Introduction to China's M&A Tax Rules

In the past, due to the rudimentary nature of China's merger and acquisition laws, as well as restrictions on foreign investors, the primary means by which Taiwan's processing-oriented enterprises invested in China was to set up their own companies or factories there. Towards the end of the 20th century, however, China began opening up more industries to foreign investors and improving its M&A laws and regulations, and since acquiring an existing business is a quicker route to gaining market access or new technology, or entering a new line of business, Taiwan-based corporations increasingly choose M&A for rapid expansion into the mainland market.

Among the myriad factors to consider in an merger or acquisition, one thing corporations need to bear in mind is that different forms of combination have different tax outcomes. But with China's M&A taxation regulations scattered among various laws and official proclamations and bulletins, it is not easy to get the whole picture. This article will therefore offer the reader an overall analysis of three main kinds of combination: acquisition of shares through tender offers, etc.; purchases of assets; and mergers.

Acquisition of shares

Shares can be acquired (in order to acquire a stake in a company in China or its offshore holding company) either by buying existing shares, in the case of a company limited by shares, or by contributing capital, in the case of a limited liability company. To put it another way, such acquisitions may be separated into either "acquisition of existing shares" or "subscription for shares and increase of capital".

There is no Mainland China tax burden in the case of an acquisition of an offshore holding company: Taxes will depend on the local tax laws and regulations in the shareholder's country and the country where the holding company is registered. If the holding company is located in a tax haven, then when equity changes hands there is no tax issue as far as the tax haven country or territory is concerned, but there is still the question of possible taxation in the shareholder's country. If the shareholder is a Taiwan-registered company, then unless it is an operations headquarters enjoying preferential tax treatment, it will have to include in its taxable income any capital gains made on the stock. If the shareholder is an individual taxpayer in Taiwan, then since they are considered to be overseas income, it is not necessary to include such gains in taxable income, but starting in 2009 or 2010, personal overseas income in excess of NT$ 1 million will be subject to 20% alternative minimum tax.

When a Taiwan-based company acquires shares in a company located in Mainland China, and such acquisition makes the percent of shares held by foreigners exceed 25%, the company whose shares were acquired must change its business registration, whereupon it may change its form of business to "foreign-funded enterprise". Also, with official approval, a (Mainland) Chinese shareholder in the originally domestic-funded enterprise can then continue on as a foreign-funded enterprise shareholder. This is different from being a Chinese partner in a joint venture or partnership.

Another issue that requires attention when acquiring an interest in a Chinese company is the upper limit on foreign shareholding. For example, if the targeted company is in the audiovisual equipment retail industry, the percent stake in the targeted company held by the acquiring company cannot exceed 49%, but if the acquisition is carried out through a company in Hong Kong or Macao, the percent shareholding can be as high as 70%. If a Taiwanese enterprise uses an existing foreign-invested company to acquire another domestic Chinese company, it will need to abide by certain conditions and restrictions, such as that the registered capital must be fully paid up, and the acquiring company must have begun to earn profits.

If existing shares are to be acquired, usually both buyer and seller must pay 0.05% stamp tax on the share title transfer documents. Also, the seller may need to pay income tax on the capital gains earned in the sale of the equity. If the seller is an offshore holding company, 10% withholding tax is imposed on the proceeds. If the holding company is in a location whose government has signed a treaty with China for the elimination of double taxation, it may be possible to have withholding tax reduced.

If instead a company opts for a subscription for new shares and an increase in the target's capital, the buyer does not bear a tax burden, but the investee company will have to pay stamp tax in connection with its increase in capital. When an existing foreign-invested company acquires equity through a share purchase, feasibility research expenses connected to the investment, investment loan interest expense, investment management fees, and other such expenses incurred to execute the investment, may not be deducted from the enterprise's taxable income. In addition, a foreign-invested company or foreign company does not need to pay income tax when it receives distributions of profits from a domestic (Chinese) company, so when the shareholders of the foreign-invested company or foreign company doing the acquiring calculate their own capital gains, they can deduct the price paid in the transfer of equity from retained earnings and funds set aside for various reserves. However, the amount deducted is strictly limited to the shareholder's part of the equity transfer.

Basically, the tax characteristics of the acquired company are not affected. For instance, cumulative losses that had not been made up before can still be made up within the time remaining of the five-year period for making up losses stipulated in the Income Tax Law; and the book values of the acquired company's various assets, liabilities and shareholder equity items will not change. However, if the acquired company was a domestic-funded enterprise, when it changes its registration to be a foreign-funded enterprise because of the acquisition, it may enjoy tax preferences afforded to foreign-invested enterprises.

Acquired assets can also be divided into those acquired by an existing foreign-funded enterprise and those acquired through a foreign-funded enterprise newly established by a foreign investor, but in either case it involves more types of taxation.

As for buyers (usually a foreign-funded enterprise registered in China), when they obtain land use rights and ownership of buildings, they will have to pay deed tax equal to 3~5% of the transaction price or market price. Stamp tax must be paid on the deed title transfer documents used to acquire the assets, and the amount is a percentage of the asset values recorded in the documents-0.03% in the case of inventory and fixed assets; 0.03% for technology, trademarks and other intangibles. On the tangible assets purchased (excluding land use rights and buildings) one must pay 17% input VAT, which is similar to Taiwan's "business tax". In addition, if the buyer uses non-monetary assets to buy the seller's assets, any capital gain (loss) produced in so doing must be included in the current year's gains (losses) for tax purposes. Any price premium paid by the buyer may be attributed separately to the values of the various assets purchased, or entered singly as an intangible asset (i.e., goodwill), which intangible asset may be amortized in equal installments over 10 years or the remainder of the operating period. Operating periods of domestic Chinese enterprises must get official approval.

As for sellers, land value increment tax of 30 to 60% must be paid on gains earned from transfers of land use rights or buildings, less allowable deductions. On sales of inventory, the seller pays 17% capital gains tax after deducting the seller's own input VAT. The seller must also pay stamp tax on the deed title transfer documents used in the acquisition of assets, based on the asset values given in those documents. More significantly, the seller must pay 5% sales tax on sales of land use rights and buildings, and one must still add any income from the sale of property to the enterprise's taxable income.


The tax characteristics of the buyer and seller do not change after a transaction is completed: Each continues to make up their respective accumulated losses, and there is no question of "succession" (of losses).

Business combinations

Business combinations fall into two categories: mergers, in which all but one of the combining entities are dissolved, and consolidations, in which a new corporation is formed to take over the assets of the dissolved company or companies. The company that continues on after the merger, or the newly founded company, generally assumes all of the rights and obligations of the participating companies, but foreign investors can not, on account of a business combination, exceed the prevailing limits on foreign shareholding.

The various asset, liability and shareholders' equity items must still be entered at their book values. If financial accountants adjust the book values, and depreciation or amortization is calculated and entered on that basis, then corresponding adjustments need to be made in the tax return. There are two methods for making those corresponding adjustments: One is to differentiate between different asset items and make corresponding adjustments in the depreciation or amortization numbers for each item every year. The other method is to make a comprehensive adjustment without breaking it down by asset item, averaging the corresponding adjustment in depreciation or amortization over 10 years.

In principle, a post-combination company that is still eligible to use limited-duration tax credits and exemptions will enjoy all of the tax privilege eligibility remaining to the participating companies before the combination took place. If the eligibility periods are different, or if one of the enterprises is not eligible for limited-duration tax breaks, the post-combination company will need to partition and keep separate the corresponding income and tax payable. Again, there are two methods for partitioning the corresponding income and tax payable: One is to recognize the verified amounts recorded on the books. The other method is to make calculations in proportion to the relative income, expenses, number of employees, etc.

Furthermore, when different tax rates apply to the companies participating in the deal, the post-combination entity must partition the corresponding income, following the same principle as above, and apply the different tax rates. If different tax rates apply and the tax privilege periods are different, then in principle, the accumulated losses of each of the participating companies must be made up from the income of the respective companies using the same tax collection treatment that applied to them before the combination.

Other considerations in acquisitions

In mergers and acquisitions, there are still many factors that we have yet to consider. The following is just a partial list:

1. Holding company structure