M&A Issues for Accountants Tax Considerations

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1 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) M&A Issues for Accountants Tax Considerations

2 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 Institute), the speaker(s) and the firm(s) that the speaker(s) is representing take no responsibility for any errors or omissions in, or for the loss incurred by individuals or companies due to the use of, the materials of this seminar / workshop / conference. No claims, action or legal proceedings in connection with this seminar/workshop/conference brought by any individuals or companies having reference to the materials on this seminar / workshop / conference will be entertained by the Institute, the speaker(s) and the firm(s) that the speaker(s) is representing. 2

3 Agenda A General Review: Hong Kong & PRC Corporate Taxes Merger & Acquisition: Asset Deal & Share Deal Offshore Transfer Restructuring Tax Cases 3

4 A General Review: HK and PRC Corporate Taxes 4

5 General Overview of Hong Kong Profits Tax Turnover COGS GP G&A expenses Other Income Profit before tax HK Profits Profit after tax $xxxx ($yyy) $zzzz (aaa) bbb XYZ (fff) ABC Territorial concept No capital gain tax No Turnover Tax (e.g. VAT, sales tax etc.) Low Profits Tax Rate: 16.5% 5

6 General Overview of PRC Corporate Taxes a) Corporate Income Tax (CIT) b) Turnover Tax Turnover $xxxx VAT/BT Business Tax (BT) COGS ($yyy) Valued Added Tax (VAT) Consumption Tax (CT) c) Withholding Tax (WHT) GP G&A expenses $zzzz (aaa) WHT? Dividend Other Income bbb VAT/BT Interest Royalties d) Other Tax Profit before tax CIT XYZ (fff) CIT Land Appreciation Tax (LAT) Profit after tax ABC Stamp Duty 6

7 Corporate Income Tax Resident Enterprise a) PRC incorporated company; or b) Foreign company with effective management and control in China or Within PRC Outside PRC Subject to CIT at 25% (Global Income) 7

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 8

9 Corporate Income Tax Non-Resident Enterprise Active income (e.g. service fee) Subject to CIT at 25% if PE created (deemed profit rate) Passive income (e.g. capital gain, dividend) Subject to withholding tax at 10% Within PRC Enterprise outside PRC (e.g. a HK Co.) 9

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%) 10

11 General VAT Payer VAT payable = Output VAT - Input VAT Output VAT: Collected from buyer Input VAT: Paid by taxpayer during procurement or importation Small-scale VAT payer VAT Payable = [Turnover / (1+ VAT rate)] x VAT rate No input credit is allowed Cost of Sales 11

12 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 12

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 13

14 Merger & Acquisition 14

15 Importance of Due Diligence Any hidden liabilities and exposures? Disclosed information presented properly? 15

16 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. 16

17 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. 17

18 Acquiring a Business in Hong Kong Vendor Buyer Equity Transfer HK Co. No Capital Gain Tax in HK No Turnover Tax in HK Transfer of Shares: Stamp will be imposed on each of the sell and buy notes of shares transfer 18

19 Acquiring a Business in China Must observe the Foreign Investment Guideline Encouraged Restricted Prohibited Permitted Levels of approval Foreign Participation Limitation 19

20 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 20

21 Equity Transfer Seller Equity Transfer Buyer PRC Co. 21

22 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 22

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 23

24 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) (b) (c) If seller is a PRC resident enterprise, 25% CIT will apply If seller is a an individual, the capital gain will be subject to IIT of 20% Gain on transfer Stamp duty 0.05% Execution of contractual document 24

25 Equity Transfer PRC Tax Implications (Buyer) Types of Tax Tax rate Tax Basis Stamp duty 0.05% Execution of contractual document 25

26 Asset Transfer Investor A Investor B PRC Co. (Seller) PRC Co. (Buyer) Asset Transfer 26

27 Trading Stock Seller s Tax Implication CIT VAT (collected from buyer) CT (if applicable) Stamp Duty Buyer s Tax Implication VAT (collect by seller) Stamp duty 27

28 Land And Buildings Seller s Tax Implication CIT BT LAT Stamp Duty Buyer s Tax Implication Deed Tax Stamp Duty 28

29 Used Fixed Assets Seller s Tax Implication CIT VAT (collected from buyer) CD and import VAT (Claw back) Stamp Duty Buyer s Tax Implication VAT (Collect by Seller) Stamp Duty 29

30 Intangibles Seller s Tax Implication CIT BT Stamp Duty Buyer s Tax Implication Stamp Duty 30

31 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 31

32 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) Claw-back of Customs duty and import VAT To be determined by Customs Gain on disposal of land use rights and buildings Disposal of imported tax/duty free equipment within the Customs supervision period Stamp duty 0.05% Execution of contractual document 32

33 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 33

34 Seller 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. Buyer 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. 34

35 Offshore Transfer 35

36 Equity Transfer Seller Equity Transfer Buyer PRC Co. 36

37 Offshore Indirect Transfer of PRC Investment Non Resident Seller Equity Transfer Non Resident Buyer Intermediate holding company Overseas PRC Co. PRC 37

38 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 38

39 Offshore Indirect Transfer Non Resident Seller Equity Transfer Non Resident Buyer Intermediate holding company e.g. HK/BVI Co. Effective tax burden < 12.5%; or Offshore income tax exempted Overseas PRC Co. PRC 39

40 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. 40

41 Commercial Substances lacks of business objectives substance over form Disregard offshore intermediary company Tax on NR Seller 41

42 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. 42

43 Restructuring 43

44 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 44

45 Six Categories of Reorganization Change of legal form Debt restructuring Equity acquisition Asset acquisition Merger Spin-off 45

46 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. 46

47 Tax Basis and Recognition Timing Tax Basis Ordinary Reorganization Special Reorganization 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) 47

48 Cross Border Reorganization Type I A foreign enterprise transfers its PRC subsidiary s equity to another non-prc wholly owned subsidiary Non-PRC Co. A Non-PRC Co. A X % 100% Non-PRC Co. C 100% Non-PRC Co. C X % PRC Co. B PRC Co. B 48

49 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) 49

50 Cross Border Reorganization Type II A foreign enterprise transfers its PRC subsidiary s equity to another wholly owned subsidiary in China Non-PRC Co. A X % 100% Non-PRC Co. A 100% PRC Co. B PRC Co. C PRC Co. C X % PRC Co. B 50

51 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. PRC Co. A Assets/equity 100% Equity/share Non-PRC Co. B 51

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. 52

53 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. 53

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. 54

55 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: Sale of Company B Company A Company C Company C: Tax basis: 200 FMV: % Transfer of 50% equity interest Company B: Tax basis: 100 FMV: 200 Company B 55

56 Illustration (Cont d) For the transaction to qualify for treatment applicable to special reorganizations, the conditions as stated before should be satisfied. Company A 50% 100% Company C Company B Company C s original shareholder 50% 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. 56

57 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: Taxable gain for Co. A Tax basis of investment in Co. C held by Co. A Tax basis of investment in Co. B held by Co. C Remarks $0 Taxability of gain deferred $100 Tax basis of investment in Co. C should be Co. A s original tax basis in Co. B $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) 57

58 Illustration (Cont d) - Ordinary Reorganization If no application is made, the transaction will be regarded as an ordinary reorganization. Taxable gain for Co. A Tax basis of investment in Co. C held by Co. A Tax basis of investment in Co. B held by Co. C Remarks $100 $200 (FMV of Co. A) - $100 (tax basis) $200 The tax basis of the equity is the FMV of the investment $200 The tax basis of the equity received is the FMV of the investment posttransaction 58

59 Tax Cases 59

60 Chongqing Case (Nov 2008) Sing Co A 100% Sing Co A transfers 100% equity interest in Sing Co B to PRC Co D Sing Co B (registered capital:s$100) 31.6% Overseas PRC Co D PRC Co C PRC 60

61 Xinjiang Case (Guoshuihan [2008]1076) Capital Gain = USD45.97M 33.8M = USD12.17M (c) Sale back 33.3% ~ US$45.97M US Shareholder Barbados Co. PRC Shareholder PRC Co. A (a) Acquire 33.3% ~ US$33.8M PRC Co. C (b) Capital increase 61

62 Guiyang Case (Apr 2010) HK Seller Buyer 100% Sell BVI Co (register a branch in HK) 100% Overseas PRC 100% PRC Co. (Guiyang) 62

63 Jiangdu Case (June 2010) US Investor Shareholdings Transfer US Buyer 100% Overseas Holding Co (HK) PRC PRC Shareholder 49% 51% PRC Co. (Jiangdu, Jiangsu Province) 63

64 Shantou Case (Nov 2010) Group BVI Seller 100% BVI 1 BVI 2 Sell 100% HK Listed Co BVI Co. Overseas HK Co 100% PRC Co. (Shantou) 64

65 Kunshan Case (Nov 2010) Taiwan Group US Group Hold Co A Sell Hold Co. B 50% 50% increased to 100% Mauritius Co. Overseas PRC 100% PRC Co. (Kunshan) 65

66 Qidong Case (May 2011) Seller Sell Buyer BVI Co Hold Co. 100% Overseas PRC PRC Co. 1 PRC Co. 2 66

67 Circular Shuizonghan [2013]82 Seller 100% -> 65% 65% -> 0% Sell 35% Sell remaining 65% Buyer (BVI) BVI Holding Overseas PRC 100% PRC Entities 2 Stage 2007: sell 35% 2012: sell remaining 65% 67

68 Shenzhen Case (2011) Shareholdings Transfer Singapore Co. 100% Holding Co (HK) Overseas PRC 100% PRC Company (Shenzhen) 68

69 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 69

70 Questions 70