Editor's Note: Recently, a number of well-known listed companies have been subject to tax adjustments by tax authorities on the grounds that their equity and asset transfers by book-entry fail to meet the conditions for special tax treatment. According to the disclosed case details, the core challenge from tax authorities focuses on the following: the transferor, which received equity payment in the transfer, transferred the acquired equity to a third party within 12 months after the completion of the equity transfer, resulting in a change in the equity structure. Then, does the statutory condition for special tax treatment on equity and asset transfer by book-entry include the continuity of shareholder interest principle? Will the transfer of the acquired equity by the transferor within 12 months after the transfer disqualify the restructuring transaction from special tax treatment? The author conducts an analysis based on a typical case.

I. Case Introduction

(I) Basic Facts of the Case

Company A is mainly engaged in the real estate business. Company B is a subsidiary jointly established by Company A and natural person Li, with each holding 50% of the shares, and mainly operates a real estate project in Shandong Province. Company C is a wholly-owned subsidiary of Company A, mainly operating business in North China. In November 2024, to complete the internal resource integration of the group, Li transferred his 50% equity in Company B to Company C at a price of 20 million yuan. Subsequently, Company A transferred its 50% equity in Company B to Company C by book-entry at a net book value of 10 million yuan.

Company C made the following accounting treatment for the equity transfer and the accepted transfer by book-entry:

Debit: Long-term equity investment - Company B     20,000,000 yuan

Credit: Bank deposit       20,000,000 yuan

Debit: Long-term equity investment - Company B       10,000,000 yuan

Credit: Paid-in capital       10,000,000 yuan

Company A made the following accounting treatment for the equity transfer by book-entry:

Debit: Long-term equity investment - Company C       10,000,000 yuan

Credit: Long-term equity investment - Company B       10,000,000 yuan

During the annual final settlement and payment of enterprise income tax (EIT) in 2025, Company A filed a tax return for special tax treatment in respect of the above equity transfer by book-entry, and temporarily did not recognize the income from the equity transfer. The transferee Company C filed the corresponding tax return simultaneously. In June 2025, Company A transferred 45% of its equity in Company C to Company D, reducing its shareholding ratio in Company C to 55% after the transfer. Before and after the equity transfer by book-entry in November 2024 and the equity transfer in June 2025, the main business of Company B did not change in any way, and it has been continuously operating the real estate project in Shandong Province.

(II) Position of the Tax Authority

The tax authority held that the above equity transfer by book-entry of Company A is not eligible for special tax treatment, and shall be subject to general tax treatment to pay overdue tax and late payment surcharge, with two core reasons:

1.Failure to meet the subject qualification requirements for special tax treatment: The subjects eligible for special tax treatment on equity transfer by book-entry shall be between parent and subsidiary companies with 100% direct holding relationship, or between subsidiaries directly 100% controlled by the same parent company or multiple identical parent companies. Within 12 months after the completion of the equity transfer in this case, Company A, the transferor and parent company, transferred part of the equity of Company C, the transferee and subsidiary, resulting in Company A's shareholding ratio in Company C falling below 100%, thus losing the subject prerequisite for applying the policy.

2.Failure to meet the continuity of shareholder interest requirement for special tax treatment: The original major shareholders who received equity payment in the enterprise restructuring shall not transfer the acquired equity within 12 consecutive months after the completion of the restructuring. Company A received equity payment from Company C in this equity transfer by book-entry, but transferred the acquired equity in Company C within 12 months after the completion of the transfer, which violates the continuity of shareholder interest principle.

(III) Position of the Enterprise

Company A claimed that the equity transfer by book-entry fully meets the conditions for special tax treatment, with two main defense reasons:

1.Neither the Notice of the Ministry of Finance and the State Taxation Administration on Issues Concerning the Enterprise Income Tax Treatment for Promoting Enterprise Restructuring (Caishui [2014] No. 109, hereinafter referred to as "Circular 109") nor the Announcement of the State Taxation Administration on Issues Concerning the Administration of Enterprise Income Tax on Asset (Equity) Transfer by Book-Entry (Announcement of the State Taxation Administration No. 40 of 2015, hereinafter referred to as "Announcement 40") explicitly stipulates that the transferor parent company must maintain a 100% shareholding relationship in the transferee subsidiary within 12 months after the completion of the equity transfer by book-entry.

2.China's special tax treatment policies for enterprise restructuring are divided into two categories: The first category applies to restructuring transactions including debt restructuring, equity acquisition, asset acquisition, merger and division, including the Notice of the Ministry of Finance and the State Taxation Administration on Issues Concerning the Enterprise Income Tax Treatment of Enterprise Restructuring (Caishui [2009] No. 59, hereinafter referred to as "Circular 59"), Article 1 and Article 2 of Circular 109, and the Announcement of the State Taxation Administration on Several Issues Concerning the Administration of Enterprise Income Tax on Enterprise Restructuring Business (Announcement of the State Taxation Administration No. 48 of 2015). The second category is the special policies applicable exclusively to equity and asset transfer by book-entry, including Article 3 of Circular 109 and Announcement 40. The continuity of shareholder interest requirement is a condition set by Circular 59. This case involves an equity transfer by book-entry transaction, which is not subject to the provisions of Circular 59, and there are no relevant restrictions on the continuity of shareholder interest in the special policies for equity transfer by book-entry.

II. Legislative Logic and Statutory Conditions for Special Tax Treatment on M&A and Restructuring

(I) Legislative Rationality of Special Tax Treatment on M&A and Restructuring

An EIT liability arises upon the occurrence of a taxable transaction. In tax collection, the tax authority, in principle, respects the established civil and commercial transaction facts and takes the actual transaction consideration as the tax basis. However, if the consideration is not fair and without justifiable reasons, the tax law may adjust the elements of the civil and commercial legal relationship and take the fair value of the transaction object as the tax basis, which is the anti-avoidance rule of the tax law.

The essence of special tax treatment is the exceptional application of anti-avoidance rules (not the only exception), that is, it allows both parties to the transaction to confirm the tax basis based on the net book value of the transaction object, and exempts tax adjustment even if the net book value is much lower than the fair value of the transaction at the time of the transaction. This exceptional rule is mainly applicable to M&A and restructuring scenarios, and its core rationality lies in that: M&A and restructuring of group enterprises are often different from general market transactions. Their core purpose is internal resource integration and optimization of group organizational structure, rather than making profits through transactions. The nature of the transaction is a paper transaction of "transferring assets between affiliated entities within the same group". The group's control over the transaction object has not been substantially transferred, and the transaction object has not been transferred to an unrelated third-party market entity. From the perspective of transaction results, the parties to the transaction have obtained little or no cash consideration, and lack the necessary funds for full tax payment. Based on the comprehensive consideration of transaction purpose, transaction nature and transaction results, such M&A and restructuring should not be subject to EIT as general market transactions.

(II) Core Prerequisites for the Application of Special Tax Treatment

To realize the compliant restriction on transaction purpose, transaction nature and transaction results, the applicable conditions of special tax treatment are mainly set around three core principles:

1.Continuity of Shareholder Interest Principle: It requires that the transaction object is ultimately controlled by the same shareholder or multiple identical shareholders before and after the transaction, and the original shareholder's rights and interests in the transaction object are continued. For example, in this case, regardless of other factors, Company A originally directly held 50% of the equity of Company B. After transferring the equity to Company C by book-entry in exchange for the additional equity issued by Company C, Company A lost direct control over Company B, but realized indirect control over Company B through controlling Company C, completing the continuation of rights and interests before and after the transaction.The continuity of shareholder interest principle is the core basis to prove that the transaction is not for profit purposes — the original shareholder has not "completely sold the underlying assets to the outside", and the essence of the transaction is a paper transaction. At the same time, based on the requirements of this principle, the transaction consideration must be mainly equity payment, which also ensures that there is almost no cash consideration in the transaction results. Therefore, this principle is in the core position in the special tax treatment rule system.The continuity of shareholder interest principle is reflected in two dimensions in specific rules: First, the transaction must take equity payment as the main consideration to ensure that the parties to the transaction can continue their rights and interests in the transaction object through the shareholding relationship. Second, the party that receives the equity payment shall not transfer the acquired equity within a specified period to ensure the substantial continuation of the rights and interests.

2.Continuity of Business Enterprise Principle: It requires that the transaction object shall not change its substantive business activities before and after the transaction, which is an auxiliary proof of the reasonable commercial purpose of the transaction, and is used to prove that the core purpose of the transaction is only to integrate existing resources. In view of its auxiliary status, the requirements for business continuity in national legislations are usually relatively loose. For example, when the transaction object has a number of main businesses, most countries do not require all businesses to be maintained, only the core main business needs to be continued.The continuity of business enterprise principle is reflected in two dimensions in specific rules: First, the substantive business activities of the transaction object shall not be changed within a specified period. Second, if an overall business activity needs to be realized through the coordination of multiple assets, and the business activity is the only continuous business activity before and after the transaction, such assets shall be regarded as the minimum transaction unit and shall not be split for transaction, otherwise the continuity of business will be damaged.

3.Reasonable Commercial Purpose Test: It requires that the transaction must have a reasonable commercial purpose and shall not be mainly for the purpose of reducing, exempting or deferring tax payment. This test is not used to prove that the transaction itself meets the core restrictive conditions of special tax treatment, but is mainly used to crack down on tax avoidance acts abusing the special tax treatment policy.

(III) Specific Provisions of China's Legislation on the Conditions for Special Tax Treatment

Circular 59 comprehensively stipulates the three core principles: the continuity of shareholder interest principle, the continuity of business enterprise principle, and the reasonable commercial purpose test:First, the continuity of shareholder interest principle, which includes two specific requirements: (1) The amount of equity payment involved in the restructuring transaction consideration meets the statutory ratio requirements; (2) The original major shareholders who received equity payment in the enterprise restructuring shall not transfer the acquired equity within 12 consecutive months after the completion of the restructuring.Second, the continuity of business enterprise principle, which includes two specific requirements: (1) The ratio of assets or equity of the acquired, merged or divided part meets the statutory ratio requirements; (2) The original substantive business activities of the restructured assets shall not be changed within 12 consecutive months after the completion of the enterprise restructuring.Third, the reasonable commercial purpose test, that is, the transaction has a reasonable commercial purpose and is not mainly for the purpose of reducing, exempting or deferring tax payment.The scope of application of Circular 59 is limited to five types of restructuring transactions: debt restructuring, equity acquisition, asset acquisition, merger and division.

Article 3 of Circular 109 and Announcement 40 provide special provisions on the conditions for the application of special tax treatment on asset and equity transfer by book-entry: First, the requirement of reasonable commercial purpose test is fully retained. Second, the requirement of the continuity of business enterprise principle that "the substantive business activities shall not be changed within 12 months" is retained, and the relevant provisions on the statutory ratio of the transaction object are deleted. Third, major adjustments have been made to the continuity of shareholder interest principle: (1) The core requirement is adjusted to "no gain or loss is recognized by both parties to the transaction in accounting"; (2) The restrictive provision that "the acquired equity shall not be transferred within 12 consecutive months after the completion of the restructuring" is deleted; (3) Strict subject qualification requirements are added, limiting the scope of application to between parent and subsidiary companies with 100% direct holding relationship, and between subsidiaries directly 100% controlled by the same parent company or multiple identical parent companies.

III. Analysis of the Core Dispute on Whether Special Tax Treatment Applies to This Case

(I) The Rules of Circular 59 Shall Not Apply to This Case

In this case, the tax authority denied the application of special tax treatment on the grounds that "the parent company that received the equity payment transferred the equity within 12 months, which violates the continuity of shareholder interest requirement". In essence, it defines the relationship between Circular 109 and Circular 59 as the relationship between special law and general law. The author holds that the two documents are not the relationship between general law and special law, but parallel rules applicable side by side, with the following core reasons:

First of all, equity and asset transfer by book-entry is different from equity acquisition and asset acquisition, and transfer by book-entry is not a special case of acquisition. The concept of "transfer by book-entry" originates from the system of gratuitous transfer of state-owned enterprises. Gratuitous transfer is different from transfer at par value and transfer at zero price: both transfer at par value and transfer at zero price are based on the "existence of consideration". Transfer at par value determines the consideration based on the cost amount, which is reflected as zero gross profit; although the consideration for zero-price transfer is zero, the consideration clause is still set, which is reflected as negative gross profit and loss formation. Gratuitous transfer is a non-consideration transfer of ownership, and its legal nature is similar to donation.

From the perspective of tax law principles, only paid transfers (i.e., acquisition transactions) have transaction consideration, which will give rise to issues such as "whether the transaction consideration is fair, whether anti-avoidance adjustment needs to be initiated, and whether tax adjustment can be exempted through special tax treatment". However, gratuitous transfer itself has no tax basis, and the above issues have no applicable premise. The current tax law does not recognize gratuitous transfer as "obviously low tax basis". The tax adjustment method for gratuitous transfer is mainly deemed sale (i.e., treated as paid transfer), which is essentially different from the tax adjustment logic for "obviously low tax basis".

According to the provisions of Announcement 40, "no gain or loss is recognized in accounting" includes two situations: one is that the restructuring consideration is the equity payment made by the wholly-owned subsidiary to the parent company, and the whole transaction is a capital transaction, so no gain or loss is recognized; the other is a non-consideration restructuring transaction, which naturally cannot recognize gain or loss due to no consideration, that is, the aforementioned gratuitous transfer. The latter is in an obvious parallel relationship with acquisition transactions, rather than an inclusion and included relationship. Although the former is not a gratuitous transfer, it is also completely different from acquisition transactions — although the party to the transaction has received equity payment, the payment is made by the wholly-owned subsidiary to the parent company. This transaction mode is closer to the nature of gratuitous transfer rather than paid acquisition. Strictly speaking, this transaction mode has no direct corresponding concept in the civil and commercial law system, and is a special transaction type created by tax law. The tax law stipulates it side by side with gratuitous transfer, which fully shows that their tax law status is basically equivalent, and it cannot be recognized as a special case of acquisition.

In summary, the rule cited by the tax authority that "the original shareholder who received the equity payment shall not transfer the equity within 12 months" is based on Circular 59, whose scope of application does not include equity transfer by book-entry transactions. Circular 109 does not set such restrictive provisions on equity transfer by book-entry transactions. Therefore, this claim of the tax authority constitutes an error in law application.

(II) Special Tax Treatment Shall Not Unconditionally Require the Continuity of 100% Equity Relationship Between Subjects

Another core reason of the tax authority is that the 100% shareholding relationship between the parent and subsidiary companies has changed after the completion of the transfer, which has a certain legal basis. Although Circular 109 does not make explicit restrictive provisions on the equity relationship after the transfer, it implies relevant requirements for the continuity of equity relationship from the adjustment logic of the document on the continuity of shareholder interest principle.

The adjustment of the continuity of shareholder interest principle in Circular 109 is a deliberate legislative arrangement. The added and deleted clauses complement each other to jointly achieve the complete legislative purpose. Precisely because the parties to the transaction are parent and subsidiary companies with 100% direct shareholding relationship, after the parent company transfers the equity to the subsidiary by book-entry, the parent company will inevitably indirectly enjoy the rights and interests in the transferred equity through directly holding the equity of the subsidiary, thereby realizing the continuity of shareholder interest principle. Therefore, there is no need to additionally set the restrictive clause that "the parent company that received the equity payment shall not transfer the acquired equity within 12 months".

However, it should be clear that the requirement for the continuity of equity relationship shall be bounded by the realization of the continuity of shareholder interest principle; and the realization of the continuity of shareholder interest principle does not necessarily take the parent company's maintenance of 100% shareholding in the subsidiary as a necessary prerequisite.

In this case, the object of the transfer transaction is the 50% equity of Company B held by Company A. As long as Company A's control over the rights and interests corresponding to the 50% equity of Company B has not been substantially changed before and after the transaction, the core requirements of the continuity of shareholder interest principle are met. The control interest of Company A in Company B exceeding 50% after the transaction is not in essential conflict with the equity structure before the transaction. This part of the new interest comes from the equity held by natural person Li, who has paid the tax in full at the fair value in the equity transfer link. This part of the transaction is not within the scope of the special tax treatment in this case, and the change of its rights and interests does not affect the application of special tax treatment to the transfer transaction in this case.

In this case, after Company A transferred 45% of the equity of Company C, the proportion of its indirect interest in Company B through Company C is 55% × 100% = 55%, which is still higher than the 50% proportion directly held before the transfer. The core rights and interests corresponding to the 50% equity of Company B, the transferred object, have been fully continued by Company A, which fully complies with the requirements of the continuity of shareholder interest principle. From the perspective of the overall transaction chain, Company A has recognized the transfer income at fair value and paid tax in the link of transferring the equity of Company C. The tax liability deferred due to the application of special tax treatment has been fully performed in this equity transfer link, without causing the loss of state tax revenue. The indirect interest in Company B held by the new shareholder Company D introduced in this transaction has been fully taxed by Li in the previous equity transfer link, which does not damage the continuity of shareholder interest principle of this transfer transaction.

In conclusion, the change of equity structure does not necessarily lead to the loss of the application basis of special tax treatment. The tax authority shall strictly examine the substantial impact of the overall transaction on the continuity of shareholder interest principle, and shall not make tax adjustments for transactions that do not damage the continuity of shareholder interest principle, comply with the continuity of business enterprise principle and have reasonable commercial purposes. Otherwise, it will violate the principle of tax neutrality and the original legislative intention of special tax treatment.