Recently, the SAT issued the Bulletin on Certain Issues in Relation to Special Tax Treatment of Equity Transfers by Non-resident Enterprises, SAT Bulletin  No. 72 (“Bulletin 72”), to fill in the procedural gaps left by Caishui  No. 59 (“Circular 59”) on the tax-free treatment of cross-border share acquisitions. As background, in 2009, China published Circular 59 to provide tax-free treatment for corporate reorganizations. Six types of corporate reorganizations are covered by Circular 59: change of legal form, debt restructuring, share acquisition, asset acquisition, merger and de-merger.
To qualify for tax-free treatment, the following baseline requirements must be satisfied:
- The reorganization has reasonable commercial purposes, and reduction, exemption or deferral of taxes is not a major purpose of the reorganization;
- The assets or shares transferred under an acquisition must meet the prescribed proportion, i.e., no less than 75% of the total assets or shares of the target;
- The key business activities cannot be changed within 12 months after the reorganization;
- The equity consideration in the reorganization must meet the prescribed proportion, i.e., no less than 85% of the total consideration; and
- The original main shareholder(s) that receive equity consideration under the reorganization cannot transfer the equity interest(s) within 12 months after the reorganization.
In addition to these baseline requirements, cross-border share acquisitions must also satisfy additional conditions described in article 7, paragraphs 1 and 2. In order to qualify for tax-free treatment, the cross-border share acquisition must involve either:
- A non-resident enterprise transferring shares in a resident enterprise to another resident enterprise over which the transferor has “direct 100% share control”; or
- A non-resident enterprise transferring shares in a resident enterprise to another non-resident enterprise over which the transferor has “direct 100% share control” where:
- such transfer would not alter the withholding tax burden on capital gains to be derived from the transferred shares in the future; and
- the transferor undertakes in writing to the competent tax bureau not to transfer the shares received from the transferee as consideration within the three years following the reorganization.”
These additional conditions under Circular 59 severely limit the number of cross-border acquisitions that qualify for tax-free treatment.
In addition, PRC tax authorities have been reluctant in practice to grant the tax-free treatment for cross-border corporate restructurings because Circular 59 does not provide detailed procedural instructions on how they should implement the tax benefit. According to Bulletin 72, in order for a cross-border share acquisition to qualify for tax-free treatment, relevant contracts and documents must be filed with the in-charge tax authority within 30 days from the later of (i) the date when the share purchase agreement (“SPA”) takes effect or (ii) the date when the industrial and commercial registration is changed. Then, the in-charge tax authority must, within 30 working days from the date of accepting the filing, decide whether to grant tax free treatment and submit its decision and the supporting recordal materials to the provincial tax authority.
Although Bulletin 72 aims to make it easier to apply for tax-free treatment for cross-border share acquisitions, it remains to be seen whether Bulletin 72 will actually result in more cross-border share acquisitions being granted tax-free treatment. The still restrictive rules under Bulletin 59 and the historical reluctance of tax authorities to grant tax-free status make it uncertain whether Bulletin 72 can achieve its aim.
On the substantive side, according to Article 8 of Bulletin 72, no claim to a preferential dividend withholding rate under a China tax treaty is permitted for the transferred enterprise’s retained earnings that arose before the equity transfer if the transferor and the transferee are not in
the same jurisdiction. Multinational companies considering tax-free share acquisitions may want to cause the Chinese subsidiary being transferred to distribute dividends before the acquisition if the original shareholder can enjoy treaty benefit.