Income Tax Treatment of Enterprise Debt Restructuring Measures

(Issued by the State Administration of Taxation on January 23 2003 and effective as of March 1 2003.)

Article 1: These Procedures have been formulated in accordance with the PRC Enterprise Income Tax Tentative Regulations and its implementing rules, in order to strengthen the administration of the income tax treatment of enterprise debt restructuring and to prevent the loss of tax revenue.

Article 2: For the purposes of these Procedures, the term "debt restructuring" means all matters between a creditor (enterprise) and a debtor (enterprise) that involve modification of the conditions of the debt.

Article 3: Debt restructuring includes the following methods:

(1) the cash discharge of a debt at less than its tax base;

(2) the discharge of a debt with non-cash assets;

(3) debt-to-capital swap, including State-owned enterprise debt-to-equity swaps;

(4) modification of other conditions of the debt, such as granting of time, granting of time combined with charging of additional interest, granting of time combined with reduction of the principal of the debt or interest on the debt, etc.; and

(5) hybrid restructuring carried out by combining two or more of the above methods.

Article 4: Unless otherwise provided for in the enterprise's restructuring or liquidation, the income tax treatment of a debtor's (enterprise's) discharge of a debt with non-cash assets shall be based on a breakdown into two economic items, viz. the transfer of the non-cash assets at their fair value and the payment of the debt with the monetary amount corresponding to the fair value of the non-cash assets. The debtor (enterprise) shall recognize the income (or loss) from the transfer of the assets. The tax basis of the non-cash assets acquired by the creditor (enterprise) shall be determined according to the fair value of the assets (including taxes and fees related to the transfer thereof), whereupon items deductible before enterprise income tax such as fixed asset depreciation charges, intangible asset amortization charges or carried-over merchandise sales costs shall be calculated on the basis of such tax basis.

Article 5: In the course of debt-to-capital restructuring, the difference between the book value of the restructured debt and the fair value of the equity held by the creditor by virtue of the relinquishment of his claim shall be recognized by the debtor (enterprise) as debt restructuring income and booked as taxable income for that period, and the fair value of the equity held by the creditor shall be recognized by the creditor (enterprise) as the tax basis of the investment, unless otherwise provided for in the enterprise's restructuring or liquidation.

Article 6: In the course of debt restructuring, if the concessions that the creditor makes to the debtor include debt payment with cash, non-cash assets, etc. at less than the tax basis of the debt, the debtor shall recognize the difference between the tax basis and the cash amount paid or the fair value of the non-cash assets (including the taxes and fees related to the transfer thereof) as debt restructuring income and book the same as taxable income for that period. The creditor shall recognize the difference between the tax basis of the restructured claim and the cash or the fair value of the non-cash assets received as a debt restructuring loss for that period and offset it against its taxable income.

Article 7: If debt restructuring is carried out by means of modification of other conditions of the debt, the debtor shall write down the tax basis of the restructured debt to the amount payable in the future, and recognize the amount of the writedown as debt restructuring income for that period. The creditor shall write down the tax basis of the claim to the amount receivable in the future, and recognize the amount of the writedown as a debt restructuring loss for that period.

Article 8: If the asset transfer income or debt restructuring income recognized in the course of debt restructuring by virtue of debt payment with non-cash assets or by virtue of concessions granted by the creditor is relatively large and payment of tax in a lump sum would cause genuine difficulty, the income may be broken up into equal amounts to be included in the annual taxable income over a period of not more than five tax years, subject to the approval of the tax authorities-in-charge.

Article 9: Subject to the approval of the tax authorities-in-charge, if the terms of a debt restructuring between affiliated parties involve a concession whereby one party's profits are passed to the other party, the matter may be handled in accordance with Article 4 through Article 8 of these Procedures, as appropriate, provided that there is a genuine business need to do so and the debt restructuring:

(1) has been approved in a court ruling; or

(2) has been provided for in an agreement consented to by all the creditors; or

(3) takes the form of an approved debt-to-equity swap by a State-owned enterprise.

Article 10: In principle, if a debt restructuring between affiliated parties involves concessionary terms but does not comply with the conditions stipulated in Article 9 hereof, the creditor may not recognize the restructuring loss and the concession shall instead be deemed to be a gift, which the debtor shall recognize as gift revenue. If the debtor is a shareholder of the creditor, the concession made by the creditor shall be inferred to be a distribution by the enterprise to the shareholder and the matter shall be handled in accordance with Item (2) of Article 1 of the State Administration of Taxation, Several Income Tax Questions Concerning Enterprise Equity Investments Circular (ref. Guo Shui Fa [2000] No.118).

Article 11: For the purposes of these Procedures, the term "fair value" means the fair price of a business transaction conducted at arm's length.

Article 12: These Procedures shall be implemented as of March 1 2003.