Proposed changes to Hong Kong SAR’s company amalgamation rules
Lewis Lu and John Timpany of KPMG discuss the proposed changes to taxing the amalgamation of companies.
On January 4 2021, the Legislative Council Panel on Financial Affairs released its discussion paper on the proposed amendments to the taxation of the amalgamation of companies, along with proposals to increase electronic filing of electronic tax returns. Draft legislation of the proposed measures is expected to be introduced in March or April 2021.
Since the introduction of simplified procedures for company amalgamations in 2014, the tax consequences of amalgamations have been an area of controversy. A view held by many, and which had been applied in a number of amalgamations prior to the new ordinance, is that an amalgamation takes place through universal succession, such that the surviving entity inherits all the historic attributes of the amalgamating entity, including its tax positions. This would mean that capital allowances, losses and other tax attributes of both companies would be available for use in the continuing entity.
The Inland Revenue Department (IRD) has taken a different view, which it has published as guidance on its website. It has argued that the amalgamating company ceases to exist on the day immediately before the amalgamation, resulting in a realisation of trading stock at open market value. Although it has allowed the succeeding entity to continue to claim capital allowances, it has argued that the amalgamating entity’s losses cannot be used by the succeeding entity and has imposed restrictions on the use of the pre-amalgamation losses of the succeeding entity.
It is a welcome move for Hong Kong SAR to finally introduce legislation to provide some clarity to taxpayers. However, the legislation is broadly consistent with the non-legislative framework previously set out by the IRD and will allow amalgamating companies in a qualifying amalgamation to make an election for continuity of tax treatment pre- and post-amalgamation.
This would include the losses of both entities, although there will be restrictions and anti-avoidance clauses such that losses will only be available to the extent they arose while both companies were in the same 100% group, where the companies conduct the same trade and the amalgamated company has sufficient financial resources. In its application of its guidance to date, the IRD has taken a very narrow view of what constitutes the same trade, and this may be an argument that continues after the introduction of the new law.
The bill will introduce a rule that where specified assets are transferred without a sale, other than as part of a qualifying amalgamation or as a result of a person’s death, they will be deemed to be disposed of at market value for tax purposes.
One important point to note is that the paper suggests a qualifying amalgamation will be one conducted under Division 3 of Part 13 of the Companies Ordinance. It is therefore not clear whether foreign companies conducting business in Hong Kong SAR will qualify for the amalgamation provisions, or whether any such amalgamations would automatically be caught by the deeming provisions.
Further details will be provided in the bill. While most jurisdictions have anti-avoidance provisions to address the artificial transfer of losses (and Hong Kong SAR already has section 61A), it is important that the process is flexible enough that taxpayers can undertake commercially driven mergers without undue tax cost and that the law is administered in this spirit.
Filing of tax returns
The other area of focus of the paper is to increase the electronic filing of tax returns. This is to be welcomed and many find it surprising that a leading financial centre had continued to be so focused on paper filings. The paper announces that electronic filings would be optional and that the Legislative Council will be consulted prior to any decision to make it compulsory.
The IRD is also proposing to allow service providers to file returns on behalf of taxpayers and to introduce a range of penalties for service providers who fail to meet their obligations in this regard. These appear to be in addition to any penalties for the taxpayer.
Partner, KPMG China
Partner, KPMG China