Income Tax on Equity Investments and M&A Activities

The income tax shall be payable when the general reserve or undistributed profit is converted into the registered capital of the company, although not being distributed to the company's shareholders as dividends. If the dividends are distributed in non-monetary assets, the income tax shall be calculated on the price of such assets concerned as if such assets were traded at arm's length. However, the dividends distributed in stocks shall be taxed on the par value of such stocks.

Disposal of Investments

The income of the receiving, disposal of or liquidation of an investment after deducting the cost of the original investment shall be subject to income tax. According to the Notice, if the dividends received by the investor exceed all the accumulated undistributed profits and general reserve of the investee company, such dividends, after deducting the cost of the original investment, shall be subject to income tax.

Any loss incurred by a company in receiving, disposal of or liquidating its investments can be deducted before tax. However, any deductible investment loss in a tax year shall not be higher than all the realized gains of the investments and the disposals of the investments in the same tax year. If the investment losses exceed the investment gains in a tax year, the un-deducted part can be indefinitely deferred to the following tax years.

Investment in Non-Monetary Assets

If an investment is made in non-monetary assets, such investment shall be deemed as a realized sale of such invested assets at arm's length. Consequently, the income tax shall apply to such non-monetary assets. Meanwhile, according to the Notice, such investment costs may be deducted in the future while taxing the investment gains.

If the value of such invested non-monetary assets is huge and the investor is not able to pay the income tax in the current tax year, subject to the approval of the tax authority, such income can be deferred to no more than five following tax years.

Bulk Asset Transfer

The bulk asset transfer under the Notice means that a company transfers, without dissolving itself, its entire business or the entire business of one of its branches, including all of the assets and liabilities, to another company, in exchange for the equity interest of the transferee company. According to the Notice, in principle, such bulk transfer shall be deemed to be a realized sale of the entire assets of the transferor and therefore, the income tax shall apply. However, it is not indicated in the Notice, whether the liabilities transferred can be deducted in taxing the transferred assets.

If the transferee pays the transferor the consideration other than the equity interest of the transferee, such consideration may not be subject to the income tax on a temporary basis, provided that such consideration is not higher than 20% of the par value of the equity interest obtained by the transferor. The Notice does not indicate whether the income tax will apply to such consideration in the future and if it does apply, how such consideration will be taxed.

According to the Notice, only the net book value is recognized in taxing the bulk asset transfer. Any valuation result will be ignored.

Bulk Asset Swap

The bulk asset swap under the Notice means that a company swaps, without dissolving itself, its entire business or the business of one of its branches, including all the assets and liabilities, for the entire business of another company or its branches. Again, the swap shall be deemed as a realized sale of the bulk assets and subject to the same tax consequence.

If, in addition to the business to be swapped, an additional price in the form of monetary asset is paid to a party, provided that such price is not higher than 25% of the value of the assets received by the payee, both parties shall be deemed as not having realized investment gain or incurred investment loss. The value of the assets above-mentioned shall be priced as if they were traded in an open market. The same as the above applies but only the net book value is recognized.

Jonathan Z Zhou
Fangda Partners, Shanghai

Endnotes:

1. According to the PRC, Company Law, a company shall set aside statutory reserve and general reserve using its profits. A company may use its accumulated general reserve to distribute as dividends to its shareholders.