China Clarifies Verification Standards for IIT after Equity Transfers

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Dec. 31 – China is making an effort to generate clear standards for taxation basis verification with regards to individual income tax (IIT) derived from income gained through equity transfers.

China’s State Administration of Taxation (SAT) issued the “Announcement on Issues Concerning the Verification of the Taxation Basis of Individual Income Tax Payable on the Equity Transfer Income” (guojiashuiwujugonggao [2010] No.27) on December 14. The document announces the standards the tax authorities can use to verify whether or not the equity transfer is completed with a fair trade price, and clarifies that other verification methods can be employed if the original taxation basis is seen as unreasonable. The announcement will take effect from January 14, 2011.

The newly issued document emphasizes that the verification of individual income tax from equity transfers should stand on fair trade prices. If the taxation authorities find the taxation basis goes obviously too low and does not hear a proper reason from the individual, they can conduct the following verification standards mentioned in the announcement.

The authorities can determine that the taxation basis is apparently low without a justifiable reason if the reported equity transfer prices meet any one of the following standards:

  • The declared equity transfer price is lower than the original investment cost, or the combination of the price and taxes paid for the equity
  • The declared equity transfer price is lower than the value of the corresponding net assets
  • The declared equity transfer price is lower than the price at which the equity would be transferred by the same shareholder or any other shareholder of the enterprise under the same or similar circumstances
  • The declared equity transfer price is lower than the price at which the equity of another enterprise in a similar industry would be transferred under the same or similar circumstances
  • Other circumstances as maybe provided by the competent taxation authority

The aforesaid “justifiable reason” an individual can provide includes any of the following ones:

  • The enterprise to which the equity belongs is in the red for more than three (inclusive) consecutive years
  • The investor sells his or her equity at an obviously low price due to any state policy adjustment
  • The equity-holder transfers the equity to his or her spouse, parent, child, grandparent, grandchild, sibling or any supporter that is directly under the obligation of support or maintenance to the equity-holder
  • Other justifiable reasons as may be provided by the competent taxation authority

The taxation authorities can adopt any of the following verification methods when they determine the taxation basis is evidently undervalued without any justifiable reason:

  • Verifying the equity transfer income in light of the value of net assets represented by each share, or the value of net assets corresponding to the equity held by the taxpayer (Where the aggregate of intellectual property, land use right, real estate, mineral exploration right, mining right or equity accounts for over 50 percent of the total assets of the enterprise, the value of net assets of the enterprise shall be assessed by a third-party intermediary)
  • Verifying the equity transfer income in light of the price at which the shareholder or any other shareholder of the same enterprise would transfer the equity in question
  • Verifying the equity transfer income in light of the price at which the equity of another enterprise in a similar industry would be transferred under the same or similar circumstances
  • Where the taxpayer objects to any of the above verification methods adopted by the competent taxation authority, he or she shall provide supporting evidence for the objection; the taxation authority may adopt another reasonable and equitable verification method after the evidence is properly assessed and accepted.

At last, the announcement clarifies the total cost of equity re-transfers will be the sum of the transfer price and all taxes and fees the buyer pays. It also excludes the share transfer of listed companies from the equity transfers referred to in the document.

Dezan Shira & Associates are a licensed tax practice in China and can advise on matters of individual income tax. Please contact the firm at tax@dezshira.com if you have concerns in this area, or download the firm’s brochure here.