Circular on Several Issues Concerning the Enterprise Income Tax Treatment of Enterprise Restructuring

Cai Shui [2009] No.59

(Issued by the Ministry of Finance and State Administration of Taxation on April 30 2009 and effective as of January 1 2008.)

Finance departments (bureaux), offices of the State Administration of Taxation and local taxation bureaux of provinces, autonomous regions, municipalities directly under the central government and cities with independent development plans and the Finance Bureau of the Xinjiang Production and Construction Corp:

Pursuant to Article 20 of the PRC Enterprise Income Tax Law and Article 75 of the Implementing Regulations for the PRC Enterprise Income Tax Law (Order of the State Council No.512) we hereby notify you on specific enterprise income tax treatment issues involved in enterprise restructuring as follows:

1. For the purposes of this Circular, the term “enterprise restructuring” means a transaction that occurs other than in the normal course of business of an enterprise and that results in a material change in its legal structure or economic structure, and includes changes in the legal form of enterprises, debt restructurings, equity acquisitions, asset acquisitions, mergers, divisions, etc.

(1) The term “change in the legal form of an enterprise” means a simple change in the registered name, domicile or corporate form of an enterprise, except those that conform with the other types of restructuring specified herein.

(2) The term “debt restructuring” means the matters concerning which, in accordance with a written agreement reached with the debtor or a court ruling, a creditor makes concessions in respect of the debts of a debtor that is experiencing financial difficulties.

(3) The term “equity acquisition” means a transaction in which one enterprise (the Acquirer) purchases equity of another enterprise (the Takeover Target) thereby gaining control of the Takeover Target. The forms in which the Acquirer pays the consideration include payment in the form of equity, payment in a form other than equity or a combination of both.

(4) The term “asset acquisition” means a transaction in which one enterprise (the Transferee) purchases substantive business assets of another enterprise (the Transferor). The forms in which the Transferee pays the consideration include payment in the form of equity, payment in a form other than equity or a combination of both.

(5) The term “merger” means a lawful merger of two or more enterprises wherein one or more enterprises (the Merger Target(s)) transfer(s) all of its/their assets and liabilities to another existing or newly-established enterprise (the Merged Enterprise) for which the shareholders of the Merger Target(s) receive payment in the form of equity in, or in a form other than equity of, the Merged Enterprise.

(6) The term “division” means a lawful division of an enterprise wherein an enterprise (the Dividing Enterprise) divests and transfers part or all of its assets to an existing or newly-established enterprise (the Spin-off), for which the shareholders of the dividing enterprise receive payment in the form of equity in, or in a form other than equity of, the Spin-off.

2. For the purposes of this Circular, the term “payment in the form of equity” means that, in an enterprise restructuring, part of the consideration paid by the party that purchases or obtains assets is in the form of equity or shares of the enterprise or its controlled enterprise. The term “payment in a form other than equity” means payment in the form of the enterprise's cash, bank deposits, receivables, negotiable securities of the enterprise or its controlled enterprise other than its equity or shares, inventory, fixed assets, other assets as well as the assumption of debts, etc.

3. Depending on the conditions, general tax treatment provisions or special tax treatment provisions shall apply to the tax treatment of enterprise restructuring.

4. Except where an enterprise restructuring satisfies the provisions hereof on the application of special tax treatment provisions, tax treatment shall be effected as follows:

(1) if an enterprise is converted from a legal person into a wholly individually-owned enterprise, partnership or other such organisation without legal personality or if its place of registration is changed to a place outside the People's Republic of China (including to Hong Kong, Macao or Taiwan), the enterprise shall be deemed to have been liquidated and its assets distributed and the shareholders to have invested in and established a new enterprise. The tax basis of all of the enterprise's assets and of the shareholders' investments shall be determined based on the fair value thereof.

If another simple change in the legal form of an enterprise occurs, amendment of tax registration may be carried out directly. Unless otherwise provided, the enterprise income tax attributes (including carrying over of losses, preferential tax treatment and other such rights, interests and obligations) shall be succeeded to by the post-change enterprise, with the exception of circumstances where a change in domicile results in the enterprise no longer satisfying the conditions for preferential tax treatment.

(2) Where an enterprise undergoes a debt restructuring, the relevant transaction shall be treated in accordance with the following provisions:

(a) if debts are discharged using non-monetary assets, the gain or loss on relevant assets shall be recognised after separating the transfer of relevant non-monetary assets and the discharge of debts at the fair value of the non-monetary assets;

(b) if a debt for equity swap occurs, the gain or loss from the debt discharge shall be recognised after separating the debt discharge and the equity investment;

(c) the debtor shall recognise the gain from the debt restructuring based on the difference from the debt discharge amount paid being less than the tax basis of the debt; the creditor shall recognise the loss from the debt restructuring based on the difference from the debt discharge amount received being less than the tax basis of the claim; and

(d) in principle, the debtor's relevant income tax payment attributes shall remain unchanged.

(3) In an enterprise equity acquisition or asset acquisition restructuring transaction, the relevant transaction shall be treated in accordance with the following provisions:

(a) the party being taken over shall recognise the gain or loss from the equity or asset transfer;

(b) the tax basis of the equity or assets obtained by the acquiring party shall be determined based on the fair value thereof; and

(c) in principle, the Takeover Target's relevant income tax attributes shall remain unchanged.

(4) In an enterprise merger, the parties shall treat matters in accordance with the following provisions:

(a) the Merged Enterprise shall determine the tax basis of the assets and liabilities received from the Merger Target(s) based on the fair value thereof;

(b) the Merger Target(s) and its/their shareholders shall effect income tax treatment on the basis of a deemed liquidation; and

(c) the losses of the Merger Target(s) may not be carried over to and made up by the Merged Enterprise.

(5) When an enterprise is divided, the parties shall treat matters in accordance with the following provisions:

(a) the Dividing Enterprise shall recognise the gain or loss from asset transfer based on the fair value of the divested assets;

(b) the Spin-off shall recognise the tax basis of the assets received based on the fair value thereof;

(c) where the Dividing Enterprise continues to exist, the consideration obtained by its shareholders shall be treated as a distribution by the Dividing Enterprise;

(d) where the Dividing Enterprise ceases to exist, the Dividing Enterprise and its shareholders shall effect income tax treatment on the basis of a deemed liquidation; and

(e) when an enterprise is divided, the losses of the relevant enterprises may not be mutually carried over and made up.

5. When an enterprise restructuring satisfies all of the following conditions, special tax treatment provisions shall apply:

(1) it is carried out for rational commercial objectives, and the principal objective thereof is not the reduction, exemption or deferment of taxes;

(2) the percentage of the assets or equity acquired, merged or divested complies with the percentage specified herein;

(3) the original substantive business activities for which the restructuring assets are employed are not changed for 12 consecutive months following the enterprise restructuring;

(4) the amount paid in the form of equity that forms part of the consideration for the restructuring transaction complies with the percentage specified herein; and

(5) the original main shareholder(s) that obtained payment in the form of equity in the enterprise restructuring may not transfer the equity so obtained for 12 consecutive months following the restructuring.

6. Where an enterprise restructuring satisfies the conditions set forth in Article 5 hereof, the parties to the transaction may effect special tax treatment in respect of the portion of the transaction paid in the form of equity in accordance with the following provisions:

(1) if the taxable income recognised in an enterprise debt restructuring accounts for at least 50% of the enterprise's taxable income for the year, the enterprise may include the same equally in its annual taxable income over five tax years.

If a debt for equity swap occurs in an enterprise, recognition of the gain or loss from the debt discharge in respect of the separate debt discharge and equity investment may be provisionally postponed and the tax basis of the equity investment shall be determined based on the tax basis of the original claim. The enterprise's other relevant income tax attributes shall remain unchanged.

(2) In an equity acquisition, if the equity purchased by the Acquirer is not less than 75% of the entire equity of the Takeover Target and the amount paid in the form of equity by the Acquirer at the time the equity acquisition occurred is not less than 85% of the total amount paid for the transaction, treatment may be effected in accordance with the following provisions:

(a) the tax basis of the Acquirer's equity obtained by the shareholders of the Takeover Target may be determined based on the original tax basis of the acquired equity;

(b) the tax basis of the Takeover Target's equity obtained by the Acquirer may be determined based on the original tax basis of the acquired equity; and

(c) the original tax basis of the assets and liabilities of the Acquirer and the Takeover Target and other relevant income tax attributes shall remain unchanged.

(3) In an asset acquisition, if the assets purchased by the Transferee are not less than 75% of all of the assets of the Transferor and the amount paid in the form of equity by the Acquirer at the time the asset acquisition occurred is not less than 85% of the total amount paid for the transaction, treatment may be effected in accordance with the following provisions:

(a) the tax basis of the Transferee's equity obtained by the Transferor may be determined based on the original tax basis of the transferred assets; and

(b) the tax basis of the Transferor's assets obtained by the Transferee may be determined based on the original tax basis of the transferred assets.

(4) In an enterprise merger, if the amount paid in the form of equity obtained by the enterprise's shareholders at the time the enterprise merger occurred is not less than 85% of the total amount paid for the transaction and the enterprise merger is one occurring between enterprises subject to the same control and one in which no consideration need be paid, treatment may be effected in accordance with the following provisions:

(a) the tax basis of the Merger Target's/Targets' assets and liabilities received by the Merged Enterprise may be determined based on the original tax basis of the Merger Target(s);

(b) the relevant pre-merger income tax attributes of the Merger Target(s) shall be succeeded to by the Merged Enterprise;

(c) limit of losses of a Merger Target that may be made up by the Merged Enterprise = fair value of net assets of Merger Target × interest rate on sovereign bonds of longest term issued by the state as at end of the year in which merger occurred; and

(d) the tax basis of the equity of the Merged Enterprise obtained by the shareholders of a Merger Target may be determined based on the tax basis of the equity of the Merger Target originally held by it.

(5) In an enterprise division, if all of the shareholders of the Dividing Enterprise obtain equity in the Spin-off proportional to their original shareholdings, neither the Spin-off or Dividing Enterprise change their original substantive business activities and the amount paid in the form of equity obtained by the shareholders of the Dividing Enterprise at the time the enterprise division occurred is not less than 85% of the total amount paid for the transaction, treatment may be effected in accordance with the following provisions:

(a) the tax basis of the assets and liabilities of the Dividing Enterprise received by the Spin-off may be determined based on the original tax basis of the Dividing Enterprise;

(b) the income tax attributes pertinent to the assets divested by the Dividing Enterprise shall be succeeded to by the Spin-off;

(c) the amount of the losses of the Dividing Enterprise that have not exceeded the statutory period for the making up thereof may be allocated in proportion to the percentage of all of the assets accounted for by the divested assets and shall be succeeded to and made up by the Spin-off;

(d) if the shareholders of the Dividing Enterprise, when obtaining equity in the Spin-off (the New Equity), are required to relinquish part or all of the equity they originally held in the Dividing Enterprise (the Old Equity), the tax basis of the New Equity shall be determined based on the tax basis of the relinquished Old Equity. If they are not required to relinquish the Old Equity, they may elect to determine the tax basis of the New Equity by either of the following two methods: (i) directly determining the tax basis of the New Equity as zero; or (ii) first reducing the tax basis of the Old Equity originally held in proportion to the percentage of all of the Dividing Enterprise's net assets accounted for by the net assets divested by the Dividing Enterprise and then allocating the reduced tax basis equally over the New Equity.

(6) If the parties to a restructuring transaction provisionally do not, in respect of the payment made in the form of equity in the transaction in accordance with Items (1) to (5) of this Article, recognise the gain or loss derived from the transfer of the relevant assets, the loss or gain derived from the asset transfer relating to the payment in a form other than equity shall nevertheless be recognised in the period that the transaction occurred, and the tax basis of the corresponding assets shall be revised.

asset transfer gain or loss relating to the payment in a form other than equity = (fair value of transferred assets – tax basis of transferred assets) × (amount of payment in a form other than equity ÷ fair value of transferred assets)

7. If an enterprise is involved in an equity or asset acquisition transaction that takes place both in China and overseas (including Hong Kong, Macao or Taiwan), in addition to satisfying the conditions set forth in Article 5 hereof, such transaction shall be required to satisfy the following conditions to be eligible for application of the special tax treatment provisions:

(1) a non-tax-resident enterprise transfers its equity interest in a tax-resident enterprise to another non-tax-resident enterprise over which it has 100% direct share control, which transfer does not later give rise to a change in the income tax withholding burden, and, furthermore, the transferring non-tax-resident enterprise gives the competent tax authority a written undertaking that it will not transfer its equity interest in the acquiring non-tax-resident enterprise for three years;

(2) a non-tax-resident enterprise transfers its equity interest in a tax-resident enterprise to another tax-resident enterprise over which it has 100% direct share control;

(3) a tax-resident enterprise invests its own assets or equity in a non-tax-resident enterprise over which it has 100% direct share control; or

(4) another circumstance approved by the Ministry of Finance and the State Administration of Taxation.

8. If a tax-resident enterprise as mentioned in Item (3) of Article 7 hereof invests its own assets or equity in a non-tax-resident enterprise over which it has 100% direct share control and opts for special tax treatment of the proceeds derived from the asset or equity transfer, it may include the same equally in its annual taxable income over 10 tax years.

9. If, in an enterprise merger by absorption, the nature of the surviving post-merger enterprise and the conditions for the applicable preferential tax treatment does not change, it shall be eligible to continue enjoying the preferential tax treatment of the pre-merger enterprise for the remaining period thereof, and the amount of such preferential tax treatment shall be calculated based on the taxable income (if a loss, then calculated as zero) of the surviving enterprise for the year before the merger.

If, in an enterprise division where the enterprise survives, the nature of the surviving post-division enterprise and the conditions for the applicable preferential tax treatment does not change, it shall be eligible to continue enjoying the preferential tax treatment of the pre-division enterprise for the remaining period thereof, and the amount of such preferential tax treatment shall be calculated by multiplying the taxable income (if a loss, then calculated as zero) of the enterprise for the year before the division by the percentage of all of the assets of the pre-division enterprise accounted for by the assets of the post-division surviving enterprise.

10. If an enterprise transacts its assets and/or equity in steps during the twelve consecutive months before and after the occurrence of the restructuring, it shall, in line with the principle of substance over form, treat the aforementioned transactions as an enterprise restructuring transaction.

11. When an enterprise restructuring satisfies the special restructuring conditions set forth herein and special tax treatment thereof is opted for, the parties shall, when filing enterprise income tax returns for the year in which the restructuring was completed, submit to the competent tax authority written record-filing information evidencing that the conditions specified for a special restructuring are satisfied. If the enterprise fails to carry out written record filing in accordance with regulations, it may not effect tax treatment as a special restructuring.

12. The State Council's finance and tax authorities shall separately provide for the enterprise income tax attributes involved in the course of an enterprise restructuring that require particular treatment.

13. This Circular shall be effective as of January 1 2008.