After an equity investment partnership loses its authorized tax status, its income tax rate on equity transfers can be up to 35%, which is a loss of tax advantage compared to direct individual shareholding. However, dismantling the shareholding platform to revert to individual shareholding status also faces the severe risk of partnership liquidation tax. Against this background, the relevant partnership-type shareholding platforms may consider adjusting the type of enterprise and applying policies such as the Circular of the Ministry of Finance, the State Administration of Taxation, the Development and Reform Commission, and the Securities and Futures Commission on the Issues of Income Tax Policies for Individual Partners of Venture Capital Enterprises (Cai Shui [2019] No. 8), to reduce the cost of the tax burden.

I. Partnership-type shareholding platform: "tax-saving tool" turns into "hot potato"

(I) Approved levy changed to checking account levy, the personal tax advantage of partnership-type shareholding platform is no more

In the past, some localities, for the consideration of attracting investments, used the approved levy as a bargaining chip for negotiation with enterprises, resulting in a large number of partnership enterprises applying the approved levy policy in violation of the approved levy conditions. In order to achieve the purpose of efficient management and convenient financing, individual investors often look for such "tax depressions" and set up shareholding platforms using the organizational structure of partnership. However, after the issuance of the Announcement on Administration of Individual Income Tax Collection on Income from Equity Investments (Announcement No. 41 of the Ministry of Finance and the State Administration of Taxation of the People's Republic of China (MOF) and the State Administration of Finance and Taxation (SAT) of 2021), sole proprietorships and partnerships holding equity, stocks, shares of partnership properties, and other equity investments are subject to the checking and levying method of individual income tax. According to the organizational structure and operation mode of Venture Capital Enterprises, their large economic volume will often bring huge income to the investors, according to which the annual taxable income usually exceeds RMB 500,000, and then the top rate of 35% will be applied to pay individual income tax. Compared with the tax burden of a partnership in its normal state, the tax rate for direct transfer of equity by an individual investor is 20% and the transfer of shares by an individual is exempted from value-added tax, which is more advantageous in terms of tax burden.

(II) Improper tax treatment of dismantled shareholding platforms and surge in tax-related risks

Considering the policy changes and tax costs, a large number of individual investors try to dismantle the shareholding platform and return to direct shareholding by individual investors through dissolution and liquidation of the partnership. However, there is a big dispute between tax enterprises on tax treatment: on one hand, whether non-transaction transfer is taxable, enterprises think that non-transaction transfer is not a transfer and does not generate tax obligations; while tax authorities think that non-transaction transfer involves the flow of equity in different subjects, and should be regarded as a transfer to generate tax obligations. On the other hand, there are different views as to whether the individual partners should pay tax on the equity allocated to them according to the "operating income", or whether they should pay tax on the amount recovered from the termination of investment and operation of the individual in accordance with the "income from transfer of property". Therefore, in the process of dismantling the shareholding platform of individual investors, it is very easy to trigger tax risks, and for platforms holding shares of listed companies, listed companies may also be issued letters by the stock exchange to inquire about the commercial reasonableness of the corresponding business.

Since the Opinions on Further Deepening the Reform of Tax Collection and Administration in March 2021, it has been clearly required to "strengthen the tax service and supervision of high-income and high-net-worth individuals in accordance with the law, and focus on the prevention and control of tax evasion by utilizing the 'tax puddles'", the transfer of equities of high-net-worth individuals has become a key focus of tax supervision and regulation. The equity transfer of high net worth individuals has become a key area of tax supervision focus, investigation and handling of tax-related violations, and the tax-related risks faced by the dismantling of the shareholding platform are summarized as follows:

1. The tax authorities may make retrospective adjustments to the equity transfer transactions that abused the approved levy policy before the introduction of Announcement No. 41;

2. Individual investors who obtain equity shares distributed in the liquidation of a partnership and fail to declare their income in accordance with the prescribed period are required to pay back taxes and late fees, and will also trigger the liability for tax evasion if they still fail to declare after being notified to do so by the tax authorities.

3. If there are tax arrears in equity transfer transactions during the existence of the partnership, the tax authorities may recover the tax arrears from the general partner who assumed unlimited joint and several liability before the cancellation of the partnership.

II. An Alternative Approach: Personal Tax Benefits for Partnership-based Shareholding Platforms

Given that unconventional transfer methods such as dismantling the shareholding platform will often be taxed by the tax authorities to penetrate the substance of the transaction, can individual investors reduce the level of tax liability without dismantling the shareholding platform? As early as 2019, the state that the Venture Capital Enterprises (funds) to give the individual tax incentives, is not lost in the current solution to the partnership-type shareholding platform tax burden of a way out.

(I) Conditions for the application of preferential income tax policies for individual partners of venture capital enterprises

1. Applicable Subjects

According to the Circular of the Ministry of Finance, the State Administration of Taxation, the Development and Reform Commission, and the Securities and Futures Commission on the Issues of Income Tax Policy for Individual Partners of Venture Capital Enterprises (Cai Shui [2019] No. 8), the subject of this tax policy includes venture capital enterprises (hereinafter referred to as "VC enterprises") and venture capital funds (hereinafter referred to as "VC funds"). "VC funds").

 2. Complete the filing and accept the supervision of the management department of venture capital enterprises

(1) Venture capital enterprises shall complete the filing in accordance with the Interim Measures for the Administration of Venture Capital Enterprises.

If a VC enterprise is registered in the State Administration for Industry and Commerce, it shall apply for filing with the management department of the State Council; if it is registered in the administration for industry and commerce at the provincial level and below, it shall apply for filing with the management department at the provincial level (including sub-provincial cities) where it is located.

(2) Venture capital funds shall complete the filing in accordance with the Interim Measures for the Supervision and Administration of Private Investment Funds.

Venture capital funds are applied for registration by various types of private equity fund managers to the Fund Industry Association, and after various types of private equity funds have been raised, they shall go through the procedures of fund filing.

In terms of filing conditions, venture capital funds exist both in the Fund Industry Association and in the NDRC for the record, in the NDRC for the record, should comply with the aforementioned "Interim Measures for the Administration of Venture Capital Enterprises" filing conditions, in the Fund Industry Association for the record, the following filing conditions must be met:

3. Standardized operation

(1) Scope of business

According to the provisions of Article 12 of the Interim Measures for the Administration of Venture Capital Enterprises, the business scope of VC enterprises is limited to the following five types of business: first, venture capital business; second, acting as an agent for the venture capital business of other venture capital enterprises and other institutions or individuals; third, venture capital consulting business; fourth, providing venture capital management services for venture enterprises; and fifth, participating in the establishment of Venture Capital Enterprises and Venture Capital Management Consulting Institutions. The Interim Measures for the Supervision and Administration of Private Equity Funds

The Interim Measures for the Supervision and Administration of Private Investment Funds do not specify the specific business scope of VC funds, but with reference to the business scope of private equity fund managers in the Several Provisions on Strengthening the Supervision and Administration of Private Investment Funds, a VC fund shall have the same or similar business scope as that of a private equity fund, i.e., it shall carry out the business of fund raising, investment management, consultancy services, management consultancy and other businesses around the management of VC funds and shall not carry out businesses that conflict with or are unrelated to it. shall not carry out business that is in conflict with or unrelated to it.

(2) Investment Scope

According to the "Interim Measures for the Administration of Venture Capital Enterprises", "Interim Measures for the Supervision and Administration of Private Investment Funds" and the "Explanation on "Business Type/Fund Type" and "Product Type" of Private Investment Funds", the investment scope of VIEs and VC funds is as follows Table 1: Investment Scope of Venture Capital Enterprises and Venture Capital Funds

(3) Survival period

Venture capital enterprises may determine a limited duration in advance, but the minimum duration shall not be shorter than 7 years.

The duration of a Venture Capital Fund shall be not less than 5 years, of which the duration is the investment period + exit period, excluding the extension period.

(II) Accounting method for the income of individual partners of VC enterprises

According to Circular No. 8 of Cai Shui [2019], partnership Venture Capital Enterprises (Funds) that comply with the relevant provisions of the Venture Capital Enterprises (Funds) and have completed the filing in accordance with the provisions and operate in a standardized manner may choose to account for the income of Venture Capital Enterprises as a whole under the accounting of a single investment fund or under the annual income of Venture Capital Enterprises as a whole

1. Determination of taxable income of individual partners under different accounting methods

According to Circular No. 8 of Cai Shui [2019], the taxable income of an individual partner should be determined in the order of the selected method of accounting, determination of the type of income, and so on.

2. Similarities and differences between the two accounting methods

Among them, there is a controversy as to whether the dividend and bonus income is merged into the operating income under the overall accounting method, which stems from the conflict between the Circular of Cai Shui [2019] No. 8 and the provisions of the Circular of Guo Shui Han [2001] No. 84. According to Circular No. 8 of Cai Shui [2019], if a venture capital enterprise (fund) chooses to account for its annual income as a whole, the dividend and bonus income is incorporated into the operating income of the venture capital enterprise and is not subject to a separate tax declaration. However, in accordance with Article 2 of the Circular of the State Administration of Taxation on the Implementation Caliber of the <Provisions Concerning the Individual Income Tax Levied on Investors of Wholly Owned Enterprises and Partnership Enterprises> (Guo Shui Han [2001] No. 84), the interest or dividends and bonuses distributed by a partnership enterprise from its foreign investments shall not be incorporated into the income of the enterprise but shall be accounted for as the income from interest, dividends, and bonuses obtained by the investor individually separately, as follows Interest, dividend and bonus income shall be calculated and paid as individual income tax under the taxable item of "Interest, Dividend and Bonus Income". According to the new law is better than the old law and the special law is better than the general law, the view that dividends and bonuses are taxed separately from operating income under the overall accounting method is not valid. Therefore, under the overall accounting method, the deduction of income and costs, expenses and losses do not distinguish between types of income and are aggregated to arrive at the taxable operating income, which is then distributed to the individual partners. However, those who do not meet the conditions for the application of the tax policy for venture capital enterprises (funds) should still be subject to the application of Guo Shui Han [2001] No. 84, applying a tax rate of 20% on dividend and bonus income for separate taxation.

III. To dismantle or not to dismantle: a comparison of individual partners' tax burden levels

If the shareholding platform is able to enjoy the tax policies of VC enterprises, not dismantling the shareholding platform can also reduce the investor's tax burden. In the case of an existing partnership-type shareholding platform, whether an individual partner dismantles the shareholding platform has to take into account not only its own investment objectives, types of shareholdings, income accounting methods and the tax burden level of shareholdings in different entities, but also the cost of dismantling the shareholding platform.

(I) To dismantle or not to dismantle: the cost of tax liability for individual partners in equity transfer

If the investor aims at capital appreciation and the realization of investment income mainly relies on equity transfer, in the case that the platform is able to enjoy the tax policy of VC enterprises, the tax burden cost of individual partners is as follows:

(II) To split or not to split: the tax cost of dividend and bonus distribution for individual partners

If the investor aims at value investment and the realization of investment income mainly relies on the distribution of dividends and bonuses of invested enterprises, the tax cost of individual partners is as follows in the case that the platform is able to enjoy the tax policy of venture capital enterprises:

As a matter of fact, whether you choose the main body of the shareholding or the specific accounting method, the scope of deduction, loss recovery and other provisions are different, and the high or low tax rate is not the only criterion for determining the tax burden. In addition, if the partnership-type shareholding platform meets the standards of venture capital enterprises and directly invests in the conditions of start-up science and technology enterprises, the individual partners can also enjoy the tax benefits of offsetting 70% of the corresponding investment amount of the transferred project in the income from equity transfer, and in the case of accounting for the annual income as a whole, the annual accounting loss can be carried forward to the next year for offsetting. The non-dismantling of the shareholding platform can even produce a superior tax-saving effect than individual shareholding.

Ⅳ. Recommendation: general partnership transformation filing venture capital enterprise (fund)

(I) Dual filing for supervision and taxation: enjoying preferential policies for VC enterprises

On the basis of the existing partnership-type shareholding platform, taxpayers shall focus on reviewing whether the platform is in line with the conditions for enjoying the preferential tax policies of venture capital enterprises (funds) if they want to enjoy the preferential tax policies of venture capital enterprises (funds) by adjusting the paid-in capital, the number of investors, the form of capital contribution, the number of practitioners as well as the ratio of R&D expenses, etc., and then the platform shall be in line with the qualifications of the investment subject and the investment object, the mode of investment, the shareholding period and other conditions. If the platform meets the conditions of the investment subject and investment object, investment mode, shareholding period, etc., it should prepare relevant materials for filing with the management authority.

After completing the regulatory filing, the VC enterprise shall consider its own investment purpose, expected exit method, expected investment income, etc., and determine the accounting method in its favor. If a VC enterprise chooses to account for its investment in a single investment fund, it shall file the accounting method with the competent tax authority and declare to enjoy the corresponding tax preferences; otherwise, it is deemed to choose to account for its annual income as a whole. Once the above accounting method is chosen, it cannot be changed within 3 years. If a VC enterprise chooses an accounting method for three years and needs to adjust it, it shall file again with the competent tax authorities before January 31 of the following year after three years.

(II) Enterprises completing the dual filing in the middle of the year should pay attention to the segmented accounting of operating income for the current year

According to the provisions of Article 1 of Circular No. 8 of Cai Shui [2019], the conditions for declaring the choice of accounting method are limited to meeting the conditions for the main qualification of VC enterprises, completing the regulatory filing and standardized operation, and do not include filing the accounting method with the competent tax authorities. Therefore, for taxpayers declaring to enjoy the tax incentives, the effect of the filing of the accounting method can be retroactive to the date of the commencement of the policy for VC enterprises that have been set up and filed before the commencement of the policy, and the effect of the filing of the accounting method can be retroactive to the date of the regulatory filing of the VC enterprises for VC enterprises that have been newly established after the commencement of the policy. The details are shown below:

Venture capital enterprises that have completed the filing before January 1, 2019, and choose to file under single investment fund accounting, will have the VC enterprises withhold and pay individual income tax on behalf of the VC enterprises by March 31 of the following year if they obtain income from the transfer of equity interests in each tax year within the period from January 1, 2019 to December 31, 2021. If the income from dividends and bonus is obtained, the Venture Capital Enterprises shall withhold and pay the individual income tax on behalf of the individual on a per-tax basis.

If a VC enterprise established after January 1, 2019 and completes the regulatory filing and chooses to file under single investment fund accounting, if it obtains income from equity transfer within the period from the date of regulatory filing to December 31, 2021, the VC enterprise shall withhold and pay individual income tax on behalf of the VC enterprise before March 31 of the following year. If the income from dividends and bonuses is obtained, the Venture Capital Enterprise shall withhold and pay the individual income tax on behalf of the individual on a sub-total basis.

However, when a partnership-type shareholding platform has been established before January 1, 2019, but meets the conditions of a VC enterprise during the implementation of the policy, and handles the regulatory filing in the middle of a tax year, and chooses to file the accounting method on the basis of a single investment fund, there may be a situation in which there are two accounting methods in a tax year:

In this case, since the enterprise (fund) does not meet the statutory conditions for selecting the accounting method before the regulatory filing, the income from equity transfer obtained during the period from January 1, 2019 to the regulatory filing should be accounted for as a whole in accordance with the annual income, which leads to the emergence of two accounting methods in a single tax year. Taxpayers should pay attention to the correct segmented accounting and actively communicate with the tax authorities to avoid tax-related risks arising from accounting errors.