China Oilfield Services Limited (COSL), the world’s sixth biggest supplier of drilling services for the oil and gas industry, delivered an announcement regarding Norwegian tax dispute on December 18th. According to the announcement, its European subsidiary, COSL Drilling Europe AS (CDE), acquired by COSL in 2008, received draft assessments from the Norwegian tax authority owing to a valuation discrepancy of certain assets in drilling platform construction contracts. The Norwegian tax authority urged CDE to pay the back tax with an additional 45% penalty, which may actually amount to 872 million RMB aside from interests.
Companies are inevitably to deal with tax issues during its business operation. And tough issues may arise significantly especially when companies are involved in complex transactions like M&A. It is no doubt that such M&A transaction will be beneficial to the company’s future development. In this case, COSL’s business income derived from drilling services increased by 67.8% and reached 10.1 billion RMB shortly after acquiring CDE in 2009. However, companies shall still be cautious about the potential tax risks when actually involved in such transactions.
1. Never ignore the potential tax risks
Tax risk is a kind of risk that a company shall never ignore under any circumstances. Every year companies troubled with tax issues from various industries come to us for tax advisories. And most companies are under great pressure facing tax penalty which usually consists of back tax, late fees of 0.05% per day and penalties ranging from 0.5 times to 5 times according to Chinese tax law. These can add up to a quite huge figure since violations of tax law are usually discovered several years later.
A best solution to avoid the potential tax risks is to carry out tax due diligences on the acquired companies. Through a detailed tax due diligence, a company can be provided with sufficient information of a certain entity on tax and is able to predict the potential tax risks during transactions by analysis.
2. Settle the possible tax dispute in a substantial way
Only based on solid legal provisions and argued in a substantial way, can a company settle the tax dispute eventually. In CDE’s case, there exists two possible methods to evaluate certain assets and CDE’s tax burden may increase dramatically if tax authority’s method is applied. Trapped in these situations, Hwuason Lawyers suggest companies struggle and defend its legal interests and seek tax professionals’ assistance if necessary.
The tax authority is not easy to cope with anywhere in the world, especially in China. Therefore, companies shall be fully prepared for the possible challenges. Evidence sometimes can be of great importance in successfully dealing with tax disputes. Hence how to find evidence and argue in a substantial way may have significant influence on the outcome of a tax dispute.
For more information or advice on the above tax issues, please feel free to contact us by Tianyong Liu (firstname.lastname@example.org) or Lingyan Hu (email@example.com). Or you can visit our website at www.hwuason.com.
Hwuason Lawyers, a prominent law firm with a focus on taxation, are committed to providing comprehensive tax law services including international tax, tax consulting, tax planning, tax incentives, tax controversy, etc. And we are granted ALB China Law Awards and Chambers China Awards respectively in 2012 for our excellent performance in taxation.
Notice 59 and China’s corporate income tax law stipulate that corporate reorganizations are subject to corporate income tax under either the general or special tax treatment rules, depending on the conditions. To qualify for special tax treatment, transacting parties must file records with their in-charge tax authorities as part of the annual corporate income tax return submission.
(1) Special Tax Treatments under Notice 59
• Corporate restructuring transactions that qualify for special tax treatment can be carried out without being subject to any capital gain tax. Such special tax treatment however only applies to consideration made in shares or stock (i.e. share consideration).
• Parties to the corporate restructuring transactions have the option to elect to adopt the special tax treatment on the relevant corporate restructuring transaction.
(2) Conditions to be satisfied for special tax treatment under Notice 59
2.1 General requirements for special tax treatment (Article 5), including:-
(i) Business purpose: the corporate restructuring should have the reasonable business purpose, and its principal purpose is not for the reduction of, exemption from, or delay in the tax payment;
(ii) Materiality: the assets or equity percentage involved in the acquisition, merger or separation must meet the percentage requirements specified under Notice 59, which generally requires that no less than 75% of equity or assets to be purchased in case of share or asset acquisitions;
(iii) Continuity of business enterprise (COBE): there must be no change in the original substantive operational activities of the reorganized assets within the continuous 12 months following the restructuring;
(iv) Equity ratio: the consideration for the restructuring in the form of share must meet the percentage requirements specified under Notice 59, which generally requires that no less than 85% of the total consideration must be in the form of share for all restructurings, other than the change of legal form or debt reorganization (please note that Notice 59 does allow for no consideration paid in a merger under the common control); and
(v) Continuity of interest (COI): the original shareholders that obtain the share consideration for the restructuring cannot transfer their shares within the continuous 12 months following the restructuring.
2.2 Further requirements for cross-border share and assets acquisitions (Article 7), including:-
(i) Foreign to foreign: a non-resident enterprise (Transferor Company) transfers its equity interest in a PRC resident enterprise to another non-resident enterprise in which the Transferor Company has 100% direct ownership (Transferee Company), so long as (i) it would not result in a change of the withholding income tax liability on the gain arising from the subsequent transfer of the subject equity in the target PRC resident enterprise and (ii) the Transferor Company undertakes in writing to the PRC tax authority in charge that it will not transfer its equity in the Transferee Company within 3 years;
(ii) Foreign to China: a non-resident enterprise transfers its equity interest in a PRC resident enterprise to a resident enterprise in which the non-resident enterprise has 100% direct ownership;
(iii) Offshore investment: A resident enterprise uses its own assets or equity to invest in a non-resident enterprise in which the resident enterprise has 100% direct ownership;
(iv) Other circumstances: as approved by the Ministry of Finance and State Administration of Taxation.
In ten years, each stage of trust industry development concludes some wonderful stories. On the occasion of decennial of Trust Law, China Trust Association held this essay activity for record the great progress of China trust industry. The competition result was released recently. The article “The legal character of real estate investment trust fund and its influence on double taxation” written by Hwuason lawyer Mr. Liutianyong was honored distinguished paper in this competitions.
The inquiries posted by Liaoning local taxation bureau in terms of returning houses after paying business in real estate enterprises and the reply of State Administration of Taxation have caused wide discussion.
Local taxation bureau deemed returning houses issues caused by the developer or sale’s problem such as misleading, false advertising, and poor quality are not subject to tax return policy. SAT replies: two types of returning houses: 1. Signed real estate business contract without property registration; 2. Signed business contract with property registration. For the first type of returning houses, taxation bureau should arrange business tax return. If having obtained the property registration certificate, returning houses is repurchasing. Therefore, in the next sales, business tax can be balanced and imposed.
According to the Law of PRC’s Business Tax, the obligations of business tax start when the taxpayer provide taxable services, transfer intangible assets or sell real estate with business income. Therefore, having business income is the prerequisite of business tax obligations. Decrease in business income will cause decrease in the taxpayers’ tax duty. Tax refund after returning houses is not legal grounded.
In article 3 item 1 of the Ministry of Finance and State Administration of Taxation on Several Business Tax Policy Issues (Caishui  No.16), it is clarified that units and individuals who provide taxable services, intangible assets transfer, and return of real estate sales are allowed to tax return or deduct respective amount in their future business income. Based on this notice, taxation authority should return the business income tax after the returning.
From the perspectives of civil law, returning houses is not a new trading act. In Article 93 of Contract Law, the trading parties can terminate the contract based on mutual agreement. In the termination, the performed session can be compensated with restoration, remedial measures by law. Sellers and buyers of real estate are not banned from further negotiations to renew the original ownership status. Restoration is retractable to the initial contract, and the original legal action is no longer valid. This is significantly with ownership status in repurchasing contract. The later contract does not affect legal actions of any kind.
From the perspectives of property law, contract becomes effective when the parties create, alter, alienate and terminate real estate property contract, except for contracts under other regulations or agreements. Lack of property registration does not affect the validity of the contract. Change of ownership status caused by returning houses, the two parties should manage to restore the property rights to original status. Therefore, new changes in registration can only change the property status but also invalid the original change of registration. In conclusion, ownership registration after returning houses is not deemed as repurchase.
I. The risks in VAT invoice
Shanghai VAT reform brings both opportunities and challenges to enterprises. When enjoying the low tax rate and deduction benefits, enterprises should be aware of new risk factors such as the billing management of VAT invoices.
Compared with general invoices, VAT invoices are more restricted in administrative penalty and incrimination. According to the criminal law and relevant provisions, forging VAT invoices that exceeding 10000 RMB or state tax 5000 RMB shall be filed prosecution and the punishment can be a life sentence. For commercial invoice, it is usually subject to tax evasion which is defined as “less tax payment”. Tax department will file a prosecution when “the amount exceeds 50000RMB and taking a share of 10% of the total taxable amount, and after the official notice from tax department the taxpayer still does respond to the noted tax amount, delaying payment and further penalty.”
II. Invoice Management that affects different pilot enterprises
In consideration of micro prospective on relationship between enterprises and tax administrations, enterprise will confront a more restrict taxation institutions, especially for their accountants. Enterprises with poor invoice management system may get exposed in front of the new positioning. Looking into the macro perspective, substitute commercial invoice with VAT invoice is promising and far-researching in fiscal system. On the other hand, more controversies, forging VAT invoice for one, will come in sight because of the pilot programs. The goal of incriminating fraud in VAT invoice is to protect state interests and tax rights in export tax rebates. It would be legitimate to distinguish VAT invoice crime and general tax evasion in further judicial interpretation.