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A S I A N TA X AT I O N G U I D E 2006MERGERS & ACQUISITIONS*

pwc*connectedthinking

MERGERS & ACQUISITIONS ASIAN TAXATION GUIDE1

FOREWORD

Today’s corporate balance sheets the world over arelooking clean and sturdy, urging businesses to expanddomestically as well as across borders. With Asia’srobust economic outlook and promise for marketliberalisation, dealmakers are courting the regionearnestly, armed with deep pockets and a resolute aim– growth.

The strategic imperative in any deal activity is to buyan interest in future profits.

For growth markets in Asia, look no further thanChina, India and Korea - the region’s dealmaking starsand top contenders on Asia’s Mergers & Acquisitions(M&A) league table in 2005.

China and India, the twin engines of growth in Asia,are unanimously the region’s star attractions toinvestors. The regulatory uncertainties and peculiarcorporate cultures no longer deter foreign investorsfrom scouring and shopping for corporate deals inthese markets. Instead, the abundance of new,fledging and under-served sectors here, coupled withstiff domestic and global competition, spur long-sighted purchasers to regard these former marketbarriers as a mere cost of doing business.

Along with ubiquitous opportunities, Asia, the neweconomic powerhouse, presents significant risks,particularly to those unfamiliar with the diverse andfragmented region.

Tax risks, for one, can add to the complexity of a dealand at worst, break it.

Particularly in this non-homogenous landscape, therelevant taxes to be considered in the context of adeal are aplenty. Specifically, the existence of variedtax jurisdictions in the region poses significantdifferences in the tax implications of an asset or stocksale.

Tax risks while high in deal activities, can bemanageable.

More importantly, it is possible to re-organise thecompanies post-acquisition, in order to maximise thetax benefits that may be associated with an assetdeal.

To ensure a successful deal, tax planning is thereforeessential. Rapt attention has to be paid to a myriad ofissues ranging from tax efficient holding companylocations, cross-border financing and treasurysolutions, managing intellectual property and intangibleassets, controlled foreign companies tax planning,income tax treaties, profit repatriation, loss utilisation,tax efficient supply chain and shared services toregional tax issues.

In this 2006 and third edition of Mergers & AcquisitionsAsian Taxation Guide, our network of M&A taxprofessionals across Asia band together to assist youachieve your goal of growth in Asia. Our in-house dealarchitects offer you valuable insights throughout theentire M&A spectrum from pre-deal negotiation, duediligence and tax structuring to post-merger integration.

This PricewaterhouseCoopers (PwC) thoughtleadership publication provides present and potentialinvestors among you a summary of the tax andregulatory landscape in 14 countries across Asia,highlighting key issues relevant to both purchasers andsellers when transferring business ownerships.

We hope you find this publication an essential readwhen riding Asia’s growth momentum.

Gautam BanerjeeRegional Leadership Team Chairman

PricewaterhouseCoopers


ACKNOWLEDGEMENTS

I take great pleasure in introducing PwC’s Mergers andAcquisitions Asian Taxation Guide 2006. The informationcontained within is drawn from the breadth and depth ofexpertise that exists within our Asia Pacific network of M&Atax professionals.

Producing this guide has been a truly regional endeavour.I would like to express my appreciation to the PwC M&A TaxServices country leaders and their respective teams fromAustralia, China, Hong Kong, India, Indonesia, Japan, Korea,Malaysia, New Zealand, Philippines, Singapore, Sri Lanka,Taiwan and Thailand. Each author has made a significantpersonal contribution to the overall effort that was required toproduce this guide.

David TohRegional Tax Mergers & Acquisitions LeaderPricewaterhouseCoopers


PricewaterhouseCoopers’ M&A Tax Services team has the largestnetwork of M&A tax specialists in the world.

www.pwc.com

For more information on PwC M&A Tax Services, contact:

Asia Pacific Global EMEA

David Toh Ian Schachter Magnus Johnsson+65 6236 3908 +1 646 471 2900 +46 8 555 331 [email protected] [email protected] [email protected]

The team offers expert deal structuring and financingadvice at all points throughout the deal cycle, helpingyou:

• assess and manage M&A risks;

• structure acquisitions to optimise net cash flows;

• carry out pre-acquisition due diligence;

• ensure tax efficient deal structuring; and

• ensure post-deal integration.

Our expertise is reinforced by the qualityand consistency of our services.

We have embedded within our M&A workpractices a proven methodology for M&A taxprojects that emphasises clearcommunication of tax and structuring issuesand provides creative solutions for businessproblems.

The value of our M&A Tax Services is much more than just a methodology or a number ofwell structured and consistently applied tools.

Our unrivalled experience, strong international network and commercial focus allow us toadd real financial value to transactions.


CONTENTS

Australia 01China 31Hong Kong 57India 75Indonesia 93Japan 105Korea 129Malaysia 149New Zealand 171Philippines 189Singapore 209Sri Lanka 231Taiwan 263Thailand 289

MERGERS & ACQUISITIONS ASIAN TAXATION GUIDE 2006

MERGERS & ACQUISITIONS ASIAN TAXATION GUIDE1 PricewaterhouseCoopers

AUSTRALIA • CHINA • HONG KONG • INDIA • INDONESIA • JAPAN • KOREA • MALAYSIA • NEW ZEALAND

PHILIPPINES • SINGAPORE • SRI LANKA • TAIWAN • THAILAND

AUSTRALIA

Country M&A TeamCountry Leader ~ Mark O’Reilly (Sydney)/Vanessa Crosland (Melbourne)

Anthony KleinChris Morris

Christian HolleDavid Pallier

Kirsten ArblasterMark HadassinMichael FrazerMike DavidsonNorah Seddon

Paul AbbeyPeter Collins

Peter Le HurayRyan Davis

Tony Clemens

mailto: [email protected]




Name Designation Office Tel Email

Sydney

Mark O’Reilly Partner +61 2 8266 2979 [email protected]

Christian Holle Partner +61 2 8266 5697 [email protected]

David Pallier Partner +61 2 8266 4700 [email protected]

Mark Hadassin Partner +61 2 8266 9074 [email protected]@au.pwc.com

Michael Frazer Partner +61 2 8266 8448 [email protected]

Mike Davidson Partner +61 2 8266 1813 [email protected]

Norah Seddon Partner +61 2 8266 5864 [email protected]

Tony Clemens Partner +61 2 8266 2953 [email protected]

Chris Morris Director +61 2 8266 3040 [email protected]

Ryan Davis Director +61 2 8266 7956 [email protected]

Melbourne

Vanessa Crosland Partner +61 3 8603 3374 [email protected]

Anthony Klein Partner +61 3 8603 6829 [email protected]

Paul Abbey Partner +61 3 8603 6733 [email protected]

Peter Collins Partner +61 3 8603 6247 [email protected]

Peter Le Huray Partner +61 3 8603 6192 [email protected]

Kirsten Arblaster Director +61 3 8603 6120 [email protected]

PricewaterhouseCoopersSydney • Darling Park Tower 2 • 201 Sussex Street • Sydney, New South Wales 2000 • AustraliaMelbourne • Freshwater Place • 2 Southbank Boulevard • Melbourne, Victoria 3000 • Australia




1. Introduction

1.1 General Information on M&A in Australia

This chapter details the main issues that are relevant to both purchasers and sellers on a transfer ofownership of an Australian business or company.

The Australian taxation system continues to undergo significant reform. The Government haslaunched various taxation initiatives in recent years, including:

• the introduction of a tax consolidation regime;

• the introduction of a simplified imputation system;

• reform of Australia’s international tax law; and

• reform of Australia’s tax treatment of financial arrangements.

Broadly, the tax consolidation rules allow resident group companies to be treated as a single entityfor income tax purposes, with transactions between such group members being disregarded forcorporate tax purposes (e.g. payment of dividends and asset transfers).

These initiatives have created a complicated tax landscape for structuring M&A transactions.Particular care needs to be exercised whenever companies join or leave a consolidated group toensure that tax attributes are known with certainty and that tax liabilities of the group members areproperly dealt with. However, there are still many opportunities to structure a M&A transaction in amanner which delivers significant value to both the vendor and purchaser – particularly in terms ofcapital gains tax (CGT) planning, and optimising funding and repatriation arrangements.

The Government announced in its 2005 Budget that for non-residents, the CGT regime will benarrowed such that the tax will only apply to the disposal of Australian real property, businessassets of Australian branches and non-portfolio interests (i.e. 10% or more) in interposed entities(including foreign interposed entities) where the value of such an interest is wholly or principallyattributable to Australian real property. Currently, only portfolio interests (i.e. less than 10%) inAustralian public companies held by non-residents are exempt from Australian CGT. The exactdetail of the proposal has still not been released. This reform would have a major impact on thestructuring of M&A transactions and is expected to apply from 1st July 2006.




Further, the Government released an exposure draft of stages three and four of the “Taxation ofFinancial Arrangements” reforms in December 2005. Under the proposed law, there will be a newtax regime for certain financial arrangements which will generally account for economic gains andlosses on an accruals basis as opposed to a realisation basis. It is proposed that equity interestswill be excluded from the regime. At the time of writing, no proposed starting date for theseprovisions has been announced. However, as this new law will have a significant impact on theAustralian tax outcomes of funding arrangements for M&A activity, its impact will need to beconsidered in the structuring of any transaction.

1.2 Corporate Tax

1.2.1 Income Tax

The corporate tax rate in Australia is currently 30%. Australian resident companies are generallytaxed on income derived directly or indirectly from all sources, whether in or out of Australia.

1.2.2 CGT

Capital gains derived by Australian companies are also generally taxed at 30%.

Where an Australian company sells an interest of more than 10% in a foreign company, anyresulting capital gain or loss is reduced by a percentage, which is broadly calculated as the level ofactive foreign assets of the foreign company divided by the foreign company’s total assets. Wherethis “active foreign business asset percentage” is less than 10%, there is no reduction to the capitalgain or loss. Where this percentage is greater than 90%, there is no capital gain or loss to theAustralian company. If the percentage is between 10% and 90%, the capital gain or loss is reducedby that percentage.

1.2.3 Dividends

To the extent that dividends are paid between resident companies that are members of a taxconsolidated group, they will be ignored for calculating Australian taxable income of the group.

To the extent that dividends are not paid within a consolidated group, the dividend will be fullytaxable to the recipient company at the corporate tax rate. A “gross up and credit” system appliesfor franked dividends (i.e. those paid out of previously taxed profits by a company that is resident)received by a company. The dividend is grossed up for the tax paid and the company is entitled to atax offset.

To the extent the dividend is unfranked (i.e. paid out of untaxed profits), the dividend is fully taxableto the recipient company and the company will not be entitled to a tax credit against tax assessed.

Non-portfolio dividends received by a resident company from foreign investments are exempt fromtax, regardless of the country of origin of the dividend. The recipient company must own shares(excluding certain finance shares) entitling the shareholder to more than 10% of the voting power inthe foreign company to obtain this exemption.

Australia has a new conduit regime for foreign-sourced dividends flowing through Australiancompanies to a foreign parent. The new conduit foreign income (CFI) rules exempt from income taxand dividend withholding tax dividends paid from the following income:

• certain foreign-sourced dividends;

• foreign income and certain capital gains derived through a permanent establishment in a foreigncountry;




• capital gains from the disposal of shares in a foreign subsidiary not being subject to AustralianCGT; and

• foreign income and gains not subject to tax due to foreign tax credits.

These rules were effective from 1st July 2005.

1.3 Withholding Tax

1.3.1 Interest, Dividends and Royalties

Interest, dividends and royalties paid to non-residents are subject to Australian withholding tax,which is a final Australian tax for these non-residents. The rates of tax vary depending on whetherAustralia has a double tax agreement (DTA) with the recipient jurisdiction. In summary, the rates areusually as follows:

It should be noted that some Australian DTAs, such as the treaties with the United States (U.S) andUnited Kingdom (U.K.), feature lower withholding tax rates.

Australia has a significant number of tax DTAs (currently around 47), which cover Australia’s largesttrading partners.

1.3.2 Fees for Services

Fees for service are not currently subject to withholding tax, provided the payments are notconsidered to be royalties.

However, foreign resident withholding tax rules have been introduced and apply to Australian-sourced payments of a kind prescribed by Regulations paid on or after 1st July 2004 to a foreignresident. One payment that has been prescribed by Regulation is a payment to foreign residents inrespect of a contract for the construction, installation and upgrading of buildings, plant and fixturesand for associated activities. The rate of withholding tax for these payments is 5%.

1.4 Goods and Services Tax (GST)

There are three types of supplies for GST purposes:

• taxable supplies, where the supplier charges GST on the supply and is entitled to claim input taxcredits on its acquisitions relating to those taxable supplies;

• GST-free supplies, where the supplier does not charge GST on the supply and is entitled toclaim input tax credits on its acquisitions relating to those GST-free supplies (an example of aGST-free supply is transfer of a “going concern”); and

• input taxed supplies, where the supplier does not charge GST on the supply and is not entitledto claim input tax credits on its acquisitions relating to those input taxed supplies.

Non-treaty rate% Treaty rate%

Interest 10 10

Royalties 30 10 – 15

Unfranked dividends (paid out of untaxed profits) 30 15

Franked dividends (paid out of taxed profits) Nil Nil




The GST rate is currently 10%. However, certain transactions such as transfer of shares are inputtaxed supplies. In addition, a transfer of a business which satisfied certain conditions may be GST-free.

1.5 Stamp Duty

Stamp duty is a state-based tax on transactions and documents. Duty is payable on certaintransactions, including transfers of “dutiable property” and the transfer of shares. Dutiable propertycould comprise land (including fixtures, interests in land and buildings), goodwill, intellectualproperty, plant and equipment (in certain cases) and shares. Duty is imposed at rates of between3.75% and 6.75%, calculated on the greater of the unencumbered value of the dutiable property, orthe consideration paid. The transfer of shares is generally subject to duty of 0.6% in most States,although in certain instances higher rates of duty apply.

As the stamp duty rules vary in each State, the stamp duty position on each transaction should beconfirmed.

1.6 Other Relevant Taxes

1.6.1 Branch Profits Tax

There are currently no taxes on the remittance of branch profits to the foreign parent. However,Australia has a peculiar law which seeks to levy tax on dividends paid by non-residents which aresourced from Australian profits. This means that if a foreign company pays Australian branchprofits to its foreign shareholders as a dividend, the shareholder is technically liable to Australian tax(which may be limited under an applicable DTA). However, in practice the Australian Taxation Office(ATO) has encountered jurisdictional difficulties in collecting this liability.

1.6.2 Other Taxes

Other taxes include:

• fringe benefits tax (a tax on the employer) at 48.5% applicable to the grossed up value of certainnon-cash benefits provided to employees;

• payroll tax (a state-based tax) paid by employers; and

• land tax (a state-based tax) paid by the owners of real property.

1.7 Foreign Investment Review Board

Foreign investors are required to obtain approval for certain investments into Australia from theForeign Investment Review Board. The types of proposals which require prior approval, andtherefore should be notified to the Government, are generally as follows:

• acquisitions of substantial interests in existing Australian businesses, the value of whose grossassets exceeds $50 million, or where the proposal values the business at over $50 million;

• proposals to establish new businesses involving a total investment of $10 million or more;

• portfolio investments in the media of 5% or more and all non-portfolio investments irrespective ofsize;




• takeovers of offshore companies whose Australian subsidiaries or gross assets exceed$50 million;

• direct investments by foreign governments and their agencies irrespective of size; and

• acquisitions of interests in urban land.

Special rules apply to investments made by U.S. investors.




2. Acquisitions

2.1 The Preference of Purchasers: Stock vs. Assets Deal

Whether a deal is structured as a stock (share) deal or acquisition of assets is typically driven bycommercial considerations. Traditionally, there has been a preference in Australia for purchasers toacquire assets rather than shares, although sellers typically preferred to sell shares.

However, as a result of Australia’s tax consolidation regime and other reforms, the differencesbetween the tax treatment of an acquisition of assets versus a share deal have narrowed, such thata purchaser may not have a distinct preference for one over the other.

The acquisition of assets traditionally had a number of advantages over the acquisition of shares,including:

• freedom from any exposure to undisclosed tax liabilities;

• the tax effective allocation of purchase price, which may enable a step up in basis fordepreciable assets and deductions for trading stock;

• valuable trademarks or other intangibles may be acquired and located outside Australia. In theabsence of deductions being available in Australia for the amortisation of certain intangibles, thisenables the licensing of the intangible to the Australian company, thereby generating allowabledeductions to reduce the overall level of Australian tax; and

• providing an opportunity for tax effective employee termination payments.

Disadvantages of an asset purchase include that tax attributes (including losses and frankingcredits) of the vendor do not flow to the purchaser, and generally stamp duty on the acquisition of abusiness can be as high as 6.75%. This is significantly higher than the stamp duty on a privatecompany share purchase (generally 0.6%, assuming that the company is not “land-rich”, althoughsome States no longer impose stamp duty on the transfer of shares in non land-rich privatecompanies).

A non-resident buyer should consider a structure which takes into account future exit andrepatriation plans and, where applicable, a push down of debt into Australia as part of theacquisition. Tax effective funding structures may also be available depending upon the homejurisdiction. Acquiring shares in exchange for scrip may enable a merger without cashflowconstraints. These points are all addressed in further details throughout this chapter.




2.2 Stock Acquisition

2.2.1 Acquisition Structure

A non-resident buyer may be concerned with structuring a share acquisition to avoid CGT on futuredisposals. This frequently involves setting up an acquisition subsidiary in a favourable non-residentjurisdiction. Selling the non-resident subsidiary which holds the Australian investment, or accessingDTA relief on the sale of the Australian company, may then mitigate CGT.

These strategies may soon need to be reconsidered as a result of the announced, but not yetenacted, non-resident CGT tax reform measure. Under this tax reform proposal, the sale of sharesin an Australian private company or the sale of non-portfolio interests (i.e. at least 10%) in Australianresident companies will no longer be subject to Australian CGT where the company’s value is not“wholly or principally” attributable to real property. It is anticipated that these changes will beeffective from 1st July 2006.

For companies holding shares on revenue account, it will still be necessary to consider the abovestructuring technique.

2.2.2 Basis Step Up

A step up in the tax basis of certain assets of the acquired company or group can be achievedunder the tax consolidation regime, where the Target Company or group is acquired by anAustralian tax consolidated group. Very broadly, the amount paid for the shares of the TargetCompany or Group is “pushed down” to the tax basis of assets of the acquired company or group.

2.2.3 Tax Losses

Once there has been a change in the ultimate beneficial ownership of a company of 50% or more,carry forward losses may only be utilised if the company carries on the same business following thechange in ownership. This continuity of ownership test (COT) is complex to administer because ofthe requirement to trace beneficial ownership, although there are tracing concessions available for“widely held companies”. A requirement that only those same shares that are held during the testperiod by the same person can be taken into account in the numerator means that capitalinjections after the loss year may be problematic. A further complication is that for losses incurred inincome years commencing on or after 1st July 2005, the same business test (SBT) is not availableto companies whose total income is more than $100 million in the year of recoupment, i.e. affectedcompanies would only be able to utilise their losses whilst they pass the COT. A transitional rulemay alleviate this problem for certain unrealised losses at the commencement of this new provision.

The SBT is facts and circumstances specific. The ATO has strictly interpreted what constitutes the“same business”. In addition, the tax consolidation regime will now make it even harder forconsolidated groups to carry forward tax losses after a change in ownership since any newbusiness acquisition will not be able to be easily quarantined from the group.

The above mentioned rules also generally apply to unrealised losses of a company, the quantum ofsuch unrealised losses being determined at the date of COT failure. The “push down” of theacquisition price under the tax consolidation regime will generally eliminate the application ofthese unrealised rules until there is a subsequent failure of the COT.




2.2.4 Tax Incentives

Depending on the nature and size of the investment project, State Governments have given rebatesfrom payroll tax, stamp duty and land tax on an ad hoc basis and for limited periods.

The major tax incentives/grants provided in Australia are outlined in section 12.

2.3 Asset Acquisition


Similar structuring issues apply to the acquisition of assets as for shares. If the assets are helddirectly by an offshore entity, the assets will nevertheless form part of the Australian CGT net inrelation to future disposals if they have the “necessary connection with Australia”. Accordingly,setting up through a foreign holding jurisdiction to minimise CGT on exit continues to be relevant inthe context of an asset acquisition.

With the proposed introduction of the exemption from CGT on the sale by non-residents of non-portfolio interests in Australian companies (where the value of the company is not “wholly orprincipally” attributable to real property situated in Australia), an asset acquisition may be lessattractive than a share deal for a foreign seller.

2.3.2 Cost Base Step Up

Where parties are dealing at arm’s length, the basis of acquired assets will be the market pricenegotiated between them. A buyer will typically try to allocate purchase price to depreciableassets rather than goodwill in order to maximise deductions post-acquisition (there is no taxamortisation of goodwill in Australia).

There are more aggressive techniques available to step up the cost base of an asset to marketvalue prior to sale, but due consideration should be given to Australia’s general anti-tax avoidancerules.

Non-deductible expenses of acquisition or sale of an asset may typically be included in the costbase of that asset.

2.3.3 Treatment of Goodwill

Under current taxation laws, there are no deductions available for the acquisition of goodwill.

The capital allowance provisions provide for amortisation deductions for certain types of intangibleproperty. While this will not extend to goodwill, a purchaser should focus on identifying the valueof specific intangibles (which may be eligible for amortisation deductions) rather than treating allintangibles as goodwill. For example, allocating purchase price to copyright, patents or industrialdesigns (or a licence in respect of any such item) could result in obtaining amortisation deductions.

2.4 Transaction Costs

The following sections summarise the GST and stamp duty costs associated with a transaction, aswell as the tax deductibility of these and other transaction costs.




2.4.1 GST

• Acquisition of Shares

The supply of shares in Australia is an input taxed financial supply and no GST is due on thesupply of those shares. However, under Australian law, the acquisition of the shares by acompany will be regarded as a financial supply by that company.

In these circumstances, the company acquiring the shares will be unable to claim all the GSTcharged to it on expenses relating to the acquisition of the shares if the company exceeds theFinancial Acquisitions Threshold (FAT). A company breaches the FAT if the acquisitions that aremade for the purpose of making financial supplies exceeded either $50,000 or 10% of theentities totals input tax credits in any twelve month period.

Nevertheless, in some circumstances, a company that makes input taxed financial supplies maybe entitled to claim 75% of the GST incurred on an acquisition as a reduced input tax credit(RITC), where it qualifies for a Reduced Credit Acquisition (RCA).

• Acquisition of Assets

Where all of the assets that are required to continue to operate a business are transferred, thesupply of those business assets may be a transfer of a “going concern” (provided that certainconditions are met) and will be GST-free. In these circumstances, the company acquiring theassets of the business will not be required to pay GST on the supply.

Alternatively, where insufficient assets to continue to operate a business are transferred, therequirements for the “going concern” provisions will not be met and the liability of supplieswill depend on the GST liability of the individual assets.

In relation to the GST costs incurred by the company acquiring the assets (including any GSTincurred on the actual acquisition of the assets), GST input tax credits (i.e. the GST amount isrefunded to or offset against any GST owed by the acquirer) will be available where theassets purchased are used by the acquiring company for a creditable purpose. GST input taxcredits may not be available where the acquiring company intends to make input taxed supplies.

2.4.2 Stamp Duty

• Acquisition of Stock

Broadly speaking, where there is a transfer of shares in an Australian registered company,stamp duty will be imposed at rates of approximately 0.6%, calculated on the greater of theunencumbered value of the shares or the consideration paid for the shares. Victoria, WesternAustralia and Tasmania have abolished share transfer duty.

If the company directly or indirectly (through downstream entities) owns land (buildings, fixturesand interests in land), the land-rich rules need to be considered. Land-rich duty is imposed atrates of up to 6.75% on the value of land deemed to be acquired.

Further, corporate trustee rules need to be considered if the Target Company is a trustee of adiscretionary trust (or owns shares in a company that is a trustee of a discretionary trust).

It should be noted that the land-rich and corporate trustee rules may apply to any transfer ofshares, regardless of where the company is registered.

• Acquisition of Assets

Whether the acquisition of assets/property will be liable to duty will depend on the types ofassets/property being transferred and their location. Where there is a transfer of a business, thetransfer of land, goods, goodwill and intellectual property, amongst other things, is subject toduty. If there is no transfer of a business (i.e. there is no goodwill), some categories of propertymay not be dutiable in certain jurisdictions.




The rate of duty varies between jurisdictions and can be as high as 6.75% on the greater of theconsideration paid or the unencumbered value of the property being transferred. Theconsideration payable for stamp duty purposes may include non-cash amounts such as anassumption of liabilities.

2.4.3 Concessions Relating to M&As

Australian income tax, GST and stamp duty law offer some concessions when a company is beingreorganised.

• Income Tax

Where assets are transferred within a tax consolidated group, the transaction is ignored forAustralian income tax purposes. However, stamp duty may still apply to transfers of dutiableproperty even if the transfer occurs within a tax consolidated group.

• GST

The GST “going concern” concession is discussed in previous sections.

Eligible companies may also form a GST group, with the effect that transfers of assets within theGST group are disregarded. However, stamp duty may still apply to transfers of dutiable propertyeven if the transfer occurs within a GST group.

• Stamp Duty

Exemptions from stamp duty are available for certain qualifying reorganisations in some States.These exemptions typically feature a “clawback” provision, which seeks to enforce the stampduty liability where certain transactions subsequently occur (such as the sale of particular assetsor entities) subsequently occur.

2.4.4 Tax Deductibility of Transaction Costs

Acquisition expenses (including acquisition of stamp duty) are typically non-deductible, but form partof the capital cost base for calculating the gain or loss on future disposals and in some cases forcalculating depreciation on depreciable assets.

However, certain costs to establish a business structure, to raise equity for a business or costs ofunsuccessful takeover attempts may be deductible over five years. In each case, the taxpayer mustincur the costs for a taxable purpose which is generally for the purpose of deriving income that issubject to Australian tax on an assessment basis.

Further changes to the law, so as to give tax relief for an extended range of otherwise non-deductible capital expenditure, is currently being considered by Parliament. Under these proposedchanges, certain business related capital costs will be able to be claimed over five years orincluded in the tax base for CGT purposes. For the expenditure to qualify, it will generally need tobe incurred in relation to an existing, past or prospective business.

Costs of borrowing money are deductible over five years, or over the life of the loan if shorter thanfive years. The return provided to the financier (such as an amount of interest) is not a borrowingcost and is deductible as mentioned in section 4.2.




3. Basis of Taxation Following Stock or Asset Acquisition


A stock acquisition can result in a step up in the tax basis of assets of the acquired company orgroup of companies where:

• the resulting group of companies elects to form a tax consolidated group for the first time;

• the acquirer of a company is a tax consolidated group; or

• the acquirer of a group of companies is a tax consolidated group.

The specific treatments of common types of acquired assets are considered in section 3.2.


Where parties are dealing at arm’s length, the cost base of an asset will be the market pricenegotiated between them. A buyer will typically try to allocate the purchase price to depreciableassets rather than goodwill, in order to step up the cost base and maximise deductions post-acquisition.

There are more aggressive techniques available to step up the cost base of an asset to marketvalue prior to sale, but these must have due consideration to Australia’s general anti-tax avoidancerules.

The cost of plant and equipment used as part of a business is generally tax depreciable over theuseful life using either a diminishing value or straight-line method. Amounts paid for computersoftware may also be tax depreciable.

Companies are able to deduct tax amortisation amounts for certain types of intellectual property(e.g. copyright, patents and industrial designs). However, no tax deduction is available in Australiafor goodwill.

Non-deductible expenses of acquisition or sale may typically be included in the cost base of anasset.




4. Financing of Acquisitions

4.1 Thin Capitalisation and Debt/Equity Distinction

4.1.1 Thin Capitalisation

Australia implemented a new thin capitalisation regime which potentially restricts the amount of taxdeductible interest (or like costs) which any multinational (whether Australian or foreign based) mayallocate to its Australian operations. Allied to this measure was a redraft of the tax distinctionbetween debt and equity.

Broadly, the thin capitalisation rules apply to outbound investors (i.e. Australian entities withcontrolled foreign investments) and also to inbound investors (i.e. non-residents with assets inAustralia and also foreign controlled Australian residents).

Importantly, the rules limit tax deductions for costs incurred in respect of debt interests (deductibledebt) issued by the taxpayer. Typically the cost will be interest on monies borrowed. In the caseof inbound investors, the debt will be issued by the non-resident to acquire the Australian assetsor issued by the foreign controlled Australian entity to fund the Australian operations.

Generally a “safe harbour” level of total debt of 75% of net Australian assets (excluding thedeductible debt itself and with certain adjustments) is available. A higher ratio is allowed for certainfinancial entities. An alternative arm’s length test requires the taxpayer to demonstrate that, havingregard to certain factors and assumptions, the actual debt level could have been obtained from anindependent lender. One of the assumptions is that any credit support actually provided is to beignored but not so that actual terms and conditions applying to the actual debt. These factors andassumptions make the arm’s length test difficult to apply. A further test for solely outbound investorsis available and allows debt to be calculated by reference to the actual debt of the worldwide groupof which the entity is a part

Modified rules apply to (non-bank) financial institutions, Australian banks and Australian branches offoreign banks.




4.1.2 Debt/Equity Distinction

At the same time as the new thin capitalisation rules were introduced, statutory tests to characteriseinstruments as debt or equity for tax purposes were enacted. Distributions may have different taximplications depending on the classification of the underlying instrument.

The distinction between debt and equity is based on a “substance over form” approach. This meansthat in some circumstances, legal form debt may be treated as equity, and legal form equity may betreated as debt for Australian tax purposes.

Generally, under these new rules, an instrument will be classified as debt, rather than equity, ifthere is an effectively non-contingent obligation for the issuer to return the initial outlay (i.e. theoriginal investment) to the investor. This calculation is based on nominal values for arrangementswhich must end within 10 years, else present values are used. In general terms, returns oninstruments classified as debt are deductible although a deduction cap may apply for certaininstruments. A return on debt may not be franked. Returns on debt instruments are also treated asinterest for withholding tax purposes. It is possible for redeemable shares with a less than 10 yearterm to be structured as debt

An equity interest will generally be characterised by returns that are contingent on the economicperformance (i.e. profitability of the issuer or part of the issuer’s activities). Returns on equity arenon-deductible but generally may be franked. Returns on equity instruments are also treated asdividends for withholding tax purposes.

Under these rules, hybrid (part debt/part equity) instruments will be classified as either all debt orall equity. If an instrument satisfies both the debt and equity test, it will be classified as debt.

Following the introduction of these new rules, particular care will need to be taken whenconsidering how the acquisition of Australian assets will be funded. For example, where theacquisition is to be partly funded by shareholder loans, there is a risk that the related arrangementprovisions may apply to deem the shareholder loans to be a non-share equity interest. Unforeseentax consequences may therefore result in the absence of any planning.

4.2 Deductibility of Interest (and Similar Costs)

Interest costs on debt interest loans and other costs incurred in obtaining or maintaining a debtinterest (debt deductions) are generally deductible in Australia where, ignoring any specificprovision which may apply to deny, limit or spread deductibility, the underlying debt is used inproducing income which is taxable in Australia

In addition, from 1st July 2001, deductions for these debt interest costs may be available to anAustralian resident where the costs are incurred in earning “non-assessable non-exempt” foreignincome (e.g. in the case of an Australian resident company certain non-portfolio dividends fromforeign countries).

Expenses associated with the derivation of exempt foreign branch income by an Australiancompany are, however, not deductible.




4.2.1 Stock Deal

• Funding Cost

Purchasers will typically use a mixture of debt and equity to fund an acquisition and theactivities of the target. For non-residents, maximising debt in the Australian target has severaladvantages. Interest paid offshore is only subject to 10% withholding tax, but is generallydeductible in Australia at 30% (subject to thin capitalisation constraints). General commentson deductibility of interest are set out in section 4.2. Repayment of debt principal is also aneffective method of repatriating surplus cash without a withholding tax or CGT cost.

With the introduction of the consolidation regime, acquisition structuring has become simplerwith intra-group dividends (i.e. within the Australian consolidated group being ignored for taxpurposes). This simplifies the repatriation of cash from operating companies to holdingcompanies in the Australian group to service debt commitments.

• Acquisition Expenses

Acquisition expenses (including acquisition stamp duty) are typically non-deductible, but formpart of the capital cost base for calculating gain or loss on future disposals.

With the introduction of a new uniform capital allowances regime, certain capital costs thatwould otherwise not be deductible because they do not relate to an underlying asset may beclaimed for tax purposes over five years. These include costs of establishing the businessstructure, costs of converting the business structure to a new structure and costs of defending atakeover or of unsuccessfully attempting a takeover. In each case, the taxpayer must incur thecosts for a taxable purpose which is generally for the purpose of deriving income that is subjectto Australian tax on an assessment basis. These costs would thus not be deductible to a non-resident acquiring stock in a resident company.

Costs of borrowing money are deductible against assessable income over five years, or overthe life of the loan if shorter than five years. The return provided to the financier (such as anamount of interest) is not a borrowing cost and is deductible as mentioned in section 4.2.

4.2.2 Asset Deal

• Debt Deductions

Debt deductions (being costs of obtaining or maintaining debt interests) are typically deductible,subject to thin capitalisation constraints. General restrictions on the deductibility of interestpayable on a debt interest where the debt is used to acquire certain foreign assets, or the debthas been created upon the acquisition of an asset from a foreign controller or an associate, havebeen lifted from 1st July 2001. The thin capitalisation regime is now viewed as the regime whichlimits the amount of debt deductions that can be claimed.

The deductibility of other borrowing costs is referred to in section 2.4.4.

• Acquisition Expense

See comments on the topic in section 4.2.1 above.




5. Mergers

There is no legal concept of a merger in Australia as it exists in other countries. The effect of a mergercan be achieved by acquiring the Target Company and then liquidating that company and transferring itsassets to the acquisition vehicle.

This can generally be achieved without any income tax or CGT, where the Target Company becomes amember of the consolidated group. However, the transfer of property from the Target Company to theacquisition company may be subject to stamp duty. Various exemptions from such stamp duty exist insome States, and therefore the ultimate stamp duty liability will depend on the location of the assets.

A cross-border merger can also be achieved in a similar way, though the relief from income tax, CGT andstamp duty is not likely to be available and therefore there will be a more significant tax cost.




6. Other Structuring and Post-Deal Issues

6.1 Repatriation of Profits

6.1.1 Taxation of Dividends

To the extent that dividends are paid between companies that are members of a tax consolidatedgroup, they will be ignored for calculating Australian taxable income of the group.

To the extent that dividends are not paid within a consolidated group, the dividend will be fullytaxable to the recipient company at the corporate tax rate. A “gross up and credit” system appliesfor franked dividends (i.e. those dividends paid out of previously taxed profits) received by acompany. The dividend is grossed up for the tax paid and the company is entitled to a tax offsetagainst tax assessed.

To the extent the dividend is unfranked (i.e. paid out of untaxed profits), the dividend is fully taxableto the recipient company and the company will not be entitled to a tax offset.

Non-portfolio dividends received by an Australian company from foreign investments are exemptfrom tax, regardless of the country of origin of the dividend. The recipient company must ownshares (excluding certain finance shares) entitling the shareholder to more than 10% of the votingpower in the foreign company to obtain this exemption.

Australia has a new conduit regime for foreign-sourced dividends flowing through Australiancompanies to a foreign parent. The new conduit foreign income (CFI) rules exempt from income taxand dividend withholding tax dividends paid from the following income:

• certain foreign-sourced dividends;

• foreign income and certain capital gains derived through a permanent establishment in a foreigncountry;

• capital gains from the disposal of shares in a foreign subsidiary not being subject to AustralianCGT; and

• foreign income and gains not subject to tax due to foreign tax credits.

These rules were effective from 1st July 2005.




6.1.2 Interest and Royalties

Interest and royalties are common and efficient methods of repatriating profits, because they aretypically deductible in Australia. The withholding tax cost is usually lower than the corporate taxsaved.

Strategies to repatriate profits using interest or royalties will need to take into account thincapitalisation constraints for interest, and transfer pricing provisions generally. Australia’s transferpricing regime is broadly consistent with OECD guidelines, but comparatively strict and effectivelypoliced by the ATO.

Interest withholding tax is imposed at a rate of 10%, with royalty withholding tax being imposed at30% (unless a lower rate is available under a DTA).

6.1.3. Capital Return

A capital return on shares is generally not assessable to a non-resident where the shares inquestion do not cease to exist, although the distribution of capital will cause a reduction in basisof the shares in the Australian entity for CGT purposes. To the extent the distribution exceeds thecost base (excluding certain finance shares) entitling the shareholder to a capital gain will occur.

However, a capital return can be treated as a dividend under specific anti-streaming rules whichmay apply where generally, capital is returned to the shareholder on the basis that the capital haseffectively been replaced by retained profits. In practice, it is common to request a ruling from theATO before making a capital return.

Share buy-backs can also be an effective method to return capital, although a deemed dividendcomponent would often arise.

6.1.4 Government Approval Requirements

Australia requires each currency transaction over $10,000, including international telegraphic andelectronic transfers, to be reported to the Australian Transaction Reports and Analysis Centre.However, this is not an approval requirement, but merely a notification issue.

6.1.5 Repatriation of Profits in an Asset Deal

If the assets are acquired directly by the foreign entity (i.e. through an Australian branch), no branchprofits tax will apply on cash paid offshore. Please refer to section 1.6.1 regarding the taxationof Australian-sourced profits.

Assets acquired by an Australian acquisition entity will have similar repatriation issues asdescribed previously for shares.

6.2 Losses

6.2.1 Tax Losses, Capital Losses and Foreign Losses

Unlimited carry forward applies to tax losses incurred in 1989-90 and subsequent years, althoughlosses may not be carried back. However, there must be a continuity of ownership (COT) of morethan 50%, or a continuity of the same business (SBT) in order to obtain a deduction for lossesincurred in the past or in any part of the current year (see section 2.2.3 for notes on these issues).Complex rules apply to losses carried forward by trusts.




As mentioned in section 2.2.3, the SBT is no longer available in respect of losses incurred in incomeyears commencing on or after 1st July 2005 for companies whose total income is more than $100million in the year of recoupment (i.e. affected companies would only be able to utilise theirlosses whilst they pass the COT).

Under the tax consolidation regime, subject to satisfying the COT or SBT at the joining time, lossesof a new group member may be transferred into a consolidated tax group. Losses transferred into aconsolidated group may have additional restrictions imposed on the rate at which they may be used.

Capital losses may only be used to offset capital gains. Capital losses may be carried forward (butnot carried back) indefinitely, subject to the COT and SBT requirements, as are for tax losses (i.e.losses on revenue account).

Foreign losses have historically been quarantined against specific classes of foreign income.However, this restriction has been lifted from 1st July 2001. There is now no quarantining of debtdeductions such as interest on a debt interest loan (except for debt deductions relating to a foreignbranch). As mentioned previously, the thin capitalisation regime limits the amount of debtdeductions claimable.

6.3 Continuity of Tax Incentives

Certain tax incentives may be lost when a business is transferred, particularly where the transfer isin the form of a sale of business assets. The terms of the relevant tax incentive should be reviewedto confirm the availability of the incentive post-deal.

6.4 Group Relief

Under the current consolidation regime, only the head company is subject to income tax. The headcompany of a consolidated group may obtain relief with respect to the use of available losses of thegroup. This relief may relate to losses created by existing companies within the group or joining thegroup (i.e. losses created before the companies joined are transferred to the group), or lossesgenerated by the head company while within the consolidation regime. Certain restrictions may beplaced on the rate at which losses generated by an entity which joins the group, may be used.

Whilst it is only the head company of a consolidated group that is subject to income tax, allmembers of the group may be jointly and severally liable for the tax in the event of a default unlessa proper tax sharing agreement applies. Where a proper tax sharing agreement is in place, eachmember is generally liable for the share of the liability allocated under the agreement. Companiesleaving a consolidated group must make a payment to the head company to discharge theirobligation under a tax sharing agreement so as to obtain a clear exit from their responsibility to paytax.




7. Disposals

7.1 The Preference of Seller: Stock vs. Assets Deal

A non-resident seller will generally prefer to sell shares rather than assets. This could be evenmore so once the proposed CGT exemption for non-residents holding interests in non land-richAustralian companies is enacted.

7.2 Share Disposal

7.2.1 Gain on Sale of Stock

• Capital Gains Tax

CGT generally applies to the disposal of shares acquired on or after 20th September 1985.Individuals or trusts that have held shares for more than twelve months may be entitled to a 50%CGT discount when calculating their taxable income. The sale of an asset acquired for thepurpose of profit making by resale will be taxable as income (subject to any DTA). In this case,the CGT rules will effectively adjust the capital gain so that there is no double tax (i.e. as incomeand as a capital gain).

A seller’s main concern will usually be CGT upon the disposal of its shares. Commercially, aseller may prefer to sell shares so as to not be left with a structure requiring liquidation orongoing maintenance.

Currently, for a non-resident, the sale or disposal of an interest in an Australian company issubject to Australian CGT if the interest is in a private company, or, in the case of an interest in apublic company, there is or has been within five years at least a 10% “associate inclusive”holding in the company.

In the case where a shareholder other than an individual makes a capital loss on sale of suchinterest, the capital loss may be reduced in certain circumstances where the company in whichthe interest is held (directly or indirectly) was a “loss company”.




The Government announced in its 2005 Budget that for non-residents, the CGT regime will benarrowed such that the tax will only apply to the disposal of Australian real property, businessassets of Australian branches and non-portfolio interests (i.e. 10% or more) in interposed entities(including foreign interposed entities) where the value of such an interests is wholly or principallyattributable to Australian real property. Currently, only portfolio interests (i.e. less than 10%) inAustralian public companies held by non-residents are exempt from Australian CGT. The exactdetail of the proposal has still not been released. This reform will have a major impact on thestructuring of M&A transactions and is expected to apply from 1st July 2006.

• Scrip-for-Scrip CGT Rollover

The “scrip-for-scrip” provisions provide rollover relief from CGT where an acquirer issues sharesto the vendor to acquire a Target Company. This allows a vendor to defer any CGT liability byreceiving shares in the acquiring entity as consideration for the transfer. This allows takeoversor mergers to occur without an immediate tax liability to the vendor.

To obtain scrip-for-scrip relief, the acquiring entity must acquire at least 80% of the voting sharesin the Target Company and issue scrip in return. The provisions are complex, and in a cross-border context their scope is largely limited to widely held entities.

• Shareholder Loans

Care needs to be taken when the Target Company has debts due to related parties which areunlikely to be repaid prior to the completion of the sale.

If the debts are simply forgiven, the Australian debt forgiveness rules may operate to deny thefuture utilisation of certain tax attributes of the Target Company (e.g. carried forward losses, bothrevenue and capital, and the tax base of certain depreciable and capital assets). Similar issuesmay arise if the outstanding debt is capitalised.

A commonly adopted alternative is to adjust the final purchase price by the amount of theoutstanding debt with the acquirer providing loan funds to the Target Company to enable thedebt to be repaid.

• Unwanted Assets

Assets held by the Target Company which are not to be included within the sale may betransferred prior to the acquisition to other members of the vendor’s wholly-owned consolidatedgroup, without giving rise to an immediate tax liability. However, a tax liability may crystallise ifthe transferred asset subsequently leaves the vendor’s group. This is therefore a factor toconsider on any future reorganisation of the vendor’s group. Also, stamp duty may apply to thetransfer of assets within a consolidated group, even if there is no income tax implication.

7.2.2 Distribution of Profits

Please refer to section 6.1 for further details.

Dividends paid to offshore investors are subject to withholding tax unless they are franked (i.e. paidfrom after tax profits). As withholding tax is a final tax, no further Australian tax is payable onrepatriated franked or unfranked dividends received by a non-resident.




7.3 Asset Disposal

7.3.1 Profits on Sale of Assets

As for shares, a seller’s main concern will be CGT upon the disposal of its assets. In addition,the sale of depreciable assets could result in a clawback of depreciation to the extent thatdepreciable property is sold above its tax written down value.

Unwinding, liquidating or maintaining the structure post sale has commercial complications which avendor may wish to avoid.


Please refer to section 6.1 for further details.

Dividends paid to offshore investors are subject to withholding tax unless they are franked (i.e. paidfrom after tax profits). As withholding tax is a final tax, no further Australian tax is payable onrepatriated franked or unfranked dividends received by a non-resident.

Where a non-resident company operates an Australian branch, there is no tax payable on theremittance of branch profits to the foreign head office. However, Australia has a peculiar law whichseeks to levy tax on dividends paid by non-residents which are sourced from Australian profits. Thismeans that if a foreign company pays Australian branch profits to its foreign shareholders as adividend, the shareholder is technically liable to Australian tax (which may be limited under anapplicable DTA). However, in practice the ATO has jurisdictional difficulties in collecting this liability.




8. Transaction Costs for Sellers

8.1 GST

GST is paid at a rate of 10% in Australia by purchasers of most goods and services. However, it isthe seller’s responsibility to correctly account for GST on the supplies made.

The sale of shares is an input taxed financial supply. GST costs incurred by the seller in relation tothe sale of the shares may not be recoverable in full.

Where a supply of assets satisfies the requirements for a sale of a “going concern”, the supply willbe GST-free. However, where the going concern requirements are not satisfied, the GST liability ofthe supply will depend on the nature of the individual assets.

The seller will be entitled to a full GST input tax credit on the GST costs incurred where the saleis a going concern or where the individual assets are all subject to GST at a rate of 10%.

8.2 Stamp Duty

Stamp duty is generally payable by the purchaser, unless otherwise stated in the purchaseagreement.

8.3 Concessions Relating to M&As

Certain concessions in relation to Australian income tax, GST and stamp duty may be available forthe reorganisation of a company prior to sale.

8.3.1 Income Tax

The transfer of assets within a tax consolidated group is ignored for Australian income tax purposes.However, stamp duty may still apply.




8.3.2 GST

As mentioned previously , there is a GST concession for the acquisition of a going concern. It isalso a possibility for eligible companies to form a GST group. This effectively allows transfers ofassets within the group to be disregarded. However, as discussed previously, stamp duty may stillapply.

8.3.3 Stamp Duty

Exemptions from stamp duty are available for certain qualifying reorganisations in some States.These exemptions typically feature a “clawback” provision, which seeks to enforce the stamp dutyliability where certain transactions subsequently occur (such as sale of particular assets or entities).

8.4 Tax Deductibility of Transaction Costs

Transaction costs incurred by a seller are typically included in the seller’s basis for the purpose ofcalculating the gain or loss on the transaction.




9. Preparation of Target Company for Sale

9.1 Transfer of Certain Assets to Another Group Company

In relation to the transfer of assets within a group, different rules apply for consolidated groups andnon-consolidated groups. Consolidated groups are able to ignore the transfer of assets betweenmembers of the group under the “single entity rule” (although stamp duty may still apply).

Transfers within non-consolidated groups may trigger a CGT gain or loss. When transferring assetsbetween entities and the consideration is not what would be regarded as arm’s length, a deemedmarket value is used to determine the gain or loss and provide the new cost base to the recipientcompany.

9.2 Declaration of Dividend Prior to Sale

Before the sale of a company, dividends may be paid in order to extract surplus cash. Where thesedividends are paid to non-residents, withholding tax will be required to be paid if the dividendsare unfranked (i.e. paid out of untaxed profits). Where the surplus cash represents repatriateddividends, no further Australian income tax will be payable.




10. De-mergers

Australian tax law offers de-merger rollover relief from CGT to tax consolidated groups and theirshareholders. The key conditions are:

• at least 80% of the de-merger group’s ownership interest in the de-merged entity must beacquired by the group’s shareholders;

• each shareholder must receive an equal corresponding proportion of interests in the de-mergedentity equal to their interest in the group prior to the de-merger;

• the total market value of each shareholder’s interests in the de-merger entity and the groupentity must at least equal the total market value of their interests in the group prior to the de-merger; and

• immediately prior to the de-merger, either 50% of the group must be held by Australian residentsor by non-residents whose interests in the de-merged entity have the “necessary connection withAustralia” (i.e. an asset which is subject to the CGT regime) after the de-merger.

De-merger dividends arising as a result of a de-merger may not be subject to Australian tax.

Shareholders of the group apportion their basis across their existing shares plus the additional shares inthe de-merged entity.




11. Trade Sale or Listing

After acquiring a target, a financial buyer generally looks for an exit route either through a trade sale oran initial public offer (IPO). The Australian tax treatment will depend upon the residence of the acquirerand whether the acquirer holds the target on revenue or capital account.

Where an Australian resident holds the target on capital account, gains on disposal will be assessed ascapital gains. A 50% CGT discount may be available to individuals or trusts if they have held the target fora period greater than twelve months. Where a resident is considered to hold the target on revenueaccount, proceeds from an IPO or other disposal, will be assessed as ordinary income.

Currently, where a non-resident holds an interest in an Australian private company on capital account, thenon-resident is subject to Australian CGT on any gain made on IPO or other disposal. However, it may bepossible that the gains are protected from Australian CGT under the relevant DTA. The same applies toshares disposed of by a non-resident in a public company where there is or has been within five years atleast a 10% associate inclusive holding in the company.

The 2005 Federal Budget included proposed changes to the CGT provisions for non-residents. Thischange would narrow the definition of assets that are subject to Australian CGT, in particular, exempting allgains made by non-residents on disposal of Australian companies from CGT where the value of theAustralian companies is not “wholly or principally” attributable to interests in real property situated inAustralia (e.g. land and mining rights). Although these changes have not yet been enacted, they areexpected to be passed by 30th June 2006.

Where a non-resident shareholder holds shares in a Target Company on revenue account, theshareholder is currently subject to tax on any gain made as such gain is considered Australian-sourcedincome, although the relevant DTA may override the domestic law. The status of the company and thelevel of shareholding are not relevant when the shares are held on revenue account. Whilst CGT may alsoapply to the disposal, there is generally a mechanism which seeks to avoid double tax.

In relation to GST, the supply of securities is treated as a “financial supply”, meaning GST is not chargedbut a credit for GST paid on related expenses may not be available. However, where the supply is made toa non-resident, it may be “GST-free”, which would allow a credit to be claimed for GST paid on relatedexpenses.

If a company is seeking to be listed on the Australian Stock Exchange, the listed vehicle, which can alsobe the acquisition vehicle, should be incorporated in Australia.




12. Tax Incentives

Depending on the nature and size of the investment project, State Governments have given rebates frompayroll tax, stamp duty and land tax on an ad hoc basis and for limited periods.

The major tax incentives/grants provided in Australia include:

• an outright deduction for capital expenditure incurred in the Australian film industry;

• a deduction over two years on any investments made in the course of obtaining copyright overAustralian films;

• an outright deduction for certain relocation costs incurred in establishing a regional headquarters;

• accelerated deductions for capital expenditure on the exploration for and extraction of petroleumand other minerals and certain quarrying operations;

• certain tax-exempt non-resident investors that satisfy Australian registration requirements areexempt from income tax on the disposal of investments in certain Australian venture capital equityheld for more than twelve months;

• pooled development funds (PDFs) are investment companies established to provide equity capitalto small and medium sized enterprises that are taxed at 25% on their net income (15% on incomefrom small and medium sized enterprises) and are entitled to imputation credits. Dividends from aPDF and gains on sale of shares in a PDF are exempt from tax;

• taxable income derived from pure offshore banking transactions by an authorised offshore bankingunit in Australia is taxed at a rate of 10%;

• Export Market Development Grant programme which provides funding of up to $200,000 forexpenditure in the development of eligible export markets; and

• a 125% deduction (increased to 175% for certain qualifying companies) for eligible research anddevelopment expenditure. A cash rebate may be available for small companies.




CHINA

Country M&A TeamCountry Leader ~ Danny Po

Becky LaiGary Chan

Howard L YuJanet Xu

Jeremy NgaiVickie Tan

Yeeckle ZhouCathy Kai Jiang

Phillis ChanWilliam LeeAnnie Qiao

Gordon ChoiJessie Li

Josephine JiangKenise Chan

Kevin LoQiuli Rao

Grace Cai






China - Hong KongDanny Po Partner +852 2289 3097 [email protected] Lai Partner +852 2289 1868 [email protected] Ngai Partner +852 2289 5616 [email protected] Kai Jiang Partner +852 2289 5659 [email protected] Chan Senior Manager +852 2289 5618 [email protected] Lee Senior Manager +852 2289 5698 [email protected] Chan Manager +852 2289 5615 [email protected] Zhou Manager +852 2289 5690 [email protected]

China - BeijingHoward L Yu Partner +86 10 6533 2007 [email protected] Choi Manager +86 10 6533 3035 [email protected] Jiang Manager +86 10 6533 3060 [email protected] Rao Manager +86 10 6533 3160 [email protected] Yee Ping Manager +86 10 6533 3156 [email protected] Cai Deputy Manager +86 10 6533 3006 [email protected]

China - ShanghaiGary Chan Partner +86 21 6123 3331 [email protected] Tan Partner +86 21 6123 2598 [email protected] Qiao Manager +86 21 6123 2901 [email protected] Li Manager +86 21 6123 3994 [email protected] Lo Manager +86 21 6123 2972 [email protected]

China - GuangzhouJanet Xu Partner +86 20 3819 2193 [email protected]

China - ShenzhenCathy Kai Jiang Partner +852 2289 5659 [email protected]

China - TianjinHoward L Yu Partner +86 10 6533 2007 [email protected]

PricewaterhouseCoopersHong Kong • 21/F Edinburgh Tower • The Landmark • 15 Queen’s Road • Central • Hong KongBeijing • 26/F Office Tower A • Beijing Fortune Plaza • 7 Dongsanhuan Zhonglu • Chaoyang District • Beijing 100020Shanghai • 11th Floor PricewaterhouseCoopers Center • 202 Hu Bin Road • Shanghai 200021Guangzhou • 25/F Center Plaza • 161 Lin He Xi Road • Guangzhou 510620Shenzhen • Room 3706 • Shun Hing Square • Di Wang Commercial Centre • 5002 Shenzhen Road East • Shenzhen518008Tianjin • 37th Floor • Golden Emperor Building • 20 Nanjing Road • Hexi District • Tianjin 300041




1. Introduction

1.1 General Comments on M&A in People’s Republic of China

This chapter details the main issues that are relevant to both purchasers and sellers on a transfer ofownership of a company in People’s Republic of China (PRC or China). It is generally assumed thatall sellers are PRC companies and that all purchases are made either by a foreign enterprise (FE)or through a foreign-invested enterprise (FIE) in PRC, unless otherwise indicated. A transfer ofownership of a PRC company may take the form of a disposal of shares or assets.

The relevant taxes to be considered in the context of a M&A transaction are detailed as follows.

1.2 Corporate Tax

Foreign Enterprise Income Tax (FEIT): Generally, PRC companies are taxed on a stand-alonebasis. FEIT taxes the profits earned by a company at a tax rate of 33%.

1.3 Withholding Tax (WHT)

A FE which has no permanent establishment, or place of business, in China but derives profit,interest and other income from sources in China is subject to WHT at the rate of 10% on suchincome.

1.4 Turnover Taxes

Value Added Tax (VAT): This is a sales tax where up to 17% is added to the sales price charged forgoods (except for certain categories of sales which are exempt from or outside the scope of VAT).

Business Tax (BT): Generally, BT of 5% is imposed on any transfer of immovable assets (e.g. landand real estate) and intangible assets (e.g. trademarks, patents and copyrights). In addition, a FEthat derives interest income from China is also subject to BT at the rate of 5%.

Consumption Tax (CT): CT is imposed on 11 categories of goods, including cigarettes, alcoholicbeverages and certain luxury items.




1.5 Stamp Tax

This tax is payable by both the purchaser and seller at rates ranging from 0.03% to 0.05% on thevalue of equity or asset transferred.


Land Appreciation Tax is imposed on the seller upon the transfer of land use rights and building andis assessed at progressive rates from 30% to 60% of the appreciated amount of the land use rightand building.

Deed Tax is payable by a purchaser at the rates ranging from 3% to 5% on the purchase price ofland use right or building.




2. Acquisitions

According to the Provisional Measure for Merger and Acquisition of Domestic Enterprises by ForeignInvestors (the Provisional Measure) effective from 12th April 2003 and issued by the Ministry of ForeignTrade and Economic Co-operation which is part of the Ministry of Commerce (MOC), the StateAdministration of Taxation (SAT), the State Administration of Industry and Commerce (SAIC), and theState Administration of Foreign Exchange (SAFE), foreign investors are now allowed to acquire PRCcompanies in one of the following ways:

• an acquisition of the equity or share holdings of a non-FIE by a foreign investor. This acquisition,subsequently, converts the target entity into a FIE (hereinafter referred to as a stock deal);

• an acquisition of the assets of a non-FIE by an existing FIE or by a foreign investor through theformation of a new FIE (hereinafter referred to as an asset deal).

In light of the above, special rules and regulations apply if foreign investors acquire stock in listedChinese companies (see section 2.2.1).


The adoption of an asset deal or a stock deal for an acquisition in China largely depends on theregulatory situations, as well as the commercial and tax objectives of the investors. For example, insome cases, an asset deal may be the only option for acquiring businesses from Chinese domesticenterprises.

2.2 Stock Deal

According to the Provisional Measure, under a stock acquisition, the Target Company remains as agoing concern subject to its originally approved operating period. The acquirer also inherits thebusiness risk and hidden or contingent liabilities, if any, of the Target Company. Accordingly, this riskshould be addressed by performing a due diligence on the target, through adjusting the purchaseprice and/or obtaining contractual warranty from the Target Company’s prior shareholders, wherecommercially viable.




Under a stock deal, there is no change in the legal existence or disruption to the attributes of theacquired PRC Company. Thus, the Target Company may not re-value its asset basis for Chinesetax purposes.

The transfer of a stock interest in a Chinese entity is subject to Stamp Tax on the transfer price.Such Stamp Tax is payable by both the buyer and the seller. Any acquisition expense incurred bythe buyer may not be allocated to the Target Company and, therefore, such expense generallyincurred by the offshore buyer may not be claimed as a tax deduction in China.

Generally, tax losses of the Target Company arising prior to the acquisition may continue to becarried forward after the stock acquisition for any period remaining within the five-year limit (seesection 6.2 for details).

2.2.1 Acquisition of Stock in Listed Chinese Companies

The stock of domestic Chinese companies may be listed on one of China’s two stock exchangeslocated in Shanghai and Shenzhen. Two classes of shares are tradable on these stock exchanges:

• Class A shares that are restricted to domestic traders and qualified institutional foreign investors(QFII); and

• Class B shares that are restricted to foreign investors and individual Chinese investors.

There are also two classes of shares that are not tradable. These two classes are:

• state-owned shares that are owned directly by the State; and

• legal person shares that are owned by another company or institution with a legal person status.

The legal person shares may be owned indirectly by the State if the shareholders of the legalperson shares are state-owned enterprises (SOEs). These non-tradable shares jointly account for60% or more of the total issued shares of a listed company.

• Acquisition of Tradable Stock

Foreign investors have long been allowed to acquire Class B shares in the Chinese market.However, Class A shares, which had previously been reserved for domestic investors,became available to foreign investors at the end of 2002 under the QFII rules jointly issuedby the China Securities Regulatory Commission (CSRC) and the People’s Bank of China.

The term “QFII” refers to foreign funds management companies, insurance companies,securities companies and other asset management institutions approved by the CSRC to investin the PRC securities market within the limitations set by the SAFE.

A QFII is able to invest in Class A shares, government bonds, convertible bonds and corporatebonds listed on China’s securities exchanges. However, for an investment in Class A shares,each QFII is allowed to hold less than 10% of particular listed company’s total issued shares. AllQFIIs together are allowed to hold in total more than 20% of particular listed company’s totalissued shares. Also, a QFII’s domestic investment activities should comply with the requirementsset out in the Guidance for Foreign Investment in Various Industries. Therefore, the QFII rulesoffer only limited possibilities for merger and acquisition activities in China.

• Acquisition of Non-Tradable Stock

Before 2003, non-tradable shares of listed Chinese companies may be transferred between theState and Chinese legal persons but were off-limits to foreign buyers. On 1st November 2002,the CSRC, the Ministry of Finance and the State Economic and Trade Commission jointly issuedthe Notice on Relevant Issues Concerning the Transfer to Foreign Investors of Listed CompanyState-Owned Shares and Legal Person Shares (the State-Owned Share Notice). This State-Owned Share Notice, effective from 1st January 2003, addresses the direct sale of both state-owned and legal person shares to foreign investors.




According to the State-Owned Share Notice, in principle, non-tradable shares may be sold bypublic bid. In the case of crucial items (which have not been defined), the sale must besubmitted to the State Council (the highest governmental administrative authority of China) forapproval. In addition, a share transfer to a foreign investor is subject to the Foreign InvestmentGuideline prohibitions and limitations on foreign investment in specified economic sectors.

Therefore, if, as a result of the proposed share acquisition, the foreign-owned interest exceedsthe limitations set out in the Foreign Investment Guideline, the transaction may not be approved.

Furthermore, a listed Chinese company that transfers its shares to a foreign investor, even if theamount of shares transferred resulted in the foreign investor having control over the company,the said company will not qualify as a FIE and, thus, it may not enjoy the various preferential taxtreatments granted to FIEs.

On 4th September 2005, the CSRC issued the Measures for the Administration of Share CapitalSegregation Reform of Listed Companies which stipulated that any sale of non-tradable shareswould require approval by at least two-thirds of all voting shareholders. It also emphasised theneed to compensate the holders of tradable shares for any significant falls, if any, in value of theshares as a result of the said sale transaction.

There are still a number of ambiguities as to how the State-Owned Share Notice will beimplemented. Therefore, foreign investments under this rule will have to be negotiated not onlywith the Chinese Target Company but also with several Chinese government authorities.

2.3 Asset Deal

In general, an asset acquisition involves the formation of a new company for the purpose ofacquiring the assets, liabilities and business of a Target Company. However, it should be notedthat the formation of a new company requires certain approval.

An asset deal is typically used in order to leave behind some of the inherent risks associated withthe Target Company. An asset acquisition helps to restrict the risks to the specific assets, liabilitiesand businesses being acquired. Thus, the acquirer generally does not assume any contingent orhidden liabilities of the Target Company. However, in certain specific situations, an asset deal is notimmune from the inherent risks related to the assets acquired. For example, if there is any defaulton the Target Company’s part of import duty and VAT on the assets acquired, PRC Customs maypursue the assets, notwithstanding that they have been sold. The seller is required to pay PRCtaxes in respect of the transfer of the following assets:

Generally, the seller and buyer may only retain and carry forward their respective tax losses andmay not transfer the tax losses to the other party through the transfer of their assets and businessoperations to the other party.

Nature of assets acquired Relevant tax

Land, building and intangibles Business tax 5%

Inventory VAT 17%

Inventory – Category of goods subject to CT CT at various rates

Used equipment sold above original cost VAT 2%

Motor vehicles sold higher than the original cost VAT 2%




2.4 Transaction Costs for Purchasers

2.4.1 Turnover Taxes

• Stock Purchase

In general, stock transfers are not subject to VAT or BT.

• Asset Purchase

From the purchaser’s perspective, if the purchaser is subject to the VAT regime and is obliged tocharge VAT on its sales (output VAT), the purchaser may recover VAT paid by it on thepurchases (input VAT) of inventory from the seller. A purchase of inventory (excluding fixedasset) on which VAT has been charged by the seller is regarded as an input for the buyer.Therefore, VAT charged by the seller may be recovered by the buyer.

Note that in some situations, depending on certain VAT related characteristics of the purchaser,the input VAT may not always be recoverable in full. Hence, to the extent to which the VAT paidmay not be recovered, such non-recoverable VAT would be a real cost to the purchaser.

For certain types of inventory, the CT paid for the purchase of inventory could be offset againstthe CT liabilities for a manufacturing purchaser if the said inventory is used for the production ofanother product that is also subject to CT. Otherwise, the CT paid would be a real cost to thepurchaser.

2.4.2 Stamp Tax and Other Relevant Taxes

• Stock Purchase

Stamp Tax of 0.05% is payable by both the purchaser and the seller on the amount ofconsideration or value of the transfer of stock, whichever is higher.

• Asset Purchase

Deed Tax of 3% to 5% of the amount or value of the transfer consideration is payable by thepurchaser on transactions related to land or real estate properties in the PRC.

In addition, under an asset deal, the sale of inventory and fixed assets is subject to a Stamp Taxat the rate of 0.03% on the value set out in the relevant sales contracts. Stamp Tax at 0.05%would be applied on the transfer of immovable or intangible assets. This Stamp Tax is imposedon both the seller and the buyer.


According to the latest notice issued by the SAT, Deed Tax will not be payable if the transfer of landor real estate ownership is caused by a SOE’s restructuring (e.g. conversion to a limited liabilitycompany) during the period from 1st October 2003 to 31st December 2005. However, it is unclearwhether the above preferential tax policy will be extended to 31st December 2008 (as regulated inthe latest circular Cai Shui [2006] No. 41).


The PRC tax laws and regulations do not provide clear stipulations on the deductibility oftransaction costs. In general, FIEs are not allowed to take deductions for expenses related tofeasibility studies, interest expense on investment loans, management expenses and otherinvestment-related expenses for FEIT purposes. Nevertheless, if a FIE uses non-cash assets(e.g. tangible and intangible assets) to acquire stock or assets, the difference between the originalbook value of the non-cash assets and the purchasing price of the acquired stock or assets istaxable profit or deductible loss of the seller in the taxable period of the transaction.




3. Basis of Taxation Following Asset or Stock Acquisition

3.1 Stock Deal

Stock purchased should be recorded by the purchaser in its books at the acquisition cost. Noadjustment to the basis of the underlying assets of the company is allowed for PRC tax purposes.Where adjustments have been made for accounting purposes (usually through revaluation) and therelevant depreciation and amortisation is based on such adjusted values (hereinafter referred to asaccounting adjustment), the taxable income of the acquired company is required to be adjusted inthe annual FEIT filing. The following are methods that may be adopted to account for such taxadjustment:

• actual annual adjustment method (Profit & Loss approach) - the annual taxable income isadjusted by the actual increase or decrease in the relevant cost or expense resulting from theaccounting adjustment for each specific asset item; and

• consolidated adjustment method (Balance Sheet approach) - all of the balance sheetadjustments for the revalued assets are consolidated (i.e. netted off against each other) andspread evenly over a 10-year period for tax adjustment purposes.

The FIE should apply for approval from the relevant tax authority before adopting either of theabove adjustment methods.

3.2 Asset Deal

Each asset purchased should be recorded on the buyer’s books at its actual purchase price. In thecase where a lump sum purchase price is paid for numerous assets or together with goodwill orbusiness operations and cannot be specifically allocated to each asset, the buyer should record asthe cost of each asset the corresponding net value on the seller’s books before the transfer. Thebalance of the purchase consideration after offsetting against the net book value of the assets isregarded as the purchase price for goodwill or business operations and should be recorded asintangible assets on the buyer’s books. The balance recorded may then be evenly amortised overthe shorter of 10 years or the remaining operation term of the buyer.





4.1 Thin Capitalisation

According to the prevailing PRC FIE laws and regulations, a FIE should comply with the followingdebt-to-equity ratio (i.e. the difference between the total investment and registered capital may befinanced by debt).

4.2 Deductibility of Interest

4.2.1 Stock Deal

For FIEs, interest expenses incurred in respect of loan used to acquire an investment are notdeductible from taxable income.

4.2.2 Asset Deal

As indicated in section 2.3, an asset deal generally involves the formation of a new company toacquire the relevant assets. In respect of a new company which is a FIE, interest incurred toacquire the relevant assets shall be capitalised and depreciated over the useful life of the assets forFEIT purposes.

Total investment (TI) (USD) Minimum registered capital

Less than 3 million 70 % of TI

Between 3 and 10 million Higher of 2.1 million or 50 % of TI

Between 10 and 30 million Higher of 5 million or 40 % of TI

More than 30 million Higher of 12 million or 331/3% of TI




5. Merger

5.1 Legal Forms

In China, a merger refers to the combination of two or more enterprises into one enterprise. Such acombination may take the form of an absorption merger or a new company merger.

An absorption merger is a merger where one party continues to exist while other parties to themerger are dissolved.

A new company merger is a merger where all the parties to the merger are dissolved, and a newenterprise is established to take over the merged business.

5.2 Typical Scenarios of Merger

• New Company Merger

Scenario 1:

A and B are liquidated

BA

SAl lSB

C

A and B distributetheir total assets and

liabilities to C

A B

SAl lSB

C

Shareholders of A (SA)and B (SB) receive sharesfrom C in exchange for all

their shares in A and B

C BA

A & B become subsidiaries of C

SA SB




Scenario 2:

• Absorption Merger

Scenario 1:

Scenario 2:

hold shares

transfer shares

transfer assets and liabilities

A and B are liquidatedA and B distribute sharesin C to sharehlders SA

and SB

A and B contribute allassets and liabilities to C inexchange for shares in C

A and B become shareholders of C

BA

SA SB

C

SA and SB become shareholders of C

BA

SA SB

C

BA

SA SB

C

B is liquidatedB distributes all its assetsand liabilities to A

Shareholders of B (SB)exchange all their shares in

B for new shares in A

SB become shareholders of AB becomes subsidiary of A

SA SB

A B

SA SB

B

A

SA SB

B

A

B is liquidatedB distributes the sharesin A to its shareholders

SB

B contributes all its assetsand liabilities to A in

exchange for shares in A

B becomes a shareholder of A

SA

A

SB

B

SA SB

A

B

SA SB

A

B






Any after-tax profit remitted by a FIE to its foreign investors is exempt from PRC taxes. However,before a FIE may distribute dividends to its foreign investor, the FIE must meet the followingconditions:

• the registered capital has been duly paid up in accordance with the provisions of its articles ofassociation;

• the company has begun to make profits (i.e. show profits after covering the accumulated taxlosses from prior years, if any);

• PRC FEIT has been paid by the FIE or the company is in a tax exemption period; and

• the statutory after-tax reserve funds (see below) have been provided for.

According to the PRC Equity Joint Venture Law, a foreign equity joint venture company is requiredto contribute its after-tax profit to statutory reserve funds before any after-tax profit may bedistributed to its shareholders as dividend. Components of the statutory reserve funds include thegeneral reserve fund (GRF), staff benefit and welfare fund (SBWF) and enterprise developmentfund (EDF). The contribution rate to the SBWF and EDF is at the discretion of the FIE. However, thecompany must contribute at least 10% of its after-tax profits to the GRF until the cumulative amountrepresents 50% of the registered capital.

A wholly foreign-owned enterprise (WFOE) is only required to provide GRF and SBWF, and not EDF.

In addition, a FIE is allowed to repatriate its after-tax profits as dividend payments in foreigncurrency upon the presentation of the following documents/certificates:

• the Board of Directors’ resolution on distribution of profits;

• audit report issued by a Chinese CPA certifying the amount of distributable profits; and

• relevant tax payment certificates.

Generally, profit remittances as dividend payments do not need the approval of the SAFE but maybe made by the remitters through their basic foreign exchange accounts in a bank. The remittanceamount may also be purchased from designated foreign exchange banks or swap centers bypresenting the above documents and certificates.




6.2 Losses Carried Forward and Applicable Tax Rate

Tax losses arising in pre-merger periods may continue to be carried forward by the surviving entityfor not more than five years.

The FEIT rates applicable to different operations of the surviving entity are determined according tothe locality and industrial nature of the actual business activities of such operations.

Where different tax holiday treatments or tax rates are applicable to different operations of thesurviving entity, an apportionment of taxable income is required for FEIT purposes. Losses carriedforward from operations entitled to different tax treatments, for example, tax holiday concessionaryrate (hereinafter referred to as tax operations), may be offset only against the correspondingapportioned taxable income of the surviving entity.

Where different tax rates apply, the taxable income of the surviving entity is apportioned based onthe rules below:

• Actual Basis

Where different tax operations are maintained by the surviving entity and separate accountingbooks are kept to record the activities of each tax operation, taxable income may be apportionedon an actual basis (i.e. based on each operation’s own accounting records). The resultingapportionment should still be accurate and reasonable.

• Deemed Ratio

Where the surviving entity does not maintain different tax operations or when the surviving entitymaintains different tax operations but is unable to compute the respective taxable income on anaccurate and reasonable basis, the surviving entity should apportion its total taxable incomeamong the tax operations based on certain financial ratios (e.g. annual turnover, cost, expense,assets, number of employees, wages and salaries). The taxpayer may use one or a weightedaverage of all such ratios subject to the tax authority’s agreement. Where the relevant ratios forthe year of merger are difficult to determine, the records for the last complete tax year before themerger may be used.

Specifically, when the surviving entity has a net profit or loss, income tax should be levied at therates applicable to the profit making operations. For the operations which have been sustaininglosses but turn profitable in a later year, special rules apply in determining the tax rate.

6.3 Continuation of Tax Incentives

6.3.1 Change of FIE Status

Unless otherwise stipulated, when the ratio of foreign investment in a FIE falls below 25% of thetotal registered capital after an acquisition, merger or de-merger, the PRC FEIT laws andregulations applicable to FIEs no longer apply to that reorganised entity. Instead, the reorganisedentity is treated as a domestic enterprise (as opposed to a FIE) for tax purposes. As a result, anyFEIT exemption or reduction already enjoyed by the original FIE during its FEIT holidays should betreated as follows:

• Foreign Investment Remains

If all of the foreign investments in the FIE still remain in the reorganised entity, no clawback ofthe exempted or reduced FEIT will be required regardless of the actual operating term of thereorganised entity.




• Foreign Investment Withdrawn

If all or some of the foreign investments in the FIE have withdrawn or transferred to domesticinvestors during the reorganisation and the operating term of the reorganised entity does notmeet the FEIT holiday requirement (normally 10 years), a clawback is required for the previouslyexempted or reduced FEIT amounts.

6.3.2 Tax Holiday

If the surviving entity still meets the requirements for a tax holiday, the surviving entity shouldcontinue to enjoy the tax holidays to which A and B were entitled before the merger. Specifically, thefollowing rules apply;

• if the tax holiday has already expired before the merger, no renewal of the tax holiday is allowedfor the surviving entity.

• if the tax holiday has not been used up by the time of the merger and the remaining holidayperiods for A and B are the same, the surviving entity should continue to enjoy the relevant taxholiday until expiration of the remaining holiday period. For instance, if both A and B are entitledto a two-year exemption and a three-year 50% reduction for FEIT purposes and both haveenjoyed the benefit of two holiday years before the merger, the surviving entity can only obtainthe benefit of the remaining three-year 50% reduction holiday period; and

• if the remaining holiday periods for A and B are different or if one entity was not entitled to anytax holiday, the taxable income of the surviving entity should be apportioned for FEIT purposes(see section 6.2 for details). After such apportionment, the surviving entity should continue toreceive the benefit of the relevant tax holiday for the taxable income attributable to the taxoperation entitled to the remaining tax holiday. However, tax holiday treatment will not apply forany remaining taxable income that is not attributable to such tax operation.

6.4 Group Relief

China has a separate entity basis of taxation for FIEs. Therefore, tax groupings are not applicablefor FIEs in China.




7. Disposals

7.1 The Preference of Sellers: Stock vs. Assets Deal

As explained in section 2.1, the adoption of an asset deal or a stock deal for an acquisition in Chinalargely depends on the regulatory situations, as well as the commercial and tax objectives of theinvestors. In some cases, an asset deal may be the only option for selling the businesses by theseller (especially for SOEs) due to regulatory restrictions.

7.2 Stock Disposal

7.2.1 Profit on Stock Disposal

Gains on the disposal of stock of a Chinese company are regarded as being sourced in China(China-sourced). Therefore, China’s tax authorities have the right to tax such gains. When theproceeds are then repatriated to the locality in which the investor is a tax resident, the local taxauthorities may impose further taxes on those same amounts. Depending on the law of suchlocality. Where there is double taxation, relief may be provided by local tax provisions or a doubletax treaty (DTT) if that locality has concluded a DTT with China.

The following table provides an overview of the PRC tax treatment for a stock disposal by differenttypes of investors.




Stock Investment – Tax on Disposal Gain


• Companies

Pursuant to the PRC FEIT laws and regulations, any FE which does not have an establishmentor place in China but derives profit, interest and other income from sources in China, is subjectto a WHT at the rate of 10% on such income. However, a FE that receives dividends or derivestrading gains from B shares is provisionally exempt from WHT. Please note that a QFII would notbenefit from this exemption as a QFII is only allowed to invest in A shares.

Gains and losses on the disposition of stock realised by FIEs are generally subject to FEIT andshould be included in the profit or loss of the FIE in the taxable period incurred. Please seesection 8.4 for more details.

• Individuals

Foreign individual investors receive the same treatment as FEs regarding their stock disposals(i.e. exempt from WHT for trading gains derived from B shares).

Type of Taxes Shares in Shares in listed companyinvestor non-listed

company A Share B Share Non-tradableshare

QFII WHT N/A Not stipulated N/A N/Ain current lawsand regulations(may be taxableat 10%)

FE WHT 10% on net N/A Exempted Not stipulated in(other than transfer gain current laws andQFII) regulations (may

be taxable at10%)

Foreign WHT N/A N/A Exempted N/Aindividual

Domestic FEIT 33% on net 33% on net N/A 33% on netinvestor transfer gain trade gain transfer gain(includingFIE)

Domestic IIT 20% on net Exempted Exempted N/Aindividual transfer gain




7.3 Asset Disposal (Companies Only)

7.3.1 Profit on Asset Disposal

A valuation for state-owned assets is required for any PRC company involved in an asset transfer,exchange or mortgage procedure. The valuation should be adopted as the pricing basis for theasset disposal (see section 9.2).

Gain arising from the sale of assets is included as taxable income for the seller and is subject toFEIT. There is no PRC tax exposure on the transfer of liabilities.

In addition, some of the fixed assets of the seller may have been imported into China free of importduty. For these import duty free assets, the Customs Office imposes a supervising period (generally,a period of five years). In the event that these assets are sold within the supervising period, therelevant portion of the import VAT and duty based on the asset’s depreciated value would berequired to be paid back before these assets can be sold.


The tax treatment for distribution of profits as asset disposal is the same as share disposal asexplained in section 7.2.2.




8. Transaction Costs for Seller

8.1 Turnover Taxes

• Stock Disposal

Disposal of stock is exempt from VAT and BT.

• Asset Disposal

Generally, the sale of tangible goods (including machinery and equipment, etc.) is subject to VAT(plus CT if tangible goods are one of the 11 categories of goods taxable for CT) at 17% normallywhich is payable by the seller. However, VAT is temporarily exempted on the sale or transfer ofused fixed assets if the following criteria are satisfied:

– the tangible goods are included in the Fixed Assets List of the seller;

– the tangible goods are managed and have been used as fixed assets; and

– the sales price does not exceed the original purchase value.

If all the above criteria are satisfied and approval is received by the in-charge tax bureau, thetransferred fixed assets may be exempted from the VAT. If only the first two criteria are satisfied,the excess of the sales price over the original purchase value is subject to VAT at the effectiverate of 2%, without any input VAT deduction.

For the sale of intangible assets (e.g. patent, land use right and goodwill) and immovable assets(e.g. real estate properties), BT at a rate of 5% of the transaction value is imposed on the seller.

8.2 Stamp Tax and Other Relevant Taxes

• Stock Disposal

Stamp Tax is payable by both buyers and sellers on the disposal of shares (see first point ofsection 2.4.2).




• Asset Disposal

Stamp Tax is payable by both buyers and sellers on the disposal of certain assets (see secondpoint of section 2.4.2).

Land Appreciation Tax is imposed on the seller upon the transfer of land use rights and buildingand is assessed at a progressive rate from 30% to 60% of the appreciated amount of the landuse right and building.


A foreign investor may transfer its ownership in a PRC FIE at cost (i.e. no capital gain) to anotherinvestor, provided that the following conditions are met:

• the transfer of share interest is connected with a corporate reorganisation of the group forgenuine business purposes; and either

• the transfer is conducted between an FE/FIE and its 100%-owned subsidiary (i.e. a companydirectly or indirectly wholly owned by the FE/FIE); or

• the transfer is conducted between an FE/FIE and another FE/FIE which is 100%-owned by acommon parent.


• Determination of Gains or Losses

Gains or losses from an exchange or transfer are determined as follows:

Transfer Gain or Loss = Transfer Value - Transfer Cost

(Where) Transfer Value = Transfer Price - Allowable Exclusion

Transfer cost refers to the original book value or actual purchase value of the investment beingtransferred.

Transfer price refers to the gross receipts from the investment transfer, including all cash and in-kind items (e.g. non-cash assets and ownership equity).

Allowable exclusion refers to the value of the undistributed retained earnings and reserves(URER) to be transferred. The URER value should not exceed the total book value of the URERto which the transferor is entitled.

Therefore, the formulas can be consolidated as follows:

Transfer Gain or Loss = Transfer Price - Allowable Exclusion - Transfer Cost

• FEIT Treatment of Gains

Gains derived from an exchange or transfer by a FIE or FE is subject to FEIT or WHT. However,as illustrated in the above formula, the transfer price attributable to URER is excluded for FEITpurposes. The reason for the exclusion is that under the FEIT law for a FIE and FE,undistributed retained earnings are not subject to further taxes when distributed.

• FEIT Treatment of Losses

Similarly, losses incurred during a transfer by a Chinese entity (including FIEs) are deductible forFEIT purposes. However, it is not clear at the moment whether the allowable exclusion cancreate a loss. For instance, in the case where the transfer price is equivalent to or less than thetransfer cost, the authorities are unlikely to allow the exclusion of the URER value (stated in thetransfer agreement).




9. Preparation of Target for Sale

9.1 Pre-deal Planning

A foreign investor should view preliminary targets based on the following aspects before taking thefirst step to conduct the actual tax and regulatory due diligence review.

• Regulatory efficacy: Restrictions of the proposed investment under the current PRC laws andregulations.

• Funding options: Capital contribution requirement and financing options for the proposedinvestment project.

• Investment evaluation: Tax attributes and the possible business scope to be approved for theproposed investment.

• Exit strategy: Options for future disposal of the China investment and the related tax andregulatory considerations.

9.2 State-owned Assets Valuation

A valuation for the state-owned assets for the entities involved would be required in any of thefollowing situations:

• an entity or a part of an entity is restructured into a limited liability company or company limitedby shares;

• the use of non-cash assets for investment purposes;

• a merger, division or liquidation;

• a change in the equity holding percentage of the original investors (except for listed companies);

• a transfer of all or a part of the ownership or equity of a company (except for listed companies); or

• an asset transfer, exchange or mortgage.

The entities required to obtain a valuation for the state-owned assets should engage specialisedvaluation agencies with relevant qualifications.

In addition, the entities conducting the transactions that require a valuation should use suchvaluation as the basis for pricing such transaction. In case the actual price has a difference of morethan 10% compared to the valuation result, such entities should provide a written explanation forsuch price difference to the in-charge financial authorities (or the group company and other relevantauthorities).




9.3 Anti-trust Review

The Provisional Measure has anti-trust implications, although the term itself is not used. Investorsare required to report an acquisition of shares or assets in certain circumstances. The authoritiesmay prohibit the acquisition if they believe it would create an obstacle to future market competition,or would be harmful to consumers’ interest. However, the lack of definitions for many terms(e.g. market) suggests that many of the requirements may be difficult to apply.




10. De-mergers

In China, a de-merger refers to the split of one entity (referred to as A below) into two (or more) entities(referred to as the surviving entities) according to the relevant PRC laws and regulations.

10.1 Split-off De-merger and Spin-off De-merger

De-mergers can be separated into the following two categories:

• Split-off De-merger

The shareholders of A receive shares of newly established surviving entities in exchange for allof their shares in A. A then distributes all of its assets and liabilities to the surviving entities andliquidates afterwards. Alternatively, A may contribute all of its assets and liabilities to thesurviving entities in exchange for shares in the latter. A then distributes the shares of thesurviving entities to the shareholders of A and is liquidated afterwards.

• Spin-off De-merger

The shareholders of A receive shares of the newly established surviving entity B (or entities) inexchange for newly issued shares or for part of their shares in A. A then distributes thecorresponding portion of its assets and liabilities to the new surviving entity. A split-up of A and Boccurs when the distribution is in exchange for the newly issued shares or a part of the shares inA. Alternatively, A may contribute a part of its assets and liabilities to the new surviving entity B inexchange for shares in the latter. A then distributes the shares in the new surviving entity to itsshareholders.

A continues to exist (as a surviving entity) after the de-merger.

For both types of de-mergers, the following applies:

• for split-off de-mergers, A does not need to be liquidated for tax purposes;

• the shareholders of A may decide to hold shares in all or some of the surviving entities (includingA after the de-merger); and

• all of the assets and liabilities of A should be transferred to or partially remain in the survivingentities after the de-merger according to the statutory procedures and stipulations in thede-merger agreement. The relevant shareholders should be able to determine the split ratio forassets and liabilities in the de-merger agreement.




10.2 Tax Consequences

Business operations of the surviving entities should be treated as a continuation of the businessoperation of A before the de-merger for tax purposes. If the surviving entity qualifies as a FIE, therelevant FEIT treatment discussed below would apply. Otherwise, please refer to section 6.3.1 fordetails.

• Revaluation (Step Up Value)

The rules are similar to those discussed in section 3.1.

• FEIT Preferential Treatments

The FEIT treatment (including rates, continuation of tax holiday, etc.) applicable to eachsurviving entity should be determined based on its locality and business nature according to therelevant provisions in the FEIT law and its detailed rules and regulations.

In areas pertaining to a tax holiday, the following rules should be observed:

– Business nature remains the same: If the surviving entities assume the same businessnature (as that of A) for tax purposes, it should continue to enjoy tax holidays applicable to Ain the remaining holiday period. No renewal of tax holidays is allowed for the survivingentities.

– Business nature changes: In the case where the tax holidays applicable to A no longer applyto one of the surviving entities due to its business nature, that surviving entity would notcontinue to enjoy the relevant treatments. That surviving entity may, however, continue toenjoy the tax holidays (starting from the first profit making year of the original entity A) in theremaining holiday years after the de-merger if it qualifies for the tax holidays. For instance, ifthe new business nature allows the surviving entity to enjoy a two-year exemption and three-year 50% reduction, and the original entity began to make profits two years before the de-merger, the surviving entity may only enjoy the remaining three-year 50% reduction holidayperiod from the year of de-merger.

• Losses Carried Forward

Tax losses arising prior to the de-merger should be split among the surviving entities accordingto the de-merger agreement. Each surviving entity may then carry forward its own portion of theabove losses within the five-year limit. Agreement for the appropriate split of losses should beobtained from the tax bureau.




11. Listing/Initial Public Offer (IPO)

The tax status of a company being listed and its subsidiaries is generally unaffected by listing/IPO.

11.1 Issue of New Stock by Listed Company

The issue of new stock by the listed company would result in a capital increase and would,therefore, trigger a stamp tax at the rate of 0.05% of the increased capital.

11.2 Disposal of Stock by Existing Shareholders

If the listing/IPO involves the disposal of stock by existing shareholders, the tax position for thoseshareholders is as outlined in section 7.2.




HONG K ONG

Country M&A TeamCountry Leader ~ Guy Ellis

Nick DignanRod Houng-Lee

Tony TongJames Strong

Patrick YimSandy FungNicholas Lui






Guy Ellis Partner +852 2289 3600 [email protected]

Nick Dignan Partner +852 2289 3702 [email protected]

Rod Houng-Lee Partner +852 2289 2472 [email protected]

Tony Tong Partner +852 2289 3939 [email protected]

James Strong Senior Manager +852 2289 3709 [email protected]

Patrick Yim Senior Manager +852 2289 3717 [email protected]

Sandy Fung Senior Manager +852 2289 3716 [email protected]

Nicholas Lui Manager +852 2289 3708 [email protected]

PricewaterhouseCoopers • 21F Edinburgh Tower • The Landmark • Central • Hong Kong




1. Introduction

1.1 General Comments on M&A in Hong Kong

This chapter details the major tax issues that are relevant to both purchasers and sellers in thetransfer of ownership of a Hong Kong business.

A transfer of ownership of a Hong Kong business can take the form of a share or asset transfer.Their different tax implications will be discussed later in this chapter. As the Hong Kong companylaw does not include the concept of “merger”, a business combination is generally implemented byway of the transfer of business from one company to another or by transferring the business of bothcompanies to a third one.

The relevant taxes to be considered in the context of a M&A transaction are detailed below.

1.2 Corporate Tax

General Tax Regime

Hong Kong imposes profits tax on a person carrying on a trade or business in Hong Kong in respectof his assessable profits sourced in Hong Kong from that trade or business. Gains arising from thedisposal of capital assets and income of non-Hong Kong sources are not subject to profits tax.

The rules apply equally to Hong Kong incorporated entities (generally limited liability companies)and foreign entities carrying on business in Hong Kong through a branch.

The principal forms in which a business may be conducted in Hong Kong are as follows:

• company incorporated in Hong Kong;

– private

– public (normally listed on the Stock Exchange of Hong Kong)

• branch of a foreign company;

• representative or liaison office of foreign company;

• partnership; and

• unincorporated joint venture.




Private Hong Kong companies and branches of foreign companies are the business entities mostcommonly used by foreign investors, since limited liability is usually desirable. From a Hong Kongprofits tax perspective, the choice between the two is neutral. Some investors may prefer to use abranch of a foreign company for the following reasons:

• it is not required to prepare audited accounts in Hong Kong;

• there is no Hong Kong stamp duty on transfer of shares in a foreign company, unless the sharesconstitute Hong Kong stock (see section 1.5 below); and

• there may be home country tax advantages for some foreign investors.

Tax Rates

The profits tax rate for incorporated businesses is currently 17.5%. This rate has been applicablesince the Year of Assessment 2003/04.

Unincorporated businesses are charged to profits tax at the current rate of 16%. This rate has beenapplicable since this Year of Assessment 2004/05.

Taxation of Dividends

Dividends whether received from a company in Hong Kong or from overseas, are not subject toprofits tax in Hong Kong.

1.3 Withholding Tax

Withholding taxes are only charged in respect of royalties or similar payments to a non-residentparty. The rate at which withholding tax applies is either 5.25% or 17.5%. The higher rate applieswhere the payer and the payee are related and the intellectual property in question was previouslyowned by a person in Hong Kong. This rate of withholding tax may be reduced if the recipient of theroyalty is entitled to the benefits of one of the few comprehensive double tax agreements to whichHong Kong is a party.

Except for the above, Hong Kong does not impose withholding taxes on other payments such asdividends and interest.

1.4 GST/VAT

There are currently no GST/VAT or turnover taxes in Hong Kong.

1.5 Stamp Duty

Stamp duty at progressive rates of up to 3.75% applies on conveyances of immovable property,payable by each party to the contract in equal shares (subject to any commercial negotiation). Therate for the transfer of Hong Kong stock, being shares the transfer of which is required to beregistered in Hong Kong, is 0.2% which is payable by the seller and purchaser in equal shares(i.e. 0.1% each). The level of duty is computed by reference to the higher of consideration or themarket value of the assets being transferred. There is an exemption from stamp duty (providedcertain conditions are fulfilled), for a conveyance of an interest in immovable property or a transferof Hong Kong stock, between companies with at least a 90% common shareholding. Thisexemption must be obtained by application to the Stamp Office supported by relevant documentaryevidence.

The term “Hong Kong stock” generally means those shares or stock, the registry of which ismaintained in Hong Kong.





Property tax applies to the net assessable value of real property located in Hong Kong. However, ifcompanies are subject to profits tax on income received from the property, property tax will not beapplied.

Capital duty of 0.1% applies to increases in authorised share capital (capped at HK$30,000 perincrease) of a company.




2. Acquisition

2.1 The Preference of Purchasers: Stock vs. Asset Deal

From a tax perspective, a purchaser of a Hong Kong business may prefer an asset deal as thiswill allow for the re-setting of the tax bases of depreciable assets as well as ensuring deductibilityof interest on acquisition debt. However, there may be circumstances in which a stock deal resultsin lower tax transaction costs.

Tax considerations for each option are set out below.


A purchaser generally has a variety of considerations to bear in mind, apart from the basiccommercial and financial implications of the chosen method of acquisition. Factors that may offsetthe usual concerns over the unknown liabilities, which may be locked in a company, include:

– losses that would be preferable to be preserved and utilised in the Target Company;

– real estate in the Target Company, which would result in a significantly higher stamp duty cost ifan asset purchase takes place;

– potentially higher tax bases for depreciable assets; and

– simplified transaction formalities (e.g. contracts previously entered into by the Target Companymay remain undisturbed).

• Tax Losses Carried Forward

In this connection, while tax losses may generally be carried forward indefinitely to offset againsta company’s future taxable profits, there is a provision in the tax legislation that may restrict thecarry forward of tax losses in the Target Company if the sole or dominant purpose of the changein shareholding of the company is to use up those losses. This provision is unlikely to be invokedfor a commercially driven company acquisition/restructuring.




• Unutilised Tax Depreciation Carried Forward

For Hong Kong profits tax purposes, tax depreciation in any one year must be calculated and willform part of the deductions from taxable profits taken into account in arriving at the taxable profit(or loss) for the year. Therefore there is no concept of unutilised tax depreciation in Hong Kongand no specific rules for recoupment of it.

• Tax Incentives

There are no specific tax incentives that would be impacted by a change in ownership of thestock in the Target Company.


Subject to the fulfilment of certain statutory requirements, an asset acquisition generally enables thepurchaser to avoid exposure to the risk of any historic tax liabilities that may not specifically berecoverable through the sale agreement. Liabilities associated with a company whose business isbeing sold remain the responsibility of the company and do not become the responsibility of thepurchaser unless the parties contract to transfer specified liabilities to the purchaser.

An asset transaction may also allow the purchaser to step up the costs of the underlying businessassets for tax depreciation purposes, although no tax deduction is available for goodwill.


Tax losses in the Target Company may not be transferred to the purchaser in an asset deal.However, the availability of tax losses may allow the seller and the purchaser to allocate a highervalue more appropriate to the market value of items such as inventories and depreciable assets.


As indicated above, there is no concept of unutilised tax depreciation in Hong Kong.

• Incentives

There are no specific tax incentives.

• Others

One issue that purchasers should be aware of is that if the Target Company has claimed anexemption from stamp duty within two years, such duty will become payable on the TargetCompany ceasing to be a member of its former (90% or more) associated group as a result ofchange in share capital of the Target Company in the beneficial ownership of the associatedgroup.


2.4.1 GST/VAT


2.4.2 Stamp Duty

• Stock Purchase

The rate for the transfer of Hong Kong stock, being shares the transfer of which is required to beregistered in Hong Kong, is 0.2% which is payable by the vendor and purchaser in equalproportion (i.e. 0.1% each).




Exemption from stamp duty may apply for a conveyance of an interest in immovable property ora transfer of Hong Kong stock between companies with at least a 90% common shareholding ifcertain conditions are satisfied.

• Asset Purchase

Stamp duty at progressive rates of up to 3.75% applies on conveyances of immovable property,payable by each party equally (subject to any commercial negotiation).

As indicated above, stamp duty is chargeable on the transfer of Hong Kong stock, the details ofwhich are set out in section 1.5.


Hong Kong has no specific concessions relating to M&A transactions.


In general, a business expense will be treated as being deductible in so far as it is incurred in theproduction of Hong Kong assessable profits. Whether or not certain transaction costs aredeductible will therefore depend on a number of factors, including:

• whether the purchaser or seller is carrying on business in Hong Kong and derives incomesourced in Hong Kong (note: dividends are generally not subject to profits tax in Hong Kong andexpenses incurred in generating such dividend income are not eligible for tax deduction). Thus,costs incurred in connection with a share acquisition are normally not deductible;

• whether the purchaser or seller incurs the expenditure in producing such Hong Kong assessableprofits; and

• whether the expenditure is capital or revenue in nature (capital expenditure is generally not taxdeductible).

In general terms, the position can be summarised as follows:

• Finance costs

Interest is only deductible in Hong Kong if it is incurred for the purposes of producing assessableprofits and meets one of a number of specified conditions. Thus, interest paid on debt incurredfor the purposes of acquiring shares (from which non-assessable dividends will be derived) isnot tax deductible, whereas interest on debt incurred under an asset deal should prima facie betax deductible (although see comments regarding restriction of interest deduction at section4.2.2).

Share dealers, venture capitalists and private equities which carry on business in Hong Kongshould, however, be treated differently. They will normally be subject to profits tax on Hong Kongsourced profits from a share deal. However, they should be allowed a tax deduction on intereston debt used for acquiring such shares. Share dealers, venture capitalists and private equitieswhich do not carry on business in Hong Kong would not be subject to tax on profits from thedisposal of shares, and accordingly would not be able to obtain a tax deduction for any interestcosts.

• Due Diligence and Other Deal Costs

For share dealers, venture capitalists and private equities that carry on business in Hong Kongand derive Hong Kong assessable profits from “trading” of their investments, the due diligenceand other deal costs should prima facie be deductible.

On the other hand, if the due diligence and other deal costs are incurred in relation to theacquisition of a capital asset held for investment purposes, no deduction will be available.






In a share acquisition, there will generally not be a change of tax basis for either the purchaser orthe Target Company. However, as mentioned above, there are provisions in the legislation that mayrestrict the carry forward of unutilised tax losses in the Target Company if the sole or dominantpurpose of the transfer is to utilise such losses.

As there is no tax consolidation or group relief regime in Hong Kong, profits and losses arising indifferent companies of the same group are dealt with separately and have to be carefully managedso as to minimise profits tax on a group basis.


In an asset acquisition, the purchaser is eligible to claim initial allowances (tax depreciation) inrespect of qualifying capital expenditure incurred on the acquisition of plant and machinery items (at60% of qualifying cost). Annual allowances (at 10%, 20% or 30% depending on the nature of theasset) are also available each year on a reducing balance basis.

Initial allowance at 20% is available on the qualifying capital expenditure incurred by the purchaseron the acquisition of a new industrial building or structure. Annual industrial building allowancesand annual commercial building allowances are also available each year at 1/25th (i.e. 4%) of thequalifying capital expenditure. For the acquisition of second-hand industrial building or structure andother commercial buildings or structures, the purchaser is only eligible to claim annual allowanceson the original historic qualifying cost of construction of the building (rather than the amount actuallypaid for it) and the amount of annual allowances are subject to the age of the building.

Goodwill is not eligible for tax depreciation or deduction. A tax deduction is generally available to thepurchaser on the acquisition of patent rights or technical know-how, notwithstanding that theexpenditure incurred is of a capital nature. However, a deduction is not allowed where the transfer ismade between associated parties.




In a transfer of a trade or business where the seller ceases to carry on the said trade or business,the purchaser will normally receive tax basis on the inventory equal to the value of considerationbeing paid (irrespective whether or not the parties are related) if the purchaser carries on thebusiness of the seller and it can claim a Hong Kong tax deduction on the inventory cost. In othercases where the purchaser is unable to claim any Hong Kong tax deduction for the cost of theinventory, the inventory should be treated as being transferred at market value as at the date ofcessation of the business by the seller. Similar rules apply to the transfer of work in progress.

Typically, trade debtors are acquired at net book value. Where the amount subsequently received isequal to the net book value, no taxable profit or loss arises. If one of the debts proves irrecoverable(whether in full or in part), the tax deduction is not allowed to the purchaser for the debt which is notrecovered.






There are no formal debt-equity restrictions in Hong Kong. However, there are stringent conditionsfor the deductibility of interest, which may effectively restrict the use or method of overseas debtfinance.

There are no regulatory consents that are required to approve the raising of finance, unless the debtin question is publicly marketable in the Hong Kong Stock Exchange.


4.2.1 Stock Acquisition

Interest on borrowings used to acquire shares will not be deductible. This is because dividendsreceived from a company are not chargeable to profits tax.

4.2.2 Asset Acquisition

In the case of an asset deal, a Hong Kong profits tax deduction may be obtained for financing costs,provided certain conditions are met. In principle, interest on finance obtained from a Hong Kong oroverseas financial institution is deductible, but interest on finance from a non-financial institution isgenerally only deductible if the interest is subject to Hong Kong profits tax in the hands of therecipient (unlikely in the case of interest payments to an overseas company). There are stringentanti-avoidance provisions that operate to deny a deduction for interest under “back-to-back” (orsimilar) arrangements with financial institutions. There are further conditions that permit a deductionin certain circumstances for interest paid on loans to solely finance the acquisition of inventory andfixed assets, and on debentures and marketable instruments.

Due to the interest deduction restrictions on intra-group financing for asset purchases, complexstructures have been developed which may achieve the effect of an interest deduction for offshorefinance, although at the increasing risk of being challenged by the tax authorities.




5. Merger

Hong Kong company law does not include the concept of a “merger”. A merger may be achieved by atransfer of trade and assets, either from one company to another company, or by transferring the trade andassets of both companies to a third one. See section 4.2.2 on asset acquisition.



Repatriation of profits via dividends is tax-free as Hong Kong does not assess dividends to profitstax and there is no withholding tax on dividends.

6.2 Losses Carried Forward and Unutilised Tax Depreciation Carried Forward

Losses may be carried forward and be utilised in future years. Losses may not be carriedbackwards to offset against assessable income from prior years. Note that losses incurred by apartnership are treated differently.

6.3 Tax Incentives

Hong Kong has no particular tax incentive regimes for M&A transactions.

6.4 Group Relief

Hong Kong does not have any group relief for members of the same group. This means that lossesmay not be transferred to other group members for utilisation.




7. Disposal

For the Hong Kong and foreign-based investor alike, investments in Hong Kong (either in the TargetCompany or New Company to which the Target Company’s assets have been transferred) are oftenstructured through a holding company in a tax haven or low tax jurisdiction, such as the British VirginIslands. In the absence of withholding taxes or tax on capital gains, this involves no additional Hong Kongtax cost, and may provide flexibility for stamp duty planning. Some investors also believe that such astructure mitigates political risk.

As indicated previously , profits derived from the sale of a long-term investment, such as the interest in anassociated company or a subsidiary company, should not be taxable in Hong Kong.

A seller will be concerned to ensure that no Hong Kong or overseas tax arises in respect of the disposal,other than tax that can be sheltered using existing tax losses. In suitable situations, pre-sale restructureshould be considered.

A buyer will be mainly concerned with structuring the investment (and minimising Hong Kong andoverseas taxes on any exit), financing the investment, and the different transaction costs of the alternativeroutes. Careful planning from the outset should assist in maximising the buyer’s rate of return on itsacquisition.

7.1 Preference of Sellers: Stock vs. Asset Deal

Subject to the clawback of any tax depreciation allowances previously claimed in respect of therelevant depreciable assets and the impact of any stamp duty cost, a Hong Kong seller of aHong Kong company will often be neutral over whether to sell the company’s shares or assets, asgains on both shares and capital assets should generally not be taxable while the distribution ofretained profits after an asset sale is similarly non-taxable. However, the following issues shouldalso be considered:

• the issue of what constitutes a capital asset has been the subject of many court decisions inHong Kong. Thus, it will be prudent to ascertain the true nature of such asset before deciding onthe type of deal to enter; and




• a non-Hong Kong seller will also have foreign tax considerations to take into account. Manyinvestments into Hong Kong are made through holding companies based in low tax jurisdictions,in which case a share disposal may be preferred if the capital gains derived from the disposal ofthe holding company may be treated more advantageously under the tax legislation of theultimate owner’s home tax jurisdiction.

7.2 Stock Sale

7.2.1 Profit on Sale of Stock

Profit on the sale of stock should be considered as a capital gain which is not taxable. Unless asindicated in section 7.1, the business of the seller is one of trading in stock, in which case the profitsshould be regarded as trading profits.


Profits may be distributed tax-free as there is no withholding tax on dividends.

7.3 Asset Sale

One issue that a seller should be aware of in an asset deal is the apportionment of consideration,particularly in relation to assets qualifying for tax depreciation. For such assets, where theconsideration received exceeds the tax written down value, a taxable “balancing charge” (limited toallowances previously claimed) will arise to the seller. Conversely, where the tax written down valueexceeds the consideration, a deductible balancing allowance will arise for the seller. Therefore, theseller will generally seek to minimise the allocation of consideration to those assets which havebeen depreciated over a shorter period for tax purposes than for accounting purposes, therebyminimising the amount of clawback of any taxable balancing charge. Where the seller has taxlosses, the reverse may apply, especially since the purchaser will in turn inherit the higher taxbases for future depreciation purposes.

The following points may also be noted in relation to asset valuation:

• real estate should be transferred at market value, otherwise the value for stamp duty purposesmay be challenged;

• the tax authorities have the power to deem transfer of assets between connected persons fortax purposes at market value;

• subject to consideration of general anti-avoidance rules, inventory may be assigned at anychosen value (irrespective of whether the parties are connected persons or not), provided thetransfer results from a cessation of business and the purchaser can claim a Hong Kong taxdeduction for the inventory cost. Otherwise, market value should apply; and

• an asset purchase that involves a substantial payment for goodwill, which as previously noted isnot tax deductible, may dilute future accounting earnings (subject to compliance with applicableGAAP).




7.3.1 Profit on Sale of Assets

As mentioned previously, whether the profit on sale of assets will be assessable will be determinedby whether the asset is of a capital or revenue nature. Where it is the former, and there is merely arealisation of an investment, then the profits should not be taxable.


Profits can be distributed tax-free as there is no withholding tax on dividends.





8.1 GST/VAT


8.2 Stamp Duty

Please refer to section 2.4.2 which sets out the stamp duty applicable on the transfer of Hong Kongstock and immovable property in Hong Kong.


There are no specific concessions relating to M&As.


Please refer to section 2.4.4.





9.1 Stock Sale

In relation to a stock sale, there are no specific actions that a vendor should take. As the purchaseris likely to undertake due diligence, the vendor may wish to review the tax compliance status of thecompany to ensure that there are no “surprises” uncovered by the purchaser during due diligencethat may adversely impact the sale price.

9.2 Asset Sale

Provisions against (and write-offs of) trade debts are tax deductible only by the company whichrecorded the corresponding sale. The company to which trade debtors are transferred cannot obtaina tax deduction for a subsequent provision or write-off. Thus, bad debts should be fully provided forby the transferor company before the transfer is made.

It should be noted that a tax deduction claim for a provision against (or write-off of) debtsimmediately prior to the transfer may be challenged by the tax authorities on the basis that thecharge merely represents a (non-deductible) capital loss arising from the revaluation of an asset incontemplation of the business disposal. A company which regularly and fully provides for bad debtrisks, irrespective of a potential business disposal, may be able to rebut this argument.




10. De-mergers

Hong Kong has no specific regime for de-merging a business to shareholders.


The sale of the stock of a Hong Kong company (or foreign company) to the public is subject to the sametax considerations as a private sale. Potential vendors should carry out proper tax due diligence to ensurethat the offering memorandum or other public documents comply with Hong Kong Securities and FuturesExchange rules and Companies Ordinance and fairly represents the tax liabilities or potential taxexposures in the Target Company.




INDIA

Country M&A TeamCountry Leader ~ Somnath Ballav

Kaushik Mukerjee






Somnath Ballav Partner +91 33 2357 7209 [email protected]

Kaushik Mukerjee Senior Manager +91 80 2555 9039 [email protected]

PricewaterhouseCoopers • 20A Park Street • Suite No. 9 • Calcutta - 700 016 • India




1. Introduction

1.1 General Information on M&A in India

India is the largest democracy in the world with a stable political system. Although agriculture playsa crucial role in maintaining its economy, the developing Indian economy is supported by asophisticated industrial base with a wide spectrum of industries. There has been a phenomenalgrowth in the service sector in the past few years particularly in the areas of financial services,computer software development, IT-enabled services and telecommunications.

With substantial foreign exchange reserves showing a rising trend, India’s balance of paymentsposition is comfortable. Its current inflation rate is among the lowest in the world.

Some factors which make India an attractive destination for foreign investors include an establishedand fair judicial system, the widespread use of English in business and commerce, and a pool oflow-cost and highly skilled workforce especially in the field of software development and IT-enabledservices. These factors, coupled with the burgeoning middle class, have turned the Indianmarketplace into a hot spot for foreign investors.

1.2 Corporate Tax

The corporate income tax rates for a domestic company and a foreign company are as follows:

All incomes accruing or arising in India are taxable in India. A resident of India is liable for tax on itsworldwide income subject to double tax relief provided under either the domestic law or a relevantdouble tax agreement. A non-resident is only subject to India tax on income sourced or received inIndia.

Taxable income is computed for uniform accounting year, i.e. the fiscal year from 1st April to 31stMarch.

The taxable income, called “Total Income”, is computed after adding certain disallowances, such asbook loss on sale of asset and miscellaneous expenditure written off, and reducing certainallowances/benefits from the book profits.

Domestic Company: 33.66% (30% plus surcharge of 10% and education cess of 2%)

Foreign Company: 41.82% (40% plus surcharge of 2.5% and education cess of 2%)(Branch/Project office)




1.2.1 Minimum Alternate Tax

With an object to bring zero tax companies under the tax net, Minimum Alternate Tax (MAT) at 7.5%(plus applicable surcharge and education cess) of book profits is levied on companies whose taxpayable under normal Income Tax provisions is less than 7.5% of book profits. MAT rate is proposedto be increased to 10% with effect from 1st April 2006 under the Finance Bill 2006.

However, an exemption is granted in the case of profits of units set up under the 100% ExportOriented Units (EOU), Software Technology Park (STP), Export Processing Zones (EPZ), SpecialEconomic Zones (SEZ) scheme and developer of an SEZ.

A credit of such tax paid under MAT provisions by a company with effect from FY 2005/2006 isallowed against the tax liability which arises in subsequent five years under the normal provisions ofthe Income Tax Act. The Finance Bill 2006 has proposed to increase the MAT credit period to sevenyears.

The effective MAT rates are as follows:

• in the case of a domestic company - 8.42%, including surcharge and education cess (11.22%w.e.f. 1st April 2006); or

• in the case of a foreign company - 7.84%, including surcharge and education cess (10.46%w.e.f. 1st April 2006).

Per the proposals of Finance Bill 2006, MAT is also payable on otherwise exempt long-term capitalgains from the sale of listed equities through stock exchange or units of equity oriented mutualfunds.

1.2.2 Dividends

Dividend income is exempt in the hands of the shareholders. However, a dividend distribution tax at12.5% (plus surcharge and education cess) is levied on companies declaring dividend. Anexemption from this tax is granted in the case of profits from SEZ developments. Effective dividenddistribution tax rate on domestic companies is 14.03%.

1.2.3 Capital Gains

Gains on sale of assets are subject to tax at the rates depending on the duration of ownership. Therates are as follows:

Short-term capital assets Normal corporate/tax rates(other than short-term capital assetsbelow – refer to Note A)

Short-term capital assets: 10% (refer to Note B)Listed shares and units of equity fund,which have been charged to SecuritiesTransaction Tax (STT)

Long-term capital assets: Exempt (Refer to Note C)Listed shares and units of equity fund,which have been charged to STT

Other long-term capital assets 20%




Notes:

• Short-term capital asset is one which is held for a period of less than three years (one year inthe case of shares and securities).

• Short-term capital gains on securities sold by any person, including a registered ForeignInstitutional Investor (FII), through a recognised stock exchange are taxed at a flat concessionalrate of 10% (plus applicable surcharge and education cess) provided such sales have beencharged to STT ranging from 0.013% to 0.2% (0.017% to 0.25% w.e.f. 1st April 2006) dependingon nature and mode of transaction.

• Income from transfer of stocks and securities with a holding period of 12 months, through arecognised stock exchange in India, is exempted from tax provided such transfer has beencharged to STT. However, such income will be subject to MAT w.e.f. 1st April 2006, per theproposal of Finance Bill 2006.

Indexation of the cost of acquisition and improvement of a long-term capital asset other thandebentures is available to residents.

1.2.4 Tax Losses

Change in ownership of a “widely held” company through share acquisition does not affect the carryforward and setoff of unabsorbed business loss and unabsorbed depreciation within the permittedperiod.

However, where the acquired company is a company in which the public is not substantiallyinterested (i.e. a closely held company whose shares are not listed in any recognised Indian stockexchange), the benefit of unabsorbed business loss is lost if on the last day of the fiscal year inwhich the acquisition takes place, shares carrying at least 51% of the voting rights are notbeneficially held by the same shareholders who beneficially held shares of the acquired companycarrying not less than 51% of the voting power as on the last day of the fiscal year in which the losswas incurred.

The above restriction is not applicable where the acquired company is a subsidiary of a foreigncompany and at least 51% of the shareholders of the parent foreign company pursuant to a schemeof amalgamation or de-merger continue to remain shareholders of the amalgamated or de-mergedforeign company.

1.2.5 Thin Capitalisation

India does not have formal thin capitalisation rules for tax purposes. But for the prescribed debt-equity ratio under the exchange control regulations, debt-equity mix is generally driven bycommercial considerations.

1.3 Other Taxes

Other taxes relevant for the purpose of mergers and acquisitions are as follows.

1.3.1 Value Added Tax (VAT) & Sales Tax

State level sales tax has been replaced by VAT with effect from 1st April 2005 in a majority of IndianStates. The sales tax regime will continue in the States which have decided against introducing VATat this point of time.




Under the VAT regime, the VAT paid on goods purchased from within the State will be eligible forVAT credit. The input VAT credit may be utilised against the VAT/Central Sales Tax (CST) payableon the sale of goods thus ensuring that cascading effect of taxes is avoided and only the valueaddition is taxed.

CST will continue to coexist with the State VAT. Inter-state procurement, on which CST is chargedby the originating State, will not be eligible for input tax credit. Further, inter-state branch/consignment transfers will be exempt from VAT and hence not eligible for input tax credit. However,certain States are allowing input tax credit in excess of 4% on inter-state stock transfers.

Presently, there would be no VAT on imports into India. Exports will be zero-rated. This would meanthat while output exports will not be charged with VAT, inputs purchased and used in themanufacture of export goods will be refunded.

The State VAT will be charged at uniform tax rates of 1%, 4% and 20%. Goods that are presentlycharged at either 8% or 12% will be charged at a Revenue Neutral Rate (RNR) of 12.5%. Mostgoods will thus be charged at this RNR.

Turnover thresholds have been prescribed to keep out small traders from the ambit of the VAT. Aturnover tax may be levied on such small traders in lieu of the VAT.

VAT registered dealers will need to issue serially numbered invoices with prescribed particulars.

The periodicity of filing of VAT returns will remain the same as prescribed in the erstwhile sales taxregime.

With this introduction of a comprehensive self assessment VAT, turnover taxes, surcharges,additional surcharges and the special additional tax have been abolished.

An Empowered Committee is currently considering introduction of coding in terms of theHarmonised System of Nomenclature for commodities under the VAT.

1.3.2 Stamp Duty

Stamp duty is not imposed on transfer of shares held in the dematerialised mode. However, transferof shares held in physical form attracts stamp duty generally at 0.5% statutorily payable by thebuyer. Stamp duty is levied on transfer of immovable property at rates varying from state to state.

1.3.3 Banking Cash Transaction Tax

With effect from 1st June 2005, banking cash transaction tax is imposed at 0.1% on amount of cashwithdrawn or cash received on encashment of term deposits on a single day from an account(except savings account) exceeding:

• INR 25,000 in the case of individual; and

• INR 100,000 in other cases.




1.4 Common Forms of Business Entity

The principal forms of business organisation in India apart from Government concerns are:

• Company

A company may be incorporated under the Indian Companies Act either as a public or privatecompany. To qualify as a private company, its Articles of Association must provide for therestriction of the right to transfer its shares, limit the number of shareholders to 50 and prohibitinvitation to the public to subscribe to shares or debentures. All companies other than privatecompanies are public companies.

The liability of the company may be limited by shares.

• Partnership

The Indian Partnership Act is the governing law which prohibits partnerships of more than 10persons from carrying on the business of banking and more than 20 persons for other business.

Limited liability partnerships are currently not legally recognised. However, as per the partnershipbill introduced in the Parliament, there is a proposal to allow limited partnership for certain kind ofprofessionals.

• Sole Proprietor

There are no special provisions corresponding to Companies Act or Partnership Act governingsole proprietorships. However, the Indian Income Tax Act makes it obligatory to have compulsoryaudit if the turnover/gross receipts from a business or profession exceeds certain prescribedlimits.

• Association of Persons

A joint venture, distinct from a partnership, is formed for a specific purpose. It is not a legal entityseparate from the joint venture members. For tax purposes, a joint venture formed with theintention of carrying out a common purpose and produce income jointly is treated as anassociation of persons and constitutes a taxable entity.

1.5 Foreign Ownership Restrictions

1.5.1 Foreign Direct Investment (FDI)

Today, India has probably one of the most open liberal investment regimes among the emergingeconomies with a conducive FDI environment. Opportunities exist for investment in India in sectorsas diverse as tourism, infrastructure, petrochemicals and mining technology and engineering. Thereare new areas where companies may invest such as real estate development, biotechnology andbio-informatics. Indian’s government has passed the Special Economic Zones Act 2005 whichprovides an internationally competitive and comfortable environment to manufacture and/or provideservices for export out of India.

The combination of macro economic stability, commitment to continued liberalisation and theexpanding trade and economic linkages make India an attractive destination for companiesworldwide. During the first two months of FY 2005/2006, India received FDI inflows of USD 912 million,registering an increase of more than 116% over the same period during the last FY. There havebeen a number of key elements in India’s growth, but among the most critical is a democracy withpolitical consensus on the economy. India has a well-established, independent judiciary wherenormal business risks are tempered by the presence of independent courts, politicians, and a free




press. India has an abundantly qualified and competent human resource base – fluent in Englishwith research and development (R&D) skills, technological training and managerial capabilities.India has untapped natural resources, rich mineral base, agricultural surplus and a hugemanufacturing capability spanning almost all sectors. The consumer market is large and expandingexponentially. Special investment and tax incentives are available for promoting exports and forinfrastructural development. In terms of potential, with its large scale investment absorption capacityand with strong economic fundamentals and momentum, India offers attractive returns toprospective investors.

1.5.2 Automatic Route

FDI up to 100% for new and existing companies, joint ventures and firms is permitted under theautomatic route (i.e. without requiring prior approval) for all items and activities except the following:

• proposals that require compulsory industrial licensing;

• where the foreign collaborator has an existing venture/tie-up in India in the same field (“samefield” means 1987 NIC code) as on 12th January 2005, with the exception of the following caseswhich would not require prior approval from the regulatory authority - Foreign InvestmentPromotion Board (FIPB):

– investment by a Venture Capital Fund registered with Substantial Acquisition of Shares andTakeover (SEBI);

– existing joint venture has less than 3% investment by either party; and

– existing joint venture is defunct or sick.

• acquisition of shares from resident shareholders of an existing Indian company in the followingcases; and

– Indian company is engaged in the financial services sector; and

– where the SEBI Regulation 1997 is triggered.

• proposals falling outside notified sectoral policy/caps or sectors in which FDI is not permitted.

1.5.3 FIPB Route

In all other cases of foreign investment, where the project does not qualify for automatic approval(as given above), prior approval is required from FIPB. Decision of the FIPB is normally conveyedwithin 30 days of submitting the application. The proposal for foreign investment is decided on acase-to-case basis depending upon the merits of the case and in accordance with the prescribedsectoral policy.

Generally, preference is given to projects in high priority industries, infrastructure sector, thosehaving export potential, large-scale employment opportunities, linkages with agro sector, socialrelevance or relating to infusion of capital and induction of technology.

1.5.4 Downstream Investment

Downstream investments by foreign-owned Indian holding companies are treated at par with FDIguidelines. Prior approval of FIPB is required to act as a holding company. Domestic funds may notbe leveraged by the foreign-owned Indian holding company for downstream investments.




1.5.5 Investment by Non-Resident Indians (NRIs)

NRIs are also permitted to purchase and sell shares/convertible debentures under the portfolioinvestment scheme on repatriation and/or non repatriation basis through a branch designated by anauthorised dealer for the purpose and duly approved by the RBI, subject to fulfillment of certainconditions.

Under the non-repatriation scheme (i.e. capital is not allowed to be repatriated outside India), NRIsare permitted to invest in all activities except in a company which:

• is a Chit-Fund;

• a Nidhi Company; or

• is engaged in agricultural/plantation activities, or real estate business, or construction offarmhouses or dealing in transfer of development rights.

The total holding by each NRI may not exceed 5% of the total paid-up equity capital or 5% of thepaid-up value of each series of convertible debentures issued by an Indian company. Further, thetotal holdings of all NRIs put together cannot exceed 10% of paid-up equity capital or paid-up valueof each series of convertible debentures. This limit of 10% may be increased to 24% by theconcerned Indian company by sanction of the shareholders through a special resolution.

1.5.6 Investment by Way of Acquisition of Shares

Acquisitions may be made from an existing Indian company which is either a privately heldcompany or a company in which the public is interested (i.e. a company listed on stock exchange),provided a resolution to this effect has been passed by the Board of Directors of the Indiancompany.

Acquisition of shares of a public listed company is subject to the guidelines of the SEBI. SEBI’sTake-Over Code Regulations require that any person acquiring 15% or more of the voting capital ina public listed company should make a public offer to acquire a minimum 20% stake from the public.

Foreign investors looking at acquiring equity in an existing Indian company through stockacquisitions can do so without obtaining approvals except in the financial services sector, provided:

• such investments do not trigger off the takeover provisions under the SEBI’s SubstantialAcquisition of Shares and Takeovers Regulations 1997; and

• the non-resident shareholding after transfer complies with sectoral limits under FDI Policy.

As per RBI valuation norms, acquisition price should not be lower than:

• prevailing market price (in the case of listed companies); and

• Fair Market Value as per CCI valuation guidelines (in the case of unlisted companies).

1.5.7 Investment by Foreign Institutional Investors

A registered Foreign Institutional Investor (FII) may, through SEBI, apply to RBI for permission topurchase the shares and convertible debentures of an Indian company under the PortfolioInvestment Scheme.

FIIs are permitted by RBI to purchase shares/convertible debentures of an Indian company throughregistered brokers on recognised stock exchanges in India. They are also permitted to purchaseshares/convertible debentures of an Indian company through private placement/arrangement.




The total holding by each FII/SEBI approved sub-account of FII cannot exceed 10% of the totalpaid-up equity capital or 10% of the paid-up value of each series of convertible debentures issuedby an Indian company. Further, the total holdings of all FIIs/sub-accounts of FIIs put togethercannot exceed 24% of paid-up equity capital or paid-up value of each series of convertibledebentures. This limit of 24% may be increased to the specified sectoral cap/statutory ceiling, asapplicable, by the Indian company concerned by passing a Board of Directors’ resolution followedby sanction of the shareholders through a special resolution to that effect.

1.5.8 Technology Transfer

For promoting an industrial environment, which accords priority to the acquisition of technologicalcapability, foreign technology induction is encouraged both through FDI and through foreigntechnology collaboration agreements. Foreign collaboration agreements are permitted eitherthrough the automatic approval route or with prior approval from the Government.

1.5.9 Automatic Approval

No approvals are required in respect to all those foreign technology agreements, which involve:

• a lump sum payment of up to USD 2 million; and

• royalty payable up to 5% on net domestic sales and 8% on exports, subject to a total paymentof 8% on sales, without any restriction on the duration of royalty payments;

1.5.10 Government Approval

Government approval from the Ministry of Industry is necessary for the following categories offoreign technical collaboration agreements:

• proposals attracting compulsory licensing;

• items of manufacture reserved for the small-scale sector;

• proposals involving any existing joint venture, or technology transfer/trademark agreement inthe ”same field” in India; and

• proposals not meeting any or all of the parameters for automatic approval.

It is permissible for an Indian company to issue equity shares against lump sum fee and royalty inconvertible foreign currency already due for payment/repayment, subject to meeting all applicabletax liabilities and procedures.




2. Structuring a Share Deal

2.1 Seller’s Perspective

2.1.1 Profit on Sale of Shares

Gains derived from transfer of shares in Indian companies are subject to tax in India at the ratesprescribed previously as Capital Gains (see section 1.2.3).

For the purpose of computing the capital gains tax liability, the cost of acquisition, expensesincurred in connection with the transfer and the consideration receivable for the transfer arerequired to be converted in the same foreign currency as that utilised for the purchase of suchcapital asset and the resultant capital gain reconverted into INR.

However, no capital gains tax is imposed on transfers of shares in Indian companies by one foreigncompany to another in a scheme of amalgamation, if at least 25% of the shareholders of theamalgamating company continue to remain as the shareholders of the amalgamated company andthe transfer is exempt from capital gains tax in the country where the amalgamating company islocated.


Distribution of profits will depend on the form of the business entity of the Target Company. In acorporate entity, Indian Company Law regulations require a maximum retention up to 10% of theprofits prior to distribution of dividends except in the case of liquidation. Under the existing laws, thecompany distributing dividend of the balance of the profits after the retention of the amount requiredunder the Indian Company Law regulations has to pay dividend distribution tax at an effective rateof 14.03%.

The balance may be distributed to the shareholders by way of dividend without any withholding taxbecause dividends under the existing laws are not taxed in the hands of the shareholders.




2.2 Buyer’s Perspective


In a share deal, the cost of the assets may not be revalued. Further, in the case of the acquisition ofa listed company, the acquirer has to comply with the Takeover Code regulations which, inter alia,make it mandatory for the acquirer to make an open offer to the public shareholders of the acquiredcompany for purchasing their holding.

Acquisition through an overseas intermediate company (having substance) located in Mauritius orSingapore can be considered because of preferential tax treatment with regard capital gains taxunder the respective treaties.

This remains the most preferred method of acquisition and it is also cost effective as compared toan asset deal because of stamp duty implications.

2.2.2 Funding Costs

Under the existing tax regime, it is preferable to treat the financing costs incurred in acquiring theshares as a part of the cost of acquisition because such costs are not tax deductible against thedividend income which is exempt from tax in the hands of the shareholders.

2.2.3 Acquisition Expenses

The acquisition expenses directly related to the share purchase are allowed to be added to the costof the shares and are eligible for tax deduction in determining capital gains on sale.

2.2.4 Debt/Equity Requirements

There are no prescribed debt-equity ratios (except under the exchange control regulations), whichare generally driven by commercial considerations.

2.2.5 Preservation of Tax Losses

The benefit of tax concessions, incentives, carry forward of prior years’ tax losses and unabsorbeddepreciation is not lost in a share deal involving the acquisition of a company except in case of acompany in which the public is not substantially interested to the extent indicated undersection 1.2.4.

2.2.6 Repatriation of Profits

Repatriation of profits in a share deal can only be through the dividend route. The tax implications,both for the company distributing the dividend and the shareholders, have been dealt with undersections 1.2.2 and 2.1.2.

Stock dividends (on equity shares) in the form of bonus shares are not taxable in the hands of therecipient. However, the entire consideration received on any subsequent sale of such shares wouldbe subject to capital gains as the cost of acquisition of such shares is considered to be nil.




3. Structuring an Asset Deal



In the case of depreciable assets, the income tax written down value of the block of assets (ITWDV)is reduced by the consideration received from the sale and consequently depreciation at the rateapplicable to the block of assets is allowed on the reduced ITWDV. If the consideration receivablefor the transfer of the assets exceeds the ITWDV, the excess is considered to be a short-termcapital gain and subjected to tax at the corporate tax rate applicable to the entity. In the case of non-depreciable assets, the short-term capital gain is taxed at the corporate tax rate applicable to theentity whereas the long-term capital gains computed (after allowing indexation benefits andsubstitution of the cost price as on 1st April 1981 if purchased prior to that date) attracts capitalgains tax at 20% plus applicable surcharge and cess.

For the purpose of computing the capital gains tax liability, the valuation adopted by the registrationauthorities for levy of stamp duty in connection with the transfer of immovable property shall beadopted if it is more than the consideration receivable for the transfer of the said immovableproperty.

The seller would be liable to VAT/sales tax on movable property at appropriate rates depending onwhether it is an inter-state or intra-state sale.


Distribution of profits will depend on the form of the business entity of the Target Company. In acorporate structure, it can be distributed by way of dividends. The tax implications for both thecompany distributing the dividend and the shareholders have been dealt with under sections 1.2.2and 2.1.2.






In an asset deal, the acquirer may opt to buy the assets of the company for a slump price and,based on a valuation report, allocate the purchase price properly to the respective assets to ensurethe maximum benefit on account of depreciation and amortisation allowed under the tax laws.

It should be kept in mind that the buyer would be liable for stamp duty on transfer of immovableproperty at a rate which varies from state to state.

The purchase of assets of an Indian company by a foreign company requires the permission of theregulatory authorities unless the purchase is routed through an Indian subsidiary of the foreigncompany.

3.2.2 Funding Costs

If the assets are acquired through an existing Indian subsidiary engaged in business, the interest onloan taken for the acquisition of the assets is considered as a tax-deductible expenditure to theIndian company.

3.2.3 Acquisition Expenses

The acquisition expenses directly related to the purchase of the assets will be added to the cost ofthe assets and be eligible for depreciation allowance in the case of depreciable assets. For non-depreciable assets, such costs will be eligible for tax deduction when the assets are sold.


In an asset deal, the acquirer may opt for buying the assets of the company for a slump price andbased on a valuation report allocate the purchase price properly to the respective assets to reapmaximum benefit on account of depreciation allowance and amortisation allowed under the taxlaws.

This may be resisted by the seller for adverse income tax as well as sales tax implications.

3.2.5 Treatment of Goodwill

The goodwill arising out of an asset deal cannot be amortised by the buyer to claim tax benefits.However, the benefit of the cost of acquisition is available on subsequent disposal. Currently, thecost of intangible assets (such as know-how, patents, copyrights, trademarks, franchises or anyother business/commercial rights of a similar nature) can be depreciated at the prescribed rates.Due regard should therefore be given for identifying and allocating proper values to such intangibleassets.

3.2.6 Other Matters

An asset deal normally attracts heavy incidence of stamp duty at rates varying from state to state ontransfer of immovable property which the acquirer has to bear.




4. Concessions Relating to M&As

Any “transfer”, unless specifically exempted, attracts capital gain tax. However, subject to conditions,specified reorganisation schemes, such as amalgamations or de-mergers are exempted from the levy ofsuch tax.

4.1 Amalgamations

Specified conditions in case of an amalgamation of one or more companies into one includes allassets and liabilities of the amalgamating companies become assets/liabilities of the amalgamatedcompany and the shareholders holding 75% of the share value in the amalgamating companiesbecome shareholders of the amalgamated company.

4.2 De-mergers

A “de-merger” refers to the transfer, pursuant to a scheme of arrangement under the IndianCompanies Act, by a de-merged company of one or more of its undertakings to any resultingcompany in such a manner that all the assets and liabilities being transferred by the de-mergedcompany becomes the property of the de-merged company and appear at its values and theresulting company issues, in consideration of the de-merger, its shares to the shareholders of thede-merged company on a proportionate basis.

Moreover, the shareholders holding at least 75% in value of the shares in the de-merged companybecome shareholders of the de-merged company and the transfer of the undertaking is on a goingconcern basis.

4.3 Amortisation of the Amalgamation/De-merger Expenses

In computing taxable income, the reorganisation expenses on account of amalgamation/de-mergeris amortised at 20% per annum over a five year period.




4.4. Provisions Relating to Carry Forward and Set off of Accumulated Loss and UnabsorbedDepreciation Allowance in Amalgamation or De-merger

Subject to certain conditions, the accumulated tax loss/depreciation of an amalgamating companyengaged in industrial undertaking/ship/hotel/banking business shall be considered as deemed taxloss/depreciation of the amalgamated company provided:

• the amalgamating company having brought forward tax loss/depreciation has been engaged inthat business for at least three years, and it has held continuously (as on the date of theamalgamation) at least 75% of the book value of fixed assets for two years prior to the date ofamalgamation; and

• the amalgamated company holds at least 75% of the book value of fixed assets of theamalgamating company as well as continuing with the business for five years, besides adheringto certain other prescribed conditions.

4.5 Slump Sale

“Slump sale” refers to the transfer, where an undertaking is transferred at a lump-sum considerationwithout values being assigned to the individual assets and liabilities in such sales. Anyconsideration in excess over the “net worth” arising from the slump sale is chargeable to capitalgain tax.

The term “net worth” is the excess of book assets over the value of liabilities of the undertakingtransferred. The net worth computation requires authentication by a Chartered Accountant.




5. Exit Route

The exit route, in the case of a share deal, is the transfer of the shares of the Indian company. The taximplications are indicated under section 2.1.1. Transfer of shares of offshore holding company can also beconsidered.

The exit route, in the case of an asset deal, is the transfer of the assets. The tax implications are indicatedunder section 3.1.1.

6. Ending Remarks: Preparation for a Deal

The relative considerations of the buyer and seller will depend on the facts of each case. The buyer shouldweigh the possibility of increasing the asset base through asset acquisition against high stamp duty, loss ofunabsorbed losses and depreciation, and recapture of past capital allowances. The buyer should ensurethat the acquisition is structured in a manner which will result in improving shareholder value andoptimising return on investments.




INDONESIA

Country M&A TeamCountry Leader ~ Melisa Himawan

Ray HeadifenChristian Pellone

Dionsius Damijanto






Melisa Himawan Partner +6221 521 2901 6 ext. 7700 [email protected]

Ray Headifen Partner +6221 521 2901 6 ext. 7707 [email protected]

Christian Pellone Director +6221 521 2901 6 ext. 7760 [email protected]

Dionsius Damijanto Senior Manager +6221 521 2901 6 ext. 7716 [email protected]

PricewaterhouseCoopers • Gedung PricewaterhouseCoopers 7th Floor • JL Rasuna Said Kav • C-3 Kuningan •Jakarta 12920 • Indonesia




1. Introduction

1.1 General Information on M&A In Indonesia

With a population of over 220 million people and significant natural resources, Indonesia representsboth a significant market and potential supplier to the world economy. The Indonesian Governmentofficially welcomes both domestic and foreign private investment. Over the past several years, theGovernment has progressively sought to liberalise the local rules governing foreign investment.

Indonesia is in the midst of a serious effort to promote foreign investment, capital accumulation andthe export of goods other than oil and gas to expedite economic development and to becomeinternationally competitive. A broad range of deregulatory measures has been implemented, andadditional measures can be expected to further enhance the investment climate.

The Indonesian Government has passed a number of broad ranging amendments to the tax lawsarising from a recent tax reform review.

1.2 Corporate Tax

Indonesian companies are subject to tax on their worldwide income. A non-resident of Indonesia is,however, subject to Indonesia tax on its Indonesia sourced income.

The corporate tax rates are as follows:

Income (Rp) Tax rate

Up to 50 million 10%

From 50 million to 100 million 15%

Greater than 100 million 30%




1.3 Withholding Tax

Indonesian tax system relies heavily on a withholding tax mechanism for tax collection purposes.

Certain payments made by a resident taxpayer or an Indonesian permanent establishment (PE) ofa foreign company to another resident taxpayer or another Indonesian PE are subject towithholding tax at the following rates:

Such withholding tax typically constitutes prepaid tax for the income recipients which may becredited against the corporate income tax ultimately payable at year end. Exceptions arewithholding tax on bank interest and listed bond interest, the income tax withheld from whichconstitutes final income tax (i.e. the only income tax due on the income concerned).

Certain payments made by a resident taxpayer or an Indonesian PE of a foreign company to anon-resident which does not have an Indonesian PE are subject to withholding tax at the followingrates:

At present, Indonesia has signed tax treaties with more than 50 countries.

Description Non treaty rate1 Treaty rate1

Dividends 20% 10/12.5/15/20%

Interest 20% 0/5/10/12.5/15%

Royalties 20% 0/10/12.5/15%

Branch-profit tax 20% 10/12.5/15/20%

Insurance/Reinsurance premiums 1/2/10% –

Fees for services 20% –2

1Of the gross amount payable.2Exceptions are fees for technical, management, and consulting services payable to residents ofSwitzerland, Germany, Luxembourg and Pakistan which are subject to withholding tax at 5%, 7.5%,10% and 15% respectively.

Nature of payment Withholding tax rate1

Dividends 0%/15%

Interest 20%/15%

Royalties 15%

Prizes/Awards 15%

Rentals 3%/6%/10%

Fees for services 2%-7.5%

1Of the gross amount payable.




1.4 Taxation of Dividends

Dividends received by an Indonesian corporation or Indonesian PE from other Indonesiancorporations are assessable at the normal income tax rate. However, such dividends will not besubject to tax if all the following conditions are met:

• the dividends are paid out of retained earnings;

• the recipient corporation holds at least 25% of the paid-in capital in the dividend-payercorporation; and

• the recipient corporation has an “active business” other than shareholding.

For the taxation of dividends payable to non-resident parties, please refer to section 1.3.

Dividends are non-deductible to a payer for corporate income tax purposes.

1.5 Tax Losses

Losses may be carried forward for a maximum of five years. However, for a limited category ofbusiness in certain regions, the period may be extended up to 10 years. Losses are not permitted tobe carried backwards. Indonesia does not have continuity of ownership or continuity of samebusiness tests that operate to restrict tax loss utilisation.

In general, one company’s tax losses may not be transferred to another company. However, as partof the merger scheme, tax losses of the dissolved companies may be transferred to the survivingcompany provided all the following conditions prevail:

• the companies have undertaken fixed assets revaluation;

• the companies are still actively running their business before the merger; and

• the surviving company has to continue running its business at least two years after the merger.

1.6 Other Taxes

1.6.1 Value Added Tax (VAT)

VAT is imposed on importers, providers of most goods and services, and users of intangible goodsand services originating from outside Indonesia or within Indonesia. The rate of VAT is currently10%. The export of goods from Indonesia is zero rated.

1.6.2 Luxury Sales Tax (LST)

LST is imposed once only, upon the delivery or sale of specified luxury goods by a manufacturer orupon import. The rates of tax range from 10% to 75% depending on the type of goods.

1.6.3 Stamp Duty

Only nominal stamp duty is payable, at either Rp 6,000 (US$0.60) or Rp 3,000 (US$0.30) on certaindocuments, such as letters of agreement, proxies, statement letters and notarial deeds.

1.6.4 Land and Building Tax

Land and building tax is payable annually on land and building and on a permanent structure. Theeffective rate is generally not more than 0.1% to 0.2% per annum of the value of the property.




1.6.5 Land and Building Transfer Tax

The seller and buyer are each required to pay a tax of 5% which is computed on the transfer valueor the value forming the basis of the land and building tax (NJOP), whichever is higher. The taxpayable by the seller represents a prepayment of its corporate tax liability and is available as acredit to the seller when calculating its final tax liability.

The tax payable by the purchaser may not be claimed as a credit and therefore represents anadditional cost of such an acquisition. The duty payable by the purchaser on the acquisitions of titleto land and buildings is extended to acquisition via inheritance or as part of a business merger,consolidation, or expansion. The duty may be reduced by 50% where the land and/or building aretransferred in connection with a merger. The contractual date of a business merger, consolidation orexpansion is considered as the due date for the payment of such duty.

1.7 Tax Issues Relating to Mergers

There are special rules which provide concessions for certain qualifying mergers andconsolidations. These concessions include:

• no gain or loss on the transfer of assets;

• the transferor company would not be subject to 5% tax on the transfer of land and/or buildings;and

• subject to certain conditions (including a revaluation of the transferor’s fixed assets), atransferor’s tax losses may be carried over to the surviving company.

1.8 Thin Capitalisation and Debt/Equity Regime

1.8.1 Thin Capitalisation Regime

There is no thin capitalisation regime. However, interest payable to related parties not at an arm’slength basis may result in the tax authority denying a portion of the interest as a deduction.

1.8.2 Debt/Equity Regime

The tax law authorises the Minister of Finance (MoF) to stipulate the acceptable debt/equity ratiounder MoF regulations. However, up to now the MoF has not issued any regulation on this matter. Inpractice, a debt/equity ratio requirement is normally imposed only in the investment registration andapproval process by the Foreign Investment Coordinating Board (BKPM).


The following are the common forms of business carried out in Indonesia:

• Corporation

The corporation is the most common form of business enterprise in Indonesia. As an investmentvehicle, a corporation is regulated by the 1995 Limited Liability Company (PT Company) law.Being a legal entity distinct from its shareholders, a PT Company is taxed as separate entity.

Where foreign investors hold more than 50% of the company shares, such a company is referredto as a foreign investment (PMA) company. Otherwise, it is a domestic investment (PMDN)company.




• Partnership

Partnerships are normally used by professionals, such as accountants and lawyers, as a vehicleto conduct their business. A partnership is taxed in respect of its income as a single entity whilepartnership profit distribution to partners is not taxable to the partners.

• Joint Operation

As an unincorporated cooperation between two (or more) legal entities, this vehicle is commonlyused in the telecommunication business and for running public works or governmental foreignaid funded projects. As far as income tax is concerned, a joint operation is a flow-through entity.However, wherever applicable, it is a taxable entity for VAT.

• Branch

Foreign corporations are allowed to register branches in Indonesia only in exceptionalcircumstances. It is, however, the most common vehicle for foreign investors engaged in the oiland gas industry by virtue of Production Sharing Contracts (PSCs).

Except for joint operations, all other entities above are subject to corporate income tax in respect oftheir income.


A foreign investor may acquire shares in an existing foreign-owned company (PMA) or convert alocally-owned company (PMDN) to a PMA. Acquisition of such a company is permitted as long asthe proposed business activities of the company are open for foreign investment.

There are various restrictions on foreign investment which are dependent on the type and nature ofactivity undertaken. Four broad categories of business restrictions exist:

• business closed to all investors including local investors, for example, harmful chemicalproduction;

• business closed to foreign investors, for example, natural forest concessions and radio/televisionbroadcasting services;

• business where a foreign investor may be a joint venture party, for example, shipping, electricityproduction, transmission and distribution; and

• business investment open to all investors but subject to certain restrictions, for example,aquaculture and pulp wood industries.

The types of activities listed in each of the above categories are extensive. These are contained inwhat is referred to as a negative investment list. Foreign investors should therefore enquire as tothe foreign investment rules governing the appropriate sectors of their investments beforeembarking on any merger or acquisition deal in Indonesia.

A foreign investor may now own 100% of the shares in an Indonesian company. However, it is stillrequired to be owned by two or more shareholders. Although there is no specific indication of therequired percentage, a transfer of at least a nominal proportion of equity (divestment) by the foreigninvestor to an Indonesian party or parties is required within 15 years.

At the time of the establishment of a joint venture company operating in a sector previously closedto foreign investment, an Indonesian shareholding of at least 5% is required. A foreign investmentcompany may set up new companies and purchase shares of a PMDN and non-facility companiesas long as the business activities of the company are open for foreign investment. However, whileholding companies are common among local conglomerates, foreign-owned holding companiesare not commonly used.




2. Structuring a Stock Deal



There are a number of considerations surrounding a stock (or shares) acquisition by an offshoreentity. The sale of shares in an unlisted Indonesian company by a non-resident attracts awithholding tax of 5% of the gross proceeds due to the vendor. However, the vendor may beprotected from this tax under a tax treaty. It should be noted that where the seller is a resident ofAustralia or Singapore, Indonesia’s tax treaties with Australia and Singapore do not provide for suchan exemption.

Any capital gain on the sale of unlisted shares by resident corporations is treated as ordinaryincome and subject to corporate tax at normal corporate rates. Shares listed on an Indonesianstock exchange are subject to a tax of 0.1% of gross proceeds (0.6% for founder shares).

The sale of shares is likely to be the preferred approach for the seller, as this tax liability is a once-off income tax on the profit on disposal. In many cases, offshore elements are often introduced intoshare transactions so as to further limit the Indonesian tax on disposal.

2.1.2 Stamp Duty

Only nominal stamp duty is payable on the issue of shares at Rp 6,000 per document.

2.2. Buyer ’s Perspective


Most share acquisitions are structured as direct investments from outside Indonesia. The acquirorgenerally seeks to hold Indonesia Target Companies through a company located in a country whichhas entered into a double tax treaty agreement with Indonesia so as to minimise dividendwithholding tax and/or capital gains tax. The choice of a suitable jurisdiction will depend on theacquiror’s own tax considerations.




2.2.2 Funding Cost

Interest paid on borrowing to finance a share acquisition must satisfy normal tests for deductibility.Where a local corporate taxpayer uses borrowing to finance a share acquisition, interest wouldgenerally not be deductible because any dividends received would not be taxable. Dividends arenot taxable where:

• the dividends are paid out of retained earnings;

• the relevant shareholders hold at least 25% of the paid-in capital; and

• the relevant shareholders have an “active business” other than shareholding (i.e. a holdingcompany).

Interest on borrowing used to finance equity investment in newly established companies or toparticipate in rights issues is deductible by way of capitalisation to the share investment.

2.2.3 Equity Structure

The minimum capital requirement is Rp 20 million. The minimum allowable foreign investment maybe determined by the investors on the basis of the scale of the business. It may comprise both debtand equity.

2.2.4 Preservation of Tax Losses, Tax Depreciation and Tax Incentives

A change in ownership of the shares of a company does not alter the depreciation allowancesclaimed by the company or its carry forward tax losses. There is no facility for stepping up orincreasing the basis of assets to reflect the purchase price. The acquisition of shares in a tax losscompany in theory provides flexibility in loss utilisation because of the lack of provisions forcontinuity of ownership or business.

2.2.5 Unpaid Taxes of the Acquired Company

Unpaid taxes or unrecorded liabilities of the company being acquired remain with the company. It isgenerally recommended to obtain warranties and indemnities from the seller to meet unknown andundisclosed tax and other liabilities.




3. Structuring an Asset Deal


3.1.1 Profit on Sale of Assets and Goodwill

Capital gains derived by a company on the transfer of goodwill and assets are taxed as ordinaryincome and (after utilising any carry forward tax losses) are subject to income tax at the maximumcorporate rate of 30%. The transfer of land and/or building will attract a transfer tax of 5% of theproceeds. This tax is creditable against the transferor company’s annual income tax liability.

3.1.2 Value Added Tax

The transfer of assets is subject to 10% VAT. Specific concessions may be available, for example,where the transferor company is a company not required to be registered for VAT purposes.

3.1.3 Stamp Duty

Stamp duty is not payable on the transfer of assets.


3.2.1 Selection of Acquisition Vehicle

An asset acquisition or transfer is subject to the approvals of various government departmentsincluding that of the foreign investment regulatory body (BKPM). The acquisition of assets may beeffected either by an existing subsidiary company or through a newly established Indonesian entity.

Generally, an asset acquisition is preferred in Indonesia because of the difficulties in determiningthe undisclosed liabilities (such as tax) of the targets. For years after 1994, the Indonesia Tax Officehas 10 years to initiate a tax audit and therefore potential tax exposures can arise long after anacquisition has been completed. In addition, the legal uncertainties in trying to enforce warrantiesand indemnities against vendors generally mean that assets acquisitions are preferred.




3.2.2 Unpaid Taxes of the Transferor Company

Unpaid taxes or unrecorded liabilities remain with the seller.

3.2.3 Funding Cost

The buyer in an asset acquisition would be entitled to deductions for interest expenses on loansused to acquire such assets, provided the assets are used in generating income and the transactionhas been effected at arm’s length. Interest paid to non-residents will be subject to 20% withholdingtax (which may be reduced under most tax treaties).


On an acquisition of assets, the assets should be recorded at transfer value for tax purposes. Anasset appraisal may be required for related party transaction to determine the market value at thetime of acquisition.

Purchased goodwill and cost of intangible property may be amortised under Indonesian accountingprinciples using the declining-balance method or the straight-line method. The method adoptedmust be applied consistently. The amortisation will generally be deductible for tax purposes.

Assets other than buildings are divided into four classes. Depreciation is calculated on an asset-by-asset basis. Buildings are divided into two classes: permanent (useful life of 20 years) and non-permanent (useful life of 10 years). The current rates of depreciation are as below:

Costs incurred to extend certain rights over land (such as right to build, right to commercial use, andright to use), may be amortised over the useful life of the rights. Land acquisition costs are notamortisable.

3.2.5 Value Added Tax

VAT paid by the buyer should be available as input VAT which may be recovered against outputVAT, or by claiming a refund. A request for a refund will automatically trigger a tax audit. Specialconcessions may be available, for example, where the transferor company is a company notrequired to be registered for VAT purposes.

3.2.6 Land and Building Transfer Tax

On acquiring land and/or building, the purchaser must pay 5% transfer tax which is computed on thetransfer value or the value forming the basis of the land and building tax (NJOP), whichever ishigher. The tax paid is considered as cost of the acquiring company, that is, it is not creditableagainst income tax.

3.2.7 Withholding Tax

No Indonesian withholding tax should apply on the transfer of assets.

Asset category Declining-balance (%) Straight-line (%)

Class I 50 25

Class II 25 12.5

Class III 12.5 6.25

Class IV 10 5

Permanent building 5

Non-permanent building 10




4. Exit Route

The sale of the shares in an Indonesian company can provide a tax-free exit mechanism for foreigninvestors provided the seller is resident in a treaty country and the “capital gains” article in the treaty givesprotection from the 5% withholding tax discussed previously. Other profit extraction techniques such asinterest, technical service fees and dividends can be used to provide an exit route for Indonesian profitsbut care must be taken to limit withholding taxes and ensure that Indonesia’s transfer pricing rules are notinfringed.

5. Ending Remarks: Preparation for a Deal

Indonesia represents significant opportunities for foreign investors. However, while warmly welcomingforeign investment, doing business in Indonesian often poses a unique set of challenges. Careful planningis recommended at the earliest stage of consideration of a merger or acquisition in Indonesia. The legal,tax, government, regulatory and human resources teams will need to work together to ensure thatunnecessary hurdles are not overlooked at the outset.




JAPAN

Country M&A TeamCountry Leader ~ Kan Hayashi

Shinji IshiguroAlfred Zencak






Kan Hayashi Partner +813 5251 2877 [email protected]

Shinji Ishiguro Partner +813 5251 2428 [email protected]

Alfred Zencak Senior Manager +813 5251 2431 [email protected]

PricewaterhouseCoopers • Kasumigaseki Building • 15th Floor • 2-5, Kasumigaseki 3-chome •Chiyoda-ku, Tokyo 100-6015 • Japan




1. General Introduction

1.1 General Comments on M&A in Japan

This chapter details the main issues relevant to purchasers and sellers of the transfer of ownershipin a Japanese company or business.

Non-tax considerations normally play a major role in determining the form taken by Japanese M&Atransactions (e.g. regulatory or licensing issues, employment laws,etc.). Some of theseconsiderations are noted where appropriate in this chapter.

1.2 Corporate Tax

1.2.1 General Tax Regime

The Japanese corporate income tax generally consists of a national tax, prefectural and inhabitantstaxes, and an enterprise tax.

The corporate tax rates are as follows:

• corporations with paid-in capital of over JPY100 million: 30%

• corporations with paid-in capital of JPY100 million or less:

– first JPY8 million of taxable income 22%

– over JPY8 million of taxable income 30%

The inhabitants’ tax is a local tax consisting of prefectural and municipal taxes. It is levied on acorporation in each prefecture in which the corporation has an office to carry on its activities and iscomputed as a percentage of the corporation tax. The allocation to each local jurisdiction is basedon the number of employees. In addition, each local Government levies an equalisation per capitatax on each corporation that has an office or business place in its jurisdiction. This equalisation taxvaries depending on the amount of paid-in capital, plus capital surplus, and the number ofemployees.




The enterprise tax is a prefectural tax levied on a corporation in each prefecture in which thecorporation has offices to carry on its activities. For a corporation with paid-in capital of JPY100million or less, the enterprise tax liability will be calculated simply by multiplying the taxable incomethat is allocated to each prefecture by the appropriate tax rate. The allocation is generally made onthe bases of the number of employees. The rates vary depending on the amount of thecorporation’s taxable income. For a corporation with paid-in capital exceeding JPY100 million, theenterprise tax liability will be the sum of three different factors (i.e. an income-based factor, a capitalfactor and a value-added factor), each with its own tax rate and calculation rules.

The effective tax rate (including local enterprise and inhabitants’ tax) is generally around 42% forbusinesses with income exceeding JPY8 million since the enterprise tax is deductible in computingthe taxable income. However, the effective corporate tax rate may differ depending on the amountof corporate taxable income and the way the enterprise tax is calculated.

1.2.2 Tax Losses

Tax losses may be carried forward in Japan for seven years for losses incurred in fiscal yearsbeginning on or after 1st April 2001. Currently, the tax loss carry back provision is suspended for taxlosses arising in years ending through 31st March 2006. However, tax losses may currently becarried back for tax losses incurred by small and medium sized corporations (i.e. a corporationwhose capital is JPY100 million or less and 50% or more of its stock is not held by a “largecompany”, including foreign company) in their first five years of operation. Such losses may becarried back one year upon application by the taxpayer.

A change in the ownership of shares in a company, or a change in the nature of a company’sbusiness, does not give rise to the expiration or limitations on the use of tax losses in Japan.“Latent” tax losses (e.g. the difference between the Japanese tax book value of assets andtheir actual market value) are generally not realised until a taxable event (e.g. a sale of theassets or a transfer of assets pursuant to a merger).


Dividends, net of attributable financing costs, which are received by a Japanese company(ParentKK) from another Japanese company (SubKK), may be excluded from the taxable income ofParentKK provided that ParentKK owns 25% or more of SubKK. If ParentKK owns less than 25% ofSubKK, only 50% of the dividends from SubKK, net of attributable financing costs, may be excludedfrom the taxable income of ParentKK. There are also special rules relating to minority shareholdingand investment trusts and certain types of interest that may be excluded from the above definition offinancing costs that should be considered.

However, exclusion from taxable income is not permitted for dividends on shares that were acquiredwithin one month prior to the year-end of the company paying the dividends concerned and soldwithin two months after the same year-end.

The Japanese income tax (at 20%) that is withheld by the Japanese dividend-paying company isgenerally recoverable by the recipient either as a credit against its tax liability or a refund, if therecipient is in a tax loss position. There may be situations where the credit is not available and therecipient may only report the withheld tax as a deduction against income.




1.3 Withholding Taxes

Japanese-sourced dividends, interest, royalties, service fees, and rent received by a foreigncorporation are generally subject to withholding tax at the rate of 20% under Japanese domesticlaw. Service fees that are not sourced in Japan and remittances of branch profits are not subject towithholding tax.

Japan has a comprehensive network of double tax agreements, which operate to reducewithholding tax and exempt business profits derived by a company resident in a treaty country thatdoes not have a permanent establishment in Japan.

Where a non-resident entity conducts its operations in Japan through a permanent establishment(e.g. a branch), the above mentioned Japan-sourced income would be subject to tax under thesame procedure as that applicable to a resident entity.

Under the new Japan-U.S. Tax Treaty (Treaty) which was ratified on 30th March 2004, withholdingtaxes on payments between the two countries were significantly reduced. Beginning from 1st July2004, all royalties paid by residents of one contracting State to residents of the other may be paidwithout being subject to withholding tax at source. The Treaty also eliminates withholding tax atsource on dividends where the shareholder owns more than 50% of the dividend-paying company.The withholding tax rate on dividends is reduced to 5% where the beneficial ownership is between10% and 50% and the rate is reduced to 10% where the beneficial ownership is less than 10%.However, complex rules and detailed tests in order to substantiate treaty entitlements have beenincluded in the Treaty. These tests, in the form of a comprehensive limitation of benefits test, anti-conduit rules for certain income, and the legal concept of beneficial ownership, must be fullycomplied with by taxpayers when submitting their treaty relief forms.

The payment of a royalty and interest to foreign related parties will be subject to the Japanesetransfer pricing regulations (and thin capitalisation rules for interest).

1.4 Consumption Tax (GST/VAT)

Japanese consumption tax (currently 5%) applies to goods sold and services rendered in Japan(excluding shares or securities but including goodwill). Export and certain services invoiced to non-residents are zero-rated. Such tax may be recoverable by the payers depending on theirconsumption tax recovery position. Typically it would not be recoverable for an individual who is notregistered for consumption tax purposes. It may only be partially recoverable for a company in thefinancial sector and fully recoverable for manufacturing or other service companies.

1.5 Stamp Tax

Stamp tax ranging from JPY200 to JPY600,000 is payable on documents which require formalstamping to have legal effect. This includes agreements for the sale of certain assets. Stamp tax isgenerally payable by the purchaser, unless otherwise stated in the agreement.


Where compulsory registration of real property applies, there is an imposition of registration andlicence tax. This also applies on the registration of a company or branch. The rate varies dependingon the type of property.




2. Acquisition


In many situations, the purchaser and seller could have conflicting interests regarding whether tostructure the transaction as a sale of shares or assets.

For purposes of corporate taxation, there is no distinction between the taxation of capital gains onthe sale of shares or assets. However, in some cases, purchasers may want to purchase onlyselected assets or businesses to avoid issues such as acquiring contingent or unrecorded liabilities,or incurring a substantial amount of time and expense in completing a due diligence if shares areacquired. The purchase of a business may also enable the purchaser to report and deductamortisable goodwill.

Further, a purchaser may prefer to acquire assets, for example, where the target does not haveattractive tax attributes, such as tax operating loss carryovers or there is an intention to integratethose assets into its existing business.


Generally, an acquisition of a Japanese company is achieved through a direct acquisition by aforeign investor of the shares in the Japanese company. Where a purchaser intends to exit insubsequent years, it may wish to use an appropriate holding company in the U.S., Netherlands,Switzerland or Germany as the Japanese tax treaties with these countries provide exemptions fromJapanese tax on gains from the sale of shares in a Japanese corporation.

An acquisition of the target’s shares will permit the survival of any Japanese corporate taxattributes of the target, including tax net operating loss carry forwards. However, where a premiumis paid to acquire shares, the goodwill arising from the purchase of shares is not amortisable to thepurchaser for Japanese tax purposes.

The target’s tax basis in its assets remains unchanged in connection with a share purchase, asthere is no change in the tax attributes of the target. Further, there would not necessarily be anycosts from the transfer of employees, which tend to be normal features of asset purchases. On theother hand, subsequent decisions made by the purchaser regarding personnel issues may beconstrained by the target’s existing work rules, severance and retirement plans.




Currently, Japanese accounting principles do not require extensive financial statement disclosuresand permit, in certain situations, the recording of assets and liabilities off balance sheet in thefinancial statements of non-consolidated subsidiaries. It is expected that several new accountingrules, including an accounting policy for stock options, will be introduced to improve the level ofdisclosures in the financial statements.


If a purchaser does not have a presence in Japan, it could form a domestic corporation (e.g. a KK)that would purchase the assets and take over the business operation of the Target Company.

Any accumulated tax net operating losses of the target will remain with the target under an assetacquisition.

An asset acquisition will generally allow the purchaser to avoid exposure to contingent orunrecorded liabilities. These liabilities will remain with the seller unless they are contractuallyassumed by the purchaser under the sale and purchase agreement.

However, asset acquisitions are more likely to encounter regulatory difficulties. Many industrysectors are subject to one or more forms of regulation or licensing. Obtaining consent to transferlicences (or perhaps more accurately, obtaining a new licence) can be a long process.

Employment law can also be a key issue, as the transfer of employees in an asset (or business)transfer requires each transferring employee’s individual consent.

From a tax perspective, an asset purchase at above historic tax basis will allow a step-up of its taxbasis. Goodwill, in particular, may generally be amortised on a straight-line basis over a five-yearperiod, provided it has also been recognised for financial accounting purposes. A valuation tosupport any goodwill paid should be considered to avoid any issues being raised at a later tax audit.

One point of detail to note in the case of an asset acquisition relates to provisions for retirementbenefits. Japanese companies often operate unfunded pension arrangements, where provisions aresimply set up on the companies’ own balance sheets. These provisions are generally non-taxdeductible. In the event of a business disposal by means of an asset transfer, the purchaser may bepaid by the seller to take over these pension liabilities. This amount would be taxable income tothe purchaser in the period in which it is received. However, the purchaser would not receive animmediate tax deduction for setting up a corresponding provision on its own balance sheet. Thus,the failure to plan in advance may result in an unexpected “up-front” tax liability to a purchaser.

2.4 Transaction Costs to Purchasers

2.4.1 Consumption Tax (GST/VAT)

• Stock Deal

Consumption tax does not apply to the sale of stock.

• Asset Deal

Consumption tax is imposed on the transfer of assets, including goodwill. Consumption tax isneither imposed on the transfer of monetary assets, such as cash or receivables, nor land.Consumption tax that is paid by the purchaser may be recovered, depending on the purchaser’sconsumption tax position.




2.4.2 Stamp Tax

• Stock Deal

No stamp tax is payable on an agreement for the sale of stock.

• Asset Deal

Stamp tax is payable on documents which require formal stamping to have legal effect. Thisincludes agreements for the sale of real property, intangible assets, or businesses, agreementsfor corporate reorganisations, and stock certificates. Stamp tax is generally payable by thepurchaser, unless otherwise stated in the agreement.

2.4.3 Registration and Licence Tax

• Stock Deal

Registration and licence duties are not applicable to stock acquisitions.

• Asset Deal

Registration and licence duties are imposed on the registration of real property or intangibleassets, a company’s commercial registration, as well as other transactions. For example, wheretitle to real estate is transferred and the new owner is registered, tax may be imposed on thevalue of the real estate that is transferred.

A registration and licence tax will also be imposed when new share capital is issued (e.g. whenan acquisition company is incorporated and funded in order to complete an asset acquisition).The current tax rate is 0.7% of the amount of capital that is allocated to the paid-in capitalaccount (or 0.15% in the case of capital increase in the course of a merger to the extent of theformer share capital of the disappearing company).

2.4.4 Assets Transfer Tax (Real Property Acquisition Tax)

The acquisition of real property (e.g. land, building and factory) is subject to a real propertyacquisition tax at the rate of 3% or 4% of the asset value. The tax rate that will apply depends onthe date of acquisition.


No consumption tax is imposed in the case of a merger or a spin-off. In the case of a contributionin-kind, consumption tax is imposed. It is, however, calculated based on the value of the sharesissued in exchange for the transferred assets and liabilities (i.e. upon the net value of the assetsand liabilities. (See section 5 for more detailed information regarding M&As.)

The consent of each employee who will be transferred to the transferor is required in the case of abusiness transfer, although this is not required in the case of a spin-off and merger.


• Stock Deal

Acquisition costs incurred by a Japanese company with respect to the acquisition of shares inanother Japanese company are not deductible. Such costs may be capitalised and deductiblefor tax purposes when the shares are sold.




• Asset Deal

For asset acquisitions, the cost of the acquisition (including professional fees, taxes, andcharges) should, to the extent identifiable, be added to the cost of the relevant assets that areacquired. The tax treatment of these costs should then correspond with the tax treatment of theunderlying assets (i.e. depreciable, amortisable or tax deductible when the assets are finallysold).






The purchase price generally constitutes the purchaser’s tax basis in the purchased stock. The taxbasis in the underlying assets does not change. Therefore, a stock acquisition would not allow thepurchaser to maximise the tax benefits which are generally available in an asset deal.


The purchaser’s basis in the target’s assets, for Japanese tax purposes, will determine the amountof allowable depreciation and the cost of goods sold that may be deducted for purposes ofdetermining the purchaser’s taxable income after the acquisition. The purchaser will take a costbasis in an asset acquisition and will be required to allocate the purchase price among the assetsacquired for purposes of calculating future depreciation deductions to be reported.

If the target’s fair market value (including any goodwill arising from the asset acquisition) exceedsthe adjusted tax basis of its assets, an asset acquisition allows the purchaser to record the assets attheir respective fair market values and obtain tax deductions for depreciation and amortisation.






The Japanese thin capitalisation rules provide for a 3 to 1 debt:equity ratio and apply to allcompanies having interest-bearing debt due to foreign related parties. The portion of interestexpense that exceeds this ratio is permanently disallowed as a deduction. This excess interest maystill be subject to withholding tax.

The rules state that interest expense will be permanently disallowed to the extent that the averagebalance of interest-bearing indebtedness to a foreign-controlling shareholder (who owns at least a50% direct or indirect ownership interest) exceeds three times the net equity of the foreign-controlling shareholder in the debtor company. However, if the total interest-bearing debt of thedebtor company is less than three times its net assets, then the thin capitalisation rules do notapply.

Net assets will not be less than the capital account (i.e. paid-in capital and capital surplus).Therefore, if there is a deficit in retained earnings, then the capital account is deemed to be the netassets of the company.

Third-party loans guaranteed by a related foreign party will not be subjected to the thincapitalisation rules.

The thin capitalisation rules provide a comparable company ratio exception, which is determinedbased on standards similar to those that should be used under a transfer-pricing context. Under thisexception, it is permissible to use a ratio that is higher than 3:1, if such ratio is also used by aspecific Japanese company of similar size conducting similar business activities. It should be noted,however, that the tax authorities take a very strict position on the comparability exception.






Interest incurred by a Japanese company on funds used to acquire shares in another Japanesecorporation is not tax deductible in the year that the company receives a dividend from a Japanesecorporation since the dividend from a Japanese subsidiary to a Japanese shareholder is generallytax-free.


The debt to equity ratio of the Japanese company could be structured so that it is within the scopeof the conditions stated under the thin capitalisation rules (see section 4.1) to maximise the interestdeduction.

Since the Japanese national and local tax rates are relatively high, the use of debt financing couldreduce the Japanese company’s overall tax liability.




5. Reorganisations and Share-for-Share Transactions

5.1 Corporate Reorganisations

Under the corporate reorganisation rules, assets and liabilities may be transferred at their tax basissuch that no taxable gain or loss would be recognised, provided that certain conditions are met. Asa result, the capital gain or loss that would be realised on the transfer will be deferred.

Currently, if cash or assets (other than shares) are paid to the transferor, the merged company orshareholders of the transferor/merged company as consideration, the assets must be transferred attheir fair market value (i.e. the transaction will be a taxable reorganisation).

The corporate reorganisation rules apply to the following types of corporate reorganisations:

• qualified corporate spin-offs and split-ups;

• qualified investment (contribution) in-kind;

• qualified post-establishment transfers; and

• qualified mergers.

5.1.1 100% Ownership in Subsidiary

A transfer of a business unit to a new or existing wholly-owned subsidiary in return solely for shares/stock in the subsidiary may be accomplished on a tax-free basis. No other tests need to besatisfied.

5.1.2 More than 50% Ownership in Transferee Corporation

Tax-free transfers of a business unit to a less than 100% owned subsidiary may be accomplished ifthe transferor owns more than 50%, directly or indirectly, in the transferee corporation and thefollowing conditions are satisfied:

• transfer of business unit – it is expected that about 80% or more of the employees in thetransferred business unit will continue to be engaged in the transferred business at thetransferee corporation;




• continuing business requirement – the business that is transferred will continue to be operatedby the transferee corporation after the transfer;

• the principal part of the business assets and liabilities used in the transferred business unit willbe transferred to the transferee corporation; and

• in case of spin-offs and split-ups, more than 50% of the existing ownership is expected tocontinue after the spin-off or split-up.

5.1.3 Joint Business Reorganisation (50% or Less Ownership)

In the case of a reorganisation between two companies that share a group relationship of less than50% (i.e. a joint business reorganisation), the reorganisation may still be treated as a qualifiedreorganisation if the following conditions are satisfied:

• the conditions for a tax-free transfer applicable to a more than 50%-owned subsidiary as statedabove are satisfied;

• continuing shareholding requirement (this is not required for a corporation with the number ofshareholders exceeding 50) – in general, more than 80% of the former shareholders of thetransferor corporation must continue to hold the shares of the transferee corporation;

• business relevancy requirement – the business transferred by the transferor and one of thebusinesses of the transferee must be relevant to each other; and

• comparable business size requirement – either of the following must be satisfied:

– the ratio of either sales, number of employees, or other appropriate measure, of the transferredbusiness unit and the transferee’s relevant business must be no greater than 5:1; or

– if the above cannot be met, this condition will still be satisfied if the transferor corporationsends at least one of its management-level persons to the management of the transfereecorporation.

5.1.4 Investment In-Kind

An investment in-kind, or contribution to capital, which generally meets the above conditions may beaccomplished on a tax-free basis. Under this scenario, an entire business unit need not betransferred, but single assets may be transferred as a contribution to capital on a tax-free basis if itis made to a wholly-owned subsidiary. Transfers to less than 100% affiliated companies may bemade tax-free if the transfer is of a business unit, and the requirements discussed above are met.(See sections 5.1.2 and 5.1.3.)

5.1.5 Post-Establishment Transfer

Under a post-establishment transfer, the transferor corporation first incorporates a new corporation(transferee corporation) via a cash contribution and the transferee corporation then uses the cash topurchase the transferred assets. This transaction may be accomplished tax-free if the followingconditions are satisfied:

• the transferor company held all of the outstanding shares of the transferee company throughoutthe period up to and including the asset transfer;

• the transferor company expects to continue to hold all of the outstanding shares of thetransferee company;




• the assignment of assets was planned at the time of the establishment of the subsidiary, and theassets were actually transferred within six months from the establishment of the subsidiary; and

• the amount of cash paid to the transferor company is approximately the same as the amountcontributed by the transferor company to the transferee company.

5.1.6 Merger

In general, a tax-free merger may be accomplished if the above-mentioned conditions are satisfied.All assets and liabilities of the merged company are transferred to the surviving company at the taxbasis (tax book value). Thus, no taxable gain or loss will be incurred with respect to the merger.There will be no deemed dividend payment with respect to the liquidation of the merged company.Note that a cancellation loss on the merged corporation shares held by a merging corporation at thetime of the merger will not be tax deductible.

Thus, the merger will be tax-free if:

• the merger of 100% affiliated group companies is solely for stock;

• the merger of more than 50%, but less than 100% affiliated companies, meets the conditions insection 5.1.2; or

• the merger of less than 50% affiliated companies meets the conditions in section 5.1.3.

5.1.7 Restriction on Using Carried Over Losses

In a tax-free merger, the tax losses of the merged company will be carried over to the survivingcompany if certain conditions are satisfied. In general, tax net operating losses that arose while bothcompanies were owned by the same interests (group years), may be carried forward in a tax-freemerger. There are limits placed on tax net operating losses carried over from pre-group years aswell as limits on built-in losses.

The limitations on the use and carry over of tax losses apply equally to both the merged companyand the surviving company.

In the case of spin-offs, split-ups (except for split-ups which may be regarded as merger equivalent),or contributions in kind, the tax losses will remain with the transferor corporation.

5.2 Stock-for-Stock Exchanges and Transfers

Under a stock-for-stock exchange (Kabushiki Kokan), the issued and outstanding shares that areheld by shareholders of a company that will become a 100%-owned subsidiary (Company B) will betransferred to a company that will become the 100% parent company of Company B (Company A).Company A will issue new shares to Company B’s shareholders in exchange for the shares inCompany B.

Under a stock-for-stock transfer (Kabushiki Iten), shares of a company that will become a 100%-owned subsidiary (Company B) which are held by Company B’s shareholders will be transferred toanother newly established company (Company A). Company A will issue new shares to CompanyB’s shareholders so that Company A will become the 100% parent company of Company B.

The recognition of the capital gain that would be realised by the shareholders of Company B on thetransfer of Company B’s shares pursuant to a stock-for-stock exchange or transfer for tax purposesis deferred, provided the following conditions are satisfied:

• Company A reports the shares obtained from the former Company B shareholders at an amountthat is equal to or less than the total book value (or tax basis) of the shares that were held by theCompany B’s shareholders prior to the stock-for-stock exchange or transfer; and




• the total amount of shares that the Company B’s shareholders should receive as a result of thestock-for-stock exchange or transfer should be at least 95% of the consideration that is received.

If the number of shareholders in Company B is 50 or more, the book value of the Company Bshares that must be recorded by Company A is the net asset book value (for tax purposes) ofCompany B immediately before the stock-for-stock exchange or transfer.

When cash or other assets are granted to the Company B shareholders at the time of thestock-for-stock exchange or transfer, gain or loss must be recognised. The amount of the gainor loss is equal to the amount of the cash or other property (at their fair market value) receivedless the book value of the shares transferred that is allocable to the cash or other propertyreceived.

5.3 New Corporation Law

A new Corporation Law (Law) was passed by the Japanese Diet on 29th June 2005 andpromulgated by the government on 26th July 2005 (to be effective in May 2006 although the exacttiming has not been determined). The purpose for the Law is to modernise the overall corporatelegislation in response to the changing societal and economic circumstances. The Law is designedto stimulate the formation of new companies and allow more flexible corporate management.

In the area of corporate M&A, the Law provides greater flexibility in reorganising companies as wellas the implementation of counter measures against hostile takeover attempts. For example, theLaw relaxes the rules relating to the type of consideration that may be used for merger transactionsas well as cross-border M&A transactions so that in-kind dividends of shares may be used toreorganise a company. In addition, cash as well as foreign shares may be used as consideration tobe paid to shareholders of the non-surviving company in a reorganisation (i.e. a so called triangularmerger will become possible, although it will be a taxable merger unless the Japanese corporate taxlaw is changed to allow for such merger to be tax-free).

The Law also allows for simple corporate mergers that do not need shareholders’ approval. Forexample, under a simplified reorganisation (e.g. merger and spin-off), a surviving company of amerger is not required to obtain approval from its shareholders under certain circumstances.

In addition, the Law allows for a short form reorganisation in which a Japanese controllingcorporation which owns 90% or more of the voting rights of a controlled corporation may complete areorganisation (including merger) without approval of a shareholders’ meeting by a controlledcorporation.

Further, it allows for a reorganisation (i.e. merger, spin-off and share exchange), even if it mayresult in a capital deficit to the surviving company or transferor company. Such capital deficit may berecognised from a merger where the acquired entity has a capital deficit or the consideration to bepaid for the merger is greater than the net assets of the acquired entity. Under the current JapaneseCommercial Code, such merger or other reorganisation that would result in a capital deficit is notpermitted.

The portion of the Law relating to the relaxation of the type of consideration that may be used formergers and other types of reorganisation will not go into effect until Spring 2007 due to concerns ofa possible increase in foreign takeovers of Japanese companies. The delayed enforcement will giveJapanese companies time to prepare counter measures for possible hostile takeovers (e.g. poisonpills).






The payment of royalty and interest will be subject to the Japanese transfer pricing regulations (andthin capitalisation rules for interest). See sections 1.2.3 and 1.3 for a discussion of the withholdingtax implications relating to the payment of dividends, royalties, and interest paid to Japaneseshareholders and foreign shareholders.


Please refer to sections 2.2 and 2.3.

6.3 Tax Incentives

Tax incentives enjoyed by a target are generally preserved through a stock deal.

Where the target enjoys any tax incentives, these would generally be lost when the business istransferred through an asset deal.

6.4 Group Relief

Japanese tax law allows for the filing of consolidated tax returns by a Japanese company and its100% owned Japanese subsidiaries. Adoption of the consolidated tax system is optional but it hasto be continuously applied once elected, and all of the 100% subsidiaries are subject toconsolidation without exception.

Parent companies should file tax returns and pay taxes on the consolidated corporate income. Thesystem applies only to the national corporation tax. The local inhabitants taxes and local enterprisetax will continue to be imposed on each member company.

The parent company and its subsidiaries will be jointly and severally liable for tax liability. Taxallocation will be made according (and limited) to each company’s taxable income or tax liability.The parent company will pay the tax on behalf of the entire group and later seek tax reimbursementfrom its subsidiaries, or record it as a credit on its books until receipt of payment from thesubsidiaries.




The recognition of profits or losses from intra-group transactions will be deferred until the assets aretransferred to a party outside the consolidated group when the consolidated group dissolves, orwhen a member company withdraws. However, this rule will not apply to transfers of inventory (i.e.no deferral of profits or losses is allowed).

With very limited exceptions, the only tax losses incurred pre-consolidation which may be utilisedagainst consolidated profits are those of the parent company of the consolidated group.

Immediately before consolidating (or after joining a group), subsidiary companies will generally berequired to separately recognise gains/losses and pay tax on the built-in gains. This rule will notapply to the parent company or to subsidiaries that have been associated with the parent for acertain period. This rule will not apply to companies joining the group under a tax-qualifiedreorganisation, excluding a Kabushiki Iten transaction.




7. Disposal


A seller of a profitable business is more likely to be interested in selling shares since this maymitigate the consequences of possible double taxation on gains at both the corporate andshareholder levels.

However, where the seller has operating loss carry forwards which are available to shelter gains onappreciated assets, a seller may be willing to dispose of its assets.

There is no distinction under Japanese corporate tax law between capital gains and ordinaryincome. In most cases, the tax and accounting basis in the assets should be the same since there isa close degree of book and tax conformity (e.g. in the case of depreciable assets).

7.2 Stock Sale


Gains realised by a Japanese seller company from the sale of stock are included as income to theseller and taxed at the normal tax rates.

Under Japanese domestic tax law, a disposal of shares by a non-resident will be subject toJapanese law if the non-resident seller owns 25% or more of the shares in a Japanese companyand sells 5% or more of the shares during the taxable year.

Gains derived by a foreign seller on the disposition of shares of a Japanese company may not besubject to Japanese tax, if the seller is a resident of a country with which Japan has a treaty and thetreaty exempts profit from the sale of shares in a Japanese company from Japanese tax.

Capital gains derived by an individual seller from the sale of stock are taxed separately from otherincome. There is no distinction between short-term and long-term gains.

In principle, net capital gains are subject to a flat 15% national tax and an additional (non-deductible) local tax of 5%, for a total of 20%.




However, for the period from 1st January 2003 to 31st December 2007, an individual shareholderwill be subject to tax at the rate of 10% (7% national tax and 3% local tax) for transfers of listedshares under certain circumstances. Individual sellers who have losses in the same incomecategory may deduct such losses against share gains in the same year. Individual sellers may notgenerally carry forward losses.


Capital gains may be distributed as dividends to the shareholders without any restrictions. Seesections 1.2.3 and 1.3 for a discussion of the withholding tax implications relating to the payment ofdividends to Japanese shareholders and foreign shareholders. Please see also section 6.1 onrepatriation of profits.

7.3 Asset Sale


A business may be transferred from one entity in Japan to another by way of a sale of the assetsand liabilities of the business (Business Transfer) at fair market value for Japanese tax purposes.The seller will record profit or loss for Japanese tax purposes based on the difference between theproceeds received for the transfer and the book value of the business that is transferred.

The difference between the transfer price and the fair market value of the assets and liabilities in theBusiness Transfer will generally be treated as goodwill for Japanese tax purposes. A paymentreceived by the seller for goodwill will be included in its taxable profit, but any carried forward taxnet operating losses of the seller may be used to offset against such taxable profit.

In the absence of real estate or marketable securities or goodwill, it may be possible to structure theBusiness Transfer so that most of the business assets are transferred at net book value without therecognition of taxable gain.

In the case of asset disposals by non-resident companies, both national and local corporate incometaxes will arise if the asset is held through a Japanese permanent establishment. If the assets arenot held through a Japanese permanent establishment, taxation will be limited to national corporateincome tax on profits from the disposal of Japanese shares or Japanese real estate. Some, thoughnot all, Japanese double tax treaties exempt capital gains on certain categories of asset.


Capital gains may be distributed as dividends to the shareholders without any restrictions. Seesections 1.2.3 and 1.3 for a discussion on the withholding tax implications relating to the payment ofdividends paid to Japanese shareholders and foreign shareholders. Please see also section 6.1on repatriation of profits.





8.1 Consumption Tax (GST/VAT)

The seller of assets is required to collect Japanese consumption tax (current rate is 5%) from thepurchaser in connection with a sale of assets that are located in Japan. Depending on the seller’sconsumption tax position, it may be required to remit to the tax authorities the excess ofconsumption tax collected over consumption tax paid.

8.2 Stamp Tax

As stated previously, stamp tax is generally payable by the purchaser, unless otherwise stated inthe agreement.


No consumption tax is imposed in the case of a merger or a spin-off. In the case of a contributionin-kind, consumption tax is imposed, however it is calculated based on the value of the sharesissued in exchange for the transferred assets and liabilities (i.e. upon the net value of the assetsand liabilities). Please see section 5 for more detailed information regarding M&As.

The consent of each employee who will be transferred to the transferor is required in the case of abusiness transfer, although this is not required in the case of a spin-off and merger.


Transaction costs may generally include legal fees, any costs required to conclude the saleagreement, arrangement fees, etc. Such costs should generally be deductible to the seller.





9.1 Distribution of Surplus Cash

Dividends paid from a Japanese subsidiary to a Japanese corporate shareholder (a corporation)may be partly or wholly non-taxable, subject to certain conditions. There may be an incentive for aseller to extract the maximum possible value from a subsidiary by way of a dividend prior to itsdisposal.

The Japanese Commercial Code provides the following rules to the payment of dividends:

• dividends may be paid on an annual basis after approval at the annual general shareholder’smeeting; a Japanese company whose business year is one year may stipulate in the Articles ofIncorporation that it may distribute an “interim dividend” by resolution of the Board of Directors,only once per year, and within three months after a fixed date stipulated in the Articles ofIncorporation.

Under the new Corporation Law (to be effective in May 2006 although the exact effective datehas not been determined), Japanese companies will be able to pay dividends whenever and asmany times during the fiscal year as they want, subject to a shareholders resolution (under thecurrent Law, only at an annual general shareholders meeting) unless the Articles ofIncorporation stipulate that a dividend may be paid by a board member’s resolution where theBoard of Directors as well as an independent auditor exists. Interim dividends as describedabove will remain. However, the Law stipulates that regardless of the size of the capitalisation,companies with net assets of less than JPY3 million may not pay dividends to shareholderseven if they have enough retained earnings to do so, in order to protect the interests ofcreditors.

Please refer also to section 6.1 on repatriation of profits.

9.2 Transfer Assets to be Retained to Another Affiliate

For assets that will be retained, the seller may want to transfer (e.g. via spin-off and split-off) thetarget’s assets (that will not be sold to the purchaser) to another Japanese affiliate and then sell theshares in the target to the purchaser. Alternatively, the seller may want to transfer the assets to besold to another Japanese Company and then sell the shares of that Japanese company.




10. De-mergers

A de-merger usually takes place through the sale of assets or a business. The implications of ade-merger should be the same as an asset deal as discussed in sections 2.3 and 7.3.


After acquiring a target, a financial buyer generally looks for an exit route either through a sale or an IPO.Since the objectives of a financial buyer are to maximise its return on investment and optimise its exitmultiples, any profits derived from the exit route through an asset or stock sale are generally regarded asincome subject to tax. To realise profits in a tax efficient manner, an appropriate structure should be put inplace to effect the acquisition.

For a non-Japanese resident, there are no special tax laws or regulations applicable to capital gainsarising from an IPO in Japan (preferential tax treatment exists for an individual resident investor).Therefore, profits derived from an IPO by a financial buyer may be subject to tax in Japan, as the gainswill be regarded as income, unless the shares are held through a company that is resident in a treatycountry that exempts such gains.




KOREA

Country M&A TeamCountry Leader ~ Park Dae-Joon

Lee Jin-YoungSong Sang-Keun

Ko Kyung-Tae






Park Dae-Joon Partner +822 709 0551 [email protected]

Lee Jin-Young Partner +822 709 0557 [email protected]

Song Sang-Keun Partner +822 709 0559 [email protected]

Ko Kyung-Tae Senior Manager +822 709 4099 [email protected]

PricewaterhouseCoopers • Kukji Center Building • 21F 191 Hankang-Ro-2-Ka • Yongsan-Ku • Seoul 140-702 •Korea




1. Introduction

1.1 General Information on M&A in Korea

M&A opportunities in Korea have dramatically increased since the Asian Economic Crisis in the late1990s. Cross-border acquisitions have been particularly brisk in various industries. Sales ofdistressed companies have represented a large proportion of M&A deals in Korea since the AsianEconomic Crisis. In recent years, a growing number of companies are turning their attention to M&Aopportunities in order to increase corporate revenues and/or to gain various synergistic benefits.M&A activities among listed companies are also expected to become more common asshareholders become more knowledgeable about the advantages of M&A activities and related taxand legal issues. Although the number of M&A deals in Korea is growing, the Korean governmentcontinues to provide tax and other benefits to actively promote M&A activities.


The following forms of business entity are available in Korea. However, Chusik Hoesa is by far themost common form of business entity although recently Yuhan Hoesa has been used by some U.S.companies as it may be used to benefit from “check-the-box” rules under the U.S. tax code.

• Chusik Hoesa

Chusik Hoesa (CH) is the only Korean business organisation permitted to publicly issue sharesor bonds and, therefore, is the most common form of business entity used in Korea.

• Yuhan Hoesa

A Yuhan Hoesa (YH) is a closely held corporation which may not have more than 50shareholders. A YH may not publicly issue debentures. In most other respects, the formation,structure and conduct of a YH are similar to those of a CH.

For U.S. tax planning, one possible advantage of using a YH is that it may be possible to obtain“flow-through” tax treatment in the U.S. At present, a Korean YH is an eligible entity under theU.S. “check-the-box” regulations and as such it may make an election to be treated as apartnership or “disregarded entity” for U.S. tax purposes. By contrast, a Korean CH is on the listof “per-se” corporations under the U.S. “check-the-box” regulations, and thus is not eligible tomake such an election.




• Hapmyong Hoesa (Partnership)

A Hapmyong Hoesa is organised by two or more partners who bear unlimited liability for theobligations of the partnership. Hapmyong Hoesa itself is subject to corporate income tax.

• Hapja Hoesa (Limited Partnership)

A Hapja Hoesa consists of one or more partners having unlimited liability and one or morepartners having limited liability. Hapja Hoesa itself is subject to corporate income tax.


Foreign investors may invest in most industries without any ownership restrictions. However, for afew industries such as newspaper and magazine publishing, telecommunications and cablebroadcastings, the Korean government encourages foreign investors to establish a joint venturecompany with Korean partners rather than a wholly-owned subsidiary by restricting the amount offoreign ownership to a certain designated percentage.

1.4 Corporate Tax

A corporation, formed under Korean laws is subject to Korean tax on its worldwide income. AKorean corporation is entitled to either a deduction or a tax credit for foreign taxes paid with respectto the foreign-sourced income.

A branch of a foreign corporation is subject to tax on its income generated in Korea.

The corporation tax rates are as follows:

* Resident surtax is a local tax which is levied at 10% of corporation tax.

Korea has specific tax provisions dealing with transfer pricing rules, anti-thin capitalisation and anti-tax haven.

1.5 Tax Losses Carry Forward/Carry Backward

In general, tax losses may be carried forward for five years without having to satisfy any tests. Carryback of tax losses is generally not allowed except for one year carry back of losses which isavailable to small and medium sized companies.

1.6 Tax Groupings

Tax groupings are not available.

Tax base Corporation tax Resident surtax* Total

W0 – W100 million 13% 1.3% 14.3%

Over W100 million 25% 2.5% 27.5%




1.7 Tax Incentives for Foreign Investment

Foreign invested corporations may be entitled to tax incentives if they are involved in attractingadvanced technologies or industry supporting services, as defined under the Special Tax TreatmentControl Law, or are located in a designated Foreign Investment Zone, or the investment is of onethat is designated by the Presidential Decree as being essential to attract foreign investments. Theincentives may include exemption from and/or reduction in income tax, acquisition tax, registrationtax, property tax and aggregate land tax, exemption from customs duties, special excise tax andVAT on capital goods imported and withholding tax exemption on payment of dividends androyalties to a foreign supplier of technology.




2. Acquisitions: Buyer’s Perspective

2.1 Stock or Assets Acquisition

An acquisition of ownership of a Korean company may be achieved through asset or stockacquisition.

Buyers often prefer an asset deal to a stock deal, primarily to minimise the business, legal andfinancial risks of acquiring a company with cross-guarantees, uncollectible receivables, contingentliabilities and a host of other unknowns. Furthermore, when assets are acquired rather thanshares, the buyer may be able to step up the basis of the assets to fair market value and toamortise goodwill resulting from the transaction over a period of five to twenty years.


Acquisition of shares in a Target Company may be achieved in the following forms:

• Purchase of Existing Shares from Existing Shareholders by Foreign Investors

A foreign investor may purchase shares in a Target Company from existing shareholders. Theconsideration for the shares would be paid to the existing shareholder who would be subject tocapital gains tax in Korea on the gains. If the share ownership of the foreign investor equals toor exceeds 51%, the foreign investor would be subject to acquisition tax as explained below.

A foreign investor would not be eligible for tax incentives under this type of share acquisitionwhere existing shares are acquired.

• Purchase of New Shares of the Target Company by Foreign Investors

A foreign investor may increase its share ownership in the Target Company through purchase ofnewly issued shares of the Target Company. The acquisition tax may also apply in this case.This type of foreign investment may be eligible for tax incentives applicable to foreigninvestment.




• Purchase of Shares in a Target Company through a Holding Company

A foreign investor may set up a holding company in Korea to purchase existing shares or newshares in a Target Company.

However, the investment by a holding company in a Target Company will not be treated asforeign investment. As such, the Target Company may not be eligible for tax incentives availableto foreign-invested corporations.


An asset acquisition may take the form of a “business transfer” which means “a comprehensivetransfer of all the rights and obligations of a transferor related to the business” as defined under thePresidential Decree of the Basic National Tax Law. Where a transferee acquires only a portion ofthe target business assets or liabilities, it is usually called an “asset transfer” which is notconsidered “a comprehensive business transfer”. However, in many cases it may be difficult toclearly differentiate between an “asset transfer” and a “business transfer”.

2.2 Taxation


• Deemed Acquisition Tax

When a purchaser acquires 51% or more interest, together with related parties, in a TargetCompany, the purchaser is deemed to have acquired the target’s assets and is subject toacquisition tax as described above. Through careful planning, the concerned tax may beminimised.

• Withholding Tax

A foreign acquirer’s dividend income paid by a Target Company is subject to withholding tax at27.5% (including surtax), or at a treaty reduced rate, if applicable.

• Secondary Tax Liability

An acquirer would bear secondary tax liability of a Target Company as a majority shareholder(i.e. holder of 51% or more of the target’s outstanding shares) for any taxes in arrears (to theextent such tax liability is fixed on or after the acquirer becomes the majority shareholder) aswell as relevant penalties, interest, collection expenses, and any remaining tax liabilities afterappropriation of the target’s property to pay such taxes.

• Government Reporting Requirements

An acquisition of Target Company’s shares would qualify as a foreign direct investment (FDI)subject to reporting requirements under the Foreign Investment Promotion Act (FIPA).


• Acquisition Tax

The acquisition tax ranging from 2.2% to 11% (including surtax) on the acquisition price ofassets such as real estate, vehicles, certain construction equipment, aircrafts, vessels, miningrights, golf memberships, health club memberships, etc. transferred would generally be imposedat the time of acquisition.




• Registration Tax

Registration tax ranging from 1.2% to 6% (including surtax) on the value of assets such as realestate, vehicles, certain construction equipment and aircrafts would be imposed at the time ofregistration of a change in ownership.

• Capital Registration Tax

If the acquirer uses a new company as an acquisition vehicle, the acquirer is required to pay aregistration tax of 0.48% (or 1.44%, where the surviving company is located in a prescribedmetropolitan area, the registration tax rate would be levied at three times the regular rate) of thenominal value of paid-in-capital upon establishment or incorporation of the new company.

• Exemption or Reduction of Registration Tax or Acquisition Tax

Certain local governments may grant exemptions or reductions of registration tax and acquisitiontax arising in the course of a comprehensive business transfer. If a transferee of a business isexempt from registration and acquisition taxes in accordance with the concerned localgovernment’s ordinance, only the Special Tax for Rural Development shall be paid at the rate of20% of the amount of the exempted registration and acquisition taxes.

• Secondary Liability for Taxes in Arrears

An acquirer of a complete business (comprehensive business transfer) bears secondary taxliability for national taxes, penalty taxes, interest on deferred payments and expenses forcollection of such taxes as well as local taxes, in arrears, but only to the extent of the liability ofthe transferor of the business at the date of the business transfer and limited to the value ofassets transferred. Therefore, the potential purchaser of a comprehensive business shouldconfirm with the relevant tax authorities whether the transferor has any tax liabilities in arrearsbefore proceeding with the business purchase.

In the event that a transferee acquires only a portion of the target business assets or liabilities(asset transfer), then the transferee may not be subject to secondary tax liability.

• Preservation of Tax Losses and Tax Incentives

Tax loss and tax rate incentives of a Target Company are not allowed to be transferred to theacquiring company.

2.2.3 Tax Treatment of Transaction Costs

For example, due diligence fee and legal service fee, if any, incurred by a foreign buyer before theincorporation of a Korean entity, may not be allowed as deduction since such expenses are notrelevant to the business of the Korean entity but are related to the acquisition of new business bythe foreign buyer.




3. Impact on Basis


The acquisition price of stock forms the cash base of the acquirer’s stock in a Target Company, andthere is no election available to step up the tax basis of the underlying assets.


If a comprehensive business is purchased at fair market value, the acquisition cost of the targetbusiness assets may be stepped up (or down, as the case may be) to fair market value. If thetransferee pays consideration in excess of the fair market value of the net target business assetsacquired, the excess will be regarded as goodwill. For tax purposes, goodwill may be amortised inaccordance with the accounting amortisation which is over five years or longer (but not longer than20 years) using the straight-line method.




4. Tax Issues in Connection with Financing of Acquisitions

4.1 Debt

Specific tax issues relating to the overall level of borrowings and interest charged on debt are asfollows.


Interest payments to foreign lenders are subject to withholding tax at 27.5% (including surtax).This rate may be reduced to a lower rate by a double tax treaty with a country of which the foreignlender is a resident and the treaty provides for such a reduction. However, interest payments toforeign lenders may be exempt under local rules from withholding tax if certain conditions are met.

4.1.2 Deductibility of Interest/Thin Capitalisation

Interest expense incurred in relation to a trade or business is generally deductible, subject to debt-equity ratio limitation.

A Korean subsidiary, or a Korean branch of a foreign corporation, is subject to thin capitalisationrules (the “thin-cap rule”). Under the thin-cap rule, if loans from overseas controlling shareholders(OCS) or loans guaranteed by OCSs exceed three times (six times in the case of financialinstitutions) the equity held by OCSs, the interest on the excess amount of the loans is notdeductible. For purposes of the thin-cap rules, an OCS may be defined as any of the following:

• a foreign shareholder owning directly or indirectly 50% or more of the Korean company’s shares;

• any foreign company in which the parent company (foreign shareholder of a Korean company,as defined above) owns directly or indirectly 50% or more of the shares; or

• any related/unrelated foreign shareholder company which has substantial control or influenceover the Korean company.




4.1.3 Key Non-Tax Issues

A loan with maturity of five or more years made by a foreign parent to a Korean subsidiary wouldqualify as foreign direct-investment subject to reporting requirements under FIPA.

4.2 Equity

The capital registration tax is imposed at a rate ranging from 0.48% to 1.44% (including surtax) onthe amount of paid-in capital on the acquisition of new stock.

Dividends paid on stock are not tax deductible to the company paying the dividends.

Dividend income received by a Korean company constitutes taxable income of the company.However, a qualified holding company under the Free Trade Act (FTA) that owns 50% (30% in thecase of a listed subsidiary) or more of the equity in its subsidiary will be allowed a deductionequivalent to 60% to 100% of the dividend received.

A company which is not a qualified holding company under the FTA will be allowed a deductionequivalent to 30% to 100% of the dividends received if certain conditions are met.

In order to prevent a holding company and any other company from expanding control over theirsubsidiaries through borrowings, dividend received deduction is reduced as borrowings and interestcosts of the parent company is increased.

Dividend income paid by a Korean company to a non-resident is subject to withholding tax whichis to be deducted by the Korean payer from the gross payment.




5. Disposals: Seller’s Perpective

5.1 Stock Disposal

5.1.1 Capital Gains Tax

A domestic corporate shareholder, including a taxable permanent establishment or branch of aforeign person, will generally be subjected to 27.5% corporate income tax rate on gains derivedfrom the sale of shares in a Korean entity. The capital gain is generally calculated as the differencebetween the acquisition cost of the shares and the sales proceeds received in the exchange. Thesecurities transaction tax paid will be deducted from the sales proceeds of the shares for thepurpose of calculating the capital gain.

Under Korean tax laws, non-resident shareholders’ capital gains on the sale of shares in a Koreancompany are generally subject to income tax (by way of withholding) at the lesser of 11% of thegross proceeds received or 27.5% of the net capital gain.

However, gains derived from the sale of shares in a Korean company are not subject to Koreantax if a foreign transferor meets the following conditions:

• the foreign transferor does not have a permanent establishment (PE) in Korea;

• the shares being transferred are publicly listed; and

• the foreign transferor did not own 25% or more of the shares of the publicly listed entity duringthe last five years.

In addition, the above tax rates may be reduced or eliminated in accordance with the provisions ofan applicable double tax treaty.

5.1.2 Securities Transaction Tax

A security transaction tax of up to 0.5% may apply (based on the fair market value of the unlistedshares transferred). This tax shall generally be paid by the seller and applies even where thetransfer is a share exchange between foreign companies. In certain cases, a transferor may beexempt from or subject to a lower rate of the securities transaction tax. To the extent the fair marketvalue of the shares is not readily ascertainable, the value may be assessed in accordance with theInheritance and Gift Tax Law.




5.2 Asset Disposal

5.2.1 Corporate Income Tax on Capital Gains

Corporate income tax will generally apply to any taxable gains realised by the seller in a businesstransfer. The applicable tax rate will be the regular corporate income tax rate. It should be noted thatthere exists a risk of double taxation because dividend distributed to shareholders would also besubject to Korean taxation.


Generally, the seller in a “comprehensive business transfer” is not required to charge the 10% VATfor the assets transferred to the buyer, because a “comprehensive business transfer” is generallynot regarded as a supply of goods for VAT purposes.

However, in the event that a buyer acquires only a portion of the target business assets orliabilities, the transfer may be subjected to VAT.

5.2.3 Corporate Income Tax on Liquidation Income

If, after a business transfer, the transferor company is liquidated, the liquidating company may besubject to corporate income tax on the “liquidating income”.

5.2.4 Income Tax on Shareholders’ Unrealised Gains as Deemed Dividends

When a corporation is liquidated and the remaining assets are distributed to shareholders, to theextent the proceeds received by a shareholder exceed the acquisition price for its shares, theshareholder would be deemed to have received the excess as dividends.

Korean corporate shareholders must include such deemed dividends when calculating their taxableincome.

Foreign corporate shareholders will be subject to Korean withholding tax on the deemed dividends(assuming the dividend is not connected with a PE of the foreign shareholder in Korea). The rate ofwithholding tax on such dividends under Korean domestic law is 27.5%. However, the tax rate maybe reduced under an applicable double tax treaty between Korea and the resident jurisdiction of theforeign shareholder.




6. Mergers

Mergers are legally allowed in Korea, but only between Korean domestic companies.

6.1 Tax Consequences

Unless carefully planned and executed, a Korean merger may result in a Korean tax liability for thedissolving company, shareholders of the dissolving company, and/or the surviving company asmentioned below.

However, through careful planning and agreement among the shareholders, substantially all of themerger-related taxes may be mitigated or deferred, particularly if the merger is considered a“Qualified” merger, as further outlined below.

A merger meeting the following basic conditions will be considered a “Qualified Merger” for Koreantax purposes:

• both involved companies – surviving and dissolving (merged) companies, have been engaged inbusiness for one year or longer as of the merger date;

• if consideration is paid, at least 95% of the consideration paid to the shareholders of themerged company consists solely of shares in the surviving company; and

• the surviving company continues to carry out the operations of the transferred business until theend of the fiscal year in which the merger takes place.

6.1.1 Tax Implications for Target Company (Dissolving Company)

Liquidation income may result when a Target Company in a merger is liquidated in connection withthe merger into the surviving company. Generally, liquidation income (calculated at the TargetCompany level) is the amount of the excess of the adjusted net equity of the dissolving company.Such income is subject to the regular corporate income tax (generally 27.5%) in the hands of theTarget.




6.1.2 Tax Implications for Shareholders of the Target

Where the proceeds (surviving company’s shares, cash and other consideration) received by thetarget’s shareholders exceed the acquisition costs of such shares, the difference will generally betreated as a deemed dividend for Korean tax purposes. Deemed dividend income to a Koreancorporate shareholder is included in its taxable income. Generally, deemed dividend to a foreignshareholder is subject to withholding tax at 27.5%, or lower treaty rate, if applicable.

6.1.3 Tax Implications for Surviving Company

• Registration Tax

In the case of a merger, an exemption from registration taxes may be available for theregistration of certain properties acquired in a merger between companies that have been inexistence for at least one year.

• Acquisition Tax

Assets acquired in a merger should generally be exempt from acquisition tax which ranges from2.2% to 11%.

• Corporate Tax on Appraisal Gains

If in the course of a merger, the surviving company records assets transferred from a mergedcompany at an appraised value that is in excess of the book value of the dissolved company,such appraisal gain would normally be treated as taxable income for the surviving company.However, in a “Qualified Merger”, the corporate income tax on gain resulting from the appraisalof real estate assets may be deferred until the surviving company disposes of such assets.Nevertheless, it should be noted that if the surviving company discontinues the business of thedissolved company within three years of the merger, the deferred income will be recaptured fortax purposes at that time, regardless of whether the assets are sold.

• Others

– Unfair Mergers

If the stock exchange ratio between related companies is manipulated in such way that oneof the shareholders obtains a disproportionate economic advantage, the transferor of thebenefit (Donor) is subjected to the “Denial of Unfair Transactions” and the benefitting party(Beneficiary) is subject to the “Tax on Deemed Income from Unfair Transaction”.

– Succession of Tax Attributes

Certain tax attributes of the dissolving company could be transferred to the survivingcompany.

– Succession of Net Operating Loss (NOL)

If certain conditions under tax laws are met, the NOL of the dissolving company could betransferred to the surviving company.




7. De-mergers

De-merger structures may involve various tax implications and must be carefully designed to minimisepotentially negative tax consequences. For example, Korean tax rules permit various tax benefits in split-offs (and spin-offs) that satisfy certain requirements (qualified split-off requirements). The qualified split-off/spin-off requirements are as follows:

• the divided company must be a domestic company which has been in business for at least five yearsprior to the split-off registration date;

• 100% of the consideration received by the divided company’s shareholders must be in shares ofthe new split-off company, and must be distributed in proportion to the shareholders’ ownership ratio;

• the split-off company must be a business unit which is capable of carrying on its business wholly on itsown, and the assets and liabilities of the divided business unit(s) must be comprehensively transferredto the split-off company;

• the split-off company must carry on the historic business of the divided company until the end of thetaxable year in which the split-off occurred.

7.1 Type of De-mergers

• Split-off (Injuk-boonhal)

A split-off is defined as the separation of a company’s business division to a new entity assubsidiary of the company’s parent or shareholders.

• Spin-off (Muljuk-boonhal)

A spin-off is defined as the separation of a company’s business division to a new entity assubsidiary of the company




7.2 Split-off

7.2.1 Acquirer

• Deemed Dividend Income

This tax normally applies to shareholders of a spun off company which receives compensation ofa spin-off.

7.2.2 A New Split-off Company

• Tax on Appraisal Gains

Appraisal gains (i.e. appraisal value of assets transferred less their book value) may berecognised from a split-off. However, if the requirements for a qualified split-off are met, tax onsuch gains may be deferred.

• Transfer of Tax Attributes

All tax attributes could be transferred to the new company, provided that it satisfies requirementsfor a qualified split-off and the assets are transferred at book value of the parent company

• Acquisition/Registration tax

In general, 2.2% acquisition tax and 2.4% registration tax would be payable by a new split-offcompany (in the case of Seoul Metropolitan area, triple rate may apply). However, if therequirements for a qualified split-off are met, these taxes may be exempt.

7.2.3 Target (From Which a New Company is Split Off)

• Capital Gains Tax

Capital gains (i.e. consideration received by target less amount of capital reduction at target)would be recognised upon split-off.

7.3 Spin-off: Tax and Other Considerations

7.3.1 A New Spun-off Company

• Acquisition/Registration Tax

In general, 2.2% acquisition tax and 2.4% registration tax would be payable by a new spun-offcompany (in the case of Seoul Metropolitan area, triple rate may apply). However, if therequirements for a qualified spin-off are met, these taxes may be exempt.

• Transfer of Tax Attributes

Certain tax attributes could be transferred to the new company.




7.3.2 Target (From Which a New Company is Spun Off)

• Gains from the Transfer of Asset

In the case of a spin-off, if the consideration for the transferred asset and liabilities to the newcompany exceeds the book value of the parent company, such gains would normally be treatedas taxable income for the parent company. However, if the requirements for a qualified split-offare met, these taxes may be deferred.

It should be noted that there exists a risk of potential double taxation because capital gains fromasset transfer upon spin-off would be taxed at the target’s level and dividends later distributed tothe target’s shareholder would also be taxed at the shareholder’s level.




8. Other Pertinent Issues

8.1 Exit Route

The Korean government has in recent years opened up its economy to encourage foreigninvestments. Before entering a deal to acquire an investment in Korea, a foreign buyer would needto consider its investment strategies and if applicable, the exit strategies. As indicated, an assetdeal will result in a host of tax issues to the seller whereas a share deal may be structured more taxeffectively.

Therefore, by selecting an appropriate buying entity for a Korean Target, a foreign investor may exitKorea with a relatively reduced tax cost.




MALAYSIA

Country M&A TeamCountry Leader ~ Frances Po

Peter WeeChang Huey Yueh






Frances Po Partner +603 2693 1077 ext. 1118 [email protected]

Peter Wee Managing Consultant +603 2693 1077 ext. 1122 [email protected]

Chang Huey Yueh Senior Consultant +603 2693 1077 ext. 1474 [email protected]

PricewaterhouseCoopers • Wisma Sime Darby • 11 Flr Jalan Raja Laut • 50350 Kuala Lumpur • Malaysia




1. Introduction

1.1 General Comments on M&A in Malaysia

This chapter details the main issues that are relevant to both buyers and sellers on the transfer ofbusiness or shares in a Malaysian company.

In Malaysia, there is no statutory concept of “merger” and the mode of a merger typically involvesan acquisition of shares or business assets (and liabilities) of another company when structuringM&A transactions in addition to commercial considerations, income tax (including impact on taxincentives), stamp duty and real property gains tax implications should be considered . Non-taxconsiderations, such as exchange control and foreign equity participation requirements may alsoimpact the transactions.

1.2 Corporate Tax

Malaysia operates a unitary tax system on a territorial basis. Tax residents of Malaysia, whethercorporate or individuals, are taxed on income accruing in or derived from Malaysia or receivedin Malaysia from outside Malaysia. However, resident companies (except for those carrying onbanking, insurance, sea or air transport operations) and resident individuals are exempted fromincome tax on foreign-sourced income remitted to Malaysia. Non-residents are only taxed onincome accruing in or derived from Malaysia.

The corporate tax rate for resident and non-resident corporations (including branches of foreigncorporations) is 28%. However, with effect from the Year of Assessment 2004, companies residentin Malaysia with paid-up capital not exceeding RM2.5 million are subject to income tax at the rate of20% on chargeable income up to and including RM500,000. The remaining chargeable income willcontinue to be taxed at the prevailing corporate tax rate of 28%.

The basis of income assessment is on a current year basis and a self-assessment system oftaxation was introduced in stages, starting with companies, in the year 2001.

Generally, capital gains are not subject to tax in Malaysia. However, gains derived from the ordinarycourse of business would be treated as ordinary income and subject to tax at the prevailingcorporate tax rate.




• Taxation of Dividends

Malaysia has an imputation system of taxing dividends. The ability of a company to paydividends to a shareholder depends on the availability of tax franking credits (see Section 108credit) and its distributable profits. If the company does not have sufficient franking credits(which is the amount of income tax paid by the company less the amount already used to frankpayments of dividends), any dividend paid would be subject to tax at the current rate of 28%.Such tax paid is not creditable against any future tax liability of the company.

Exempt income, generated from offshore income or pioneer income derived by the company,may be distributed to the shareholders without having to satisfy the above-mentioned frankingrequirement.

Under the imputation system, Malaysian-sourced dividends received by shareholders aredeemed to have suffered tax at source at the corporate tax rate (currently 28%) by the payingcompany. If there are expenses incurred in deriving such dividends, these expenses are taxdeductible and may result in the Malaysian shareholders receiving a tax refund.

Where dividends are paid out of tax-exempt profits, such dividends are not subject to tax in thehands of the shareholders.

There is no withholding tax on dividends paid by Malaysian companies.

1.3 Withholding Tax

The Malaysian income tax legislation provides for withholding tax to be deducted at source oncertain payments made to non-residents. The withholding tax rates are as follows:

*Effective from 21st September 2002, payments to non-residents in respect of management/technical services rendered outside Malaysia will not be subject to withholding tax

Malaysia has a comprehensive network of double tax treaties which may reduce the withholding taxrates on the above payments made to a resident of a treaty country.

Malaysia also imposes withholding tax on payments made to non-resident contractors in respect ofservices rendered in Malaysia at the following rates:

• 10% of contract payment on account of tax which is, or may be, payable by the non-residentcontractor; and

• 3% of contract payment on account of tax which is, or may be, payable by employees of thenon-resident contractor.

It is generally the view of the Malaysian tax authorities that reimbursement of out-of-pocketexpenses to non-residents in respect of services rendered by the non-residents in Malaysia, or therental of moveable properties from non-residents, will be considered as part of the contract valueand be subject to withholding tax.


Interest 0 – 15 0 – 15


Management/Technical fees* 10 0 – 10

Rental of moveable properties 10 0 – 10




1.4 Goods and Services Tax/Value Added Tax

Currently, Malaysia does not have a value added tax (VAT) system. However, the Government hasproposed to implement, with effect from 1st January 2007, a consumption tax system based on thevalue-added model to be known as Goods and Services Tax (GST). GST is proposed to replace theexisting consumption taxes of sales tax and service tax.

Based on the discussion paper issued by the Government, it is proposed that the transfer of goingconcern is disregarded for GST/VAT purposes on the basis that it is neither a supply of goods norservices.

Currently, the following indirect taxes may be imposed on goods and services, as the case may be:

• import duties at specific rates, ad valorem rates (up to 60%) or composite rates, on dutiablegoods imported into Malaysia;

• sales tax at specific rates or ad valorem rates (5% and 10%) on taxable goods that aremanufactured in, or imported into, Malaysia;

• excise duties at specific rates or ad valorem rates (up to 250%) on goods subject to excise dutythat are manufactured in, or imported into, Malaysia; and

• service tax at 5% on taxable services provided by taxable persons, which are prescribed by wayof regulations.

1.5 Stamp Duty

Malaysia imposes stamp duty on chargeable instruments executed in certain transactions. In astock deal, Malaysian stamp duty is payable at the rate of 0.3% on the consideration paid or marketvalue of the shares (whichever is higher). In an asset deal, stamp duty ranging from 1% to 3% ispayable on the market value of the dutiable properties transferred under the instrument. Stamp dutyis payable by the buyer.

Specific exemptions from stamp duty are available provided stipulated conditions are met (seesection 2.4.3).

1.6 Real Property Gains Tax

There is no capital gains tax regime in Malaysia. Real property gains tax (RPGT) is howeverimposed on gains derived from the disposal of real property situated in Malaysia or shares in a realproperty company (RPC). Depending on the period of ownership, these gains will be subject toRPGT at rates ranging from 5% to 30%. A RPC is a controlled company, the major assets of whichconsist substantially of real property or RPC shares.

Specific exemptions from RPGT are available, provided stipulated conditions are met (see section7.3.1). Approval for exemption must be secured prior to the disposal.




2. Acquisitions


The benefits and drawbacks of either a stock or asset acquisition would depend on various factors,including the tax attributes of the Target Company, the acquiring company, business fit of theTarget Company with the buyer, and most importantly, the commercial considerations. Potentialbuyers can also improve shareholder values and returns on investment through tax efficientstructuring and planning.

In a stock acquisition, the buyer may be exposed to liabilities and exposure in the Target Company.As such, the buyer would need to carry out a due diligence exercise on the Target Company’sbusiness in a stock acquisition compared to an asset acquisition.


The main advantage of a stock acquisition is that the tax attributes such as unabsorbed tax losses,tax incentives or dividend franking credits remain with the Target Company.

• Preservation of Tax Losses and Unutilised Tax Depreciation Carried Forward

Generally, companies are allowed to carry forward their accumulated tax losses and unutilisedtax depreciation to be set off against their future business income. Such tax treatment isaccorded for an unlimited period of time. Furthermore, companies that ceased operations forseveral years may still utilise accumulated losses and unabsorbed capital allowances to be setoff against new business income.

Based on the recently enacted Finance Act 2005, effective from the Year of Assessment 2006,accumulated tax losses and unutilised tax depreciation of a Target Company shall be disregardedin the event there is a change of more than 50% of the shareholding in the Target Company.However, the Minister of Finance may, under special circumstances, exempt a company fromthe above provisions.

At this stage there has not been any ruling issued by the tax authorities as to what are the“special circumstances” under which this new restriction would be relaxed.




• Continuity of Tax Incentives

Where the Target Company is entitled to any tax incentives or exemptions, the conditionsattached to the incentives or exemptions should be examined to ensure that a change in ownership will not affect the target’s entitlement to such incentives or exemptions.

• Others

As highlighted previously, the buyer may be exposed to liabilities in the Target Company in astock acquisition. Hence, a thorough due diligence exercise on the Target Company’s businessin a stock acquisition will need to be conducted. This step will help identify the potential tax costsand, where appropriate, explore means of minimising the impact or applying for exemption. Thedue diligence could also contribute towards managing potential risks in the future.


In an asset acquisition, any tax attributes such as unabsorbed tax losses, tax incentives anddividend franking credits remain with the Target Company and may not be transferred to the buyer.

• Preservation of Tax: Losses and Unutilised Tax Depreciation Carried Forward

Generally, unabsorbed tax losses and unutilised tax deprecation of a Target Company may notbe transferred to the acquiring company in an asset acquisition.

• Continuity of Tax Incentives

Under an asset deal, any tax incentives or exemption currently enjoyed by the Target Companywill unlikely be transferred to the acquiring company. Generally, the buyer will have to submit anew application for tax incentives or exemptions upon acquiring the business, if it is eligible.

• Others

In an asset acquisition, the buyer has the choice of determining the assets/liabilities to beacquired. However, the buyer should still need to carry out a limited due diligence exercise onthe assets to be acquired.

2.4 Transaction Cost

2.4.1 GST/VAT

As mentioned in section 1.4, based on the discussion paper issued by the Government, it is proposedthat the transfer of going concern is disregarded for GST/VAT purposes on the basis that it isneither a supply of goods nor services.

2.4.2 Stamp Duty

In a stock deal, Malaysian stamp duty is payable by the buyer at the rate of 0.3% on theconsideration paid or market value of the shares (whichever is higher). For an asset deal, stampduty ranging from 1% to 3% is payable by the buyer on the market value of the dutiable propertiestransferred under the instrument.

Specific stamp duty exemption is available provided stipulated conditions are met (see section 2.4.3).





The Malaysian Income Tax Act and Stamp Act provide some concessions when a company is beingreorganised.

• For income tax purposes, sale of tax depreciable assets between related parties may be effectedat the tax written down value of the assets. This means that the seller will not have any taxablebalancing charge or deductible balancing allowance arising from the sale. The buyer will also bedeemed to have acquired the assets at its tax written down value. The transfer value of thefixed assets will be disregarded and the buyer would be entitled to claim annual allowancesbased on the original acquisition cost of the fixed assets but restricted to the tax written downvalues of the assets acquired. No initial allowance may be claimed on these fixed assets.

Additionally, the costs incurred in acquiring a foreign company will also be allowed a taxdeduction over a period of five years provided stipulated conditions are met. For instance, theacquisition is for the purpose of acquiring high technology for production within the country or foracquiring new export markets for local products; the acquirer must be a company incorporated inMalaysia with at least 60% Malaysian equity ownership and is involved in manufacturing ortrading/marketing activities and the acquired entity must be a foreign company with 100%foreign equity ownership that is located abroad and involved in manufacturing or trading/marketing activities.

• In respect of corporate restructuring or amalgamations, relief from stamp duty is available underthe following circumstances:

– if the acquisition of shares or assets is in connection with a scheme of amalgamation orreconstruction and the consideration comprises substantially of shares in the transfereecompany; or

– if the shares or assets are transferred between associated companies (i.e. there must be90% direct or indirect relationship between the transferee and the transferor).

In addition to the above, to further encourage public listed companies to expand and competeglobally, it has been proposed in the budget announcement on 30th September 2005 that stampduty exemptions would be given on M&A undertaken by companies listed on Bursa Malaysia.The M&A must be approved by the Securities Commission between 1st October 2005 and 31stDecember 2007 and completed not later than 31st December 2008.


Generally, transaction costs incurred during M&A exercises are not tax deductible to the buyer.However, to the extent to which the expenses are incurred in relation to the purchase of tradingstock, such expenses should be deductible.






In general, the acquisition price will be the tax cost base of the shares. If the shares acquired areshares in a RPC, the shares would be a chargeable asset and any subsequent gain on disposal ofthe shares would attract real property gains tax. A RPC is a controlled company that owns realproperty with a defined value of not less than 75% of its total tangible assets at the time the realproperty was acquired. The purchase price of the RPC shares would, under certain circumstances,be determined by a statutory defined formula. It is therefore important to ascertain, at the time of astock deal, whether the shares acquired are RPC shares.


In the purchase of assets, the buyer would generally be treated as having acquired the assets attheir acquisition price. The buyer may claim initial and annual allowances on the acquisition price ofplant and machinery. It may be possible to achieve a step up in the cost base of depreciable assetsfor the buyer. However, in allocating the purchase price of the assets, an independent professionalvaluation report should be obtained to support the reasonable allocation of the purchase price to thevarious asset categories.

The step up in cost base is not relevant where fixed assets are transferred between companiesunder common control, as the tax provisions would deem the transfer of fixed assets to be at theirtax written down values. The transfer value of the fixed assets will be disregarded and the buyerwould be entitled to claim annual allowances based on the original acquisition cost of the fixedassets but restricted to the tax written down values of the assets acquired. No initial allowance maybe claimed on these fixed assets.

No tax deduction is available for the amortisation of acquisition goodwill to the buyer. Therefore, thepurchase price on an asset deal should ideally be allocated as much as possible to inventory,depreciable capital assets, and other items which are entitled to a tax deduction or tax depreciation.






There is currently no thin capitalisation rule in Malaysia.


4.2.1 Stock Deal

In a stock deal, interest expense incurred on money borrowed to finance the acquisition of shares istax deductible to the extent that dividend income is received in the same year. This could result in atax refund to the shareholder company.

For example, assume that a Malaysian company receives a gross dividend of RM100 from itsMalaysian subsidiary. In the same year, the Malaysian company incurred interest expense of RM90on the investment. As the interest expense will be tax deductible against the dividend income, therewill be a tax refund to the Malaysian company.

RM

Dividend (gross) 100

Interest expense, say (90)

Net dividend 10

Tax on net dividend 2.8

Tax paid (imputation system) (28.0)

Tax to be refunded 25.2

It is important to time the payment of interest with the flow of dividends to maximise the interestdeduction and therefore maximise the tax refund. It should be noted that excess interest costs arenot eligible for offset against other income, nor can they be carried forward to offset against futuredividend income.




4.2.2 Asset Deal

Interest incurred on funds used to acquire a business under an asset deal should be fully taxdeductible. Since there is no thin capitalisation rule in Malaysia, it is possible to maximise theamount of debt used to fund the acquisition of business.




5. Mergers

In Malaysia, there is no statutory concept of a “merger”. The mode of merger in Malaysia involves eitherthe acquisition of shares in an existing Malaysian company, or an acquisition of assets (and liabilities) ofanother entity.

All proposed acquisitions of assets (including a subscription of shares), or any interests, mergers andtakeovers of a Malaysian business or company requires strict approval of the Foreign InvestmentCommittee (FIC), which is responsible for the co-ordination and regulations of such matters under theRegulation of Acquisition, Mergers and Takeovers.

Generally, acquisition of assets or interests in Malaysian incorporated companies of more than RM10 millionin value, or acquisition which results in the transfer of ownership or control to foreign interests, or wherethere is an acquisition of 15% or more of the voting rights in a Malaysian company by foreign interest,requires the prior approval of the FIC. The FIC may impose foreign equity restrictions.






The common methods of repatriation of profits are through payments of dividends, interest, royaltiesand management fees.

The ability of a company to pay dividends to a shareholder (resident or non-resident) would dependon the availability of retained earnings and dividend franking credits. Companies with insufficientdividend franking credits will suffer additional tax charge to the extent of the shortfall of the frankingcredits. Exempt income (e.g. offshore income or pioneer income of the company) may bedistributed to the shareholders without having to satisfy the franking requirement. There is norestriction for exchange control purposes on dividend distribution by Malaysian subsidiary to non-residents.

Payment of interest and royalties to non-residents would be subject to withholding tax, at rateswhich may be reduced under the relevant double tax treaty. As for management and technical fees,if the services are performed wholly outside Malaysia, there is no withholding tax on the payment.


As explained earlier, a company is allowed to carry forward its accumulated tax losses andunutilised tax depreciation to be set off against its future business income provided that there is nochange of more than 50% of its shareholding. Exemption from the above provision (i.e. the 50%continuity of shareholding requirement) may be obtained by the Minister of Finance under specialcircumstances.

Unutilised tax depreciation may also be carried forward indefinitely, subject to the 50% shareholdingrequirement, but can only be used to offset against future income of the same business source. Inother words, these unutilised balances may not be applied against income of a new businesssource.

Unabsorbed tax losses, unutilised tax deprecation and dividend franking credits may not betransferred to the acquiring company under an asset deal.




6.3 Tax Incentives

Under an asset deal, any tax incentive or exemption currently enjoyed by the Target Company isunlikely to be transferred to the acquiring company. Generally, the buyer will have to submit a newapplication for tax incentives or exemptions upon acquiring the business, if it is eligible.

For a stock deal, the conditions attached to the incentives should be examined to ensure that achange in ownership will not affect the Target Company’s entitlement to such incentives orexemptions.

Unutilised tax incentive may be carried forward indefinitely but may only be used to offset againstfuture income of the same business source.

6.4 Group Relief

Beginning from Year of Assessment 2006, tax losses of a Malaysian company may be utilised to setoff against the aggregate income of another company within the same group provided stipulatedconditions are met.

The group relief is limited to 50% of the current year’s unabsorbed losses of the surrenderingcompany. The following conditions need to be satisfied before the losses may be surrendered:

• the claimant and surrendering companies each must have a paid-up capital in respect ofordinary share of more than RM2.5 million;

• both the claimant and the surrendering companies must have the same accounting period;

• the shareholding, whether direct or indirect, of the claimant and surrendering companies in thegroup must not be less than 70%. In determining the 70% shareholding relationship, shares withfixed dividend rights are to be ignored;

• the 70% shareholding must be on a continuous basis during the preceding year and the relevantyear;

• the claimant company must be able to demonstrate that it is beneficially entitled, directly orindirectly, to at least 70% of the residual profits and assets (in the case of liquidation) of thesurrendering company, available for distribution to all equity holders (and vice versa); and

• the companies are not enjoying tax incentives in the year where tax losses are beingsurrendered or claimed.

Losses resulting from the acquisition of proprietary rights, or a foreign-owned company, should bedisregarded for the purpose of group relief.




7. Disposal


In preparing for a deal, it would be appropriate for the seller to identify the income tax and realproperty gains tax impact on any gains arising from the stock or asset deal. Where possible, the taxcosts should be quantified and the potential tax exposure minimised. Positive tax attributes andvalue of tax shelters (e.g. the availability of carry forward tax losses, unutilised tax depreciation andavailability of tax franking credits) could also be factored in and used as a bargaining tool whennegotiating with the buyer. As mentioned earlier, accumulated tax losses and unutilised taxdepreciation of a Target Company shall be disregarded in the event there is a change of more than50% of the shareholding in the Target Company unless an exemption to comply with the continuityof same ownership test is obtained.

Generally, from a seller’s perspective, it may be less complicated to sell a target through a stockdeal.

7.2 Stock Sale


Unless the seller is in the business of dealing in shares, the profits on the sale of shares should notbe subject to income tax as such profits are considered capital in nature. Malaysia does not have acapital gains tax regime, except for real property gains tax. Where the shares represent interests ina RPC, the gains from the disposal thereof are subject to real property gains tax. Real propertygains tax is levied at scale rates from 5% to 30% depending on the period of ownership.


Provided that the seller has sufficient dividend franking credits, the profits made from the sale ofstock can be distributed as dividend to the shareholders. Otherwise, the payer company wouldsuffer additional tax cost to the extent of the shortfall of the franking credit.




If the profits from the sale of shares are significant and the company does not have sufficientdividend franking credit to distribute such profits, it may need to transfer its existing business, if any,to a separate entity and then liquidate the company. Proceeds paid to shareholders on liquidationare not subject to franking credit restrictions.

7.3 Asset Sale


Generally, the sale of real property (land and building) or shares in a RPC would be subject to realproperty gains tax.

However, exemptions are available under the Real Property Gains Tax Act 1976. The most notableexemptions relate to the transfer of real property between companies in the same group. It ispossible to apply for an exemption from real property gains tax on the transfer of assets betweencompanies in the same group if the asset is transferred to bring about greater efficiency inoperations.

The exemption may, provided the scheme is in compliance with the Government policy on capitalparticipation in industry, also cover assets:

• transferred between group companies under any scheme of reorganisation, reconstruction, oramalgamation; or

• distributed by a liquidator in the case of a liquidation made under any scheme of reorganisation,reconstruction, or amalgamation.

Transactions in these categories must obtain the prior approval of the Malaysian tax authorities.

In respect of the sale of trading stock, the gain would be subject to income tax as it is considered aspart of the business income.

Any gain on the sale of fixed assets would not be subject to income tax. For transactions betweenunrelated parties, a balancing adjustment (balancing charge or allowance) may arise. If the transfervalue exceeds the tax written down value of the asset, the difference, known as a balancing charge,is taxable to the company. The balancing charge is restricted to the amount of allowances previously claimed. If the transfer value is less than the tax written down value of the asset, the shortfall,a balancing allowance, is deductible against the adjusted income of the company. If the transactionis between related parties, no balancing adjustment arises on the seller as the assets are deemedto be transferred at their tax written down value.

Currently, there is no indirect tax implication for the disposal of real properties (e.g. factory andoffice premises) and for the sale of machinery/equipment and trading stocks, where import dutyand/or sales tax have been paid. In addition, disposal of shares will not be subject to any indirecttaxes in the form of import duty/excise duty/sales tax/service tax.

If the seller has any exemptions from import duty and/or sales tax, including any facility for licensedmanufacturers in Malaysia (licensed under the Sales Tax Act), the following indirect tax implicationswould apply:

• the sale of exempt dutiable and/or taxable machinery/equipment (inclusive of spare parts) andraw materials would result in the import duty and/or sales tax becoming due and payable, unlessthe buyer is able to obtain exemption of import duty and/or sales tax for the purchase of the saidmachinery/equipment and raw materials from the relevant authorities; and




• in respect of sales tax-free raw materials, taxable work-in-progress and taxable finishedgoods manufactured by the seller, who is a licensed manufacturer under the Sales Tax Act,there are provisions in the Sales Tax Act to allow the buyer to purchase these items free ofsales tax subject to certain conditions being met. However, the buyer has to be a licensedmanufacturer as well. Otherwise sales tax would be due and payable upon sale by the seller.


As mentioned under section on stock sale, the gain arising from the disposal of assets may bedistributed as dividend to the shareholders provided there is sufficient dividend franking creditswhich may be used to frank the payment of such dividend.





8.1 GST/VAT

As mentioned in section 1.4, based on the discussion paper issued by the Government, it isproposed that the transfer of going concern is disregarded for GST/VAT purposes on the basis thatit is neither a supply of goods nor services.

8.2 Stamp Duty

Insofar as stamp duty is concerned, the stamp duty cost is borne by the buyer for any transfer ofshares or real properties.


The Malaysian Income Tax Act and Real Property Gains Tax Act provide some concessions when acompany is being reorganised.

• For income tax purposes, sale of tax depreciable assets between related parties can be effectedat the tax written down value of the assets. This means that the seller will not have anybalancing charge or balancing allowance arising from the sale.

• Specific exemptions from real property gains tax are available to M&A transactions providedstipulated conditions are met. For example, exemption may be granted if it can be clearly shownthat the transfer of property between group companies results in increased operational efficiency(and for consideration consisting substantially of shares) or where an asset is transferred in anyscheme of reorganisation or reconstruction in compliance with Government policy on capitalparticipation in industry.

In addition to the above, to further encourage public listed companies to expand and competeglobally, it has been proposed in the budget announcement on 30th September 2005 that realproperty gains tax exemptions would be given on M&A undertaken by companies listed on BursaMalaysia. The M&A must be approved by the Securities Commission from 1st October 2005 to31st December 2007 and completed not later than 31st December 2008.





Generally, transaction costs incurred on M&A exercises are not tax deductible to the seller.However, to the extent to which the costs are incurred in relation to the sale of trading stock, suchcosts shall be tax deductible.





In preparing for a deal it would be appropriate for the seller to identify the income tax and RPGT impact onany gains arising from the share or asset deal. Where possible, the tax costs should be quantified and thepotential tax exposure minimised. Positive tax attributes and value of tax shelters (e.g. the availability ofcarry forward tax losses, unutilised tax depreciation and availability of tax franking credits) could also befactored in and used as a bargaining tool when negotiating with the buyer. As mentioned earlier,accumulated tax losses and unutilised tax depreciation of a Target Company shall be disregarded in theevent there is a change of more than 50% of the shareholding in the Target Company unless anexemption to comply with the continuity of same ownership test is obtained.

• Intra-group Transfer of Assets Being Retained

In preparing for a sale of assets, it is important to do an identification of the assets to be transferred,identification of costs and net book values of the assets to be transferred and to engage anindependent professional appraiser to value the assets.

• Pre-sale Dividend

A company may decide to pay a dividend to its shareholders prior to a sale of the shares in thecompany. The ability of a company to pay dividends would depend on the availability of retainedearnings and dividend franking credits or exempt credits. There is no adverse tax implication arisingfrom a distribution of pre-sale dividends.




10. De-mergers

There is no statutory concept of a “de-merger” in Malaysia. The mode of de-merger in Malaysia typicallyinvolves either a disposal of shares/assets to another party or a distribution in specie of the shares/assetsto the shareholders either via dividend distribution or a capital reduction exercise (which requires Courtapproval).

The taxation treatment of a disposal is as stated above under section 7.

Where the de-merger is by way of a dividend in specie, the company paying the dividend must havesufficient franking or exempt tax credits when shares/assets are distributed. The shareholders receivingthe distribution will be taxed on the dividend distributed (see section 4.2.1.).

Where the de-merger is effected through a return of capital via a capital reduction exercise, theshareholders would generally not be taxed on the capital distribution (unless the shareholders are treatedas share dealers).


Where an IPO is concerned, there should be no tax implications if the shares have been held as long-terminvestments and are non-RPC shares.




NEW ZEALAND

Country M&A TeamCountry Leader ~ Peter Boyce

Arun DavidDeclan Mordaunt

Todd StevensDavid RhodesEleanor WardMark Russell

Peter J Vial








Auckland

Peter Boyce Partner +649 355 8547 [email protected]

Arun David Partner +649 355 8306 [email protected]

Declan Mordaunt Partner +649 355 8302 [email protected]

David Rhodes Director +649 355 8435 [email protected]

Eleanor Ward Director +649 355 8396 [email protected]

Mark Russell Director +649 355 8316 [email protected]

Peter J Vial Director +649 355 8272 [email protected]

Wellington

Todd Stevens Partner +644 462 7331 [email protected]

PricewaterhouseCoopersAuckland • 23 - 29 Albert Street • Auckland • New ZealandWellington • PwC Centre • 113 - 119 The Terrace • Wellington • New Zealand




1. Introduction

1.1 General Information on M&A in New Zealand

This chapter outlines the key New Zealand tax issues that should be considered when buying orselling a business in New Zealand.

The New Zealand tax base is reasonably broad and includes, in addition to income tax, a flat rateconsumption tax (goods and services tax) and a comprehensive international tax regime. NewZealand does not have a specific capital gains tax but certain capital gains are taxed under differentregimes.

A foreign investor tax credit regime allows a resident company’s profits to be distributed to foreigninvestors without the economic cost of non-resident withholding tax in certain circumstances.Conduit tax relief provisions provide tax relief for foreign investors making equity investments in aforeign company via a New Zealand company.

Reforms under consideration include significant changes to the rules governing the taxation ofincome from offshore equity investment (including the possible partial removal of the current “greylist” concessions under the foreign investment fund regime) and reform of the tax rules governingspecial partnerships to bring those rules into line with the limited partnership rules adopted in anumber of other jurisdictions.

Company and tax laws allow companies to amalgamate. Amalgamation can be used as analternative to a share purchase or as part of a post acquisition restructuring.

Companies are also able to migrate both into New Zealand and out of New Zealand.

New Zealand’s tax legislation allows companies to carry forward (but not to carry back) lossessubject to shareholder continuity requirements. Losses may be offset amongst commonly ownedgroup companies.

Companies in a 100% group may elect to enter into a tax consolidated group, which enables thegroup to be treated as a single entity for income tax purposes.

New Zealand has a general anti-avoidance provision which allows the Commissioner of InlandRevenue to strike down arrangements that have a purpose or effect (not being incidental) of taxavoidance. Any structuring transaction aimed at achieving tax efficiency should be reviewed in lightof this provision.




1.2 Corporate Tax

1.2.1 Income Tax

Income tax is levied at the rate of 33% on a New Zealand resident company’s worldwide income.Non-resident companies are taxed at the rate of 33% on their New Zealand-sourced income. Thereare no state or local income taxes.

Whilst New Zealand does not have a specific capital gains tax, capital gains on certain transactionsare deemed to be income subject to income tax. For example, profits from the sale of real andpersonal property purchased with the purpose of resale or in specified other circumstances aresubject to income tax.

1.2.2 Dividends

The income tax payable by a shareholder on a dividend depends on the number of imputationcredits which are attached to the dividend. Imputation credits are generated through the payment ofincome tax by the company and may be carried forward by companies from year to year provided a66% continuity of shareholding test is maintained.

Provided sufficient imputation credits are attached to a dividend, effectively that dividend may bepaid to both resident and non resident shareholders without the economic cost of furtherwithholding tax being imposed. Under the foreign investor tax credit regime, the withholding tax incertain instances may be funded effectively by payment of a supplementary dividend. Subject tocertain restrictions, the paying company may claim a tax credit for the cost of the supplementarydividends.


Interest, dividends and royalties paid to non-residents are subject to New Zealand withholding tax.The rate of withholding tax varies depending on whether or not New Zealand has entered into adouble tax agreement with the recipient entity’s country of residence. New Zealand currently hasdouble tax agreements in force with 29 countries and a further 3 treaties have been signed but arenot yet in force.

Generally, the rates are:

Although withholding tax is levied on dividends, as noted above, effectively the withholding tax maybe funded at no additional cost to the company if sufficient imputation credits are attached.

The rate of withholding tax imposed on interest is a minimum tax in the case of non-treaty andcertain treaty countries. It can also be reduced to nil if interest is paid to a non-associated party,the security is registered with the Inland Revenue Department and a 2% “approved issuer” levy onthe gross interest amount is paid.

There is no specific withholding tax on service or management fees. However, the definition of“royalty” is very wide and can include what might be regarded as service fees in some otherjurisdictions. In addition, New Zealand has a strict transfer pricing regime and service chargesimposed must be at arm’s length.


Interest 15 10 – 15


Dividends 15 – 30 15





GST is a transaction-based tax and is levied on the supply of goods and services in New Zealandand on goods imported into New Zealand (in addition to any Customs duty). GST is levied at therate of 12.5%, although some supplies are taxed at zero percent (principally exported goods, certain“exported” services and the transfer of a going-concern) and other supplies including the supply offinancial services (other than those which are zero-rated) are exempt from GST.

A “reverse charge” mechanism requires the self-assessment of GST on the value of servicesimported by some registered persons. If certain thresholds and criteria are satisfied, the recipient ofthe services must account for GST output tax as if they were the supplier of the inbound services.The reverse charge applies to imported services that are acquired for purposes other than makingtaxable supplies and that would have been subject to GST if they had been provided in NewZealand.

1.4 Stamp Duty and Gift Duty

Stamp duty has been abolished in respect of instruments executed after 20th May 1999. There is nocapital duty on the issue of shares.

Gift duty is levied progressively on most transactions where the consideration provided is less thanmarket value.


The most common form of business entity used in New Zealand is the limited liability company. Acompany can be incorporated with relative ease at the Companies Office, which offers an onlineincorporation service.

Another popular investment vehicle is the branch, which, unlike the company, is not a separate legalentity. If operated by a non-resident, the branch is treated as a non-resident for New Zealand taxpurposes enabling profits to be repatriated free of withholding tax. The other benefit of a branchstructure is the potential to utilise branch losses to offset foreign income. Like the company, abranch must file an income tax return in respect of its New Zealand-sourced income. Whenascertaining the taxable income of the branch, head office costs can be allocated.

The branch and the company must both file annual audited financial statements with the CompaniesOffice. A non-resident company which operates in New Zealand via a branch must also file its ownfinancial statements with the Companies Office.

Other popular investment vehicles include partnerships, trusts and unincorporated joint ventures.Partnerships and unincorporated joint ventures are not treated as separate entities for assessmentpurposes and tax is assessed by looking through to the participants.


Irrespective of which structure is utilised, a non-resident may need to obtain consent from theOverseas Investment Office (OIO) to acquire or establish (or acquire a 25% or more ownership orcontrol interest in):

• business or non-land assets worth more than NZ$100 million; or

• “sensitive land”; or

• fishing quotas or entitlements.




2. Acquisitions


In most cases, vendors prefer to sell stock (shares) in the Target Company rather than thecompany’s assets. Purchasers, on the other hand, generally prefer to buy assets rather than sharesas asset deals ensure that the tax history (and risk) remains with the vendor and often allow costbase uplifts.

As a general rule, asset transfers must be made at market value for tax purposes. With limitedexceptions, New Zealand’s Income Tax Act does not prescribe how transferred assets are to bevalued; simply that they are deemed to be disposed of for a consideration equal to market value.

Specific anti-avoidance provisions address share dealing transactions and cost allocations. Theshare dealing provisions are designed to counter dividend stripping and loss utilisationarrangements, while the cost allocation provisions give the Commissioner of Inland Revenue thepower to determine the cost of some assets transferred on sale.

With a share sale, it is usual for the purchaser to seek substantial warranties from the vendor tolimit the purchaser’s potential liabilities.


2.2.1 Tax Losses

Losses may be carried forward by companies, branches, trusts and individuals, provided a 49%continuity of ownership test is satisfied from the time the losses are incurred to the time the lossesare utilised. There is limited scope to refresh losses before a shareholding change occurs. Lossesmay not be carried back.

Losses incurred by companies may be used to offset income of other companies in the same groupwhere a 66% commonality of shareholding ownership test is satisfied.

Where a target has a significant amount of tax losses and has appreciating assets, the buyer mayconsider an asset deal with cost base step up.




2.2.2 Imputation Credits and Other Memorandum Accounts

Imputation credits and other memorandum account credits (such as branch equivalent tax accountcredits, dividend withholding payment account credits and conduit tax relief account credits) requirean at least 66% continuity of ownership test to be satisfied from the time the credits arise to the timethey are utilised. Where continuity is breached, any brought forward credits are extinguished.

Where a Target Company has significant imputation credits, a pre-sale dividend or taxable bonusissue should be considered.

2.2.3 Tax Incentives and Concessions

Legislation enacted in 2004 provides an exemption from income tax for gains derived by certainnon-residents from the sale of “shares” in New Zealand unlisted companies that do not have certainprohibited activities as their main activity. The concessions are known as the venture capital taxrelated reforms.

The legislation targets foreign investors who are materially affected by the imposition of NewZealand tax as they cannot claim or make use of credits for any tax they pay in New Zealand in theirown jurisdiction. The rules apply to foreign investors who are resident in all of the countries withwhich New Zealand has a double tax agreement (except Switzerland) and who invest into NewZealand venture capital opportunities.


An asset sale must be conducted at arm’s length terms or risk being deemed to have been made atmarket value. However, when the vendor and the purchaser are unrelated, the Commissioner ofInland Revenue generally accepts the prices agreed between the parties.

It is prudent to ensure that the values for different assets or categories of asset agreed between thevendor and the purchaser are specified in the sale and purchase agreement.

2.3.1 Depreciation

All depreciation recovered is taxable in the year of sale. Generally, proceeds in excess of theoriginal cost of an asset give rise to a non-taxable capital gain.

For an asset deal, generally the purchaser wishes to attribute as much of the purchase price aspossible to depreciable assets. A third-party purchaser should be able to “step up” the value ofdepreciable assets to maximise depreciation claims, but it would be advisable for the “step up” to besupported by a valuation and for the vendor and purchaser to have agreed the purchase priceapportionment.

2.3.2 Goodwill

In most cases, the vendor wishes to attribute as much of the sale price as possible to goodwill.Generally, the disposal of goodwill is not subject to income tax. If the vendor is a company, capitalgains can be distributed free of income tax only on liquidation (and then generally only to residentshareholders).

The purchaser is not entitled to a tax deduction for goodwill. However, the initial cost of specifictypes of intangible property, which have a fixed legal life, such as the right to use a copyright, patentor trademark, and which satisfy other criteria may be depreciable.





2.4.1 Goods & Services Tax (GST)

The transfer of shares is an exempt supply for GST purposes.

The sale of assets is not subject to GST, provided the assets are sold as part of a going concernand certain criteria are satisfied.

2.4.2 Stamp Duty and Gift Duty

No stamp duty is payable on the transfer of real and personal property (including shares) in NewZealand and there is no capital duty on the issue of shares.

Gift duty is levied progressively, at marginal rates from 0% to 25%, on most transactions that involveconsideration being provided at less than market value (although certain exemptions may apply).


The Income Tax Act contains some concessions which apply to qualifying amalgamations and taxconsolidated groups. Please refer to section 5.


In general, acquisition expenses are accorded the same tax treatment as the assets purchased. Fora stock acquisition, therefore, the costs are a non-deductible capital item. By comparison, an assetacquisition allows for such expenses to be allocated to the assets purchased. To the extent thatthose assets are depreciable, a tax deduction should be available over time for the acquisitioncosts.






Under a stock deal, assets maintain the values they had prior to the acquisition and no step up ofthe cost basis of the assets is possible.

Most new depreciable assets acquired in New Zealand are eligible for a 20% “economic loading” onthe applicable depreciation rate. If the loading was applied to the assets prior to the acquisition ofthe company’s shares by the purchaser, the loading continues to apply to those assets after theacquisition (i.e. the purchaser retains the benefit of the depreciation loading).


Under an asset deal the purchaser may be able to step up the cost basis of the assets acquired fortax purposes from the cost base used by the vendor. To the extent the purchase price fordepreciable assets exceeds the vendor’s cost base, then the third-party purchaser should beentitled to increase depreciation claims. However, as the assets acquired by the purchaser are notnew assets, the 20% depreciation rate loading does not apply to the assets post acquisition.






New Zealand resident companies and other entities controlled by non-residents (by a 50% orgreater ownership interest or any other means) are subject to thin capitalisation rules. Under therules, a deduction for interest is denied to the extent the taxpayer’s total interest-bearing debt/totalasset ratio exceeds:

• 75% of the New Zealand group debt percentage; and• 110% of the worldwide group debt percentage.

All interest-bearing debt is included in the calculation, not only debt with associated parties.


Generally, acquisitions are financed with a mixture of debt and equity.

Interest is deductible where it is incurred in deriving income or incurred in the course of carrying ona business for the purpose of deriving income. Most companies are allowed a deduction for interestwithout the need for a nexus to income. Interest is deductible where funds are borrowed to acquireshares in a subsidiary. As a result, the use of holding companies in New Zealand is common.

Notwithstanding the thin capitalisation rules, costs incurred in the course of raising finance arenormally deductible.

Debt instruments are subject to a specific financial arrangements accruals regime, which requiresthe economic income and expenditure under an instrument to be spread over the life of theinstrument on a methodical basis, generally irrespective of when the payments under the instrumentare made.

Certain debt instruments with a very specific set of characteristics are treated as equity for taxationpurposes. Such instruments include certain debentures that have been issued in substitution forequity and debentures under which the amount paid is linked to the profit or dividends of thecompany.




5. Mergers

New Zealand has a set of tax and company law rules which allow companies to amalgamate with eachother. When two or more companies amalgamate, from the date of amalgamation, one companynominated by shareholders succeeds to all rights and obligations of the other amalgamating company orcompanies. The other companies are struck off the company register.

Wholly-owned groups of companies may be amalgamated using a simple “short form” procedure. Groupsof companies not wholly-owned must amalgamate under a more complicated ”long form” procedure. Fortax purposes, the company succeeding on amalgamation takes over the tax obligations of all theamalgamating companies. In the case of a “qualifying amalgamation”, the general rule is that there is notransfer of assets or liabilities for tax purposes, as these are assumed to have been held throughout by thesame party.

As an alternative to amalgamation, companies in a 100% group may elect to enter a tax consolidatedgroup which enables the group to be treated as one company for tax purposes. The main advantages oftax consolidation are that transfers of assets between consolidated group members are ignored for taxpurposes and compliance requirements are simplified. Care is needed on the exit from a tax consolidatedgroup to ensure previous tax concessions are not unwound. Members of a tax consolidated group arejointly and severally liable for the tax liabilities of group members.






Profits may be repatriated in a number of ways, most commonly by the payment of dividends,repayment of debt, royalties, service fees or interest. Each method of repatriation needs to beconsidered in light of withholding taxes and/or the transfer pricing rules.

As capital gains are not taxable in New Zealand, it is more common for non-residents wishing to exitinvestments to sell shares rather than assets. However, irrespective of whether an investor sellsassets or shares, an objective is to minimise withholding tax on repatriation of any surplus cash.

This can be achieved in three ways:

• payment of a fully imputed dividend utilising the foreign investor tax credit regime, i.e. if sharesare being sold, the payment of a dividend before sale enables imputation credits to be usedbefore they are forfeited;

• capital reduction, i.e. New Zealand’s company law legislation allows a company to repurchase itsown shares if it is permitted to do so under its constitution. Subject to certain “bright line tests”,a share repurchase is not treated as a dividend to the extent of the company’s availablesubscribed capital; and

• migration of the company, i.e. New Zealand’s company law legislation allows a company to beremoved from New Zealand’s register and placed on an overseas register. Under legislationenacted in April 2006, a migrating company is treated as if it has been liquidated and adistribution paid to its shareholders. The new rule applies to companies that migrate on or after21 March 2005. The resulting deemed distribution will be free of withholding tax only to theextent of available imputation credits and the company’s available subscribed capital. Acompany’s ability to migrate depends on whether the foreign jurisdiction’s corporate law providesfor migration.

The repayment of debt from an overseas associate is not subject to withholding tax, and is thereforea simple method of repatriating cash.




6.2 Conduit Tax Relief

New Zealand’s conduit tax relief provisions provide relief from New Zealand income tax for a foreigninvestor making an equity investment in a foreign company via a New Zealand company. The levelof relief is dependent on the extent to which the New Zealand company is owned by non-residentshareholders.

Essentially the conduit tax relief regime shelters from New Zealand tax, taxable income derivedfrom controlled foreign companies and dividends from foreign companies to the extent that theshareholders of the New Zealand company are non-residents. Upon ultimate distribution to non-resident shareholders, a 15% non-resident withholding tax is imposed (30% if the non-residentshareholders are residents of a country with which New Zealand does not have a double tax treaty).




7. Disposal - The Preference of Sellers: Stock vs. Asset Deal

7.1 Stock Deal

There are generally no tax consequences for the vendor on a sale of shares provided the sharesare held by the vendor as capital assets. Although a share sale is beneficial for the vendor, it isusual for the purchaser to seek substantial warranties/indemnities from the vendor to limit potentialtax liabilities.

Generally, with an asset sale the vendor will aim to attribute values that are as high as possible toitems such as goodwill or other capital assets where any gain on disposal should be non-taxable.


If the vendor is a New Zealand company, the distribution of sale proceeds to shareholders as adividend (and, in certain instances, on liquidation) attracts withholding tax unless imputation creditsare attached. The sale itself generally will not generate imputation credits as the gain is usually anon-taxable capital gain.

Other methods of distribution, which allow shareholders to receive sale proceeds tax free if certainrequirements are met, are often possible.

7.2 Asset Sale - Profit on Sale of Assets

Most vendors prefer to attribute as much of the sale proceeds as possible to goodwill as thedisposal of goodwill is not generally subject to income tax.

Depreciation previously claimed on an asset is reversed and, therefore, subject to tax if the saleproceeds exceed the asset’s tax depreciated value. Proceeds in excess of original cost generallygive rise to a non-taxable capital gain.

If the vendor is a company, goodwill can be distributed tax-free only on liquidation of the company(and then only to resident shareholders).





8.1 GST

As noted in section 2, the sale of shares is exempt from GST. If assets are sold as part of the saleof a going concern, the transaction may be zero-rated for GST purposes subject to certain criteria.

8.2 Stamp Duty

No stamp duty is payable on the sale of either shares or assets.

8.3 M & A Concessions

See previous comments in respect of amalgamation.


If a vendor has held the shares being sold as a capital asset, the transaction costs associated withselling those shares are generally not tax deductible. Transaction costs incurred on the disposal ofassets used in the income producing process are generally tax deductible.





9.1 Transfer of Assets to be Retained to Another Group Company

Generally, transfers of assets between group companies must be made at market value. This ruledoes not apply to transfers of assets between members of a consolidated tax group. If the vendorwishes to retain some of a target’s depreciable assets without any adverse tax consequences, itcould transfer the assets to be retained to another company where both companies are within thesame tax consolidated group. If the company is sold later, it will cease to be a member of theconsolidated group. However, provided it no longer holds assets that have been transferred to itfrom another consolidated group member, the sale should have no income tax consequences.There are certain anti-avoidance provisions that will need to be considered.


Given that a company loses any brought forward tax losses and imputation credits on a breach ofthe relevant shareholder continuity tests, the losses and imputation credits should be utilised to theextent possible prior to any share sale. One way of utilising imputation credits is to declare a pre-sale dividend or taxable bonus issue. A pre-sale dividend could be appropriate where the companyhas surplus cash or assets which can be distributed to shareholders, and the company is able toimpute the dividend fully.




10. De-mergers

New Zealand’s income tax legislation contains no specific provisions relating to de-mergers or spin-offs,although there are certain concessions which can apply for the shareholder continuity test. A de-mergeris normally achieved by the sale of assets. However, under the tax consolidation regime, reorganisationsmay be achieved by transferring assets between member companies with tax consequences deferred fortax purposes until an “exit” event occurs. An exit event occurs generally only when a company leaves theconsolidated group, and then only to the extent that it holds assets transferred to it whilst a member of thegroup.


For companies that are contemplating undertaking an IPO or otherwise listing on a stock exchange, thereare a variety of New Zealand tax issues that need to be considered. Usually, careful consideration ofwhether tax losses or imputation credits will be forfeited due to the shareholder changes will be needed.Certain concessions for the shareholder ownership continuity tests could be applicable. To the extentthere is reorganisation or transfers of assets in preparation for IPO/listing the usual New Zealand taxissues will need to be considered.

12. Preparation for a Deal

The New Zealand tax and investment environment provides opportunities for structuring investments andtax efficient exit strategies. Careful planning is required to ensure that pitfalls are avoided.




PHILIPPINES

Country M&A TeamCountry Leader ~ Alex Cabrera

George LavadiaGenevieve M. LimboJoel Roy C. Navarro

Hermes G. Diolola








Alex Cabrera Partner +632 845 2728 ext. 2002 [email protected]

George Lavadia Partner +632 845 2728 ext. 2005 [email protected]

Genevieve M. Limbo Manager +632 845 2728 ext. 2017 [email protected]

Joel Roy C. Navarro Manager +632 845 2728 ext. 2111 [email protected]

Hermes G. Diolola Manager +632 845 2728 ext. 2015 [email protected]

PricewaterhouseCoopers • 29/F Philamlife Tower • 8767 Paseo de Roxas • Makati City • Philippines




1. Introduction

1.1 General Comments on M&A in the Philippines

Mergers and acquisitions activities in the Philippines in the past two to three years have been verytrivial. Major acquisitions involved Independent Power Producer companies that have existing Build-Operate-Transfer agreements with the government, call centres, banks and other financialinstitutions.

Nevertheless, the Philippine government promotes the principles of transparency and freeenterprise, and believes that economic development is best led by the private sector. Inboundforeign investment is actively encouraged, and generous incentives are available for investmentactivities that will facilitate the country’s development or export capacity. These incentives aregranted to:

• Board of Investment registered enterprises;

• Philippine Economic Zone Authority registered enterprises;

• Subic Bay Freeport registered enterprises;

• regional headquarters; and

• regional operating headquarters.

Entities carrying on approved activities may take advantage of reduced/preferential tax rates or fullexemption from income tax and certain taxes for a specified period (generally between four to eightyears depending on the nature of tax incentives).

The most common forms of business entity in the Philippines are locally incorporated companies orbranches of overseas companies. Other forms of business such as partnerships (generally forprofessionals) and joint ventures are also available.

Investment laws permit 100% foreign ownership in an enterprise in the Philippines, unless theenterprise will be undertaking activities listed in the Foreign Investment Negative Lists (FINL). Forexample, a maximum of 40% foreign equity is allowed for ownership of private land and operation ofpublic utilities.




1.2 Corporate Tax

The Philippines imposes income tax on income derived in the Philippines and in the case ofdomestic corporations, on income including that derived from outside the Philippines.

The current corporate income tax rate which has been effective from 1st November 2005 is 35%(from the previous 32%). This increase is to help address budget concerns. However, the rate willbe reduced to 30% starting from 1st January 2009.

A minimum corporate income tax rate (MCIT) of 2% of the gross income is imposed, if it is higherthan the normal corporate income tax. MCIT is imposed on a corporation from the fourth taxableyear following the year in which such corporation was registered with the Bureau of InternalRevenue.

Dividends received by a resident corporation from a domestic corporation are not subject to tax.Dividends received by a domestic corporation from a non-resident corporation are subject tocorporate tax. However, the tax paid in the foreign country may be used as tax credit subject tocertain limitations.

1.3 Withholding Tax

1.3.1 On Payments to Non-residents

Dividends, interest, leases, royalties and other technology transfer related services, managementand other service fees paid by a resident of the Philippines to non-residents may be subject towithholding tax. The rates are as follows:

The Philippines has a comprehensive network of double tax agreements which operate to reducewithholding tax and exempt business profits derived by a company resident in a treaty countrywhich does not have a permanent establishment (PE) in the Philippines.

1.3.2 Branch Profits Tax

Any profit remitted by a branch to its overseas head office is generally subject to 15% branch profitremittance tax unless reduced by a tax treaty. However, profits from activities registered with thePhilippine Economic Zone Authority are not subject to branch profit remittance tax.

1.3.3 On Payments to Domestic Companies

• Interest Payments

Interest payments made by a domestic company to another domestic company are generallynot subject to withholding tax. However, if the payor belongs to the top ten thousand privatecorporations, the interest payments are subject to 2% expanded withholding tax (EWT).


Interest 20 10 – 15

Dividends 15 – 32 10 – 25

Leases and royalties (technology transfer related services) 32 4.5 – 25

Services and management fees 32 Exempt ifno PE




Moreover, interest payments on borrowings obtained from an expanded foreign currency depositsystem of a domestic bank or offshore banking unit are subject to 10% final withholding tax.

Interest paid on funds sourced from the public is subject to final withholding tax of 20%. Incomederived by domestic corporations and individuals from a depository bank under an expandedforeign currency deposit system is subject to 7.5% final tax.

• Royalties

Payments for royalties and services involving technology transfer by a resident to a domesticcompany are subject to 20% final withholding tax.

• Other Payments

Certain domestic payments are subject to EWT which is creditable against income tax due by arecipient of the relevant income. Following are some of the payments, which are subject to EWTand the applicable EWT rates:

1.4 Value Added Tax (VAT)

Generally, 10% or 0% VAT is imposed on the sale of goods and services. The 0% VAT applies onlyto specific transactions.

Further, payments to non-residents for services rendered in the Philippines are subject to 10%withholding VAT. In this event, the local payer, as the withholding agent, is required to remit the VATto the government by filing a separate return on behalf of the non-resident payee. The dulyvalidated VAT return, however, shall be used to support the input VAT claims of the local payer.

However, a new law (Republic Act No. 9337) was passed on 24th May 2005 which provides for(among others) an increase of VAT from 10% to 12% effective from 1st January 2006, after any ofthe following conditions has been satisfied:

• VAT collections as a percentage of Gross Domestic Product (GDP) of the previous year exceed2.80%; or

• the national government deficit as a percentage of GDP of the previous year exceeds 1.5%.

Nature of payments Applicable EWT rates

Professional and talent fees for services paid to domestic 15% if the gross income for thecorporations and resident individuals, including fees paid to current year exceeds P720,000medical practitioners and 10% if otherwise

Income payments to partners of general professional 10%partnerships

Rent for the use of real and personal properties 5%

Payments to customs, insurance, stock, real estate, 10%immigration and commercial brokers and agents ofprofessional entertainers

Payments to certain contractors 2%

Certain payments by credit card companies 1% based on half of the grossamounts paid




1.5 Stamp Duty

The Philippines imposes stamp duty on certain transactions evidenced by documents including:

• issuance and transfer/sale of shares, at the rates of 0.5% and 0.375% respectively based on thepar value of the shares;

• loan agreement/document, at the rate of 0.5% based on the issue price of debt instrument;

• transfer of real estate, at the rate of 1.5% based on the selling price or the market value,whichever is higher.


1.6.1 Fringe Benefit Tax (FBT)

FBT, at the rate of 32%, is imposed on the grossed-up monetary value of fringe benefits furnished orgranted to the employee (except for rank and file employees) unless the fringe benefit is required bythe nature of the trade, business or profession of the employer, or when the fringe benefit is for theconvenience or advantage of the employer. The value of fringe benefits granted is divided by 68%to arrive at the grossed-up amount.

The term “fringe benefit” is defined to mean any goods, services or other benefits furnished orgranted in cash or in kind by any employer to an individual who is a non-rank and file employee.

1.6.2 Local Business Tax (LBT)

LBT, at the rate not exceeding 0.75%, imposed on the gross receipts of the preceding calendar yearis payable to the local government units where its principal and/or branch office(s) is/are located.However, LBT is not imposed on an enterprise which has been granted certain tax incentivesprovided certain conditions are met.

1.6.3 Real Property Tax (RPT)

RPT, at the rate not exceeding 2%, is imposed on the assessed value of the real properties andfixed machineries and equipment of a domestic company. An additional 1% of the assessed value ofthe real property may be collected, in addition to the basic RPT, for the Special Education Fund.RPT is not imposed on an enterprise which has been granted certain tax incentives provided certainconditions are met.

1.6.4 Transfer Tax

Transfer tax of 0.5% is imposed on the selling price or the fair market value, whichever is higher, ofthe real property transferred.

1.6.5 Capital Gain

Generally, gains from sale of shares of stock (not traded in the stock exchange) are subject tocapital gains tax of 10% (5% for the first P100,000) unless exempted under a tax treaty. Sale ofshares listed and traded through the local stock exchange are also subject to stock transaction taxof 0.5% based on the gross selling price, which is payable by the seller or transferor.




Generally, gains on sale of real and personal property are subject to the normal income tax if thereal property is used in trade or business. However, gains on sale of real properties which aretreated as capital assets are subject to 6% final tax based on the gross selling price or fair marketvalue, whichever is higher.

1.6.6 Percentage Tax/Gross Receipts Tax (GRT)

Percentage tax ranging from 3% to 30% is imposed on the sales or receipts of certain corporationsengaged in activities or industries which are not subject to the VAT. Among such activities arebanking, insurance, common carriers or transportation contractor, overseas dispatch, amusement,etc.

1.6.7 Excise Tax

Excise tax is imposed on certain goods or articles manufactured or produced in the Philippines fordomestic sale or consumption, or for any other disposition, and to certain imported items. Forimports, the excise tax is in addition to any applicable customs duties and VAT.

The Philippines has both specific excise tax (i.e. excise tax based on weight or volume capacity)and ad valorem excise tax (i.e. excise tax based on selling price or specified value of an article).Among the articles covered by excise tax are alcohol products, tobacco products, petroleumproducts, mineral products, jewellery, perfumes, automobiles and cinematographic films.




2. Acquisition


The Philippines has no restrictions on acquisitions, mergers or consolidations, unless they will resultin unfair competition, or restrain trade to artificially prevent free competition in the market, or resultin foreign ownership that violates the Foreign Investment Negative List.

Accordingly, general principles of taxation would apply while structuring a deal and choosingbetween an acquisition of assets or stock.

Whether a deal is structured as a stock deal or asset deal should largely depend on commercialconsiderations.


The main advantage of a stock deal (for shares not traded in the stock exchange) over an assetdeal is the lower capital gains tax of 10% as compared with the 35% (32% before 1st November2005) corporate income tax, payable by the seller.

Sale of shares listed in the stock exchange is subject to 0.5% stock transaction tax.

Documentary stamp tax of 0.375% applies on the par value of the shares sold.

Therefore, under a stock deal, even with any stock transaction tax applicable, the deal should beless tax burdensome to the seller because of the lower capital gains tax rate.

2.2.1 Tax Loss Carried Forward

Net operating losses may be carried forward by a company for a period of three consecutive yearsimmediately following the year of such loss. However, net loss carry over shall not be allowed ifthere has been a substantial change (i.e. more than 25%) in the ownership of the company.

Where a Target Company has accumulated losses carried forward and the buyer wishes topreserve the losses, it will have to acquire the business through a stock deal as there are noprovisions to transfer losses from one entity to another.




2.2.2 Unutilised Tax Depreciation Carried Forward

Unutilised tax depreciation is preserved under a stock acquisition. It is not subject to the three-yearexpiration period unlike the net loss carry over.

2.2.3 Incentives

If a Target Company has been granted tax incentives, the buyer will have to acquire the shares ofthe company if it wishes to preserve the incentives. However, approval from the relevantgovernment body must be obtained.


An asset deal allows a purchaser to select the desirable assets to be acquired and to transferassets between one or various entities (including offshore entities) so as to optimise future intra-group payments. It often allows the buyer to step up the cost basis of acquired assets for taxpurposes. This enables tax deductions to be maximised through depreciation or amortisation and/oradditional interest costs if the acquisition is funded by debt.

However, in transferring the business, care should be taken to ensure that the income tax (on thegain), value added tax and local business tax (based on gross selling price), documentary stamptax and transfer tax (particularly with respect to the transfer of property) are minimised.

Moreover, the sale/transfer of real property is subject to 0.5% transfer tax based on the selling priceor the fair market value, whichever is higher.

Further, sales of assets may be covered by the Bulk Sales Law (BSL). The primary objective of BSLis to compel the seller to execute and deliver a verified list of his creditors to his buyer, and notice ofintended sale to be sent in advance to said creditors. Non-compliance with the requirements underthe law would not only render certain transactions void, but would also subject the violators tocriminal liabilities. The sworn statement of the listing of creditors must be registered with theDepartment of Trade and Industry.


2.4.1 VAT

• Stock Deal

Sale of shares is not subject to VAT.

• Asset Deal

Sale of assets is subject to 10% VAT (12% starting from 1st January 2006), which may bepassed on to the buyer, and 0.75% local business tax based on the gross selling price.

2.4.2 Stamp Duty

• Stock Deal

Documentary stamp tax of 0.375% applies on the par value of the shares sold.

• Asset Deal

In the case of an asset sale, documentary stamp tax applies only on sale/transfer of realproperty. Stamp duty is 1.5% based on the selling price or the fair market value, of the realproperty, whichever is higher.





For income tax purposes, no gain or loss shall be recognised if such gain or loss occurs inconnection with a plan of merger or consolidation, such as:

• a corporation (which is a party to a merger or consolidation) exchanges property solely for stockin a corporation (which is a party to the merger or consolidation);

• a shareholder exchanges stock in a corporation (which is a party to the merger or consolidation)solely for the stock of another corporation (which is also a party to the merger or consolidation); or

• a security holder of a corporation (which is a party to the merger or consolidation) exchangeshis securities in such corporation, solely for stock or securities in another corporation (which isalso a party to the merger or consolidation).

Likewise, the transfer of property (assets or shares) may be done through a tax-free exchange. Toqualify for a tax-free exchange, the property must be exchanged for shares of the transferee entityand as a result of such an exchange, the transferor would gain control of the transferee entity.However, a ruling from the Philippine tax authorities is required to confirm the tax-exempt status ofthe transaction.

In addition, transfers of properties (which qualify for a tax-free exchange and merger) are notsubject to VAT, except for real properties held for sale or lease, and documentary stamp tax.


• Stock Deal

Under a stock deal, acquisition costs, which include, among others, professional fees and taxespassed on to the buyer, relating to the acquisition are not deductible for income tax purposes.The same may be capitalised or form part of the costs of the investment.

The said expenses, however, shall be allowed as deduction for purposes of calculating thecapital gains tax which is applicable in case of subsequent disposal of the shares.

• Asset Deal

In the case of an asset deal, the transactions costs which may be attributed to the variousassets shall form part of the costs of the relevant assets and may be depreciated or amortisedbased on the tax treatments of these assets.

The professional costs, which cannot be allocated to the costs of specific assets, are charged toexpense and may be claimed as a tax deduction.






A stock deal will not allow the buyer to step up the basis of the assets owned by the TargetCompany. Thus, it would not allow the buyer to maximise tax benefits which are generally availableto an asset deal.


An asset deal often allows the buyer to step up the cost basis of acquired assets for tax purposes.This would enable the buyer to maximise tax benefits through allocating (if possible) higher costs toinventories, depreciable assets and intellectual properties.

In addition, no tax deduction is available for the amortisation of goodwill. Therefore, the purchaseprice on an asset deal should (if appropriate) be allocated as much as possible to inventory,depreciable capital assets, and other items (such as intellectual property) that will generate a taxdeduction.






There are no thin capitalisation rules in the Philippines.

The decision to set a debt to equity ratio is generally governed by commercial considerations or byother government agencies (i.e. the Board of Investments in order for the Board to monitor if thecompany meets the requirements for the incentives granted). However, where a company is set upto take advantage of a tax concession or requires a special licence from the government (e.g.banking and insurance), the regulatory body may require certain ratio to be complied with.



Interest expense incurred in respect of borrowings used to acquire shares may not be taxdeductible.


Interest incurred on funds used to acquire a business under an asset deal is tax deductible.




5. Merger

As mentioned earlier, there are no restrictions on mergers or consolidations in the Philippines unless theywill result in unfair competition, or will restrain trade to artificially prevent free competition in the market, orwill result in foreign ownership that violates the Foreign Investment Negative List.

However, mergers involving two corporations must be approved by a majority vote of the board of directorsor trustees, by the stockholders owning or representing at least two-thirds of the outstanding capital of theconstituent corporations, and by the Securities and Exchange Commission. Those involving specialisedindustries commonly also require approval from the appropriate government agency.

In a merger, the assets of the absorbed companies, including the tax assets (input tax and creditable inputtax), are assumed by the surviving company. However, the absorbed company’s net operating losseswhich have been transferred through a merger, may only be used by the surviving entity if as a result ofthe said merger, the shareholders of the absorbed companies gain control of at least 75% or more innominal (par or stated) value of the outstanding issued shares or paid-up capital of the surviving company.






Distribution of profits/dividends by a domestic corporation to a resident or domestic corporation shallnot be subject to tax. Distributions by a domestic corporation to non-resident foreign corporationsare generally subject to 35% (32% before 1st November 2005) income/withholding tax. However,the tax rate may be reduced to 15% if the country where the recipient is domiciled allows a creditagainst the tax payable by the said recipient in respect of taxes deemed to have been paid in thePhilippines or if such country does not impose any tax on such dividends.

Moreover, the foreign company investor may be entitled to the preferential tax treaty rate (if any), ifsuch treaty rate is more favourable.

There are other avenues whereby the profits of the Target Company may be repatriated to the homecountry by means other than dividends. These include the payment of license fees, royalties,interest and management fees. Such payments are generally subject to income/withholding taxesas follows:

Management fees 32%

Interest 20%

Royalties 32%

Technical assistance/service fees 32%

However, appropriate tax treaties may reduce the applicable income/withholding tax rates or evenexempt the relevant income from the Philippines tax. For example, interest payments to aNetherlands entity may be subject to 10% income/withholding tax in the Philippines provided certainconditions are met.

Management fees in consideration for services rendered outside the Philippines that are rechargedat costs should not be subject to withholding tax. In addition, even if such fee is charged at a profit,it may also be exempt from the Philippines tax under an appropriate double tax agreement whichexempt the fee from tax due to the non-existence of a permanent establishment in the Philippines.




The Philippines tax legislation does not contain specific anti-treaty shopping provisions and wherean arrangement (with commercial substance) takes advantage of a tax treaty, the reduced rateprovided under that treaty should generally prevail.

6.2 Losses Carried Forward

Net operating losses may be carried forward for a period of three consecutive years immediatelyfollowing the year of such losses unless there is a substantial change (more than 25%) of ownershipin these three years.

6.3 Tax Incentives

Where the Target Company enjoys any tax incentives, these would generally be lost when thebusiness is transferred through an asset deal. However, it may be possible to obtain approval fromthe authority granting the incentive to ensure the continued applicability of the incentive to thetransferred business.

Tax concessions enjoyed by a Target Company is generally preserved through a stock deal.However, prior approval from the respective government body is required.

6.4 Group Relief

The Philippines has no group relief system. Related companies are taxed separately.




7. Disposal


From a seller’s view point, it would be less complicated to sell a Target Company through a stockdeal.

7.2 Stock Sale


Generally, gains on sale of shares (not traded in the stock exchange) are subject to capital gains taxof 10% (5% for the first P100,000). Likewise, sale of shares traded in the stock exchange is subjectto stock transaction tax of 0.5% based on the selling price. However, the sale may be exemptedfrom capital gains tax and stock transaction tax under a tax treaty.

The Philippines taxes gains derived from any subsequent disposal of an investment in thePhilippines. However, this may be minimised depending on the residence of the holding company ofthe Philippines target. For residents of countries such as the Netherlands and Singapore, any gainsderived from the sale of the shares of the Philippines target should not be subject to tax in thePhilippines. However, in respect of gains derived by the Singapore investors, the exemption wouldapply provided that the target’s major assets do not consist of immovable properties.

For this purpose, when considering acquiring a Target Company in the Philippines, the residence ofthe holding company should be considered. One should note that the setting up of a holdingcompany in the Philippines may no longer be tax efficient due to the imposition of the 10%improperly accumulated earnings tax on unreasonable retained profits. Retention due to reasonablebusiness needs must be proven to avoid this tax. However, retention of profits in a holding companyis prima facie evidence of unreasonable profit retention. Hence, a holding company within thePhilippines may no longer be a tax efficient structure to park dividends.


Dividends may only be declared out of the company’s unrestricted retained earnings. Equity in netearnings in subsidiaries may not be declared as dividends unless received as dividends.




7.3 Asset Sale


Any gains/profits on the sale of inventories or tax depreciable assets would be subject to income taxin the hands of the seller. The gains are the difference between the selling price and the costs of theassets.

Likewise, any price received for sale of goodwill is taxable in the hands of the seller. However, thebuyer may claim deduction only if the same form part of depreciable assets, amortisable intangiblesand inventories.

A corporate seller may be willing to enter into an asset deal if it has tax losses to off set against anygains from the sale of assets.


Dividends may only be declared out of the company’s unrestricted retained earnings. Equity in netearnings in subsidiaries may not be declared as dividends unless received as dividends.

Please note, however, that in case of liquidation (after all the assets are sold) the proceeds of thesale of assets must be appropriated to payment to corporate debts and liabilities before anydistribution among stockholders may be made. Debts secured by liens are entitled to somepreferences. This preference is also applied to claims given a priority by stature. Stockholders areentitled to participate in the assets, after the payment of the creditors, in proportion to the number ofshares held by each, unless the articles of incorporation regulate the distribution of corporate stockamong stockholders.





8.1 VAT

As indicated previously, the VAT of 10% which is applicable on the sale of assets/business may bepassed on to the buyer, while the sale of shares is not subject to VAT.

8.2 Stamp Duty

As indicated above, the sale/transfer of shares is subject to documentary stamp tax of 0.375%based on the par value of the shares. The said tax can be paid by either of the parties.

On the other hand, the sale/transfer of assets/business may also be subject to documentary stamptax if it involves real properties.


As indicated previously, no gain or loss shall be recognised if such gain or loss occurs in connectionwith a plan of merger or consolidation.

In addition, transfers of properties, which qualify for a tax-free exchange and merger, are not subjectto VAT and documentary stamp tax.


Transaction costs involving sale of assets are deductible from gross income of the seller for incometax purposes while transaction costs involving sale of shares shall not form part of the cost of theshares for purposes of computing the gain subject to capital gain tax.





The target’s management may conduct a tax due diligence review for purposes of determining deal issueswhich may have an impact on the success and the pricing of the deal. The management may decide onappropriate actions in respect of the issues identified during such review.

10. De-mergers

Business spin-off is the most common de-merger activity taking place in the Philippines. It usually occurswhen a company with several business lines decides to sell one or more of its business segments, or splitits business operations by creating a new company to undertake one or more of its business lines.

In either way, the tax effects of this procedure are similar to that of an asset sale or a tax-free exchange asdiscussed previously.





Another exit route for investors may be through an IPO. The acquisition vehicle/acquired company may belisted in the Philippines Stock Exchange provided certain requirements are complied with.

Generally, sale of shares through IPO is taxed at the rates specified below based on the gross sellingprice or gross value of the shares sold in accordance with the proportion of shares sold to totaloutstanding shares of stock after the listing in the local stock exchange:

However, the above tax may not apply if the holding company of the Philippines target is located incountries such as the Netherlands and Singapore as provided under the respective treaties of the saidcountries with the Philippines. However, in respect of gains derived by the Singapore investors, exemptionwill apply provided that the target’s major assets do not consist of immovable properties.

Under existing rules, the availability of tax treaty protection needs to be preceded by an application for taxtreaty relief with the Philippines tax authorities, not later than 15 days from the transaction date.

Up to twenty-five percent (25%) 4%

Over twenty-five percent (25%) but not over thirty-three and one third percent (33 1/3%) 2%

Over thirty-three and one third percent (33 1/3%) 1%




S INGAPORE

Country M&A TeamCountry Leader ~ David Toh

Abhijit GhoshDavid Sandison

Peter TanWong Sook Ling






David Toh Partner +65 6236 3908 [email protected]

Abhijit Ghosh Partner +65 6236 3888 [email protected]

David Sandison Partner +65 6236 3675 [email protected]

Peter Tan Partner +65 6236 3668 [email protected]

Wong Sook Ling Senior Manager +65 6236 3689 [email protected]

PricewaterhouseCoopers • 8 Cross Street • #17-00 PWC Building • Singapore 048424




1. Introduction

1.1 General Information on M&A in Singapore

This chapter provides an overview of the main issues that are relevant to both purchasers andvendors on a transfer of ownership of a Singapore business.

A transfer of ownership of a Singapore business can take the form of a disposal of stock or assets.While there are significant differences in the tax implications of an asset or stock sale, it may bepossible to reorganise the companies post-acquisition, in order to maximise the tax benefits thatmay be associated with an asset deal.

A number of incentives are available for industries and activities encouraged by the SingaporeGovernment. A detailed list of incentives is provided in section 12 of this chapter.

The relevant taxes to be considered in the context of a M&A transaction are detailed below.

1.2 Corporate Tax

The general income tax rate for resident and non-resident companies (i.e. branches of foreigncompanies) is 20%. However, beginning with the 2002 tax year, three-quarters of the first S$10,000of chargeable income (i.e. the amount on which tax is imposed) and half of the next S$90,000 ofchargeable income is exempt from tax. Thus, for the first S$100,000 of chargeable income, S$52,500thereof is exempt from tax. The remaining portion of the chargeable income is subject to the normalcorporate tax rate of 20%. Dividends received from Singapore companies are not to be taken intoaccount while computing the above exemption.

Singapore imposes income tax on income derived in Singapore, and on income which is derivedoutside Singapore but received in Singapore. Foreign-sourced income will be regarded as beingreceived in Singapore if it is:

• remitted to, transmitted or brought into Singapore;

• applied in or towards satisfaction of any debt incurred in respect of a trade or business carriedout in Singapore; or

• applied to purchase of any movable property which is brought into Singapore.




The following categories of foreign-sourced income received in Singapore by Singapore taxresidents may be exempted from tax:

• dividends derived from companies which are not Singapore tax residents;

• trade profits earned by a branch of a Singapore resident company, located in a foreign territory;and

• foreign-sourced service income (service income is considered as being foreign-sourced if theservice is rendered in the course of trade, business or profession through a fixed place ofoperation in a foreign jurisdiction).

The exemption will be available provided that the following conditions are met:

• in the year in which the income is received in Singapore, the headline tax rate (this refers to thehighest corporate tax rate of the foreign jurisdiction, but need not be the effective tax rate) in theforeign jurisdiction from which the income is received, is at least 15%; and

• the relevant foreign income has been subject to tax (including withholding tax) in the foreignjurisdiction from which it is received. However, this condition will be considered as having beenmet even if no taxes were imposed in the relevant foreign jurisdiction as a consequence ofa tax incentive for carrying out substantive business activities in that jurisdiction.

It was announced in the Singapore Budget 2006 that even if these conditions are not met due totechnicalities (e.g. the dividend paid by the offshore dividend paying company does not qualify forthe exemption, however, the dividend paid by its operating subsidiary would have qualified for theexemption, had such dividend been paid directly to a Singapore Company), it is possible to apply fortax exemption on the basis that the underlying income was derived from substantive economicactivities carried out in a foreign jurisdiction, with a headline tax rate of at least 15%.

As Singapore does not have capital gains tax, only gains of a revenue nature are taxable. Gainsderived from the ordinary course of business or from a transaction entered into with the intention ofrealising a profit, should be treated as ordinary income which is subject to tax.

1.3 Withholding Tax

Interest, loan-related payments, royalties, rent for use of movable property, management fees andtechnical assistance fees paid to non-residents of Singapore may be subjected to withholding tax.There is no withholding tax on dividends paid by Singapore resident companies to non-residentshareholders.

* Non-treaty rates reduced to 10% with effect from 1st January 2005. Reduced rate will also apply totreaty rates if such rates are higher than 10%.

Where the services relating to the derivation of certain payments such as loan fees and technicalservice fees are performed entirely outside Singapore, and the payments are at an arm’s length,such payments are not subject to withholding tax. Management fees paid to related entities, whichare charged at cost by the recipient, are also not subject to withholding tax.

In addition, payments of interest and royalties may also be exempted from tax under a relevant taxconcession granted to a payer.


Interest, loan-related payments and rent for 15 0 – 15

use of movable property

Management fees and technical assistance fees 20 0 – 20

Royalties* 10 0 – 15




Singapore has a comprehensive network of tax treaties which operate to reduce withholding tax andexempt business profits derived by a company resident in a treaty country which does not have apermanent establishment in Singapore.

Where a non-resident entity conducts its operations in Singapore through a permanent establishment(for instance, a branch), it may obtain a waiver (subject to the satisfaction of certain conditions) fromwithholding tax on income (which will ordinarily be subjected to withholding tax) received from a residentof Singapore, and such income will be subjected to tax under the same procedure as that applicable toa resident.


GST is charged at 5% on supplies of goods and services made in Singapore by a GST registeredperson. Certain supplies may be charged at a zero rate but these are primarily exports of goodsand services.

Some supplies are exempt from GST (e.g. sale of shares). This means that no GST is charged ontheir supply. It also means that no GST can be recovered on the costs relating to the making of thatsupply. GST can be an issue for both the purchaser and the vendor, and it can create significantcash flow costs.

1.5 Stamp Duty

Singapore imposes stamp duty on documents relating to the transfer of shares (at a rate of 0.2% onthe higher of the purchase price or net asset value) and transfers of real estate (at ad valorem ratesof up to 3% on the higher of the purchase price or market value). Exemptions may be available incertain circumstances such as group restructuring.




2. Acquisitions

2.1 Preference of Purchasers: Stock vs. Asset Deal

Singapore does not have detailed legislation dealing with the tax treatment of acquisitions.Accordingly, general principles of taxation will apply while structuring a deal and choosing betweenacquisition of assets or stock.

Whether a deal is structured as a stock deal or asset deal may largely depend on commercialconsiderations. A stock deal may, however, be subsequently restructured as an asset deal to allowit to be completed on a more tax efficient basis.


Generally, it is less expensive for a purchaser to acquire the business under a stock deal, as thestamp duty on the transfer of shares is 0.2%, whereas the transfer of real property under an assetdeal is subject to a maximum duty of 3%.

• Preservation of Unabsorbed Tax Losses/Capital Allowances

Where a Target Company has unabsorbed tax losses and capital allowances and the purchaserwishes to preserve the tax losses/capital allowances, it will have to acquire the business via astock deal, as there are no provisions to transfer unabsorbed tax losses/capital allowances fromone entity to another. In addition, the Target Company would need to seek a waiver from theMinistry of Finance to comply with the continuity of substantial ownership test, for such taxlosses/capital allowances to be carried forward for set off against its future income. Generally, ifthe acquisition price is not affected by the availability of the unabsorbed tax losses/capitalallowances, the waiver should be granted.

• Continuity of Tax Incentives/Concessions

Where the Target Company enjoys any tax incentives/concessions, the purchaser will have toacquire the stock in the company if it wishes to preserve the tax incentives/concessions, andseek prior approval from the relevant Government body to continue to benefit from theincentives/concessions.





An asset deal allows a purchaser to select the desirable assets to be acquired and to transferassets between one or various entities (including offshore entities) so as to optimise future intra-group payments.

Where a vendor insists on a stock deal, the purchaser may restructure the target after acquisitionby transferring the business to a subsidiary to maximise the step up tax cost base of certain assetsand to maximise the deductibility of interest costs.


2.4.1 GST

GST is collected by a GST-registered person (i.e. vendor) and is payable by the end user (i.e.purchaser). However, supplies of goods or services, such as transfer of shares, are exempt fromGST. A transfer of a business which satisfies certain conditions is also exempt from GST.

2.4.2 Stamp Duty

Singapore imposes stamp duty on documents relating to the transfer of shares (at a rate of 0.2%)and transfers of real estate (at ad valorem rates of up to 3%). The stamp duty is payable by thepurchaser unless otherwise stated in a contract.

2.4.3 Concessions Relating to M&A

The Income Tax Act, GST Act and Stamp Duty Act provide some concessions when a company isbeing reorganised:

• For income tax purposes, where tax depreciable assets are sold to a related party, the transferorand transferee may elect to transfer these assets at tax written down value, without giving rise tothe clawback of tax depreciation previously allowed. Parties are related where the purchasercontrols the vendor or vice versa, or where they belong to the same group of companies. Aconsequence of the election is that the purchaser can only claim tax depreciation on the taxwritten down value of the relevant asset;

• For GST purposes, a transfer of a business as a going concern would not be regarded as ataxable supply and would therefore not be subject to GST. In order for a transfer of a businessto qualify as a transfer of a business as a going concern, certain strict tests must be met. Forexample, the assets must be used by the transferee to carry on the same kind of business asthat of the transferor. Where only part of a business is transferred, that part must be capable ofseparate operation in the same kind of business in order for the transfer to meet the goingconcern requirement; and

• Corporate reconstructions and amalgamations may be exempt from stamp duty (on the transferof shares or real estate as stamp duty is not applicable on the transfer of other assets) if thefollowing conditions are met:

– the transfer is in connection with a scheme for the reconstruction or amalgamation ofcompanies;

– a transferee company has been incorporated, or has increased its capital, with a view toacquisition of the business undertaking or of not less than 90% of the issued share capital ofthe Target Company; and




– at least 90% of the consideration for the acquisition (excluding the discharge ofliabilities) consists of shares issued by the transferee company.

The stamp duty concession may be available when the restructuring occurs in connection withan initial public offer (IPO).


Acquisition expenses are generally not tax deductible to the purchaser in Singapore, except anyexpenses which may be attributed to the purchase of inventory. Thus, if appropriate, it is preferableto book the non-deductible expenses in a country where an appropriate tax deduction may beavailable.






A stock deal will not allow the purchaser to step up the tax cost base of the assets owned by aTarget Company. Thus, it would not allow the purchaser to maximise tax benefits which aregenerally available to an asset deal. In addition, there are limitations on the deductibility offinancing costs associated with a stock deal (refer to section 4.2.1 in relation to deductibility ofinterest in a stock deal).


An asset deal often allows the purchaser to step up the cost base of acquired assets for taxpurposes. This would enable the purchaser to maximise tax benefits through allocating, if possible,higher costs to inventory, depreciable assets and intellectual property rights (IPR).

Generally, the cost of plant and equipment may be depreciated on a straight-line basis over theuseful life of such plant and equipment. Alternatively, the cost of plant and equipment may bedepreciated on a straight-line basis over a period of three years. The cost of automated or similarequipment may be fully depreciated in the first year.

A Singapore company which purchases certain types of IPR is entitled to claim a deduction on astraight-line basis over a period of five years for capital expenditure incurred in acquiring that IPR.The types of intellectual property covered are patents, copyrights and related rights, trademarks,registered designs, geographical indications, layout designs of integrated circuits, trade secrets andinformation that have commercial value. Legal and economic ownership of the IPR must beacquired. The IPR must be used in the acquirer’s trade or business. Third-party valuations arerequired where the capital expenditure incurred in acquiring the IPR is S$2 million or more (forunrelated party transactions), or S$0.5 million or more (for related party transactions).

Previously, both legal and economic ownership of IPR were required to be acquired. However, itwas announced in the Singapore Budget 2006 that the acquisition of only economic ownership ofIPR would be sufficient, provided an approval from the Economic Development Board (EDB) isobtained.

No tax deduction is available for the cost of goodwill or any impairment in value of such goodwill.Therefore, the overall purchase price in an asset deal should, if appropriate, be allocated as muchas possible to inventory, depreciable assets and other items that qualify for tax deductions.






There are no thin capitalisation rules in Singapore. The decision to set a debt to equity ratio isgenerally governed by commercial considerations. However, where a company is set up to takeadvantage of a tax concession or requires a special licence from the Government (e.g. banking,insurance and telecommunications), the regulatory body may require certain ratios to be compliedwith.


4.2.1 Stock Deal

If a Singapore company is used to acquire a Target Company, interest expenses would have taxdeductible value only where the company receives franked dividends (refer to section 6.1).Otherwise, dividend income received from companies that have moved to the one-tier system (referto section 6.1) is exempt from tax and therefore, no deduction would be allowed for the interestexpenses.

In order to obtain a tax deduction for the interest cost, after the stock deal, the business of theTarget Company should be transferred to a new company and the debt should be pushed down tothe new company level so the new company may obtain a tax deduction for the interest.

4.2.2 Asset Deal

Interest incurred on funds used to acquire a business under an asset deal should be tax deductible.Since Singapore does not have a debt to equity ratio requirement for tax purposes, it is possible tomaximise the amount of debt used to acquire a business.

Where, however, the business acquired consists of assets which may not produce regular returns,interest would not be tax deductible if no income is derived from such assets in a particular year.Thus in an asset deal, it is preferable for non-income producing assets to be acquired by separateentities, and the debt/equity financing mix of each particular entity being structured appropriately tomaximise interest deductibility.




5. Mergers

Singapore Companies Act contains specific provisions for the amalgamation of companies. Under the Act,two or more companies may amalgamate and continue as one company, which may be one of theamalgamated companies or a new company. This law has come into effect from 30th January 2006.

Thus, a “merger” could take place as follows:

• One Company to Merge its Business with Another Company

Under this example, the business of Company A is merged with Company B’s in consideration forshares in Company B, and the merged business will be carried on by Company B.

• Two Businesses are Merged into a New Company

Under this example, the businesses of Company A and Company B will be merged and be carriedon by a new company (Company C).

Company A Company B

Merge business

Company A Company B

Merge business

Company C

New Company

Merge business




The shareholders of the amalgamating company may, in consideration of the company’s businessbeing amalgamated, receive shares issued by the amalgamated company or receive other forms ofconsideration from the amalgamated company.

Under the Companies Act, the effects of the amalgamation includes:

• all the property, rights and privileges of each of the amalgamating companies shall be transferredto and vested in the amalgamated company;

• all the liabilities and obligations of each of the amalgamating companies shall be transferred toand become those of the amalgamated company;

• all proceedings pending by or against any amalgamating company may be continued by oragainst the amalgamated company;

• any conviction, ruling, order or judgement in favour or against an amalgamating company may beenforced by or against the amalgamated company; and

• the shares and rights of the members in the amalgamating companies shall be converted into theshares and rights provided for in the amalgamation proposal approved under the Act.

It should, however, be noted that at present, there is no tax law dealing with such amalgamation. Assuch, until such law is enacted, companies considering amalgamation should seek rulings from theSingapore tax authorities as to the tax impact of the amalgamation to the companies involved.






6.1.1 Dividend Payments

Singapore does not impose any restrictions on the repatriation of profits. Since 1st January 2003,Singapore has had a one-tier corporate tax system. Under this system, tax collected from corporateprofits is final and all dividends paid by companies in Singapore are tax-exempt in the hands of theshareholders, regardless of the shareholder’s tax residence status or legal form.

Prior to 1st January 2003, to avoid double taxation at corporate and shareholder levels, Singaporeadopted an imputation system for the taxation of dividends. Under the imputation system, incometax paid by a Singapore resident company is imputed to the dividends paid to its shareholders suchthat the shareholders are deemed to have paid the tax equivalent to the underlying tax paid by thecompany.

To enable resident companies to make full use of unutilised dividend franking credits as at 31stDecember 2002, the Finance Minister introduced a five year transitional period from 1st January2003 to 31st December 2007 for such companies to pay franked dividends out of their unutiliseddividend franking credits as of 31st December 2002. During this period, shareholders will continueto receive franked dividends which carry tax credits and will be entitled to set off the tax creditsagainst their tax liability. Companies also have the option to make an irrevocable election to opt intothe one-tier tax system at any time during this transitional period.

6.1.2 Deemed Dividend Payments

Companies that repurchase their shares, subject to legal restrictions, are considered to have paid adividend out of distributable profits in respect of the amount paid in excess of the contributed capital(i.e. share capital and share premium, excluding any profits capitalised through bonus issues).Similarly, payments under share capital reductions or redemptions of redeemable preference sharesin excess of the relatable capital contribution would be treated as a dividend distribution. All suchdividends would carry franking credits or be treated as exempt dividends under the one-tier system.




6.1.3 Other Payments

There are various avenues whereby the profits of the Target Company may be repatriated to thehome country by means other than dividends. These include the payment of royalties, interest andmanagement fees. However, the payment of such amounts may be subject to withholding taxesas discussed in section 1.2.

Appropriate tax treaties may reduce the withholding tax rates. For example, payment of interest toa Mauritius entity is not subject to withholding tax, provided that certain conditions are met.Management fees in consideration for services rendered outside Singapore that are recharged atcost should not be subject to withholding tax, or should not be taxed if an appropriate tax treatyoperates to exempt the fee from tax due to the non-existence of a permanent establishment inSingapore. Singapore tax legislation does not have any specific anti-treaty shopping provisions,and where an arrangement (with commercial substance) takes advantage of a tax treaty, thereduced rate provided under that treaty should generally apply.

6.2 Unabsorbed Tax Losses and Capital Allowances

Unabsorbed tax losses from operating a trade may be carried forward indefinitely and appliedagainst income in future years. A company may utilise its tax loss as long as its shareholders,on the last day of the year in which the loss was incurred, are substantially the same as theshareholders on the first day of the Year of Assessment in which the loss is to be utilised. Theshareholders are considered to be substantially the same if 50% or more of the shareholders at thetwo points in time are the same.

Unabsorbed capital allowances may also be carried forward indefinitely if the company carries onthe same business, and the shareholders on the last day of the Year of Assessment in which theallowances arose, are substantially the same as the shareholders on the first day of the Year ofAssessment in which the unabsorbed allowances would be utilised.

A waiver to comply with the above ownership requirements may be obtained from the Minister forFinance where the substantial change in shareholding is not for the purpose of obtaining a taxbenefit. Unabsorbed tax losses and capital allowances, which would otherwise be forfeited, maythen be utilised, but generally only against income from the same business in respect of which theywere incurred.


Tax incentives would generally be lost when the business is transferred under an asset deal.However, it may be possible to obtain approval from the authority granting the incentive to ensurethe continued applicability of the incentive to the transferred business.

Tax incentives enjoyed by a Target Company are generally preserved through a stock deal, unlessprior approval is required as a condition of the initial granting of such incentives to the target.

6.4 Group Relief

Under the group relief system, current year unabsorbed tax losses and capital allowances of acompany may be used for set off against the assessable income of another company belonging tothe same group. Two Singapore incorporated companies are regarded as members of the samegroup if:




• at least 75% of the ordinary share capital of one company is beneficially held, directly orindirectly, by the other; or

• at least 75% of the ordinary share capital in each of the two companies is beneficially held,directly or indirectly, by a third Singapore company.

In determining whether the minimum 75% shareholding threshold is achieved, equity interests heldthrough foreign companies and shares with fixed dividend rights are to be ignored. Additionally, theshareholder company must be beneficially entitled, directly or indirectly, to at least 75% of residualprofits and assets (in the case of liquidation) available for distribution to all equity holders in therelevant company.

To be eligible for group relief, the companies in question must have a common year end and theshareholding requirement must be fulfilled for a continuous period that ends on the last day of thecommon accounting period. If the above continuous period ends on the last day of the accountingperiod, but does not actually cover the entire accounting year, then only the loss items attributable tothat continuous period may be transferred.

Group relief may be diagrammatically illustrated as follows:

• No Group Relief

• Group Relief Available to Singapore Company A, Singapore Company B, Singapore Company Cand Singapore Company D

Foreign Company

Singapore Company A Singapore Company B

100% 100%

Singapore Company A

Singapore Company B Singapore Company C

100%

≥ 75%

Foreign Company

50%

Singapore Company D




7. Disposal

7.1 Preference of Vendor: Stock vs. Asset Deal

From a vendor’s view point, it would be less complicated to sell a target through a share deal.

7.2 Stock Disposal

7.2.1 Profit on Sale of Shares

Generally, unless the vendor is a share dealer or venture capitalist, the profits derived from the saleof shares should not be subject to tax, as such profits should be of a capital nature. As a result,from the vendor’s perspective, it is generally preferable to sell shares. Where a vendor is a privateequity investor, it is generally accepted that the acquisition would be for a short-term gain andthus the profit derived from the subsequent disposal of shares should be of an income nature. Inthis regard, it may be beneficial to acquire the Singapore target through a company set up in arelevant jurisdiction with which Singapore has a tax treaty that exempts from Singapore tax profitson the disposal of shares in a Singapore company.

It was announced in the Singapore Budget 2006 that companies which have been granted theInternational Headquarters (IHQ) award may apply to the EDB for approved holding companystatus, to obtain certainty that gains from the sale of shares in approved subsidiaries will be treatedas capital in nature and hence not subject to Singapore tax. Conversely, any loss from the saleof shares in approved subsidiaries cannot be set off against other income. The concession will lastfor five years from the date the approved holding company status is granted. The approved holdingcompany must have a shareholding in the approved subsidiary of at least 50%, which has beenheld for at least 18 months.


Under the one-tier system, all profits (including capital gains which have not been subject to tax)may be distributed as tax-free dividends to the shareholders.




7.3 Asset Disposal


In an asset deal, any price received for sale of goodwill (including self generated intellectualproperty which has been used in the business) should not be subject to tax in the hands of thevendor. However, any profits on the sale of inventory or tax depreciable assets (i.e. to the extent ofthe tax depreciation recouped) should be subject to tax in the hands of the vendor.

A corporate vendor may be prepared to enter into an asset deal if it has unabsorbed tax losses orcapital allowances, or if the sale price of the inventory and tax depreciable assets is notsubstantially higher than their tax value.

In allocating the overall sale price to specific assets sold, the value allocated to inventory and taxdepreciable assets should be on an arm’s length basis, otherwise the allocation may be challengedby the tax authorities.


Under the one-tier system, all profits (including capital gains which have not been subject to tax)may be distributed as tax-free dividends.




8. Transaction Costs

8.1 GST

As indicated in sections 1.3 and 1.5, the GST rate is 5%. GST is collected by a GST-registeredservice provider (i.e. vendor) and is payable by the end user (i.e. purchaser). However, certaingoods or services, such as transfers of shares, are exempt from GST. A transfer of a businesswhich satisfies certain conditions is also exempt from GST.

8.2 Stamp Duty

As indicated in section 2.4.2, stamp duty is generally payable by the purchaser unless otherwisestated in a contract.


As stated in section 2.4.3, the Income Tax Act, GST Act and Stamp Duty Act provide the followingconcessions when a company is being reorganised:

• for income tax purposes, in respect of sales of tax depreciable assets to a related party, thetransferor and transferee may elect to transfer these assets at tax written down value, withoutgiving rise to the tax depreciation previously allowed being recharged to the transferor. Partiesare related where the purchaser controls the vendor or vice versa or where they belong to thesame group of companies;

• for GST purposes, a transfer of a business as a going concern would not be regarded as ataxable supply and would therefore not be subject to GST. In order for a transfer of a businessto qualify as a transfer of a business as a going concern, certain strict tests must be met. Forexample, the assets must be used by the transferee to carry on the same kind of business asthat of the transferor. Where only part of a business is transferred, that part must be capable ofseparate operation in the same kind of business in order for the transfer to meet the goingconcern requirement; and




• corporate reconstructions and amalgamations may be exempt from stamp duty (on the transferof shares or real estate as stamp duty is not applicable on the transfer of other assets) if thefollowing conditions are met:

– the transfer is in connection with a scheme for the reconstruction or amalgamation ofcompanies;

– a transferee company has been incorporated, or has increased its capital, with a view toacquisition of the business undertaking or of not less than 90% of the issued share capital ofthe target company; and

– at least 90% of the consideration for the acquisition (excluding the discharge of liabilities)consists of shares issued by the transferee company.

The stamp duty concession may be available when the restructuring occurs in connection withan IPO.


Transaction costs are generally not tax deductible to the vendor in Singapore, except for anyexpenses which may be attributed to the sale of inventory.




9. Preparation of Target Company for Sale

9.1 Transfer of Certain Assets to Another Group Company

As discussed in sections 2.4.3 and 8.3, it is possible to elect for the transfer of assets betweenrelated parties to occur at tax written down value, so that the transferor is not subject to anassessable balancing charge. This election may be useful in the context of a stock deal where thevendor wants to transfer certain assets which are to be retained to another group company.


One of the means of extracting surplus cash in a company that is identified for sale is throughdividends. Where the company identified for sale has an imputation balance, a franked dividendshould be declared to the maximum extent. The imputed tax may, in certain circumstances, beencashed (i.e. in a loss situation, group relief etc.).

10. De-mergers

There are no specific provisions in relation to de-mergers. A de-merger usually takes place through thesale of assets or business. It is important to note that any unabsorbed tax losses or capital allowancesmay not be transferable. The implications of a de-merger would generally be the same as for an assetdeal.

11. Trade Sale or Listing/IPO

After acquiring a target, a financial purchaser generally looks for an exit route either through a trade saleor a public listing/IPO. Since the objectives of a financial purchaser are to maximise its return oninvestment and optimise its exit multiples, any profits derived from the exit route through an asset or sharesale are generally regarded as income subject to tax. To realise profits in a tax efficient manner, anappropriate structure should be put in place to effect the acquisition (e.g. interposition of a Mauritiusholding company to benefit from the Singapore-Mauritius Tax Treaty).




12. Tax Incentives

As mentioned in section 1, there are a number of tax incentives granted for doing business in Singapore.These include the following:

• regional headquarters (RHQ)/international headquarters (IHQ) awards;

• pioneer enterprise incentive;

• investment allowance;

• development and expansion incentive;

• export of services;

• overseas enterprise incentive;

• enterprise investment incentive;

• overseas investment incentive;

• finance and treasury centre;

• approved fund managers;

• approved international shipping enterprise;

• global trader programme; and

• approved venture company.

Entities carrying on approved activities may take advantage of a concessionary tax rate ranging from 0%to 15% for a specified period (generally between 5 to 15 years) on specified income, depending on theparticular tax incentive and the outcome of negotiations with the relevant Government agency.




SRI LANKA

Country M&A TeamCountry Leader ~ Daya Weeraratne

Hiranthi Ratnayake






Daya Weeraratne Head of Tax Division +94 11 471 9838 ext. 403 [email protected]

Hiranthi Ratnayake Partner +94 11 471 9838 ext. 408 [email protected]

PricewaterhouseCoopers • P.O. Box 918 • 100 Braybrooke Place • Colombo 2 • Sri Lanka




1. Introduction

1.1 General Information on M&A in Sri Lanka

This chapter sets out the main issues that would be of concern to the transacting parties involved intransfer of ownership of a Sri Lankan business or company.

A transfer of ownership of a Sri Lankan business entity can take the form of a disposal of its stockor of its assets. The tax implications arising from a disposal of stock significantly differ from thosearising from a disposal of assets.

The Government of Sri Lanka encourages foreign investments, subject to certain restrictions, thedetails of which are given in Appendix A.

Many fiscal incentives are accorded to industrial and other business activities promoted by theSri Lankan Government. A detailed list of such incentives is provided in Appendix B.

1.2 Corporate Income Tax

The tax residents of Sri Lanka are taxed on their worldwide income. Non-residents are taxed onlyon their profits and income arising in, or derived from, Sri Lanka. Taxable profits/income for non-residents are defined to include all profits and income derived from services rendered in Sri Lanka,properties in Sri Lanka and businesses transacted in Sri Lanka, whether directly or through anagent.

A resident company, for purposes of income tax, is one which has its registered or principal office inSri Lanka or whose business is managed or controlled from Sri Lanka.

The current rate of income tax for a resident company, effective from the Year of Assessment 2003/2004, is 32.5%. The standard rate will be increased to 35% from the Year of Assessment 2006/2007. Lower rates of 15% or 20% apply to specific activities.




The corporate income tax rates for the Years of Assessment 2005/2006 and 2006/2007 are asfollows:

* For a five-year period from the date of listing.

Non-resident companies are liable for income tax at 32.5% (to be increased to 35% from 2006/2007)of taxable income and at 10% of the remittances of profits abroad.

On profits and income 2005/2006 2006/2007(%) (%)

Companies engaged in non-traditional exports, 15 15promotion of tourism, construction work and foroverseas management activities paid for inforeign currency

Companies with taxable income not exceeding 20 15Rs 5 million (other than a unit trust mutual fundor a venture capital company)

Specialised Housing Banks 20 20

Existing venture capital companies or new venture 20 20capital companies not qualified for tax exemption

Unit trusts and mutual funds – profits under 10 10specified areas

Unit trusts and mutual funds – profits under 20 20unspecified areas

Companies offering professional services 30/32.5 15outside Sri Lanka for payment in foreign currency

Shipping Agents approved by the Director of 30/32.5 15Merchant Shipping in respect of profits attributableto trans-shipment fees received in foreign currency

All other companies:• Quoted Public (with 300 shareholders or more) 30 33 1/3*

• Others 32.5 35




1.3 Taxation of Dividends

Dividends are generally subject to a withholding tax of 10% of the gross dividend unless otherwisedistributed out of tax exempt profits by a company which has entered into an agreement withBoard of Investment of Sri Lanka (BOI) under Section 17 of the BOI Law No. 4 of 1978 prior to6th November 2002 or a company qualified for an exemption prior to 6th November 2002, ordistributed to a non-resident shareholder by a company which has entered into an agreement withthe BOI under Section 17 of the BOI Law No. 4 of 1978, prior to 31st December 1994, on anapplication made prior to 11th November 1993.

The tax withheld is required to be paid to the Sri Lankan tax authorities within 30 days of distributionof the dividends.

Corporate shareholders are not required to include dividends in their assessable income if suchdividends are paid by a resident company which has deducted tax from the said dividends, or if thedividends are paid out of dividends received from another resident company. The 10% dividend taxpaid will be the final tax applicable on any dividends distributed.

1.4 Withholding Tax

Dividends, interest, rent, royalties and service fees paid by a resident company to another residentcompany or a non-resident company are subject to withholding tax. The rates are as follows:

*Lower rate of 10% applies with respect to countries with which Sri Lanka has entered into doubletaxation treaties.

Withholding tax paid may be set off against the income tax payable by the recipient concerned,provided such income is included in the taxable income.

Resident Non-residentcompany company(Paid by) (Paid to)

Dividends 10% 10%

Interest 10% 20%*

Royalty/Annuity > 50,000 per month 10% 20%*or 500,000 per annum

Service or management fees 5% 5%

Non-residential rents 10% –

Lottery prizes > Rs 500,000 10% –





VAT is chargeable at the time of supply on the value of goods imported by any persons and on thevalue of the local supply of goods or services made by a registered person at the following rates.

1.6 Stamp Duty

Stamp duty, other than stamp duty payable to Provincial Councils on the transfer of movable andimmovable property, was abolished with effect from 1st April 2002. Stamp duty is payable by thepurchaser at 3% on the first Rs 100,000 and 4% on the balance of the consideration (or marketvalue in the absence of a consideration) in excess of Rs 100,000 when acquiring immoveableproperty.

The Government announced in the Budget for 2006 that stamp duty would be reintroduced,effective from 1st February 2006, in repect of instruments and documents other than those whichare subject to debits tax, letters of credit which are subject to the Ports and Airports DevelopmentLevy and share market transactions.

The precise documents and instruments that would be subject to stamp duty have not beenannounced.

Category Rate Items Input tax(%) allowability (%)

Zero rate 0 Applies to export of goods, services connected Full, other thanwith international transportation of goods and on goods andpassengers, and with any movable or immovable servicesproperty outside Sri Lanka, any services provided chargeableto a person outside Sri Lanka to be consumed to Output VAToutside Sri Lanka, for which payment is received at 20%, on whichin full in foreign currency through a bank in input VAT creditSri Lanka, “deemed” exports to export companies is restricted toregistered with Textile Quota Board, and services 15%provided by garment buying offices.

Basic rate 5 Applies to basic food items – sugar, dhal, milk 0powder, dried fish, chillies, potatoes and onions(it was proposed in the Budget 2006 to applyVAT on the above products only at the point ofimport and not on subsequent sales).

Standard rate 15 Items not included under zero rate, basic rate 15and luxury rate, and other than exempt andexcluded supplies.

Luxury rate 20 Applies to goods deemed as luxury goods – 15any kind of liquor, air conditioners, refrigerators,washing machines, dish washing machines,television sets, television antennas, cameras,jewellery, motor vehicles (other than threewheelers, passenger transport buses, motorcycles and bicycles), services provided by hotels,restaurants for wedding receptions and othersimilar receptions.

Pursuant to the Budget 2006, the supply of financialservices, previously chargeable at 15%, has beenbrought under the 20% rate.




1.7 Economic Service Charge (ESC)

ESC is levied annually, effective from 1st April 2004, on every person or partnership in respect ofthe liable turnover of every trade, business profession or vocation carried on by such person orpartnership. This is provided that the liable turnover is not less than Rs 50 million (proposed to bereduced to Rs 40 million from the Year of Assessment 2006/2007) in the relevant Year ofAssessment and the commercial operations had commenced three years prior to the first day of therelevant year. The maximum ESC chargeable is Rs 50 million for a Year of Assessment (proposedto be increased to Rs 60 million from the Year of Assessment 2006/2007).

ESC rates are as follows:

* Effective from 1st April 2005.

** Effective from 1st April 2006.

From the Year of Assessment 2006/2007, ESC may be set off against the total income tax payablefor the relevant year. Any balance may be set off against the total income tax payable for the nexttwo succeeding years. The limitation of set off to income tax payable on profits from trade,business, profession or vocation will be removed. No part of the ESC is refundable.

Rate of ESC

On such part of liable turnover of an entity, the profits of which are 0.25%exempt from income tax.

On such part of the liable turnover of an entity, which has entered intoan agreement with BOI under Section 17 of the BOI Law and which:

• enjoys income tax exemption on its profits and income; 0.25%

• is entitled to pay income tax at any rate not higher than 15%; 0.5%

• is not referred to in either of the above. 1.0%

On such part of the liable turnover of the entity being the turnover:

• from wholesale or retail trade of goods, not manufactured or 0.5%produced by the dealer;

• of any tea, rubber coconut processing factory**; 0.5%

• whose profits are charged to income tax at:

– lower rates specified in the 6th Schedule to the Inland Revenue Act; 0.5%

– rates other than those rates specified in the 6th Schedule. 1.0%




1.8 Share Transaction Levy

A levy at the rate of 0.2% is imposed on the buyer and seller each on the turnover on listed sharetransactions.

1.9 Tax on Unlisted Shares

The 15% tax is payable on any gain from the sale of unlisted shares, if the holding period of suchshares is less than two years.

1.10 Other Taxes

Excise duties and Special Excise Levies are charged on tobacco, cigarettes, liquor, motor vehiclesand selected petroleum products.




2. Acquisitions


Sri Lanka does not have specific legislation dealing with the tax treatment of acquisitions.Accordingly, general principles of taxation would apply when structuring a deal and choosingbetween an acquisition of assets or stock.

Whether a deal should be structured as a stock deal or asset deal may largely depend oncommercial considerations.


Generally, it is less expensive for a purchaser to acquire the business under a stock deal, ascurrently no stamp duty is payable on a transfer of stock. However, the Government announced inthe Budget for 2006, the reintroduction of stamp duty in respect of instruments and documentsother than those which subject to debits tax and letters of credit subject to the Ports and AirportsDevelopment Levy as well as share market transactions. However, the applicability and, if so, therate of stamp duty on documents with respect to acquisitions of stock have not been announced.

2.2.1 Preservation of Tax Losses

Where a Target Company has accumulated losses carried forward and the buyer wishes topreserve the losses, it will have to acquire the business via a stock deal as there are no provisionsfor transfer of losses from one entity to another. The tax statute provides that, where there has beena change in the ownership of a company resulting in more than 33 1/3% of the issued capital of thatcompany being held directly or through nominees who did not hold such share capital in the taxyear in which the loss was incurred, the carry forward losses may only be set off against the profitsderived from the same business.

The amount of loss incurred by a company in any Year of Assessment commencing on or after1st April 2004, in any trade, business, profession or vocation, including any brought forward loss,may be set off only up to 35% of the total statutory income excluding any income that does not formpart of the assessable income.




2.2.2 Continuity of Tax Incentives

Where the Target Company enjoys any tax incentives, the business has to be acquired via a stockdeal to ensure the continued applicability of the incentives.


An asset deal allows a purchaser to select the desirable assets to be acquired and to transferassets between one or more entities, including offshore entities, so as to mitigate the future inter-group tax payments.



• Stock Deal

The transfer of shares is exempt from VAT.

• Asset Deal

A transfer of a continuing business which satisfies certain conditions is also exempt from VAT.However, the transfer of assets is liable for VAT at the standard rate of 15% or luxury rate of 20%depending on the type of the assets. If the asset is used in the production of income and taxdepreciation can be claimed, the input VAT suffered could be claimed, provided the asset ispurchased from a VAT registered person.

2.4.2 Stamp Duty

Stamp duty was abolished with effect from 1st April 2002, other than stamp duty payable toProvincial Councils on the transfer of moveable and immoveable property. Stamp duty is payable bythe purchaser at 3% on the first Rs 100,000 and 4% on the balance consideration (or market valuein the absence of a consideration) in excess of Rs 100,000.

The Government announced in the Budget for 2006 the reintroduction of stamp duty in respect ofinstruments and documents other than those which are subject to debits tax, and letters of creditsubject to the Ports and Airports Development Levy and share market transactions.

However, the applicability (if any) and rate of stamp duty on documents with respect to acquisitionsof stock have not been announced.

2.4.3 Share Transaction Levy

A levy at the rate of 0.2% is imposed on the buyer ands eller each on the turnover on listed sharetransactions.


The share transaction levy is not tax deductible to the buyer. Similarly, the stamp duty, if levied,would also not be deductible for tax purposes as it relates to a capital transaction.

Any input VAT not claimable could be capitalised and added to the purchase price of the relevantassets acquired.






Sri Lanka does not have any rules in regard to thin capitalisation. The Government announced inthe Budget for 2006 that, effective from 1st April 2006, interest payments made between membersof a group of companies will be restricted in computing profits and income in the debt-equity ratioof 2:1 in the case of manufacturing companies and 3:1 in the case of other companies.


3.2.1 Stock Deal

Prospective buyers could utilise domestic loans to fund an acquisition. There are, however,restrictions placed on Sri Lankan companies raising debts from overseas markets.

Interest on loans and overdrafts is deductible only if such loans and overdrafts are used in earningchargeable profits and income in any trade, business, profession or vocation.

3.2.2 Asset Deal

Interest incurred on loans used to acquire assets under an asset deal is tax deductible, providedsuch assets are used in the production of income.




4. Mergers

There are no specific provisions relating to mergers. Specifically, the transfer of carried forward losses andof unabsorbed capital allowances may not be made from the merging entities to the merged entity. Thus,where a company has substantial tax losses or unutilised capital allowances, the profit making companyshould, subject to commercial considerations, be merged into the loss making company.



Sri Lanka does not impose any restrictions on the repatriation of profits, other than on any capitalprofit. Dividends distributed out of prior year profits need specific exchange control approval forremittance abroad.

5.2 Losses Carry Forwards and Unabsorbed Capital Allowance

Operating losses may be carried forward indefinitely and applied against income in future years.However, the amount of losses that may be set off is restricted to 35% of the total statutory income,excluding any income that does not form part of the assessable income.


Where the Target Company enjoys any tax incentives, the business has to be acquired via a stockdeal to ensure the continued applicability of the incentives.

5.4 Group Relief

No such group relief system is available in Sri Lanka.




6. Disposals

6.1 The Preference of Seller: Stock vs. Assets Deal

From a seller’s viewpoint, it would be less complicated to sell a Target Company through a stockdeal.

Generally, when the investor wants to exit, he may sell his investment through a stock or asset deal.Where a non-resident investor is selling stock in a Sri Lankan company, the investor will beexposed to liability for income tax on any gains arising from the sale of unlisted stocks if such stockswere held for less than two years. The potential exposure to income tax on the gains derived fromthe sale of stocks could be mitigated, if commercially viable, by:

• listing the stock of the Target Company and making the sale after the listing. However, thiswould attract a share transaction levy of 0.2% on the sale/purchase price from the buyer andthe seller each; or

• holding the investment through a company located in a country with which Sri Lanka has adouble tax treaty (DTT) as such treaty exempts Sri Lankan tax on the capital gains; or

• holding the investment through a company located in a tax haven country and when the SriLankan investment is to be sold, the company in the tax haven be sold instead.

Listing the stock of the Target Company will also avoid exposure to stamp duty, if any, onsubsequent transfers of stock.

If the exit is via a sale of assets, the seller will be liable for income tax on the profit on sale. From atax efficiency perspective, a stock deal is the preferred route.

6.2 Stock Disposal


Gains from sale of unlisted stocks is liable for income tax at 15% if the stocks were held for lessthan two years or no share transaction levy (which is applicable for listed shares) is paid. Suchgains may be exempt from the aforesaid tax if the owner resides in a country which has entered intoa DTT with Sri Lanka and the DTT exempts taxation of capital gains in Sri Lanka.





Dividends are generally subject to a withholding tax of 10% of the gross dividend unless otherwisedistributed out of tax exempt profits by a company which has entered into an agreement with theBoard of Investment of Sri Lanka (BOI) under Section 17 of the BOI Law No. 4 of 1978 prior to6th November 2002 or a company qualified for an exemption prior to 6th November 2002, ordistributed to a non-resident shareholder by a company which has entered into an agreement withthe BOI under Section 17 of the BOI Law No. 4 of 1978, prior to 31st December 1994, on anapplication made prior to 11th November 1993.

Corporate shareholders are not required to include dividends in their assessable income if thedividends are paid by a resident company which has deducted tax from the dividends, or thedividends are paid out of dividends received from another resident company. The 10% dividend taxpaid would be the final tax applicable to any dividends distributed.

Avenues by which profits of the Target Company could be repatriated to home country (other thanby way of dividends), include such payments as interest, royalties, technical and management fees.However, the tax authorities may disallow payments in excess of what is considered reasonable andcommercially justifiable.

6.3 Asset Disposal


In an asset deal, any price received for sale of goodwill (including self generated intellectualproperty which has been used in the business) should not be subject to tax in the hands of theseller. However, any profits on the sale of inventories or tax depreciable assets (i.e. to the extent ofthe tax depreciation recouped) should be subject to tax in the hands of the seller.

A corporate seller should be prepared to enter into an asset deal if it has tax losses or un-utilisedtax depreciation, or if the sale price of the inventories and tax depreciable assets are notsubstantially higher than their book value.

In allocating the price for the assets sold, the value allocated to inventories and tax depreciableassets should be on an arm’s length basis, lest it may be challenged by the tax authorities.


Dividends are generally subject to a withholding tax of 10% of the gross dividend unless otherwisedistributed out of tax exempt profits by a company which has entered into an agreement with theBoard of Investment of Sri Lanka (BOI) under Section 17 of the BOI Law No. 4 of 1978 prior to 6thNovember 2002, or a company qualified for an exemption prior to 6th November 2002, or distributedto a non-resident shareholder by a company which has entered into an agreement with the BOIunder Section 17 of the BOI Law No. 4 of 1978, prior to 31st December 1994, on an applicationmade prior to 11th November 1993.

Corporate shareholders are not required to include dividends in their assessable income if thedividends are paid by a resident company which has deducted tax from the dividends or thedividends are paid out of dividends received from another resident company. The 10% dividend taxpaid would be the final tax applicable to any dividends distributed.

Avenues by which profits of the Target Company could be repatriated to the home country (otherthan by way of dividends), include such payments as interest, royalties, technical and managementfees. However, the tax authorities may disallow payments in excess of what is consideredreasonable and commercially justifiable.





7.1 Profits on Sale of Assets

An asset deal could involve the disposal of assets on which depreciation for tax purposes has beendeducted and the disposal of assets on which tax depreciation has not been deducted.

The gain representing the excess of the sale proceeds over the tax depreciated value on the sale ofassets is taxed at normal rates as part of business profits.

The profit from the disposal of assets (tangible and intangible) on which tax depreciation has notbeen deducted is not subject to tax.

The assets should be transferred at their open market value. In certain circumstances, in respect ofdepreciable assets, the tax authorities may accept a valuation based on the net book value.


The sale of assets will be subject to VAT at 15% (20% if falls into the category of luxury goods)on the consideration for the assets sold. The seller has to charge and account for VAT to the taxauthorities. However, if the buyer is VAT registered, the buyer is entitled to claim a credit in respectof the VAT paid. The sale of the assets will not be subject to VAT provided they are sold as part ofa going concern.

7.3 Stamp Duty

Stamp duty, if imposed, would generally be payable by the purchaser unless otherwise stated in acontract.


The only concession that was provided in respect of acquisitions is the tax holiday granted foracquiring non-performing or under-performing enterprises.





Transaction costs are generally not tax deductible to the seller in Sri Lanka, except any expenseswhich may be attributed to the sale of inventories.




8. Preparation of a Target Comapnay for Sale

8.1 Declaration of Dividend Prior to the Sale

One of the means of extracting surplus cash in a company that is identified for sale is throughpayment of dividends. Where the company identified for sale has revenue reserve that could bedistributed, dividends should be declared to the maximum extent provided the payment of dividendsdoes not adversely affect the sale price.

9. De-mergers

There are no specific provisions in relation to de-mergers. A de-merger usually takes place through thesale of assets or business. It is important to note that any brought forward losses, unabsorbed capitalallowances may not be transferred. The implications for a de-merger would be the same as an asset dealas discussed in section 2.





Generally, when the investor wants to exit, he may sell his investment through a stock or asset deal.Where a non-resident investor is selling stock in a Sri Lankan company, the investor would be exposed toliability for income tax on any gains arising from such sale if the shares were held for less than two years.The potential exposure to income tax on the gains derived from the sale of stocks could be mitigated by:

• listing the shares of the Target Company and making the sale after the listing. However, this wouldattract a share transaction levy of 0.2% on the sale/purchase price or from the buyer and the sellereach; or

• holding the investment through a company located in a country, with which Sri Lanka has a doubletax treaty as such treaty exempts Sri Lankan tax on the capital gains; or

• holding the investment through a company located in a tax haven country and when the Sri Lankaninvestment is to be sold, the company in the tax haven to be sold instead.

Listing the shares of the Target Company will also avoid exposure to stamp duty, if any, on subsequenttransfers of shares.

If the exit is via a sale of assets, the seller will be liable for income tax on the profit on sale. From a taxefficiency perspective, a share deal is the preferred route.

Avenues by which profits of the Target Company could be repatriated to the home country (other than byway of dividends), include such payments as interest, royalties, technical and management fees.However, the tax authorities may disapprove payments in excess of what is considered reasonable andcommercially justifiable.




Appendix A

1. Common Forms of Business Entity

Business may be conducted in Sri Lanka in any of the following forms:

• company incorporated in Sri Lanka;

– private

– public

– quoted

• branch office of a foreign company;

• representative or liaison office of a foreign company;

• partnership;

• sole proprietorship; or

• offshore company.

The private limited liability companies and branches of foreign companies are the types of businessentities most commonly used by foreign investors. Certain tax concessions are available to foreigninvestors, depending on the amount of investment and type of business activity carried out in SriLanka.

2. Foreign Ownership Restrictions

Since the opening of the Sri Lankan economy in 1977, Sri Lanka has adopted a policy ofencouraging foreign investment. Except for investment in certain business activities (see below),foreign investors are permitted to set up wholly-owned subsidiaries in Sri Lanka.

The following businesses are restricted to citizens of Sri Lanka:

• money lending;

• pawn broking;

• retail trade with a capital of less than USD one million;




• coastal fishing; and

• providing personal services other than for the export and tourism sectors.

3. Areas Subject to Automatic or Conditional Approval

Foreign investments in the areas listed below would be approved, limited to 40% of equity:

• production of goods where Sri Lankan exports are subject to internationally determined quotarestrictions;

• growing and primary processing of tea, rubber, coconut, cocoa, rice, sugar and spices;

• mining and primary processing of non-renewable natural resources;

• timber based industries using local timber;

• fishing (deep-sea fishing);

• mass communications;

• education;

• freight forwarding;

• travel agencies; and

• shipping agencies.

Foreign ownership in excess of 40% will be approved on a case by case basis by the BOI.

4. Regulated Areas

Foreign investments in the areas listed below will be approved by the respective governmentagency or BOI (up to the percentage of foreign equity specified by BOI):

• air transportation;

• coastal shipping;

• industrial undertaking in the Second Schedule of the Industrial Promotion Act No. 46 of 1990,namely;

– any industry manufacturing arms, ammunitions, explosives, military vehicles and equipmentaircraft and other military hardware

– any industry manufacturing poisons, narcotics, alcohols, dangerous drugs and toxin,hazardous or carcinogenic materials

– any industry producing currency, coins or security documents

• large scale mechanised mining of gems; and

• lotteries.

The BOI assists potential investors by referring applications to the appropriate agency and approvalis usually straightforward.




Appendix B

Tax Incentives

1. Introduction

Sri Lanka offers to private investors, fiscal incentives designed to stimulate investment. This is inexpectation that more investment in the Sri Lankan economy would produce enhanced employmentopportunities, yielding higher income for Sri Lankans. Tax holidays, tax-rate concessionsand customs duty waivers have been the major instruments granted under the incentive system.

The fiscal incentives are offered by the BOI and also under the tax statute. Pursuant torationalisation of the incentive structures, the fiscal incentives now offered by the BOI followsubstantially similar incentives offered under the tax statute. Discussed below are the current fiscalincentives offered under the tax statute and under the BOI.

2. Agricultural and Industrial Projects

2.1 Qualifying Activities

Tax incentives are granted in respect of the profits of:

• An Undertaking Carried On by a Company:

– incorporated before 1st April 2002 and commenced commercial operations between 1st April2002 and 31st March 2004 with a minimum investment of Rs 2 1/2 million;

– incorporated before 1st April 2002 and commenced commercial operations on or after 1stApril 2004 with a minimum investment of Rs 50 million;

– incorporated and commenced to carry on the undertaking on or after 1st April 2002 butbefore 1st April 2004; or

– incorporated on or after 1st April 2004 with a minimum investment of Rs 10 million.




The designated activities include:

– agriculture (i.e. cultivation of land with plants of any description and rearing of fish);

– agro processing (i.e. processing of any agricultural product or fishing product other thanprocessing of black tea in bulk) ;

– industrial and machine tool manufacturing;

– information technology and allied services;

– electronics;

– export of non-traditional products which means export of any goods (other than export ofblack tea in bulk, crepe rubber, sheet rubber, scrap rubber, latex, fresh coconuts)including deemed export of goods (i.e. manufacture of non traditional products andsupplied to an exporter), where not less than 80% of the total turnover of suchundertaking for any year of assessment is from the export or deemed export of such non-traditional goods;

– animal husbandry including poultry farms, veterinary and artificial insemination servicesand other support services;

– deep sea fishing;

– manufacture of machinery; and

– export or deemed export of services.

• an undertaking carried on by a company on or after 1st April 2002 but before 1st April 2004 withan investment in excess of Rs 250 million;

• any designated project carried on by a company incorporated before 1st April 2002 and whichundertaking commenced operations on or after 1st April 2004, with a minimum investment of Rs50 million;

The designated projects include:

– manufacture of ceramics, glassware or other mineral based products;

– manufacture of rubber based products;

– any projects in light or heavy engineering industries;

– any projects engaged in the provision of refrigerated transport services or cold room storageservices;

– Export Production Village Company as defined in Section 17 (3) of the Inland Revenue Act,No. 38 of 2000; and

– management of any offshore company or maintaining a back office in relation to any activityin a foreign country.

Note: The minimum investment is not required in respect of an Export Production VillageCompany.)

• any pioneering project carried on by a company on or after 1st April 2004 with an investment inexcess of Rs 250 million.




2.2 Incentives offered are as follows:

Where the investment exceeds Rs 1 billion in any pioneering undertaking, the concessions offeredwill be as follows:

*The tax exemption period will be granted from the tax year in which the undertaking commencesto make profits, but not later than two years from the commencement of commercial operations.

3 Infrastructure Projects – Large Scale


Tax incentives will be granted to any company on its profits and income from an undertakingcarried on by it on or after 1st April 2002 for:

• development of any airport, sea-port, highway or railway;

• development of any industrial park;

• development of any warehouse or store;

• provision of any sanitation facility or solid waste management system;

• power generation, transmission or distribution;

• development of water services; and

• urban housing or town centre development.

Period Tax rate%

1 – 5th year* 0

6th & 7th year 10

8th year onwards• agriculture and non-traditional exports 15

• others 20

Amount of minimum investment Tax exemption period(Rupees million) (Years)

1000 to 2499 08*

2500 and above 10*

After the end of the tax exemption period Tax rate %

Immediately succeeding two years 10

Thereafter:• agriculture & non-traditional products 15

• others 20




3.2 Qualifying investment criteria and incentives offered are as follows:

*The tax exemption period will be reckoned in the same manner as for agricultural and industrialprojects.

After the expiry of the tax exemption period, a 15% tax rate will apply.

4 Infrastructure Projects – Small Scale


Tax incentives will be granted to any company on its profits and income from an undertakingcarried by it on or after 1st April 2002 and which is engaged in infrastructure development for:

• generation of power;

• tourism;

• recreation;

• warehousing and cold storage;

• garbage collection and disposal;

• construction of houses;

• construction of hospitals; and

• redevelopment of housing schemes.

4.2 Qualifying Investment Criteria

The investment, of not less than 10 million rupees, should be made within one year ofcommencement of the undertaking.


*The tax exemption period will be reckoned in the same manner as for agricultural and industrialprojects

Amount of minimum investment Tax exemption period*(Rupees million) (Years)

1,000 6

2,500 8

5,000 10

7,500 12

Period Tax rate%

1st – 5th year* 0

6th – 7th year 10

8th year onwards 20




5 Research and Development


Tax incentives will be granted to any company which commences a new undertaking which isengaged in research and development.

“Research and development” is defined to mean any systematic or intensive study carried out in thefield of science and technology with the object of using results thereof for the production orimprovement of materials, devices, products, produce or process (other than quality control ofproducts or routine testing materials, devices, products or produce, research in social sciences orhumanities, routine data collection, efficiency surveys or management studies and market researchor sales promotion).


A minimum investment of 2 million rupees should be made within one year from the commencementof the new undertaking.

*The tax exemption period will be reckoned in the same manner as for agricultural and industrialprojects. The exemption would be limited to the income earned from the research and developmentactivities only.

6 Acquisition of Non-Performing or Under-Performing Enterprises


Tax incentives will be granted to a company which:

• acquires (i.e. acquiring the ownership of the enterprise or acquiring not less than 51% of theenterprise with management rights or by becoming the partner or a joint venture);

• a non-performing (which means failure to carry out commercial operations) business enterprise; or

• an under-performing (which means the incurring of operational losses for a period not less thantwo consecutive years of assessment) business enterprise;

• engaged in the manufacture of textiles, poultry, farming, fish rearing, or any other area as maybe determined by the Minister by Order published in the Gazette;

• to rehabilitate (which means to recommence the commercial operations of the enterprise on asustainable basis) such enterprise.

Period Tax rate%

1st – 5th year* 0

5th year onwards 15





This incentive is subject to:

• terms approved by the Minister; and

• adequate provision being made to meet the statutory liabilities outstanding at the time ofacquisition of the enterprise concerned.

Note: A proposal should be forwarded to the Minister of Finance, with details of the provision forsettlement of statutory liabilities (for example, EPF and ETF dues) of such acquired enterprise, andapproval obtained.

• Acquisition should be completed and commercial operation of the acquired enterprisecommenced prior to 1st April 2004.


The acquiring company will be granted a three-year tax exemption period, reckoned from the taxyear in which the acquired enterprise commences to make profits, but not later than two years fromthe date of commercial operations of such acquired enterprise.

7 Expansion of Industrial Undertakings for Export of Non-Traditional Products


Tax incentives are granted to a company which:

• has an undertaking engaged in the manufacture of non-traditional products, and undertakes theexpansion of such products; and

• makes the full amount of investment (see below) prior to 1st April 2004.


An investment of not less than 10 million rupees, but not exceeding 100 million rupees, should bemade prior to 1st April 2004.

Note: Investment in any capital asset used in the expansion of the undertaking will satisfy theeligibility criteria. However, there should be an expansion of activities as a result of the investment

Period Tax rate%

1st – 3rd year 0

4th year onwards• agriculture, promotion, tourism and construction work 15

• others 20





A tax exemption period of two years will be granted in respect of the entire profits and income of thecompany undertaking the expansion.

The two year tax exemption period will be granted:

• if the company is already entitled to a tax emption period on the export of non-traditional goods,from the end of such tax exemption period; and

• in every other case, from the date of commercial operations of such expansion.

8 Expansion of Industrial Undertakings for Traditional Exports & Non-Exportable Goods


Tax incentives will be granted to any company:

• which has an undertaking that is engaged in the manufacture of products (other than non-traditional products for export), and undertakes the expansion of such undertaking; and

• makes the full investment (see below) prior to 1st April 2004.


An investment of not less than 10 million rupees should be made prior to 1st April 2004.

Note: Investment in any capital asset used in the expansion of the undertaking will satisfy theeligibility criteria. However, there should be an expansion of activities as a result of the investment.

8.3 Incentives Offered

Tax exemption for a period of two years will be granted on the profits and income attributable tothe expansion of the undertaking (i.e. the incremental profits and income).

The period of two years will be granted from the year in which the expansion of the undertakingcommences to make profits, but not later than 1st April 2006.

Note: In this section, the incremental profits, in relation to any year of assessment which is qualifiedfor tax exemption, means the trade profits of that undertaking for that year of assessment less theaverage annual profits of that undertaking computed by reference to three years immediatelypreceding the year of assessment in which the tax exemption period commences.

9 Agricultural Undertakings

Agricultural undertakings, carried on by any individual, partnership or company, qualify for taxexemption on their profits and income.

Period Tax rate%

1st – 2nd year 0

3rd year onwards 15




9.1 Period of Tax Exemption

Tax exemption is granted for a period of five years from the commencement of the year ofassessment commencing on 1st April 2005.

9.2 Incentives Offered

The profits and income from the cultivation of land and the sale of the produce are exempt for fiveyears.

Where the undertaking is also engaged in any process of production or manufacture of the producefrom the said cultivation of land, such produce should be deemed to have been sold for productionor manufacture at the prevailing open market price and the profits and income should be computed,based on such deemed sales.

10 Dividend Exemption

The dividends paid by companies carrying on the aforesaid projects and activities out of theirexempt profits during the period of tax exemption, or one year thereafter, will be exempt fromincome tax in the hands of the shareholders. Such exemptions will not apply to any dividendspaid on or after 1st April 2004 by any company which qualified for tax exemption on or after 6thNovember 2002.

11 Other Tax Concessions Under the Tax Statute

Profits attributable to the export of non-traditional goods by an undertaking are entitled to payincome tax at a maximum rate of 15%.

Non-traditional goods are defined to include goods other than black tea sold in bulk, crepe rubber,sheet rubber, scrap rubber, and latex fresh coconuts.

Profits attributable to the performance by an undertaking of any of the following services forpayment in foreign currency are made liable to income tax at a maximum rate of 15%:

• ship repair;

• ship breaking;

• repair and refurbishment of marine cargo containers;

• provision of computer software, computer programmes, computer systems or recordingcomputing data; and

• such other services as may be specified by the Minister of Finance by notice published in theGazette.

Profits attributable to the production or manufacture and supply to any specified undertaking, of non-traditional goods (for export by that undertaking of such goods or for the production or manufactureof any commodity for export) by such undertaking would be liable for income tax subject to a ceilingof 15% of such profits. This is provided the undertaking is chargeable at the concessionary rate of15% and there is documentary evidence to satisfy the Inland Revenue Department that the exportsrelating to such supplies were made.

Profits by any resident company or partnership in Sri Lanka attributable to services rendered outsideSri Lanka in the course of carrying out a trade, profession, vocation or a construction project areexempt from income tax, where the respective profits are earned in foreign currency and areremitted to Sri Lanka.

Corporate profits from agriculture, fisheries, livestock, tourism and specified constructionundertakings are taxed at 15%.




Profits earned by any partnership in Sri Lanka attributable to services rendered in Sri Lanka to anyperson or partnership outside Sri Lanka in the course of any profession or any vocation (in the fieldof literature or fine arts) carried on or exercised by such individual or partnership in Sri Lanka aremade liable to income tax at a maximum rate of 10%, where the respective profits are earned inforeign currency and are remitted to Sri Lanka.

12 Other Tax Incentives - Under the BOI Regime

There are a few tax exemptions and incentives, which are offered only under the BOI regime.

12.1 Export Trading Houses

• Qualifying Activities:

– export, in entirety, of the locally procured manufactured products or re-export, in entirety, ofimported products; and

– location of warehouse within an Export Processing Zone (EPZ) which is continuouslysupervised by Sri Lanka Customs.

• Qualifying Investment Criteria:

– no minimum investment is required.

• Incentives offered:

No minimum investment is required.

12.2 Export Oriented Services

• Qualifying Activities:

– provision of services to persons outside Sri Lanka, for which payment should be made inforeign currency.


– minimum investment of US$ 150,000.

• Incentives offered :

Export value Incentives

US$ 5 million to 10 million 10% tax rate for 5 years and 15% tax rate thereafter

US$ 10 to 25 million 5% tax rate for 5 years and 15% tax rate thereafter

Over US$ 25 million Tax holiday for 5 years and 15% tax rate thereafter

Period Tax rate%

1st – 5th year 0

6th – 7th year 10

8th year onwards 20




12.3 Regional Operating Headquarters

• Qualifying Activities

– provision to offshore companies of two or more of the following services: administration,business & co-ordination, sourcing of raw materials & components, R&D services, technicalsupport services, financial & treasury management, marketing & sales promotion.


– no minimum investment is required.


12.4 Information Technology (IT) and/or IT Enabled Services

• Qualifying Activities

– IT enabled services include call centres or contact centres, transcription (data entry), datacentres, hosting centres, e-governance related projects and any other related activitydetermined by the BOI with the concurrence of the Minister in charge.

• Qualifying Investment Criteria

– employment of 15 technically qualified persons.


Period Tax rate%

1st – 3rd year 0

4th – 5th year 10

6th year onwards 20

Period Tax rate%

1st – 3rd year 0

4th – 5th year 10

6th year onwards 20




12.5 IT Related Training Institutes

• Qualifying Activities and Criteria

– provision of IT related training.


– Training must have minimum of 300 students.


Note: The tax exemption period will, in all abovementioned activities, be reckoned from the taxyear in which the enterprise commences to make profits but not later than two years from thecommencement of commercial operations.

Period Tax rate%

1st – 3rd year 0

4th – 5th year 10

6th year onwards 20




TAIWAN

Country M&A TeamCountry Leader ~ Steven Go

Elliot LiaoEric Chao-An Tsai

Tony LimViolet Lo






Steven Go Partner +886 2 2729 5229 [email protected]

Elliot Liao Partner +886 2 2729 6217 [email protected]

Eric Chao-An Tsai Partner +886 2 2729 6687 [email protected]

Tony Lim Partner +886 2 2729 5980 [email protected]

Violet Lo Senior Manager +886 2 2729 6666 [email protected]

PricewaterhouseCoopers • International Trade Building • 23th Flr 333 Keelung Road • Section 1 • Taipei 110 •Taiwan




1. Introduction

1.1 General Information on M&A in Taiwan

During the recent years, domestic M&A activities have been active, particularly in the financialindustry as it has been the government’s intention to reduce the number of financial institutions.

In order to increase the global competitiveness of Taiwanese enterprises, the Taiwan governmenthas also enacted the Enterprise Merger and Acquisition Law (EMAL), the Financial InstitutionMerger Law (FIML), the Financial Holding Company Law (FHCL) and amended the Statute forUpgrading Industries, which provide various tax incentives to M&A transactions of Taiwancompanies. These tax incentives offer significant tax savings for foreign investors wanting to acquireTaiwan companies.

1.2 Corporate Tax

The income tax regime in Taiwan is divided into personal consolidated income tax for individuals(individual income tax), and profit-seeking enterprise income tax for business enterprises (businessenterprise tax or corporate income tax). The term “business enterprise” refers to an entity thatengages in profit-seeking activities, including sole proprietorship, partnership, company, or anyother form of organisation that is organised for profit-seeking purposes.

A resident corporate taxpayer is subject to income tax on its worldwide income. For non-residentcorporate taxpayers, including those that do not have a permanent establishment (PE) in Taiwan,only Taiwan-sourced income is subject to tax in Taiwan (normally in the form of withholding tax).

Taiwanese corporations and foreign corporations operating in Taiwan through branches are subjectto progressive corporate tax rates depending on their level of taxable income. Below is a table ofprogressive corporate tax rates.

Taxable income Tax

Up to NT$50,000 ExemptNT$50,001 to NT$71,428 50% of taxable income, less NT$25,000NT$71,429 to NT$100,000 15% of taxable incomeNT$100,001 and over 25% of taxable income, less NT$10,000




The President Office announced the third reading of a special law (known as Alternative MinimumTax law or AMT law) on 28th December 2005, which took effect on 1st January 2006. Pursuant tothe law, companies (which are residents in Taiwan and foreign companies having permanentestablishments in Taiwan) and resident individuals have to calculate an AMT amount under therelevant formulae and compare such tax amount with regular income tax amount. If the former ismore than the latter, taxpayers have to pay income tax based on regular income tax amount plusthe difference between the AMT amount and the regular income tax amount.

Below is a table illustrating salient points of the law.

Items

AMT rate

Tax exemption amount

Taxable base

Companies

10% to 12%

NT$2 million

Regular taxable income withadjustments for the followingitems:

Plus

• tax-exempt capital gain onsales of domestic marketablesecurities and futures;

• tax-free income provided bythe Statute for UpgradingIndustries (including taxholiday and OperationalHeadquarter incentives);

• tax-free income provided byother laws (including taxholiday granted for investmentin industries at scientific parkand participation inconstruction of communicationand public work);

• tax-free income provided bythe EMAL (carry over of taxholiday);

• tax-free income earned byoffshore banking unit (OBU);and

• other tax-free incomeannounced by the Ministryof Finance (MOF);

Minus

• loss deriving from domesticsecurities and futurestransactions;

• loss incurred by OBU; and

• other loss announced by theMOF.

The deduction of each type ofthe said losses is limited to thesame type of income and can becarried forward for five years.

Individuals

20%

NT$6 million

Regular taxable income withadjustments for the following items:

Plus

• non-Republic of China-sourced andMacau and Hong Kong-sourcedincome over NT$1 million;

• tax-exempt life or annuity insuranceproceeds paid for death over NT$30million;

• tax-exempt capital gain on sales ofnon-listing and non-OTC shares andprivate-placement shares, mutualfunds, etc;

• deducted non-cash contribution;

• tax-exempt difference betweenmarket price and face value ofemployee stock bonus; and

• other tax-free income or deductionannounced by the MOF;

Minus

• loss on sales of shares non-listingand non-OTC shares and private-placement shares, mutual funds, etc;and

• other loss announced by theMOF.

The deduction of each type of the saidlosses is limited to the same type ofincome and can be carried forward forthree years.




• Dividend

Taiwan adopts the imputation tax system in relation to the taxation of dividend income. Thesystem is designed to reduce the overall tax liabilities of a shareholder in respect of dividends,which have effectively suffered corporate tax (on corporate level) and personal consolidatedincome tax (on individual level). Under this system, for dividends received from a Taiwancorporation out of profits which have been subject to corporate tax, a resident individual share-holder is entitled to offset the company’s underlying corporate tax paid against his/her ownpersonal consolidated income tax liabilities. As a result, the effective tax rate for a residentindividual taxpayer with the highest marginal rate may be reduced from 55% to 40% on suchdividends.

Domestic dividends received by a Taiwanese corporate shareholder are exempt from tax in thehands of such shareholder. Any dividends paid by such a corporate shareholder to its residentindividual shareholders would, in turn, carry the underlying tax credit for corporate tax paid by itssubsidiary.

A 10% profit retention tax may be imposed on any part of the current year’s profit (after statutoryreserves) that is not distributed as dividends. This rule also applies to FIA subsidiaries (i.e. thosecompanies which were established with the approval of the Foreign Investment Board). Thisretention tax paid by the company may be used by a resident individual shareholder to offsetagainst the shareholder’s tax liabilities once the company distributes dividends from thecorresponding undistributed earnings in subsequent years.

For non-resident shareholders, the 10% profit retention tax may be credited against the dividendwithholding tax once the company distributes dividends from the corresponding retainedearnings in subsequent years. Effectively, the imputation tax system has little impact on foreigninvestors.

1.3 Withholding Tax

Payments made to foreign recipients (which do not have a PE in Taiwan) will normally be subject towithholding tax at the following rates:

Dividends paid by a FIA company to a foreign shareholder are taxed at 20%. Dividends paid by anon-FIA company to a foreign corporate shareholder are taxed at 25% and to a foreign individualare taxed at 30%.

Withholding tax rates on dividends, interest and royalties may be reduced if a recipient is a taxresident of one of the tax treaty countries and the relevant treaty provides for a reduced rate. As ofOctober 2005, tax treaties with Australia, New Zealand, Indonesia, Singapore, Malaysia, Vietnam,South Africa, Swaziland, Gambia, Macedonia, Netherlands, United Kingdom, Senegal, and Swedenhave been signed and effected.

A Taiwan branch of an overseas company may remit after-tax profits to its head office without anyfurther Taiwan tax.

Type of income Withholding tax rates

Dividends 30%/25%/20%Interest 20%Royalties 20% or Nil (for approved royalty)Service Fees/Rental 20% or 3.75% (for approved technical services/

equipment lease/construction)Commission 20%Other 20% or 2.5% (for approved international transportation

services) or 25% (for gain on sale of property)




1.4 Business Tax

Business taxes are levied on sale of goods or services in Taiwan and on importation of goods.Business tax consists of value added tax (VAT) and non-value added tax (Non-VAT). Generally, theformer is applicable to general industries whereas the latter is applicable to financial institutions.

Under the VAT system, each seller collects output VAT from the buyer at the time of sale, deductsinput VAT paid on purchases from output and remits the balance to the government. Where inputVAT exceeds output VAT, the excess will be refunded or carried forward to be offset against futureVAT liability. The current rate is 5%. However, revenues derived from exclusively authorisedbusinesses of the banking, insurance, investment trust, securities, futures, commercial paper, andpawnshop industries are subject to the rate of 2%.

1.5 Stamp Duty

Stamp duties are imposed on each copy of the following business transaction documents, propertytitles, permits, and certification executed within the territory of Taiwan.


1.6.1 Securities Transaction Tax

Transfer of stock is subject to securities transaction tax of 0.3% of the gross proceeds. Securitiestransaction tax is also imposed on transfer of corporate bonds issued by Taiwanese companies,mutual funds issued by Taiwanese security investment trust enterprises, Taiwan depositorycertificates, and other securities at 0.1% of the gross proceeds. The Statute for UpgradingIndustries currently exempts sales of corporate bonds and financial bonds from such tax.

Securities transaction tax is imposed on a seller.

1.6.2 Land Value Increment Tax

Land value increment tax is levied when the title to land is transferred and is payable by the seller.The tax is levied on the increment in the government-announced value between the time ofpurchase and sales. The government-announced value at the time of purchase is adjusted forgovernment-announced consumer price index during the ownership period for the purposes ofcalculating the increment. The tax rate ranges from 20% to 40%. To encourage an owner to holdland for more than 20 years, a tax deduction is granted for land ownership exceeding 20 years.The tax paid, may be refunded if another piece of land is acquired within two years for the purposeof use of factory and other stipulated conditions are met.

1.6.3 Deed Tax

A title deed tax is levied on the transfer of the title to real estate and payable by the buyer. Transferof land is not subject to the title deed tax if the seller is subject to land value incremental tax. Thetax rate ranges from 2% to 6% of the government-assessed value.

Type Stamp duty

Monetary receipt 0.4% of amount receivedService contract 0.1% of considerationReal property transfer contract 0.1% of value announced by governmentSales contract for personal movable property NT$12 per copy




1.7 Exchange Control

Foreign exchange control regulations restrict the outward remittance of funds exceeding a certainamount. A resident individual is allowed to remit outward funds up to US$5 million per annumwithout obtaining a prior approval from the Central Bank of China. However, if any single remittanceis in excess of US$1 million, the bank may seek consent from the Central Bank of China beforeremittance. A resident corporation is allowed to remit outward funds up to US$50 million per annumwithout obtaining a prior approval from the Central Bank of China.

Overseas investment shall be reported to the Investment Commission of the Ministry of EconomicAffairs (ICMOEA). Nonetheless, any overseas investment of more than US$50 million requires aprior approval from the ICMOEA. Any investment in the People’s Republic of China (even if theinvestment is made through a third country) requires a prior approval from the ICMOEA.




2. Acquisition


The EMAL of Taiwan provides certain tax incentives to qualified asset acquisitions while the generalprinciple of taxation would apply to stock acquisitions and unqualified asset acquisitions.

Nevertheless, whether a deal is structured as a stock deal or asset deal would depend oncommercial considerations. In terms of tax costs, a stock deal may be preferable since itincurs less tax costs than an asset acquisition.



The Target Company may continue to enjoy the unutilised taxes losses carried forward that havebeen granted before the stock deal.


The Target Company may continue to depreciate the fixed assets at the same tax base after thestock acquisition, i.e. there is no change in the cost base and the method of depreciating theassets.

• Tax Incentives

The Target Company may continue to enjoy the unused tax incentives (i.e. investment tax credit,tax holiday, etc.), after the stock acquisition.

• Others

In general, since only the shareholder portfolio is different after the stock deal, the financialaccounting books and the tax basis of the Target Company would not be affected. Also, taxattributes of the Target Company prior to the stock deal generally remain unaffected after thedeal.






The tax losses carried forward in the Target Company may not be transferred to the acquiringcompany in an asset deal.

In general, gains arising from transfer of tangible and intangible assets (except for lands andsecurities) are taxable at a corporate income tax rate of 25%. If the Target Company has taxlosses carried forward, gains may be offset against the tax losses for corporate income taxpurposes. The aforementioned gains may be exempt if certain requirements are met, pursuant tothe EMAL.


An asset deal potentially allows the purchaser to step up the basis of acquired assets for taxpurposes. Such step up in value enables the buyer to reduce its future tax liability through alarger amount of depreciation of the tangible assets or amortisation of the intangibles.

The differences between the transaction price and the fair market value (or, in some cases, thebook value) of the assets transferred shall be recognised as “business right” or “goodwill” of theTarget Company. For corporate income tax purposes, the business right shall be amortised overthe period for no less than ten years and the goodwill shall be amortised over the period for noless than five years.

• Tax Incentives

In general, the tax incentives (i.e. investment tax credits on qualified machinery and equipmentor qualified research and development expenditures, tax holiday, etc.) may not be carried overby the transferee (the acquiring company in an asset deal). Furthermore, the transfer of qualifiedmachinery and equipment, on which the investment tax credits were granted, may lead to arecapture of previously used tax credits if the qualified machinery and equipment are transferredwithin three years when the tax credits are obtained.

Where an asset deal meets all the criteria as set forth under the EMAL, the unutilised tax holidayand the investment tax credits on the qualified machinery and equipment may be transferred tothe acquiring company. However, the amount of tax holiday and investment tax incentives thatmay be carried over by the acquiring company are limited to the portion of taxable income/taxpayable attributed to the Target Company.


2.4.1 VAT

• Stock Acquisition

The transfer of stock falls outside the scope of VAT.

• Asset Acquisition

In an asset deal, the seller is generally required to issue Government Uniform Invoice (GUIs)and charge VAT at the rate of 5% to the buyer for the sale of its operating assets, includinginventories, fixed assets and intangibles. The sale of land and marketable securities is exemptfrom VAT.

However, the VAT is exempted for the transfer of tangible or intangible assets if the assetacquisition is carried out in accordance with the EMAL and the acquiring company issues votingshares accounting for more than 65% of the total considerations to the Target Company for theasset acquisition.




2.4.2 Stamp Duty


For disposal of qualified securities (e.g. stock in the Taiwanese company organised as acompany limited by shares), a securities transaction tax at the rate of 0.3% on gross proceedsreceived from the disposition would apply.


The acquiring company shall pay for the stamp duty on the contract for sale of chattelsconcluded within Taiwan at NT$12 for each original contract as well as on the contract fortransfer of real estate (such as building and land) at 0.1% of the government-announced value.

2.4.3 Deed Tax


Title Deed Tax is not applicable in respect of stock deal since there would not be a transfer oftitles of real estate.


The acquiring company should bear the title deed tax levied on the contract for sale of building,at 6% of the government-assessed value.

2.4.4 Land Value Increment Tax


Land value increment tax is not applicable in respect of a stock deal since there would not be atransfer of land.


The land value increment tax is levied on the increase in the government-announced value andapplicable progressive tax rates are between 20% and 40%.



Costs (including professional fees, securities transaction tax, etc.) on a stock deal incurred by aforeign investor are not tax deductible for Taiwan tax purposes. In addition, such costs are alsonot deductible to a Taiwan acquiring company.


Transaction costs are generally deductible. Some transaction costs incurred on fixed assets aregenerally capitalised as part of the costs of the relevant assets acquired. If the assets are eligiblefor tax depreciation or amortisation, such cost could also be depreciated or amortised. Costsrelating to purchase of land and marketable securities are generally not tax deductible.

VAT paid pay the acquirer, if a VAT entity, may be creditable to the acquirer.

Professional fees are generally recorded as expenses. If the professional fees can be directlyattributed to a certain real estate, such fees will also follow the tax treatment of relevant asset.






A stock deal will not allow the buyer to step up the basis of the assets owned by the TargetCompany. The asset value would remain unchanged as it was before the stock deal. Thus, it wouldnot allow the buyer to maximise tax benefits that are potentially available to an asset deal. .


An asset deal allows the buyer to step up the basis of acquired assets for tax purposes, thus,enabling the buyer to reduce its future tax liability through depreciation of the fixed assets oramortisation of the intangibles. Generally, the costs of plant and equipment may be depreciatedover their respectively useful life prescribed by the tax authority.

Furthermore, the difference between the consideration price paid and the fair market value (or, insome cases, the book value) of the assets transferred may be recognised as operating right orgoodwill. The minimum amortisation period is ten years for operating right and five years forgoodwill. A ten-year amortisation period on goodwill is required for M&A cases completed pursuantto the EMAL.






Equity falls into two categories, namely common share and preferred share. There are no thincapitalisation rules in Taiwan. The decision to set a debt to equity ratio is generally governed bycommercial considerations. Except for certain restricted industries (e.g. financial industry), theminimum equity capital is NT$1 million for a company limited by shares and NT$0.5 million for alimited company.



The interest incurred by a foreign investor on purchase of stock in a Taiwan target is not taxdeductible against the dividend income paid by the Target Company.

Alternatively, the foreign investor may set up a new company in Taiwan to acquire shares of theTarget Company. In such a case, the new Taiwan company may obtain funds through either localfinance vehicles or cross-border inter-company loans to finance the acquisition with an aim toreduce the dividend withholding tax. However, the interest expenses may not be tax deductible bythe new Taiwan company at the time of calculating the 25% corporate income tax.

When a foreign loan is obtained, the payment of interest may be subject to interest withholding tax.


Interest incurred on funds used to acquire fixed assets generally needs to be capitalised andamortised in accordance with the nature of the assets. Furthermore, since capital gains arising fromsale of land and marketable securities are exempt from income tax, the interest relating to thepurchase of the land and marketable securities is not deductible for corporate income tax purposes.




5. Mergers

For most M&A cases to the extent to which the issues are covered in the EMAL, the EMAL prevails overother laws, such as the Company Law, Securities Trade Law, Statute for Upgrading Industries, Fair TradeLaw, Labour Standard Law, Statute for Foreigner Investment, etc. Any M&A matters not dealt with in theEMAL, should then be governed by these other laws

M&A of financial institutions are subject to the FHCL, and the FIML. Any M&A matters not dealt with inthese two laws should be governed by the EMAL failing which the other laws would apply.

In the Taiwan context, a “merger” could take place as follows.

• Merger

Under this example, the business and assets of Company A are transferred to Company B. In return,Company B issues shares to shareholders of Company A in exchange for business in Company A.Company A is subsequently dissolved.

Shareholder A Shareholder B Shareholder A Shareholder B

Company A(Dissolving)

Company B(Surviving)

Company B(Surviving)

Rights & ObligationsAssets & Liabilities

New B’s Shares




• Consolidation

Under this example, the business and assets of Company A and B are transferred to newly establishedCompany C. Company C issues shares to shareholders of Companies A and B. Companies A and Bare subsequently dissolved.

The EMAL also allows cash, shares in other company and other property as payment for theconsideration.

Shareholder A Shareholder B Shareholder A Shareholder B

Company A(Dissolving)

Company B(Dissolving)

Company C(New)

Rights & ObligationsAssets & Liabilities

Company C(New)

New C shares






Taiwan does not impose significant restrictions on the repatriation of profits. The Company Lawrequires the company to reserve 10% of the current year’s profit as legal reserve which may notfreely be distributed as dividends. Also, some laws require reservation of part of profit as specialreserve. Except for the said reserve requirements, FIA companies may remit dividends overseasfreely.

Under the imputation tax system, for dividends received from a Taiwan corporation out of profitswhich have been subject to corporate tax, a resident individual shareholder is entitled to offset thecompany’s actual underlying corporate tax paid against his/her own personal consolidated incometax liabilities. Such dividends received by a resident corporate shareholder are exempt from tax inthe hands of such a shareholder.

Dividends paid to non-residents of Taiwan are subject to withholding tax. Dividends paid by a FIAcompany to a foreign shareholder are taxed at 20%. Dividends paid by a non-FIA company to aforeign corporate shareholder are taxed at 25% and to a foreign individual are taxed at 30%.Withholding tax rates on dividends may be reduced if a recipient is based in one of the tax treatycountries and the relevant treaty provides for a reduction in the dividend withholding tax rate.Taiwan has entered into comprehensive tax treaties with Senegal, United Kingdom, Sweden,Australia, New Zealand, Indonesia, Singapore, Malaysia, Vietnam, South Africa, Swaziland,Gambia, Macedonia, and the Netherlands.

For non-resident shareholders, the 10% profit retention tax may be credited against the dividendwithholding tax once the company distributes dividends.

There are various avenues whereby the profits of the Target Company may be repatriated to thehome country by means other than dividends. These include the payment of license fees, royalties,interest and management fees. However, the payment of such amounts may be subject towithholding taxes. Generally, the withholding tax rates are 20%. Tax treaties may reduce thewithholding tax rates.




6.2 Losses Carried Forward

Net operating loss (NOL) may be carried forward for five years if the company’s income tax return iscertified by a certified public accountant or it has received an approval to use a blue form incometax return and if it maintains complete and adequate accounting records.

According to the EMAL, after the merger, the surviving or newly formed company may deduct fromits net income, the NOL resulted from each merged entity in the preceding five years. Thedeductible amount would be calculated according to the proportions of shares in the surviving ornewly formed company held by shareholders of each merged entity.

6.3 Tax Incentives

Remaining tax incentives of the Target Company may be carried over to the acquiring company.However, some requirements must be met:

• With Respect to Tax Holiday

– the M&A activity is conducted pursuant to the EMAL or the Statute for Upgrading Industries;

– the acquiring company continues to produce the same products or render the same servicesas those that produced or rendered by the acquired company before the M&A deal and hasbeen awarded the carry over tax holiday;

– the carry over tax holiday may only apply to income derived from the corresponding productsor the services that have been awarded the carry over tax holiday and that can beindependently produced or rendered; and

– the acquiring company has to meet the same tax holiday requirements as those applicable tothe Target Company.

• With Respect to the Investment Tax Credit

– the M&A activity is conducted pursuant to the EMAL or the Statute for Upgrading Industries;

– the carry over investment tax credit may only apply to income that is attributable to the TargetCompany; and

– the acquiring company has to meet the same tax credit requirements as those applicable tothe Target Company.

6.4 Group Relief

After the M&A deal under the EMAL is completed, the acquiring company may choose to file asingle consolidated corporate income tax return (including profit retention tax return) with the 90%-or-more-owned Target Company if the acquiring company continuously holds shares in TargetCompany for 12 months in a taxable year.

The group relief regime applies only to Taiwan companies. It is not applicable to foreign companies.




Group relief may be diagrammatically illustrated as follows.

Taiwan Company A

Taiwan Company B Taiwan Company C

≥ 90%

Foreign Investor

50%

Group relief applies to Taiwan Company A, Taiwan Company Band Taiwan Company C

Taiwan Company A Taiwan Company B

100%

Foreign Investor

No group relief

100%

Group relief available toTaiwan Company A and Taiwan Company B




7. Disposal


The seller generally favours a stock deal for the following reasons:

• stock sale procedures are much simpler;

• gains on the sale of shares of companies limited by shares are currently exempt from tax unlessthe seller is taxed on AMT basis; and

• asset sales may result in corporate income tax on gains from the sales of assets.

7.2 Stock Sale


Gains derived from sales by the seller of a Target Company’s shares are exempt from income taxunless the seller is taxed on AMT basis. However, the sales are subject to securities transaction taxof 0.3% on the proceeds from the share transfer. Such tax is borne by the seller. The EMALexempts the securities transaction tax arising from qualified share swap.

Accordingly, for a shareholder of the Target Company, a stock sale may be the most tax efficientway to reap the gains from its investment. In the event that the Target Company has a considerableamount of undistributed earnings, by selling its shares in the Target Company at a fair market value(which should include the value of the undistributed earnings), the seller effectively receive all thegains from the disposal, tax-free, unless the seller is taxed on AMT basis.


Under the imputation tax system, all profits including capital gains may be distributed as dividendthat will not be assessable unless such dividends are received by the shareholders who areresident individual shareholders or non-resident shareholders. Dividends distributed to foreignshareholders are subject to a withholding tax.




7.3 Asset Sale


Generally, capital gains arising from a sale of assets, including intangibles, are taxable at acorporate income tax rate of 25%. If the seller has NOL, the capital gains may be used to offsetagainst the NOL. The capital gains may be exempted from corporate income tax if prescribedrequirements are met, pursuant to the EMAL. The gain from sales of land is exempt from corporateincome tax, but is subject to land value increment tax. The gain on sale of Taiwanese marketablesecurities is also tax exempt unless the seller is subject to AMT.


Please refer to section 7.2.2.





8.1 VAT

As indicated previously, VAT should be levied on all goods sold and services rendered in Taiwan.Hence, the Target Company is required to issue Government Uniform Invoice and charge VAT at therate of 5% to the acquirer for sale of some assets, such as inventories and fixed assets. The 5%VAT paid by the acquirer may be used to offset its output VAT if the acquirer is a Taiwan company.The sale of land and marketable securities is exempt from VAT.

8.2 Stamp Duty

As indicated previously, stamp duties are imposed on certain types of business transactiondocuments such as property title deed, money receipts, and contracting agreements. Those whokeep the original afore-mentioned transaction document bear the tax liabilities.

8.3 Securities Transaction Tax

Securities transaction tax is levied on securities transaction at the rate of 0.3% on gross proceedsfrom the sale of stocks. The Target Company should bear the liability of security transaction tax.

8.4 Land Value Increment Tax

The Target Company should pay the land value increment tax upon selling land to the acquirer. Thetax is levied on the increment in the government-announced value at progress rates ranging from20% to 40%.

8.5 Deed Tax

Generally speaking, the acquirer pays deed tax on transfer of title to buildings. The tax rate isgenerally 6% on the government-assessed value.




8.6 Income Tax

The Target Company has to pay corporate income tax on gains, if any, from the sales of assets.When the gains are distributed as dividends, the dividends will not be taxable unless the dividendsare received by resident individual shareholders or non-resident shareholders. Some investment taxcredits granted pursuant to the Statute for Upgrading Industries may be clawed back. However, ifthe deal complies with EMAL and other laws, the tax may be exempted and the investment taxcredits would not have to be clawed back.


The EMAL provides for certain transaction tax concessions on mergers, spin-offs and acquisitions(refer to section 12.1). Furthermore, the FIML, the FHCL, and the Statue for Upgrading Industriesprovide similar transaction tax incentives on M&A activities if the prescribed requirements are met ora prior approval is obtained.


• In general, the stamp duty is deductible for income tax purposes, unless they are incurred as aresult of selling land and domestic marketable securities. The stamp duty paid for purchase ofreal estate should be capitalised as costs of relevant assets.

• The land value increment tax is not deductible for income tax purposes, because it is deemed tobe one of the cost items of selling land and gain/loss on sale of land is exempted from incometax.

• The securities transaction tax is not deductible for income tax, because the gain on sales ofmarketable securities is the exempted from income tax.

• The deed tax for purchase of buildings should be included in the purchasing costs.





9.1 Declaration of Dividend Prior to the Sale

One of the means of extracting surplus cash in a company that is identified for sale is throughdividends. For foreign investor, withholding tax shall be levied upon dividend payment. Where thecompany identified for sale has imputation credit balance deriving from the 10% profit retention tax,the dividend withholding tax liability may be reduced.

9.2 Capital Reduction Prior to the Sale

Another mean of extracting original investment cash in a company is through capital reduction.Return of principal investment amount will be generally exempted from tax. For domestic investors,investment loss shall be recognised from corporate income tax perspectives if the companyidentified for sale has net operating loss. Though this is an efficient way to recognise tax loss forinvestors, the company identified for sale itself may lose qualification to enjoy some of unutilised taxincentives due to the capital reduction.




10. De-merger

There are no specific provisions in relation to de-mergers. A de-merger usually takes place through thesale of assets or business.


After acquiring a target and having a satisfied investment return, a financial buyer generally looks for anexit route either through a sale of business or sale of shares, including by way of forming the company intoIPO. Tax implications on sale of business are identical with the acquisition of asset deal mentionedpreviously. As to sales of shares, it is exempted from income tax unless the seller is subject to tax on AMTbasis but only subject to 0.3% security transaction tax, irrespective of whether the company is a listed or aprivate company limited by shares.

If a company is seeking a listing on the Taiwan Stock Exchange, the listed vehicle must be incorporated asa Taiwanese company limited by shares.




12. Tax Incentives

There are a number of tax incentives available under the Enterprise Merger & Acquisition Law and Statuefor Upgrading Industries on Taiwan’s M&A activities.

12.1 Tax Incentives Provided by the Enterprise Merger & Acquisition Law

If requirements are met (e.g. voting shares delivered account for 65% of total considerations of theM&A deal), the following main tax incentives may be available:

• deeds, agreements and money receipts created for M&A are exempted from stamp duty;

• transfer of title to acquired immovable property is exempted from deed tax;

• securities transaction tax payable is exempted;

• transfer of goods or service is deemed as not falling within the scope of business tax;

• land value increment tax payable can be postponed until next transfer;

• goodwill is amortised over 15 years;

• expenses incurred from M&A is amortised over 10 years;

• capital gain on transfer of main business and/or assets can be exempted from corporate incometax;

• a five-year tax holiday is granted on the income deriving from the assets or businesses acquired;

• exchange loss from a company applying its business or assets in subscription or exchange forthe shares of another company is amortised over fifteen years;

• group taxation is available; and

• tax incentives of the acquired company are carried over to the acquiring company.




12.2 Income Tax Incentives Granted for Doing Business in Taiwan

Main income tax incentives granted for doing business in Taiwan are set forth below:

• a five-year tax holiday granted to Pioneer, Important and Strategic Industries;

• income tax exemption granted on foreign-sourced income received by Operational Headquarter;

• income tax exemption granted on domestic sales made by Logistic Distribution Center;

• withholding tax exemption granted on royalty for using technological know-how, trademark orpatent of a foreign profit-seeking enterprise;

• investment tax credit granted on purchase of equipment or technological know how, expenditureof research and development, personnel training, and investment in underdeveloped areas orPioneer, Important and Strategic Industries;

• deduction allowed for reserve for loss in overseas investment;

• tax exemption granted on gain from evaluation of fixed assets; and

• a deferral of tax on gain deriving from exchange of patent, technological know-how, or right touse either one for subscription of shares.




THAILAND

Country M&A TeamCountry Leader ~ Paul B.A. Stitt

Sira IntarakumthornchaiSudarat Isarakul






Paul B.A. Stitt Partner +662 344 1119 [email protected]

Sira Intarakumthornchai Partner +662 233 1244 [email protected]

Sudarat Isarakul Senior Manager +662 344 1433 [email protected]

PricewaterhouseCoopers • 15th Flr Bangkok City Tower • 179/74-80 South Sathorn Road • Bangkok 10120 •Thailand




1. Introduction

1.1 General Comments on M&A in Thailand

As with most countries, M&A transactions in Thailand can take the form of stock acquisition orasset acquisition. These transactions may give rise to liabilities to a number of taxes in Thailand,including corporate income tax, value added tax, specific business tax and stamp duties. However,exemptions from taxes are available in certain circumstances.

1.2 Corporate Tax

1.2.1 General Tax Regime

A juristic company or partnership incorporated in Thailand is generally subject to corporate incometax at a rate of 30% on its worldwide income. The corporate income tax may be reduced in thefollowing cases:

• Regional Operating Headquarters (ROH) Established in Thailand;

Provided that certain conditions are met, a ROH is subject to corporate income tax at a rate of10% on certain income streams. An exemption from tax is also granted for dividends receivedfrom its domestic and overseas affiliated companies.

• Companies Listed on the Stock Exchange of Thailand (SET) before 6th September 2001;

Corporate income tax at the rate of 25% is imposed on the first Baht 300 million of net profits.The normal rate of 30% is imposed on the balance of the net profits. This reduced rate is onlyapplicable to companies that were listed on the SET prior to 6th September 2001, and appliesfor the five accounting periods commencing on or after that date.

• Companies Listed on the SET after 6th September 2001; and

Corporate income tax at the rate of 25% applies to all net profits.

• Companies Listed on the Market for Alternative Investment (MAI) after 6th September 2001.

Corporate income tax at the rate of 20% applies to all net profits.




The reduced rates for the latter two situations apply only for five accounting periods and only tocompanies that are listed on the SET or MAI prior to 31st December 2005.

Exemptions/reductions of corporate income taxes may also be granted to enterprises promoted bythe Board of Investment.


Dividends derived by a Thai company from another Thai Company are exempt from tax if therecipient is either:

• a company listed on the SET; or

• a company that holds at least 25% of the voting shares in the company paying the dividendsprovided there is no direct or indirect cross shareholding.

If the dividend is not exempt from tax, it may nevertheless qualify for partial exemption, under whichonly 50% of the dividend is subject to tax. In order to qualify for either full or partial exemption, therecipient must hold the shares for at least three months before and after the dividend is paid. Wherethis holding period is not met, the full amount of the dividend received will be subject to tax.

Exemption from tax is also available for dividends received from companies which have beengranted a tax holiday by the Board of Investment, provided the dividend is paid out of tax exemptprofits during the period of the tax holiday.

Dividends received by a branch of a foreign company are fully taxable.

1.2.3 Tax Losses

Tax losses may generally be carried forward for five accounting periods for offset against profitsfrom all sources. There is no provision for loss carry back. Extended loss carry forward (effectivelyup to 13 years) is available under privileges granted by the Board of Investment.

Each company’s losses are dealt with separately; there is no group relief.

1.3 Withholding Tax

A foreign company that does not carry on business in Thailand is subject to final withholding tax onthe following categories of income derived from Thailand:

• dividends;

• brokerage and fees for provision of services;

• royalties;

• interest;

• rent from property; and

• capital gains.

Withholding tax is imposed at the rate of 15% on the remittance of all of the above types of incomeor profits, except dividends (which are subject to a withholding tax rate of 10%).




The rate of withholding tax may be reduced under a double taxation agreement as follows:

• some double taxation agreements may exempt brokerage, service fees and capital gains fromThai tax;

• the rate of withholding tax on interest may be reduced to 10% if paid to a foreign financialinstitution; and

• the rate of withholding tax on copyright royalties may be reduced to 5% under some doubletaxation agreements.

No double taxation agreement reduces the rate of withholding tax on dividends to below thedomestic rate of 10%.

Dividends may be exempt from withholding tax if paid by:

• a ROH to a foreign company or partnership (provided the dividend is paid out of qualifyingincome); or

• a promoted business during tax holiday.


VAT is levied on the import and supply of most goods and services. VAT is levied at a current rate of7% (scheduled to increase to 10% effective from 1st October 2007) on the total price of the goodsdelivered or services provided or imported.

The supply of certain goods and services, such as immovable property and educational services, isexempt from VAT.

Exports of goods and services are subject to VAT of 0%.

Input VAT on purchase of goods or services related to a VAT registered business may be creditedagainst output VAT. Surplus input VAT may be carried forward against future output VAT liabilities orrefunded in cash.

1.5 Stamp Duty

Certain types of documents and transactions are subject to stamp duty at various rates. Among themore significant instruments subject to stamp duty are lease contracts for immovable property,share transfers, hire purchase contracts, and contracts for the hire of work. These are all subject toduty of 0.1% (without limit). Stamp duty is also applied on loan documents which are subject to dutyof 0.05% (with a limit of Baht 10,000).

1.6 Specific Business Tax (SBT)

SBT is collected on certain types of gross revenue at fixed rates. Among the more significant typesof revenue subject to SBT are interest and proceeds on transfers of immovable property, bothsubject to SBT of 3.3% (including municipal tax).




2. Acquisition

2.1 The Preference of Purchasers: Assets vs. Stock Deal

Thailand does not have detailed legislation dealing with the tax treatment of acquisitions.Accordingly, general principles of taxation apply when structuring a deal and choosing between anacquisition of assets or stock. Whether a deal is structured as a stock deal or asset deal maylargely depend on commercial considerations.


Most share acquisitions are structured as direct investments from outside Thailand, except whereforeign ownership restrictions necessitate the establishment of a holding vehicle in Thailand.

If it is intended that the whole, or part of the, investment in the Thai target will ultimately be sold, itmay be advantageous to hold the investment through a holding company located in a country whichhas entered into a double tax agreement with Thailand that exempts gains on subsequent sale ofthe stock of the Thai target from Thai tax.

Recently, foreign investors have had the opportunity to invest through property or equity funds.Investments through such funds have been used both in order to take advantage of preferential taxtreatment granted to such funds and as a mechanism for avoiding foreign ownership restrictionsunder the Foreign Business Act (FBA).


In most asset acquisitions, the purchaser will form a new limited company in Thailand through whichthe assets would be acquired. Rarely may a foreign investor directly acquire assets and therebyform a branch in Thailand.

In most circumstances, the capital of a limited company will consist only of ordinary shares. Whereforeign ownership restrictions require the participation of local shareholders, such shareholders mayhold preference shares, carrying diluted rights.




Preference share financing may also be used where the company acquiring the assets would not beable to utilise interest deductions, for example, where it has been granted a corporate income taxholiday under investment promotion privileges. In such circumstances, the preference shares will beused as quasi-debt, with mechanisms being put in place to effectively redeem the preferenceshares (through a capital reduction) on termination of the tax holiday.

In the case of acquisitions of real property assets, where foreign ownership restrictions apply,foreign investors may acquire ownership of the assets via a property fund.


2.4.1 Valued Added Tax (VAT)

• Stock Deal

A transfer of shares is not subject to VAT.

• Asset Deal

A sale of movable assets will usually be subject to VAT, based on the value of the assetstransferred. However, provided certain conditions are met, exemption from VAT is available for astatutory merger of companies (an amalgamation) and the transfer of a company’s entirebusiness.

If a transfer is not otherwise exempt from VAT, then, provided it is VAT registered at the time ofthe transaction, the purchaser should be entitled to recover (with certain exceptions) VAT paid onthe acquisition of the assets. The recovery may be made either by offsetting the VAT paidagainst future liability to output VAT, or by claiming a cash refund.

2.4.2 Stamp Duty

• Stock Deal

A document effecting a transfer of shares in a Thai company are subject to stamp duty, wheresuch documents are executed in Thailand, or executed overseas and subsequently brought intoThailand. Stamp duty is calculated at 0.1% of the greater of the selling price, or the paid-upvalue, of the shares.

Unless otherwise agreed, stamp duty is payable by the seller of the shares.

• Asset Deal

In the case of an asset deal, stamp duty will usually only be payable if it is necessary to executenew documents which are subject to duty (e.g. leases and hire purchase contracts).

2.4.3 Specific Business Tax (SBT)

• Stock Deal

A transfer of shares is not subject to SBT.

• Asset Deal

Sales of immovable property are generally subject to SBT of 3.3% of the gross income received.Unless otherwise agreed, SBT is payable by the seller.

A sale may be fully exempt from tax if immovable property forms part of an entire businesstransfer or an amalgamation.





Provided that certain conditions are fulfilled, an amalgamation and a transfer of entire business maybe exempt from:

• corporate income tax;

• VAT;

• stamp duty, and

• SBT for the sale of an immovable property.

The main conditions for the exemption are:

• there must be an amalgamation (as per the Civil Code) or a transfer of an entire business;

• the merging companies or the transferor and transferee must both be VAT registrants (if VATexemption is sought); and

• in the case of a transfer of business, the transferor company must commence liquidation in thesame accounting period as the transfer.


Acquisition expenses are typically non-deductible, but form part of the capital cost base forcalculating profit on future disposals and for calculating depreciation on depreciable assets.




3. Basis of Taxation Following Asset or Stock Acquisition


The acquisition by a foreign investor of the shares of a domestic company has no tax consequencesfor the investor but, if the shares are subsequently sold and sale proceeds are paid from or inThailand, the investor would be liable to tax on any gains realised on the sale. The target wouldcontinue to be liable to corporate income tax on the same basis as before the sale (i.e. there is nostep up of the cost base on the assets owned by the target).

The utilisation of tax losses is not affected by a change in shareholding.

Interest charges incurred by the foreign investor on borrowings for the share acquisition are notdeductible against the income of the target.


Unless the transfer of assets has taken place on a tax-free basis (e.g. through an amalgamation orentire business transfer), the purchaser is entitled to depreciate assets acquired based on theacquisition price. The purchaser may therefore obtain a step up in the cost basis of the asset. Thepurchaser will depreciate the asset as if it was acquired new. The fact that the asset has previouslybeen depreciated would not result in a reduction in the minimum depreciation periods to thepurchaser.

Maximum tax depreciation rates are imposed by statute. The maximum depreciation rates forcertain categories of asset are illustrated below.

Asset category Maximum depreciation rate (%)

Durable buildings 5

Temporary buildings 100

Cost of acquisition of goodwill, patents, trademarksand other rights:– if period of use is not limited 10– if period of use is limited 100/Period of use

Other assets 20




• Goodwill

Goodwill purchased as a separately identifiable asset may be capitalised for tax purposes anddepreciated over a period of not less than 10 years.

No goodwill may be recognised for tax purposes on a tax-free amalgamation or an entirebusiness transfer.

• Tax-Free Amalgamation or Entire Business Transfer

In the case of an amalgamation, the new company formed through the amalgamation continuesto depreciate assets on the same basis as the original companies. However, any tax losses inthe merging companies may not be transferred to the new company formed through the merger.

Under an entire business transfer, the transferee continues to depreciate assets on the samebasis as the transferor company. As with a merger, the tax losses in the transferor may not betransferred to the transferee.






Thai limited companies are permitted to issue only ordinary shares or preference shares. Neithercategory of shares may be issued as redeemable. There are few restrictions on the rights that maybe attached to preference shares. For example, preference shares may have diluted voting rightscompared with ordinary shares.

Thailand currently has no thin capitalisation rules that restrict the amount of interest that may bededucted for tax purposes. Interest paid by a Thai company will usually be deductible provided therate of interest is within the limits provided by transfer pricing rules and civil law.

Certain debt/equity ratios may be imposed on companies that are seeking tax concessions underthe Investment Promotion Act.



Interest on loans taken out by a Thai company and used to fund investments is deductible fromprofits, if any, subject to corporate income tax. However, as Thailand has no group relief orconsolidated filing, the use of a leveraged Thai acquisition vehicle is not tax effective. In addition, asdividends received by the holding vehicle should be fully exempt from tax, the holding vehicle wouldhave no taxable income against which to offset interest costs.





Interest on loans used to acquire assets is generally fully deductible in calculating profits subject tocorporate income tax. One exception is where the acquired asset is not immediately brought intouse in the business. In such circumstances, interest should be capitalised as part of the cost ofacquiring the asset. The capitalised interest may be depreciated as part of the cost of the asset.

Interest is deductible when it falls due for payment. Where the acquiring company is unable toutilise interest deduction, such as where it benefits from a tax holiday, financing may be providedusing discounted notes in order to defer interest deductions. If the debt is appropriately structured,the discount on the note would only be deductible upon the redemption of the note. If this takesplace after the tax holiday, deduction for interest payments may be deferred until tax relief may beobtained.




5. Merger

Under a statutory merger of companies (an amalgamation), the merging companies are dissolved and anew company is formed. For tax purposes, the merging companies recognise no gain or loss on thetransfer of assets. The new company formed through the merger continues to depreciate assets on thesame basis as the original companies. However, any tax losses in the merging companies may not betransferred to the new company formed through the merger.






In addition to dividends, profit may be repatriated through the payments of royalties, service feesand interest. However, each of these is subject to various limitations in terms of withholding taxesand/or the transfer pricing regime (see section 1.4 for withholding tax implications relating to thesepayments).


• Stock Deal

A change in ownership of a company does not affect its carry forward of tax losses.

• Asset Deal

Tax losses are not transferable on a sale of assets, even where the sale represents the transferof an entire business.

6.3 Tax Incentives

• Stock Deal

A change in ownership through a stock deal will generally not affect the availability of taxincentives, provided there is no breach of any ownership condition imposed by the Board ofInvestment.

• Asset Deal

Tax incentives would generally be lost when the business is transferred through an asset deal.However, they may be transferred at the discretion of the Board of Investment.

6.4 Group Relief

There is no form of group relief or consolidated filing in Thailand.




7. Disposal

7.1 Preference of Sellers: Asset vs. Stock Deal

From a seller’s point of view, it would be less complicated to sell a target through a stock deal.

7.2 Stock Sale


Capital gains derived by a Thai company from the sale of shares are included in income subject tocorporate income tax. The gain is calculated as the difference between the sales proceeds and thecost of investment.

Gains derived by a foreign investor on the sale of shares in a Thai company are generally subject towithholding tax of 15% if the gain is paid “in or from” Thailand. If the sale is made between twooffshore entities, the gain will not usually be paid “in or form” Thailand and is not subject to Thaitaxation. If the exit route is a sale to a Thai resident, or via the Thai exchange, tax on the gain maybe mitigated either by:

• holding the investment through a company located in a territory having a double tax agreementwith Thailand that provides for exemption from Thai tax on gains from the sale of shares; or

• stepping up the cost base of the shares via an offshore sale before the sale into Thailand so thatno gain is generated on the exit sale.


If the seller is a Thai company, the distribution of sale proceeds to shareholders as a dividend willattract withholding tax at the rate of 10% unless the shareholder is a company listed on the SET, ora company that holds at least 25% of the voting shares in the dividends paying company (andsubject to the other conditions noted in section 1.1.2).




7.3 Asset Sale


A company that sells any assets, which may include its entire business, is liable to corporate incometax on any gain derived on the sale. The company may offset its tax losses, if any, against the gain.The gain is calculated as the difference between the proceeds received less the tax book value ofthe assets.

Various tax exemptions apply to a statutory merger of companies and the transfer of a company’sentire business (see section 8).


Profits including capital gains may be distributed to shareholders as a dividend (see section 7.2.2).Alternatively, the shareholder may consider liquidating the company, when all or a substantial part ofthe business is being sold off. Generally, liquidation proceeds in excess of the cost of investmentpaid to offshore shareholders are subject to a withholding tax of 15%. However, the liquidationproceeds received from an amalgamation or an entire business transfer may be exempt from tax,provided that certain conditions are met.





8.1 Valued Added Tax (VAT)

Please refer to section 2.4.

8.2 Stamp Duty


8.3 Specific Business Tax (SBT)



Exemption from income tax may be provided for the transfer of assets under an amalgamation andan entire business transfer where the transferor enters into liquidation in the same accountingperiod as the transfer.

Please refer to section 2.4 for other concessions available for an amalgamation and an entirebusiness transfer.


Transaction costs are generally tax deductible to the seller in Thailand.





In preparing for a deal, it would be expedient for the seller to identify tax costs arising from the stock orasset deal. Tax concessions relating to mergers and acquisitions should be taken into account in order tominimise the tax costs. Positive tax attributes and value of tax shelters, for example, the availability ofcarry forward tax losses, could also be factored in and used as a bargaining tool when negotiating with thebuyer.

10. De-mergers

There are no specific provisions in relation to de-mergers. A de-merger usually takes place through thesale of assets or business. It is important to note that any brought forward losses may not be transferable.The implications for a de-merger would be the same as an asset deal as discussed in sections 2.3 and7.3.


After acquiring a target, a financial buyer generally looks for an exit route either through a sale or an IPO.There are no special tax laws or regulations applicable to capital gains derived by a corporate shareholderand arising from an IPO in Thailand. The implications for profits derived from an IPO would be the sameas a stock deal as discussed in section 7.2.

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PricewaterhouseCoopers has exercised professional care and diligence in the preparation of this publication. However, theinformation contained herein is intended to be a general guide and should not be used or relied upon as a substitute of specificprofessional advice. While every effort has been made to ensure accuracy, no liability is accepted by PricewaterhouseCoopers or anyemployee of the firm on any grounds whatsoever to any party in respect of any errors or omissions, or any action or omission to actas a result of the information contained in this publication.

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