On December 7, 2014, the State Administration of Taxation has issued the Measures for Administration of Individual Income Tax on Income Derived from Equity Transfer (for Trial Implementation) (the "Measures"). The Measures, once taking into effect on January 1, 2015, will abolish the Notice of the State Administration of Taxation on Strengthening Administration of the Collection of Individual Income Tax on Income Derived from Equity Transfer (Guo Shui Han [2009] No. 285), and the Announcement of the State Administration of Taxation on Issues Relating to Determining Verifying the Taxation Basis for Individual Income Tax on Income Derived from Equity Transfer (Announcement of the State Administration of Taxation [2010] No. 27) (the “Announcement”).

The Measures have specified considerable rules regarding individual income tax on income derived from equity transfer which are listed as follows, among others:

1. Overview

1.1 Proper Taxpayer

Pursuant to Article 2 and Article 5 of the Measures, individual shareholders who invest equities or shares into enterprises or organizations established within the territory of China, excluding sole proprietorships and partnerships, shall be regarded as the proper taxpayer. During transfer transactions, the equity transferor is regarded as the tax payer and the transferee is deemed as the withholding agent.

1.2 Competent Tax Authorities

Pursuant to Article 19 of the Measures, competent tax authorities for the individual income tax (“IIT”) on the income derived from equity transfer by individuals are local tax authorities where the invested enterprise is located.

1.3 Circumstances of Equity Transfer (Scope of Tax Collection)

Pursuant to Article 3 of the Measures, the equity transfer means the individual transfers his/her equity to other individuals or legal entities, specifically includes:

a. The sale of equity;
b. The repurchase of equity by enterprises;
c. When the issuer initiates the public offering of shares, shareholders of the invested enterprise also sell their shares to the investors by way of the public offering;
d. The equity is compulsorily transferred by judicial or administrative authorities;
e. Equity investment or any non-monetary transactions;
f. The equity is used for clearing off debts;
g. Other equity transfer conducts.

1.4 Calculation of Taxable Income of Equity Transfer

Pursuant to Article 4 of the Measures, the IIT shall be calculated and paid in the name of "asset transfer income" based on the taxable income during the equity transfer. The taxable income refers to the balance of "equity transfer income" minus "original value of equity and reasonable cost". "Reasonable cost" refers to relevant taxes paid to competent tax authorities for the equity transfer.

2. Identification of Original Value and Equity Transfer Income

2.1 Original Value

Pursuant to Article 15 of the Measures, the original value of the transferred equity shall be identified through the following methods:

Situation	Calculation Method of Original Equity Value
Acquisition of the equity by cash;	Actual payment plus reasonable taxes directly related to the equity transfer;
Acquisition of the equity by the contribution of non-monetary assets;	The non-monetary asset price at the time of investment recognized or verified by the tax authorities plus reasonable taxes directly related to the equity transfer;
Acquisition of the equity by way of transfer without consideration (as listed in the Item 2 of Article 13 of the Measures);	Reasonable taxes directly related to the equity transfer and the original value of equity of the previous holders;
Increase the share capital with the capital reserve, surplus reserve and undistributed profit by invested enterprises whereas individual shareholders have already paid the IIT;	The added value plus related taxes shall determine the original value of the equity of the newly added share capital;
Other situations.	The competent tax authorities shall reasonably determine the original value of equity under the principle of "avoiding double collection of individual income tax".

2.2 Equity Transfer Income

Pursuant to Article 7, Article 8 and Article 9 of the Measures, the "equity transfer income" refers to the economic income acquired in such forms as cash, physicals and securities for equity transfers, which also includes liquidated damages, compensation, as well as other payments, assets, and interests under other items. Moreover, the subsequent income acquired by a tax payer under a contract after meeting the agreed terms shall also be regarded as the equity transfer income.

3. Income Determined by Competent Tax Authorities

3.1 Pursuant to Article 11 of the Measures, competent tax authorities may determine the equity transfer income under any of the following circumstances:

a. The declared equity transfer income is obviously low and unjustified;
b. Relevant taxes have not been declared before the deadline and such taxes are still not declared after tax authorities have ordered to declare taxes within a limited period;
c. The transferor fails to or refuses to provide information of the equity transfer income;
d. Other circumstances under which the equity transfer income shall be determined.


3.2 Pursuant to Article 14 of the Measures, competent tax authorities shall adopt the following methods in turn to determine the equity transfer income:

a. Confirmation by Net Asset
b. The method of analogue
c. Other reasonable methods

3.3 Pursuant to Article 12 and Article 13 of the Measures, the circumstance that “the equity transfer income is obviously low” is defined in order to prevent the tax avoidance during the equity transfer, which is clarified as follows:.

a. Equity Transfer Income is Obviously Low Without Reasonable Causes (Article 12)

i. The declared equity transfer income is lower than the net asset share corresponding to the equity, amongst which, if the invested enterprise has land use rights, buildings, unsold real properties of real estate companies, intellectual property, right of prospecting, mining rights, equity and other assets, the declared equity transfer income is lower than the fair value of the net asset fair value share corresponding to the equity;
ii. The declared equity transfer income is lower than the initial investment cost or lower than the price and related taxes paid for the acquisition of the shares;
iii. The declared equity transfer income is lower than the equity transfer income of the same shareholders or other shareholders of the same company under the same or similar conditions;
iv. The declared equity transfer income is lower than the equity transfer income of enterprises in the similar industry under the same or similar conditions;
v. Unjustified transfer of equity or shares without consideration;
vi. Other circumstances determined by competent tax authorities.

b. Equity Transfer Income is Obviously Low With Reasonable Causes (Article 13)

i. Valid documents can be provided to prove that invested enterprises transfers the equity at a low price because the corporate production and operation are significantly affected due to national policy adjustments;
ii. Inheritance, or equity transfer to spouse, parents, children, grandparents, grandchildren, brothers and sisters who can provide valid legal proof of the identity and relationship, or equity transfer to financial supporters of the transferors who undertake direct duties of the financial support;
iii. Internal transfer of equity held by enterprises' employees, which cannot be transferred externally and have relevant documents that can fully prove the reasonability and the authenticity of the transfer price;
iv. Any other reasonable circumstances where the transferors and transferees can provide valid certificates to prove the reasonability.

4 Timeline of IIT Payment and Submission of Documents

4.1 Timeline of Tax Payment

Pursuant to Article 6 of the Measures, the withholding agent/transferee shall report the relevant information to competent tax authorities within five working days after the relevant equity transfer agreement is signed.

4.2 Submission of Documents

Pursuant to Article 21 of the Measures, the following documents shall be submitted competent tax authorities for the tax payment (withholding) declaration:

a. The equity transfer contract (agreement);
b. The identification certificates of transferors and transferees of the equity transfer;
c. Asset value appraisal reports on net assets or land/real properties issued by qualified agencies if required according to relevant provisions;
d. Documents proving that the tax calculation basis is obviously low for certain reasonable causes;
e. Other documents required by competent tax authorities.

Comments

In general, compared to the Announcement, the Measures provide a more comprehensive guideline for the Chinese tax authority to supervise the payment of IIT during the equity transfer cases in respect of the following critical elements:

1) Clarify the scope of equity share, equity share income and tax payment;
2) Identify the equity transfer income and incorporate the subsequent income acquired by a tax payer under a contract after meeting the agreed terms as the equity transfer income;
3) Specify the circumstance “the equity transfer income is obviously low” and the exception;
4) Establish methods for competent tax authorities to determine the equity transfer income;

Detailed and clear rules regulated in the Measures, especially the elements mentioned above, will definitely facilitate the supervision of IIT payment by the Chinese tax authority in order to prevent the tax avoidance of individuals during the equity transfer transactions.

However, the Measures still have certain unclear sectors which need to be improved regarding the IIT derived from the equity transfer as follows:

1) During non-monetary transactions such as the investment with equity as one of circumstances of equity transfer, in general, there is no cash income incurred. As a result, it will be difficult to determine the income since the anticipated revenue will normally be different from the actual income. In practice, under certain circumstances, there still exist difficulties to determine the income.

2) With regard to the value adjustment mechanism (“VAM”), although the Measures regulates the subsequent income acquired by a tax payer under a contract after meeting the agreed terms as the equity transfer income in Article 9, which is one type of VAM, other types of VAM is still not taken into account. Therefore, the IIT involving other types of VAM needs to be further clarified.

3) With regard to “reasonability” in the item 4 of Article 13, it is still unclear what situations the “reasonability” shall prevail.

Therefore, no matter the transferor, the transferee or the invested enterprises shall keep a close eye on the Measures and the following improvements or adjustments.