Editor’s Note: When tax authorities conduct tax inspections on enterprises that engage in illegal activities such as off-book business operations and concealed income, they usually adopt the deemed collection method to assess and recover underpaid Corporate Income Tax (CIT) on the enterprises’ off-book income. During the defense and explanation process in response to such inspections, enterprises often have disputes and disagreements with tax authorities over issues including whether off-book income and book-recorded income should be taxed separately or deemed collectively for collection, whether taxable income increased upon tax inspection may be used to offset prior-year losses, and whether annual taxable income after inspection adjustment is eligible for preferential tax treatment for small and micro enterprises. Based on a specific case, this article analyzes these three difficult controversial issues.

01 Case Introduction

Company A is a manufacturing enterprise mainly engaged in the processing and sales of cement, a general VAT taxpayer, and adopts audit-based collection for CIT. Company A incurred a loss of RMB 500,000 in 2019, a loss of RMB 200,000 in 2020, book-recorded operating income of RMB 30 million and total costs and expenses of RMB 30.3 million in 2021, resulting in a loss of RMB 300,000 for 2021.

In October 2025, the local tax inspection bureau received a tip-off reporting tax evasion by Company A and launched a tax inspection against it. Upon inspection and verification, Company A obtained off-book income (converted to VAT-exclusive amount) of RMB 20 million in 2021. During the tax inspection, although Company A provided records of various raw materials, costs and expenses related to the off-book income in 2021, lawful and valid pre-tax deduction vouchers such as invoices were difficult to obtain due to the long time lapse. The tax inspection bureau therefore decided to adopt the deemed collection method to assess and recover CIT of Company A for 2021, and characterized Company A’s off-book operations as tax evasion for punishment. In March 2026, the tax inspection bureau issued a Tax Treatment Decision and a Tax Administrative Penalty Decision to Company A. Regarding CIT, the treatment decision of the inspection bureau was as follows:

The total book-recorded income and off-book income of Company A in 2021, amounting to RMB 50 million, shall be adjusted to deemed collection. With a taxable income rate of 7%, the taxable income for CIT of Company A in 2021 is determined as RMB 50,000,000 × 7% = RMB 3,500,000, and the CIT payable is RMB 3,500,000 × 25% = RMB 875,000.

Company A refused to accept the aforesaid tax treatment decision and raised the following three defense opinions:

First, only the off-book income of 2021 shall be subject to deemed collection, and the collective deemed collection of both off-book income and book-recorded income shall not be adopted. That is, the taxable income increased upon inspection in 2021 shall be RMB 20,000,000 × 7% = RMB 1,400,000.

Second, after applying deemed collection to the off-book income of 2021, the determined taxable income shall be allowed to offset the current-year loss under audit-based collection as well as prior-year losses. That is, the taxable income increased upon inspection of RMB 1.4 million in 2021 shall first offset the 2021 loss of RMB 300,000, and the remaining RMB 1.1 million shall further offset the total losses of RMB 700,000 in 2019 and 2020. Thus, the final taxable income of 2021 shall be confirmed as RMB 400,000 (1.4 million − 300,000 − 500,000 − 200,000).

Third, since the taxable income of Company A in 2021 is RMB 400,000 and it meets other requirements and conditions for small and micro enterprises, the preferential policies for small and micro enterprises shall apply to calculate the tax payable. Pursuant to the Notice on Implementing Inclusive Tax Reduction and Exemption Policies for Small and Micro Enterprises (Caishui [2019] No. 13) and the Announcement on Implementing Income Tax Preferential Policies for Small and Micro Enterprises and Individual Industrial and Commercial Households (Announcement of the Ministry of Finance and the State Taxation Administration [2021] No. 12), the additional tax payable of Company A for 2021 shall be RMB 400,000 × 25% × 20% ÷ 2 = RMB 10,000.

It can be seen that in this case, the tax authority and the enterprise have disputes over three aspects: the applicable method of deemed collection, whether the inspection-increased taxable income can offset prior-year losses, and the application of preferential policies for small and micro enterprises. The huge discrepancy between the additional tax amounts of RMB 875,000 and RMB 10,000 also arises from these three controversial focuses.

02 Controversial Focus I: Can Book-Recorded Income and Off-Book Income Be Deemed Collectively for Collection?

In the cited case, the tax inspection bureau held that only one CIT collection method could be applied in the same tax year for a taxpayer, i.e., audit-based collection and deemed collection could not coexist. Since Company A had incomplete accounting records that made audit-based calculation impracticable in 2021, it decided to treat its entire 2021 income under deemed collection.

The author holds that neither the Corporate Income Tax Law and its Implementation Regulations nor relevant policy documents of the State Taxation Administration on CIT collection methods stipulate that only one collection method can be adopted in the same tax year. Therefore, the opinion of the tax inspection bureau has no basis in laws, regulations and policies. Meanwhile, official interpretations issued by the State Taxation Administration have mentioned the view that audit-based collection and deemed collection may be applied to the same enterprise simultaneously.

On June 19, 2012, the State Taxation Administration issued the Announcement on Issues Concerning Deemed Collection of Corporate Income Tax (State Taxation Administration Announcement [2012] No. 27). This Announcement mainly stipulates that enterprises exclusively engaged in equity (stock) investment businesses shall not be subject to deemed CIT collection. The official interpretation of this Announcement by the State Taxation Administration explained the background and reasons for its formulation.

The interpretation states: “The Announcement clarifies that enterprises exclusively engaged in equity (stock) investment businesses shall not be subject to deemed CIT collection. The main consideration is that such enterprises generally have dedicated financial and investment expert teams, possess the ability and advantage of maintaining books and conducting accounting, and equity (stock) transactions leave obvious traces which are relatively easy to accurately account for. They do not conform to the policy orientation of CIT deemed collection and shall be subject to audit-based CIT collection. Of course, this provision mainly prohibits ex-ante deemed collection on the enterprise’s entire income. If an enterprise falls under the circumstances specified in the Tax Collection and Administration Law, the tax authority may still conduct ex-post deemed collection on certain items of its income in accordance with the law.”

In accordance with the aforesaid official interpretation, for enterprises exclusively engaged in equity (stock) investment businesses, ex-ante deemed collection on their entire income is absolutely prohibited, and audit-based collection must be maintained. However, if such enterprises generate other income that meets the circumstances specified in the Tax Collection and Administration Law, ex-post deemed collection may be applied separately to such other income. The policy implementation caliber of this interpretation is relatively clear: an enterprise may remain under audit-based collection while ex-post deemed collection is applied to certain special items of income, i.e., the coexistence of audit-based collection and deemed collection in the same year is permitted.

Applied to the cited case, the author holds that the tax inspection bureau’s inclusion of book-recorded income in the scope of deemed collection essentially denies the authenticity and accuracy of Company A’s legally declared book-recorded income, yet the inspection bureau provided no evidence proving false declaration of book-recorded income. Forcing deemed collection on book-recorded income without evidence to deny its authenticity violates the statutory applicable circumstances and rules of deemed collection. Since off-book income and book-recorded income are independent of each other in accounting, incomplete cost vouchers for off-book income does not mean flawed accounting of book-recorded income. The inspection bureau’s logic of denying the eligibility of book-recorded income for audit-based collection on the ground that costs of off-book income cannot be accounted for is untenable. In line with the State Taxation Administration’s opinion permitting audit-based collection on an enterprise’s entire income and deemed collection on individual items of income, this case shall apply ex-post deemed collection only to the off-book income on the basis of maintaining Company A’s 2021 CIT audit-based collection and recognizing the annual loss of RMB 300,000 declared in the final settlement. That is, the calculation method of the inspection-increased taxable income shall be RMB 20,000,000 × 7% = RMB 1,400,000.

03 Controversial Focus II: Can Inspection-Increased Taxable Income Be Used to Offset Prior-Year Losses?

In the cited case, the tax inspection bureau held that the entire 2021 income of Company A had been adjusted to deemed collection, so the taxable income of the deemed collection year could not be used to offset losses incurred in prior years under audit-based collection. The author holds that this view of the inspection bureau is not entirely correct.

The mainstream view in practice holds that if an enterprise’s overall annual collection method is changed from audit-based collection to deemed collection, the taxable income generated in the deemed collection year shall not be used to offset losses incurred in prior years under audit-based collection. Article 6 of the Measures for Deemed Collection of Corporate Income Tax (Trial) (Guoshuifa [2008] No. 30) stipulates that for enterprises subject to deemed CIT collection by taxable income rate, taxable income = taxable income amount × taxable income rate. Article 2 of the Notice on Several Issues Concerning Deemed Collection of Corporate Income Tax (Guoshuihan [2009] No. 377) further clarifies that taxable income amount = total income − non-taxable income − tax-exempt income. It can be seen that the taxable income calculated under deemed collection is not affected by prior-year losses, which differs from the calculation method of taxable income specified in Article 5 of the Corporate Income Tax Law (total income − non-taxable income − tax-exempt income − various deductions − allowable prior-year losses). The aforesaid two provisions are regarded as the main tax law basis for the mainstream view.

In the cited case, if the tax inspection bureau’s adjustment of Company A’s entire 2021 income to deemed collection was lawful, the recalculated taxable income would be subject to the aforesaid two provisions and thus could not offset prior-year losses. However, the author holds that since the tax inspection bureau’s adjustment of Company A’s entire 2021 income to deemed collection lacks specific tax law basis and violates the statutory applicable conditions of deemed collection, the practice itself is unlawful and therefore the provisions of Guoshuifa [2008] No. 30 and Guoshuihan [2009] No. 377 shall not be directly applied. The next question is: if audit-based collection is maintained for Company A’s 2021 book-recorded income and deemed collection is applied to its 2021 off-book income, can the increased taxable income of RMB 1.4 million be consolidated with the loss of RMB 300,000 under audit-based collection, and further be used to offset the losses of the previous two years first?

First, separate deemed collection on Company A’s 2021 off-book income is a closed calculation method, so there is no double-counting of income or costs, nor any conflict between the RMB 300,000 loss under audit-based collection and the RMB 1.4 million income under deemed collection. From the perspective of the basic tax law principle of taxation based on ability to pay, consolidating the two figures can reasonably, objectively and accurately reflect Company A’s tax-bearing capacity without logical defects or loopholes. Therefore, the author supports the method of consolidating deemed income and audit-based loss, i.e., the inspection-increased taxable income shall be RMB 1.1 million.

Second, since individual ex-post deemed collection on Company A’s off-book income does not change its 2021 audit-based collection method, the result of consolidating deemed income and audit-based loss is essentially a scenario dominated by audit-based collection with deemed collection as an exception, which can be defined as an outcome of audit-based collection and eligible for offsetting prior-year losses pursuant to Article 5 of the Corporate Income Tax Law.

In addition, the Announcement on the Treatment of Offsetting Prior-Year Losses with Inspection-Increased Taxable Income (State Taxation Administration Announcement [2010] No. 20) stipulates: “Where a tax authority increases taxable income when inspecting an enterprise’s tax payment in prior years, if the enterprise has incurred losses in prior years that are eligible for offset under the Corporate Income Tax Law, the increased taxable income shall be allowed to offset such losses. If there is any balance after offsetting such losses, Corporate Income Tax shall be calculated and paid in accordance with the Corporate Income Tax Law.” The aforesaid provision does not limit inspection-increased taxable income only to that increased under audit-based collection, and shall be interpreted as covering both inspection increases under audit-based collection and deemed collection. Both scenarios may be used to offset prior-year losses before calculating tax payable. Therefore, Company A’s claim that the inspection-increased taxable income of RMB 1.1 million in 2021 may first offset the losses of 2019 and 2020 is lawful and valid.

04 Controversial Focus III: Can Preferential Policies for Small and Micro Enterprises Apply After Inspection-Increased Taxable Income?

Under the tax policy documents in effect in 2021, an important criterion for small and micro enterprises is that annual taxable income does not exceed RMB 3 million. Essentially, the root cause of this controversial issue lies in whether the entire 2021 income of Company A shall be adjusted to deemed collection or individual ex-post deemed collection is permitted only for its 2021 off-book income. In the former case, the 2021 taxable income is RMB 3.5 million, which does not meet the criteria for small and micro enterprises. In the latter case, the 2021 taxable income is RMB 1.1 million before offsetting prior-year losses and RMB 400,000 after offsetting, both of which meet the preferential criteria for small and micro enterprises. Therefore, this controversial issue is essentially an extension of the first one and requires no further analysis.

Relevant enterprises are hereby reminded that assuming an enterprise has no off-book income in a certain year, all income of the year is recorded in the books, but pre-tax deduction vouchers such as invoices are invalidated due to violations including falsified invoices and lose pre-tax deduction function, and the amount of costs and expenses accounted for with such invalid invoices accounts for a high proportion of the recorded costs and expenses of the year, the tax authority will usually directly adjust the enterprise’s entire income of the year to deemed collection. If the taxable income calculated after overall adjustment to deemed collection meets the criteria for small and micro enterprises, tax payable shall still be calculated in accordance with the preferential policies for small and micro enterprises. In other words, violations by enterprises such as tax evasion and obtaining falsified invoices shall not affect the application of preferential tax policies for small and micro enterprises.

Conclusion: Since the Measures for Deemed Collection of Corporate Income Tax (Trial) (Guoshuifa [2008] No. 30) mainly targets the determination of an enterprise’s overall collection method and does not foresee the mixed scenario of “off-book income discovered by inspection during an audit-based collection year”, there are certain institutional deficiencies and gaps regarding whether audit-based collection and deemed collection can coexist in the same year. Local tax authorities have inconsistent implementation calibers, which further triggers a series of derivative disputes over taxable income calculation and eligibility for offsetting prior-year losses. Enterprises encountering such controversial issues are advised to actively seek professional support from tax lawyers, conduct effective response and defense through legal remedies such as administrative reconsideration and administrative litigation, and strive to protect their legitimate rights and interests in accordance with the law.