2023.01.20 CHENG, Hong (Julie)、LIN,Peng、YANG,Yating
The Circular on Further Improving the Inspection Service Regarding Individual Income Tax Payment Certificates for the Registration of Equity Transfers (“《关于进一步做好股权变更登记个人所得税完税凭证查验服务工作的通告》” in Chinese, Circular  No. 3, the “Circular”) was jointly issued by the Shanghai Tax Bureau of the State Taxation Administration (the “STA”) and the Shanghai Administration for Market Regulation (the “AMR”) and became effective on December 20, 2022. The Circular stipulated that “if an individual applies for a shareholder change registration of the equity transfer, before the change registration with the AMR authority (the “AMR Registration”), the withholding agent or the taxpayer shall file a tax declaration with the in-charge tax authority of the Invested Enterprise (hereinafter referred to as the “Tax Filing Before AMR Registration Regime”). The Circular also stipulates that the tax authorities and the AMR authorities shall implement an automatic information exchange mechanism on the individual equity transfer, and the AMR authorities in Shanghai shall process the AMR Registration of the equity transfer according to the Statement of Tax Payment Status of Individual Shareholder during the Change of Equity (“《自然人股东股权变更完税情况表》” in Chinese) issued by the tax authority.
Will the implementation of the Circular trigger a new challenge between parties of individual equity transfer transactions? Does the Circular signal increasingly strengthened tax supervision on individual equity transfers? This Article will discuss these issues to assist enterprises and individuals mitigate risks during individual equity transfer transactions.
According to the Administrative Measures for Individual Income Tax on Income from Equity Transfer (Trial Implementation) (“《股权转让所得个人所得税管理办法（试行）》” in Chinese, the STA Bulletin  No. 67, “Bulletin 67”), an individual equity transfer refers to the transfer of equity or shares in an enterprise or organization incorporated in the People’s Republic of China (“PRC”) (collectively referred to as the “Invested Enterprise”, excluding sole proprietorship enterprises and partnership enterprises) by an individual shareholder (the “Transferor”) to another individual or entity (the “Transferee”). The Transferor shall be subject to individual income tax (the “IIT”) on the gains derived from the equity transfer, which shall be treated as “income from the transfer of property”, and the taxable income shall be equivalent to the transfer price minus the original cost of the equity and other reasonable expenses (i.e., the relevant statutory taxes to be paid at the time of the equity transfer). The Transferee shall be the withholding agent.
Bulletin 67 explains the timetable for tax filing for individual equity transfers. The withholding agent and the taxpayer shall make a tax filing to the competent tax authorities within the first 15 days of the following month under any of the following circumstances:
(1) The transferee has made a full or partial payment of the equity transfer;
(2) The equity transfer agreement has been executed and has come into effect;
(3) The transferee has fulfilled the shareholder’s obligations or has received the shareholder’s equity interests;
(4) The judgment, registration or announcement of the relevant national authorities has come into effect;
(5) An action stipulated in item (4) to item (7) of Article 3 of Bulletin 67 has been completed; or
(6) Other circumstances where the tax authorities deem that there is evidence to prove that the equity has been transferred.
It could be concluded from the circumstances set forth in Bulletin 67 above that the timing when “the equity has been transferred” is one of the key timelines to trigger the tax filing obligation. But how can we confirm when “the equity has been transferred”? Under the PRC Civil Code (“《中华人民共和国民法典》” in Chinese), the PRC Company Law (“《中华人民共和国公司法》” in Chinese) , the PRC Administrative Regulation on the Registration of Market Entities (“《中华人民共和国市场主体登记管理条例》” in Chinese) and other PRC laws and regulations, it is not clear that the AMR Registration is a prerequisite to confirm that “the equity has been transferred”. However, according to the relevant judicial interpretations, it is certain that after the equity transfer, the Transferee may claim that it actually holds the equity and may enjoy the corresponding shareholder’s rights; the validity of the equity transfer will not be affected even if the AMR Registration has not been completed, except that the Transferee may not defend against a bona fide third party. Thus, among the various circumstances requiring the tax declaration set forth in Bulletin 67, the AMR Registration is not the only circumstance triggering the tax filing.
Although Bulletin 67 provides tax authorities with relatively broad discretion in interpreting the timing for the tax filing, tax authorities in practice primarily rely on public information. such as that from the AMR Registration and self-disclosed by enterprises themselves to identify and collect the potentially unpaid IIT on income derived from the individual equity transfer. In light that the payment of the transfer price and the execution of the equity transfer agreement are not publicly available information, and it is difficult for tax authorities to identify that “the equity has been transferred” if the parties of the transaction do not disclose more details of the transaction except in certain public transactions. In fact, the STA specified that the completion of the AMR Registration of an equity transfer is an important signal in confirming that “the equity has been transferred” in its reply to the Sichuan Tax Bureau (i.e., the Reply on Issues Concerning the Collection of the Individual Income Tax on the Repurchase of the Transferred Equity by the Taxpayer (Guo Shui Han  No. 130, “《关于纳税人收回转让的股权征收个人所得税问题的批复》” in Chinese) in 2005.
Regardless of whether the Tax Filing Before AMR Registration Regime set forth in the Circular breaks through the definition that “the equity has been transferred” in Bulletin 67 and other PRC civil and commercial laws and regulations, it is certain that the Circular is the implementation rule of Article 15 of the PRC Individual Income Tax Law (“《中华人民共和国个人所得税法》” in Chinese, the “IIT Law”). This provides that if an individual completes the change registration of the equity transfer, the competent AMR authorities shall inspect the IIT payment certificates relating to the said equity transfer.
In light of the foregoing, more and more tax authorities at the provincial and municipal levels have issued local policies respectively in connection with the Tax Filing Before AMR Registration Regime. As of the issuance of the Circular in connection with the Tax Filing Before AMR Registration Regime in Shanghai, the top four first-tier cities (i.e., Beijing, Shanghai, Guangzhou and Shenzhen) have explicitly announced tax filing policies regarding the Tax Filing Before AMR Registration Regime (please see the Annex for the summary of more local policies in connection with the Tax Filing Before AMR Registration Regime). To be specific, the Tax Filing Before AMR Registration Regime has been implemented in Beijing since September 1, 2021, in Guangzhou since April 1, 2021, and in Shenzhen since June 18, 2021.
3. Impact of the Circular on the Parties of Equity Transfer Transactions
Based on our practical experience, during some individual equity transfer transactions, the parties may agree that the AMR Registration shall be one of the closing conditions or post-closing matters. To be specific, the parties may agree that an Invested Enterprise shall complete the AMR Registration within a certain period of time after other closing conditions are satisfied; upon completion of the AMR Registration by the Invested Enterprise, the Transferee shall pay the equity transfer price to the Transferor within a certain period of time, and the Transferor shall fulfill the IIT filing obligation within the first 15 days of the following month after receiving the transfer payment or within the time period otherwise agreed to by the parties.
The issuance of the Circular would undoubtedly affect the above-mentioned transaction arrangements. Meanwhile, the parties will face a new challenge on how to balance the transaction risks of both sides. From the Transferor’s perspective, it is usually difficult for the Transferor, or the Transferor is unwilling, to bear the high tax liabilities before the Transferee actually pays the transfer price. If the transaction is subsequently terminated, it is uncertain whether the paid-in tax could be refunded. From the Transferee’s perspective, if the equity transfer price is paid before the AMR Registration, it is difficult for the Transferee to effectively urge the Transferor to provide assistance during the AMR Registration. It would be costly to enforce against the Transferor for breach of contract at a later stage, particularly if the Transferee is an overseas enterprise or individual.
In practice, some local tax authorities that implement the Tax Filing Before AMR Registration Regime may allow the parties to submit tax filing materials before the AMR Registration and do not require settlement of the IIT payable in advance. It is worth noting that such arrangements depend on the actual circumstances of the transaction (e.g., in case the consideration for the equity transfer can only be determined after the completion of the AMR Registration) subject to the in-charge tax authority’s discretion. Thus, the said arrangement may not be applicable to all individual equity transfer transactions. It would be difficult to draw a conclusion from the Circular that in Shanghai there is no need to pay the IIT at the time of tax filing based on the literal interpretation. It is worth noting that if the Tax Filing Before AMR Registration Regime requires the IIT to be paid before the AMR Registration, it would mean that the provisions of the IIT Law providing that the Transferor shall pay the IIT before June 30 of the following year5 if the Transferee fails to fulfill the withholding obligation would be infeasible in practice.
4. Increasingly Strengthened Tax Supervision
As mentioned above, the public information, such as information from the AMR Registration, would be an important source for tax authorities to implement IIT supervision. However, the Tax Filing Before AMR Registration Regime under the Circular not only reflects the mindset of the tax authorities in respect to tax supervision on individual equity transfers transferred from “post-supervision” to “in-progress supervision,” but it also reflects the increasingly strengthened tax supervision on individual equity transfers by Shanghai tax authorities and even by national tax authorities.
In addition, the Circular also points out that the automatic information exchange mechanisms between the tax authorities and the AMR authorities will strengthen the communication and cooperation between them. Currently, the procedure for exchange and cooperation between these two authorities is that upon completion of the AMR Registration with the competent AMR authorities, the in-charge tax authority will conduct tax supervision once the information regarding the equity transfer has been received.
It is worth noting that the information system’s exchange and cooperation between the tax authorities and the other governmental authorities is a requirement of the tax collection and supervision reform. According to the Opinions on Further Deepening the Reform of Tax Collection and Supervision (“《关于进一步深化税收征管改革的意见》” in Chinese) issued by the General Office of the CPC Central Committee and the PRC General Office of the State Council on March 24, 2021, the following targets are to be achieved by 2025: establish a normalized and institutionalized data sharing and coordination mechanism between the tax authorities and the relevant authorities; secure access to the necessary tax-related and expense-involved information in accordance with the relevant laws and regulations; and building up a smart tax system with deep integration and efficient linkage for the tax enforcement, service, supervision and intelligent application of big data. At the third “One Belt and One Road” Tax Collection and Supervision Cooperation Forum (“’一带一路’税收征管合作论坛” in Chinese) held in September, 2022, Wang Jun, the chief of the STA, announced that the development of the Golden Tax System (“GTS 4”, smart tax) was expected to be fundamentally completed by the end of 2022. The launch of GTS 4 was expected to realize data co-construction, sharing, collaboration and governance among various tax-related parties including the financial authorities, customs, AMR authorities, police departments, payment platforms, etc., and urges the relevant governmental authorities to provide information regarding tax-related parties based on their statutory tax obligations, to realize digital government and the common governance of taxation6. This will help improve the efficiency of tax collection and supervision.
With the launch of GTS 4, the exchange mechanism between the tax authorities and other governmental authorities will make it easier and more transparent for tax authorities to obtain key information in relation to individual equity transfer transactions such as the consideration of the equity transfer and the payment schedule. In this regard, the tax authorities will have a more accurate and timely judgement to determine when “the equity has been transferred.” Therefore, even if the parties of the transaction intend to evade tax obligations by nonperformance of the AMR Registration, or by lowering the transfer price through arrangements such as a “drawer agreement,” they will be exposed to higher tax risks under the supervision system of GTS 4.
5. Our Suggestions
Given that local policies in connection with the Tax Filing Before AMR Registration Regime have a significant impact on individual equity transfer transactions, it is suggested to communicate in advance with the competent tax authority and AMR authority where the Invested Enterprise is located to confirm the local requirements in connection with the Tax Filing Before AMR Registration Regime, and to avoid the occurrence of the actual tax payment made before the AMR Registration if possible. In addition, it is suggested to communicate with the in-charge tax authority to confirm the feasibility of cancellation for tax filing or the feasibility of tax refunds when a transaction is terminated. For any transaction where the Transferor is required to pay the tax before the AMR Registration, it is suggested to take the following transaction arrangements into account based on the actual circumstances of the transaction and the relevant due diligence results:
(1) Making a specific agreement regarding the tax payment schedule, the tax refund procedures and each party’s responsibility if the transaction is terminated;
(2) Setting up a compensation mechanism for breach of contract if the Transferor or the Invested Enterprise fails to cooperate in the completion of the AMR Registration;
(3) Agreeing on the installment payment arrangement of the transfer price, and only settling the payment equivalent to the tax payable expected to be paid before the AMR Registration for the purpose of pushing through the transaction. Where necessary, the payment schedule could be arranged in accordance with the filing schedule for the AMR Registration; and
(4) Making the AMR Registration and the completion of the tax payment closing conditions.
1. The actions under item (4) to item (7) of Article 3 of Bulletin 67 include mandatory equity transfers enforced by the judicial or administrative authorities, the use of equity for external investment or any other non-monetary transactions, the debt and equity swap, and any other actions of equity transfer.
2. According to Article 8 of the Notice of the Supreme People’s Court on Issuing the Minutes of the National Court Work Conference for Civil and Commercial Trials (“《最高人民法院关于印发<全国法院民商事审判工作会议纪要>的通知》” in Chinese), where the parties transfer their equity in a limited liability company among each other, and the transferee claims that it has obtained the equity on the grounds that its company name has been recorded in the register of shareholders, the People’s Court shall uphold such claim, unless the equity transfer shall be effective upon approval as prescribed by laws and administrative regulations. Without a change of registration with the local company registry authorities, the transferee cannot defend against any bona fide third party.
3. According to Guo Shui Han (2005) No. 130, after the completion of the original equity transfer, if the parties of the transaction otherwise execute and perform the equity repurchase agreement, such execution and performance shall be regarded as an independent individual equity transfer. The IIT levied on the original equity transfer is not refundable. As for the meaning of “the equity has been transferred,” the STA interpreted it in Guo Shui Han (2005) No. 130 as “the equity transfer agreement has been performed completely, the change registration of the equity transfer has been completed and the earnings have been realized”.
4. In some individual equity transfer transactions, the parties may agree that the Transferor shall perform the IIT filing obligation by itself. It is common to have such an agreement if the Transferee is an overseas enterprise or individual and cannot withhold the IIT. Please note that in practice, the transaction arrangements of the individual equity transfer may be different from the arrangements exemplified in this article due to different demands of the parties, transaction background, negotiation results, transaction structure and other factors.
5.According to Article 13 of IIT Law, if a taxpayer receives taxable income but the withholding agent fails to withhold tax, the taxpayer shall pay such tax before June 30 of the following year in which the income is received. Where the tax authorities notify the taxpayer a deadline for payment, the taxpayer shall pay the tax in accordance with the deadline.
6.Zhou Kaijun, Smart Tax: Past, Present and Future, China Taxation News (“中国税务报” in Chinese), last reviewed on January 1, 2023, available at http://xiamen.chinatax.gov.cn/xmswcms/mobile/content/S44520.html.