Navigating the dangers of mergers – Guangdong Focus

China has entered a critical stage of economic restructuring after 30 years of steady growth. Many industries have suffered from overcapacity, slowing growth, falling profits and soaring costs, and are facing challenges of optimising and upgrading their industrial structure.

More and more foreign investors strive to eliminate outdated capacity and build new competitive edges through the restructuring of their China businesses and operations. They naturally come up with the idea of corporate restructuring by the way of merger, which, through reducing the numbers of corporate entities, may facilitate the reduction of management costs, enhancement of operation efficiency, optimisation of resource utilisation and, most importantly, achievement of tax benefits through utilising losses of the merged companies. Moreover, the tax liabilities arising from ordinary assets transfer are normally not applicable to mergers. Nevertheless, the aforesaid benefits could be substantially compromised by the merger process, which is very complicated and time-consuming in reality. The business may even be interrupted if the merger is not properly planned and executed.

Chapter 9 of the PRC Company Law provides for two types of mergers, namely a consolidation merger (新设合并), under which two or more companies will be dissolved and consolidated into one newly established company, and an absorption merger (吸收合并), under which one or more companies (the dissolving company) will be dissolved and absorbed into an existing company (the surviving company), which will absorb the former and survive the merger.

Complicated and time-consuming process

An absorption merger is supposed to be simple and straightforward (compared with an ordinary assets transfer) because the assets and liabilities of the dissolving company conceptually would be automatically succeeded and assumed by the surviving company. However, according to Article 179 of the Company Law, as well as the Merger and Division of Foreign Investment Enterprises Provisions (关于外商投资企业合并与分立的规定) jointly issued by the State Administration for Industry and Commerce (SAIC) and the predecessor to the Ministry of Commerce in 2001, the dissolving company is required to undergo de-registration with the authorised local Administration of Industry and Commerce (AIC), which leads to a number of complications.

Firstly, as a result of the AIC de-registration, the de-registrations with tax authorities will need to be completed beforehand, according to the Implementing Rules for the PRC Law on the Administration of the Levy and Collection of Taxes (税收征收管理法实施细则) promulgated by the State Council in 2002 and amended in 2012. Due to the lack of special procedures of tax de-registration for the merger, in practice, the dissolving company would have to go through essentially the same procedures as those for the normal dissolution and liquidation of a company, a complicated and lengthy process that could take over a year.

During the process, the tax authorities may scrutinise the historical tax filings of the dissolving company, initiate a tax audit and impose penalties for any irregularities or non-compliance spotted.

Furthermore, many tax authorities will not process the tax de-registration unless and until the dissolving company ceases to generate revenue or incur liabilities, which comes from the customary practice and requirement for normal dissolution and liquidation (where there will no business generating revenues or incurring liabilities during the course of tax de-registration). Meanwhile, for mergers, the practice will force the dissolving company to cease its business and operations and transfer all its business, employees and necessary operating assets to the surviving company prior to tax de-registration, which essentially requires the completion of the assets and business transfer prior to the merger and, consequently, dilutes the tax benefit (as ideally the merger will not trigger the tax liabilities which arise from an ordinary assets transfer) and further complicates and prolongs the merger process.

Secondly, in order to ensure the continuity of the surviving company's business and operation, in many cases the company will need to set up a branch to take over essentially the same or similar operation at the premises of the dissolving company. If the business and operation of the dissolving company are subject to the possession of any extraordinary or special governmental approval, license or permit, the surviving company will also need to spend a substantial amount of time and resources to re-apply for such approval, license or permit, because none of these are directly transferrable (except for a few governmental authorities such as the Ministry of Construction, which formulated a simplified application procedure for mergers).

As a result of the above, in reality it may take a surprising two or three years to complete the entire merger process. It is rather complicated, costly and hard to manage, and it can unnecessarily divert the time and resources of the management.

Conflicting resolutions

The government has tried to simplify and facilitate the merger process. For instance, the State Council issued the Opinion on Promoting the Merger and Re-organisation of Enterprises (关于促进企业兼并重组的意见) and the Opinions on Further Optimising the Market Environment for Enterprise Mergers and Restructuring (进一步优化企业兼并重组市场环境的意见) in 2010 and 2014 respectively. In response, the SAIC issued the Opinions on Duly Registering Company Mergers and Divisions so as to Support Enterprise Consolidation and Re-organisation (关于做好公司合并分立登记支持企业兼并重组的意见) in 2011 and some other rules. Nevertheless, none of them worked out as intended due to the absence of adequate endorsement or corresponding rules from other government bodies such as the tax authorities.

For instance, the aforesaid SAIC rules permit the direct transfer of the branches of the dissolving company to the surviving company through the direct change of AIC registration, without going through AIC de-registration of the branches, but this may not be so feasible in practice. We have seen many cases in which tax authorities tend to ignore these SAIC rules and require the completion of tax de-registration of the branches concurrently with or prior to the tax de-registration of the dissolving company. Due to the lack of special tax de-registration procedures for mergers, the SAIC alone is unable to reconcile the discrepancies between its rules and the procedural requirement of the tax authorities.

Like other corporate restructuring subject to approvals and registrations, governmental support and endorsement could help expedite and smoothen the merger process, but the government appears to be less helpful with mergers compared with other corporate restructuring, due to the lack of coordination among the different authorities at both the legislation and execution levels.

What companies need to do

Companies in China should be careful with restructuring by way of merger, particularly those with extensive operations and a large number of corporate entities (including branches) and that are subject to regulation by many governmental authorities. In order to minimise the interruption to business and expedite the process, they must well-prepare a detailed merger plan that is reviewed from legal, financial, tax, business and compliance perspectives. They are also recommended to have pre-consultations with relevant local governments (regarding the re-application of operating licenses and permits by the surviving company, and most importantly, the tax de-registration procedure). Nevertheless, there will still remain uncertainties, difficulties and even risks associated with the merger process. Therefore, to justify the needs for mergers in China, it must be ensured that the benefits would substantially outweigh these risks.


Luo Ke and Zhang Yuhan, Fangda Partners, Shenzhen