China Regulatory Brief: Foreign Trade Development Plan Released and China-Canada Social Security Agreement Reached

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Plan to develop foreign trade throughout 13th Five Year Plan released

The Ministry of Commerce (MOC) has issued a plan consisting of eight tasks to develop foreign trade during the 13th Five Year Plan period. The plan emphasizes collaborating with competent companies to extend the industry chain, conduct transnational mergers and acquisitions, gain brand advantage as well as core technology and marketing channels, and improve operations to meet international standards. It also espouses the promotion and development of an “Online Silk Road” economic cooperation pilot zone, noting that e-business among the countries and regions within the “One Belt and One Road” should be improved. Financial leasing is an important aspect, and the plan notes that financial leasing enterprises will be encouraged to conduct financial leasing for imported equipment. Competent enterprises are encouraged to carry out overseas resource and energy development as well as the processing, production and import of products that are needed in China.

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Case Study: Capital Increases and IIT Calculation During Equity Transfers in China

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By: James Zheng
Editor: Jake Liddle

Equity transfers are a common component of the mergers and acquisitions process. Taxation of equity transfers are often a complex issue; if entities have incorrectly calculated their tax obligations, then they risk being reprimanded by tax authorities. In this article, a case study will provide a scenario exploring several issues that hinder clear tax declaration when executing an equity transfer.

Case study

An equipment manufacturing company based in Nanjing’s New High Tech Zone (Company D) is a leading enterprise within its industry, with a registered capital of RMB 30.3679 million. It obtained high tech enterprise status in 2015, and before entering the market, had a sales income of RMB 60 million. Its shares are distributed between Ms. Wang, a natural person, who holds 6.55 percent, and a limited responsibility company, hereafter ‘Company A’, which holds 93.45 percent.

In May 2015, Ms. Wang transferred her total shares of Company D to Mr. Li, also a natural person, with a transfer value of RMB 2.09 million. Ms. Wang was represented by Company D’s financial manager at the High Tech Zone’s local tax bureau to declare IIT, and her original capital total was RMB 1,990,465.19. The tax declaration calculation is as follows:

Stamp duty: 2,090,000 x 5 ÷ 10,000= RMB 1,045.

Individual income tax (IIT): (2,090,000 – 1,990,465.19 – 1,045) x 20% = RMB 19,697.96.

The local tax bureau made a due audit of Company D, and discovered that according to the provided financial reports, as of May 31, 2016, its total net assets stood at RMB 50,331,939. Ms. Wang’s corresponding share was RMB 3,296,742 (50,331,939 x 6.55%). Under Article 12 of the State Administration of Taxation’s Administrative Measures on Individual Income Tax on Income Derived from Equity Transfer (hereby referred to as the Measures), which requires that “the declared income derived from equity transfer is less than the net assets corresponding to the equity”, the equity transfer was clearly undervalued. Therefore, the local tax bureau modified the income derived from the transfer according to Company D’s present net assets of RMB 3,296,742. Thus, Ms. Wang was obliged to pay an IIT of RMB 261,046.4 ((3,296,742 – 1,990,465.19 – 1,045) x 20%). Ms. Wang had no objection, and was willing to comply with the appraisal and ratification of the tax department and the amount of tax returns suggested. Proceedings appeared to be going smoothly, until tax officers took issue with Company D’s financial information from the previous three years.

When Company D was established in 1991, its registered capital stood at US$757,700, with Ms. Wang’s original share at 40.89 percent, and Company A’s share at 59.11 percent. The tax bureau discovered that in March 2015, Company A injected RMB 25.5 million in capital into Company D, and when the capital injection was finalized, its registered capital stood at RMB 30,367,800, of which Ms. Wang’s share was 6.55 percent, and Company A’s share was 93.45 percent. The tax bureau took issues with the following:

Professional Service_CB icons_2015RELATED: Tax and Compliance Services from Dezan Shira & Associates

Before the capital injection: Company D’s net assets was RMB 31,403,843.65, and Ms. Wang’s share of the net assets as calculated was RMB 31,403,843.65 x 40.89% = RMB 12,841,032.

After the capital injection: Ms. Wang’s share of the net assets as calculated should have been (RMB 31,403,843.65 + 25,500,000) x 6.55% = RMB 3,727,202.

After the capital injection, where did Ms. Wang’s RMB 9,113,830 go?

Regulatory analysis

There are three main questions to ask:

  1. Did Company A benefit from Ms. Wang during Company D’s capital increase in March 2015?
  2. Was Ms. Wang obliged to pay tax under this capital increase?
  3. How is the transaction taxed?

Firstly, Company A’s net asset share was:

Before the capital injection: RMB 31,403,843.65 x 59.11% = RMB 18,562,811.98

After the capital injection: (RMB 31,403,843.65 + RMB 25,500,000) x 93.45% = RMB 53,176,641.89

Company A’s net asset share increased by RMB 9,113,830 after the capital injection, discounting the capital injection itself (RMB 53,176,641.89 – RMB 18,562,811.98 – RMB 25,500,000). Therefore, Ms Wang’s missing share went directly to Company A. According to the Company Law of the People’s Republic of China, the capital increase is legal as it was an agreement by the board of shareholders. However, a value transfer did occur, and Ms Wang and Company A did not provide an explanation why.

Secondly, according to Article 3 of the Measures, Ms. Wang did not conduct an equity transfer, and therefore has no tax obligation. However, while the local tax bureau does not think that it could lead to a tax evasion case, Ms. Wang could be obliged to pay IIT for the share rights transfer.

Thirdly, Article 4 of the Measures states that, “In the case of equity transfer by an individual, the taxable income amount shall be the balance from deduction of the equity’s original value and reasonable expenses from the income derived from equity transfer, and the individual shall pay individual income tax as per income from transfer of property”. The income derived from the transaction has been confirmed as RMB 3,296,742, and both parties are in agreement. However, the local tax bureau and Company D did not agree on expenses. Ms. Wang and Company D think that the expense of the transfer is the original value of Ms. Wang’s equity share of RMB 1,990,465.19, and the capital increase does not factor in. The tax bureau thinks that during the capital increase, the net asset of Company D had increased, and that therefore, Ms. Wang’s share value had changed. Thus, according to the tax bureau, the expense should be calculated as Ms. Wang’s original share value minus the amount of value transfer during the 2015 capital increase. Here, the value transfer is not classed as income derived from transfer, but still needs to be offset from the expense:

Expense of the transfer: RMB 1,990,465.19 – RMB 9,113,830 = RMB – 7,123,364.81

Taxable amount of this transfer: RMB 3,296,742 – (- RMB 7,123,364.81) – RMB 1,045 = RMB 1,041,9061.81

IIT: RMB 10,419,061.81 x 20% = RMB 2,083,812.362.

Key takeaways

In the event of a shareholder’s capital increase, the portion of other shareholders’ assets will be diluted. This may mean that the shareholders of the diluted shares, in fact, transfer equity value to shareholders who conduct the capital increase. Such transfer of value may not be subject to capital gains tax regarding the capital increase and the subsequent share dilution, but it will have an impact on future transfer of shares as the cost base of capital gains taxes. The case study explored in this article shows that it is important for entities conducting equity transfer during the M&A process to fully consider issues, such as base registered capital and capital increase when declaring tax.


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The Chinese government recently published a series of official measures to boost the development of the country’s culture and entertainment industry, including the Opinions on Promoting the Upgrade of Cultural and Entertainment Industry and the Film Industry Promotion Law (effective on March 1, 2017). China has seen rapid growth in the culture and entertainment industry in recent years, owing to government support as well as a growing middle class consumer base. According to a recent report on the Entertainment & Media (E&M) industry by PwC, China’s E&M market has increased by 50 percent since 2010 and is forecast to rise at a compounded annual growth rate (CAGR) of 8.8 percent over the next five years. The internet advertising, film, and video game segments will be the main intra-industry dynamics that will drive growth, with a projected CAGR from 2015 to 2020 of 13.9 percent, 18.9 percent, and 7.4 percent, respectively. However, as the Chinese government aims to use the cultural sector as a ‘soft power’ tool, such political intentions will inevitably lead to a certain extent of sensitivity for foreign participation in China’s culture and entertainment industry.

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