Newsletter
LAND VALUE INCREMENT TAX CAN BE DEFERRED OVER MULTIPLE MERGERS
Article 34 of the Corporate Mergers and Acqui-sitions Act (CMAA) provides that when land is transferred due to a merger, a demerger or an acquisition in which at least 65% of the consid-eration is given in the form of shares, land value increment tax (LVIT) can be first calculated and recorded, and payment can be deferred until such time as the acquiring company transfers the land to another party, at which point the deferred tax becomes payable together with the tax arising out of the period following the merger or acqui-sition.
It is clear that if land acquired through a merger or acquisition is transferred again due to a sub-sequent merger or acquisition, then the LVIT arising out of the period between the two trans-actions can be deferred. However, there has been doubt as to whether tax that was deferred at the time of the first M&A transaction can be further deferred, or whether it must be paid at the time of the land transfer pursuant to the second transaction.
According to a literal interpretation of the wording of the CMAA, deferred LVIT becomes payable upon any subsequent transfer of land ownership. The mere fact of a transfer of own-ership satisfies the conditions for the tax to be-come payable, regardless of the reason for the transfer. However, the underlying legal principle that justifies a deferral is that a merger or acqui-sition is not a substantive disposal of assets, and the transfer of land is merely a change of formal ownership, whereas the benefits and risks of ownership remain in the same hands through shareholding relationships or a general assump-tion of rights and duties. Therefore deferral of tax is allowed so as not to create a disincentive to a merger or acquisition.
By this line of reasoning, both the first and the second M&A transactions involve merely formal transfers of ownership; therefore, deferral of tax should be permitted on both occasions if the legislative spirit of the provision is to be upheld. Accordingly, on 29 December 2003 the Ministry of Finance (MOF) issued an interpretation stat-ing that if a post-merger company subsequently participates in another merger or demerger, it is permissible to defer LVIT further.
The above interpretation refers only to mergers and demergers, and not to cases in which the second transfer of land ownership is due to an acquisition. Thus doubt remained as to whether such cases could be handled in the same way. On 8 March 2004 the MOF issued a further in-terpretation stating that if land transferred in a merger is subsequently transferred again because the surviving or newly incorporated post-merger company is acquired by another company, pre-viously deferred LVIT may be further deferred.
However, in the case of an acquisition, the ac-quiring company does not make a general as-sumption of the rights and obligations of the acquired company as they existed prior to the acquisition. In view of this, although on the one hand the MOF is willing, in the event of a second M&A transaction, to allow deferred tax to be transferred to the acquiring company and further deferred, on the other hand, if the acquiring company were under no legal obligation to pay the deferred tax, the tax revenue might be lost. Therefore, to avoid subsequent disputes, the in be approved only on condition that the acquisi-tion agreement explicitly requires the acquiring company to assume the duty of paying the pre-viously deferred LVIT, and that the acquiring company provides to the tax collection authority a written undertaking to do so.
In terms of the legal relationships involved, if an acquisition agreement stipulates that the acquir-ing company assumes the duty to pay previously deferred LVIT in respect of the transferred land, in effect the previous obligation of the acquired company is transferred to the acquiring company by contract. If the acquiring company fails to perform its obligations under the acquisition agreement, the acquired company can do no more than make a claim against the acquiring company, on the basis of its rights under the agreement, for an amount equivalent in value to the amount of tax due. The public law duty to pay tax cannot itself be transferred by virtue of a private law contract.
Furthermore, an acquisition agreement cannot fully secure the tax authority's rights as a creditor. Liability to pay LVIT is usually secured by the land on which the tax liability arises. But this security only remains effective for as long as the tax liability remains attached to the land on which it arises. If the land is transferred to an-other entity, but the duty to pay tax remains with the transferor, then the tax authority may find its right unsecured. This explains why tax authori-ties may have concerns over such deferral.
Thus, the MOF interpretation requires that a company that acquires land by the acquisition of another company must, when reporting the cur-rent value of the land at the time of transfer, submit a written undertaking that it is willing to pay the amounts of tax that continue to be de-ferred. This written undertaking is a public law contract, which gives the tax authority the power to pursue the acquiring company for payment of tax, and places the acquiring company under a duty to pay tax on behalf of the original taxpayer.
Nevertheless, there is a difference in the degree of obligation between a duty to pay tax assumed under such a written undertaking, and one im-posed by a general assumption of rights and du-ties in case of a merger. Thus there may still be different views as to whether the future payment of LVIT deferred under such arrangements takes precedence over all other debts and mortgages. Also, both of the above MOF interpretations re-fer to a situation in which the first M&A trans-action was a merger. Whether this affects the further deferral of LVIT at the time of a second transaction if the first transaction was a demerger or acquisition, is an issue remains to be settled, through on may infer an answer from the above analysis.