qualify as non-taxable income exempt from CIT. However, misjudging eligibility could result in substantial tax reimbursements and late fees. For example, a branch of a listed company in Ganzhou received automobile industry subsidies totaling ¥358.7022 million from the Ganzhou Economic Development Zone Management Committee between 2016 and 2021, which were declared as non-taxable income. On November 29, 2024, the tax authority issued a notice demanding CIT reimbursement of over ¥47 million plus late fees. In another case, a company received ¥392,200 in fiscal support funds in 2020 but failed to meet Circular 70’s conditions. The tax authority required CIT reimbursement of ¥39,220 and imposed a 50% penalty for tax evasion.  

If fiscal subsidies do not qualify as non-taxable income, enterprises must recognize them as taxable income upon receipt and declare CIT accordingly. Failure to do so may trigger penalties. For instance, in *Xu Tax Audit Penalty [2024] No. 19*, a company was penalized for omitting ¥188,000 in government subsidies from its 2021 taxable income. Similarly, in *Jining Tax Audit Penalty [2024] No. 25*, a company underreported ¥1.1126 million in investment promotion subsidies received in 2019, leading to a tax evasion designation and fines.  

2.Key Risks: The Four Conditions for Non-Taxable Income and Criteria for Tax Evasion

Focus 1: Analysis of the Four Conditions for Non-Taxable Income

Disputes often arise due to ambiguities in Circular 70’s conditions. Enterprises must carefully assess eligibility and retain supporting documents. Key considerations include:  

Source of Funds: Subsidies from county-level or higher governments qualify. Funds from town/village-level authorities or unapproved economic development zones may not.  

Fund Allocation Documentation: The documentation must specify the designated use but need not follow strict formalities (e.g., official notices or public records). However, tax authorities may question their validity.  

Management Rules: Either dedicated management rules or specific requirements suffice. Enterprises should verify the legal validity of such rules (e.g., publication status).  

Separate Accounting: Maintain dedicated ledgers, bank records, contracts, and invoices to segregate funds from operational capital.  

Focus 2: Tax Evasion Designation Requires Tax Loss and Intent

Misclassifying subsidies as non-taxable does not automatically constitute tax evasion. Two factors are critical:  

1.Tax Loss: Adjusting non-taxable income to taxable status may not cause loss if related expenditures are deductible. For example, fully expensing the subsidy in the same year negates tax liability.  

2.Subjective Intent: Tax evasion requires intent to underpay. Authorities reference the *Tax Collection and Administration Law* (Article 63) and precedents (e.g., *SAT Reply [2016] 274*), which emphasize that genuine policy misinterpretations lacking malicious intent should not be penalized as tax evasion.  

3. Risk Mitigation: Prudent Compliance and Proactive Response

Enterprises should:  

- Accurately assess eligibility for non-taxable income, maintain separate accounting, and retain all supporting documents.  

- File tax returns correctly, even for non-taxable income, and ensure timely utilization of funds to avoid adjustments.  

- Scrutinize the legality of subsidy sources to prevent clawback risks.  

If disputes arise, engage proactively with tax authorities. Argue against tax evasion allegations by demonstrating no tax loss or intent. For eligible subsidies, assert non-taxable status; for ineligible ones, emphasize deductible expenditures or good-faith errors.