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Optimising asset structures for maximum capital effect is crucial to investment and financing strategy in China. Investment merger and ownership restructuring may reduce circulation links between affiliated enterprises or between upstream and downstream enterprises, allowing for lawful and reasonable circumnavigation of both income and commodity turnover taxes.

In practice, companies can plan their tax strategy effectiveness regarding China investment activities in three distinct phases: during investment entry, during the holding phase, and during the investment withdrawal phase. In terms of tax strategy, timing is everything.
Focusing on Investment Size and Progress

By making corporate borders more fluid, investment mergers may transform inter-company transactions into internal deals. As neither the transfer of commodity ownership nor verification of labour transaction applies to internal arrangements, such deals do not legally constitute circulation, and thus avoid commodity turnover tax.

Upon completion, investor and investee become related parties, and transfer pricing may serve as a tax moderator between related entities. However, many countries have adopted anti-tax avoidance measures targeting transfer pricing by related parties, which may lead to extra tax management costs. Chinese tax authorities require companies to prepare and keep contemporaneous related-party transaction documents for at least ten years for purposes of official scrutiny.

Choosing Forms of Investment in Mergers
Investment and funding mergers are usually divided into four categories:

  1. asset purchasing with currency,
  2. equity purchasing with currency,
  3. exchanging equity for assets and
  4. exchanging equity for equity.

For shareholders of the target company, it is usually unnecessary to verify the capital gains from an equity-for-equity merger exchange. However, the last two years have seen Chinese tax authorities increasingly concerned about tax payment on equity transfer gains, especially when overseas shareholders enact domestic equity transfers.

Focusing on Financial Leverage
Interest cost incurred by debts is income tax-deductible, since such expenditures may be deducted from profits of the same term. Therefore, the merger company may opt for appropriate debt financing forms, with the strength of the company’s financial leverage taken into consideration to collect the funds necessary for the merger. This increases the overall debt, as well as the overall tax-deductible amount.

If the investment and financing plan involves foreign debts, consider factors such as operability risk under China’s foreign exchange control, exchange rate risk and differences in inflation before finalising details.  

Summary
Tax effectiveness planning is an organic component of investment and finance strategy and is intrinsically linked with the company’s financial goals. Companies should give comprehensive consideration to external taxation laws and regulations as well as international financial status, while balancing their tax burden reduction and tax risk control.  

THIS COLUMN IS SPONSORED BY CPL CONSULTING
CPL Consulting provided auditing services for CBBC China for the financial year 2010-2011. For more information, contact Queena Ye at Queena.ye@cplchina.biz, +86 (10) 6591 6000 602, www.cplchina.biz

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