The use of intermediary "conduit enterprises" to indirectly transfer the equity of resident enterprises in mainland China in an attempt to avoid paying enterprise income tax
The domicile of the parent company and the counterparty is intriguing, and the business practices of the parent company are full of doubts...... Is this equity transaction, which is worth billions of yuan, really a "collaborative integration" between enterprises, or an arrangement with ulterior motives, as the overseas parties claim?
Recently, the Shenzhen Futian District Taxation Bureau of the State Administration of Taxation, based on the clues found in the announcement of the Hong Kong Stock Exchange, confirmed through tracking and verification that the transfer of the equity of its subsidiaries by the overseas non-resident enterprise Company M was an indirect transfer of the equity of the mainland resident enterprise Company S through the implementation of an arrangement that did not have a reasonable commercial purpose. According to the provisions of the mainland tax law, it should be reclassified as a direct transfer of the equity of a Chinese resident enterprise, and Company M should pay enterprise income tax to the mainland tax authorities on the income from the transfer.
The Shenzhen Futian District Taxation Bureau confirmed the income of 1.729 billion yuan from the equity transfer of Company M in accordance with the law, and made a decision to pay 169 million yuan of enterprise income tax, and the tax of the transaction has been fully recovered and put into the treasury.
Shareholders of resident enterprises suddenly change hands
In April 2023, the International Tax Department of the Futian District Taxation Bureau carried out special risk response work for indirect equity transfer of non-resident enterprises, and tax personnel used big data technology to screen and extract third-party public information such as announcements of the Hong Kong Stock Exchange, and compared and analyzed it with the information of foreign-funded enterprises in the jurisdiction. In the process, they discovered that a resident company called S Corporation in the jurisdiction had recently changed its foreign non-resident shareholders, which immediately attracted the attention of tax officials.
According to the corporate information disclosed by the Hong Kong Stock Exchange, Company M signed an equity transfer agreement with Hong Kong-listed Company W in early 2023, and transferred 100% of the equity of its subsidiary Company B and 45 million Hong Kong dollars of debt to Company W at a price of 2.38 billion Hong Kong dollars.
According to the company's announcement information, the tax officer further analyzed the transferred company B and found that the company held 100% of the shares of a company named company C. After comparing the collection and management data information, they found that Company C had a resident enterprise under the name of Company C, Company S, located in Shenzhen, and Company C owned 100% of Company S. Seeing the series of enterprises under Company B, combined with the transactions between Company M and Company W, the experienced tax personnel believed that the transfer of the equity of Company B by Company M was suspected of indirectly transferring the equity of Company S in mainland China.
In order to verify the judgment, the tax officer used the enterprise information query tool to check the registered address of the relevant enterprise, and found that Company M and Company B were both registered in the British Virgin Islands, Company W was registered in the Cayman Islands, and Company C was registered in Hong Kong. The British Virgin Islands (BVI) and the Cayman Islands (Cayman Islands) are well-known tax havens in the world, and neither of them levies income tax on equity transfers, while Hong Kong adopts the principle of territoriality and does not levy profits tax on income derived from sources outside Hong Kong.
The results of the verification of the registered place of the enterprises involved in the transaction have aggravated the doubts of the tax officials, who believe that the transfer of the equity of Company B from Company M to Company W is suspected of avoiding the payment of mainland enterprise income tax by implementing an arrangement that does not have a reasonable commercial purpose.
The international taxation department of the Futian District Taxation Bureau immediately decided to follow up and verify with the risk management department, starting with Company S to understand the specific situation of the transaction and verify whether the essence of the equity transfer is the transfer of equity of enterprises in mainland China, so as to avoid the loss of tax revenue.
Is there a legitimate business purpose, or is there another purpose?
Article 1 of the Announcement of the State Administration of Taxation on Several Issues Concerning the Enterprise Income Tax on Indirect Transfer of Property by Non-resident Enterprises (Announcement No. 7 [2015] of the State Administration of Taxation) stipulates that: "If a non-resident enterprise indirectly transfers the equity and other property of a Chinese resident enterprise through the implementation of an arrangement that does not have a reasonable commercial purpose, thereby avoiding the enterprise income tax liability, it shall, in accordance with Article 47 of the Enterprise Income Tax Law, recharacterize the indirect transfer transaction and confirm it as a direct transfer of the equity and other property of the Chinese resident enterprise." "According to this regulation, the key to determining whether the essence of this transaction is a direct transfer of the equity of the Chinese resident enterprise Company S is to confirm whether all the arrangements related to the transfer of the transaction of Company S have a reasonable commercial purpose. If it does not have a reasonable commercial purpose, the mainland tax authorities have the right to reclassify the nature of the transaction as a direct transfer of equity in a PRC resident enterprise, and Company M shall pay income tax on the proceeds of its transactions in accordance with the relevant provisions of the Enterprise Income Tax Law.
The tax officer interviewed the personnel of Company S, but the results of the interview were not satisfactory. Company S personnel said that since the foreign shareholders do not usually work in Shenzhen, they do not know the specific details of the transaction and cannot cooperate with the tax authorities. The tax officer believed that Company S, as an important related party of the equity transaction, could not have been ignorant of the transaction.
Therefore, the tax officer visited Company S and conducted detailed tax law publicity to the relevant person in charge of Company S to understand the benefits and disadvantages. After patient persuasion, the personnel of Company S finally agreed to cooperate with the tax authorities as much as possible.
With the assistance of Company S, the tax officer contacted the tax agent of the transferor, Company M, and obtained the equity transfer agreement of the transaction, the equity structure chart of the enterprise before and after the equity transfer, the financial statements, production and operation conditions, and asset appraisal reports of the transferred company B and its subordinate company C.
The tax officer carefully examined the financial statements of Company B and found that Company B's operating income in 2022 was zero, the total assets were only 8,780 Hong Kong dollars, and the management expenses for that year were only 22,000 Hong Kong dollars, and these management expenses were all expenses such as the company's annual review and qualification review. From the perspective of business operation, Company B is an enterprise with no actual business activities.
Subsequently, the tax officer analyzes the financial statements of Company C. According to the report, Company C is mainly engaged in product sales and brand promotion. In 2022, the operating income was 220,000 Hong Kong dollars, and the expenses incurred during the period were about 2.2 million Hong Kong dollars, including management expenses of 1.17 million Hong Kong dollars and sales expenses of 600,000 Hong Kong dollars. In addition, Company M also provided relevant information such as the employment contract of Company C's employees, the lease contract of the sales store, and the sales of products.
However, after checking the operation and profit of Company C in the previous year, the tax officer found that the company's operating income in 2021 was also zero, and the company only incurred management expenses of HK $5,570, and the company had no other costs and expenses. This situation shows that the company has no substantive business activities in 2021.
In order to confirm whether Company C had substantive business activities before the equity transfer, the tax officer carefully reviewed the supporting materials provided by Company M and found that most of the business activities submitted by Company M took place after Company M signed the equity transfer contract.
After verification, the tax officer confirmed that Company M's claim that it could prove that Company C's Hong Kong sales store had substantial business activities actually obtained the right to use it in the fourth quarter of 2022, and that the store only started some small business activities at the end of 2022, and less than three months thereafter, Company M signed an equity transaction agreement with Company W.
Based on the various issues and evidence found in the investigation, the tax officers held that Company B and its subsidiary, Company C, located in Hong Kong, had no substantive business activities, and that Company M's indirect transfer of the equity of Company S, a resident enterprise in mainland China, should be recharacterized as a direct transfer of the equity of a Chinese resident enterprise.
The truth emerges, and the taxes are collected
The tax officer interviewed the tax agent of Company M. During the interview, the tax agent of Company M admitted that Company B did not have substantive business activities, but its subordinate Company C had stores and was an enterprise with substantive business activities for the purchase and sale of products, and that the core objective of the transaction was to achieve strategic cooperation and synergy of advantages of the two parties as a whole, and that Company M would become the second largest shareholder of Company W after the completion of the transaction. Therefore, the equity transaction between Company M and Company W did not meet the requirements set out in Article 1 of Announcement No. 7 of 2015 of the State Administration of Taxation, and Company M was not required to pay enterprise income tax to the PRC tax authorities on the transaction results.
In this regard, the tax personnel made a targeted refutation based on the investigation and evidence collection. The tax officer said that the financial statements and business status verification results of Company B and Company C showed that the two companies had no substantive business activities before the equity transfer.
Combined with the balance sheet data of Company C and the amount of dividends distributed to Shenzhen Company S in recent years, it can be confirmed that the assets of Company C are mainly Company S, a resident enterprise invested in China, and its equity value is mainly derived from Company S. Therefore, in this equity transaction of Company M, Company B and Company C are only "conduit companies", and the value of their equity transactions mainly comes from Company S, a mainland resident enterprise.
In addition, the tax officer pointed out that the equity transaction of Company M was a formal transfer of the equity of its subsidiaries Company B and Company C, and that Company M was not required to pay relevant taxes for the transaction in accordance with the relevant laws and regulations of the British Virgin Islands, where the company is located, and Hong Kong, the mainland.
According to the tax officer, based on the above verification results, in accordance with Article 47 of the Enterprise Income Tax Law of the People's Republic of China and Article 1 of the Announcement No. 7 of 2015 of the State Administration of Taxation, the Chinese tax authorities confirmed that the transaction of the transfer of the equity of its subsidiary Company B to Company W did not have a reasonable commercial purpose, and therefore the Chinese tax authorities should recharacterize the transaction as a direct transfer of the equity of a Chinese resident enterprise, and levy enterprise income tax on Company M in accordance with the law.
After several interviews with the tax officer, Company M finally recognized the opinion of the Shenzhen tax department. According to Article 3 of the Announcement on Issues Concerning the Withholding of Income Tax at Source for Non-resident Enterprises (Announcement No. 37 [2017] of the State Administration of Taxation), the tax officer subsequently calculated the income and net equity value of the equity transaction together with the tax agent of Company M, and confirmed that the transfer income attributable to the transaction in mainland China was RMB 1.729 billion, and Company M should pay enterprise income tax of RMB 169 million.
In order to facilitate the payment of taxes by enterprises, the Futian District Taxation Bureau coordinated with relevant departments to provide detailed guidance on the declaration business for Company M, and smoothed the channel for remittance and transfer. A few days ago, the case came to an end with the full amount of tax paid by Company M.
Blow away the fog and clarify the essence of the transaction
Author: Sun Guoying, Director of the Taxation Bureau of Futian District, Shenzhen, State Administration of Taxation
■Comment on important cases
This case is a typical case of transferring the equity of a non-resident enterprise under its name, but in fact it is an attempt to evade the payment of enterprise income tax by using an intermediate "conduit enterprise" to indirectly transfer the equity of a resident enterprise in mainland China.
The indirect equity transfer activities of non-resident enterprises are usually characterized by high tax amounts, strong concealment, and great difficulty in verification. In this case, the non-resident enterprise involved in the case made a lot of "preparatory work" in order to cover up its indirect equity transfer activities, trying to make the transferred "conduit enterprise" appear to have "substantial business activities" and make the transfer "have a reasonable commercial purpose", so as to achieve the purpose of avoiding the payment of enterprise income tax. In the case of information asymmetry, if the tax authorities fail to discover clues in time during the supervision process, identify the "blindfolds" of the transaction parties through verification, and accurately characterize the essence of the transaction, then there is a great risk of loss of tax on relevant cross-border equity transactions.
Taking the case as a reference, in order to strengthen the supervision of indirect equity transfer of non-resident enterprises and prevent the loss of tax revenue, the tax authorities should further improve the relevant management mechanism to enhance the ability to prevent and control tax risks in cross-border equity transactions.
Strengthen the dynamic supervision of foreign-funded enterprises, and obtain the initiative in the supervision of equity transactions of non-resident enterprises. In order to timely understand the changes in the equity of foreign-funded enterprises in the jurisdiction and grasp the opportunities of tax administration, the tax authorities should strengthen the collection and correlation analysis of the operation and management data of foreign-funded enterprises and the dynamic information of foreign shareholders. While paying attention to the business dynamics of foreign shareholders of foreign-funded enterprises, such as investment and mergers and acquisitions, it is necessary to strengthen visits to foreign-funded enterprises in the jurisdiction to understand and grasp the information on the organizational structure, equity composition and production and operation status of enterprises, and carry out targeted tax law publicity and business guidance for enterprise personnel. If it is found that a foreign-funded enterprise has changed hands, changed its management personnel and changed its business model, it should quickly check whether the foreign shareholder has traded the equity of the enterprise, and take corresponding measures for collection and management in a timely manner.
Establish a database of typical cases to enhance verification and response capabilities. The tax authorities should establish a database of typical cases on the basis of extensive collection of typical anti-avoidance cases of cross-border equity transactions. Organize anti-tax avoidance personnel to conduct in-depth research on the business characteristics, organizational structure, financial statement analysis methods, and verification methods of indirect equity transfer of non-resident enterprises based on cases, and enhance the ability of anti-tax avoidance personnel to identify and verify high-risk businesses such as indirect equity transfer through simulation drills and targeted training, and continuously improve the efficiency of supervision.
Source: China Tax News Author: Lin Jianrong, reporter of this newspaper