m&a issues for accountants tax...

M&A Issues for Accountants

Tax Considerations

Presented by : Samuel Chan, Tax Director of RSM Nelson Wheeler

Venue: Hong Kong Institute of CPAs, 27/F., Wu Chung House

Date: 25 July 2013 (6:30 pm – 8:00 pm)

Disclaimer

The materials of this seminar / workshop / conference are intended to

provide general information and guidance on the subject concerned.

Examples and other materials in this seminar / workshop / conference are

only for illustrative purposes and should not be relied upon for technical

answers. The Hong Kong Institute of Certified Public Accountants (The

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take no responsibility for any errors or omissions in, or for the loss incurred

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No claims, action or legal proceedings in connection with this

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© Hong Kong Institute of Certified Public Accountants, 2013. All rights reserved.

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Agenda

A General Review: Hong Kong & PRC Corporate Taxes

Merger & Acquisition: “Asset Deal” & “Share Deal”

Offshore Transfer

Restructuring

Tax Cases


4

A General Review:

HK and PRC Corporate Taxes


5

Territorial concept

No capital gain tax

No Turnover Tax (e.g. VAT,

sales tax etc.)

Low Profits Tax Rate: 16.5%

Turnover $xxxx

COGS ($yyy)

GP $zzzz

G&A expenses (aaa)

Other Income bbb

Profit before tax XYZ

HK Profits Tax @16.5% (fff)

Profit after tax ABC

General Overview of Hong Kong Profits Tax


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a) Corporate Income Tax (CIT)

b) Turnover Tax

Business Tax (BT)

Valued Added Tax (VAT)

Consumption Tax (CT)

c) Withholding Tax (WHT)

Dividend

Interest

Royalties

d) Other Tax

Land Appreciation Tax (LAT)

Stamp Duty

General Overview of PRC Corporate Taxes

Turnover $xxxx

COGS ($yyy)

GP $zzzz

G&A expenses (aaa)

Other Income bbb

Profit before tax XYZ

CIT (fff)

Profit after tax ABC

CIT

VAT/BT

WHT?

VAT/BT


7

Subject to CIT at 25% (Global Income)

Within PRC

or

Outside PRC

a) PRC incorporated company; or b) Foreign company with “effective management and control” in China

Corporate Income Tax – Resident Enterprise


8

Guoshuifa [2009]82 – Effective Management & Control

Locations of the following:

Senior executives / departments;

Office/personnel who made / approved

financial and HR decisions;

Principal assets, accounting books,

official seals, board and shareholders

meetings minutes etc.

Voting Rights


9

Corporate Income Tax – Non-Resident Enterprise

Subject to CIT at 25% if PE created

(deemed profit rate)

Active income (e.g. service fee)

Within PRC Enterprise outside PRC

(e.g. a HK Co.)

Subject to withholding tax at 10%

Passive income (e.g. capital gain, dividend)


10

Value Added Tax (VAT)

Sales of tangible goods in China

Provision of processing, repair and

replacement services in China

Importation of tangible goods into China

Pilot Program (modern service and logistics)

Taxpayer

General Taxpayers (17% or 13%)

Pilot Program (6% or 11%)

Small-scale taxpayers (3%)


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“VAT payable = Output VAT - Input VAT”

Output VAT: Collected from buyer

Input VAT: Paid by taxpayer during procurement or importation

General VAT Payer

Small-scale VAT payer

VAT Payable = [Turnover / (1+ VAT rate)] x VAT rate

No input credit is allowed

Cost of Sales


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Business Tax (BT)

Provision of BT taxable services (either the service recipient or the

service provider is in the PRC)

Transportation (3%)

Building and Construction (3%)

Financial and Insurance (5%)

Communication (3%)

Cultural and Sport (3%)

Entertainment (5% - 20%)

Other Services: logistics, agency etc. (5%)

Transfer of intangible assets (5%)

Transfer of immovable property (5%)

“BT Payable = Turnover (Gross) x applicable tax rate”


13

Other Tax

Consumption Tax

CT Payable = Assessable Value or Assessable Quantity x Tax Rate

Land Appreciation Tax

Progressive Rate from 30% - 60% on capital gain

Deed Tax

3% - 6% on Transfer Consideration

Stamp duty


14

Merger & Acquisition


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Importance of Due Diligence

Any hidden liabilities

and exposures ?

Disclosed information

presented properly?


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Common Types of Due Diligence Review

Type of DD Focuses on

Legal • Examine the legality of asset ownership such as licence, property

rights, titles, land use right, corporate legal documentation, contingent

liabilities and receivables, insurance, compliance status, outstanding

legal issues, and regulatory requirements.

Financial • Assess if the target company’s assets and liabilities are properly

stated, the true quality of earnings and other financial issues such as

related party transactions, transfer pricing, etc.

Tax

• Review major applicable taxes relating to past operations of the

target

• Identify any major tax schemes and related party transactions

which cannot be rationally supported by the current tax law and

regulations.


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Depending on the characteristics of the transaction, due diligence

on other areas may also be carried out

Type of DD Focuses on

Commercial • Market position of its products and/or services, relationships and

operations, market studies and the likelihood of it achieving (or

exceeding) its forecasts in the coming years, etc.

• Looks for potential post-transaction gains as well as identifying key

risks.

Operational • Assess if the target has the capability to meet the buyer’s strategic

objectives;

• whether there are serious operational risks that the potential buyer

should be concerned.

Other areas include IT, HR, Management, Internal control, intellectual property, real and

personal property, insurance and liability coverage, debt instrument review, employee

benefits and labour matters, immigration, and international transactions, etc.


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Acquiring a Business in Hong Kong

Vendor Vendor

Equity Transfer

HK Co. HK Co.

Buyer Buyer

No Capital Gain Tax in HK

No Turnover Tax in HK

Transfer of Shares: Stamp duty @0.1% will be imposed on each of the sell

and buy notes of shares transfer


19

Acquiring a Business in China

Must observe the “Foreign Investment Guideline”

“Encouraged”

“Restricted”

“Prohibited”

“Permitted”

Levels of approval

Foreign Participation Limitation


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Acquisition Method

Pursuant to Decree [2006] No 10 :

Equity acquisition

Asset acquisition

Various considerations:

Target’s financial conditions;

Approval requirements

Transaction time

Tax consequences

Due Diligence findings


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Equity Transfer

Seller Seller Equity Transfer

PRC Co. PRC Co.

Buyer Buyer


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Offshore Transfer of a PRC Enterprise

Tax filing should be performed either by the seller or through an

agent with the in-charge tax bureau

The following information / documents are required:

Equity transfer agreement

Valuation report issued by a Chinese appraisal firm; and

Other documents as required by the relevant tax authorities

The PRC Enterprise should also assist the tax bureau in the

collection of tax from the seller


23

Transfer Gain – Guoshuihan [2009]698

Gain on the offshore equity transfer = the difference between the

consideration for the transfer and the cost of equity investment:

Equity Transfer Gain = Equity Transfer Price – Cost of Equity Investment

Retained earnings and other after-tax reserve funds of the PRC

investee company should not be deducted from the transfer price


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Equity Transfer – PRC Tax Implications (Seller)

Types of Tax Tax Rate Tax Basis

CIT/IIT

(a) If seller is overseas

company, 10% on capital

gain will apply (lower rate

may apply subject to the

relevant DTAs)

•

Gain on transfer

(b) If seller is a PRC resident

enterprise, 25% CIT will

apply

(c) If seller is a an individual,

the capital gain will be

subject to IIT of 20%

Stamp duty • 0.05% • Execution of

contractual document


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Equity Transfer – PRC Tax Implications (Buyer)

Types of Tax Tax rate Tax Basis

Stamp duty • 0.05% • Execution of contractual document


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Asset Transfer

PRC Co.

(Seller)

PRC Co.

(Seller)

Asset Transfer

Investor A Investor A Investor B Investor B

PRC Co.

(Buyer)

PRC Co.

(Buyer)


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Seller’s Tax Implication

CIT

VAT (collected from buyer)

CT (if applicable)

Stamp Duty

Buyer’s Tax Implication

VAT (collect by seller)

Stamp duty

Trading Stock


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CIT

BT

LAT

Stamp Duty


Deed Tax

Stamp Duty

Land And Buildings


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CIT

VAT (collected from buyer)

CD and import VAT (Claw back)

Stamp Duty


VAT (Collect by Seller)

Stamp Duty

Used Fixed Assets


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CIT

BT

Stamp Duty


Stamp Duty

Intangibles


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Asset Transfer – PRC Tax Implications (Seller)

Types of tax Tax rate Tax basis

CIT • 25% • Gain on the disposal

BT • 5% • Transfer of immovable

or intangible assets

VAT

• 17% (collect from buyer) • Transfer of inventory

• 2% / 17% (collect from

buyer)

• Transfer of used

equipment, boats,

vehicles and

motorcycles


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Asset Transfer – PRC Tax Implications (Seller)

Types of tax Tax rate Tax basis

CT • Various rates • Category of goods subject

to CT

LAT • 30% – 60%

(Progressive rate)

• Gain on disposal of land

use rights and buildings

Claw-back of

Customs duty

and import VAT

• To be determined by

Customs

• Disposal of imported

tax/duty free equipment

within the Customs

supervision period

Stamp duty • 0.05% • Execution of contractual

document


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Asset Transfer – PRC Tax Implications (Buyer)

Types of Tax Tax Rate Tax Basis

VAT • 17% • Transfer of inventory

• 2% / 17% • Used equipment, boats,

vehicles and motorcycles

Deed Tax • 3% – 5% • Purchase of land-use rights

or real estate property

Stamp duty • 0.03% or 0.05% • Execution of contractual

document


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Seller Buyer

Prefer Share Deal:

it can avoid immediate

recognition on revaluation gain

of the assets;

it can avoid turnover taxes on

transfer of assets/business; and

it can avoid any claw-back on

preferential tax treatment

enjoyed.

Prefer Asset Deal:

It will not inherit the hidden or

contingent commercial, legal or tax

liabilities of the target company

through an asset deal.

It restricts the risks to specific

assets, liabilities and businesses

being acquired. The buyer has the

option of not acquiring any

undesirable assets.

Acquiring equity may trigger

additional capital gains tax

consequences.


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Offshore

Transfer


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Equity Transfer

Seller Seller Equity Transfer

PRC Co. PRC Co.

Buyer Buyer


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Offshore Indirect Transfer of PRC Investment

Non Resident

Seller

Non Resident

Seller Equity Transfer

PRC Co. PRC Co.

Overseas

PRC

Non Resident

Buyer

Non Resident

Buyer

Intermediate holding

company


company


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Circular Guoshuihan [2009]698

Effective 1 January 2008

Information/documents should be submitted to the PRC tax

bureau within 30 days if:

effective tax burden in the jurisdiction of the offshore

intermediary holding company being transferred <12.5%; or

corporate income tax is not levied on the offshore income of

its resident enterprise


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Offshore Indirect Transfer

Non Resident

Seller

Non Resident

Seller Equity Transfer

PRC Co. PRC Co.

Overseas

PRC

Non Resident

Buyer

Non Resident

Buyer


company

e.g. HK/BVI Co.


company

e.g. HK/BVI Co.

• Effective tax burden < 12.5%; or

• Offshore income tax exempted


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Required Information

Equity transfer agreement;

Relationship between NR Seller and the offshore intermediary

holding company in respect of financing, operation, sales and

purchase etc.;

Operation, personnel, finance and properties of the offshore

intermediary holding company;

Relationship between the offshore intermediary holding company

and the PRC subsidiary in respect of financing, operation, sales and

purchase etc.;

Commercial purpose of NR Seller in setting up the offshore

intermediary holding company; and

Other relevant information.


41

“Commercial Substances”

lacks of business objectives

“substance over form”

Disregard

offshore intermediary company

Tax on NR Seller


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Indirect Transfer of Two or more PRC Resident Enterprises located in Different Provinces

Report the transaction to any one of the local PRC tax bureaus in those

provinces (cities).

The in-charge tax bureau should coordinate with other in-charge tax

bureaus and report the case to the SAT.

substantially reduce the reporting administrative burden.

Two or More Non-Resident Enterprises

If two or more non-resident enterprises indirectly divests of a PRC

resident enterprise’s equity interest, either one of them could report

the indirect transfer to the local PRC tax bureau where the PRC

resident enterprise is located.


43

Restructuring


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CIT Law

“Rule of thumb” on restructuring (Art 75 of IR) is as follows:

any gain or loss resulting from the transfer of the relevant assets under a

corporate restructuring is recognized at the time of transfer; and

the tax basis of the relevant assets will be adjusted to the transaction values

(unless otherwise prescribed by MOF and SAT)

Important Circulars

Circular Caishui [2009]59 - “Notice on Corporate Income Tax

Treatment of Corporate Reorganization”

Special Reorganization

Ordinary Reorganization

SAT Announcement [2010]4 - “The Administrative Measures of

Corporate Income Tax Treatments of Corporate Reorganization”


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Six Categories of Reorganization

Change of legal form

Debt restructuring

Equity acquisition

Asset acquisition

Merger

Spin-off


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Special Reorganizations - Requirements

Must have a commercial purpose (should not be for tax reduction,

avoidance or deferral)

Must be a significant acquisition: Equity/assets acquired should

be no less than 75% of total equity/assets being acquired.

No changes to the business activities for the immediate 12

consecutive months after the restructuring.

For asset and equity acquisitions, mergers as well as spin-offs, at

least 85% of the total consideration must be for equity payment.

The original major shareholder cannot transfer the equity payment

received for 12 months following transaction.


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Tax Basis and Recognition Timing

Ordinary Reorganization

Special Reorganization

Tax Basis

• Revalued to fair market value (FMV)

• Gain or loss on future disposal will be

computed using this FMV value

• Same as the transferor's tax basis (i.e. the

historical tax basis)

Recognition Timing

Ordinary Reorganization • Taxable gain or loss will be recognized at the

time when the transaction takes place.

Special Reorganization • Recognition is deferred (except for the portion

relating to the non-equity consideration)


48

Cross Border Reorganization – Type I

A foreign enterprise transfers its PRC subsidiary’s equity

to another non-PRC wholly owned subsidiary

100%

X %

X %

100%

Non-PRC Co. A Non-PRC Co. A

Non-PRC Co. C Non-PRC Co. C

PRC Co. B PRC Co. B


PRC Co. B PRC Co. B

Non-PRC Co. C Non-PRC Co. C


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Additional conditions for Type I

The non-PRC transferor (i.e. non PRC Co. A) should have a

100% direct ownership of the non-PRC transferee (i.e. non

PRC Co. C)

The PRC capital gains withholding tax burden between the

transferor and the transferee should be the same

The shares of the transferee (i.e. non PRC Co. C) cannot be

transferred again for 3 years following the transaction (i.e. the

structure should keep at lest 3 years)


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Cross Border Reorganization – Type II

A foreign enterprise transfers its PRC subsidiary’s equity

to another wholly owned subsidiary in China

X % 100%

100%


PRC Co. C PRC Co. C PRC Co. B PRC Co. B


PRC Co. B PRC Co. B

PRC Co. C PRC Co. C

X %


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Cross Border Reorganization – Type III

A PRC company transfers its assets/equity to its 100%

owned non-PRC subsidiary in exchange for the non-PRC

subsidiary’s shares.

Equity/share Assets/equity

100%

PRC Co. A PRC Co. A

Non-PRC Co. B Non-PRC Co. B


52

Special Reorganization - Confirmation

Application has to be made to its in-charge tax bureau

(which in turn reports to the provincial level tax authorities

for review)

The review and confirmation should be completed by the

tax authorities before annual CIT’s filing due date.


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Special Reorganization - Confirmation

The following should be provided:

A detailed description of the reorganization and the

underlying “commercial business purpose”;

The related transfer/restructuring agreement;

Shareholding structure of each party;

Approval of the restructuring obtained from the regulatory authorities;

Asset or equity valuation report

Documents stating the book value and tax basis of the asset or liabilities being transferred;

Documents supporting eligibility for a special reorganization; and

Other documents as required by the relevant tax authorities.


54

“Commercial Business Purpose”:

Taxpayers should provide the following information to justify the

transaction’s underlying “commercial business purpose”:

Form of the restructuring, including the transaction model,

background, date, operations before and after the reorganization and

related common business practices;

The form, substance and outcome of the transaction from both a legal

and a business perspective;

The potential impact on the tax position of the parties involved;

The potential impact on the financial position of the parties involved;

Whether the transaction will result in any abnormal economic benefits

and/or potential obligations (which would not arise under ordinary

market principles) to any of the parties involved; and

Relevant information on the involvement of any non-resident enterprise

in the reorganization.


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Illustration

Assume Co. A wholly owns Co. B; and Co. C wants to

acquire the entire interest in Co. B. In return Co. A

receives 50% of Co. C’s equity:

Transfer of 50% equity

interest 100%

Company A Company A Company C Company C

Company B Company B

Sale of Company

B

Company C:

Tax basis: 200

FMV: 400

Company B:

Tax basis: 100

FMV: 200


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For the transaction to qualify for treatment applicable to special

reorganizations, the conditions as stated before should be satisfied.

For acquisition of equity, the

equity acquired should be no

less than 75% of the total

equity of the entity being

acquired. Since Co. C is

acquiring 100% equity of Co.

B, this condition is fulfilled.

At least 85% of the total

consideration received by the

vendor must be equity

payment. As Co. A receives

the consideration for selling

Co. B entirely in equity, this

condition is also satisfied.

50% 50%

100%

Company C Company C

Company A Company A

Company B Company B

Company C’s original

shareholder

Illustration (Cont’d)


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Illustration (Cont’d) - Special Reorganization

Assuming that the other 3

conditions are also satisfied,

the transaction could be

treated as a special

reorganization.

In this case the tax treatment

of the transferor (i.e. Co. A)

and transferee (i.e. Co. C)

under a special reorganization

is summarised as:

Remarks

Taxable gain

for Co. A

$0 Taxability of gain

deferred

Tax basis of

investment in

Co. C held by

Co. A

$100 Tax basis of

investment in Co. C

should be Co. A’s

original tax basis in

Co. B

Tax basis of

investment in

Co. B held by

Co. C

$100 The transferee (i.e.

Co. C) ’s tax basis

of the equity

acquired will be the

original tax basis of

the transferor (i.e.

Co. A)


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If no application is made, the

transaction will be regarded

as an ordinary reorganization.

Illustration (Cont’d) - Ordinary Reorganization

Remarks

Taxable gain

for Co. A

$100 $200 (FMV of Co. A) -

$100 (tax basis)

Tax basis of

investment in

Co. C held

by Co. A

$200 The tax basis of the

equity is the FMV of

the investment

Tax basis of

investment in

Co. B held

by Co. C

$200 The tax basis of the

equity received is the

FMV of the

investment post-

transaction


59

Tax Cases


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Chongqing Case (Nov 2008)

Sing Co A transfers 100%

equity interest in Sing Co B to

PRC Co D

PRC

100%

PRC Co C PRC Co C

Overseas

Sing Co A Sing Co A

Sing Co B

(registered capital:S$100)

Sing Co B

(registered capital:S$100)

31.6%

PRC Co D PRC Co D


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Xinjiang Case (Guoshuihan [2008]1076)

(c) Sale back 33.3% ~

US$45.97M

(a) Acquire 33.3%

~ US$33.8M

(b) Capital

increase PRC Co. C PRC Co. C

PRC

Shareholder

PRC

Shareholder

PRC Co. A PRC Co. A

Barbados Co. Barbados Co.

US Shareholder US Shareholder Capital Gain

= USD45.97M – 33.8M

= USD12.17M


62

Guiyang Case (Apr 2010)

100%

100% Sell

100% PRC

PRC Co.

(Guiyang)

Overseas

HK Seller HK Seller

BVI Co (register a

branch in HK)

BVI Co (register a

branch in HK)

Buyer Buyer


63

Jiangdu Case (June 2010)

100%

Shareholdings Transfer

51% 49%

PRC

PRC Co.

(Jiangdu, Jiangsu Province)

Overseas

US Investor US Investor

Holding Co

(HK)

Holding Co

(HK)

PRC Shareholder

PRC Shareholder

US Buyer US Buyer


64

Shantou Case (Nov 2010)

100% Sell

100%

PRC Co.

(Shantou)

Overseas

BVI Seller BVI Seller

HK Co

HK Co

BVI 2

BVI 2

HK Listed Co HK Listed Co

BVI 1

BVI 1

BVI Co.

BVI Co.

100%

Group

Group


65

Kunshan Case (Nov 2010)

50% 50% increased

to 100%

Sell

100% PRC

PRC Co.

(Kunshan)

Overseas

Hold Co A Hold Co A

Mauritius Co.

Mauritius Co.

Hold Co. B Hold Co. B

Taiwan Group Taiwan Group US Group US Group


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Overseas

100%

Sell

PRC

PRC Co. 1

BVI Co BVI Co

Hold Co.

Hold Co.

Seller Seller Buyer

Buyer

PRC Co. 2

Qidong Case (May 2011)


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Circular Shuizonghan [2013]82

100% -> 65%

65% -> 0%

Sell 35%

Sell remaining 65%

100% PRC

PRC Entities

Overseas

Seller Seller

BVI Holding

BVI Holding

Buyer

(BVI)

Buyer

(BVI)

2 Stage

• 2007: sell 35%

• 2012: sell remaining 65%


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Shenzhen Case (2011)

100%

Shareholdings Transfer

100%

PRC

PRC Company

(Shenzhen)

PRC Company

(Shenzhen)

Overseas

Holding Co

(HK)

Holding Co

(HK)

Singapore Co. Singapore Co.


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Points to note

Commercial purpose

Commercial substance

Various sources:

Public Announcement

Annual Report / Prospectus

Tax clearance for remittance

Daily communication with the local PRC

entities

Internet

FMV vs. Cost

GAAR as legal basis


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Questions

[email protected]

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