Individual tax risks with M&A

Among the many taxation issues involved in company mergers and acquisitions (M&A), this article focuses on the individual income tax issues faced by natural-person shareholders of a target company for transferring shares in the event that the target (an unlisted limited company or an unlisted public limited company) is acquired by a listed company with payment of cash plus equity.

Pursuant to the Individual Income Tax Law, the Implementing Regulations of the Individual Income Tax Law, and the Administrative Measures for Individual Income Tax on Equity Transfer Incomes (Trial), a natural-person shareholder who transfers equities must be deemed as obtaining “income from property transfer”, and must pay individual income tax at 20% on the balance after deducting the original value of the equities transferred and reasonable amount of other taxes and fees from the equity transfer income.

Consider the acquisition of a limited company by a listed company: in 2010, six natural-person shareholders jointly contributed RMB100 million (US$14.5 million) to set up a limited company which, in 2016, was acquired by a listed company with a consideration of RMB1 billion. The acquisition agreement specifies that the listed company must acquire 100% of the equity of the target company, as held by the six original natural-person shareholders, by paying them a lump-sum cash amount of RMB200 million and making a private placement of shares worth RMB800 million. These shares obtained by the six natural-person shareholders may be transferrable and tradable only after being unlocked in batches according to certain percentages over a three-year period.