Private equity taxation plans under fire

Draft measures to impose a floating profit tax on limited partnership private equity funds have been strongly criticised by economists and investors

The State Administration of Taxation is considering implementing rules imposing a floating profit tax. The Draft Implementation Measures of Income Tax on Partnership Enterprises and Partners《合伙企业及合伙人所得税实施办法》相关草案（下称“草案”）is still in the consultation stage with private equity (PE) practitioners and auditors, according to the website PE Daily.

The draft Measures propose a rate of around 35% to 40% of the added value, which is the difference between the price paid for the initial investment and the actual initial public offering (IPO) price. This is in contrast with the current 25% corporate income tax.

This means that investments made at an early stage will be subject to heavier burdens than those made during the pre-IPO period, when the fund is no longer open to public offerings.

“It would not be reasonable to impose tax on an unrealised gain at the time of an IPO when an investor has not exited its investment, even though the value of the investment has appreciated as reflected in the IPO valuation,” said Chuan Li of Kirkland & Ellis.

“Generally the timing for imposing tax on investment gains should be when the gains are realised, usually at the time of an exit,” added the Shanghai based partner.

The timing of when the tax becomes payable has been heavily criticised. Ren Zhiqiang, chairman of Huayuan Real Estate, was quoted in the Shanghai Financial News as saying taxation has “gone crazy”. Ba Shusong, chief economist of the China Banking Association said this is a move that is “rarely seen”.

The increasing popularity of partnership PE is largely attributed to its advantages of having flexibility, efficiency and not being subject to double taxation.

According to statistics from Zero2 IPO, from 2004 to 2012, 10% of PE investments went to companies that planned for IPOs, which means that only one out of ten with PE investments went on to become successful IPOs.

An analyst at ChinaVenture said that floating profit taxation could force limited partnership transfer backwards to incorporated PE structures.

However, commentators noted the advantage of limited partnership structures, such as flexibility in the form of investment, profit allocation, taxation and dissolution. This means there is a strong trend towards imposing added-value tax.

The new Measures are likely to be announced in May.

By Janice Qu

Private equity taxation plans under fire

Further reading:

This premium content is reserved for
China Law & Practice Subscribers.

Private equity taxation plans under fire

Further reading:

This premium content is reserved for China Law & Practice Subscribers.

This premium content is reserved for
China Law & Practice Subscribers.