Amalgamations and tax planning
The enactment of the new Companies Ordinance in 2014 introduced a new, court-free amalgamation procedure for companies incorporated in Hong Kong, with a view to facilitating corporate reconstructions.
An amalgamation is in substance a species of corporate merger. Companies may amalgamate horizontally where the amalgamating companies are wholly owned by the same body corporate, or vertically, when one company is wholly owned by the other.
Amalgamations potentially offer a number of tax planning solutions, which, in the right circumstances, can give rise to considerable fiscal savings and long-term advantages.
Companies chargeable to Hong Kong profits tax may carry forward trading or business losses indefinitely and those losses may be set-off against the profits of any trade or business carried on by the same company. That means that in each year of assessment, the aggregate loss carried forward must be set-off against assessable profits from any trade or business, and any unutilised loss carried forward to the subsequent year of assessment. There is, however, no provision in the Inland Revenue Ordinance for the transfer of losses from one company in a group to another company.
Thus, where one company has significant losses carried forward, and no prospect of utilising them, and another company in the same group is envisaged to realise extensive profits, but has no losses carried forward, a tax-efficient solution could be to amalgamate the two companies, enabling the profit-making company to utilise the losses of the loss-bearing company, and so minimise its own liability to profits tax. It makes no difference that the profit-making company carries on a trade or business different from that of the amalgamating company.
Whilst our view differs from that of the Inland Revenue Department (“IRD”) (see below) we consider loss-carry forward after an amalgamation to take place automatically and by operation of law. That is because the Companies Ordinance is clear that the amalgamating companies continue as one. In other words, the companies subject to the amalgamation process become one entity, but do not cease to exist. Instead, they continue in the form of a single company, preserving all their corporate and fiscal characteristics.
In light of the continuity of the amalgamating company, capital allowances would likewise be transferable to the successor company, post-amalgamation. As is the case with losses carried forward, this could offer substantial tax advantages to the successor company, by enabling it to decrease the amount of its taxable profits through the deduction of capital allowances.
Consider the case of a company holding Hong Kong real estate, or Hong Kong shares, and wishing to make an intra-group transfer of the same. In the ordinary course, the transfer of Hong Kong real estate or shares in a Hong Kong company give rise to a charge to ad valorem stamp duty. Historically, the preferred solution for avoiding liability to stamp duty was to apply for relief under section 45 of the Stamp Duty Ordinance, which in summary exempts certain intra-group transfers from stamp duty. Section 45 relief, however, requires that the transferor and transferee companies remain associated – i.e., one is beneficial owner of 90 per cent of the issued share capital of the other, or both are 90 per cent beneficially owned by a third body corporate – for two years after the transfer has taken place.
Company amalgamation offers a more flexible solution. Because stamp duty is a tax on instruments of transfer, and not on transactions, there must in a given transaction exist some instrument of transfer to bear the stamp duty. In the case of an amalgamation, no such instrument of transfer exists – it follows that no stamp duty is payable where a company holding Hong Kong real estate amalgamates. In this case, the transfer of the Hong Kong real estate to the successor company would take place free from stamp duty and would not further be constrained by the two-year association condition for section 45 relief. That same reasoning would apply to the case of an amalgamating Hong Kong company holding shares the transfer of which would ordinarily give rise to a charge to stamp duty.
The views of the Inland Revenue Department
The IRD has recently updated its guidance on amalgamations and the carry-forward of losses, which may be accessed here: http://www.ird.gov.hk/eng/tax/bus_cfa.htm. That guidance purports to impose extensive and onerous conditions on the carry-forward of losses from an amalgamating company to the successor company. Notably, the IRD asserts that the unrelieved losses of an amalgamating company may be utilised by the successor company only if such losses are set-off against the profits of the successor company derived from the same trade or business with respect to which the losses were originally incurred. The IRD has stated in its guidance that it will take a highly restrictive view of that which, for those purposes, constitutes the ‘same’ trade or business.
There is no statutory basis for the conditions set forth in the IRD guidance, given the clear reference in the relevant tax legislation to set-off being available against the profits of any trade or business carried on by the successor company, rather than the same trade or business carried on by the amalgamating company. We therefore consider the IRD’s position to be wrong in law. We would encourage taxpayers to assert their statutory rights and reject the imposition by the IRD of extra-statutory additional conditions to matters that are properly and statutorily governed by the Companies Ordinance and the Inland Revenue Ordinance.
As regards stamp duty, the IRD has yet to publish its position on the effect of an amalgamation, though we understand that, as a matter of unwritten policy, the Stamp Office should accept that a transfer of assets by way of a merger – presumably including an amalgamation – should not give rise to a charge to stamp duty.
How we can help
The tax and corporate law implications of an amalgamation are complex and that is why we consider it crucial to seek legal advice in this regard. Our role is to assist both with structuring and implementing a tax-efficient amalgamation, and in advising on and managing any dispute with the IRD. We would in particular encourage interested parties to explore tax structuring solutions under the new Companies Ordinance with us before the Inland Revenue Ordinance is amended specifically to reflect the new corporate law in Hong Kong. There is now a unique window of opportunity for tax-efficient planning, where the current drafting of tax legislation very much favours the taxpayer.
In this regard, we note that legal professional privilege applies only between duly instructed lawyers and their clients and does not therefore apply between accountants and their clients.