Editor’s Note:To further encourage and guide private individual investment and alleviate taxpayers’ difficulties in raising sufficient funds for tax payment, the Ministry of Finance and the State Administration of Taxation jointly issued theNotice on Individual Income Tax Policies Related to Individual Non-Monetary Asset Investment(Caishui [2015] No. 41), which provides that individual income tax arising from non-monetary asset investment shall be paid, and if a lump-sum payment poses hardship, the tax may be paid in installments within five calendar years. If during the installment payment period the taxpayer transfers the equity interest in the investee enterprise and receives cash proceeds, such cash proceeds shall be prioritized for payment of the outstanding tax arising from the non-monetary asset investment. In practice, some tax authorities take the view that once an individual transfers the equity interest in the investee enterprise during the installment period, the installment payment plan must be terminated. This article examines whether such view has a legal basis, through the lens of a case study.

I. Case Introduction

(I) Basic Facts

In 2010, Individual A and Individual B each invested RMB 10 million to establish Company A. By the end of 2021, the net asset value of Company A was estimated at RMB 110 million. A and B entered into aReorganization Agreementwith Company B, stipulating that A and B would establish a partnership enterprise with their shares in Company A, and that the partnership enterprise would then contribute the shares in Company A to subscribe for the capital increase of Company B. In January 2022, A and B, as agreed, contributed their shares in Company A, valued at RMB 110 million, to establish the partnership enterprise, which then contributed the shares in Company A, also at RMB 110 million, to subscribe for the increased registered capital of Company B, resulting in the ownership structure: "A and B → Partnership Enterprise → Company B → Company A." The ownership structure before and after the transaction is illustrated below:

For tax purposes, A and B reported to the competent tax authority the "income from property transfer" arising from the non-monetary asset investment (i.e., contributing shares in Company A to establish the partnership), and concurrently applied for installment payment of individual income tax for non-monetary asset investment. A and B confirmed their installment payment plans as follows: each had individual income tax payable of RMB 10 million, with a final payment deadline of December 31, 2027, and a scheduled payment date of December 31, 2027, for the full amount. The competent tax authority issued theFiling Form for Installment Payment of Individual Income Tax for Non-Monetary Asset Investment.

In July 2025, due to strategic adjustments, Company B decided to reduce its registered capital. The partnership enterprise's investment was treated as a return of investment, reducing the corresponding registered capital from RMB 110 million to RMB 25 million. However, Company B did not return any cash, physical assets, or other assets to the partnership; instead, it recognized a payable liability, and the partnership enterprise correspondingly recognized a receivable claim. As the capital reduction was conducted at par, the partnership realized no gain from the return of investment, and consequently reported zero taxable individual income tax. In terms of accounting, the partnership enterprise debited "other receivables" to record the return of investment, while Company B credited "other payables" for the capital reduction.

Recently, A and B receivedTaxation Matters Noticesfrom the tax authority, confirming that their installment payment plans should be terminated as of July 2025, and that each should be assessed an additional RMB 10 million in individual income tax, plus late-payment penalties at the rate of 0.05% per day.

(II) Views of the Tax Authority

Pursuant to Article 11 of theAnnouncement of the State Administration of Taxation on Issues Concerning Tax Administration of Individual Income Tax for Individual Non-Monetary Asset Investment(SAT Announcement [2015] No. 20), "[w]here a taxpayer transfers equity during the installment payment period, the taxpayer shall file a tax return and pay the tax to the competent tax authority by the 15th day of the month following the date of equity transfer." The tax authority interprets that "pay the tax" refers to the tax obligation arising from the non-monetary asset investment. The tax authority contends that A and B, by holding partnership interests, indirectly held shares in Company B, and that Company B's capital reduction in July 2025 constituted, in substance, an indirect transfer of shares in Company B by A and B. As this occurred during the installment payment period for A and B's non-monetary asset investment (2022–2027), A and B should terminate their installment plans and each pay RMB 10 million in individual income tax by August 15, 2025. Since A and B failed to file and pay within the prescribed period, the tax authority is lawfully recovering the taxes.

(III) Views of A and B

A and B argue that: First, the capital reduction by Company B was a transfer of shares in Company B by the partnership enterprise, and A and B themselves did not transfer their partnership interests; therefore, it should not be deemed that they have transferred equity. Second, under Article 4, paragraph 2 of Caishui [2015] No. 41, which states that "[i]f an individual transfers all or part of the equity held by the individual during the installment payment period and obtains cash proceeds, such cash proceeds shall be prioritized for payment of the outstanding tax," even if the capital reduction were treated as an equity transfer by A and B, they did not receive any cash proceeds from the reduction, and thus the condition of "obtaining cash proceeds" is not satisfied; therefore, the filed installment plan should not be terminated.

(IV) Key Issues in Dispute

Based on the divergent views, the key issues are summarized as follows:

First, during the installment payment period for individual non-monetary asset investment, does the "transfer of equity" regulated by tax law include indirect equity disposals (capital reductions) carried out through a partnership structure? Can the tax authority "look through" the partnership and directly characterize the capital reduction as an individual equity transfer?

Second, is the actual receipt of cash proceeds a necessary prerequisite for terminating the installment plan and accelerating full tax payment? Given that the capital reduction generated no cash inflow, can the installment plan be terminated?

II. Tax Law Analysis of Individual Non-Monetary Asset Investment

To address the above issues, it is necessary to review the development of the individual income tax regime for non-monetary asset investment and compare it with the corresponding corporate income tax rules, so as to reveal the differences in the conditions for terminating installment payment plans under the two tax systems.

(I) Historical Evolution of Individual Income Tax for Non-Monetary Asset Investment

1. Before April 12, 2005: Period of Policy Controversy

When the Individual Income Tax Law was first promulgated in 1980, property transfer was not included in the taxable items. After the 1993 amendment, "income from property transfer" was formally included as a taxable item, and the 1994 Implementing Regulations further clarified that equity transfer falls under income from property transfer. However, due to the lack of specific policy rules for non-monetary asset investment, tax authorities held differing views on whether individual income tax should be imposed on such investments. One view held that an individual who invests with non-monetary assets in exchange for equity in the investee enterprise has obtained income in the form of marketable securities and thus incurs a tax liability on the appreciation portion of the investment. Another view, drawing on Article 2 of theNotice of the State Administration of Taxation on Issues Concerning Individual Income Tax on Quantified Assets Acquired by Individuals in Enterprise Restructuring(Guo Shui Fa [2000] No. 60), which provided that "quantified enterprise assets acquired by employees in the form of shares with ownership rights shall be subject to deferred individual income tax; tax shall be levied on the balance of the transfer proceeds after deducting the actual expenses paid and reasonable transfer expenses when the shares are subsequently transferred," argued that appreciation on non-monetary asset investment should likewise be deferred until actual transfer. This divergence led to inconsistent enforcement across tax authorities.

2. From April 13, 2005 to January 3, 2011: Period of Temporary Non-Imposition

In response, the Fujian Provincial Local Taxation Bureau sought guidance from the State Administration of Taxation (SAT) on whether individual income tax should be levied on appreciation arising from individual non-monetary asset investment. On April 13, 2005, the SAT issued theOfficial Reply on the Temporary Non-Imposition of Individual Income Tax on Appraised Appreciation of Non-Monetary Assets(Guo Shui Han [2005] No. 319, now invalid), clarifying that appraised appreciation from individual non-monetary asset investment shall be temporarily exempt from individual income tax, and tax shall be levied when the investment is withdrawn, transferred, or liquidated. Although this Reply was a case-specific response, it was broadly applied nationwide and helped unify enforcement practices to some extent.

3. From January 4, 2011 to March 31, 2015: Pilot Installment Payment Period

In 2011, the SAT repealed Guo Shui Han [2005] No. 319 and, in theOfficial Reply on Individual Income Tax Issues Concerning Individuals Participating in Private Placements of Listed Companies with Equity Interests(Guo Shui Han [2011] No. 89), clarified that an individual's participation in a private placement using equity interests constitutes an equity transfer and is subject to individual income tax. In 2014, theMeasures for the Administration of Individual Income Tax on Equity Transfer (Trial)(SAT Announcement [2014] No. 67) further clarified that equity investment or non-monetary exchange by an individual is taxable as income from property transfer. During the same period, the State Council approved the Shanghai Pilot Free Trade Zone to pilot an installment payment policy for non-monetary asset investment, allowing tax payment in installments within five years. At this stage, the tax liability for individual non-monetary asset investment was already triggered at the investment stage, but no nationwide preferential installment policy existed outside the Pilot Free Trade Zone; taxpayers outside the Zone still faced the dilemma of "having income but lacking cash to pay tax."

4. After April 1, 2015: Nationwide Promotion of Installment Payment

In 2015, the State Council decided to extend the Shanghai pilot policy nationwide. The Ministry of Finance and the State Administration of Taxation jointly issued Caishui [2015] No. 41, setting forth the substantive rules for individual non-monetary asset investment, followed by SAT Announcement [2015] No. 20, which detailed the procedural rules.

On the substantive side: (i) It clarifies the taxable act and tax category, deeming the investment as a simultaneous transfer of non-monetary assets and investment, with the gain taxable as "income from property transfer." (ii) It specifies the tax base, i.e., the taxable income equals the appraised fair value of the transferred non-monetary assets minus the original cost and reasonable expenses. (iii) It defines the time when the tax liability arises as the date when the individual transfers the non-monetary assets and obtains the equity of the investee enterprise. (iv) It sets the filing deadline as the 15th day of the month following the tax liability trigger. (v) It provides the installment payment preference: if a lump-sum payment poses hardship, tax may be paid in installments within five calendar years from the date of the taxable act. (vi) It establishes the priority of cash consideration and cash proceeds from equity transfers for tax payment: on the one hand, cash consideration received during the transaction shall be used first to pay tax, and only the insufficient portion may be paid in installments; on the other hand, if during the installment period the individual transfers equity and obtains cash proceeds, such proceeds shall be prioritized for payment of outstanding tax.

On the procedural side, it specifies the place of tax payment, the determination of original cost and reasonable expenses of non-monetary assets, the formulation, modification and filing of installment plans, and the reporting obligations of the investee enterprise.

(II) Comparative Analysis of Individual vs. Corporate Non-Monetary Asset Investment Policies

The individual installment policy for non-monetary asset investment, on one hand, draws from the corporate income tax installment policy for non-monetary asset investment; on the other hand, it refines the policy in light of the differences between individual and corporate income tax regimes.

Similarities:(i) The installment period is the same—both allow installment payment within five years. (ii) The basis for recognizing investment income is the same—both require the appraised fair value as the basis for transfer income. (iii) The policy objectives are aligned—both aim to encourage investment, ease taxpayer cash flow pressures, and promote capital market development.

Differences:(i) The specific rules for installment differ. For individual income tax, taxpayers may determine the amount payable in each year at their discretion, without requiring equal installments; for corporate income tax, the taxable income must be evenly allocated across each installment year. (ii) The conditions for terminating the installment plan differ. Under the individual income tax regime, if during the installment period the taxpayer transfers all or part of the equity and receives cash proceeds, such proceeds shall be used first to settle the outstanding tax under the filed plan; any shortfall remains subject to the original installment schedule, without shortening or extending the original period. Under the corporate income tax regime, if the equity is transferred or the investment is withdrawn during the deferral period, the deferral policy shall cease to apply, and the unrecognized non-monetary asset transfer income for the deferral period shall be fully included in the taxable income for the year of transfer or withdrawal in the final settlement of corporate income tax.

This comparison demonstrates that the individual income tax installment regime places greater emphasis on the "ability-to-pay" or "cash availability" principle. The tax authority's attempt in this case to mechanically apply the corporate termination logic would, in substance, conflate the normative foundations of the two tax systems.

III. The Tax Authority's Position Lacks Legal Basis

Through the above policy review and comparative analysis, and upon re-examining the tax authority's determinations in this case, the following conclusions can be clearly drawn:

(I) The Partnership's Equity Reduction Should Not Be Deemed a Personal Equity Transfer by A and B

First, from a textual interpretation perspective, Article 2, paragraph 2 of Caishui [2015] No. 41 provides that "[f]or an individual's non-monetary asset investment, the income from the transfer of non-monetary assets shall be recognized at the time when the non-monetary assets are transferred and the equity of the investee enterprise is obtained," and Article 4, paragraph 2 provides that "[i]f an individual transfers all or part of the equity held by the individual during the installment payment period and obtains cash proceeds, such cash proceeds shall be prioritized for payment of the outstanding tax." The term "the aforesaid equity" in that provision refers to the equity in the investee enterprise directly obtained by the individual as a result of the non-monetary asset investment, and does not include equity indirectly held through a partnership enterprise. The tax authority's expansive interpretation of "transfer of equity" to include "indirect transfer of equity" exceeds the textual scope of the provision.

Second, from the perspective of legal personality independence, A and B established a partnership enterprise by contributing their shares in Company A. This act was treated as a transfer of non-monetary assets by individuals for tax purposes, and was duly reported and approved for installment payment. Thereafter, the partnership enterprise contributed the shares in Company A to subscribe for the capital increase of Company B. The legal entity carrying out this transaction was the partnership enterprise, not A and B individually. Similarly, the capital reduction by Company B was legally effected by the partnership enterprise, and has no legal nexus with A and B's individual installment plans. In this case, A and B did not transfer their partnership interests.

Third, from the principle of legality in taxation, a comprehensive review of the entire tax normative framework for non-monetary asset investment reveals no provision that explicitly extends the scope of "transfer of equity" during the installment period to include "indirect transfer of equity." The principle of legality requires that tax authorities shall not adopt expansive interpretations adverse to taxpayers in the absence of a clear legal basis. The tax authority's "look-through" characterization in this case lacks a clear statutory basis.

(II) The Installment Payment Plan Should Not Be Terminated in This Case

First, termination of the installment plan is conditional on "obtaining cash proceeds." Article 4, paragraph 2 of Caishui [2015] No. 41 explicitly stipulates that cash proceeds are a necessary precondition for triggering accelerated payment. The logic of this provision is that only when the taxpayer transfers equity during the installment period and thereby obtains cash flow does the taxpayer have the actual ability to pay ahead of schedule; if no cash proceeds are obtained, the condition for application is not met. In this case, the capital reduction by Company B generated no cash proceeds for the partnership enterprise from the return of investment, and A and B themselves received no cash proceeds whatsoever. Plainly, the precondition for accelerated payment is not satisfied.

Second, even setting aside the indirect transfer issue for the moment, this case does not necessarily lead to termination of the installment plan. As noted above, the individual and corporate income tax regimes differ fundamentally in their rules for terminating installment plans. The individual income tax regime places greater emphasis on the "ability-to-pay" principle, such that if the cash proceeds obtained by the taxpayer are insufficient to cover the full outstanding tax, the remaining amount may continue to be paid in installments, and the original installment plan is not automatically terminated. In a press interview on April 9, 2015, a responsible official from the Income Tax Department of the State Administration of Taxation explicitly illustrated this point: if Mr. Wang still has RMB 2 million in tax unpaid and, after transferring part of his equity, receives RMB 1.6 million in after-tax proceeds, then RMB 1.6 million shall be used first to pay tax, and the remaining RMB 400,000 shall continue to be paid in installments. This interpretation fully demonstrates that termination or modification of the installment plan is premised on "obtaining cash proceeds," and that when cash proceeds are insufficient, the installment plan remains effective.

IV. Conclusion

In this case, A and B established a partnership enterprise by contributing their shares in Company A, and duly filed an installment payment plan for individual income tax with respect to that non-monetary asset investment. Subsequently, the partnership enterprise completed the capital increase in Company B and the later capital reduction, during which A and B themselves did not transfer their partnership interests, nor did they receive any cash proceeds. The tax authority's "look-through" characterization of the partnership's capital reduction as a personal equity transfer by A and B, and its order to terminate the installment plan and accelerate tax payment, lacks legal basis. A and B are entitled to pursue legal remedies to protect their lawful rights and interests.