30 March 2021
Proposed amendments to the Inland Revenue Ordinance
The enactment of the new Companies Ordinance (“CO”) in 2014 introduced a new, court-free amalgamation procedure for companies incorporated in Hong Kong, enabling companies to merge without a court order. Surprisingly, the Legislature made no immediate effort to enact consequential amendments to the Inland Revenue Ordinance (“IRO”). Practitioners were instead asked to rely on the guidance published by the Inland Revenue Department (the “IRD”), which was wholly unsatisfactory. Indeed, in 2017, we commented (see our Client Alert dated 13 January 2017) that the IRD guidance had no statutory basis and was wrong in law. On March 19 2021, the Inland Revenue (Amendment) (Miscellaneous Provisions) Bill 2021 was finally gazetted, proposing amendments to the Inland Revenue Ordinance (“IRO”) to codify the tax treatment for court-free amalgamations (the “Bill”).
As regards the critical issue of tax loss – that is, whether absorbed company can transfer its unrelieved tax losses to the fused, or merged company – the Bill largely mirrors section 34C of the Singapore Income Tax Act, which is perhaps logical as the Singaporean tax code is very similar to the IRO, and the amalgamations regime in the CO is based on the Singaporean model. This alert focuses on two critical aspects of the Bill: (i) the immediate tax consequences following a court-free amalgamation as regards the stock-in-trade of the amalgamating company; and (ii) the tax treatment of unrelieved losses of the amalgamating company carried forward.
For the avoidance of doubt, the term ‘amalgamating company’ means the company whose shares are cancelled pursuant to the amalgamation (i.e., the company which is absorbed) and the term ‘amalgamated company’ means the company that carries on, post-amalgamation (i.e., the absorbing company).
Amalgamating company and amalgamated company
As a preliminary point, the corporate amalgamations regime is a species of merger. Companies may amalgamate horizontally or vertically:
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(1) |
Horizontal amalgamation involves the merger of wholly owned subsidiaries of the same company. |
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(2) |
Vertical amalgamation involves the merger of a holding company and one or more of its wholly owned subsidiaries. |
Immediate tax consequences
As a preliminary note, on the terms of the CO the amalgamating and amalgamated companies “continue as one company”; that is, the amalgamating company is not dissolved, but continues to exist, albeit subsumed within the legal personality of the amalgamated company. Conversely, the default position under the IRO as contemplated in the Bill would be that the amalgamating company would be treated as having ceased to carry on its business on the day immediately before the amalgamation. This has potentially wide-ranging profits tax consequences because under section 15C of the IRO, the cessation of a business entails the deemed disposal of trading stock at market value, which would in turn give rise to an immediate charge to profits tax on any gains arising from that deemed disposal. The Bill does not, however, specify that the amalgamating company otherwise disappears as a taxable subject and so does not derogate from the corporate law position that the amalgamating company continues to exist, albeit subsumed into the merged whole of the amalgamated company.
The Bill proposes to constitute an opt-in regime, which, subject to certain conditions, will enable the amalgamating company to transfer its tax attributes in a tax-neutral manner to the amalgamated company. The tax regime in the Bill does not consequently automatically apply to all amalgamations. The amalgamated (i.e., successor) company may irrevocably elect for the special tax treatment to apply to it and each amalgamating company. The election may be made within one month after the amalgamation date or such further period as the Commissioner of Inland Revenue may allow.
If the amalgamating companies did not opt for special tax treatment, however, the default rules in the IRO would apply. This may cause a potential tax charge on the deemed disposal of trading stock upon cessation of a business, but should in principle preserve interesting tax planning opportunities as regards the carry-forward of losses, since it is arguable that under the IRO generally such losses would automatically and without condition be transferred to the amalgamated company, post-amalgamation. Thus, the default position outside of the opt-in regime should, technically, be more favourable to the amalgamating companies than the regime contained in the Bill.
Upon the making of the said election, any trading stock of the amalgamating company will be treated as having been acquired by the amalgamated company on a tax neutral basis, with the taxation of any gain deferred to the time when the trading stock is actually realised. What that means is that the amalgamated company is treated as having inherited the ‘base cost’ of the trading stock from the amalgamating company. This privileged tax treatment will, however, only be available if the amalgamated company continues to hold the assets in question as trading stock. If they cease to be held as trading stock, then s.15C of the IRO would apply, and the assets in question would be deemed to be sold and bought at market value upon the amalgamation taking effect, thereby potentially giving rise to an immediate charge to profits tax.
A similar, comparatively generous tax-neutral succession regime should apply to the vesting of plant, machinery, industrial and commercial buildings, and intellectual property rights in an amalgamated company pursuant to an amalgamation. The advantage of having a specific opt-in regime for those purposes is to provide legal certainty on the tax consequences of an amalgamation.
Loss carry-forward
The position as regards the unrelieved trading losses carried forward by the amalgamating company is much more complex. Generally, the IRD is concerned about the aggressive tax planning opportunities afforded to the taxpayer by the amalgamations regime as currently in force. As we have discussed in previous alerts, the better position as a matter of law is that the amalgamated company succeeds wholly and unconditionally to the unrelieved losses carried forward by the amalgamating company, subject only to the specific anti-avoidance provision in section 61B of the IRO. The conditions that the IRD purported to impose on the carry-forward of losses were devoid of any statutory grounding: they were in effect unilaterally decreed by the IRD. Now, the IRD proposes that the conditions previously contained in its practical guidance notes be put on statutory footing.
The table below summarises the conditions attached to the carry-forward of losses, as described in greater detail below:
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Set off |
Profits from the trade or business of: |
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Amalgamating company (as succeeded by amalgamated company) |
Amalgamated company |
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Pre-amalgamation losses of: |
Amalgamating company |
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Cannot be set off |
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Amalgamated company |
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Set off generally available. |
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Treatment of pre-amalgamation losses of amalgamating companies
The unutilised pre-amalgamation losses of the amalgamating company can be used to set off against the profits of the amalgamated company derived from the same (i.e., identical) trade or business succeeded from the amalgamating company (the “Same Trade Condition”) if:
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(1) |
those losses were incurred after: (i) in the case of a horizontal amalgamation, the amalgamating company and the amalgamated company had become wholly owned subsidiaries of the same company, or (ii) in the case of a vertical amalgamation, the amalgamating company had become a wholly owned subsidiary of the amalgamated company (the “Post-entry Condition”); and |
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(2) |
the Commissioner of Inland Revenue is satisfied that the amalgamation is carried out for good commercial reasons and not for tax-avoidance purpose (the “Purpose Condition”). |
The aim of these conditions is to ensure that the corresponding losses and profits relate to the same trade or business of the same group company. They aim to prevent tax structuring by arranging for the introduction of a company with extensive unutilised losses being brought into a corporate group for the purposes of amalgamating it with one or more profitable companies with a view to utilising its unrelieved losses.
A corollary of the Same Trade Condition is that the unutilised losses of the amalgamating company can only be set off against the profits of the amalgamated company to the extent that that the amalgamated company succeeds to the same trade or business, and the set-off is therefore limited to the profits arising to the amalgamated company from that specific trade or business and not, by extension, any other trade or business it may carry on.
Treatment of pre-amalgamation losses of amalgamated companies
The unutilised pre-amalgamation losses of the amalgamated company can be used to set off against the profits of the amalgamated company derived from the trade or business both succeeded from the amalgamating company and of its own, if the conditions summarised below are met.
To set off against the profits of the amalgamated company derived from the trade or business to which it has succeeded from the amalgamating company, all of the following conditions must be satisfied:
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(1) |
The amalgamated company has sufficient financial resources to purchase the trade or business of the amalgamating company otherwise than through amalgamation. Such resources exclude loans from associated companies (the “Financial Resources Condition”). This in effect requires the amalgamated company to show that hypothetically it could have acquired the undertaking of the amalgamating company with the resources at its disposal. |
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(2) |
The amalgamated company has continued without interruption to carry on a trade or business since those losses were incurred up to the amalgamation date (the “Trade Continuation Condition”). |
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(3) |
The Post-entry Condition, as summarised above. |
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(4) |
The Purpose Condition, as summarised above. |
Those conditions are again primarily motivated by a desire to discourage aggressive tax planning and, as far as possible, seek to allow the utilisation of losses only in scenarios where the amalgamation could, in principle, have been structured as a bona fide acquisition of a going concern.
The way forward
It is expected that the Bill will be enacted by the Legislative Council of Hong Kong in due course and in any event within the 2021 calendar year.
How we can help
The tax implications of an amalgamation are complex and that is why we consider it crucial to seek and obtain robust legal advice in this regard. We are highly experienced in advising on tax planning and structuring in connection with amalgamations, and for devising innovative structures in that regard. Given that the Bill will likely impose very stringent conditions on such planning for those companies that wish to opt-in to the specific amalgamations tax regime, we would advise clients seeking tax-efficient outcomes to discuss their plans with us with a view to effecting any envisaged amalgamation prior to the coming into force of the new legislation. Planning and mitigation options may also be available outside of the restrictive ambit of the specific amalgamations tax code we have summarised above.
For further information, please contact:
Stefano Mariani, Deacons
stefano.mariani@deacons.com.hk
