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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 5, 2010 5:50 pm

I apolosise, despite promising to give an outline of the new draft M&A tax rules today I have been swamped at work. I will endeavour to get this done over the weekend.

On a related note, yours truly and a couple of China M&A practitioners will be taking part in a M&A seminar hosted by Aust-Cham and Brit-Cham in mid-March. My talk will solely concern the tax issues inherent in M&A transactions. Some of the topics I will discuss will include the M&A rules issued last year, the impact of the new draft M&A rules, Circular 601 and Circular 298

Apart from myself, the lineup of speakers is quite impressive. Geradline Putra Johns who writes the always interesting View To China blog will be giving her insights on China’s M&A regulatory and legal regime. Geraldine is the director of a China focused M&A legal consultancy based in London who previously worked in China for several years. Given this, and based on the quality of her blog, I think she have some very interesting insights into the developments for the coming year.

The other speaker will be Alex Clar, a lawyer with the large Chinese firm Grandalls. Alex has worked in foreign direct investment field and M&A in China for a number of years. Presently his practice focuses on outbound investment (mainly US capital markets I understand). I think he will similarly have some interesting, and perhaps alternative, insights.

I am really looking forward to taking part and hearing Gerladine and Alex’s views.

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By Matthew, February 4, 2010 1:09 pm

I have just got my hands on a copy of new draft M&A procedural tax rules that should be released in the very near future. The copy I have has not been formally released at this stage so it may be subject to some changes, although this is doubtful. I havent had a chance to properly review the rules yet but I will try and give an outline of some of the salient points later today/tomorrow.

For a taste test, from my quick glance it appears that there is a new explanation of the reasonable business purpose test. These new draft rules are basically a further explanation of Caishui [2009] 59 (财税[2009] 59) which are the current tax rules governing M&A transactions in China.