Prevention and control of tax risks in equity M&A

Tax concerns over an equity merger and acquisition may have a profound impact on key issues like the transaction plan and related costs. Ignoring the tax risks associated with the deal and not taking proper legal precautions to prevent and control such issues may result in these being passed to the acquirer, thereby causing significant loss. To ensure safety and efficiency of an equity M&A, it is important that the acquirer carries out thorough tax due diligence on the target to be well informed about the target’s related risks and take appropriate legal measures either to prevent or to control them.

TAX RISKS

Failure of target to pay taxes duly in ordinary course of business. Since the transition from business tax to value added tax, implemented across China in May 2016, there are five categories made up of 17 types of taxes in the country. Of these, VAT, corporate income tax and personal income tax are the most closely related to daily operations of enterprises. According to legislation, all enterprises have to pay taxes honestly. There are, however, enterprises that evade taxes through malpractices, including holding accounts in various names, concealing income, presenting imaginary costs or expenses, fraudulent profit-and-loss accounting treatments, or submitting false tax returns. While increasing liabilities on its balance sheet, these malpractices may expose the target to risks of being ordered to pay a tax-make-whole amount, late fees or a fine or being subjected to other administrative punishments.

Lying about nature of enterprise to be eligible for tax incentives. Both the central and local governments have introduced many tax incentive policies to encourage and support the development of small and medium-sized enterprises and high-tech companies. For example, eligible high-technology enterprises are entitled to a reduced corporate income tax rate of 15%, which is generally applied at 25%. Besides, between 1 January 2017 and 31 December 2019, small low-profit enterprises, with annual taxable incomes of less than RMB500,000, are eligible to assess income tax, at a rate of 20%, on only 50% of their actual taxable incomes. To receive tax rebates or deductions, some fraudulently claim to be micro and small or high-tech enterprises through some illegal means to qualify for the relevant tax incentives. These acts carry the risk of the refunded or deducted tax amounts being confiscated or the enterprises involved being subject to relevant administrative punishment.

Yang Bin is a partner and Qiu Yafei is an associate at East & Concord Partners