Hidden Tax Risks In Employee Expense Reimbursement Of Chinese Enterprises

A large number of employee reimbursements occur in the daily operation of Chinese enterprises where there are many hidden risks which cover a wide range, including risks in labor, commercial bribery, taxation and etc. It is of vital importance for enterprises to prevent and identify various risks in reimbursements. This article mainly discusses tax issues in employees' reimbursements.

Authenticity of Reimbursement and Results

With regard to authenticity of employees' reimbursements, Chinese enterprises can tell from the following three aspects:

• the actual occurrence of expenses;
• the authenticity and validity of invoices and vouchers for reimbursement;
• compliance with the company's reimbursement policy or not.

If an employee's reimbursements request pertains to genuinely incurred expenses, complies with Chinese company regulations, falls within the stipulated limits, and is supported by authentic and valid invoices or documentation, it shall be deemed an authentic and valid reimbursement. Such reimbursements must be accounted for and processed in accordance with accounting standards and tax regulations. However, if any of these conditions are unmet—for instance, falsifying expenses; submitting fraudulent invoices or documentation for genuine expenses; claiming inaccurate reimbursement amounts or exceeding allowable limits for meals and treatments; misrepresenting personal expenses as business-related costs; or seeking reimbursement for items explicitly excluded by company policy—the reimbursement shall be classified as fraudulent. In such cases, the company may impose disciplinary measures in line with its human resources policies and employee handbook. If the fraudulent reimbursement results in financial loss to the company, the employer may terminate the employment contract and pursue criminal charges, such as misappropriation of funds or job-related embezzlement, under applicable laws.

What is "Falsely Issued Invoices"?

False expenses reimbursements by employees, especially fabricated expenses, will lead to the problem of falsely issuing invoices under Chinese laws, bringing tax risks to the enterprise. According to Art.21 para.2 of Administrative Measures of the People's Republic of China on Invoices (Third Revision on July 20, 2023), no unit or individual can engage in the following false invoice issuing behaviors:

• issuing invoices for others or for oneself that do not conform to the actual business operation situation;
• asking others to issue invoices for oneself that do not conform to the actual business operation situation;
• facilitating others to issue invoices that do not conform to the actual business operation situation.

If a Chinese enterprise engages in the aforementioned false invoicing practices with the subjective intent of evading taxes, and such actions result in underpayment or non-payment of taxes, the illegal act will constitute tax evasion. In such cases, tax authorities shall recover the unpaid or underpaid taxes and impose late payment penalties, along with a fine ranging from 50% to five times the amount of taxes evaded. If the circumstances constitute a criminal offense, the enterprise will be subject to criminal liability under relevant laws.

If employees falsify expense reimbursement claims by obtaining invoices from third-party companies that do not match actual business transactions or amounts, and the enterprise accepts these reimbursements and processes them for tax purposes, such conduct may be deemed as falsely issuing invoices.

Tax Treatment for Falsely Issued Invoices

When a Chinese company, as the recipient of invoices, is investigated for accepting falsely issued VAT invoices in the context of fraudulent expense reimbursements, this typically occurs because the tax authority overseeing the invoicing party has confirmed the false issuance. The invoicing party's tax authority will issue a Confirmed False Issuance Notice along with supporting evidence, which is then forwarded to the recipient's tax authority together with documents such as the Tax Violation Case Coordination Letter and Entrusted Investigation Credentials List. Upon receiving the Confirmed False Issuance Notice, the recipient's tax authority must conduct an audit to determine whether the recipient accepted the false invoices in good faith or bad faith. This distinction determines whether administrative penalties or criminal liability will apply. Regardless of intent, once the invoices are confirmed as false, the recipient must undertake the following tax treatments:

• Corporate Income Tax: Under Article 12 of the State Taxation Administration Announcement 2018 No. 28 (Regulations on Pre-Tax Deduction Documentation for Corporate Income Tax), invoices obtained by enterprises that are privately printed, forged, altered, invalidated, illegally obtained by the issuer, falsely issued, improperly completed, or otherwise non-compliant, as well as other external documents that do not meet the requirements of Chinese laws, regulations, or related provisions, shall not be used as tax-deductible vouchers. If the company fails to replace these invoices with compliant ones or provide evidence proving the authenticity of the expenses within the stipulated period, the corresponding expenses cannot be deducted for the relevant tax year. If the expenses were already deducted, the company must adjust its taxable income and repay the underpaid taxes.
• Value-Added Tax (VAT): For special VAT invoices, where input tax credits were claimed, the Chinese company must reverse the input tax credits, repay the VAT, and settle additional surcharges. For ordinary invoices, no action is required.

If the recipient is deemed to have knowingly accepted false invoices (non-bona fide), Chinese tax authorities may impose fines under Article 37(2) of the Administrative Measures of the People's Republic of China on Invoices: under any of the following circumstances, the tax authority shall impose a fine ranging from 10,000 yuan to 50,000 yuan; if the circumstances are serious, a fine ranging from 50,000 yuan to 500,000 yuan shall be imposed; the illegal income, if any, shall be confiscated: (II) accepting, issuing, storing, carrying, mailing or transporting invoices known or should be known to be printed privately, forged, altered, obtained illegally or nullified.

In order to prevent the aforementioned risks in employees' reimbursements in Chinese enterprises, the enterprise shall establish comprehensive reimbursement policies and workflows aligned with operational needs, labor regulations, business compliance, and tax laws. The enterprise shall also designate dedicated personnel to review the reasonableness and legitimacy of employee reimbursement.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.