Article by David Olsson and Richard Feller
China has released new rules on the tax treatment of various types of corporate reorganisations, including equity and asset acquisitions, mergers, debt restructurings and enterprise spin-offs. These rules fill a gap that has existed since China's new Corporate Income Tax Law (CIT Law) became effective on 1 January 2008 and provide clarity and guidance on what tax treatment applies during a restructure and how to qualify for the available tax benefits.
The rules are contained in a notice jointly issued by the Ministry of Finance and the State Administration of Taxation on Certain Issues on Corporate Income Tax Treatment of Corporate Restructuring Transactions (Caishui [2009] No.59) (Restructure Rules). They operate retroactively from 1 January, 2008.
What activities are affected by the Restructure Rules?
The Restructure Rules (and relevant tax treatments) apply in the following circumstances:
- Equity acquisition - Acquisition of equity in an entity with a view to acquiring control of that entity. This applies if the shareholders of the acquired entity receive equity in the acquiring entity and/or non-equity consideration.
- Asset acquisition - Acquisition of the substantive operating assets of an entity. This applies if the shareholders receive equity in the acquiring entity and/or non-equity consideration.
- Merger - Transfer of assets and liabilities by one or more entities. Transferor shareholders can receive equity in the acquiring entity and/or non-equity consideration.
- Debt restructuring - A debtor in financial difficulty obtains a creditor's concession in accordance with a written agreement or court order.
- Division - An entity carves out and transfers part or all of an entity's assets to another entity. Pre-division shareholders can receive equity or non-equity from the divided entity.
- Changes to legal form - A change to an enterprise's legal form or its place of registration outside the PRC. Simple changes such as the registered name, address, and form of corporate organisation are not included.
New rules provide flexibility
If a reorganisation or restructuring activity occurs then the Restructure Rules offer greater flexibility in the structuring of a deal to obtain the most efficient tax outcome.
Restructurings are classified as "ordinary" or "special" restructurings. Under an ordinary restructuring, the CIT Law and accompanying rules applying to normal asset transfers should apply, with each party to the transaction recognising a gain or a loss at the time of the transaction
Special tax treatment - what it involves and how to qualify
A special restructuring is a tax-free restructuring in which recognition of a gain or loss may be fully or partly deferred. To qualify for this treatment (which is optional), the following five criteria must be satisfied:
- the corporate restructuring must have a commercial purpose and its main purpose is not to reduce, avoid, or defer tax;
- the equity or assets being acquired, merged or spun-off must reach a certain ratio (essentially not be less than 75% of total equity or assets);
- there is no change to the substantive business activities within 12 months of the restructuring;
- the consideration for the restructuring must comprise at least 85% equity (or shares). Non-equity consideration such as cash, bank deposits, receivables, inventory and other assets cannot exceed 15% of total consideration; and
- the original shareholder receiving the equity consideration for the restructured assets must not transfer that equity within 12 months after completion of the restructure.
How the Restructure Rules affect cross-border restructures
Enterprises engaged in cross-border restructures can also benefit from the special tax treatment available. However, cross-border restructures are limited to the following scenarios:
- a non-resident enterprise (Parent SPV) transfers its equity interest in a resident entity to another SPV in which it holds 100% direct interest (Subsidiary SPV). Such a transfer must not affect the capital gains withholding tax that will be attached to a further sale of equity in the onshore entity. Further, the Parent SPV must not transfer equity of the Subsidiary SPV for 3 years after the restructure;
- a non-resident enterprise transfers its equity interest in an resident entity to another resident entity in which it holds 100% direct ownership; and
- a resident entity uses its assets or equity interest to invest in a non-resident entity in which it holds a 100% direct interest.
How these rules may impact business in China
The Restructure Rules provide clarity as to the thresholds that must be met in order for enterprises planning a restructure or reorganisation to qualify for special tax treatment. Enterprises will need to consider how to bring planned restructures into line with these rules starting retrospectively from 1 January 2008.
There are still some ambiguities remaining in relation to the interpretation of some of the qualification tests. We expect that these ambiguities will in time be cleared up as the relevant authorities continue to push ahead with their overall reform of the tax system.
The views set out in this publication are based on our experience as international counsel representing clients in their business activities in China. As is the case for all international law firms licensed in China, we are authorised to provide information concerning the effect of the Chinese legal environment. However we are not admitted to practice Chinese law and so are unable to issue opinions on matters of Chinese law. 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.
This publication is only a general outline. It is not legal advice. You should seek professional advice before taking any action based on its contents