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Editor's note: VAM agreements, also known as valuation adjustment agreements, have the characteristics of investment risk control and mid-level and high-level incentives, which have been favored by a large number of capital market investors and increasingly appear in commercial transactions, but because there is currently no special tax regulation to provide for the income tax issues of VAM agreements, a large number of tax issues and cases of VAM agreements have appeared in practice. This article focuses on the tax-related issues of individual income tax in VAM agreements, including the recognition of the timing of taxation, the application of the individual tax deferral policy, and the differences in taxation and refund caused by the application of "separate tax treatment" and "combined tax treatment".
The basic meaning and type of VAM agreement
In 2019, the Supreme People's Court defined a VAM agreement for the first time in the Minutes of the Nine People: "In practice, the so-called 'VAM agreement', also known as the valuation adjustment agreement, refers to an agreement designed by the investor and the financier to solve the uncertainty, information asymmetry and agency cost of the target company, including equity repurchase, monetary compensation and other adjustments to the valuation of the future target company when the investor and the financier reach an equity financing agreement, in order to solve the uncertainty, information asymmetry and agency cost of the target company."
There are many forms of VAM agreements, and for ease of understanding, there are usually three classifications: according to the payment time of "contingent consideration", it is divided into forward gambling and reverse gambling, and forward gambling means that the transferee pays the corresponding transfer amount in advance, and if the target company completes its performance, the transferee adds the corresponding consideration. Reverse VAM means that the transferee transfers the entire price in advance, and if the target company does not complete the performance, the transferor needs to pay a certain compensation; According to the different forms of compensation, it can be divided into monetary compensation and equity-type compensation, in practice, in order to reduce investment risks as much as possible, two forms of compensation may be applied at the same time; In addition, depending on the shareholding ratio, it is divided into participation and holding gambling.
Tax case analysis
(1) Case 1: The individual shareholder successfully gambled and the revenue recognized on the date of completion of the agreement was not recognized
1. Brief Facts of the Case
In 2014, Shi signed the "Profit Forecast Compensation Agreement" (hereinafter referred to as the "VAM Agreement") with Company A, Shi acquired the shares of Company A and transferred his equity in Company B to Company A, and Company A controlled 100% of Company B. It was also agreed that the shareholders of Company B such as Shi would make a commitment to the net profit of the year after the implementation of this major asset restructuring and the following two years, and if the net profit did not reach the forecast, Company A should be compensated for the part that did not meet the profit forecast. The compensation method is: first compensate with the shares subscribed, and then cash compensation when it is insufficient. In 2014, 2015 and 2016, Company B exceeded the forecast profit standard and gambled on success.
In May 2019, Shi applied to his tax office for the filing of installment payment of his individual income tax, and the filing installment tax plan time was filled in as 2017, 2018, 2019, 2020 and 2021. After review, the tax firm found that the tax liability of Shi's non-monetary asset investment transaction should have occurred in September 2014, and Shi's filing application only on May 10, 2019 did not meet the conditions for acceptance in terms of time and content, and decided not to accept it. Shi was not satisfied and applied to the tax bureau to which he belonged, and the tax bureau upheld the inadmissibility decision. Shi then filed an administrative lawsuit with the people's court, but lost both the first and second instances, and Shi applied to the local higher people's court for a retrial, which was rejected.
2. Focus of Dispute
The taxpayer believes that the time of taxation of the VAM agreement should be when the performance of the agreement is completed. Shi believes that the following two conditions should be met to confirm his acquisition of equity: first, Shi transfers the equity of Company B to Company A; Secondly, Shi actually acquired the ownership of the shares of Company A. The VAM Agreement attached conditions to Shi's acquisition of the equity of Company A, and the final vesting of the equity of Company A has not yet been realized, and Shi's taxable income should not be recognized in September 2014, but after the expiration of the VAM Agreement, due to the Announcement of the State Administration of Taxation on Individual Income Tax Collection and Administration Issues Related to Individual Non-monetary Asset Investment (SAT Announcement No. 20 of 2015, hereinafter referred to as "Document No. 20") ) does not stipulate that taxpayers lose the right to defer tax if they fail to file within the prescribed time. In summary, Shi believes that the tax authority should accept the deferred tax record.
The tax authorities believe that the tax time of the VAM agreement starts from the date when the equity is registered. The plaintiff exchanged shares with Company A with Company B and obtained the equity of Company A, and completed the equity registration in September 2014. According to the tax law, the plaintiff's investment transactions in non-monetary assets have realized income in September 2014. Moreover, according to the provisions of Document No. 20, Shi should apply to the competent tax authority for deferred tax filing procedures within 30 days from the date of issuance of Document No. 20, and the time limit for Shi's declaration obviously exceeded the prescribed time limit.
The courts of first instance, second instance and retrial all supported the view of the tax authorities, holding that the plaintiff's tax liability in this case occurred before April 1, 2015, and its application for installment payment in September 2019 obviously did not meet the above requirements.
(2) Case 2: The VAM clause was not realized, and the enterprise was fined 3.5 million yuan for failing to withhold and pay individual tax
In 2015, Listed Company Y signed a VAM agreement with Company A and B, stipulating that Company Y would acquire the equity of Company Z at a price of 29 million, and agreed that A's equity transfer price would be paid within 20 days from the date of completion of equity registration, and B's equity transfer payment would be paid to B according to the completion of performance commitments. Since Company Z did not achieve the promised net profit in 2015, the two parties signed the Supplementary Agreement to repurchase 40% of the equity of Company Z at a parity price, and completed the industrial and commercial registration in August 2016. In June 2022, the local inspection bureau of Company Y issued the Notice of Tax Administrative Penalty Matters, fining Company Y more than 3.5 million yuan for failing to withhold and pay individual income tax.
Confirmation of the point at which the VAM agreement is taxed
(1) Document No. 67 clearly stipulates that the time of taxation is the date when the agreement takes effect
In practice, tax authorities usually apply the Individual Income Tax Law and its implementing regulations, as well as the Measures for the Administration of Individual Income Tax on Income from Equity Transfer (Trial) (SAT Announcement No. 67 [2014], hereinafter referred to as Document No. 67), if non-monetary asset investment is involved, the Notice on Individual Income Tax Policy on Individual Non-Monetary Asset Investment (Cai Shui [2015] No. 41) will be supplemented. hereinafter referred to as Circular No. 41).
Article 20 of Document No. 67 stipulates: "In any of the following circumstances, the withholding agent or taxpayer shall declare the tax payment to the competent tax authority within 15 days of the following month in accordance with the law: (2) the equity transfer agreement has been signed and takes effect; (4) Where the judgment, registration or announcement of the relevant state departments takes effect", Document No. 67 does not use vague expressions such as "realizing equity transfer income" as the time point for filing tax declarations, but clarifies the specific time points for individual equity transfer declaration and taxation.
(2) The provisions on non-monetary investments in Circular No. 41 do not affect the determination of the tax payment point
Paragraph 2 of Article 2 of Document No. 41 stipulates: "When an individual invests in non-monetary assets, the realization of income from the transfer of non-monetary assets shall be recognized when the non-monetary assets are transferred and the equity of the invested enterprise is acquired." However, since "transfer of non-monetary assets" and "acquisition of equity in the invested enterprise" are actually two points in time, especially in the VAM agreement, the two points may be separated by several years, but Circular 41 does not specify this. Since both documents No. 41 and No. 67 are departmental normative documents, Circular No. 41 was issued in 2015, later than the issuance time of Circular No. 67, and the content of the provisions is only aimed at the income tax issue of investment in non-monetary assets, which is more targeted than Circular No. 67, so in practice, some taxpayers believe that the provisions of Circular No. 41 should be applied to confirm their tax liability when they actually acquire the equity of the invested enterprise.
However, based on practice and cases, this view has not been supported. First of all, Document No. 67 clearly stipulates the tax time point for the transfer of individual equity, and does not distinguish the nature of the acquired property, if only because the nature of the acquired assets is different, it is not in line with the principle of tax fairness. Secondly, Document No. 41 stipulates that "acquiring the equity of the invested enterprise" includes conditional acquisition, so the return of the corresponding equity without the completion of the VAM clause does not affect the "acquisition" of the equity, and Document No. 41 does not specify that the two conditions of "transfer of non-monetary assets" and "acquisition of equity of the invested enterprise" should be met at the same time, and there is a deviation in the taxpayer's understanding of this provision. Finally, the term stipulated in the VAM agreement is long, and if the tax liability is recognized according to the time of achievement of the VAM clause, it will not guarantee the realization of the national tax revenue, and will increase the difficulty of taxation by the tax authorities. Therefore, in practice, no matter what form of investment is used to sign a VAM agreement, the tax return must be completed within the specified period after the agreement takes effect or the registration of the change of equity is completed.
Individual income tax deferral policy applies
Another point of contention in Case 1 is the application of the deferred tax tax incentive for personal income tax. Article 3 of Circular No. 41 stipulates: "Individuals shall declare their taxes to the competent tax authority within 15 days of the month following the occurrence of the above-mentioned taxable acts (non-monetary asset investments). Where taxpayers have difficulties in paying taxes at one time, they may reasonably determine the installment payment plan and report it to the competent tax authority for the record, and pay individual income tax in installments within no more than 5 calendar years (inclusive) from the date of occurrence of the above-mentioned taxable acts. That is, individual shareholders who invest in non-monetary assets can apply a deferred tax policy of up to 5 years, such as in Case 1, Shi obtained the equity of Company A by replacing the equity of Company B held by him, and in accordance with the provisions of Document No. 41, he could choose to apply the tax deferred tax incentive.
Document No. 20 refines and clarifies the applicable rules for deferred taxation, such as Article 8: "If a taxpayer needs to pay individual income tax in installments for investment in non-monetary assets, he shall, within 15 days of the month following the date of acquiring the equity of the invested enterprise, formulate a tax payment plan by himself and submit to the competent tax authority the "Individual Income Tax Filing Form for Installment Payment of Investment in Non-monetary Assets", taxpayer's identity certificate, investment agreement, proof of the appraisal price of non-monetary assets, and relevant materials that can prove the original value of non-monetary assets and reasonable taxes." If the investment in non-monetary assets occurred before April 1, 2015, the period is less than 5 years, the tax treatment has not been carried out and the individual income tax needs to be paid in installments, the taxpayer shall complete the tax payment filing procedures with the competent tax authority within 30 days from the date of issuance of this announcement. "It clarifies the materials that taxpayers should submit when applying for tax deferral, and stipulates the time limit for filing investment behavior applications before April 1, 2015.
If the gambling fails, whether the performance compensation is subject to personal income tax
(1) According to Letter 130, the two share transfers of the VAM agreement should be treated as "separate tax"
The first paragraph of the Reply of the State Administration of Taxation on the Issue of Individual Income Tax Levy on Taxpayers' Recovery of Transferred Equity (Guo Shui Han (2005) No. 130, hereinafter referred to as Letter No. 130) stipulates: "According to the relevant provisions of the Individual Income Tax Law of the People's Republic of China and its implementing regulations and the Tax Collection and Administration Law of the People's Republic of China, if the performance of the equity transfer contract has been completed, the equity has been changed and registered, and the income has been realized, the income from the equity transfer obtained by the transferor shall be subject to individual income tax according to law. After the end of the transfer, the parties sign and execute the agreement to terminate the original equity transfer contract and return the equity, which is another equity transfer, and the individual income tax levied on the previous transfer will not be refunded. "That is, if the change of equity has been completed, the recovery of the transferred equity shall be regarded as another separate equity transfer and shall be taxed separately. Therefore, in Case 2, the tax authority held that B first sold 50% of its equity to Company Y, and Company Y transferred 40% of Company Z's equity to B at a fair price, which were two separate equity transfers, and should be taxed separately, B should pay tax on the income from the first transfer of equity, and Company Y needs to pay tax again on the income from the transfer of 40% of the equity, and according to Article 5 of Document No. 67, Company Y, as the withholding agent of individual shareholders, has not performed its withholding obligations. It is not inappropriate for the tax authorities to impose penalties on them in accordance with Letter 130 and relevant laws and regulations.
(2) In practice, there is a view that "consolidated tax treatment" should be carried out
Some scholars have pointed out that "separate tax treatment" goes against the true expression of intent between civil and commercial entities. The intention of the parties to the VAM agreement to have only one capital contribution or capital increase transaction indicates that it is divided into multiple transactions only by the form of transactions, which violates the principle of economic substance. At the same time, "separate tax treatment" can adjust the tax liability of the enterprise in the year to which it belongs, which may bring tax avoidance risks and lead to the loss of national taxes.
Therefore, there is a view that the performance compensation of the VAM agreement should be treated in the form of "consolidated tax treatment", that is, the multi-stage transaction of the VAM agreement should be regarded as a single transaction, taking Case 2 as an example, the use of "consolidated tax treatment" is regarded as B selling 50% of the equity to Company Y with conditions, and Company Y needs to perform the withholding obligation, if the performance does not meet the standard, B needs to compensate Company Y for 10% of the equity and 40% of the equity equivalent consideration, and the equity purchase price should be adjusted accordingly and the tax payable should be reduced. Since there is currently no relevant provision that VAM agreements can adopt the method of "consolidated tax treatment", and "consolidated tax treatment" often involves cross-year adjustments, it is difficult to effectively implement in practice. Therefore, in practice, there is still considerable controversy as to whether the method of "consolidated tax treatment" or "separate tax treatment" should be adopted, and the implementation path of tax authorities in different regions is different, resulting in confusion in the actual treatment.
(3) The issue of individual tax refund after the gambling fails
As mentioned above, the use of "consolidated tax treatment" will reduce the tax payable, causing the problem of individual income tax refund, but since there is currently no tax policy that explicitly supports the right to refund individual income tax under VAM agreements, it is difficult for individual shareholders to apply for individual tax refund in practice. At the same time, because some regional tax authorities do not support the "consolidated tax treatment" method, taxpayers will also be unable to apply for tax refunds.
Source Chinese tax