Hidden costs

With China set to join the WTO in 2000, more market sectors will open up to foreign investors. Many are now reviewing their investment strategies in China, including the possibility of mergers and acquisitions. Through a successful merger, a foreign investor can capitalise on the strengths of the Chinese partner (such as extended domestic sales networks) and the foreign investor (including strong financial resources, advanced technology and management know-how).

Foreign investors need to consider many issues before deciding to merge with or acquire a local entity. The determination of an ?acquisition price' acceptable to both parties is particularly important to the success of the negotiations. In China, specific rules and regulations concerning state-owned assets valuation and local taxes in relation to the transaction would certainly affect the acquisition price.

If the foreign investor acquires a state-owned enterprise or forms a joint venture with a Chinese entity that involves state-owned assets (such as land or buildings), it has to perform an asset valuation. This valuation should be performed prior to the merger or acquisition; otherwise, the transaction would be regarded as void.

Generally, the Chinese entity is required to submit the asset valuation application with the approval of the government authority pertaining to that industry. Once the application is approved, the Chinese entity should appoint a qualified independent consulting firm, an accounting or audit firm that is certified to perform state-owned asset valuation.

The asset valuation result is subject to examination by the State Administration of State-owned Assets Commission, which will determine whether the valuation result is ?fair and just.? Once the result confirmation is obtained, it becomes the base price of the relevant transaction and is usually valid for one year.

The merger/acquisition tax costs of both the transferor (Chinese entity) and the foreign investor would affect the acquisition price negotiations. Various taxes, including business tax, land appreciation tax, stamp duty and income tax, could be applicable to the transaction. In most cases, the Chinese entity would not have funds to pay for these and so it would transfer the tax burden to the foreign investor by increasing the transaction price.

If the acquisition/merger involves the transfer of the Chinese entity's immovable property (such as land and buildings) or intangible assets (such as trademarks or good-will), the transferor would be subject to a business tax levied at 5 percent of the transfer price of such immovable property or intangible assets. The tax does not apply if assets form part of the Chinese party's capital contribution the joint venture.

In addition, the transfer of state-owned land-use rights, buildings and fixtures on such land would be subject to land appreciation tax. However, if the transfer of such real estate is a result of a merger or acquisition, it could be exempt from land appreciation tax with the approval of the local tax authority. It is also necessary to pay back the land premium before the state-owned land-use right can be transferred to the new entity.

In general, any gains on the sale of assets are taxable income to the seller. However, this would not apply if the gains on the transfer of state-owned assets were directly remitted to the state treasury according to government regulations.

The contract of the transfer of assets is subject to stamp duty at the rate of 0.05 percent and both parties to the contract are liable to pay the stamp duty separately.

A merger/acquisition involving a local Chinese company may be affected by way of share transfer. In theory, business tax is only imposed on the transfer of share or equity interest if the transferor originally contributed immovable property or intangible assets in exchange for share/equity interest. The capital gain on share transfer is taxable income of the transferor and any capital losses would be creditable to the transferor.

The contract of share transfer is also subject to stamp duty at the rate of 0.05 percent, payable by both parties to the contract.