Research on Zhiheng Law: Analysis of Tax-related Matters under the New Company Law (Part 2)- Zhiheng Law Firm

Author | Liu Shifeng, Zhiheng Shanghai Law Firmlawyer

With the profound revision and formal implementation of the new round of the Company Law, China’s corporate legal system has ushered in a milestone transformation. The new law has comprehensively optimized and reshaped numerous aspects, including the registered capital regime, methods of contribution, profit distribution, corporate governance, and even exit mechanisms. These reforms not only directly affect a company’s establishment, operation, and dissolution, but are also closely linked to its tax treatment and planning, thereby exerting far-reaching influence.

Tax law and corporate law are like two main threads in the operation of a business, interwoven and mutually influential. Any amendment to corporate law may trigger a “butterfly effect” in the tax sphere. For example, how does the shift from a subscribed capital system to a time-limited paid-in capital requirement affect tax obligations? What tax considerations are concealed behind innovative methods such as non-monetary asset contributions and debt-to-equity swaps?

Can the registered capital be used to cover losses, and if so, how? Moreover, how will this affect corporate income tax? Furthermore, the tax treatment during the company’s dissolution and liquidation phase represents the critical “last mile” that cannot be overlooked throughout a company’s lifecycle.

To help entrepreneurs and finance and tax professionals accurately grasp key tax issues and effectively mitigate risks under the new legal framework, this article will focus on the core changes introduced by the new Company Law. It will systematically analyze and present insights across four critical areas: the impact of provisions related to registered capital on taxation; the impact of provisions governing methods of contribution on taxation; the impact of provisions concerning the use of registered capital to offset losses on taxation; and the impact of provisions on company dissolution on taxation.

We hope to provide you with clear guidance and valuable reference for your tax-related decision-making in the context of the new law.

4393 c159-bd9b-4363-a751-dea35a297ae2.jpg

Provisions regarding the methods of capital contribution

Impact on taxation

(II) The impact of the method of contribution on taxation

2) Corporate income tax

2.2 Special Provisions — Income Tax Treatment of Debt Restructuring

(2) Special Tax Treatment

① Basic requirements for the application of special tax treatment

(I) It has a reasonable commercial purpose and is not primarily intended to reduce, exempt, or defer tax payments.

(II) The proportion of assets or equity of the acquired, merged, or split-off portion meets the requirements specified in this notice.

(III) Within 12 consecutive months after the enterprise reorganization, the original substantive operating activities of the reorganized assets shall not be changed.

(IV) The amount of equity payments in the restructuring transaction consideration meets the proportion stipulated in this notice.

(V) The original major shareholders who receive equity payments during a corporate reorganization shall not transfer the equity they have received within 12 consecutive months after the reorganization.

[Example] (Debt forgiveness) Company A owes Company B RMB 55 million. The reorganization agreement stipulates that, within 60 days after the effective date of the agreement, Company A shall repay RMB 20 million to Company B in cash, and the remaining RMB 35 million shall not be repaid. Company A’s taxable income for the year was RMB 40 million. (Assuming that the basic conditions for special tax treatment are met)

[Tax Analysis]

Company A’s taxable income from debt restructuring for the year is RMB 35 million, calculated as RMB 55 million minus RMB 20 million.

The taxable income recognized by Company A from the debt restructuring accounts for 87.5% of the company’s taxable income for the year, which is calculated as 3,500/4,000 = 87.5%, exceeding 50%.

Therefore, Company A may allocate the amount evenly over a period of five tax years and include it in its taxable income for each year.

Company A should recognize annual taxable income from debt restructuring of 35 million yuan/5=7 million yuan.

[Example] (Debt-to-Equity Swap) Company A owes Company B RMB 55 million. The reorganization plan stipulates that Company A will issue an additional 10 million shares at a market price of RMB 2 per share (with a par value of RMB 1 per share) to settle its outstanding debt to Company B. (Assuming that the basic conditions for special tax treatment are met)

[Tax Analysis]

Finance and Taxation Document No. 59 [2009] stipulates that when an enterprise undertakes a debt-to-equity conversion transaction and such transaction is subject to special tax treatment, no gain or loss shall be recognized for either the debt settlement or the equity investment at this time; the tax basis of the equity investment shall be determined based on the original tax basis of theCreditor's right. Other income tax-related matters of the enterprise remain unchanged. Accordingly:

① Neither Company A nor Company B recognizes any gain or loss on either the debt settlement or the equity investment.

② The tax basis of the equity in Company A acquired by Company B is the original tax basis of the claim, which is RMB 55 million.

2.3 Special Provisions — Income Tax Treatment for Non-Monetary Asset Investments Received by Invested Enterprises

“Announcement of the State Taxation Administration on Several Issues Concerning the Taxable Income for Enterprise Income Tax” (State Taxation Administration Announcement No. 29 of 2014)

2. Corporate income tax treatment for assets transferred from shareholders to the enterprise

(I) When an enterprise receives assets transferred from its shareholders (including assets donated by shareholders, assets received by a listed company from original non-tradable shareholders and new non-tradable shareholders during the share-split reform, and equity in the enterprise that shareholders have waived; the same shall apply hereinafter), if such assets are stipulated in contracts or agreements to be treated as capital (including capital reserves) and have been accounted for accordingly, they shall not be included in the enterprise’s total revenue. The enterprise shall determine the tax basis of such assets based on their fair value.

(II) When an enterprise receives assets transferred from its shareholders and treats them as income, such assets shall be included in the total revenue at their fair value for the purpose of calculating and paying corporate income tax, and the tax basis of the asset shall be determined based on its fair value.

3) Individual income tax

Is personal income tax payable when an enterprise invests in another enterprise with non-monetary assets?

Notice on the Personal Income Tax Policies Relating to Investments in Non-Monetary Assets by Individuals (Cai Shui [2015] No. 41)

1. When an individual invests with non-monetary assets, it is considered that the transfer of non-monetary assets and the investment occur simultaneously. Income derived from an individual’s transfer of non-monetary assets shall be subject to individual income tax in accordance with the law, under the “income from property transfers” category.

2. When an individual invests with non-monetary assets, the income from the transfer of such assets shall be recognized at the assessed fair value. The taxable income is the balance remaining after deducting the original cost of the non-monetary asset and any reasonable taxes and fees from the income derived from its transfer.

An individual who makes an investment with non-monetary assets shall recognize the realization of income from the transfer of such assets upon the transfer of the non-monetary assets and the acquisition of equity in the invested enterprise.

3. Individuals shall file and pay taxes with the competent tax authority by the 15th day of the month following the occurrence of the aforementioned taxable activities. If a taxpayer has difficulty paying the tax in a lump sum, they may, after submitting a reasonable installment payment plan for record with the competent tax authority, pay the individual income tax in installments over a period of no more than five calendar years (inclusive) from the date on which the taxable event occurs.

“Announcement of the State Taxation Administration on Issues Concerning the Administration of Individual Income Tax Related to Individuals’ Investments in Non-Monetary Assets” (State Taxation Administration Announcement No. 20 of 2015)

4. If an individual receives a cash compensation during a non-monetary asset investment transaction, the cash portion shall be used first to pay taxes; if the cash is insufficient to cover the tax liability, the remaining amount may be paid in installments.

If an individual transfers all or part of the aforementioned equity interests held during the installment tax payment period and receives cash proceeds, such proceeds shall be used in priority to pay any outstanding taxes.

5. Non-monetary assets as referred to in this notice shall mean assets other than monetary assets such as cash and bank deposits, including equity interests, real estate, technological inventions, and other forms of non-monetary assets.

For the purposes of this Notice, “non-monetary asset investment” includes establishing a new enterprise by contributing non-monetary assets, as well as engaging in investment activities such as participating in a company’s capital increase and share expansion, private placement of shares, equity swaps, and restructuring or reorganization through contributions of non-monetary assets.

4) Land appreciation tax

When an enterprise invests in another enterprise with non-monetary assets, is land appreciation tax payable?

Article 2 Units and individuals who transfer the use rights of state-owned land, as well as the buildings and fixtures thereon (hereinafter referred to as “transfer of real estate”) and derive income therefrom shall be the taxpayers of the land appreciation tax (hereinafter referred to as “taxpayers”) and shall pay the land appreciation tax in accordance with these Regulations.

Announcement on the Continued Implementation of Land Value-Added Tax Policies Related to Enterprise Restructuring and Reorganization (Ministry of Finance and State Taxation Administration Announcement No. 51 of 2023)

4. When entities and individuals contribute real estate as capital during restructuring, the transfer or change of ownership of such real estate to the invested enterprise will be temporarily exempt from land value-added tax.

5. The aforementioned land value-added tax policies related to restructuring and reorganization shall not apply to cases where either party involved in the real estate transfer is a real estate development enterprise.

5) Property tax

If an enterprise invests in another enterprise with non-monetary assets, is the recipient required to pay deed tax?

The Law of the People's Republic of China on Deed Tax

Article 1 Within the territory of the People's Republic of China, units and individuals who acquire ownership of land and houses shall be taxpayers of the deed tax and shall pay the deed tax in accordance with the provisions of this Law.

Announcement on the Continued Implementation of Stamp Tax Policies Relating to the Restructuring and Reorganization of Enterprises and Public Institutions (Ministry of Finance and State Taxation Administration Announcement No. 49 of 2023)

6. Asset transfer

Units that, in accordance with regulations, undergo administrative adjustments or transfers of state-owned land and property rights by people’s governments at or above the county level or by departments responsible for state-asset management are exempt from stamp tax.

The transfer of land and property ownership among enterprises under the same investor, including transfers between a parent company and its wholly owned subsidiary, between wholly owned subsidiaries of the same company, and between the same natural person and the sole proprietorship or single-member limited liability company established by that person, is exempt from deed tax.

When a parent company increases the capital of its wholly owned subsidiary by contributing land and property rights, such contribution is treated as a transfer and is exempt from deed tax.

6) Stamp duty

If an enterprise invests in another enterprise with non-monetary assets, is the receiving party required to pay stamp duty?

The Stamp Tax Law of the People's Republic of China, with attached: Stamp Tax Items and Rates Table

The stamp duty rate for instruments of transfer of land use rights, ownership of buildings and structures (excluding the transfer of land contract management rights and land operation rights) is 0.05% of the transfer price.

Announcement on Stamp Tax Policies Relating to Enterprise Restructuring and Reorganization, as well as the Reform of Public Institutions (Ministry of Finance and State Taxation Administration Announcement No. 14 of 2024)

3. Stamp duty on instruments of transfer of property rights

Stamp duty is exempted for property transfer documents executed in connection with enterprise restructuring, mergers, divisions, bankruptcy liquidation, and the restructuring of public institutions.

For property transfer documents executed by people’s governments at or above the county level, or by their subordinate departments responsible for state-owned asset management, in connection with administrative adjustments of land use rights, ownership of buildings and structures, equity interests, and other such assets as prescribed, stamp duty shall be exempted.

Property transfer documents executed for the internal transfer of land use rights, ownership of buildings and structures such as houses, and equity interests within the same investing entity shall be exempt from stamp duty.

Provisions Regarding the Replenishment of Registered Capital Shortfalls

Impact on taxation

Provisions Regarding the Replenishment of Registered Capital Shortfalls

Article 207 of the Company Law of the People's Republic of China: A company shall establish its financial and accounting systems in accordance with laws, administrative regulations, and the provisions of the financial department of the State Council.

Article 210, Paragraph 1: When a company distributes its after-tax profits for the current year, it shall set aside ten percent of such profits into the company’s statutory reserve fund. If the accumulated amount of a company’s statutory reserve fund reaches or exceeds fifty percent of its registered capital, no further contributions to the reserve fund are required.

Article 210, Paragraph 2: If a company’s statutory reserve fund is insufficient to cover prior years’ losses, it shall first use the current year’s profits to make up such losses before making the statutory reserve fund contribution as prescribed in the preceding paragraph.

Article 214, Paragraph 1: The company’s reserve fund shall be used to cover the company’s losses, expand its production and operations, or be converted into an increase in the company’s registered capital.

Article 214, paragraph 2 (added by the new Company Law): When using reserve funds to cover a company’s losses, discretionary reserve funds and statutory reserve funds shall be utilized first; if such funds are still insufficient to cover the losses, capital reserve funds may be used in accordance with the relevant provisions.

Article 207 A company shall establish its financial and accounting systems in accordance with laws, administrative regulations, and the provisions of the financial department of the State Council.

Article 224, Paragraph 1: When a company reduces its registered capital, it shall prepare a balance sheet and an inventory of assets.

Article 224, Paragraph 2: The company shall, within ten days from the date on which the shareholders’ meeting adopts the resolution to reduce the registered capital, notify its creditors and, within thirty days, publish an announcement in a newspaper or through the National Enterprise Credit Information Publicity System. Creditors shall, within thirty days from the date of receiving the notice, or within forty-five days from the date of the public announcement if no notice was received, have the right to demand that the company repay its debts or provide corresponding guarantees.

Article 225 (added by the new Company Law) Where, after making up losses in accordance with paragraph 2 of Article 214 of this Law, a company still has outstanding losses, it may reduce its registered capital to cover such losses. If a company reduces its registered capital to cover losses, it may not distribute any assets to its shareholders, nor may it relieve shareholders of their obligation to contribute capital or pay for shares.

Where the registered capital is reduced in accordance with the preceding paragraph, the provisions of paragraph 2 of the preceding article shall not apply; however, an announcement shall be made in a newspaper or on the National Enterprise Credit Information Publicity System within thirty days from the date on which the shareholders’ meeting adopts the resolution to reduce the registered capital.

After the Company reduces its registered capital in accordance with the provisions of the preceding two paragraphs, it shall not distribute profits until the aggregate amount of its statutory and discretionary reserve funds reaches fifty percent of the registered capital.

Key Point 1: Items that can be used to offset losses

According to the new Company Law, items that may be used to offset losses include current-year profits, capital reserves (newly added), discretionary reserves and statutory reserves, as well as a reduction in registered capital (newly added).

Key Point 2: The Order for Offsetting Losses

The order for offsetting losses is as follows: first, the discretionary reserve fund and the statutory reserve fund; then, the capital reserve; and finally, a reduction in the registered capital.

Key Point 3: Simplified capital reduction procedure for offsetting losses by reducing registered capital (new)

Is corporate income tax payable when a company reduces its capital?

1. The State Taxation Administration’s 12366 Taxpayer Service Platform has included the Liaoning Provincial Tax Bureau’s responses from 2019.

Question: Our company is a Sino‑foreign joint venture, with all shareholders being corporate entities. In order to optimize the capital structure, we plan to offset accumulated losses from prior years through a capital reduction, with the reduced capital not being remitted to the shareholders. The accounting treatment is as follows: Debit Share Capital; Credit Retained Earnings. How should the related corporate income tax be handled for this transaction?

Reply: According to the "Decision of the Standing Committee of the National People's Congress on Amending the Income Tax Law of the People's Republic of China" (Presidential Order No. 64 of the People's Republic of China), Article 6 states: "The total revenue of an enterprise shall include all income obtained from various sources in both monetary and non-monetary forms."

Including (VIII) acceptance of donation income; Article 7 The following items in the total revenue shall be non-taxable income: (I) fiscal appropriations; (II) administrative and public service charges and government funds collected in accordance with the law and incorporated into fiscal management; (III) other non-taxable income as prescribed by the State Council. Article 18: Losses incurred by an enterprise in a tax year may be carried forward to subsequent years and offset against income in those years; however, the carryforward period shall not exceed five years.

Based on your description, if the capital reduction proceeds are not remitted to the shareholders—meaning that after the capital reduction, your company returns the funds to the shareholders, who then donate the same amount back to your company to cover losses—then, in accordance with the relevant provisions of the aforementioned documents, you should recognize the income as required and use it to offset the losses in compliance with the law.

2. Dalian Municipal Tax Service Bureau of the State Taxation Administration

Question: Our company’s paid-in capital is RMB 700 million, and the accumulated undistributed profits amount to -RMB 450 million. To improve the financial statement structure, and following consultations among all shareholders, it is proposed to restructure resources through a nominal capital reduction to offset losses—specifically, by using paid-in capital to cover undistributed profits. This will leave the company’s net assets unchanged, and no actual cash flow will occur between the company and its shareholders.

In accordance with the Provisions of the State Administration of Taxation on Several Issues Concerning Enterprise Income Tax (Announcement No. 34 of 2011 issued by the State Administration of Taxation), operating losses incurred by the investee shall be offset by the investee in accordance with applicable regulations; the investor shall neither reduce its investment cost nor recognize such losses as investment losses.

According to this policy, if the investing enterprise is not allowed to recognize investment losses and thus does not reduce its taxable income, should the investee enterprise likewise refrain from recognizing income for offsetting prior‑year losses and, consequently, avoid increasing its taxable income? Could you please outline the tax-related matters applicable to both the investee enterprise and the investing enterprise?

Dalian Municipal Tax Bureau 12366 Call Center Response:

The 12366 Taxpayer Service Center of the Dalian Municipal Taxation Bureau of the State Taxation Administration responds:

Dear taxpayer, hello! We have received your online inquiry and hereby respond as follows:

First, the question refers to the following: “Operating losses incurred by the investee shall be carried forward and offset in accordance with applicable regulations; the investor shall not adjust or reduce its investment cost, nor shall it recognize such losses as investment losses.” Regarding the interpretation of the relevant provisions, we believe that the investee and the investor are two independent tax entities. Under normal operating conditions, they may not offset each other’s losses. When the investee incurs an operating loss, unless the investor disposes of its equity interest or the investee undergoes liquidation, the investor may neither reduce its investment cost nor recognize an investment loss.

Second, regarding the issue of nominal capital reduction to offset undistributed profit losses as mentioned in the corporate matter, we believe that, for corporate income tax purposes, the transaction should be treated in two steps: First, the company’s shareholders reduce their capital contribution, recognizing investment income while the investee company records a payable liability due to its inability to make an actual payment; second, the reduced paid-in capital is returned to the company, reducing the payable liability and treating it as revenue that is included in the company’s total income.

Thank you for your understanding and support of our tax work.

Replying Agency: Dalian Municipal Tax Bureau

Response time: 2020-09-15

3. Hot-Topic Questions for the June 2021 Issue of the 12366 Tax Service Hotline of the Henan Provincial Tax Service Bureau of the State Taxation Administration

Question 21: If shareholders reduce their capital contributions to cover losses, how should the corporate income tax be handled?

Reply: A shareholder’s capital reduction to cover losses should be treated as two separate steps: first, the company reduces its capital and returns the funds to the shareholder; second, the shareholder donates those funds back to the company to offset the losses.

In the first step, corporate shareholders shall be treated in accordance with Article 5 of State Administration of Taxation Announcement No. 34 of 2011, while individual shareholders shall be treated in accordance with State Administration of Taxation Announcement No. 41 of 2011.

Corporate shareholders: According to the "Announcement of the State Taxation Administration on Several Issues Concerning Enterprise Income Tax" (State Taxation Administration Announcement No. 34), "5. Tax treatment for withdrawal or reduction of investment by investing enterprises."

When an investing enterprise withdraws or reduces its investment in an investee enterprise, the assets received shall be allocated as follows: the portion equivalent to the initial investment shall be recognized as a recovery of investment; the portion corresponding to the investee’s accumulated undistributed profits and accumulated surplus reserve, calculated based on the proportion of the reduction in paid-in capital, shall be recognized as dividend income; and the remaining portion shall be recognized as gain from the transfer of investment assets.

Operating losses incurred by the investee shall be carried forward and offset in accordance with applicable regulations; the investor shall not adjust or reduce its investment cost, nor shall it recognize such losses as investment losses.

(Continued)

1. Individual shareholders: According to the “Announcement of the State Taxation Administration on the Collection of Individual Income Tax on Proceeds Received by Individuals upon Termination of Investment Operations” (State Taxation Administration Announcement No. 41 of 2011), “1. Where an individual terminates investment, joint ventures, business cooperation, or other activities for various reasons and receives income from equity transfers, liquidated damages, compensation, indemnities, or other funds received under different names from the invested enterprise, the cooperative project, other investors in the invested enterprise, or the business partners of the cooperative project, all such proceeds shall be considered taxable income for individual income tax purposes and shall be subject to individual income tax calculated and paid in accordance with the provisions applicable to the ‘income from transfer of property’ item.”

The formula for calculating taxable income is as follows:

Taxable income = Total amount received by the individual from equity transfer proceeds, liquidated damages, compensation, indemnity, and other payments under various names – the original actual capital contribution (investment amount) plus related taxes and fees.

In the second step, if an investing enterprise withdraws or reduces its investment in the investee enterprise and the investee enterprise reduces its paid-in capital without providing any consideration to the investor, then regardless of whether the enterprise uses the reduced amount of paid-in capital to offset prior-year losses or to increase its capital reserve, the reduced amount shall be recognized as current-period donation income and included in taxable income for corporate income tax purposes.