Mergers and Acquisitions in China

This work was prepared by Pierluigi Damiano Lenge. This work is intended for general information purposes only and is not intended to provide, and should not be
used in lieu of professional advice. The publisher Lenge & Partners assumes no liability for readers’ use of the information herein and readers are encouraged to
seek professional assistance with regard to specific matters. Any conclusions or opinions are based on the specific facts and circumstances of a particular matter
and therefore may not apply in all instances.
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Mergers and Acquisitions (M&A) Guide in China 2016

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TABLE OF CONTENTS
Introduction
PRC M&A Legal Framework
Mergers and Acquisitions Basic Concepts
Mergers and Acquisitions in China
Motivations
Main issues of M&A in China
Valuing an Acquisition in China
Structuring an M&A in China
Types of Mergers and Acquisitions operations in China
Equity acquisition
Asset acquisition
Merger
Off-shore acquisition
The Acquisition process
Asset Acquisition
Equity Acquisition
Merger
Taxation of M&A in China
Overview
Taxation of Acquisitions
Stock Acquisition
Asset Acquisition
Transaction costs for purchasers
Basis of taxation following stock/asset acquisition
General and special tax treatments

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Stock acquisition: General and special tax treatments
Asset acquisition: General and special tax treatments
Taxation of Mergers

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Introduction
In recent years, the number of investments, both inbound and outbound, in
China through merger and acquisition activities has grown significantly.
The global financial crisis and current Chinese market scenario, are the
main factors of this great escalation.
The global economic downturn, in fact, has changed the landscape for
mergers and acquisitions and identified new M&A targets.
Companies are responding to the crisis by focusing on growth outside their
home country regions, expanding their geographic diversification and investment
in secondary markets.
As result, the Asian market (where China is the leader) and its companies
have become the new targets and protagonists of M&A deals.
Focusing on China's cross-border M&A activity, the largest Chinese firms,
both private and state-owned, after gained enough resources required to engage
into international mergers and acquisitions, have started to invest in various
sectors globally.
From the first metals and mining M&A deals, China has moved to more
consumer-centric industries like technology, machinery, food and energy.
Over the last five years, for example, China’s overseas food-related
acquisitions have amounted to nearly $20 billion, and, according to Dealogic’s
March 2016 Statshot, China is the world’s leading acquiring nation for technology
M&A.
So far in 2016, China’s outbound mergers and acquisitions have already
reached about $68 billion, making cross-borders M&A part of the long-term
strategy for many Chinese companies.
Foreign investments in China through M&A vehicle have also increased
considerably. As main reasons of this growth we can include the privatizations

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and sales of many state-owned enterprises (SOEs), the recent and transforming
reforms related to foreign-invested enterprises (FIEs) in China, and the current
Chinese domestic market.
Regarding the domestic market, surely the difficulty to understand it and to
reach Chinese consumers as well as the echo of some resounding failures, has
pushed foreign investors to consider merging with or acquire a Chinese company
already operating, a way of access to market better than join an unknown partner
or venture alone.
But if mergers and acquisitions are becoming more and more a suitable
investment vehicle for China, structuring a successful M&A strategy implies, in
addition to a perfect mastery of it and its different strategies, to be aware of the
many risks and issues that foreign investors have to face and try to prevent.
Every M&A strategy in China has to be planned by taking into consideration
a less developed system of property rights protection, less reliable financial
information, cultural differences in negotiations, and a higher degree of
competition for the best targets.
PRC Mergers and Acquisitions Legal Framework
China's mergers and acquisitions regulations changed significantly in
recent years. Remarkable efforts have been made to regulate the M&A market by
adjusting the previous incomplete and confused legal framework.
However, the new M&A regulatory framework has still some gaps due to
the conflicting goals of China’s government. China does not want to miss the
chance to take great advantages from the western companies especially in the
field of the most advanced industries, and for this purpose the government has
encouraged mergers to create large, competitive local conglomerates that can
compete with large foreign enterprises.
At same time, China wants to still protect its economic sovereignty from
foreign influence by limiting the penetration of the largest foreign conglomerates

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in the most important industries through the acquisition of the main SOEs or major
Chinese private companies.
So, if the new M&A laws and regulations allow foreign investors to acquire
assets or equity of Chinese companies, yet they have to go through complex
procedures made by various registrations, validation or approval procedures from
different approval authorities which, depending upon the size of the investment
and the industry, may take long time before the deal is finalized.
Furthermore, the government has not yet taken truly effective measures to
make the banking, and financial information system in general, transparent and
reliable for foreign investors.
The main regulations (but not limited to) that apply to mergers and
acquisitions in China are:
Foreign investment industrial guidance catalogue 2015
Anti-Monopoly Law of the People’s Republic of China (Order No. 68 [2007])
Provision on Merger and Division of Foreign Investment Enterprises (2001)
Administrative Measures on Strategic Investments in Listed Companies by
Foreign Investors (Order No. 28 [2005])
Provisions on the Merger and Acquisition of Domestic Enterprises by
Foreign Investors (MOFCOM Order No. 6 [2009])
Interim Provisions on Investment by Equity Interests in respect of Foreign-
invested Enterprises (MOFCOM Order No. 8 [2012])
Circular on the Establishment of Security Review System for Mergers and
Acquisitions of Domestic Enterprises by Foreign Investors (State Council
Circular No. 6 [2011])
Circular regarding Improving Administrative Measures on Business
Operation of Payment and Settlement of Foreign Currency Capital of FIEs
(SAFE Circular No. 142 [2008])
Measures for the Administration of the Takeover of Listed Companies
Procedures (Order No. 8 [2012])

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Supplementary Circular on Issues Relating to Improving Business
Operations with Respect to The Administration over Payment and
Settlement of Foreign Exchange Capital of Foreign-invested Enterprises
(SAFE Circular No. 88 [2011])
Circular of the State Administration of Taxation on Strengthening
Administration of Enterprise Income Tax on Non-Resident Enterprises’
Equity Transfer Income (Circular No. 698 [2009])
Announcement Concerning Issues of Adopting Special Tax Treatment in
Equity Transfers for Non-tax Residents (Announcement No. 72 [2013])
Revised Guiding Opinion on Reporting of Concentrations of Business
Operators (issued by the Anti-monopoly Bureau of MOFCOM on June 6,
2014).
Mergers and Acquisitions Basic Concepts
Mergers and acquisitions (M&A) are transactions in which the ownership
of companies, other business organizations or their operating units are transferred
or combined.
As an aspect of strategic management, M&A can allow enterprises to
grow, shrink, change the nature of their business or improve their competitive
position.
From a legal point of view, a merger is a legal consolidation of two entities
into one entity, whereas an acquisition occurs when one entity takes ownership
of another entity's stock, equity interests or assets.
From a commercial and economic point of view, both types of
transactions generally result in the consolidation of assets and liabilities under one
entity, and the distinction between a "merger" and an "acquisition" is less clear.
A transaction legally structured as a merger may have the effect of placing
one party's business under the indirect ownership of the other party's
shareholders, while a transaction legally structured as an acquisition may give

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each party's shareholders partial ownership and control of the combined
enterprise.
An acquisition or takeover is the purchase of one business or company
by another company or other business entity. Such purchase may be of 100%, or
nearly 100%, of the assets or ownership equity of the acquired entity.
Consolidation occurs when two companies combine to form a new
enterprise altogether, and neither of the previous companies remains
independently.
Acquisitions are divided into "private" and "public" acquisitions, depending
on whether the acquiree or merging company (also termed a target) is or is not
listed on a public stock market.
Acquisition usually refers to a purchase of a smaller firm by a larger one,
but in case of reverse takeover, the smaller firm acquires management control of
a larger and/or longer-established company and retains the name of the latter for
the post-acquisition combined entity.
Another type of acquisition is the reverse merger, a form of transaction that
enables a private company to be publicly listed in a relatively short time frame. A
reverse merger occurs when a privately held company buys a publicly listed shell
company, usually one with no business and limited assets.
The terms "demerger", "spin-off" and "spin-out" indicate a situation
where one company splits into two, generating a second company which may or
may not become separately listed on a stock exchange.
Mergers and Acquisitions in China
Motivations
Before to start to plan any merger or acquisition strategy, investors must
have clear their motivations-goals and figure out if they can be achieved in China
through an M&A operation.

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Usually M&A operations are useful for the acquiring firms to improve
financial performance and reduce risks, but also to break into a new market using
business entities already operating, grow, consolidate and expand their presence
in a market, beat competitors, diversify investments and portfolios.
However, there are different ways to achieve the same strategic and
financial goals in China and investors have some alternative options that should
be analyzed before to choose M&A as investment vehicle, such as:
Wholly-foreign owned enterprise: Foreign companies that would like to
break into Chinese market and have the full control of their resources and
management may choose to set up a wholly-foreign owned enterprise
(WFOE).
Joint Venture: Sino-foreign joint ventures have been used by foreign
investors much earlier than M&A, and they were the first business form to
enter in those industries restricted by China’s government. A JV is usually
formed to give access to complementary competencies as well as share
risk and expertise, with each party participating in the overall management.
The selection of an appropriate Chinese partner is generally the most
difficult and important task in forming a joint venture. Unlike WFOEs, foreign
investors in joint ventures need to spend a lot of time and effort to cultivate
relationships with Chinese partners. In fact, the success of a joint venture
is largely dependent on the degree of cooperation between the parties.
Strategic alliances: Strategic alliances are generally used for research,
marketing or distribution purposes. They do not involve equity or debt
transactions, but offer the advantage of being an inexpensive way to access
new markets.
Licensing: Licensing is a form of strategic alliance that minimizes capital
investment. A company will receive an up-front payment from an interested
party for the right to produce or market one or more of its products. Like
strategic alliances, licensing is an inexpensive way to access new markets.
The licensor's control can be limited.

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Franchising: A franchiser will be compensated by an up-front payment plus
a continuous future royalty stream. In certain instances, there will be an
agreement where the franchiser will sell materials or supplies to the
franchisees. Franchising remains an easy way to expand a business rapidly
where other parties invest the capital. However, a franchiser will generally
have no control in the franchisee's business and the growth in returns can
be limited.
Contract processing: A foreign entity may engage local low cost
manufacturers to produce products for an overseas market by supplying
the materials, technologies, and supervision required to ensure the quality
of the products being produced. This strategy avoids heavy capital
investment in China especially when most of the products are sold to an
overseas market. However, it may create quality control and intellectual
property protection issues, and is often not a preferred long term strategy
for companies seeking to penetrate the local market. In addition,
manufacturing in China is also becoming.
There also some other aspects that should be considered and evaluated
before to start an M&A operation, such as:
Economy of scale – the combined company, by removing duplicate
departments or operations and reducing its fixed costs, will increase profit
margins? by how much?
Economy of scope – How the efficiency associated with demand-side
changes will be affected?
Increased revenue or market share – to increase revenue and market
share the buyer has to absorb a major competitor, is it possible in China?
Taxation – what will be the tax consequences for the buyer? How to use
the Chinese target company to enjoy tax advantages?
Resource transfer – how to distribute resources of the target and acquiring
firm to create value?

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Hiring – by acquiring the target staff, the acquiring firm will hire useful
talents or will just be exposed to legal issues?
Main Issues of M&A in China
As in all M&A operations, there are some typical issues that unfortunately
in China require more attention and prudence by investors due to, as already
mentioned it, different culture in negotiation and different corporate culture,
asymmetry of information and in the exchange of information, a banking still hardly
trustable, and most generally to a competition in an unfair environment.
Thus, some of the main issues to take “carefully” into account are:
Transfer of technology and capabilities: Transfer of technologies and
capabilities are very difficult tasks to manage because of complications of
acquisition implementation. The risk of losing implicit knowledge is always
associated with the fast pace acquisition. It is important to not forget that in
China the IPs protection system is still “poor” for some circumstances and
therefore investors must coordinate all the negotiations steps till the
finalizing phase with a protection strategy of their IP assets. In addition,
some acquired firms would like to keep their symbolic and cultural
independence which is the base of technology and capabilities.
Brand problems: Mergers and acquisitions often create brand problems,
beginning with what to call the company after the transaction and going
down into detail about what to do about overlapping and competing product
brands. Decisions about what brand equity to write off are not
inconsequential. And, given the ability for the right brand choices to drive
preference and earn a price premium, the future success of a merger or
acquisition depends on making wise brand choices. The factors influencing
brand decisions in a merger or acquisition transaction in China can range
from political to tactical. Ego can drive choice just as well as rational factors
such as brand value and costs involved with changing brands. Beyond the
bigger issue of what to call the company after the transaction comes the

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ongoing detailed choices about what divisional, product and service brands
to keep.
Quality information: In China this is maybe one of the biggest issue that
acquiring firms will have to face. The quality and accuracy of asset valuation
is heavily dependent upon the quality and accuracy of the information and
data upon which it is based, and improper documentation and changing
implicit knowledge makes it difficult to share information during acquisition.
Many Chinese firms keep two sets of books or maintain poor accounting
records. They have a high volume of off-book sales, failing to make a
distinction between corporate and personal funds. Usually their accounting
records lack of an understanding of basic accounting principles, and they
are not able to provide a satisfactory estimate of production capacity. China
comparisons are also difficult, as indicators and benchmarks which are only
two years old may not be the best signs of the current economic and
financial situation in China.
Accounting standards: The Ministry of Finance (MOF) has reduced the
gap between Chinese and international accounting standards in the last
years, but China’s accounting procedures cannot still fully meet
international standards. There are clearly a number of issues to overcome,
such as possible fraudulent transactions.
Hidden liabilities: Another difficult task for foreign acquiring firms is that of
discovering all the liabilities or any other lack of compliance with regulations
that can be easily hidden by Chinese companies. For example, in an asset
acquisition, investors must be sure that the Chinese target has the
ownership of its asset which can be legally transferred to the acquiring firm.
In an equity acquisition it must be sure that the target is not hiding financial
burdens such as loans, debts and bad inventories, and human resource
issues such as unpaid social security, employee income taxes, labor
contract clauses and labor disputes.

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Valuing an Acquisition in China
Accurate business valuation is one of the most important aspects of M&A
as these valuations impact on the price that a business will be sold for.
Objectively evaluating the historical and prospective performance of a
business is an hard task. To yield the most value from a business assessment,
objectives should be clearly defined and the right resources should be chosen to
conduct the assessment in the available timeframe.
The five most common ways to value a business are:
asset valuation
historical earnings valuation
future maintainable earnings valuation
relative valuation (comparable company and comparable transactions)
discounted cash flow (DCF) valuation.
Professionals who value businesses generally do not use just one of these
methods but a combination of some of them, in order to obtain a more accurate
value.
However, professionals and acquiring firms usually start from an asset
valuation of the target and in China, according to the PRC Provisions on the
Acquisition of Domestic Enterprises by Foreign Investors, it is required the
employment of an outside asset appraisal organ and the use of the subsequent
appraisal as a basis for the determination of the transaction price.
More specifically, according to the provisions:
Parties to acquisition (both equity and asset related) must determine price
on the basis of equity interest to be transferred or assets to be sold as
assessed by an asset appraisal organ
Parties are prohibited from transferring equity interest or selling assets at a
price lower than the assessed value

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All foreign firms involved in M&A with a domestic enterprise must seek
outside asset appraisal organs
Asset appraisal of non-SOE enterprises is to be conducted using
internationally accepted appraisal standards, and asset appraisal of SOE
enterprises is subject to state-owned enterprises.
The valuation of intangible assets is a relatively new operation in China. If
for standard international practice, usually the amortization process is extended
to a period of 20, in China, intangibles, including goodwill, are amortized using the
straight line method over their useful lives and no more than 10 years.
Intangible assets must be valued on an annual basis, and if the book value
is greater than their recoverable value, they are required to provide for the
devaluation.
R&D costs incurred before legally obtaining an intangible asset such as a
patent, if any R&D costs arise, must be expensed in the period in which they are
incurred.
The management of state-owned enterprise valuation is provided by the
different authorities managing the businesses at the different levels – central,
provincial, local city and county.
Financial enterprises, for example, are managed by the Ministry of Finance,
the provincial state resource committee supervises state-owned provincial
enterprises, the local city’s state resource committee supervises the state-owned
local enterprises and the county committees supervise state-owned county
enterprises.
The China’s asset appraisal industry is approved by the State Council
under the administration of departments like the State Owned Assets Supervision
and Administration Commission of the State Council.
At the same time valuation falls under the respective industrial and self-
disciplinary management of industrial associations including the China Appraisal

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Society, China Institute of Real Estate Appraisers, China Real Estate Valuer
Association and China Automobile Dealers Association.
This distribution of competences determines some anomalies including that
valuers cannot be substituted by each other. Especially for assets valuation, real
estate valuation and land valuation, the three areas can only be carried out at the
same time by three different types of qualified valuers upon approval by the
competent authorities from the three different industries.
Structuring an M&A in China
The determination of an optimal M&A transaction structure is a complex
process driven by a number of considerations, and more than other strategies, it
must be structured and developed considering a precise business model through
which the different corporate strategies can work in synergy and perfect harmony.
Often the implementation of an M&A strategy implies a review of the entire
corporate strategy adopted until that moment, as well as a review of the original
corporate objectives-goals.
Thus, a company global overview is the first criteria to guide the senior
management in the choice of one of the three M&A options:
Stock purchase – where the buyer purchases the target company’s stock
from its stockholders and the target company remains intact, but with new
ownership
Asset sale/purchase – where the buyer purchases only assets and
assumes liabilities that are specifically indicated in the purchase agreement
Merger – where two companies combine to form one legal entity, and the
target company’s stockholders receive cash, buyer company stock, or a
combination.
After the “new” strategic objectives are clear and the M&A option has been
chosen, the acquiring firm has to focus on the identification of the best target.

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Prior to the target screening activity, companies have to create profiles of
their potential targets according to criteria which should consider (but not limited
to) the type of industry, the competitive position of the target in the specific sector
of industry, revenue and size, market capitalization and location(s) of operations.
The criteria used for the target screening activity should be developed
based on the M&A strategic objectives and the major sections of the analysis of
potential candidates should be focused on:
business strategy
product summaries/assessment analysis
major news announcements
customer data (as available)
consolidated financial data
regional/international benchmarked performance data
cultural assessment
organizational assessment
integration options available: absorb, maintain on stand-alone basis, or
partially absorb
list of subsidiaries, affiliates, properties, directors and executives.
During the target screening phase, firms have to collect target data that in
China, as already mentioned, is more difficult than in other developed countries.
The quality of information is a big issue and firms have to deal with a lack of
sufficient data, especially for targets from the private sector, data integrity and
lack of local and equity industry research.
Extensive and accurate due diligence and investigation activities are the
only way to overcome this major shortcoming.

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Types of Mergers and Acquisitions operations in China
The common structural alternatives for foreign M&A transactions in China
are:
Equity acquisition
Asset acquisition
Merger
The acquisition of equity interests or shares in China by foreign companies
may be:
Direct onshore where the seller is a Chinese entity
Direct offshore where the seller is a foreign entity
Indirect offshore where the seller is a foreign entity
An equity transaction is subject to full approval of the Chinese authorities
and thus is time-consuming and may also expose you to existing liabilities. An
investor will assume all of the existing obligations, liabilities and restrictions of the
target company so careful due diligence must be carried out.
Asset acquisition
There two types of acquisition of assets of domestic enterprises by foreign
investors:
Foreign investor establishes and capitalizes a Foreign-invested enterprise
(FIE) and then purchases the assets of a domestic Chinese enterprise
through that FIE
Foreign investor purchases the assets of a domestic Chinese enterprise
and establishes/capitalizes an FIE with those assets
The differences between the two types of acquisitions are in terms of
identity and type of buyer, funding mechanism (purchase price payment and forex
matters), capital contribution to new FIE, etc.

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Merger
According to Chinese law, mergers are only possible as onshore transactions.
Foreign investors must have set up a FIE in China in order to be able to complete
a merger deal. Mergers may be by absorption and by new establishment.
A merger by absorption occurs when one company is absorbed by another
and the absorbed companies registered capital and assets are merged into the
remaining entity. The legal entity of the absorbed business then ceases to exist.
A merger by new establishment occurs when each of the companies in
question are dissolved and a new legal entity is formed by combining the assets
and registered capital of the old companies.
An offshore acquisition is only possible in the case that the target company
has a foreign parent and it would only apply to the acquisition of the foreign
investor’s equity.
An investor may purchase some or all of the off-shore shares held by the
company’s foreign parent, thus acquiring or increasing control of the target
company.
The Acquisition Process
A letter of intent (LOI) and/or a memorandum of understanding (MOU) are
usually the first acts to approach the target. It is important to know that If in some
countries as US, those documents have no binding value and parties are free to
walk away from negotiations without any formality, in China, under some
circumstances, a LOI or a MOU can be cause of action for a breach of pre-contract.
After parties agreed on the deal and its structure, the acquisition must be
submitted for approval to the Ministry of Commerce (within one month for
investment in domestic companies and FIEs) whilst the State Administration of

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Industry and Commerce (SAIC) and its local branches are in charge for the
registration of the new entity.
Equity acquisition
An equity acquisition involves the transfer or subscription of the registered
capital of the target company and it is subjected to review of the Ministry of
Commerce.
An equity acquisition requires the following documentation:
Unanimous shareholders resolution of the target domestic company on the
contemplated equity acquisition
Application for the converting establishment of the FIE
Contract and articles of association of the FIE to be formed after acquisition
Agreement on the foreign investor’s acquisition of equities of shareholders
of the domestic company or on its subscription of the capital increase of the
target domestic companies
Audit report on the financial statement of the previous fiscal year of the
target domestic company
Notarized and certified documents for the foreign investor’s identity,
registration and credit standing the descriptions about the enterprises
invested in by the target domestic enterprise
Duplicates of the business licenses of the target domestic enterprise
Proposal to arrange employees in the target domestic enterprise
Documents relevant to the agreements on liabilities of the domestic
company, appraisal report issued by an appraisal institution and disclosure
and explanations for the associated transaction, if applicable
Other documents related to the business scope and scale, rights may be
required
Equity acquisitions by foreign investors may be carried out through an
indirect offshore acquisition or as a direct onshore acquisition. Chinese law also
allows existing FIEs to make equity acquisitions if certain conditions are satisfied.

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Asset acquisition
In order to set up an asset acquisition, a foreign investor must establish a
new FIE which purchases and operates the assets, or buy the assets and inject
them into a new or existing company.
An asset acquisition requires the following documentation:
Resolution of property rights holders or power authority of the domestic
enterprise on the consent of the sale of the assets
Application for the establishment of the post-acquisition FIE
Contract and articles of association of the FIE to be established
Asset purchase agreement signed by the foreign-funded enterprise to be
established and the domestic enterprise, or by the foreign investor and the
domestic enterprise
Articles of association and the business license (duplicate) of the target
company
Creditor notification issued by the target company and the creditor’s
statement on the contemplated acquisition
Notarized and certified documents for the identity, registration and credit
standing of the foreign investor
Proposal to arrange employees in the target domestic enterprise
Documents relevant to the target company’s liabilities arrangement,
appraisal report and disclosures and explanations made by the parties to
the acquisition
Other documents as required
A Chinese acquisition vehicle is usually established at the same time as the
acquisition to permit the operation of the assets. However sometimes the
procedure may take more time for some checks by local authorities such as
examination of the auditors’ notification and formal consultations with the target’s
workers.

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Merger
A merger will generally be approved by the original approval authority of the
relevant FIE. The registration procedures should be submitted to the SAIC or its
local branches.
When a merger may be capable of creating industry monopolies or market
dominance over specific commodities or services, it will be subject to antitrust
review and scrutiny by the authorities.
If the target company is to be dissolved in the merger, then all creditors
must be notified within 10 days of receiving an initial approval reply from the
approval authority according to the PRC liquidation and dissolution procedures.
They will be subjected to a multi-step approval process with preliminary approvals
required from both the surviving and dissolving entities’ approval authorities and
a final approval required from the surviving entity’s approval authority.
When the merger involves more than one competent authority, it has to be
approved by the appropriate authority having jurisdiction over the post-merger FIE.
Following the approval, relevant registration procedures should be carried
out with the SAIC or its local branches. Pre-approval review for possible impact
on competition in China is required if the assets or revenues in China exceed
specified thresholds.
In addition, if the target company is being dissolved in a merger, all creditors
must be notified within 10 days of receiving a reply from the approval authority,
pursuant to the PRC liquidation and dissolution procedure.
Approvals generally require 30 days but a number of factors (such as size,
approval level, locality, etc.) may have a significant effect on the approval time
period.
Any amendments to the registration or company particulars must be filed
with the competent Administration of Industry and Commerce and updated
appropriately.

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Taxation of M&A in China
Overview
The Chinese tax provisions related to mergers and acquisitions changed
significantly with the introduction of the new Corporate Income Tax (CIT) law
system in 2008.
It is important to remind that the taxation is one of the most important aspect
of M&A transactions because from its level of tax advantages-disadvantages
depends the choice of what the acquiring firm should purchase, if asset or equity,
the choice of the acquisition vehicle and how the acquisition vehicle should be
financed.
China’s tax legal system assumes, in case of ownership transfer of a
company, through a disposal of shares or assets, that all sellers are Chinese
companies and all purchases are made either by a foreign enterprise (FE) or
through a foreign invested enterprise (FIE) in the PRC, unless otherwise indicated.
Thus, M&A deal are subject to the following taxes:
Corporate tax
Turnover taxes
Stamp tax
Other relevant taxes.
Generally, Chinese companies are taxed on a stand-alone basis. After
January 2008, the FIE taxation is covered by a unified corporate income tax (CIT).
The profits earned by a company are taxed at the CIT rate of 25% or lower where
tax incentives apply.
A FE which has no permanent establishment, or place of business, in China
but derives profit, interest and other income from sources in China, is subject to
withholding tax (WHT) at the rate of 20% on such income with a possibility of
exemption or reduction of 10%.

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Belongs to turnover taxes the Value added tax (VAT) which is a sales tax
where up to 17% is added to the sales price charged for goods, except for certain
categories of sales which are exempted or charge at lower VAT rate.
Consumption tax (CT) is imposed on 14 categories of goods, including
cigarettes, alcoholic beverages and certain luxury items.
Aside from the turnover taxes mentioned above, urban construction and
maintenance tax and education surcharge are imposed based on 1% / 5% / 7%
(depending on different locations) and 3% of the turnover taxes paid respectively.
Furthermore, local education surcharge will also be imposed based on 2% of
turnover taxes paid.
Stamp tax is payable by both the purchaser and seller at rates ranging from
0.03% to 0.05% on the value of equity or assets transferred.
Other relevant taxes are land appreciation tax which is imposed on the
seller upon the transfer of land use rights and buildings with a progressive rates
from 30% to 60% of the appreciated amount of the land use right and building,
and the deed tax which is payable by a purchaser at rates ranging from 3% to 5%
on the purchase price of land use right or building.
Taxation of Acquisitions
The adoption of an asset or a stock deal for an acquisition in China largely
depends on the regulatory situations, as well as the commercial and tax objectives
of the investors. For example, in some cases, an asset deal may be the only option
for acquiring businesses from Chinese domestic enterprises.
Stock acquisition
Under a stock deal, there is no change in the legal existence or disruption
to the attributes of the acquired Chinese company. Thus, the target company may
not revalue its asset basis for Chinese tax purposes, whilst under a stock
acquisition, the target company remains as a going concern subject to its originally
approved operating period.

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The acquirer also inherits the business risk and hidden or contingent
liabilities, if any, of the target company. Accordingly, this risk should be addressed
by performing a due diligence on the target, through adjusting the purchase price
and/or obtaining a contractual warranty from the target company’s shareholders,
where commercially viable.
The transfer of a stock interest in a Chinese entity is subject to stamp tax
on the transfer price. Stamp tax is payable by both the buyer and seller. Any
acquisition expense incurred by the buyer may not be allocated to the target
company and therefore, such expense generally incurred by the offshore buyer
may not be claimed as a tax deduction in China.
Generally, tax losses of the target company arising prior to the acquisition
may continue to be carried forward after the stock acquisition for any period
remaining within five years.
Asset acquisition
An asset deal is typically used in order to leave behind some of the inherent
risks associated with the target company. An asset acquisition helps to restrict the
risks to the specific assets, liabilities and businesses being acquired.
Thus, the acquirer generally does not assume any contingent or hidden
liabilities of the target company. However, in certain specific situations, an asset
deal is not immune from the inherent risks related to the assets acquired.
For example, if there is any default on the target company’s part of import
duty and VAT on the assets acquired, PRC Customs may pursue the assets,
although that they have been sold. The seller is required to pay PRC taxes in
respect of the transfer of the following assets: Equipment, Intangibles, Inventory,
Inventory – category of goods subject to CT, Land and buildings, Transfer
contracts.

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Generally, the seller and buyer may only retain and carry forward their
respective tax losses and may not transfer the tax losses to the other party through
the transfer of their assets and business operations to the other party.
Transaction costs for purchasers
Asset deal
From the purchaser’s perspective, if the purchaser is subject to VAT and is
obliged to charge VAT on its sales (output VAT), the purchaser may recover VAT
paid by it on purchases (input VAT) of inventory and production-related equipment
from the seller.
A purchase of inventory and production-related equipment on which VAT
has been charged by the seller is regarded as input VAT to the buyer. Therefore,
VAT charged by the seller may be recovered by the buyer.
Depending on certain VAT related characteristics of the purchaser, input
VAT may not always be recoverable in full. Hence, to the extent to which the VAT
paid may not be recovered, such non-recoverable VAT would be a real cost to the
purchaser.
For certain types of inventory, the CT paid for the purchase of inventory can
be offset against the CT liabilities for a manufacturing purchaser if the inventory
is used for the production of another product which is also subject to CT.
Otherwise, the CT paid is a real cost to the purchaser.
If the transferor transfers its entire property right (including assets,
receivables, liabilities and labour force), the disposal of movable assets involved
can be considered as outside the scope of VAT.
Stamp tax of 0.05% is payable by both the purchaser and the seller on the
consideration or value of the transfer of stock, whichever is higher.

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Deed tax of 3% to 5% of the amount or value of the transfer consideration
is payable by the purchaser on transactions related to land or real estate
properties in the PRC.
In addition, under an asset deal, the sale of inventory and fixed assets are
subject to a stamp tax at the rate of 0.03% on the value set out in the relevant
sales contracts. Stamp tax at 0.05% would be applied on the transfer of
immovable or intangible assets. Stamp tax is imposed on both the seller and buyer.
The deed tax concessions relating to M&A are:
In an equity transfer, deed tax will not be payable if there is no transfer of
ownership of land and real estate
In a merger, where two or more enterprises combine into one enterprise
with the existence of original shareholders, the merged enterprise taking
over the land and real estate from the original parties shall be exempted
from deed tax
In a spin-off, deed tax will not be payable if the shareholders of the spin-off
enterprise remain the same as the original shareholders of the enterprise
being spun-off.
The CIT law does not provide clear rules on the deductibility of transaction
costs. Under the old Foreign Enterprise Income Tax (FEIT) law, Foreign-invested
enterprises were explicitly not allowed to take deductions for expenses related to
feasibility studies, interest expense on investment loans, management expenses
and other investment-related expenses for FEIT purposes.
Nevertheless, if a FIE uses non-cash assets (e.g. tangible and intangible
assets) to acquire stock or assets, the difference between the original book value
of the non-cash assets and the purchase price of the acquired stock or assets is
a taxable profit or deductible loss of the seller in the taxable period of the
transaction.

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The CIT law also imposes deduction restrictions on intangible assets,
where goodwill arising from the acquisition would not be an amortizable item. This
goodwill would only be deductible when the acquired entity is subsequently
disposed of or liquidated.
Basis of taxation following stock/asset acquisition
The Detailed Implementation Rules (DIR) to the CIT law provides a general
rule that where an enterprise undergoes a corporate restructuring, it has to
recognize a gain or loss resulting from the transfer of the relevant assets at the
time of the restructuring.
In addition, the tax basis of the relevant assets shall be revised according
to the transaction prices, unless it is otherwise prescribed by the MOF and SAT.
As general tax treatments the general principle is that enterprises which
undergo corporate restructuring should recognize the gain or loss from the
transfer of the relevant assets and/or equity at fair value when the transaction
takes place, and the tax basis of the relevant assets in the hands of the transferee
should be revised according to the transaction prices.
In summary, the tax consequences to the parties involved in the corporate
restructuring are instantly recognized.
As special tax treatments if all the following prescribed conditions under the
Restructuring Rules are satisfied, it is possible for the parties involved in the
corporate restructuring to choose a special tax treatment.
The corporate restructuring has to be reasonable commercial and the main
purpose of the corporate restructuring is not for tax reduction, avoidance or
postponement of tax payment.
The equity or assets being acquired, merged or spun-off have to reach a
certain prescribed ratio to reflect the significance of the corporate restructuring. In

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an equity acquisition deal, the equity acquired should not be less than 75% of the
total equity of the enterprise being acquired. Whereas in an asset acquisition deal,
the assets acquired should not be less than 75% of the total assets of the
enterprise that transfers the assets.
No change in the original actual business activities within 12 consecutive
months (compulsory operating period) after the restructuring.
The deal consideration should mainly comprise of equity (or shares) and
the portion of equity payment has to exceed 85% of the total consideration. The
non-share equity (commonly known as ‘Boot’ which includes cash, bank deposits,
receivables, tradable securities, inventories, fixed assets, other assets and
undertaking of liabilities, etc.) cannot exceed 15% of the total consideration.
The original shareholder who received the equity-payment on the corporate
restructuring must not transfer the shares received within the compulsory holding
period.
Stock acquisition: General and Special tax treatment
When an enterprise undergoes a restructuring transaction in the form of a
share acquisition, the relevant transactions shall be treated in the following ways:
The transferor shall recognize the gain or loss for the shares transferred
The tax basis of the shares acquired by the transferee shall be determined
according to the fair value
The income tax matters of the target company shall, in principle, remain
unchanged.
As special tax treatment in an equity acquisition, the parties involved may
elect to adopt the following treatment, provided that the acquiring enterprise
acquires no less than 75% of the shares of the acquired enterprise, and the
amount of equity payment settled at the time the equity acquisition takes place is
not less than 85% of the total consideration for the transaction:

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The tax basis of the equity of the acquiring enterprise received by the
shareholders of the acquired enterprise shall be determined according to
the original tax basis of the equity of the acquired enterprise
The tax basis of the equity of the acquired enterprise received by the
acquiring enterprise shall be determined according to the original tax basis
of the shares of the acquired enterprise
The tax basis of all the original assets and liabilities and other income tax
matters of both the acquiring enterprise and the acquired enterprise shall
remain unchanged.
Asset acquisition: General and Special tax treatment
When an enterprise undergoes a restructuring transaction in the form of an
asset acquisition, the relevant transactions shall be treated in the following ways:
The transferor shall recognize the gain or loss for the assets transferred
The tax basis of the assets acquired by the transferee shall be determined
according to the fair value
The income tax matters of the target company shall, in principle, remain
unchanged
In an asset acquisition, the parties involved may elect to adopt the following
treatment provided that the transferee enterprise acquires no less than 75% of the
assets of the transferor enterprise and the amount of the equity payment settled
at the time the asset acquisition takes place is not less than 85% of the total
consideration for the transaction:
The tax basis of the equity of the transferee enterprise received by the
transferor enterprise shall be determined according to the original tax basis
of the assets transferred
The tax basis of the assets received by the transferee enterprise from the
transferor enterprise shall be determined according to the original tax basis
of the assets transferred

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Under the special tax treatment for share acquisition and asset acquisition,
where the parties involved in the restructuring do not have to recognize the gain
or loss from the relevant assets transfer corresponding to the equity payment
temporarily, the gain or loss arising from the assets transferred corresponding to
the non-equity payment shall still be recognized in the transaction period, and the
tax basis of the relevant assets shall be adjusted accordingly.
Taxation of Mergers
General and Special tax treatment
In a merger of enterprises, the parties involved shall treat the transaction
as follows:
The merged enterprise shall determine the tax basis of the items of assets
and liabilities received from the enterprise being merged based on the fair
value
The enterprise being merged and its shareholders shall treat the transaction
as a liquidation for income tax purposes
The parties involved may elect to adopt the following treatment, provided
the amount of equity payment received by the shareholders at the time the merger
takes place is not less than 85% of the total consideration of the transaction.
Where the enterprises being merged and the merged enterprise are under
common control, and consideration is not needed to be paid:
The tax basis of the assets and liabilities received by the merged enterprise
from the enterprise being merged shall be determined according to their
original tax basis to the enterprises being merged
The merged enterprise shall inherit the relevant pre-merger income tax
matters of the enterprises being merged
The tax basis of the equity of the merged enterprise received by the
shareholders of the enterprises being merged shall be determined
according to the original tax basis of equity of the enterprises being merged.

Mergers and Acquisitions in China

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