Based on the new Enterprise Income Tax Law implemented since 2008and the following tax collection and administration documents issued by the State Administration of Taxation (“SAT”)on their own or in combination with the Ministry of Finance(“MOF”),the enterprise income tax (“EIT”)policies and management system on corporate restructuring transactions have been initially established. On January 8, 2015, the SAT officially released the Notice of the MOF and the SAT on Issues concerning the EIT Treatment for the Promotion of Enterprise Restructurings (Caishui  No.109, “Circular 109”) and the Notice of the MOF and the SAT on Issues concerning the EIT Policies for Non-Monetary Asset Investments (Caisui  No.116, “Circular 116”).Both Circular 109 and Circular 116 took effect on January 1, 2014 apply to previous cases that are not yet concluded on their tax treatments. The release of Circular 109 and Circular 116 is a significant improvement to corporate merger and acquisition (“M&A”) transactions. As follows, we will make general analysis of China’s M&A tax environment under the current tax system in connection with Circular 109 and Circular 116 for your reference. M&A Policy Environment is Increasingly Improving Although the capital transactions have become increasingly diversified and the market innovations have become more active in recent years, the updating of finance and tax policies on corporate restructuring transactions has not fully met the expectations of market participants yet. Year 2014 witnessed the firm steps taken by the State Council and its ministries in the decentralization and regulatory transition, which contributed to the improvement of the overall supervision environment for corporate M&As. 8 For more detailed information, please refer to the CSRC’s (News Conference on December 26, 2014): http://www.csrc.gov.cn/pub/newsite/zjhxwfb/xwfbh/201412/t20141226_265703.htmlHAN KUN LAW OFFICES BEIJING SHANGHAI SHENZHEN HONG KONG www.hankunlaw.com On March 7, 2014, the State Council issued the Opinions on Further Improvement of Market Environment for Corporate M&As(Guofa No.14), which proposes to let the enterprises play the key functions in conducting M&As, to amend and improve the policies of special tax treatment for corporate restructurings, to relax the threshold on the proportion of equity (assets) acquired in the total equity (assets) of the target company in order to broaden the applicable scope of special tax treatment policies, and to study and improve the EIT policies related to non-monetary asset investment transactions and the land value-added tax policies related to corporate restructurings. Existing Tax Collection and Management Policy System for Corporate M&As Based on the tax resident enterprise (“TRE”) and non-tax resident enterprise (“non-TRE”) taxation collection and management system built under the new EIT Law, the following documents formed the existing tax collection system for domestic and cross-border M&As. Tax Collection and Management Rules Release Date Effective Date Salient Points Notice of the MOF and the SAT on Several Issues concerning the EIT Treatment on Enterprise Reorganization (CaishuiNo.59,“Circular 59”) Apr. 30,2009 Jan. 1,2008 for the first time clarify the applicable principles of general tax treatment and special tax treatment Notice of the SAT on Improving the EIT Administration on Non-TREs’ Equity Transfer Income (GuoshuihanNo.698) Dec. 10,2009 Jan.1,2008 put the offshore indirect transfer by means of abuse of organizational forms and other arrangement subject to China’s collection and management system Measures for the EIT Administration of Enterprise Reorganizations (SAT Announcement  No. 4) Jul. 26,2010 Jan. 1,2010 further explains issues concerning collection and management of special tax treatment Announcement of the SAT on Issues concerning the Application of Special Tax Treatment in the Equity Transfer of Non-TREs (SAT Announcement  No. 72) Dec. 12,2013 Dec. 12,2013 clarify the application of special tax treatment in the equity transfer of non-TREs Analysis of the Preferential Tax Policies under Circular 109 (1) Relaxation of the Threshold for Application of Special Tax Treatment in Equity Acquisitions Article 6(2)of Circular59 stipulates that in the event of equity acquisition, the application of special tax treatment requires the equities purchased by the acquiring enterprise be no less than 75% of the HAN KUN LAW OFFICES BEIJING SHANGHAI SHENZHEN HONG KONG www.hankunlaw.com total equities of the acquired enterprise. Circular 109 relax the threshold to 50%. (2) Relaxation of the Threshold for Application of Special Tax Treatment in Assets Acquisitions Article 6(3)of Circular 59 stipulates that in the event of asset acquisition, the application of special tax treatment requires the assets acquired by the receiving enterprise be no less than 75% of the transferring enterprise's total assets. Circular 109 relax the threshold to 50%. Han Kun Analysis: EIT collection on M&As consists of general tax treatment or special tax treatment. M&As subject to general tax treatment are taxable when the transaction occurs, while M&As subject to special tax treatment could thereby qualify for deferral tax treatment. Under common classification standards, M&A transactions are generally divided into the equity deal and the asset deal. Circular 109 has relaxed the minimum threshold of application of special treatment in both equity and asset acquisitions from 75% to 50%, a decline of as much as 1/3. This reduction actually lowers the threshold for enterprises to enjoy the benefits of deferred tax treatment in corporate restructurings, and provides the M&A participants with more flexibility in their tax planning. (3) Special Tax Treatment for Equity and Asset Assignments The arm’s length principle prescribed in the new EIT Law has posed significant challenges for tax arrangements in intra-group restructuring transactions. Circular 59 was unclear on whether the transaction prices in intra-group restructurings must comply with the arm’s length principle and thereby caused uncertainty in transaction structure designs and tax collection and administration practices. Circular 109 now clearly stipulates that in equity or asset transfer transactions where(1)the transfer happens between TREs who have 100% direct investment relationship with each other or are 100% owned by the same TRE holder or the same group of TRE holders; (2) the assignment of equity or assets is effected at net book value; (3) the transaction is conducted for reasonable commercial reasons, not for tax purposes such as tax deduction, exemption or delay); (3)there is no change in the transferor’s original operating activities within 12 months after the transaction; and (4)neither the transferor nor the transferee has recognized profit/loss for accounting purposes, such transactions could be subject to the following tax treatment: (1) neither the transferor nor transferee need to recognize any income derived from the transfer; (2) the tax basis of the assets or equity received by the transferee shall be determined based on the original net book value in the hands of the transferor; (3) the depreciation deduction of the assets received by the transferee shall be calculated based on the original net book value. Han Kun Analysis:HAN KUN LAW OFFICES BEIJING SHANGHAI SHENZHEN HONG KONG www.hankunlaw.com Under the EIT Law of the People's Republic of China for Foreign-Invested Enterprises and Foreign Enterprises (expired on January 1, 2008), the SAT had released the Notice on EIT Treatment on Equity Transfers of Foreign-Invested Enterprises and Foreign Enterprises(GuoshuihanNo.207,“Circular 207”), which provided that in group restructurings for reasonable business purposes, if the foreign enterprise transfers its equity in a Chinese domestic enterprise, or a foreign-invested enterprise transfers its equity in a Chinese or foreign enterprise, to an enterprise(including domestic investment enterprises) with which it has 100% direct or indirect holding investment relationship or are 100% owned by the same person, the transfer price could be the cost price of the equity and be exempted from EIT since no profit or loss is recognized in the transaction. Circular 207 gave rise to a wave of equity transfers at cost price in multinational enterprises in 2007. After the new EIT Law became effective, equity transfers at cost price has lost its taxation rules basis. Circular 109 now clearly sets out that the intra-group assignment of equity or assets at net book value between Chinese TREs with 100% investment holding relationship could be subject to special tax treatment, and that neither the transferor nor transferee needs to recognize profit. This new policy will produce positive impacts on the tax cost controls in intra-group transactions and promote the corporate resource combinations and business restructurings in a healthy way. Analysis of Preferential Tax Policies under Circular 116 Circular 116 expands the application scope of the deferred tax treatments for non-monetary asset investments from the Shanghai Pilot Free Trade Zone to the rest of China. (1) Categories of Non-Monetary Assets and Non-Monetary Asset Investments Under Circular 116, non-monetary assets include assets other than cash, bank deposits, accounts receivable, notes receivable, bonds held until maturity or monetary assets in other forms. Non-monetary asset investments occur only when non-monetary assets are invested to establish new TREs or injected into existing TREs. (2) Tax Treatment for TRE Non-Monetary Asset Investment According to Circular 116, the income arising from non-monetary asset transfer recognized by a TRE that makes non-monetary asset investment may be included in the taxable income of the corresponding year by equal installments within 5 years, and the EIT shall be calculated and paid in accordance with such deferral. Recognition of Taxable Income An enterprise that makes non-monetary asset investment shall evaluate the non-monetary assets HAN KUN LAW OFFICES BEIJING SHANGHAI SHENZHEN HONG KONG www.hankunlaw.com and calculate and recognize the income from non-monetary asset transfer based on the balance of the fair value as evaluated after deduction of the tax basis. Determination of Time of Revenues Recognition An enterprise that makes non-monetary asset investment shall recognize the income from non-monetary asset transfer when the investment agreement becomes effective and the equity registration is completed. (3) Tax Basis of Income arising from Non-Monetary Asset Investment According to Circular 106, for an enterprise acquiring equity in the invested enterprise with non-monetary asset investment, the tax basis shall be subject to yearly adjustment by combining the original tax basis of the non-monetary assets and the income from the transfer of non-monetary assets recognized yearly. As for the invested enterprises, the tax basis for acquisition of the non-monetary assets shall be based on the fair market value of such assets. (4) Adjustment of Tax Treatment if Changes Occur to the Original Transaction within Five Years The deferred tax treatment over a period of up to five years will produce a preferential tax environment for TREs. Notwithstanding, if the enterprise transfers the acquired equity or recoup such investment within five years from the investment, the deferred tax treatment shall be ceased and the EIT on unconfirmed gains for remaining deferral period shall be calculated and paid in a lump sum at the annual EIT filing in the year when such transfer of equity or recouping of investment occurs. The tax basis of income derived from the equity transfer shall be recognized based upon the original tax basis of the non-monetary assets. If the enterprise is deregistered within five years, the deferred tax treatment shall be ceased and the EIT on unconfirmed gains for remaining deferral period shall be calculated and paid in a lump sum at the annual EIT filing in the year of the deregistration. Han Kun Comments: The promulgation of Circulars 109 and 106 definitely are welcomed by business communities as they brought over relaxed requirements and new favorable tax treatment for corporate M&A transactions. Tax preferential treatments will provide support and guidance for Chinese enterprises in updating the industrial structures and enhancing their competitiveness. Since the two circulars took effectretroactivelyonJanuary1, 2014, we recommend corporate executives to reassess the on-going transactions to explore more favorable tax benefits.