Editor's Note:According to the Notice of the Ministry of Finance and the State Administration of Taxation on Regulating the Administration of Individual Income Tax Collection for Individual Investors (Caishui [2003] No. 158), if an individual shareholder borrows funds from the company they invest in within a tax year and fails to repay the loan or use it for the company's production and operation by the end of that tax year, the outstanding balance may be deemed as dividend distribution from the company to the shareholder. Accordingly, long-overdue loans from a company to its individual shareholders are treated as profit distribution for tax purposes.

However, for corporate shareholders, can tax authorities deem long-outstanding inter-company loans as profit distribution? Since profits can only be distributed after corporate income tax is settled, if the lent funds are deemed as profit distribution, does the company incur additional corporate income tax liabilities on such funds? This article analyzes and discusses this issue based on a practical case.

I. Case Introduction

Company A, a limited liability company incorporated on January 1, 2022, has a paid-in capital of 50 million yuan in cash. After one year of operation, it accumulated 30 million yuan of undistributed profit by the end of 2022. In 2023, Company A generated 100 million yuan in operating revenue. In the same year, Company B — a corporate shareholder of Company A — borrowed 100 million yuan from Company A, with a repayment schedule set for mid-2024. For accounting purposes, Company A recorded this loan under the Other Receivables account.

Upon maturity, Corporate Shareholder B failed to repay the principal as agreed. In March 2024, Company A convened a shareholders' meeting. Given that no dividends had been distributed since incorporation, the meeting resolved to convert the 100 million yuan shareholder loan directly into dividend payments to Corporate Shareholder B, releasing B from its repayment obligation.

Recently, the tax risk control authority issued a tax risk alert to Company A's competent tax bureau, which subsequently launched a tax inspection. During the inspection, the tax bureau noted an abnormally high ending balance of the "Other Receivables" line item on Company A's 2025 year-end balance sheet, and followed up with the company's management and finance team. Verification confirmed that the long-standing balance stemmed from an accounting oversight: the finance staff had neither reversed the shareholder loan nor recorded the profit distribution in the books.

The competent tax authority held that, under Article 210 of the Company Law of the People's Republic of China, "The remaining after-tax profits of a limited liability company, after offsetting losses and allocating the statutory reserve fund, shall be distributed to shareholders in proportion to their actual capital contributions." In other words, shareholder distributions must be funded by after-tax profits.

In this case, the 100 million yuan lent to Corporate Shareholder B originated from 2023 taxable revenue. If this sum is converted to dividends, it must come from after-tax profits. After deducting the 25% corporate income tax, the distributable amount should be 75 million yuan, not 100 million yuan. By effectively distributing 100 million yuan of pre-tax revenue to shareholders, Company A was deemed to have underpaid corporate income tax. The tax bureau therefore demanded that Company A pay 25 million yuan in back corporate income tax on the 100 million yuan deemed dividend.

Company A disputed this, arguing that the profits distributed to Corporate Shareholder B were sourced from after-tax earnings and that no additional tax was due.

The core dispute in this case is: does converting a shareholder loan into a deemed dividend trigger a corporate income tax payment obligation?

II. Does the Transaction Create Corporate Income Tax Liability?

Under Article 5 of the Enterprise Income Tax Law of the People's Republic of China, "The taxable income of an enterprise for each tax year equals its total annual income, minus non-taxable income, tax-exempt income, permitted deductions, and allowable carry-forward losses from prior years."

Simply put, corporate income tax is calculated on taxable revenue net of deductible costs and expenses. The tax liability depends on the volume of taxable revenue and the amount of qualifying deductions. To clarify the dispute, below is a comparative analysis of accounting and tax treatments under different scenarios, excluding value-added tax and operating costs/expenses for simplicity.

A.Accounting & Tax Treatment: Standard After-Tax Profit Distribution

1.Recognize sales revenue in 2023

Debit: Bank Deposit 100,000,000 yuan

Credit: Main Business Revenue 100,000,000 yuan

2.Accrue and settle income tax in 2023

Debit: Income Tax Expense 25,000,000 yuan (100 million yuan × 25%)

Credit: Taxes Payable – Corporate Income Tax 25,000,000 yuan

Debit: Taxes Payable – Corporate Income Tax 25,000,000 yuan

Credit: Bank Deposit 25,000,000 yuan

3.Close annual profit in 2023

Debit: Main Business Revenue 100,000,000 yuan

Credit: Income Tax Expense 25,000,000 yuan

Credit: Profit for the Year 75,000,000 yuan

4.Distribute profits to Shareholder B in 2023

Debit: Dividends Payable – Shareholder B 75,000,000 yuan

Credit: Profit for the Year 75,000,000 yuan

Under statutory profit distribution procedures, Company A would generate 75 million yuan of distributable after-tax profit for the year and pay 25 million yuan in corporate income tax.

B.Accounting & Tax Treatment: Actual Transaction Flow

1.Recognize sales revenue in 2023

Debit: Bank Deposit 100,000,000 yuan

Credit: Main Business Revenue 100,000,000 yuan

2.Lend funds to Shareholder B in 2023

Debit: Other Receivables – Shareholder B 100,000,000 yuan

Credit: Bank Deposit 100,000,000 yuan

3.Accrue and settle income tax in 2023

Debit: Income Tax Expense 25,000,000 yuan (100 million yuan × 25%)

Credit: Taxes Payable – Corporate Income Tax 25,000,000 yuan

Debit: Taxes Payable – Corporate Income Tax 25,000,000 yuan

Credit: Bank Deposit 25,000,000 yuan

Under the actual bookkeeping, Company A distributed 25 million yuan more in dividends than would be permitted from current-year after-tax profits. However, since Other Receivables is a balance sheet (not expense) account, Company A still incurred the full 25 million yuan corporate income tax liability on its 100 million yuan of taxable revenue.

Compared with standard statutory distribution, this treatment does not reduce corporate income tax payable; it only increases the nominal amount of distributed profits. The excess 25 million yuan of distributions is funded by Company A's 30 million yuan of undistributed profit carried forward from 2022.

C.Accounting Treatment: Formal Conversion of Loan to Dividends

1.Recognize sales revenue in 2023

Debit: Bank Deposit 100,000,000 yuan

Credit: Main Business Revenue 100,000,000 yuan

2.Lend funds to Shareholder B in 2023

Debit: Other Receivables – Shareholder B 100,000,000 yuan

Credit: Bank Deposit 100,000,000 yuan

3.Accrue and settle income tax in 2023

Debit: Income Tax Expense 25,000,000 yuan (100 million yuan × 25%)

Credit: Taxes Payable – Corporate Income Tax 25,000,000 yuan

Debit: Taxes Payable – Corporate Income Tax 25,000,000 yuan

Credit: Bank Deposit 25,000,000 yuan

4.Record profit distribution per shareholders' resolution (March 2024)

Debit: Profit Distribution – Dividends Payable 75,000,000 yuan

Debit: Profit Distribution – Undistributed Profit 25,000,000 yuan

Credit: Dividends Payable – Shareholder B 100,000,000 yuan

5.Offset dividends payable against the shareholder loan

Debit: Dividends Payable – Shareholder B 100,000,000 yuan

Credit: Other Receivables 100,000,000 yuan

It is clear that the 2024 loan-to-dividend conversion does not distribute 2023 pre-tax profits nor extract any corporate income tax benefit. It simply distributes 25 million yuan of the 30 million yuan 2022 accumulated undistributed profit to the corporate shareholder in 2024.

In conclusion, reclassifying other receivables as profit distribution in this case does not result in underpayment of corporate income tax, and the tax bureau's demand for back taxes lacks legal basis.

III. Would There Be Tax Underpayment If Company A Had No Prior-Year Undistributed Profit?

If Company A had no accumulated undistributed earnings, would the 2024 loan-to-dividend conversion count as distributing pre-tax profits? The answer remains no. The nature of the transaction depends on the source of the lent funds.

A.Lent funds sourced from paid-in capital

At incorporation, Company A received 50 million yuan of paid-in registered capital in cash:

Debit: Bank Deposit 50,000,000 yuan

Credit: Paid-in Capital 50,000,000 yuan

Assuming zero prior-year undistributed profit, of the 100 million yuan converted to dividends, 75 million yuan would come from 2023 after-tax profits, and the remaining 25 million yuan would come from Company A's paid-in capital.

Under Article 12 of Judicial Interpretation III of the Company Law, "After a company is established, if the company, its shareholders or its creditors claim that a shareholder's conduct falls under any of the following circumstances and harms the company's interests, the people's court shall uphold the claim of capital withdrawal: (1) Fabricating financial statements to inflate profits for distribution."

Judicial precedents further clarify: "This refers to shareholders using their controlling position to inflate profits through falsified financial statements, and siphoning company funds under the guise of 'profit distribution' when no distributable profits actually exist. In essence, this is an illegal act disguised as a lawful transaction — the contributed capital is not retained in the company."

In this scenario, if Company A converts a shareholder loan to dividends without sufficient distributable profits, the act may constitute unlawful capital withdrawal. Even so, the amount at issue would be 25 million yuan (not 100 million yuan), and this 25 million yuan has no bearing on corporate income tax.

B.Lent funds sourced from external borrowings

Suppose Company A takes out a 25 million yuan bank loan and on-lends it to Corporate Shareholder B. Of the 100 million yuan total loan to Shareholder B, 25 million yuan would be pass-through bank financing, and 75 million yuan would come from 2023 operating earnings.

Converting 75 million yuan of the loan to dividends complies with the Company Law. The remaining 25 million yuan must either be repaid by Shareholder B to Company A, or converted to dividends in a future year when the company generates 25 million yuan of additional after-tax profits.

In summary, Company A is not distributing pre-tax profits by converting the shareholder loan to dividends; the distribution is funded by after-tax earnings. The conversion does not create new corporate income tax obligations and does not erode the tax base.

IV. Conclusion

In recent years, numerous tax disputes have arisen from differing interpretations of transaction substance, accounting standards and tax regulations. For enterprises, two principles are critical:

Strengthen internal understanding of accounting and tax rules, accurately grasp policy boundaries, and proactively mitigate tax risks.

When disputes emerge, engage in full communication with tax authorities, clearly explain the economic substance of transactions and applicable legal logic, and seek a consensus. If the tax authority upholds an unfavorable position, enterprises have the right to defend their legitimate rights and interests through formal legal remedy channels.