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A step backwards for China’s tax deferral regime

Along with 6 new categories for restructurings, from June 2015 two new rules have been issued by the tax authorities to further upgrade the tax deferral regime, known together as “Rule 40/48”, which has introduced some new qualification scenarios and new thresholds. Taxand China explains the impact of these new rules.

The Chinese government has created 6 categories for corporate restructuring:

  • Debt restructuring
  • Equity transfer
  • Assets transfer
  • Merger
  • Separation
  • And other changes of form

The Chinese Tax Deferral Regime on these 6 types of restructuring has been available since 2009. These policies have provided several scenarios to defer capital gains tax in Chinese restructurings. There are many constraints in the existing regime, which led foreign investors and local companies to bear higher tax burdens and heavier cash flow burdens during business restructurings. The new, more preferential rules on this process have been long expected. 

40/48 has discussed the updated implications on the assets/equity transfer between 100% owned parent/subsidiary company and the subsidiaries that are subject to 100% direct control of the same or several parent companies.  Additionally, Rule 40/48 has also introduced the following important clarification points:

Where special tax treatment applies to the restructuring of enterprise, the following items shall be stated one-by-one at the time of declaration to explain that the restructuring of enterprise is backed by reasonable commercial objective(s):

  • Method of restructuring
  • Substantive outcome of the restructuring
  • Change in tax status of the parties in the restructuring
  • Change in financial status of the parties in the restructuring
  • Information on participation in the restructuring by any non-resident enterprises
  • Under the application of the tax deferral regime, the following documents shall be submitted together with the Declaration Form on Special Tax Treatment for Asset (Equity) Transfer of Resident Enterprises
  • General description of equity or asset transfer, including basic information and transfer scheme and detailed description of the business purpose of the transfer
  • Where the equity or asset transfer contract (agreement) signed by both parties or multiple parties to the transaction require the approval of the competent departments (including internal and external departments), the approval documents shall be provided  
  • Description of the net book value and taxation basis of the equity or asset transferred
  • Description of both parties to the transaction transferring the equity or asset based on the net book values
  • Statement that both parties fail to recognise profit or loss in accounting treatment (shall be accompanied by the accounting treatment materials)
  • Letter of commitment on not to change the original material operating activities of the equity or asset transferred within 12 months

Another important update under Rule 40/48 is that the local in-charge tax bureau will not be able to comment on the feasibility or success of the restructuring when the company wants to obtain certainty before it is complete. This change has created more uncertainty over restructuring.

Your Taxand contacts for further queries are:
Kevin Wang
T. +86 21 6447 7878 – 526

Frank Tao
T. +86 21 6447 7878 – 517

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Taxand's Take

Generally speaking, Rule 40/48 is not more beneficial to companies as overall it has created more difficulties and dilemmas for Chinese companies. Compared to the public expectation for a more relaxed tax deferral trend, this could be viewed as a step backwards. 

Hopefully, this is only a temporary situation and companies who plan to restructure need to consider their tax implications cautiously under the new rule, and to evaluate the capital gain tax within it.

Taxand's Take Author

Kevin Wang

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