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China – Shaanxi Case: The First Tax Litigation Case On Cross-Border Share Transfers.

17 November, 2014


Legal News & Analysis – Asia Pacific – China – Tax


Earlier this year, a Chinese appellate court in Shaanxi ruled1 that the funds transferred by a buyer to a target company, which used the funds to discharge a counter guarantee made by the seller’s parent company on a loan, constitute share transfer income for the non-resident seller. This case is China’s first tax litigation case on cross-border share transfers.


In May 2012, a French company named Cimfra (China) Ltd (“Offshore Seller”) transferred its 100% share in Shaanxi Fuping Cement Co. Ltd (“PRC Target Company”) to a Hong Kong company named Faithful Alliance Ltd. (“Offshore Buyer”) in exchange for 284.2m shares of stock issued by West China Cement Ltd, the Offshore Buyer’s parent company. According to the share transfer agreement, the 284.2m shares of West China Cement Ltd constituted the total consideration for the transfer of the PRC Target Company’s shares worth RMB 504m.

Before the share transfer in April 2012, the Offshore Seller’s parent company, Ciments Francais, had issued a counter guarantee to UniCredit Banca S.p.A, which provided a guarantee to its Shanghai branch on the loan made by the Shanghai branch to the PRC Target company. According to the share transfer agreement, the Offshore Buyer had an obligation to discharge Ciments Francais’ counter guarantee within three months following the closing of the share transfer transaction. In September 2012, the PRC subsidiary company of the Offshore Buyer, Yaobai Special Cement Group Co. Ltd (“Yaobai”), transferred a set of funds to the PRC Target Company, and then the PRC Target Company used the funds to pay off the bank loan and related interest of RMB296.05 million owed by it in order to discharge Ciments Francais’ counter guarantee.

The Pucheng State Tax Bureau (“PSTB”), however, deemed the RMB 504m and the RMB 296.05m as gross income derived by the Offshore Seller for selling shares in the PRC Target Company and collected RMB 22.6m of EIT from the Offshore Seller. The Offshore Seller appealed the portion of the decision that said the RMB 296.05m should be considered part of the share transfer income it derived.

The corporate structure of this case is depicted in Diagram One below.


(Click to enlarge)



Holding And Ruling

The key substantive issue of this case on appeal was whether the RMB 296.05m should be considered as part of the share transfer income derived by the Offshore Seller. 

The appellate court held that (i) the Offshore Buyer’s obligation to get the counter guarantee discharged was one of the main provisions of the share transfer agreement; (ii) the RMB296.05 million transferred by Yaobai to the PRC Target Company was used to perform the discharge obligation; (iii) the RMB 296.05m were consideration paid by the Offshore Buyer or its related parties to perform the discharge obligation; and (iv) the RMB 296.05m should be considered as part of the share transfer income derived by the Offshore Seller.


This decision has been widely criticized by Chinese tax professionals. Other than the RMB 504m share transfer consideration, the Offshore Seller never received or derived directly or indirectly any income in any form from the Offshore Buyer, the Offshore Buyer’s related parties, or any other parties. Since the counter guarantee had not yet become a debt of the Offshore Seller’s parent company, the discharge of the counter guarantee did not constitute the cancellation of indebtedness income for the Offshore Seller or its related parties. In fact, the RMB 296.05m should be owed by the PRC Target Company to Yaobai.

Oddly, in an identical case reported in China Taxation News in its December 5 2012 issue, the tax bureau adjusted the share transfer price based on the general anti-avoidance rule under the Enterprise Income Tax Law. For more discussion of the case, please refer to the January & February 2013 issue of our China Tax Monthly. It is unclear why the application of the general anti-avoidance rule was not raised in this case on appeal.

Nonetheless, this case provides a cautionary example of how a poorly drafted share transfer agreement can result in unexpected tax costs. Therefore, it is imperative for the negotiation/drafting team and the tax team to work together to ensure that all transactional documents are drafted properly


End Notes:


1. Full text of the judgment is available (in Chinese) at http://www.court.gov.cn/zgcpwsw/shanxi/sxswnszjrmfy/xz/201408/t20140814_2510951.htm.


Baker McKenzie


For further information, please contact:


Jon Eichelberger, Partner, Baker & McKenzie

[email protected] 


Jinghua Liu, Partner, Baker & McKenzie

[email protected]


Brendan KellyPartner, Baker & McKenzie
[email protected]


William MarshallPartner, Baker & McKenzie
[email protected] 


Glenn DeSouza, Baker & McKenzie
[email protected] 


Shanwu Yuan, Baker & McKenzie
[email protected]


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