Three major amendments to new Company Law in taxation

A revision of the new Company Law was adopted on 29 December 2023 at the 14th National People’s Congress, and will come into effect on 1 July 2024. This revision will certainly have a knock-on effect on the tax treatment of company business and investment, affecting their tax costs.

This article analyses the amendments with a tax impact on companies, providing ideas for the standardisation of company compliance governance and tax management systems.

New provisions on the horizontal corporate personality denial system. Article 23 of the new Company Law introduces the horizontal corporate personality denial system, holding shareholders accountable for the actions of other controlled companies.

In practice, companies and investors that use multiple shell companies for related-party transactions to shift profits and evade taxes – or stop production and operation and restart operations under new entities after declaring bankruptcy and liquidation to evade tax obligations – will be subject to restriction and crackdown.

After implementation of the new Company Law, tax authorities are empowered to hold other controlled companies accountable under specific circumstances where the shareholders exert control.

Therefore, investors should not assume that companies are always independent of each other, and accordingly try to evade taxes through illegal operations between companies under their control. Also, companies involved in the above-mentioned situations should note that if they are deemed “related enterprises” under tax law – and “not in line with the principle of independent transactions”, which reduced taxable income or amount via transactions between related companies – special tax adjustments will apply.

Limited duration capital contribution system reforms. The new Company Law sets a five-year capital contribution period to replace the previous “zero contribution”, requiring companies to complete capital contributions within the specified period.

Failure to meet the deadline may lead companies to resort to methods such as equity transfer or capital reduction to meet legal requirements.

The new five-year deadline for capital contribution has two main impacts on company taxation:

1. Failure to meet the deadline may restrict pre-tax interest deductions for corporate income tax; and
2. Resulting capital reduction, equity transfer, etc., will increase the tax burden.

Expenses eligible for pre-tax deduction by enterprises should be reasonable and categorised as regular expenditures in production and operation. If shareholders of a company have not completed the contribution of registered capital, the interest paid by the company on borrowings (within the amount of unpaid capital) is not a reasonable expense and should not be borne by the company. It should not be deducted when calculating the company’s taxable income.

Additionally, the reduction of registered capital of the company will further affect the amount of pre-tax deductions for the portion of interest expenses on related debt in corporate income tax.

If a company elects to reduce its capital and reserve retained earnings, the shareholders may possibly recover more than the initial cost of their investment pursuant to the corresponding rules for the distribution of earnings stated in the articles of association and shareholders’ agreement.

In this case, corporate shareholders are required to pay corporate income tax on the portion of income derived from the transfer of investment assets, and individual shareholders are required to pay individual income tax on income derived from the capital reduction.

If a company chooses equity transfer, it should consider distinguishing between the individual income tax on the transfer of equity and dividends and bonuses received, ensuring compliance with corresponding withholding obligations.

For the equity transfer price, attention should be paid to the method of recognising the income from equity transfer. Cases where the price is obviously low may face the risk of adjustment by tax authorities.

Capital contribution with equity and creditor’s rights – tax burden on non-monetary contribution. Article 48 adds provisions of capital contribution with equity and creditor’s rights. For tax burden and impact, a company should note that when a company invests with equity and creditor’s rights, it should be subject to fair value assessment. This means adjusting and paying the corporate income tax year by year based on the fair value of equity and creditor’s rights at that time, minus the cost of acquiring equity and creditor’s rights and adding annual investment income from the transfer of equity and creditor’s rights.

The company may also enjoy the policy of deferred taxation within five years. However, if the equity or creditor’s rights are transferred or recovered within five years, the company will no longer enjoy the policy and become subject to a one-time payment of corporate income tax.

For an investee acquiring equity or creditor’s rights as an asset, tax should be calculated based on the current fair value of the acquired equity, or creditor’s rights without the year-to-year adjustment. If an investee acquires equity in other companies by investment and meets the conditions for company reorganisation under the tax law, a special tax treatment policy should apply to avoid overpayment of the corresponding tax.

Investment with equity or creditor’s rights by individual shareholders is a simultaneous occurrence of non-monetary assets transfer and investment. Taxable income should be calculated based on the assessed fair value of the equity or debt transfer income minus the acquisition cost and reasonable taxes and fees.

The individual income tax should be calculated and paid based on “income from transfer of property”. If a taxpayer has difficulties in paying tax in one lump sum, the taxpayer may formulate a reasonable payment plan, report it to the competent tax authorities, and pay the tax in instalments within five years of the taxable date.

Revision of the new Company Law has many effects on companies, investors and shareholders at the tax level, reflecting the adjustment and revision of tax laws and regulations in the future.

Companies should pay more attention to construction of their own financial and tax management systems, improve compliance governance and awareness of paying tax legally, and prevent taxation risks. Otherwise, they will not only be subject to recovery of tax payable, overdue tax payment penalties, fines and other administrative penalties, but may also face more serious risks of criminal liability.

Wu Jiayu and Li Tong are associates at Blossom & Credit Law Firm