High-income people's equity transactions are characterized by large amount of subject matter and complex commercial arrangements, etc. Under the background of "double random, one open" normalized tax supervision, their equity transfer has become the focus of tax audit. In the complex business background, the existing tax policy has a certain lag, the practice of equity transfer tax-related disputes are endless, in the background of strict regulation of high-income people's equity transactions there are a lot of tax-related risks, this paper to the practice of equity transfer of the five common types of tax-related risks as an entry point for discussion, for reference.
In March 2021, the General Office of the Central Committee of the Communist Party of China (CPC) and the General Office of the State Council issued the Opinions on Further Deepening the Reform of Tax Levy and Administration, which explicitly pointed out to strengthen the tax service and supervision of high-income and high-net-worth individuals in accordance with the law. The Inspection Bureau of the State Administration of Taxation subsequently issued a document stating that it would strengthen the supervision of high-income earners in key areas such as equity transfers. The Measures for Administration of Individual Income Tax on Income from Equity Transfer (for Trial Implementation) (SAT Announcement No. 67 of 2014, hereinafter referred to as "Announcement No. 67") is the main policy basis for the tax-related treatment of individual equity transfers at present, and provides regulations on individual equity transfers in terms of income from equity transfers, recognition of the original value of the equity shares, and management of tax declarations, etc. Announcement No. 67 is the main policy basis for the tax-related treatment of individual equity transfers. Circular 67 is a general provision on the transfer of equity interests by natural persons, but under the complex commercial arrangements in practice, the application of income tax on equity transfers in some cases is highly controversial, which may expose high-income earners to administrative or criminal risks.

Risk 1: Failure to declare tax on equity transfer income may face criminal risk

1.Case: Individuals transferring equity without declaring tax, were investigated and fined nearly 13.09 million taxes

In June 2019, A and B entered into an equity transfer agreement, agreeing that A would transfer 35% of the equity interest in Company A held by A to B. A obtained equity transfer income of RMB 90,000,000.00, but did not file a tax return (only individual income tax is discussed here).2021 In September 2021, the Inspection Bureau issued a Notice of Tax Administrative Penalty Matters to A, which stated that "your June 2018 equity transfer income of RMB 90,000,000.00, the original value of the equity interest of RMB 24,512,. 250.00 yuan (the actual price paid of RMB 24,500,000.00 yuan + reasonable taxes directly related to the acquisition of the equity interest of RMB 12,250.00 yuan), reasonable expenses of RMB 45,000.00 yuan (taxes and fees paid in accordance with the regulations at the time of the transfer of the equity interest), and that you shall file a declaration on the basis of the income from the transfer of property and pay the personal income tax for the month of July 2018 by July 15, 2018, which is RMB 13, 088,550.00 yuan, and RMB 13, 088,550.00 yuan. 088,550.00 yuan, you do not make a tax declaration and do not pay the June 2018 individual income tax of 13,088,550.00 yuan. ...... According to the second paragraph of Article 64 of the Law of the People's Republic of China on Administration of Tax Collection, it is proposed to impose a fine of fifty percent of the tax not paid on your non-payment of June 2018 individual income tax of RMB13,088,550.00, with a fine amount of RMB6,544,275.00".

2. Non-declaration of tax on equity transfer income may face criminal risk

According to the "Individual Income Tax Law" and its implementing regulations, No. 67 and other provisions, the transfer of equity by an individual, to the equity transfer income less the original value of the equity and reasonable expenses for the taxable income, according to the "income from property transfers" to pay individual income tax, taxpayers or withholding agents should be in accordance with the law to the competent tax authorities to declare tax. If the tax is not settled within the prescribed period, the tax authorities will often issue a notice of recovery to the taxpayer or approve the income from the transfer of equity, and require the taxpayer to pay the tax, late payment fees and penalties. High-income earners usually have higher income from equity transfer and are highly susceptible to triggering criminal liabilities if they fail to pay up in accordance with the law. Article 201 of the Criminal Law stipulates that if a taxpayer adopts deception or concealment means to make a false tax declaration or fails to make a declaration, and the amount of tax evaded reaches a certain standard, it will constitute a tax evasion offense, which will lead to criminal risk. In practice, there is no lack of high-income people in the transfer of equity did not timely declare the payment of taxes, by the tax authorities still do not pay the last trigger criminal risk situation.

3. Correctly grasp the tax point of equity transfer

In the actual equity transactions, the equity transferor may not obtain the equity transfer income at one time, there may also be conditional payment agreement, in the equity transfer tax obligation occurs at the point of time and did not obtain all the equity transfer income. However, according to the provisions of Article 20 of Announcement No. 67, "under one of the following circumstances, the withholding agent and the taxpayer shall, in accordance with the law, file a tax return with the competent tax authorities within 15 days of the following month: (i) the transferee has paid or partially paid the price of the equity transfer; (ii) the equity transfer agreement has been signed and entered into force; (iii) the transferee has actually fulfilled the duties of the shareholders or enjoys the shareholders' rights and interests; (iv) the judgment, registration or announcement of the relevant state authorities has come into effect; (v) the acts described in Items 4 to 7 of Article 3 of these Measures have been completed; and (vi) other circumstances determined by the tax authorities that there is evidence to show that the transfer of the equity interest has taken place." The 2018 revised Individual Income Tax Law has even increased the regulation of individual equity transfers, with Article 15 stipulating, "Where an individual transfers an equity interest for registration of changes, the registration authority of the market entity shall check the tax-paid certificates of the individual income tax related to the equity transaction." Subsequently, Guangzhou, Tianjin, Guangxi, Shenzhen, Beijing and other places issued announcements one after another, explicitly requiring that individuals transferring equity need to make tax declarations before registering changes in equity. Therefore, regardless of whether the payment conditions are met at a later stage, the individual income tax should be paid in accordance with the amount stated in the contract before the registration of the change of shareholding. In order to avoid administrative and criminal risks arising from non-payment of tax, high-income individuals may, on the premise of clarifying their tax obligations, take the initiative to communicate with the competent tax bureau to negotiate the tax payment deadline based on the substance of the transaction and the receipt of the payment for the transfer of equity.

Risk 2: Low tax rate applied to equity transfer through partnership is adjusted to pay back tax

1. Case: Equity transfer through partnership, the tax bureau required to pay personal tax at 35% tax rate

A is one of the actual controllers of Company A. In order to implement equity incentives and optimize the company's shareholding structure, Company A set up an employee shareholding platform, Partnership B. In March 2020, A transferred part of the equity interests in Company A indirectly held by A through Partnership B to an external investor, and Partnership B withheld and paid the individual income tax at a rate of 20% in April 2020. in July 2021, Partnership B received a notice from the tax department in charge. Partnership received a notice from the competent tax authority requesting to pay back the aforementioned equity transfer price totaling RMB17 million at a tax rate of 35%.

2. Equity transfer through partnership shall be subject to business income tax

The partnership adopts the taxation rule of "share first and tax later", i.e., the income tax is levied through individual partners or legal partners. The Announcement of the Ministry of Finance and the State Administration of Taxation on the Administration of Individual Income Tax on Business 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 of 2021, hereinafter referred to as "Circular No. 41") stipulates that, "Individuals holding equity investments such as equity shares, stocks and partnership shares are subject to income tax on business income. enterprises, and partnerships, all apply the check-and-collect method of individual income tax." The promulgation of Circular 41 broke the previous scheme of tax planning for high-income people by using the lower approved levy rate of partnership enterprises, and the controversy over the transfer of equity by individuals through partnership enterprises in practice returned to the question of whether to apply the 20% property transfer income tax rate or the 5%-35% business income tax rate.

Article 2 of the Circular of the State Administration of Taxation on Effectively Strengthening the Administration of Individual Income Tax for High Income Earners (Guo Shui Fa 〔2011〕 No.50) stipulates that, "The income obtained by sole proprietorships and partnerships engaged in the trading of equities (tickets), futures, funds, bonds, foreign exchange, precious metals, resource exploitation rights and other investment products shall be fully included in the income from production and operation, and shall be subject to individual income tax according to the law. Individual income tax shall be levied in accordance with the law." That is to say, the income from transfer of equity of a partnership shall be applied to "income from production and operation" to calculate and pay individual income tax for the natural person partners. The Guidance Opinions of the Inspection Bureau of the State Administration of Taxation on the Inspection of Equity Transfers in 2018 (Taxation General Inspection Letter [2018] No. 88) corrected the behavior of some localities in applying a 20% tax rate to equity transfers by partnerships in order to attract investment-type enterprises to settle in the localities, and considered that income from the transfer of shares by partnerships should be compared with "income from production and operation", and should be applied at 5% to 5% of the income from production and operation. It is considered that the income from stock transfer by partnership enterprises should be taxed as "income from production and business operation" with a super progressive tax rate of 5% to 35%.

It should be noted that, in order to encourage the development of VC enterprises, the Circular of the Ministry of Finance, the General 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) stipulates that, if the Venture Capital Enterprises chooses to account for the VC Enterprises on the basis of a single investment fund, the income of the individual partners from the fund from the transfer of shares and the income from dividends and bonuses should be calculated according to the tax rate of 20% and paid individual income tax.

Therefore, partnerships other than those that meet the conditions of Cai Shui [2019] No. 8 cannot arbitrarily calculate the individual income tax on equity transfer income at the 20% tax rate. High-income earners should pay full attention to the tax treatment of partnerships, especially the legality of local policies, when utilizing partnerships for equity structure adjustments, to avoid tax-related risks arising from policy uncertainties.

Risk 3: Equity transfer at par value is authorized to pay back tax because it does not have a justifiable reason

1. Case 1: Equity transfer at par was required to re-authorize the income from equity transfer

On January 28, 2021, Dongguan Municipal Tax Bureau responded to a tax-related consultation. Taxpayer's question: Natural person A holds 70% equity interest in Company A (at a cost of RMB1/share). A plans to transfer its 30% equity interest in Company A to Company B (Company B is a limited company 100% owned by natural person A and his spouse) at a price of RMB1/share, and the current net asset value of Company A is about RMB1.4/share. Is the transfer of equity required to pay individual income tax?

Answer from Dongguan Municipal Tax Bureau: According to the relevant provisions of Article 12 of the Announcement of the State Administration of Taxation on the Issuance of Administrative Measures for Individual Income Tax on Income from Equity Transfers (for Trial Implementation) (Announcement No. 67 of the State Administration of Taxation of 2014), a taxpayer's proposed income from an equity transfer that is lower than the share of net assets corresponding to its equity interest is regarded as an obviously low income from the transfer of equity interest. Meanwhile, according to the relevant provisions of Article 13 of Announcement No. 67, a taxpayer's transfer of equity interests to a limited company in which he or she holds shares with his or her spouse does not meet the circumstances of justifiable reasons as stipulated in Article 13. Therefore, the competent tax authority should approve the equity transfer income according to the method of Article 14 of Circular 67.

2. Case 2: Equity transfer at par was found to have justifiable reasons

In May 2022, the Issue Sponsor Letter on the Initial Public Offering and Listing of Liaoning Dingjiade Petrochemical Company Limited issued by Haitong Securities disclosed that on May 30, 2018, Zhang transferred 58,058,000 yuan of the registered capital of the Company held by him to Dingjiade Industry, and Xin transferred 17,017,000 yuan of the registered capital of the Company held by her to Shengjin Industry, with the transfer price of both being RMB1/registered capital. Because the new shareholder Dingji De Industry is a limited company set up by Zhang Mou, a shareholder of the company, Sheng Jin Industry is a limited company set up by Xin Mou, a shareholder of the company, in order to adjust the shareholding structure to be transferred. The Local Taxation Bureau of Laobian District of Yingkou City issued the "Reply on Whether the Natural Person Shareholder's Equity Interests Transferred to the One-Person Limited Company Established by the Natural Person Shareholder is Subject to Individual Income Tax" on May 31, 2018, which considered that the above equity transfer had justifiable reasons and did not need to be adjusted for tax purposes.

The above two cases were similar in that both cases involved natural person shareholders transferring their shareholdings in a company to another company at par for the purpose of adjusting the shareholding structure, and the transferee company was a company 100% owned by the natural person shareholder or the natural person shareholder and his/her spouse. However, the results of the two cases were different. One case was found to be unjustified and the income should be re-certified and adjusted for payment of individual income tax. The other case was considered to be justified and no tax adjustment was required.

3. High-income people should focus on the reasonableness of parity stock transfers

Article 13 of Announcement No. 67 stipulates the justifiable reasons for low tax basis of equity transfer, including low-priced equity transfer due to national policy adjustment, inheritance, conditional internal transfer, etc., and there is also a provision that "both sides of the equity transfer are able to provide effective evidence to prove the reasonableness of the other reasonable circumstances". In practice, the tax authorities have certain discretion in the determination of "justifiable reasons", and the tax authorities will not make tax adjustments for the transfer at a reasonable price. However, if there is no justifiable reason for the transfer, in addition to the risk of tax adjustment, if the transferor fails to make a tax declaration after the due date, according to Article 63 of the Law on Administration of Tax Collection, if the taxpayer refuses to make a declaration after being notified to do so, it constitutes tax evasion, and the tax authorities will recover the unpaid or underpaid tax, late payment fees and impose a fine.

In the case of parity equity transfer transactions, high-income earners should focus on the reasonableness of the transfer at parity and collect relevant evidence and information, such as proof of kinship with the transferee, proof of affiliation, proof that the transfer is an internal transfer, and proof of the net assets of the invested enterprise. For the ambiguous areas of the law, if there is a dispute between the high-income group and the tax authorities over the reasonableness of the transfer at parity, they can hire professional tax lawyers to assist in expressing their opinions to the tax authorities to fully justify the reasonableness of the price of the transfer of equity and to avoid the risk of tax adjustments and other risks.

Risk 4: The use of "yin and yang contract" to conceal the income from equity transfer and refusal to pay tax constitutes the crime of tax evasion. 

1. Case: The use of "yang contract" to conceal the essence of equity transactions and underpayment of tax constitutes the crime of tax evasion.

According to the tip-off, the tax inspection department of Huainan City, Anhui Province, found that Bao Mou, a shareholder of a pharmaceutical company in Anhui Province, signed an Equity Transfer Agreement with Yin Mou, transferring 51.09% of the equity interest of the pharmaceutical company to Yin Mou, with the actual transfer price of 70 million yuan. After Bao Mou in order to evade the relevant tax separately forged "equity transfer agreement" for tax declaration, false "equity transfer agreement" in the transfer of equity for only 3.2605 million yuan. Huainan city tax inspection department in accordance with the law to make Bao Mou recovery of taxes, late payment fees and fines for the treatment of the penalty decision, Bao Mou did not pay the tax, late payment fees and fines on time. The tax department then transferred the case to the public security authorities for investigation in accordance with the law, and Bao was prosecuted by the procuratorate.2021 In March 2012, the People's Court of a certain district in Anhui Province ruled that Bao had transferred his equity interest in a certain company to another person by means of deception and concealment to make false tax declarations, and the amount involved was huge, and his behavior constituted the crime of tax evasion, and sentenced Bao to four years of fixed-term imprisonment with a penalty of RMB 500,000 yuan.

2. the use of yin and yang contract to avoid paying taxes is the focus of the current tax collection and management of the fight!

In this case, Mr. Bao used the "yang contract" to cover up the substance of the equity transaction in order to achieve the purpose of underpayment of tax. The fight against yin and yang contracts is a major focus of tax collection and management, and the Opinions on Further Deepening the Reform of Tax Collection and Management emphasize the need to strengthen the prevention, control, supervision and inspection of tax evasion behaviors such as "yin and yang contracts". In the case of yin-yang contract, the tax authority may conclude the yang contract not based on the true intention of the taxpayer but for improper purpose, and the yin contract is the true intention of the parties, and finally make the judgment that the yang contract is invalid and the yin contract is valid, and then recover the underpaid tax from the equity transferor, which will lead to criminal risk if not paid in full and in time.

Risk 5: The hidden shareholders are required to pay tax on equity transfer under the situation of proxy holding

1. Case: the tax bureau requires the actual shareholders to pay the tax on the income from equity transfer

Natural person A held 40% of the shares of Company A. In March 2011, Company A signed an Equity Acquisition Agreement with Company B, whereby natural person A transferred his equity interest to Company B. The tax office verified that natural person A was holding the shares of Company A on behalf of natural person B. As verified by the Tax Bureau, Natural Person A was holding the shares of Company A on behalf of Natural Person B. The civil judgment of the court also determined that the shareholder of Company A in the industrial and commercial registration of Company A was Natural Person A, and that Natural Person B's 40% equity interest in Company A was held by A on behalf of Natural Person B. The Tax Treatment Decision issued by the Tax Bureau to B contained that "you transferred the equity interest of Company A to Company B, Company B paid part of the equity transfer to you and completed the registration of the change of equity interest in the industry and commerce, as the actual transferor of the equity interest, it is the taxpayer of the individual income tax, and should be declared and paid the individual income tax according to the income from the transfer of property."

2. Disputes on the subject of tax payment for equity transfer in case of proxy holding

Based on the considerations of circumventing the limitations on the number of shareholders and the proportion of shareholding, protecting personal information security, and circumventing the cumbersome industrial and commercial and decision-making procedures, the phenomenon of shareholding on behalf of shareholders is widely existed in practice. From the legal point of view, according to the Provisions of the Supreme People's Court on Certain Issues in the Application of the Company Law of the People's Republic of China (III) (as amended in 2020), the lawful holding of shareholdings in limited liability companies is in accordance with the law. However, at the level of tax law, there are many disputes over the transfer of equity under escrow, which is essentially a question of the identification of the subject of taxation, i.e. whether the nominal shareholder or the actual shareholder is the legal subject of taxation, and the provisions and operations in practice are different.

Viewpoint 1: Taking the "Letter of Reply of Xiamen Municipal Taxation Bureau of the State Administration of Taxation on the Handling of Proposal No. 1112 of the Fourth Session of the Municipal Thirteenth Chinese People's Political Consultative Conference" (Xiamen Taxation Letter [2020] No. 125, hereinafter referred to as "Letter No. 125") as an example, Letter No. 125 specifies that the apparent shareholders, as the shareholders registered in the shareholders' register, can exercise the rights of shareholders according to the shareholders' register. The register of shareholders asserts the exercise of shareholders' rights. Pursuant to the Enterprise Income Tax Law and the Individual Income Tax Law, taxpayers who meet the requirements for transferring equity and obtaining investment income shall fulfill their tax obligations in accordance with the law in respect of dividend and bonus income and income from transfer of equity. With respect to the tax obligations of the hidden shareholders, the transfer of after-tax dividend and bonus income and equity transfer income obtained by the apparent shareholders to the hidden shareholders is not an income subject to individual income tax under the law. As mentioned above, the letter considers that the tax obligation of the income from equity transfer shall be borne by the explicit shareholder, i.e., the nominee, while circumventing the problem of double taxation in the case of transfer to the actual shareholder.

Viewpoint 2: As in the aforementioned case, there is also the problem in practice of tax authorities directly taxing the beneficial shareholders. According to this viewpoint, the apparent shareholders are only nominal shareholders and are not tax liable persons. Substantively, the hidden shareholders are the actual holders of the income from the equity transfer and should fulfill the tax obligation.

Therefore, when high-income individuals hold shares in the form of shareholding and transfer the shares, there may be problems such as difficulty in recognizing the taxpayer and double taxation. In order to prevent such risks, it is recommended that high-income earners clarify the rights and obligations of both parties and their tax liabilities with the nominee when establishing the nominee holding relationship, and understand in advance the implementation caliber of the competent tax authorities on the transfer and restoration of equity shares under the nominee holding, so as to avoid double taxation and disputes between the taxpayers and the taxpayers in practice.

Against the background of increasingly tightened tax supervision, "one-person" intelligent collection of natural person tax information, and the gradual advancement of smart tax construction, the transfer of equity interests by high-income people will face more risks and challenges due to the large amount of transaction and complex business background. High-income people should strengthen their awareness of tax risk prevention, accurately understand and grasp relevant tax policies, start from the essence of equity transfer transactions, actively communicate with tax authorities on common dispute points beforehand, clarify the path of tax collection and management, reduce the risk of income tax treatment, and conduct equity transfer transactions in a more standardized manner.