IPO HANDBOOK
FOR HONG KONG 2015
With a foreword by David Graham,
Chief Regulatory Officer and Head of Listing, HKEx
MAIN CHAPTER
CHAPTER 7
Tax Considerations in an IPO
For a company, going public is a tremendous exercise which needs to be supported by different specialists.
To new players in an IPO exercise, a question often pops up as to when the tax specialists should be engaged.
The chart below briefly illustrates the tax work to be handled by an IPO applicant and will help to answer the
question.
Pre-IPO
preparation
± Determining the IPO group
structure
± Implementation of group
reorganisation
± Pre-IPO due-diligence
± Rectification of non-compliance
issues
Submission of
application
± Preparation of potential
queries from the approving
authorities
± Drafting of tax disclosures in
the prospectus
Review of
application
± Answering queries from the
approving authorities
The tax work involved in a typical IPO is heavily front-loaded. The early involvement of tax specialists is highly
recommended in order to facilitate the whole process and avoid the unnecessary tax costs stemming from
a lack of preparation. This chapter will provide the readers with a general understanding of the key IPO tax
considerations from Hong Kong and China tax perspectives as well as a hinting note on selecting your tax
advisor.
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1. HK tax considerations for pre-IPO reorganisation
Almost every IPO process involves group reorganisation, which is aimed at reorganising the companies to
be listed into a suitable listing group structure. This will usually include two phases; firstly, companies with
different shareholders but under common control are to be brought together under a common holding company.
Secondly, it is not uncommon to have a company incorporated in an overseas jurisdiction, such as British Virgin
Islands, to be the intermediate holding company which will be interposed between the listed entity and the
operating companies within the group. Two or more tiers of intermediate holding companies may be adopted
for some complex structures. Such an overseas intermediate holding company would be considered for its
flexibility in future spin-off, particularly when a non-core business is subsequently eligible for a separate listing.
1.1 Share vs business transfer
Companies can be positioned under one common holding company by a direct transfer of shares. Under the
current tax laws, transfer of shares of a Hong Kong company will be subject to ad valorem HK stamp duty at
0.2% of the market value of the shares transferred. Sometimes it is considered more appropriate to transfer
the business into the group rather than the whole company. This will often be the case from a HK stamp duty
point of view if a company also holds an immovable property in HK which is the residence of an individual owner
of the group, but the owner does not want that property to be included in the group to be listed. Since direct
transfer of a HK property out of a group can result in dire consequences, such as liable to HK stamp duty up to
a maximum of 8.5% and the added buyer’s stamp duty in certain circumstances, a logical solution will be to
transfer the business into the listing group leaving the property with the original company outside of the group.
1.2 HK stamp duty
As mentioned above, group reorganisation which involves the transfer of shares of each company in HK from
their existing individual shareholders to the new common holding company, will inevitably be subject to HK
stamp duty currently at 0.2% of the market value of the shares transferred. Most group reorganisations are
proceeded by a share swap, which is also subject to HK stamp duty and even if the shares are transferred as a
gift. It is important to bear HK stamp duty in mind, which is part of the cost to be considered in every IPO.
It is noteworthy that relief for HK stamp duty is available for transfer of shares in Hong Kong companies between
associated corporations. For two or more companies to be associated, either:
a) one of the companies must be the beneficial owner of not less than 90% of the issued capital of the other
company, or
b) a third such company must be the beneficial owner of not less than 90% of the issued capital of each of the
companies
It is not necessary for the shares to be directly held in determining the percentage of shareholdings. It is,
however, not applicable where the shares in the relevant companies are owned by the same individual.
Relief for HK stamp duty has to be adjudicated. In practice, the Collector of Stamp Duty will require any
application for relief to be accompanied by a statutory declaration made by a responsible officer of the parent
company, often a director setting out in detail the circumstances and facts of the application.
It is also noteworthy that if after the stamp relief is granted, the transferor and the transferee of shares cease
to be associated within two years from the date of shares transfer, e.g. the shareholdings of the group in the
transferee have dropped to below 90%, any relief granted will be cancelled and the HK stamp duty has to be
paid within 30 days. Although at least 25% of the shares in the listed company have to be offered to the public
upon successful listing, the HK stamp duty relief will not be disturbed.
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In case the HK stamp duty relief is not applicable, other methods have to be considered in mitigating the liability.
The most commonly adopted method is dividend stripping. Dividend distribution to the shareholders prior to
an IPO will not impact the profit threshold required during the track record period for listing purposes. In other
situations, it is advisable to consult tax advisers.
1.3 Tax loss brought forward
It is also important to consider whether any loss sustained in a company prior to the reorganisation will be
available for set off of future profits post reorganisation. There is anti-avoidance legislation in HK stipulating
that if change in shareholdings of a loss company of which the sole or dominant purpose is to obtain a tax benefit,
the loss may not be allowed to be carried forward to offset future profits. Although change in shareholdings
pursuant to group reorganisation to facilitate an IPO has been accepted as outside the avoidance context, it
is less obvious if strategic investors are introduced and new businesses are injected by them into the group to
utilise the loss.
As discussed in 1.1 above, the amount of tax loss available should be taken into account when considering
whether business or shares should be transferred to the listed group. Where business is to be transferred, the
entity with tax loss could be dropped out of the group. Under the new Companies Ordinance, tax loss could still
be available under certain reorganisation conditions.
1.4 Unutilised tax depreciation brought forward
When the reorganisation process involves the transfer of assets between group companies which are depreciable,
including but not limited to plant and machinery, furniture and fixtures, industrial or commercial buildings,
revaluation will be made to determine their transfer value. In the event their market value is larger than their
tax written down value, the transferor company has to account for the excess as a balancing charge in the HK
profits tax return in the year of transfer. A balancing charge is treated as taxable income, and if significant in
amount, will create an additional and immediate tax burden prior to listing. A balancing charge is common in
the case of commercial or residential properties in Hong Kong, whose market prices are constantly on the rise.
This would also be the case where certain prescribed assets are transferred, such as computers; the whole of the
transfer value will be subject to tax as the full amount has been tax deducted in the year of purchase. However,
the balancing charge is limited to the cost of the assets, i.e. limited to the depreciation allowance claimed. Thus,
the capital gain element is exempt from tax. Nevertheless, such balancing charge has to be borne in mind as a
cost of listing, and tax is usually payable while the IPO process is underway.
2. China tax considerations at a glance
It is very common nowadays for a proposed listed group in Hong Kong to have a significant operation or numerous
companies in China. China’s tax system is recognised by tax practitioners as far more complicated than the HK
one. In addition to enterprise income tax (“EIT”), China also implements turnover taxes (i.e. value added tax,
business tax and consumption tax) and other taxes (such as real estate tax, deed tax, land appreciation tax,
etc.). In this respect, different to HK, not only EIT and stamp duty but all applicable taxes should be considered
in preparing for an IPO. For a pre-IPO reorganisation involving Chinese equity investments, particular attention
should be paid to special reorganisation rules in China, direct equity transfers under special holding structures,
indirect transfers of Chinese resident companies and tax efficiencies for profits repatriation from China.
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2.1 Special reorganisation rules in China
As stated previously, a company that goes public should have an efficient and suitable holding structure for
investment by public investors. Before going public, some private investors, especially family businesses, may
hold their investments in China by a number of related companies, or even partnership companies and joint
ventures. In order to go public, a company may be required to reorganise its existing holding structure into
a structure which contains an ultimate holding company incorporated in a suitable jurisdiction with many
subsidiaries engaged in the core businesses suitable for listing.
For making the process of reorganisation more tax efficient, Chinese tax implications of special reorganisation
rules and direct equity transfer (please see section 2.2 below) should be attended to.
The State Administration of Taxation (“SAT”) promulgated tax circular Caishui [2009] No. 59 (“Circular 59”) in
2009 to address various tax treatments in corporate reorganisation.
Pursuant to Circular 59, the Chinese tax authority will differentiate a restructuring into “ordinary” and “special”
categories, and the corresponding tax treatments are different. For ordinary restructuring, fair value should
generally be adopted and a profit and loss should be recognised upon transaction. For special reorganisation,
profit and loss can be deferred and the tax basis can be carried forward.
There are a number of prerequisites for a Chinese equity transfer to qualify as a special restructuring such as
commercial reasons for the restructuring that it is not carried out mainly for tax purposes; not changing the
operations substantially in a prescribed minimum period; completing the reorganisation with a minimum equity
consideration received by the transferor (“Equity Swap”) and not transferring the equity obtained in a prescribed
lock-up period; satisfying the minimum equity acquisition percentage; etc.
If the enterprise satisfies all the prerequisites set out in Circular 59 and opts for tax treatment as a “special
restructuring”, the parties involved should file documentation with the competent tax authorities at the time of
the annual EIT filing of the relevant year in which the restructuring is completed. The tax treatment as special
restructuring will further be subject to review from the relevant provincial level tax authorities. Otherwise, it
could not be entitled to the tax treatment as a special restructuring.
For an equity acquisition that involves parties located outside of China, additional criteria shall be satisfied
when:
1) a non-resident company transfers its equity in a PRC resident company to another non-resident company
100% directly owned by the transferor, and such transfer will not change the withholding tax liability on
future income derived from the transfer of the subject equity; and the transferor shall provide a written
undertaking that it will not transfer its ownership of the transferee within 3 years; or
2) a non-resident company transfers its equity in a PRC resident company to another PRC-resident company
100% directly owned by the transferor; or
3) a PRC resident company contributes assets / equity to a non-resident company 100% owned by the PRC
resident company as a form of investment
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For cross-border equity transfers under situations (1) and (2) above, if the non-resident companies opt for tax
treatment as a “special restructuring”, they will have to file documentation with the competent tax authorities
within 30 days after the equity transfer agreements become effective and the business registration renewals
with the designated bureau of the State Administration for Industry and Commerce for the Chinese entities
concerned are completed.
2.2 Direct equity transfer under a special holding structure
In a pre-IPO reorganisation involving Chinese businesses, it is not uncommon for the existing investors to take
the opportunity to rationalise some special holding structures for the purpose of meeting the IPO requirements.
For those reorganisation arrangements which are unable to meet the special reorganisation rules as stated in
section 2.1 above, a direct equity transfer under an ordinary restructuring may be required to go through.
Under an ordinary restructuring, fair value should be adopted and profit and loss should be recognised upon
transaction.
Under the relevant tax regulations, if a non-resident company transfers the equity in a resident enterprise in
China, the gain derived from the transfer will be subject to withholding tax at 10% (or enjoying the preferential
tax treatment if requirements laid down in an applicable double tax treaty or arrangement (“DTA”) are met). If
the transferor is a Chinese resident company, the gain will be included in its taxable income and taxed at the
applicable EIT rate. While the transferor is a Chinese resident individual, the gain will be subject to Individual
Income Tax at 20%.
The Chinese transferor of a Chinese entity may need to pay taxes resulted from the fair market transaction.
Commercially, the Chinese transferor may not agree to bear the tax costs and the acquirer (the proposed IPO
company) may need to agree on a commercial settlement with the party concerned. Some of the arrangements
may result in a tax-on-tax effect which requires the taxpayer to calculate its tax payable at a gross-up method.
The proposed IPO company will need to maintain the equity transfer agreement as well as the legal evidence
in supporting the fair value of the equity transfer in case of a future request from the tax authorities for review.
2.3 Indirect transfer of Chinese resident company
Given the time consuming administrative procedures in transferring the equity ownership of Chinese companies,
it is not uncommon to carry out a group reorganisation through an indirect transfer of the shares of the foreign
intermediate holding company (“FIHC”) of the Chinese company. Under tax circular Guoshuihan [2009] No.
698 (“Circular 698”) issued by the SAT, if a foreign investor transfers the shares of a FIHC which holds equity in
a Chinese resident enterprise and,
1) the actual tax burden on the income generated from the share transfer is less than 12.5% in the intermediary
holding jurisdiction (“IHJ”); or
2) the IHJ does not tax foreign-sourced income of its residents generated from the share transfer for EIT
purpose;
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The foreign investor is then required to report the tax information in respect of the indirect equity transfer to the
tax bureau in charge where the Chinese resident enterprise is located within 30 days after the share transfer
agreement is signed.
The PRC tax authorities shall adopt the substance-over-form doctrine to assess if the capital gains derived by
the foreign investor from transfer of the FIHC are sourced from China. In particular, the PRC tax authorities
are empowered to invoke the general anti-avoidance rules to disregard the FIHC, if its existence serves no
commercial purpose except the avoidance of tax liabilities.
2.4 Tax efficiency for profits repatriation from China
Dividends distributed by a Chinese resident company to its foreign investors are subject to 10% withholding tax.
The withholding tax rate may be reduced under a DTA. Under the China-HK Double Tax Arrangement and the
relevant tax notice, the PRC withholding tax on dividends would be reduced to 5% if the beneficial owner (“BO”)
of the dividends is a HK tax resident company and it holds directly at least 25% of the shares/equity of the PRC
resident company for at least 12 months.
The tax authorities will conduct a comprehensive review of the BO status, including the nature of business
activities carried out by the HK company, its size of operations and its tax position in HK. The HK company could
not be a conduit company in this respect.
Proper pre-IPO reorganisation planning would be required in order to satisfy the BO substantive test and enjoy
the DTA preferences in the future taking into account the developing implementation of general anti-avoidance
rules in China.
In determining its proposed listed structure and implementing its reorganisation plan, the proposed listed
company is recommended to seek a competent tax consultant for necessary tax advice in order to minimise its
tax exposure and enhance its tax efficiency
3. Tax non-compliance during the track record period
Amongst others, tax non-compliance during the track record period could be a cause of failure in an IPO. Noncompliance which results in tax payable, late surcharge(s) and a tax penalty will be scrutinized seriously by the
Listing Division of The Hong Kong Stock Exchange. This is because it will cast doubt on the suitability of the
applicant for public listing in terms of the adequacy and effectiveness of corporate governance and internal
control systems of the applicant. In most circumstances, the applicant has to maintain an effective internal
control system to prevent the occurrence of any tax non-compliance.
For Chinese companies, tax administrative procedures are far more complicated than HK, and massive
documents will be required in fulfilling the tax compliance requirement. Companies preparing for an IPO
application should carry out a tax health check in assessing their tax compliance status and ensuring that any
special tax treatment and entitlement of tax preferences are substantiated by valid written approval documents
granted by the competent tax authorities.
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Rectification of any non-compliance issues has to be executed skilfully in order to minimise the exposure yet
meeting the evidential and compliance requirements in substantiating the fulfilment of regulatory obligations.
4. Pre-IPO tax due diligence
It is different with a private company for which only close stakeholders of the company may be able to access
the financial statements and question on the compliance status of the company. A higher demand will be
set on listed companies and correspondingly the IPO applicants on their preparation of financial statements,
compliance status, effectiveness of corporate governance, etc.
When approaching a potential IPO, the IPO sponsor may consider requesting the applicant to engage a tax
specialist to perform a tax due diligence review and document the findings and the applicant’s fulfilment of tax
compliance requirement in order to facilitate the IPO process.
A pre-IPO tax due diligence assessment also provides a company with an opportunity to improve its tax efficiency
by identifying and resolving uncertain tax positions.
5. Transfer pricing
Transfer pricing (“TP”) has been one of the most popular tax topics in recent years. With the increase in crossborder transactions resulting from economic globalisation, tax authorities have further strengthened their
enforcement of anti-tax avoidance rules to prevent from unreasonable profit shifting of their respective resident
companies therein.
The HK Inland Revenue Department (“IRD”) expresses its view in Departmental Interpretation and Practice
Notes (“DIPN”) No. 46 that it would seek to apply the Organisation for Economic Co-operation and Development
(“OECD”) principles except where they are incompatible with the express local provisions.
According to Article 123 of the Implementation Rules of the EIT law, if related party transactions do not comply
with the arm’s length principle, or an enterprise makes other arrangements without reasonable commercial
purpose, the tax authority in China has the right to make tax adjustments within 10 years after the transactions
occurred.
In view of the above transfer pricing environment in Mainland China and Hong Kong, the sponsor may conduct
an independent due diligence to ensure the financial transactions of an IPO applicant are free of material TP
risks. An IPO applicant should maintain proper and adequate documentation to justify reasonableness of its
pricing policy of its related party transactions and profit allocation among the group companies involved before
an IPO submission.
Proposed IPO companies are recommended to review the reasonableness of their related-party transactions
and methodology adopted in pricing the transactions. Unattended TP risks could result in delay of the whole
IPO process.
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6. Post IPO tax management
Companies considering going IPO are recommended to approach the whole exercise before and after its
transformation. Resources have to be committed to enhance the corporate governance. The tax function within
the organisation has to be maintained to achieve the following:
ȕ Timely monitoring of any existing or new tax risks after listing
ȕ Continuing to optimise the overall tax efficiency of the group
ȕ Keeping abreast of the latest changes in tax regulations
ȕ Evaluating the tax impact of any new business arrangement proposed by the management
ȕ Coordinating with a tax advisor to obtain professional advice to enhance overall tax efficiency and avoid
deviance when implementing the advice
CONTACT
Crowe Horwath (HK) CPA Limited
9/F Leighton Centre,
77 Leighton Road,
Causeway Bay, Hong Kong
Tel: (852) 2894 6888
Fax: (852) 2895 3752
Website: www.crowehorwath.hk
Charles Chan
Chairman and CEO
Email: charles.chan@crowehorwath.hk
154 IPO HANDBOOK FOR HONG KONG 2015
APPOINT PROFESSIONAL PARTIES
Selecting Your Tax Advisor
The global tax environment keeps evolving and tax administrative burdens are becoming heavier to taxpayers.
Both HK and Chinese tax authorities have been tightening up the enforcement on tax administration and
collection. At the same time, for globalisation, IPO applicants in these days may operate and invest across
countries and regions outside China and Hong Kong. Investors show increasing concerns to the tax functions
performed by public companies. In reaction to this, the IPO approval authorities have put more efforts in
carrying out a more stringent review of the IPO applications from a tax perspective. Potential applicants
should engage a tax advisor with an international network who will be able to cover all different jurisdictions
concerned and assist in preparing for explanations on the following aspects:
Common tax related issues raised by HKEx
ȕ Tax compliance status of each company under the proposed listing group of companies
ȕ Tax provision basis for any substantial provision amount or aged unutilised tax provision
ȕ Effective tax rate of the group should it fluctuate across the track record period or is rather low in
comparison to the statutory tax rate
ȕ Any unsettled dispute with the tax authorities
ȕ The use of low tax jurisdiction companies within the group and the corresponding commercial reasons
ȕ Transfer pricing arrangement for the related parties transactions among the group companies
ȕ Any potential penalties resulting from the above
To cope with the above, a tax advisor should be engaged ahead of the pre-IPO preparation to assist the group
in achieving the following:
Achievements through pre-IPO tax preparation
ȕ Meeting the tax compliance prerequisites
ȕ Minimising potential tax queries from the IPO approval authorities
ȕ Reducing the time required in responding to tax queries and smoothen the IPO process
ȕ Managing and controlling the necessary tax disclosures in the prospectus
ȕ Improving the group tax efficiency, controlling the tax risks and improving operational efficiency through a
properly designed IPO holding and operational structure
ȕ Improving the company’s benchmarking on tax performance and enhancing the potential investors’
confidence in the company
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APPOINT PROFESSIONAL PARTIES
Particularly for a tax efficient holding structure, a tax advisor should be able to:
ȕ Provide advice in planning and minimising the tax costs on profits repatriation or exit
ȕ Assist to perform a treaty network study in designing a tax efficient holding structure
ȕ Advise on the appropriate investment vehicle from a tax perspective taking into account the tax treatment
in the intermediary holding jurisdiction being considered
Given the complexity of works and international tax issues involved, the group should identify a tax advisor
with an international network and be able to show the eligible credentials of works.
CONTACT
Crowe Horwath (HK) CPA Limited
9/F Leighton Centre,
77 Leighton Road,
Causeway Bay, Hong Kong
Tel: (852) 2894 6888
Fax: (852) 2895 3752
Website: www.crowehorwath.hk
Charles Chan
Chairman and CEO
Email: charles.chan@crowehorwath.hk
156 IPO HANDBOOK FOR HONG KONG 2015