September 01, 2010

Measures on the Administration of Enterprise Income Tax for Corporate Restructurings

Measures on the Administration of Enterprise Income Tax for Corporate Restructurings
Issuing Body: State Administration of Taxation
Issuing Date: July 26, 2010
Effective Date: January 1, 2010

Circular on Issues Concerning Enterprise Income Tax Treatment for Corporate Restructurings
Issuing Body: Ministry of Finance, State Administration of Taxation
Issuing Date: April 30, 2009
Effective Date: January 1, 2008

Seeking to clarify lingering issues related to the tax treatment of corporate restructurings under China's Enterprise Income Tax Law, the State Administration of Taxation (SAT) issued the Measures on the Administration of Enterprise Income Tax for Corporate Restructurings (Corporate Restructuring Measures, also known as Public Notice 4) in July. The Corporate Restructuring Measures provide detailed guidance on documentation and procedural requirements for all types of corporate restructuring covered under the Circular on Issues Concerning Enterprise Income Tax Treatment for Corporate Restructurings (Corporate Restructuring Circular, also known as Circular 59). The SAT also took the opportunity to clarify certain policy-type issues left unaddressed by Circular 59.

The Corporate Restructuring Circular retroactively came into effect as of January 1, 2008. The key element of Circular 59 was its introduction of the concept of "Special Tax Treatment" (STT) for certain corporate restructuring transactions, with guidelines on qualification and procedures for obtaining STT status. Special Tax Treatment, while common in other countries, is new to China, and has certain advantages to companies involved in restructuring—most notably, the opportunity to defer taxes. However, some uncertainties, both substantive and procedural, were left unanswered by the Corporate Restructuring Circular.

Forms of Restructuring Covered

The Corporate Restructuring Circular defines and discusses the following forms of restructurings that are subject to tax treatments discussed in the circular:

  • Equity Acquisition: A company acquires the shares of another company by giving up equity, non-equity considerations, or a combination of both for the purpose of controlling the second company.
  • Asset Acquisition: A company acquires all or part of the business assets of another company by giving equity, non-equity considerations, or a combination of both.
  • Merger: One or more companies transfer all of its or their assets and liabilities to another existing or newly established company (Surviving Company) in exchange for shares of the Surviving Company and/or non-equity considerations.
  • Split: A company transfers all or part of its assets and liabilities to two or more existing or newly established companies (Split-off Companies) in exchange for shares of the Split-Off Companies and/or non-equity considerations.
  • Change of Legal Form: A company changes its registered name, address, or entity type.
  • Debt Restructuring: An arrangement between a debtor and its creditors relating to debts as a result of financial difficulties of the debtor.

General Tax Treatment

Under Circular 59, General Tax Treatment (GTT) is the norm for companies that do not obtain STT status. The general principle for General Tax Treatment is that enterprises undergoing corporate restructuring should recognize gains or losses from the transfer of relevant assets and/or equity at fair market value when the transaction takes place, and the tax basis of relevant assets in the hands of the transferee should be revised according to transaction prices. The Corporate Restructuring Circular also discusses detailed tax treatments for each of the above forms of restructuring.

Special Tax Treatment

The Corporate Restructuring Circular also allows parties involved in a restructuring to select STT, the essence of which is deferral of taxes—if certain conditions are satisfied. In contrast to General Tax Treatment, the general principle of STT is that the recognition of gain or loss by the transferor on the transfer of assets or equity (shares) may be deferred with respect to the portion that is equity payment; and the transferee shall take over the transferor's tax basis on the transferred assets or equity (shares).

STT Qualifications and Conditions

For both domestic and foreign investors, five general conditions must be met in order for a transaction to qualify for Special Tax Treatment:

  • Reasonable business purposes: The transaction must have a reasonable business purpose—the primary purpose of the transaction must not be to reduce, avoid, or defer tax payments. No further guidance is provided under Corporate Restructuring Circular about what a "reasonable business purpose" is or how to determine whether this requirement has been satisfied. The issue was further clarified in the Corporate Restructuring Measures.
  • Prescribed ratios on amount of assets or equity transferred: In equity deals, at least 75 percent of the total equity of the target company should be transferred if it is an equity acquisition. In asset deals, at least 75 percent of the total assets of the transferor should be transferred in an asset acquisition.
  • Continuity of business operations: There must be no change in the operating activities of the target company for 12 months after the restructuring.
  • Prescribed ratio on amount of equity payments required: At least 85 percent of the total consideration received by the transferor must consist of equity of the acquirer. For satisfying this condition, the acquiring companies need to consider the impact of share dilution when formulating the terms of the transaction.
  • Continuity of ownership: The major transferor must not transfer the acquired equity for 12 months after the acquisition.

STT and Cross-Border Restructuring

Special Tax Treatment may also be granted in cross-border restructurings, but only if one of the following specific conditions is satisfied, in addition to those listed above:

  • When a non-tax resident enterprise (Non-TRE Transferor) transfers equity interest in a resident enterprise (TRE) to another non-tax resident enterprise (Non-TRE Transferee) in which the Non-TRE Transferor holds 100 percent direct ownership, no change in income withholding tax of the future transfer of such equity is caused thereby, and the Non-TRE Transferor promises in writing not to transfer equity interest in the Non-TRE Transferee within three years after the transfer of the TRE.
  • A Non-TRE Transferor transfers equity interest in a TRE to another TRE in which it holds 100 percent direct ownership.
  • A TRE invests its assets and equities in a Non-TRE in which it holds 100 percent direct ownership.
  • Other circumstances as determined by MOF and SAT.

Filing Procedures

For enterprises that satisfy the above conditions and intend to apply for Special Tax Treatment, the involved parties should submit written documentation (details of which are clarified in the Corporate Restructuring Measures) to the competent tax authority to prove that they comply with the conditions stipulated at the time of completion of the annual declaration of enterprise income tax for the current fiscal year in connection with the restructuring. If the enterprise fails to make a written filing, STT will not be granted.

Clarification on STT Application Procedures

Public Notice 4 provides the timeline for restructuring parties to choose STT and seek confirmation from tax authorities (i.e. before completion of the annual declaration of enterprise income tax of the current fiscal year in connection with the restructuring). It also provides detailed guidance on follow-up reporting and review procedures after STT has been elected.

If the STT conditions listed above are violated within the prescribed period after completion of the restructuring (for example, if the company fails to meet the requirement for a 12- or 36-month holding period), the restructuring parties must make tax adjustments within 60 days of the breach. More importantly, they must re-calculate the gain or loss from the restructuring based on the fair market value at the time of the original restructuring and adjust their Enterprise Income Tax returns for the year in which the original restructuring took place. Public Notice 4 does not mention whether there would be a penalty or surcharge if the parties if the parties involved make tax adjustments within the prescribed timeframe.

Clarifications on Reasonable Business Purposes

The Corporate Restructuring Measures further clarify that enterprises filing for or submitting an application for confirmation in accordance with the above requirements shall justify the reasonable commercial purposes of the proposed restructuring from the following perspectives:

  • Form of the restructuring (i.e., background and timing of the transaction, the business mode before and after it is completed);
  • Legal form and substance of the restructuring (i.e., the legal rights and obligations arising from the restructuring, legal consequences, and the ultimate outcome);
  • Potential changes to the tax profile of all restructuring parties;
  • Changes to the financial positions of all restructuring parties;
  • Whether the restructuring will give rise to any abnormal economic benefits or potential obligations to any party involved that would not arise under ordinary market conditions; and
  • Any non-tax resident enterprise(s) participating in the restructuring.

Clarifications on Application Documentation

Enterprises that decide to choose STT should prepare and submit the following documentation to prove their qualifications:

  • General introduction of the restructuring, including the commercial purposes;
  • The restructuring agreements or contracts concluded by all parties involved;
  • Documents issued by an appraisal firm verifying the fair value of the share consideration transferred or paid in the transaction;
  • Documents showing that the restructuring satisfies all conditions for Special Tax Treatment;
  • Documents showing that the equity transfer has met the approval of relevant authorities, including the administration of industry and commerce; and
  • Other documents required by tax authorities.


Though Special Tax Treatment is common in many countries, its introduction, via the Corporate Restructuring Circular, represents a milestone in the development of China's tax structure. STT provides tax deferral opportunities for both domestic and cross-border restructuring transactions, and in particular M&A deals. However, as STT is fairly new and difficult to accomplish in practice, it will bring burdens on taxpayers in the process of filing for STT. Therefore, it is advisable for the taxpayers to weigh the costs and benefits before electing such tax deferral structures.

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