CHINA Law and Practice Contributed by: Wei Chen, Yue Zhang, Hao Peng and Yi Sun, JunHe LLP
General Tax Treatment vs Special Tax Treatment In the general tax treatment of a spin-off, the dividing enterprise will recognise gains or losses based on the fair value of the transferred assets, and the tax basis of the assets received by the spin-off enterprise will be the fair value of the assets. The consideration received by the share- holders of the dividing enterprise will be treated as distribution or liquidation. The losses of the relevant parties to the spin-off will not be carried over or utilised. In the case of special tax treatment, the tax basis of the assets received by the spin-off enterprise will be the dividing enterprise’s original tax basis of the assets. Income tax matters relat- ing to transferred assets will be succeeded by the spin-off enterprise. Part of the losses of the dividing enterprise may be utilised by the spin- off enterprise. Where the shareholders of the dividing enter- prise are required to forfeit part or all of their equity in the dividing enterprise (“old equity”), the tax basis of the equity in the spin-off enter- prise (“new equity”) received by the shareholders of the dividing enterprise will be the tax basis of the old equity forfeited by them. Where the shareholders of the dividing enterprise are not required to forfeit any of the old equity, the tax basis of the new equity will be zero. Alternatively, the tax basis of the old equity will be reduced according to the ratio of the transferred assets in the spin-off to all assets of the dividing enter- prise, and the reduced tax basis will be applied evenly to the new equity. “Tax-free” (or deferral of tax) treatment is therefore achieved.
involve a third-party escrow agent and can offer more practically viable protection to the buyers and save costs. In one exceptional category of M&A transaction where a foreign buyer acquires equity interest in a 100% domestic company in China (without any foreign shareholder), the full purchase price should be paid within one year of the change of registration of the company, which will limit how the escrow and holdback terms can be written in these cases. Representations and Warranties Insurance Insurance for non-breach of representations and warranties are not customary in China. Spin-offs are customary in the technology indus- try in China. The key drivers for considering a spin-off may include optimisation of valuation, divestiture of non-core business and expansion of access to funding. 5.2 Tax Consequences The parties to a spin-off may opt for special enterprise income tax treatment, provided that certain conditions are satisfied. Spin-Off as Defined Under Tax Regulations Under the relevant tax regulations, a spin-off refers to a transaction where an enterprise (“dividing enterprise”) splits and transfers part or all of its assets to an existing or newly estab- lished enterprise (“spin-off enterprise”), and the shareholders of the dividing enterprise receive equity of the spin-off enterprise or non-equity consideration. 5. Spin-Offs 5.1 Trends: Spin-Offs
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