Editor's Note: In recent years, affected by market fluctuation, enterprise strategic adjustment and other factors, some natural person shareholders of enterprises choose to transfer equity to exit. However, the recognition of the original value of the equity and the accounting of the transfer income in the process of equity transfer are different in different situations, coupled with the different calibre of the tax authorities in different places for the implementation of special circumstances, which leads to deviation in the application of the policy for some shareholders, which leads to the payment of additional tax, late payment and even qualification as tax evasion. This article combines three latest cases to analyse the core points that natural person shareholders need to pay attention to in the process of equity transfer, as well as the direction of defence that can be taken after the occurrence of tax-related disputes.

I. Introduction of Cases: How to Pay Personal Tax on Transfer of Equity Interests under Different Circumstances 

Case 1: Whether the transfer of equity interests to a related party of RMB 0 should be subject to personal tax?

In May 2023, Liu, a natural person shareholder of a coal mining company, transferred his 46% equity interest to a real estate company, a related party, for RMB 0 consideration. Liu claimed that the transaction was an internal equity adjustment between related enterprises under his control, which should not give rise to a tax obligation, and therefore did not file a tax return on the equity transfer. The tax authorities examined and determined that: Liu's coal mining company and the transferee real estate company belonged to the same chain of control, and the $0 transfer price seriously deviated from the fair value of the net assets corresponding to the subject equity. Therefore, the tax authorities approved its equity transfer income in accordance with the law.

Case 2: Should the indirect transfer of equity interest in a coal enterprise be subject to personal tax?

In January 2024, Zhang and six other natural person shareholders planned to transfer their 100% equity interest in an industrial and trading company to an import and export trading company. The industrial and trading company held an 11% equity interest in a coal mining enterprise, and the transaction essentially constituted an indirect transfer of the equity interest in the coal mining enterprise. Zhang and others claimed that they only transferred the equity of the industrial and trade company and did not directly trade the equity of the coal mining enterprise, so they did not generate individual income tax obligations. The tax authorities determined that the ‘long-term equity investment’ account of the coal mining enterprise had been accounted for under the equity method, but the transfer price of the equity interest of the company was significantly lower than its corresponding net assets. Based on the principle of ‘substance over form’, the tax authorities implemented penetration tax treatment for this transaction and approved the equity transfer income of Zhang and others with reference to the asset status of the invested coal mining enterprise.

Case 3: Whether the loan to the investee enterprise can be included in the original value of equity?

In November 2024, when declaring the income from equity transfer, Ren, the legal representative of a company, included the full amount of RMB30 million invested in the company in his personal name at a later stage (which was mainly used to pay for renovation expenses and purchase of equipments) in the cost of equity transfer. The tax authorities found that the relevant expenditures were essentially the company's daily operating costs, not Ren's capital investment in the company. Mr Ren claimed that the payment was his investment in the company. The tax authorities pointed out that the note information of the transfer certificate of Renmou was clearly marked as ‘loan’ rather than ‘investment’, and the company did not have any record of capital increase and relevant legal documents. In the end, Ren declared and paid personal tax according to the original value of the actual shareholding.

Case Summary 

The above three typical cases have revealed three major tax-related risk points that natural person shareholders need to pay attention to in equity transfers: judgement of the fairness of the transaction price, the method of revenue recognition of the transfer, and the basis of accounting for the original value of the equity, which will be analysed in the following paragraphs.

II. The four major points that should be concerned about the transfer of shareholdings by natural person shareholders 

(i) How to pay the tax on the transfer of shareholdings by natural persons?

In terms of personal tax, when a natural person shareholder transfers unlisted equity or listed restricted shares, his income shall be subject to the tax item of ‘Income from Transfer of Property’, and he shall declare and pay personal income tax at a tax rate of 20%. When calculating the taxable income, the initial investment cost (i.e., the actual amount of the original capital contribution or investment) and related taxes should be deducted from the income from the transfer of equity. In the event of multiple shareholdings at different prices, the original value of the shareholding shall be calculated by the weighted average method when transferring part of the shareholding. In terms of value-added tax (‘VAT’) treatment, the transfer of listed company shares by an individual is usually exempt from VAT; while the transfer of non-listed company equity by an individual is not a VAT taxable act and is outside the scope of taxation, and therefore not subject to VAT.

(ii) Tax risk exists in the transfer of equity interests at par or at a low price or even at $0. 

According to the Measures for the Administration of Individual Income Tax on Income from Equity Transfers (for Trial Implementation) (State Administration of Taxation Announcement No. 67 of 2014, hereinafter referred to as “'Announcement No. 67”') and the relevant regulations of the Individual Income Tax Law, the transfer of equity interests by shareholders shall be in accordance with the principle of arm's-length transactions. principle. In practice, equity transfers that deviate from the market price, such as transfers at par or at a low price or even at $0, may give rise to tax risks. When the price of equity transfer is deemed to be ‘obviously low’ by the tax authorities, the tax authorities have the right to approve it in a reasonable manner. 67th Circular clearly lists the following six situations that constitute ‘obviously low’:

(i) The declared income from equity transfer is lower than the share of net assets corresponding to the equity. Among them, if the investee enterprise owns assets such as land use rights, houses, unsold properties of real estate enterprises, intellectual property rights, prospecting rights, mining rights, equity, etc., the declared income from equity transfer is lower than the share of fair value of the corresponding net assets of the equity.

(ii) The declared income from the transfer of equity interests is lower than the initial investment cost or lower than the price paid for the acquisition of such equity interests and related taxes.

(iii) The declared income from the transfer of equity interests is lower than the income from the transfer of equity interests of the same shareholder or other shareholders of the same enterprise under the same or similar conditions.

(iv) The declared income from equity transfer is lower than the income from equity transfer of enterprises in the same industry under the same or similar conditions.

(v) Gratuitous alienation of equity or shares that is not reasonable.

(vi) Other circumstances determined by the competent tax authorities.

Cases I and II in Part I are in line with the situations in (iii) and (i) above, respectively, and are therefore required by the tax authorities to be authorised at a reasonable price.

In particular, in the case of transfer from a prominent shareholder to a hidden shareholder, the relevant tax laws and regulations have not clearly stipulated the tax-related matters in relation to the restoration of nominee shares, and there is a difference in the handling of such matters in different places. Some places consider that there is no taxable matter for the reversion of nominee shares to the nominee shareholder and no income tax is payable; however, some places consider that it is unreasonable for the nominee shareholder to transfer the equity interest to the hidden shareholder at $0 or a low price, and that the income from the transfer should be authorised and taxed. In actual operation, the competent tax authorities should be consulted on relevant matters to fully understand the local implementation calibre in order to reduce tax risks.

(III) Different ways to obtain equity corresponding to the original value of the calculation rules are different 

In practice, the equity transferor to obtain equity in a variety of ways, different ways to obtain the original value of the equity corresponding to different rules for the calculation of the value of the equity: 1. cash capital contribution: the original value of the equity = the actual payment of the price + reasonable taxes directly related to the acquisition of the equity; 2. non-monetary assets capital contribution: the original value of the equity = the investment of the non-monetary assets recognised or approved price + the acquisition of equity directly related to the tax authority Non-monetary assets contribution: the original value of equity = the price of non-monetary assets approved by the tax authorities at the time of investment + reasonable tax directly related to the acquisition of equity; 3. Gratuitous alienation: if in line with the circumstances stipulated in Article 13(2) of Announcement No. 67, the original value of equity = reasonable tax incurred in acquiring the equity + original value of equity of the original holder; 4. Conversion of capital stock (capital surplus, surplus, and undistributed profits): if the individual shareholders have already paid the individual income tax on the transferred portion in accordance with the law, then the original value of the equity for the new conversion = the amount of the conversion + the relevant amount of the relevant taxes. The original value of the newly converted equity = the amount of conversion + relevant taxes; 5. Other cases: the competent tax authorities follow the principle of avoiding double taxation to reasonably confirm the original value of the equity.

In addition, we need to pay attention to the special characteristics of the transfer of unpaid equity - the original value of such transfers of equity, there are differences in practice: one view, the unpaid portion of the original value of equity shall not be counted as part of the original value of the transfer of the original value of the transfer of the original value of the transfer of the 0 yuan; another view, should follow the ‘agreed priority’ principle, based on the principle of ‘priority’ between the shareholders, the original value of equity = transfer amount + related taxes. Another view is that the principle of ‘agreement first’ should be followed, based on the agreement between the shareholders to determine the value of equity. For example, if the agreement that unpaid equity is still entitled to profit distribution and other property rights, its value should not be 0 yuan. Regardless of the viewpoint, if the declared transfer income is significantly low without reasonable explanation, the tax authorities have the right to approve it in a reasonable way.

(IV) Regardless of whether the transferee pays the price, the transferor shall declare tax 

According to the provisions of Article 67, if the natural person shareholder has one of the following circumstances, he/she shall declare tax to the competent tax authority within 15 days of the following month according to the law: (i) the transferee has already paid the price for the transfer of the equity interest or partially paid the price for the transfer of the equity interest; (ii) the equity interest transfer agreement has already been signed into effect; (iii) the transferee has already practically fulfilled the responsibilities of the shareholders or enjoyed the shareholders' rights and interests; (iv) the judgement, registration or announcement of the relevant state authorities has come into effect; (v) the acts described in Items 4 to 7 of Article 3 of these Measures have been completed; and (vi) other circumstances determined by the tax authorities that there is evidence to show that the transfer of equity interests has taken place. In particular, even if the payment is received in instalments, the transfer is still regarded as a one-off transaction, and the natural person shareholder is required to file a tax return by the 15th of the following month. It should be reminded that if an individual shareholder transfers all or part of its equity interest acquired through investment in non-monetary assets and receives cash income and is still in the period of tax payment by instalments, the cash income shall be used to pay the outstanding tax with priority. In addition, the investee enterprise shall report to the competent tax authorities the changes in the taxpayer's equity interest during the period when the taxpayer invests in the enterprise with non-monetary assets to obtain equity interest and during the period of tax instalment payment within 15 days after the occurrence of the relevant matters, respectively, and shall assist the tax authorities in the performance of their official duties.

Extended Discussion: Three Major Defence Strategies for Tax Disputes on Equity Transfer by Natural Persons 

(I) Claiming that the low price of equity transfer has justifiable reasons 

According to Article 13 of Circular No. 67, the obviously low income from equity transfer that meets one of the following conditions can be regarded as justifiable reasons, and the tax authorities may not make adjustments: 1. Policy impact: effective documents can be produced to prove that the production and operation of the invested enterprise has been significantly affected by the adjustment of the state policy, and then it is necessary to transfer the equity at a low price; 2. Transfer of close relatives: transfer of equity to spouse, parents, children, grandparents, grandchildren, brothers and sisters, as well as dependents or supporters who bear direct support or alimony obligations to the transferor, and provide legally effective proof of identity; 3. Transfer of internal employees: according to relevant laws, government documents or the articles of association of the company, it is clearly stipulated that the transfer of equity is not to be adjusted. Internal Employee Transfer: Based on relevant laws, government documents or the company's articles of association, and with sufficient information to prove that the transfer price is reasonable and true, the internal transfer of equity interests held by the employees of the enterprise (usually restricted from external transfer); 4. Other Reasonable Circumstances: The parties to the transfer of equity interests are able to provide effective evidence to prove the reasonableness of the other circumstances. Therefore, if the above circumstances exist, the natural person shareholder should submit complete supporting materials in time for tax verification, otherwise the tax authorities have the right to approve the transfer of income in accordance with the law.

(II) Qualitative tax evasion should consider the subjective elements of the relative 

In practice, if a natural person is qualified as tax evasion, the tax authority generally determines that the natural person has made a false declaration or has refused to make a declaration after being notified by the tax authority to make a declaration. For the former, the Tax Collection and Administration Law does not specify the subjective fault of the party as one of the constituent elements of tax evasion, but ‘false’ has included the subjective state of the party, and the relevant approvals and a large number of judicial cases have also proved that one of the constituent elements of tax evasion is the subjective fault of the party. Therefore, when the tax authorities use ‘false declaration’ to qualify the natural person as tax evasion, the subjective state of the natural person should be taken into account. If the natural person does not have the intention to make false declaration, for example, if the natural person only makes a mistake in declaration due to the deviation in the understanding of the policy, then the natural person should not be qualified as tax evasion. For the latter, if the natural person only fails to make a declaration, resulting in non-payment or underpayment of tax, the second paragraph of Article 64 of the Law on Administration of Tax Collection shall be applied; if the natural person still refuses to make a declaration after being notified by the tax authorities, there is a risk of tax evasion. Therefore, the tax authorities shall distinguish between specific cases and deal with those that do not constitute tax evasion in accordance with Paragraph 2 of Article 64.

(III) Taxes exceeding the recovery period should not be recovered from natural persons 

According to the Reply of the State Administration of Taxation on the Issue of the Recovery Period of Undeclared Taxes (Guo Shui Han [2009] No.326): The situation that the taxpayer fails to make a tax declaration, resulting in the non-payment or underpayment of tax due as stipulated in Paragraph 2 of Article 64 of the Law on Tax Administration does not belong to the cases of tax evasion, resistance to tax and tax fraud, and the recovery period is generally three years in accordance with the spirit of the provisions of Article 52 of the Law on Tax Administration. The recovery period is generally three years, and can be extended to five years under special circumstances. From this, it can be concluded that when a natural person constitutes the situation in paragraph 2 of Article 64 but does not have the behaviour of tax evasion, resistance, fraud or tax arrears, the tax authorities will be restricted by the maximum recovery period of five years. In our opinion, if a natural person is found to have matters that should be declared but have not been declared for more than five years, but does not have the situation of stealing, resisting, cheating or tax arrears, even if the result of non-payment or underpayment of tax is produced, the tax authorities should not recover the tax from the natural person.

IV. Summary 

Generally speaking, when a natural person shareholder transfers the equity of a non-listed enterprise, the tax item of ‘Income from Property Transfer’ applies, and he should declare and pay the personal income tax at the rate of 20%. When declaring, natural person shareholders should confirm the income and original value in accordance with the principle of arm's length transactions to avoid the tax risks arising from the transfer of flat price or low price, and should fully understand the implementation calibre of the competent tax authorities for the transfer of unpaid equity and the transfer of equity from the explicit shareholders to the implicit shareholders and other relevant policies that are not yet clear to avoid the risk of underpayment or non-payment of back tax, late payment penalty or even being qualified as tax evasion. In addition, even if the share transfer is subject to the risk of tax evasion In addition, even if faced with tax inspection due to the transfer of equity, natural person shareholders should actively respond to the situation, in addition to submitting documents to prove that the calculation of income from the transfer of equity is reasonable and lawful, but also around the subjective elements, the recovery period and other aspects of the communication with the tax authorities, to safeguard their own legitimate rights and interests.