The merger of a company shall be divided into two forms: consolidation by merger and merger by incorporation. Consolidation by merger shall refer to the circumstance where one company absorbs another or others and remains in existence while the absorbed company/companies dissolve. Merger by incorporation shall refer to the circumstance where two or more companies merge into one new company and the original companies are dissolved.
The merger of companies shall mainly be required to go through four steps. First of all, according to the Company Law of the People’s Republic of China (Revised in 2018), the merger of a company must be formulated by the Board of Directors, and the merger plan must be approved by the shareholders representing more than two-thirds of the voting rights before it takes effect.
Secondly, after reaching an agreement on the merger, parties to the merger shall conclude an agreement with each other and formulate balance sheets and schedules of assets to stipulate the form, conditions, payment methods and other rights and obligations of both parties.
Thirdly, notifying creditors, with the aim of protecting creditors interests. The parties to a merger shall, within ten days of making the resolution on a merger, notify their respective creditors and, within 30 days, make a public announcement in a newspaper to inform the creditors of the company, so that they can raise objections to the merger within a reasonable time, and to notify the decision of the merger to shareholders who did not attend the shareholder meeting of the company.
Generally speaking, all known creditors should be notified by formal notice, and only those unknown or unreachable may be notified by announcement. Since the claims and debts of the parties to the merger shall be succeeded by the company that survive the merger, or by the newly-established company in case of a consolidation, creditors may, within 30 days of receiving the said notice or, in the event that the creditor does not receive such a notice, within 45 days as of the issuance of the said public announcement, require the company to repay its debts in full or to provide a corresponding guaranty. If the company fails to pay off its debts and provide guarantees, the company may not merge.
Finally, the company should go through the relevant corresponding procedures in due course, for example: the dissolved company should go through registration cancellation procedures; the surviving company shall go through the procedures of change registration; the newly established company shall go through the registration of establishment. It is important to note that he merger of the companies can only be legally recognized after registration.
For industries not permitted to be wholly operated by foreign investors, a merger shall not result in foreign investors’ holding the enterprise’s entire equity. For industries which require a Chinese party to have the holdings or have relative holdings, the Chinese party shall maintain its holdings or relative holdings in the enterprise after the enterprise in such industry merges. For industries forbidden to be operated by foreign investors, the foreign investors shall not merge any enterprise within such industry. The business scope of the original invested enterprise of the merged or acquired domestic enterprise shall satisfy the requirements of the policy concerning the foreign-invested industry.
Income Tax Treatment of a Merger
During a merger, the Transferring Company transfers its assets and liabilities to another existing or newly established enterprise (hereinafter referred to as the Receiving Company), in exchange for the equity or other property of the Receiving Company.
Normally the Transferring Company should be deemed to transfer and dispose of all assets at fair value, calculate the income from the transfer of assets, and pay income tax.
The accumulated losses of the Transferring Company shall not be carried forward to the Receiving Company for income tax deduction against future profit.
The Receiving Company accepts the relevant assets of the Transferring Company, and the cost can be determined according to the value confirmed by the assessment during tax calculation.
The shareholders of the Transferring Company obtaining the equity of the Receiving Company shall be treated as liquidation distribution.
If the Receiving Company and the Transferring Company repurchase their company’s shares from shareholders for the purpose of a merger, the difference between the repurchase price and the issue price shall be regarded as the gain or loss from the transfer of shares.
- Special Tax Treatment
In the purchase price paid by the Receiving Company to the Transferring Company or its shareholders, the cash, negotiable securities and other assets other than the equity of the Receiving Company, if they are no more than 20% of the par value of the paid equity, upon review and confirmation by the tax authorities, the parties may be eligible for special tax treatment for the equity consideration in the transaction (subject to certain conditions, i.e. the restructuring must have a clear commercial purpose and the exemption or delay of tax payments shall not be its primary purpose), in accordance with the following provisions:
- The Transferring Company does not recognize the transfer gain or loss of all assets and is not subject to income tax.
The accumulated losses of the Transferring Company could be carried forward to the Receiving Company for income tax deduction against future profit.
- The shareholders of the Transferring Company exchange their equities for the equities of the Receiving Company, which shall not be regarded as the sale and purchase of shares. The cost of exchanging new shares for shareholders of the Transferring Company shall be determined on the basis of the cost of the original shares held by them.
However, all non-equity payments obtained by the shareholders of the Transferring Company that have not exchanged new shares of the Receiving Company shall be regarded as the transfer gain of the original shares held by them.
- The taxable cost of all the assets of the Transferring Company accepted by the Receiving Company shall be determined on the basis of the original book value of the Transferring Company.
- Transactions at Arm’s Length
The merger of affiliated enterprises through the exchange of shares shall comply with the principle of an arm’s length transaction between independent enterprises. Otherwise, the tax authorities have the right to make adjustments.
If the assets and liabilities of the Transferring Company are basically equal, and the net assets are almost zero, and the Receiving Company realizes the absorption and merger by taking over all the liabilities of the Transferring Company, it is not deemed that the Transferring Company transfers or disposes all assets at fair value, as no gain is recognized from the transfer of assets. The purchased cost of all the assets of the Transferring Company by the Receiving Company shall be determined on the basis of the original net book value of the Transferring Company. The shareholders of the Transferring Company are deemed to have given up their original shares for free.
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