This article will provide you with an update on tax treatments for corporate amalgamation under the court-free procedures in Hong Kong.
Tax Treatments for Corporate Amalgamation under the Court-free Procedures
The new Companies Ordinance (Cap. 622) came into effect on March 3, 2014, and introduced court-free procedures for corporate amalgamations in Hong Kong.
Before the enactment of the recent tax legislation, the Inland Revenue Department (“IRD”) had handled amalgamation cases based on the interim assessing practice published on its website. To provide taxpayers with clarity and certainty, the IRD introduced the Inland Revenue (Amendment) (Miscellaneous Provisions) Bill 2021 (the “Bill”), which codifies the IRD’s assessing practice relating to amalgamation into the Inland Revenue Ordinance (“IRO”). It was enacted on June 11, 2021.
Key general provisions applicable to a qualifying amalgamation
A “qualifying amalgamation” refers to a vertical amalgamation or a horizontal amalgamation of companies under the Company Ordinance for which the Registrar of Companies has issued a certificate of amalgamation.
An “amalgamating company” is defined as a company that is amalgamated in a qualifying amalgamation, and the shares of which are cancelled upon amalgamation.
An “amalgamated company” is defined as a company that either amalgamates vertically with its wholly-owned subsidiaries or horizontally with its fellow subsidiaries under the Company Ordinance. The shares of which are not cancelled upon amalgamation (i.e., the surviving company).
Profits tax consequences of a court-free amalgamation may not be the same as those in specific private merger ordinances in Hong Kong or in universal succession cases under foreign laws, which are not carried out for the purpose of obtaining tax benefits.
There are two critical general provisions:
(i) An amalgamating company is treated as having ceased its trade or business on the day immediately before the date of the amalgamation, with profits tax implications, if any, that go with cessation of trade or business.
(ii) The amalgamated company must comply with all obligations, meet all liabilities and be entitled to all rights, powers and privileges of the amalgamating company under the IRO. The amalgamated company is required to furnish the profit tax return of each of the amalgamating companies for its year of cessation.
These key general provisions will apply to qualifying amalgamation, irrespective of whether the taxpayers elect special tax treatments or not.
Special tax treatments for a qualifying amalgamation
The amalgamated company (i.e., the surviving company) may elect for special tax treatments which cover the utilization of pre-amalgamation losses, the succession of business, assets, trading stocks, etc., subject to meeting certain conditions. Such election must be made, by way of an irrevocable written election, within one month after the date of the amalgamation unless a further period for election is allowed.
The special tax treatments include but are not limited to:
1. Succession of business of an amalgamating company
The trade or business of an amalgamating company is treated as being carried on by the amalgamated company from the date of the amalgamation unless the IRD is notified otherwise.
2. Succession of capital assets – Amalgamation without the sale of capital assets
If a capital asset succeeded from an amalgamating company continues to be used as a capital asset after amalgamation, the amalgamated company can continue to claim tax deductions or allowances in respect of the asset on the tax was written down value carried forward by the amalgamating company. When such capital asset is subsequently disposed of by the amalgamated company, the tax balancing charge or claw-back will be computed by reference to the sum of the tax deductions and allowances previously claimed by the amalgamating and the amalgamated company.
The various balancing charge and claw-back provisions upon sale of assets do not apply to the amalgamating company because of the succession. That is, the tax written down value would be carried over to the amalgamated company.
3. Succession of trading stock – Amalgamation without the sale of trading stock
If the amalgamated company continues to use the stock as trading stock and accounts for such stock at the carrying amount, it is deemed to have purchased the stock at the carrying amount. Section 15C (which is discussed below) does not apply to the amalgamating company. As a result, no gain or loss would arise from the succession.
Section 15C applies in relation to the valuation of trading stock on cessation of business. Upon cessation of business, if the trading stock is being sold to a person who carries on business in Hong Kong and the purchase price is deductible from the purchaser’s assessable business profits, the value of the trading stock is the amount that was realized on the sale, or if there is no consideration given, the amount which would have been realized if it had been sold in the open market on the date of cessation. This was the treatment under the interim assessing practice. However, under the Bill, the transfer would be at the carrying amount.
4. Change in use of assets upon amalgamation
Capital assets: If the amalgamating company originally holds a capital asset becomes trading stock upon amalgamation:
• The amalgamating company is deemed to have disposed of the capital asset at the fair market value at the time of the amalgamation for the purpose of computing any tax balance charges or allowances in respect of the capital asset;
• The amalgamated company is deemed to have acquired the trading stock at its fair market value at the time of amalgamation for the purpose of computing the cost of goods sold when it subsequently disposes of the asset.
Trading stock: If trading stock initially held by the amalgamating company becomes a capital asset of the amalgamated company upon amalgamation:
• The amalgamating company is deemed to have disposed of the asset to the amalgamated company at fair market value at the time of amalgamation. Any profits are subject to Profits Tax in its year of cessation of business;
• The amalgamated company is deemed to have acquired the capital asset at fair market value at the time of the amalgamation.
5. Utilization of an amalgamating company’s pre-amalgamation losses
The losses can be carried forward to be used to set off against the assessable profits of the amalgamated company if all the following conditions are satisfied:
(i) Same trade test – The assessable profits were derived by the amalgamated company from the same trade or business succeeded from the amalgamating company;
(ii) Qualifying losses (or so-called Post entry test) – The pre-amalgamating losses were incurred after the amalgamating company, and the amalgamated company entered into a “qualifying relationship”, i.e., one of the companies is a wholly-owned subsidiary of the other company, or both companies are wholly owned subsidiaries of a body corporate; and
(iii) Commissioner’s satisfaction condition – The taxpayer must satisfy the CIR that (a) there are good commercial reasons for carrying out the amalgamation (i.e., Commercial reason test) and (b) avoidance of tax is not the main purpose or one of the main purposes of the amalgamation (i.e., Anti-avoidance test).
Kindly note that the conditions for setting off tax losses in the Bill are quite similar to the IRD’s interim assessing practice. Nevertheless, the Commissioner’s satisfaction condition is newly added.
6. Utilization of an amalgamated company’s pre-amalgamation losses
Set-off of pre-amalgamation losses sustained by the amalgamated company against the assessable profits of the business succeeded from an amalgamating company is subject to all the following conditions:
(i) Post entry test – Same as the above condition (ii);
(ii) Financial resources test – The amalgamated company has adequate financial resources (excluding any loan from an associated corporation) to purchase the trade or business of the amalgamating company other than through amalgamation;
(iii) Trade continuation test – The amalgamated company has continued to carry on a trade or business since the losses were incurred up to the date of amalgamation; and
(iv) Commissioner’s satisfaction condition – Same as the above condition (iii).
Amalgamation without an election
In the case of amalgamation without election for special tax treatments, current provisions relating to the sale of assets in the IRO will apply. For example, Section 15C applies for the valuation of trading stock on cessation of business and the amalgamating company may be chargeable on the deemed trading receipts.
Regarding the transfer/succession of specified assets (including capital assets such as plant or machinery, prescribed fixed assets, buildings, patent rights, etc.), the Bill deems it as a sale at the lower of (i) the open market value of the asset and (ii) the deductions allowed / capital expenditure incurred by the person. Therefore, the amalgamating company may be chargeable on any balancing charge, or claw-back will be computed. On the other hand, the amalgamated company will be deemed to have incurred expenditure on the purchase of specified assets in the same amount and will be eligible to claim capital allowances/deductions based on that amount.
The above treatment may advance the payment of tax. It is different from the special tax treatments, which allow for continuity of tax treatments.
The Bill is an attempt by the tax authority to provide greater clarity and certainty to taxpayers instead of having to rely on the interim assessing practice.
Nevertheless, the special tax treatments for a qualifying amalgamation only apply upon an irrevocable written election made by the amalgamated company within one month after the date of the amalgamation. Companies contemplating a court-free amalgamation in Hong Kong must evaluate the related Hong Kong tax implications and consider whether to make the irrevocable election to adopt the special tax treatments and if the answer is yes, the amalgamated company must not neglect to make such an election.
The utilization of the pre-amalgamation losses of the amalgamated company or amalgamating company involves complicated qualifying conditions and needs careful evaluation. Companies may consider applying for an advance ruling to obtain certainty. For cases involving the transfer or succession of foreign assets or stocks, the foreign tax implications would need to be considered. For example, an indirect transfer of China assets could be triggered in the event of the corporate amalgamation.
Mazars can assist if companies are contemplating a court-free amalgamation.