The third review draft of the revised Company Law was submitted to the Standing Committee of the 14th National People's Congress for deliberation on August 28, 2023, in which it was proposed to "improve the registration system for the subscription of registered capital, and stipulate that the amount of capital contributed by the shareholders of limited liability companies shall be paid in full within five years from the date of the establishment of the company." At the same time, Article 53 and Article 88, Paragraph 1 of the Second Review Draft of the Company Law provide for the accelerated expiration of the time limit for shareholders' capital contribution triggered by the maturity of the debt, as well as the original shareholders' supplemental liability for the unpaid portion of the transferred equity, increasing shareholders' liability for the unpaid portion of the capital contribution, which shows the trend of the Company Law to improve the shareholders' responsibility for the capital contribution, and to safeguard the interests of the creditors. Once the above provisions come into effect, for shareholders who wish to continue to operate the company but are short of capital flow, reducing the registered capital may be the only way for the enterprise to survive. However, most enterprises still have doubts about whether the process of capital reduction involves the declaration of enterprise income tax and individual income tax, and they do not understand the differences in tax laws and financial rules related to capital reduction, and they lack the awareness of tax declaration of "repayment in kind", which leads to a lot of tax problems in the process of capital reduction by shareholders. This article attempts to analyze the tax types involved in the process of capital reduction and divestment, and discusses the risks that may exist in the application of the tax law.

I. Reduction of capital, divestment violation of procedural provisions, the company and shareholders shall bear legal liability

(I) Capital reduction and divestment shall fulfill the procedure of capital reduction.

Capital reduction generally refers to the company due to excess capital, serious losses or shareholders' personal reasons, according to the actual situation of the business, the act of reducing the registered capital according to law. Withdrawal of capital generally refers to a shareholder or part of the shareholders to withdraw their investment in the enterprise, in essence, belongs to a kind of capital reduction behavior.

Since the act of reduction of registered capital by shareholders will reduce or exempt the capital contribution obligations subscribed but not yet fulfilled by the shareholders, which will affect the interests of the creditors, the Company Law and the relevant regulations stipulate strict procedural requirements for the reduction of the company's capital. For example, Article 177 of the Company Law provides: "When a company needs to reduce its registered capital, it must prepare a balance sheet and a list of its property. The company shall notify the creditors within ten days from the date of the resolution to reduce the registered capital, and announce it in the newspaper within thirty days. Within thirty days from the date of receipt of the notice, or within forty-five days from the date of the announcement if the notice has not been received, the creditors shall have the right to demand that the company liquidate its debts or provide corresponding guarantees." That is to say, the company must comply with the requirement of satisfying the announcement and notice before going through the industrial and commercial procedures of capital reduction.

The procedure for capital reduction has been revised in the Companies Law (Draft), and as the draft has not yet been formally implemented, this article will not go into too much detail, and the provisions of the current Companies Law will prevail. 

(II) Case analysis: failure to comply with the required procedures, the shareholders will be liable for the debt to the extent of the reduction of the capital supplementary liability

Brief description of the case:

Company B registered capital of 25 million yuan, Ding contributed 20 million yuan, the actual capital contribution of 4 million yuan, a K. Contributed 5 million yuan, the actual capital contribution of 1 million yuan. February 1, 2010, company A and company B signed a "sales contract", agreed to pay 1 million yuan within three working days after the contract was signed by the company B. After the expiration of the company B was unable to repay, so in 2012 signed the Repayment Plan", to October 2013 to pay off. 2010 November 19, Company B made a decision to reduce the shareholders' capital, the registered capital of 25 million yuan reduced to 5 million yuan, Ding, a K unchanged shareholding ratio. Company B did not notify the plaintiff after the resolution to reduce capital Company A. January 20, 2011, Company B published a capital reduction announcement in the Shanghai Commercial Daily, Company B and Ding Mou, a K. Commitment to outstanding debts and secured claims, the company continues to be responsible for the liquidation, and all shareholders in the scope of the law to provide the appropriate security, after the Company B for the registration of industrial and commercial changes. After the expiration of the plan is still owed 2.36 million yuan of principal, the company filed a lawsuit to the people's court, that company B of the registered capital reduction, but did not notify the plaintiff in accordance with the provisions of the company law, and only in the local newspaper for the announcement, the reduction of capital behavior is flawed, the interests of the company's creditors to the interests of the company infringement, and demanded that Ding and K. assumed joint and several liabilities.

Court view:

The court of first instance held that on November 19, 2010, company B carried out a capital reduction of the registered capital, but did not notify the plaintiff in accordance with the provisions of the company law, and only in the local newspaper for the announcement, the capital reduction behavior is flawed, the interests of the creditors of company A formed infringement. Judgment of a kun, dingmou on company b can't pay part of the above amount, within the scope of its capital reduction to bear the supplementary liability.

The court of second instance that the registered capital of the company is the shareholders of the company to assume limited liability basis, but also the company's counterparty to judge the company's property liability ability of the important basis, the company shareholders have the responsibility of good faith to protect the company's creditors to ensure the security of the transaction, the company's reduction of its creditors have to be based on the creditor's request for liquidation or the obligation to provide a guarantee. In this case, if company b in the capital reduction in accordance with the law to notify its creditor company a, company a has the right to demand company b to settle the debt or provide the corresponding security, company a as a creditor's right is not due to the company b has been paid in the first period of the capital contribution, the actual is for the period of the capital contribution of the amount of the capital has not expired to be restricted. Therefore, the judgment rejected the appeal and upheld the original judgment.

II.Capital reduction by corporate shareholders is subject to tax treatment in accordance with the rules for enterprise liquidation

(I) Capital reduction by legal person shareholders is subject to calculation of transfer income for the determination of enterprise income tax.

The main basis for calculating income tax for capital reduction by shareholders of legal persons in China is the provisions of Article 5 of the Announcement of the State Administration of Taxation on Certain Issues Concerning Enterprise Income Tax (Announcement No. 34 of 2011 of the State Administration of Taxation, hereinafter referred to as "Announcement No. 34"). Article 5 provides that "[w]hen an investing enterprise withdraws or reduces its investment from an investee enterprise, the portion of assets acquired by the investing enterprise equivalent to its initial capital contribution shall be recognized as investment recovery; the portion equivalent to the accumulated undistributed profits and accumulated surplus reserves of the investee enterprise calculated in proportion to the reduction of paid-in capital shall be recognized as dividend income; and the remaining portion of the assets acquired shall be recognized as income from the transfer of investment assets. Operating losses incurred by the invested enterprise shall be carried forward by the invested enterprise to make up for them in accordance with the regulations; the investing enterprise shall not adjust to reduce the cost of its investment, nor shall it recognize them as investment losses."

Circular 34 stipulates that the distribution obtained from capital reduction is divided into three parts:

First, the part equivalent to the initial capital contribution shall be recognized as investment recovery;

Two, the portion equal to the investee's accumulated undistributed profits and accumulated surplus reserves in proportion to the reduction of paid-in capital shall be recognized as dividend income;

Third, the remaining portion shall be recognized as income from the transfer of invested assets, i.e., gains from the transfer of property (equity).

(II) Incorrect application of rules on income from transfer of invested assets and rising tax risk of capital reduction

According to Article 26 of the Enterprise Income Tax Law, "Dividends, dividends and other equity investment income obtained by an enterprise between qualified resident enterprises ...... is tax-exempt income." When calculating dividend income, the value of the initial capital contribution portion is relatively fixed, so the legal shareholders would like to divide more of the capital reduction distribution into dividend income, so when carrying out the recognition of dividend income, some enterprises believe that the dividend income should be calculated by the proportion of their reduced capital contribution to the registered capital. However, Circular 34 clearly stipulates that "the portion of the accumulated undistributed profits and accumulated surplus reserves of the investee enterprise equivalent to the proportion of the reduced paid-in capital shall be recognized as dividend income", and the tax law determines that the cumulative undistributed profits and cumulative surplus reserves of the enterprise's portion that is not actually paid in does not constitute dividend income from the point of view of shareholders' rights and interests protection, so as to protect the paid-in shareholders. The tax law recognizes that the accumulated undistributed profits and accumulated surplus reserves of the part not actually paid by the enterprise do not constitute dividend income, so as to protect the rights and interests of paid-in shareholders.

According to the provisions of Circular 34, the formula for calculating the income from transfer of investment by a legal person shareholder is as follows: Income from transfer of investment assets is calculated as follows: Income from transfer of investment assets = Amount of distributions from capital reduction or divestment - (Accumulated undistributed profits + Accumulated surplus reserves) x (Amount of reduced paid-in capital ÷ Total amount of paid-in capital) - Amount of initial investment x (Amount of reduced paid-in capital ÷ Total amount of paid-in capital)

As an example, Company A and other investors jointly establish Company B with a paid-in registered capital of 10 million yuan, of which 5 million yuan is paid-in. Company A decides to reduce its capital to 5 million yuan of paid-in capital due to business considerations, and obtains a distribution of 2 million yuan at the time of the capital reduction. In calculating the dividend income portion, since Company A did not reduce its paid-in capital, it received $0 for the dividend income portion.

III. Capital reduction by individual shareholders should be treated as transfer of equity for tax purposes

(I) Capital reduction by individuals shall be treated as transfer of equity interest in the invested enterprise.

The tax treatment of capital reduction by individual shareholders differs significantly from that of legal person shareholders, and the capital reduction by individual shareholders is mainly based on the Measures for the Administration of Individual Income Tax on Income from Transfer of Equity Interests (for Trial Implementation) (Announcement No. 67 of 2014 of the State Administration of Taxation (hereinafter referred to as "Announcement No. 67")) and the Announcement on the Issues of Personal Income Tax on Recovered Amounts by Individuals on the Termination of Their Investments and Operations (Announcement of the State Administration of Taxation [2011]). Announcement of the State Administration of Taxation on the Collection of Individual Income Tax on Recoveries by Individuals on Termination of Investment Operation (SAT Announcement No. 41 of 2011, hereinafter referred to as "Announcement No. 41").

Article 1 of Announcement No. 41 stipulates that: "Income from equity transfer, liquidated damages, compensation, indemnity and money recovered under other names obtained by an individual from an invested enterprise or a cooperative project, other investors of the invested enterprise and the operating partner of the cooperative project upon termination of the investment, joint venture, business cooperation, etc., for various reasons, shall be taxable income subject to individual income tax and shall be taxed in accordance with the provisions applicable to the item of income from transfer of property. be calculated and paid individual income tax in accordance with the provisions applicable to the items of income from transfer of property." That is to say, the income from capital reduction by individual shareholders shall be calculated and paid as individual income tax in accordance with the items of income from transfer of property.67 Circular 67, on the basis of the provisions of Circular 41, clarifies the relevant provisions on the calculation of individual tax in the case of capital reduction by individual shareholders.

(II) Two-step transfer of income: first recognize the income from the transfer of equity and the original value of the equity, and then specify the investment income.

Article 4 of Article 67 stipulates that "Individuals transferring equity interests shall pay individual income tax on the basis of the income from the transfer of equity interests, less the original value of the equity interests and reasonable expenses. Reasonable expenses refer to the taxes and fees paid in accordance with the regulations at the time of equity transfer." 1.

(1) Determination of income from equity transfer

Article 7 of Announcement No. 67 stipulates that "Income from equity transfer refers to the cash, in-kind, marketable securities and other forms of economic benefits obtained by the transferor as a result of the equity transfer." Article 8 stipulates, "All kinds of payments obtained by the transferor in connection with the equity transfer, including liquidated damages, compensation, and payments, assets, and rights and interests of other names, shall be included in the equity transfer income." Article 9 stipulates, "Subsequent income obtained by a taxpayer in accordance with a contractual agreement and after the fulfillment of the agreed conditions shall be treated as equity transfer income." The above three provisions clarify the specific items that should be included in the calculation of equity transfer income for individual income tax purposes.

(2) Determination of original value of equity

Article 15 of Circular 67 stipulates: "The original value of equity transferred by an individual shall be recognized in accordance with the following methods: (1) the original value of equity acquired by way of cash contribution shall be recognized in accordance with the sum of the price actually paid and the reasonable taxes directly related to the acquisition of the equity; (2) the original value of equity acquired by way of non-monetary assets shall be determined in accordance with the price of non-monetary assets at the time of the investment of equity and the price of non-monetary assets directly related to the acquisition of the equity, which is approved by the tax authorities or by the tax authorities. (b) Equity interests acquired by way of contribution of non-monetary assets shall be recognized at the sum of the price of the non-monetary assets at the time of investment or approval by the tax authorities and the reasonable tax directly related to the acquisition of the equity interests; (c) Equity interests acquired by way of gratuitous transfer shall be recognized at the sum of the reasonable tax incurred in the acquisition of the equity interests and the original equity interests of the original holders under the circumstances set out in Article 13(2) of these Measures; (d) If the investee enterprise has transferred the equity interests to the share capital by way of capital surplus, surplus, or unappropriated profits, and individual shareholders have paid individual income tax in accordance with the law, the equity interests shall be recognized at the sum of the reasonable tax incurred in the acquisition of equity interests and the original equity interests of the original holders (d) where the investee enterprise has transferred its share capital by way of capital surplus or undistributed profit, and the individual shareholder has already paid individual income tax in accordance with the law, the original value of the shareholding of the newly transferred share capital shall be recognized as the sum of the transferred amount and the relevant taxes and fees; (e) in addition to the above, the competent tax authorities shall reasonably recognize the original value of the shareholding in accordance with the principle of avoiding the repeated imposition of individual income tax." For individual shareholders to reduce their registered capital in the investee enterprise without actually paying part of the registered capital, the original value of equity is usually recognized as zero.

(3) Determination of equity transfer income

According to the Individual Income Tax Law and its implementing regulations, the income from equity transfer shall be determined in accordance with the income from equity transfer minus the original value of equity. However, the following two issues should be noted:

Retained earnings should be included in the income from equity transfer and declared for individual income tax purposes

Unlike the provisions of Article 34 for corporate shareholders, individual shareholders are not entitled to the retained earnings portion of the investee enterprise as tax-free dividends to be deducted when determining the income from equity transfer. If an individual makes a capital reduction distribution of 500,000 yuan, the original value of the equity interest is 100,000 yuan, and the share of retained earnings is 200,000 yuan, the individual income tax basis for this capital reduction is 400,000 yuan, not 200,000 yuan.

At the same time, for the capitalization of retained earnings, Article 15 (4) of the 67th Regulation stipulates that "if the investee enterprise increases its share capital by capital surplus, surplus and undistributed profits, and the individual shareholders have paid individual income tax according to law, the original value of its newly increased share capital shall be recognized by the sum of the amount of the transfer and the related tax;" it is divided into two parts. parts, the retained earnings shall first be distributed to individuals, who are required to pay individual income tax first, and then the proceeds of such distribution shall be recognized as new share capital, and the said amount of transfer and tax shall be included in the original value of equity, which may be deducted by the individuals when they carry out capital reductions.

The calculation of transfer income should be in line with the arm's length principle to avoid adjustment by the tax authorities.

Individual shareholders do not actually pay part of the capital reduction, the company may not be distributed, so individual shareholders think that can be zero declaration, and then be adjusted by the tax authorities. 67 Article 10 clearly stipulates: "equity transfer income should be determined in accordance with the principle of arm's length transactions." As mentioned before, in the process of capital reduction, even if the company has not made any distribution, there are retained earnings on the company's books, which should be regarded as distribution to individual shareholders and subject to individual income tax.

Article 11 of Circular 67 stipulates: "In one of the following cases, the competent tax authority may approve the income from equity transfer: (1) the declared income from equity transfer is obviously low and without justifiable reasons; (2) the tax declaration is not made in accordance with the prescribed period, and the tax authority orders the declaration of the tax return by the deadline, and the declaration of the tax return is not made after the expiration of the deadline; (3) the transferor is unable to or refuses to provide the relevant information on the income from equity transfer transfer income; (iv) other circumstances under which the equity transfer income should be authorized." When the above four circumstances are met, the tax authorities will authorize the transfer income of individual shareholders.

Article 12 of Circular 67: "In conformity with one of the following circumstances, it is deemed that the income from the transfer of equity is obviously low: (a) The declared income from the transfer of equity 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 and equity interests, the declared income from equity transfer is lower than the share of fair value of net assets corresponding to the equity interests; (ii) the declared income from equity transfer is lower than the cost of the initial investment or lower than the price paid for the acquisition of such equity interests and related taxes; (iii) the declared income from equity transfer is is lower than the income from equity transfer 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 without reasonableness; and (vi) other circumstances determined by the competent tax authorities." It can be seen that if the individual shareholder declares zero personal transfer income in the process of capital reduction, it is likely to be regarded by the tax authorities as the equity transfer income is obviously low, and carry out the authorization of the transfer income, which leads to the rise of tax burden.

(III) Case for insurance: capital reduction and divestment without paying tax, adjusted by tax authorities

Company A is a company jointly invested by Mr. Zhang San and Mr. Li Si, with a registered capital of RMB 10 million, and the net assets of Company A are RMB 20 million, with a fair value of net assets of RMB 30 million. The two parties, in order to change the actual controller of the company from an individual shareholder to a corporate shareholder, perform the following operations: First, an asset management company, Company B, is jointly formed by Zhang San and Li Si. Second, Company A reduces its registered capital to 100,000 yuan through capital reduction. After the capital reduction, Company B then increases its capital to Company A by $9.9 million. After the capital increase, Company B holds 99% of Company A's shares. Finally, Zhang San and Li Si divest another 100,000 yuan. Eventually, Company A became a wholly-owned subsidiary of Company B, i.e., the original natural person shareholders became legal person shareholders.

The competent tax authorities considered that the capital reduction and divestment of Zhang San and Li Si did not conform to the principle of independent market transaction, and the tax authorities had the right to approve the income from capital reduction and divestment and calculate the personal income tax payable accordingly. According to the State Administration of Taxation Announcement No. 41 of 2011, the tax authority determined that the shareholders' capital reduction or divestment was in essence of the nature of "repurchase of equity by the company". And according to the provisions of Article 10 to Article 11 of Article 67, the income from equity transfer shall be determined in accordance with the principle of arm's-length transactions, and if the income from equity transfer declared by the taxpayer is obviously low and there is no justifiable reason for it, the competent tax authority may approve the income from equity transfer. Meanwhile, the first paragraph of Article 12 of the Announcement stipulates that if the equity transfer income declared by the taxpayer is lower than the share of net assets corresponding to the equity, the equity transfer income is deemed to be obviously low. The tax authorities used the fair value of the company to calculate that Zhang San and Li Si should pay 40,000 yuan of individual income tax.

IV. Analysis of other tax issues in the process of shareholders' capital reduction

Legal and individual shareholders' capital reduction may involve the return of investment by the enterprise with non-monetary assets. The investee enterprise, due to the shortage of its own funds or out of the consideration of safeguarding the health of the enterprise's capital flow, has not completed the capital reduction in the form of capital consideration, but rather, it has valued the enterprise's properties and land for the purpose of calculating the income from the investment, which may involve value-added tax (VAT), value-added tax (VAT) on land, deed tax, and other taxes in the process.

(I) Value-added tax

Article 4 of the Rules for the Implementation of the Provisional Regulations on Value-added Tax stipulates that "the following acts of a unit or an individual industrial or commercial enterprise shall be regarded as sales of goods: ...... (vii) distributing self-produced, commissioned-processed or purchased goods to shareholders or investors;" enterprises return investments with non-monetary assets, which are regarded as sales of goods to shareholders or investors. When an enterprise returns investment with non-monetary assets, it belongs to the distribution of goods to shareholders or investors, which is regarded as sales and subject to VAT.

(II) Land value-added tax

Article 2 of the Rules for the Implementation of the Provisional Regulations on Land Value-added Tax ("PROVISIONAL REGULATIONS ON LAND VAT") stipulates that: "The transfer of the right to use state-owned land, the buildings and their attachments on the ground and the acquisition of income as referred to in Article 2 of the Regulations refers to the transfer of real estate by way of sale or in other ways in return for compensation. It does not include the act of transferring real estate without compensation by way of inheritance or gift." It can be seen that the enterprise should pay land value-added tax when it repurchases the equity held by shareholders with real estate as the consideration for capital reduction.

(III) Deed Tax and Stamp Duty

When an enterprise repurchases real estate as consideration for capital reduction, it is usually regarded as a paid transfer of real estate, and therefore needs to declare deed tax, and the shareholders who accept the real estate shall pay deed tax according to the law, and at the same time, their property right transfer documents shall be levied and collected with stamp duty.

(IV) Case Analysis: Penalized for non-payment of tax on return of investment by non-monetary assets

1.Case summary

Shengmou company is a real estate development enterprise, it is in a garden property for real estate development and sales, due to the project capital demand, in addition to the shareholders investment, there are 263 individuals as the hidden shareholders to invest in the project. 2012, due to the real estate market continues to be weak, coupled with the hidden shareholders and the shengmou company contradiction aggravation, by the defendant county government for many times to coordinate, the shengmou company and the hidden shareholders signed an agreement with the above Agreement, agreed to "to house against investment", Shengmou company to fulfill the agreement with 258 hidden shareholders signed a contract to buy houses, Shengmou company according to the "business tax tax obligation occurs when the taxpayer provides taxable services, transfers intangible assets or sells real estate and receives the business income payments or On the day when the taxpayer receives the business income or obtains the business income receipt." In 2015, the local county local tax bureau made a tax administrative penalty decision, finding that Shengmou's collection of the balance of 258 homebuyers' payments without declaring the tax constitutes tax evasion, recovering the tax and imposing a 50% fine. Sheng Mou did not accept the decision and sued to the local people's court.

2. Point

The court of first instance held that: Sheng Mou Company claimed that it had carried out the "house against investment" between its own real estate and the hidden shareholders, and did not obtain the business income, and did not actually receive the balance of the purchase price of the houses. According to the provisions of Article 24 of the Implementing Rules of the Provisional Regulations of the People's Republic of China on Business Tax, the day of obtaining the vouchers for business income shall be the day of the date of payment determined by the written contract, and therefore the time of occurrence of business tax obligation shall be determined by the day of the date of payment determined by the contract on the sale of commodities, and the behavior of Shengmou Company was not listed in the account book, and it constituted a tax evasion by not including or under-listing the income or making false tax declaration. Tax evasion.

Sheng Mou Company appealed, arguing that although it signed the purchase contract with 258 social hidden shareholders, there was no substantive transaction between the two parties, and the company used its own assets to repurchase the shares of the shareholders, which belonged to the scope of the equity transfer, and did not need to pay the business tax.

The court of second instance held that: Sheng a company appealed that there was no substantive transaction between the two parties, the company used its own assets to repurchase the shareholders' shares, no need to pay business tax, the claim lacked factual and legal basis, and was not supported. The judgment rejected the appeal and upheld the original judgment.