On December 29, 2023, the Seventh Meeting of the Standing Committee of the Fourteenth National People's Congress passed the newly amended Company Law ("New Company Law"), which will become effective on July 1, 2024. Notably, Article 47 of the New Law provides that "the contributed capital of all shareholders shall be paid in full by the shareholders within five years from the date of establishment of the company in accordance with the provisions of the articles of association of the company. At the same time, for companies that have been established with a capital contribution period of more than five years, they must be gradually adjusted accordingly."
According to the interpretation of the draft for comment, the company will have a three-year adjustment period starting from July 1, 2024, after which the company will have a maximum period of five years for paid-up capital. That means the new company law will give the companies eight years to meet its shareholders' paid-up obligations. In order for companies to be proactive, the following section will share information about the tax obligations that companies may encounter during the capital reduction process.
According to the Announcement on the Measures for Calculating the Income Associated with Corporate Contributions and Assets Divided by Investing Companies (No. 34 of 2011) issued by the State Administration of Taxation (SAT), when an investing company withdraws or reduces its investment from an investee company, the portion of the assets acquired that is equivalent to the initial investment shall be deemed to be a withdrawal of the investment; the excess portion may be derived from the undistributed profits and/or proceeds from the transfer of the invested assets.
In practice, it may be more complicated than the above, for example, if the shareholders of a company make a proportionate capital reduction for all of its shareholders, the determination of whether a tax liability arises will be based on the portion of assets acquired by the shareholders as compared with the initial investment. If the shareholders of a company carry out a non-equally proportional capital deduction, or if the shareholders carry out a targeted reduction of capital, this will involve the fact of the transaction of equity transfer among shareholders, and then the tax obligation will be further related to the share transfer tax provision. In recent months, our company has also provided numerous similar tax advisory services to our clients, enabling them to not only has fulfilled tax compliance in China but also secure reasonable related Chinese preferential policy while reducing capital or undergoing equity conversion.
Of course, there are also many companies that carry out capital reduction mainly to eliminate the unpaid part of the capital contribution obligation. In this case, the company will not pay any property to the shareholders. Additionally, there is no change in the balance sheet of the company before or after the capital reduction. This type of situation can be categorized as a “formal” capital reduction (meaning there is no substantial change of the company status). It generally does not involve the payment of corporate income tax.
Due to the current Company Law, many companies set a long period of time for shareholders to fulfill their paid-in capital obligation. With the introduction of the new Company Law, the companies will consider not only the corporate income tax issues when capital reduction takes place, but also the impact on the operational aspects after the capital reduction for foreign invested companies, as the capital reduction results in a reduction in the total amount of investment.
At PHC Advisory, we can offer you full support on matters regarding doing business in China, or any other issues your business may face in China. If you would like to know more about policies relevant to your business in China, please contact us at info@phcadvisory.com.
PHC Advisory is a company of DP Group: an international professional services conglomerate of companies with approximately 100 experienced professionals worldwide. We offer comprehensive services in tax, accounting, and financial consulting, including financial supervision, financial audit, internal audit, internal control over financial reporting, and support for audited financial statements and annual audits, ensuring clients' financial transparency and compliance.
The content of this article is provided for informational purposes only, financial advice must be tailored to the specific circumstances on a case-by-case basis, and the contents of this article do not legally bind PHC Advisory with the reader in any way.
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