New Income Tax Regulations in Enterprise Restructuring

Income Tax Treatment in Mergers

According to the Circular, a merger shall be considered as transfer or disposal of all assets of the merged company at fair value. Income tax shall be calculated and levied on such value. In the Circular, fair value is defined as the normal transaction price in the common market conditions following fair trading principles. Loss incurred by the merged company in the previous years shall not be made up by the existing company after merger. However, a merger will not be considered as transfer or disposal of all assets of the merged company at fair value if the assets of the merged company are almost equal to its debt, and no income shall be calculated from such a merger. The cost shall be ascertained by the book value of such assets rather than the appraised value.

When the shareholders of the merged company exchange the shares of the existing company with their shares in the merged company, the tax authority will not consider them as having sold out their shares and as having purchased new shares. In such a case, income tax will be calculated on the basis of the value of their shares in the merged company. The Circular provides that a merger through such exchange of shares between the related companies shall be conducted at fair price. Otherwise, the tax authority may adjust the value of the shares in the merged company if it holds the opinion that the transaction price adversely affects the income tax.

Regarding the tax preferential treatments for consolidation and merger transactions, a company established by consolidation will not enjoy any preferential tax treatments that a new company enjoys and the existing company after merger will not be regarded as a new company. If the periods have expired for the tax preferential treatments that the consolidated companies or merged company enjoy, then the new company established by consolidation or the existing company after merger shall not have such treatments. If such periods have not expired, the remaining term could apply to the new company or the existing company. In case such remaining terms are different, the income taxes shall be calculated separately till the expiring date of the preferential treatment periods.

Income Tax Treatment in Divisions

Under the Circular, a division will be considered as transfer of part or all of the assets of the divided company at fair value. Income tax shall be calculated and levied on such value. If a shareholder of the divided company obtains the shares of the new company from division and meanwhile gives up their shares in the divided company, the cost of the new shares will be ascertained on the basis of the cost of the shares given up in the divided company. However, if such a shareholder still holds the shares in the divided company, the cost of such shares will be first reduced on the basis of the proportion of the net assets of the new company from division to the whole net assets of the divided company, and then the cost of the new shares will be calculated on the basis of the reduced amount allocated in proportion.

Regarding the preferential tax treatments for division transactions, a new company established after division will not enjoy any preferential tax treatments as a newly established company does, and a divided company will not be regarded as a newly established company. If the period has expired for the preferential tax treatments that the divided company enjoys, then the divided company or the new company established after division shall not have such treatments. If such a period has not expired, the remaining term could apply to the divided company or the new company after division. The losses incurred by the company before division could be borne by the companies after division within the remaining terms for making up losses subject to the review and verification of the tax authority.

Income Tax Treatment in Share Restructurings

The Rules define share restructuring as changes of shareholders or shares of a company, including share transfer and capital increase. Regarding capital increases through issuance of new shares, the company shall book the premium of the new shares as shareholder's interests when the new shares are issued and subscribed at a price over their face value. It will not be treated as the profit of the company subject to the income tax.

Any gain from share transfers shall be subject to income tax and any loss suffered from share transfers can be deducted from the company's income as cost. The gain or loss will be ascertained by the tax authority as the difference between the price of shares transferred and the cost of such shares. It should be noted that pursuant to the Rules, the price of shares transferred might also include some types of tangible or intangible assets received as consideration of the transaction. Meanwhile, the cost of such shares can only be the actual contribution by the transferring party other than their contribution stipulated in the relevant agreements.

The preferential tax treatment enjoyed by a company before its share restructuring will not be changed after its share restructuring. The losses incurred by the company before its share restructuring can be made up by the company after share restructuring within the remaining terms for making up such losses.

By David Liu

Llinks Law Office, Shanghai