With the commencement of the Enterprise Income Tax Law in 2008, China introduced thin capitalisation rules into its tax regime for the first time. These thin capitalisation rules have been somewhat underdeveloped up until now. For a fairly detailed examination of the rules up until December 2009 you can review an article I wrote on the rules here. The most important regulation in this area is Caishui  121 （财税  121).
On 31 December 2009 the SAT issued Guoshuihan  777 （国税函 777) which makes two points. Firstly, it states that the deductibility of interest in relation to loans from individual “related parties” (such as shareholders) are also subject to the EITL and Caishui  121. This is nothing new and is really just for emphasis to avoid confusion given the following point they intend to make.
The main point of the circular is that the deductibility of interest payments on loans from internal staff or other persons (non-related parties) will be allowed if the loan meets the following conditions:
- The loan between the enterprise and individual/s are real, legitimate, effective, and do not have the illegal fund-raising purposes or other violations of laws and regulations;
- The enterprise and the individual/s have signed a loan contract.
This is not exactly ground-breaking news but it does add a little bit more certainty in this area and will be particularly relevant for small to medium size enterprises. Given the ceasing of credit that was announced this week it may now be particularly pertinent.