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April 28, 2021
2021-0867

Hong Kong introduces legislation regarding tax treatment of court-free amalgamation of companies

Executive summary

The Hong Kong Government introduced the Inland Revenue (Amendment) (Miscellaneous Provisions) Bill 2021 (the Bill) on 19 March 2021, which addresses the tax implications of court-free amalgamations of companies.1 Subject to the passage of the Bill by the Legislative Council, the provisions of the Bill will be in effect on or after the date when the law is enacted.

This Alert summarizes the key provisions of the Bill.

Detailed discussion

The key provisions of the proposed tax treatment are:

Succession of trading stock

If trading stock succeeded from an amalgamating company continues to be used as trading stock of the amalgamated company (i.e., the surviving company), such trading stock is treated as being transferred at its book cost at the date of the amalgamation.2

If trading stock originally held by the amalgamating company becomes a capital asset upon amalgamation:

  • The amalgamating company is deemed to have disposed of the asset to the amalgamated company at fair market value at the time of the amalgamation.  Any profits derived by the amalgamating company from such a deemed disposal are subject to profits tax in its final tax year.
  • The amalgamated company is deemed to have acquired the capital asset at fair market value at the time of the amalgamation for the purpose of any tax deductions or allowances in respect of the asset. 

Succession of capital assets

If a capital asset succeeded from an amalgamating company continues to be used as a capital asset after amalgamation, the amalgamated company can continue to claim tax deductions or allowances in respect of the asset based on the tax written down value carried forward by the amalgamating company. When such capital asset is subsequently disposed of by the amalgamated company, the tax balancing adjustment or claw-back on such disposal is computed by reference to the sum of the tax deductions and allowances previously claimed by the amalgamating company and the amalgamated company.

If a capital asset originally held by the amalgamating company becomes trading stock upon amalgamation:

  • The amalgamating company is deemed to have disposed of the capital asset at the fair market value at the time of the amalgamation for the purpose of computing any tax balancing charges or allowances in respect of the asset.
  • The amalgamated company is deemed to have acquired the trading stock at its fair market value at the time of the amalgamation for the purpose of computing any taxable profits when it subsequently disposes of the asset.

Utilization of an amalgamating company’s tax losses carried forward 

Utilization of tax losses of an amalgamating company is subject to the following conditions:

  • Post entry condition: the losses must have been incurred after the amalgamating company and the amalgamated company had entered into a qualifying relationship (i.e., both companies were wholly owned subsidiaries of the same company or one is a wholly owned subsidiary of the other).
  • Same trade condition: such losses can only be utilized to set-off against the profits of the same trade or business succeeded from the amalgamating company.

Utilization of pre-amalgamation tax losses sustained by the amalgamated company

Set-off of pre-amalgamation losses sustained by the amalgamated company against the assessable profits of the business succeeded from an amalgamating company is subject to following conditions:

  • Post entry condition: same as the section above.
  • Financial resources condition: the amalgamated company has adequate financial resources (excluding loans from associated corporations) to purchase the trade or business of the amalgamating company other than through an amalgamation.
  • Trade continuation condition: the amalgamated company has continued to carry on a trade or business since the losses were incurred up to the date of amalgamation.

In addition to the above conditions, no utilization of tax losses would be allowed (whether sustained by the amalgamating company or the amalgamated company) unless it is proved to the satisfaction of the Commissioner that:

  • There are good commercial reasons for carrying out the amalgamation.
  • The avoidance of tax is not the main purpose, or one of the main purposes, of carrying out the amalgamation.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young Tax Services Limited, Hong Kong

Ernst & Young LLP (United States), Hong Kong Tax Desk, New York

Ernst & Young LLP (United States), Asia Pacific Business Group, New York

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ENDNOTES

  1. In 2014, Hong Kong introduced provisions to facilitate an amalgamation of two or more wholly owned companies within a group without requiring the approval of the Court. An amalgamation of companies is a legal process that allows the property, liabilities and undertakings of two or more companies to merge and be succeeded by a single surviving company. After the process, the amalgamating companies cease to exist as separate entities and their shareholders will become the shareholders of the amalgamated company.
  2. This treatment does not apply if the trading stock is measured in the financial accounts of the amalgamated company at its fair market value at the date of amalgamation.  In such cases, for tax purposes, the trading stock is deemed to have been sold and acquired at fair market value.
 

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting or tax advice or opinion provided by Ernst & Young LLP to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader's specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The reader should contact his or her Ernst & Young LLP or other tax professional prior to taking any action based upon this information. Ernst & Young LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

 

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