Taxation of enterprise reorganisation is a current focus of PRC
tax authorities. The Circular on Several Issues Concerning the
Enterprise Income Tax Treatment of Enterprise Reorganisations
("Circular 59"), issued on 30 April 2009 and retroactive
from 1 January 2008, outlines the tax treatment of equity transfers
in connection with an enterprise reorganisation. It distinguishes
between a deal where capital gains are subject to a withholding tax
at the time of the transaction, and one where the tax is
Under Circular 59, an "enterprise reorganisation" is a
transaction occurring outside the normal course of business of an
enterprise that results in a material change in its legal or
economic structure. This includes an equity acquisition, namely, a
transaction in which one enterprise (the acquirer) acquires equity
of another enterprise (the takeover target) and thereby gains
control of the takeover target.
Generally speaking, an enterprise recognises any gain or loss
from assets (including investment assets) in the course of
reorganisation when the transaction takes place, and the tax basis
of the assets is calculated using the transaction price. Circular
59 describes this approach as the "general treatment" and
qualifies that the transaction price be determined according to the
fair value of the assets. As such, the equity transfer gain is the
difference between the actual equity transaction price and the
equity cost price, and the resultant capital gain is subject to PRC
enterprise income tax on a withholding basis.
Circular 59 allows the application of "special
treatment" provisions when an enterprise reorganisation by
means of equity acquisition satisfies all of the following
the transaction has a bona fide business purpose and the
primary purpose of the transaction is not to reduce, avoid or defer
at least 75% of the total equity (of the takeover target) is
in the case of a cross-border equity acquisition with a
non-resident transferor, the acquirer is a 100% subsidiary of the
there is no change in the original business operating
activities of the takeover target (i.e., the re-organised assets)
for 12 months after the reorganisation;
at least 85% of the total consideration received by the
transferor consists of equity in the acquirer; and
the major transferor who obtained payment in the form of equity
does not transfer the acquired equity for at least 12 months after
If these conditions are met, Circular 59 alters the
"general treatment" by allowing any capital gain to be
deferred, rather than payable on a withholding basis.
Thus, the parties concerned may effect the special tax treatment
in respect of the equity transfer in accordance with the following
the tax basis of the acquirer's equity obtained by the
shareholder of the takeover target is based on the original tax
basis of the acquired equity,
the tax basis of the takeover target's equity obtained by
the acquirer is based on the original tax basis of the acquired
the original tax basis of the assets and liabilities of the
acquirer and the takeover target and other relevant income tax
attributes remain unchanged.
"Original tax basis" as mentioned above refers to the
original cost of the investment assets (equity) in question. When
the assets are acquired with cash, the purchase price is the cost.
But when the assets are exchanged for something else, the cost is
the fair value of the assets and related taxes and charges
If the equity transfer qualifies for--and the relevant parties
select--special tax treatment under Circular 59, written
record-filing materials must be submitted to the competent tax
authority to show that the transfer satisfies the conditions
specified for a special reorganisation and that it was approved by
the provincial-level tax authority.
Because Circular 59 is still rather new to PRC tax authorities
and the relevant implementing rules have not yet been issued, local
tax officials may assess its applicability very differently. Thus,
if you are considering a reorganisation, we strongly recommend
contacting the relevant PRC tax authorities about how capital gains
from your transaction will be calculated and when the tax will be
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
To print this article, all you need is to be registered on Mondaq.com.
Click to Login as an existing user or Register so you can print this article.
Some comments from our readers… “The articles are extremely timely and highly applicable” “I often find critical information not available elsewhere” “As in-house counsel, Mondaq’s service is of great value”
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).