Due to various reasons, the debtor and creditor may discuss to make debt reorganization to repay the debt with shares or other tangible or intangible assets. Under certain situations, the creditor may decide directly to waive the debt.
Tax treatment varies for each debt reorganization method, we would discuss below by analyzing the tax regulations.
1. Situation1: creditor waives all debt
Sometimes, the creditor waives all amount of debt and the debt is written off in accounts of debtor. This situation rarely happens among third parties, but often between related parties. For example, the subsidiary is lacking of cash flow or will bede-registered. The investor may choose to waive the debt for finance support purpose or clearing current accounts for prompt de-registration purpose. For the payable to a third party, when the debt cannot be paid due to the reason of creditor, e.g. the creditor does not exist anymore or the court makes the waiving decision, the debtor can write off the debt.
In general, debt waived by creditor shall be included in income of the debtor for tax payment. According to tax document (Law of Corporate Income Tax of PRC), debt waived by the creditor falls in the scope of income for paying tax. Therefore, if company A, which is the creditor of company B, forgives the debt of company B at RMB 100, RMB 100 shall be included in income of company B to calculate corporate income tax (“CIT”).
Then how about the debt waive between investor and subsidiary? Will tax still be paid?
According to the tax document (State tax bureauannouncement (2014) 29), where the investor transfers an asset to its subsidiary, and the transfer agreement states that the asset transfer is treated as capital injection, including capital surplus, the asset transfer is allowed to be excluded in the income of the subsidiary. If the assets transfer is treated as income, tax shall be levied by the subsidiary.
According to the above tax document, if an investor waives the liability of a subsidiary, and the liability waived is treated as capital, including capital surplus, to the subsidiary, no CIT shall be levied. This is because the liability waive can be regarded as transfer of a receivable, which is one kind of assets. However, if no stipulation treating the transfer as capital is noted in the agreement, the liability waive amount will be included in income of the subsidiary for CIT payment.
2. Situation2: the creditor waives partial debt
When the debtor has difficult to repay the debt, the creditor may discuss with the debtor the debt reorganization arrangement in order to reduce the loss. The creditor largely may make a concession to agree the debtor to repay the debt with non-monetary assets, of which, the fair value might be lower than the debt amount and partial debt has to be waived. In this case, debtor would make again and the creditor has to sustain a loss.
(1) If debtor and creditor sign a debt reorganization agreement for debt payment with a non-monetary asset, the transaction shall be divided into two sub-transactions, which are transfer of assets and debt repayment. The tax base for the non-monetary asset shall be fair value. For the debt repayment transaction, if the fair value of the asset is more than the debt amount, the debtor shall recognize an income and pay tax for the excess amount. And for the creditor, it is a loss for debt reorganization arrangement.
(2) If debtreo rganization is to transfer debt to equity, according to the tax document (Caishui (2009)59), the transaction shall be divided into two sub-transactions for tax treatment, which are the debt repayment and capital investment. For the debt repayment, the same as the debt payment with non-monetary assets mentioned under above point, the income or loss from debt repayment for both debtor and creditor shall be recognized. The tax base for the shares here shall be the fair value. The debtor shall pay tax for the income.
(3) According to the tax document (Caishui (2009)59), if certain conditions are satisfied, for the arrangement that repayment includes shares, which means that the debtor use the shares of the debtor’s company or the debtor’s controlled company as part of consideration to repay debt, debtor and creditor can together apply for special tax treatment. Under special tax treatment, CIT on income from debt reorganization can be paid evenly among 5 years. And for debt to equity, temporarily, no income and loss on debt reorganization can be recognized by both debtor and creditor. The tax obligation for the income can be delayed until debtor closes the company or transfers to the shares.
If you need further assistance on the details of tax regulations or other concerns on enjoying the tax preferential policy, please contact us.
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