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By Matthew, February 22, 2010 3:06 pm

One of my aims for posts on China Tax Insights is to avoid blatant self-promotion of myself or my firm, Hwuason. Instead, I prefer to write substantive and in-depth posts that evidence the quality of legal work my firm does. However, I am going to break this rule just this once.

Over the last 7 days Asian Legal Business (ALB) released a 2010 China Watchlist – a list of firms that it predicts will be the big movers in 2010. I am pleased to note that Hwuason has made the 2010 list. Obviously, few lawyers do their work to achieve awards and we are more interested in pleasing our clients than receiving such recognition. However, this recognition is still pleasing for a firm like Hwuason that is not the biggest firm in China nor the most typical. Whereas the overwhelming majority of firms in China eschew specialisation, Hwuason has chosen to specialise in a very discrete and techical area – tax. This very much goes against the grain in China – there is a tendency here for firms, and lawyers themselves, to do any work that comes their way irrespective of their knowledge and ability in that particular area. This is actually one of the few frustrations I have about working in the legal field in China.

I very much admire Liu Tianyong, the Managing Partner of Hwuason, who four years ago recognised that the tendency of catchall firms was not appropriate for the practice of law in a more sophisticated legal environment and sought to focus his and his firms skills. Tianyong has also invested considerable recources into developing the tax law profession (Hwuason is the only specialist tax law firm in China) amongst graduates of China’s universities. For these reasons, and many others, I am pleased Tianyong has received the recognition that he and the firm deserves.

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By Matthew, February 17, 2010 11:31 am

As I mentioned a week or so ago, the SAT has prepared a draft of new detailed M&A rules. These have not been issued yet, but Hwuason managed to get  a copy of the draft. I will outline some of the more salient points over two separate posts:

Reasonable business purpose

The draft rules provide further details on the M&A Tax Rules (财税(Caishui) [2009] 59) that were issued mid last year. Caishui 59 provided a basis on which tax in respect of equity and asset acquisitions could be deferred where the transaction was in substance a reorganisation as opposed to a true sale of the company or asset. In Caishui 59 such a reorganisation is referred toas  a “special reorganisation”. One of the conditions for the special reorganisation deferral relief was that it must have a “reasonable business purpose”. The draft rules now provide a expanded definition of this term. In particular, the draft rules provide that the following factors will be relevant for determining if a transaction has a reasonable business purpose:

1. Transaction methods for restructuring activities. That is, the specific form of restructuring activities, trading background of restructuring activities, time for setting up transaction, other purposes that objectively can be classified as taking part in establishing the transaction, whether the transaction is facilitated by professional consultants and the operation methods before and after the transaction, and relevant commercial common practice.
2. The form and substance of the transaction. That is, the legal rights and liabilities derived from the transaction, what is the legal consequences of the transaction, and the final result of the transaction practically or commercially.
3. The changes of tax status to each parties brought by the restructuring activities.
4. The changes of financial status to each parties brought by the restructuring activities.Whether the restructuring activities brought to each party abnormal economic benefits or potential obligations that would not happen under normal market principles.
5. Non-resident enterprises to participate in restructuring activities.

What is clear from both Caishui 59 and the new draft rules is that tax will never be a legitimate basis for a restructure for the purpose of obtaining the special reorganisation relief. So, for example, if a group was to restructure their operations in light of Circular 698 so as to avoid the imposition of tax on any future equity transaction, then such a restructure would not be entitled to the relief unless legitimate reasons can be posed for the transaction. However, the point I have highlighted in bold above suggests how far the authorities intend to take such a principle. It is my guess that this wording will be removed from the final draft that is released but that it will nonetheless be a fairly influential factor.

Main shareholder

Under Caishui 59 entitlement to the special reorganisation relief required that the “main shareholder” of the transferred enterprise is not able to sell its  equity in the acquirer for 12 months. The term “main shareholder“ has now been defined in the draft rules to mean any shareholder that had more than a 20% interest in the transferred enterprise.

Common equity control

Under Caishui 59 a merger can receive special reorganisation relief, inter alia, if there is “common equity control”. This has now been further clarified to mean “ultimate control from the same party or multi-parties that the merged enterprises are subject to before and after the merger occurred and the control is not a temporary arrangement”. It appears that such control interests will need to be held for at least 12 months before and after the reorganisation to not be a “temporary arrangement”.

Reporting requirements

Firstly, under the draft rules all parties must be agreed as to whether a reorganisation is ordinary or special. This is obviously to avoid one party from later disputing a particular characterisation. The material in relation to the reorganisation must be submitted with the enterprises annual tax filings at the end of the tax year in which the transaction took place. The material submitted must be “consistent” with the “dominant party” responsible for organising the collection of the material. In both equity and asset transactions the dominant party is the transferor.

Where the transaction is between two non-resident enterprises, the transferred non-resident enterprise itself must report the transaction within 30 days of the contract being. This mirrors the requirements under Circular 698.

(to be continued)

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By Matthew, February 8, 2010 2:58 pm

Australian tax law permits a deduction in taxable income where a taxpayer ’s income is stolen. In particular,  section 25-45 of the Income Tax Assessment Act 1997 provides that a taxpayer can deduct a loss in respect of money if:

• the taxpayer discovers the loss in the income year,
• the loss was caused by theft, stealing, embezzlement, larceny, defalcation or misappropriation by the taxpayer’s employee or agent, and
• the money was included in the taxpayer’s assessable income for the income year or for an earlier income year.

A recent decision of the Full Federal Court – Lean v Commissioner of Taxation [2010] FCAFC 1 (28 January 2010) – examined this savings provision and found that in the circumstances of the case it did not apply. The effect of this decision is to greatly limit the operation of section 25-45.

Facts

In 2001 the taxpayer (Mr Lean) met a Mr Heffernan at a meeting organised by an organisation that provided research and services in relation to share trading. Based on the introduction, the taxpayer was led to believe that Mr Heffernan was an experienced and reputable securities trader. At this time, the taxpayer was the holder of options in Microsoft Inc. Based on the advice of Mr Heffernan, the taxpayer exercised his options and sold the shares through a US stockbroker. Mr Heffernan also recommended that the taxpayer transfer the proceeds to a “private client account” maintained by him in Hong Kong and that he would invest the money on the taxpayer’s behalf. In total, approximately AUS4,630,314 was transferred from the proceeds of the Microsoft Inc share transfers to the account maintained by Mr Heffernan. Some time after this, this money was lost. Athough it is not clear how this occurred, it appears that it was accepted that it wasnt lost through investment decisions but rather a misappropriation by Mr Heffernan.

The Administrative Appeals Tribunal found that the misappropriation was one that fell within the terms of section 25-45 as the income from the Microsoft shares were included in the taxpayer’s taxable income and it was that income that was misappropriated by Mr Heffernan.

Federal Court decison

However, the Federal Court (both single judge and the full court) disagreed with this characterisation. The Court held that the proceeds from the Microsoft transfer and the money that was misappropriated were not one and the same for the purposes of section 25-45. This was because “where money that was included in the assessable income of a taxpayer is applied by way of investment, the money has left the taxpayer’s hands, and there can be no relevant misappropriation of or in respect of that money”. As the taxpayer had instructed his US stockbroker to transfer the money to Mr Heffernan for reinvestment, the money had left his hands. In as much, the money could no longer be characterised as income from the transfer of shares and therefore there was no relevant misappropriation for the purpose of section 25-45. To the contrary, the income from the shares had been applied as instructed by the taxpayer – it had been applied for his benefit. The fact it had been later stolen was irrelevant for the purposes of section 25-45.

As a result, not only did the taxpayer lose this money but he now also needs to pay tax to the ATO for the income from the Microsoft shares.