The persistent gap

Enterprise reorganisations are central to the growth of business activities. As soon as an enterprise is formed, it could become engaged in reorganisation for various legitimate reasons. Nevertheless, multiple factors would affect whether and how to structure enterprise reorganisations. Among them, tax remains a key consideration. Enterprise reorganisations will generally be subject to tax unless they are specifically exempt. Taxable enterprise reorganisations could potentially lead to exceedingly high tax bills and force business executives to think twice before making a move. Obviously, there should be a balance on tax and economic considerations with respect to enterprise reorganisations. To encourage enterprise reorganisations, the leading economies generally lay out the mandatory conditions for tax-free treatment. To be more precise, it does not really mean a tax-free escape, but a tax deferral until a future recognition event.

China has been very slow in playing a catch-up in this area. On April 30 2009, the Ministry of Finance (Mof) and the State Administration of Taxation (SAT) jointly issued Caishui [2009] No. 59 (Circular 59) to set out the guidelines on the income tax treatment of enterprise reorganisations. Hailed as a step forward, Circular 59 has proved to have limited practical value for many reasons since its adoption. One reason is that Circular 59 lacks specifics with respect to the key terms and the implementation requirements. Both taxpayers and tax officers are struggling with difficulties in properly applying Circular 59. It has long been expected that the SAT would come up with further clarifications just to make it work.

On July 26 2010, the SAT released the Measures for the Administration of Enterprise Income Tax in Connection with Enterprise Re-organisation (企业重组业务企业所得税管理办法), SAT Announcement [2010] No. 4 (Announcement 4), to provide the supplemental rules on the application of Circular 59. Announcement 4 does not deviate from Circular 59 on the basic distinction between taxable reorganisations subject to a general tax treatment and tax-free reorganisations eligible for a special tax treatment. To be eligible for a special tax treatment, a reorganisation continues to have to meet with the five general tests: 1) reasonable business purpose; 2) transfer of substantially all shares or assets; 3) equity consideration; 4) continuity of business enterprise; and 5) continuity of proprietary interest. Instead, Announcement 4 primarily focuses on the filing requirements and the clarification of various key terms with respect to enterprise reorganisations.

Filing requirements

Enterprise reorganisations could take various forms, including change in legal form, debt restructuring, stock acquisition, asset acquisition, merger, and spinoff. The filing requirements vary with the form of enterprise reorganisation. Regardless of how a reorganisation is classified, all the parties involved must uniformly adopt the same tax treatment, either the general tax treatment or the special tax treatment. Both taxable reorganisations and tax-free reorganisations have to be filed with the Chinese tax authorities.

In the case of a taxable reorganisation, the following documents must be filed:

In the case of a tax-free reorganisation, enterprises involved are required to file with the in-charge tax authorities for record filing purposes. The filing must be able to prove that the reorganisation meets the mandatory conditions of the special tax treatment. Otherwise, enterprises cannot enjoy the tax deferral and would be subject to a general tax treatment. In addition, if desirable, enterprises involved in a tax-free reorganisation can, after the reorganisation is completed, apply for a confirmation on the election of the special tax treatment to ensure certainty. In this circumstance, the lead party of any reorganisation will submit an application to the in-charge tax authorities on behalf of all parties. The lead party is defined as follows: