Court-free Company Amalgamations

The Inland Revenue (Amendment) (Miscellaneous Provisions) Ordinance 2021 was enacted on 11 June 2021 to provide for tax treatment in relation to the amalgamation of companies under Division 3 of Part 13 of the Companies Ordinance (qualifying amalgamation). Part 6C of and Schedule 17J to the Inland Revenue Ordinance apply in relation to a qualifying amalgamation that takes effect on or after 11 June 2021. For qualifying amalgamations that took effect before 11 June 2021, the Assessor will make assessments in accordance with the following practice.

Profits tax consequences of a court-free amalgamation under the Companies Ordinance (Cap. 622) may not be the same as those in specific private merger ordinances in Hong Kong or in universal succession cases under foreign laws, which are not carried out for the purpose of obtaining tax benefits.

In the below paragraphs, the term “amalgamated company” refers to the amalgamating holding company in relation to a section 680 amalgamation and the amalgamating company whose shares are not cancelled upon amalgamation in relation to a section 681 amalgamation, whereas the term “amalgamating company” refers to each of the amalgamating companies other than the amalgamated company.

If the Commissioner is satisfied that the court-free amalgamation is not carried out for the purpose of obtaining tax benefits, the provisions in sections 61A or 61B will not be made applicable to the amalgamation (e.g. the denial of setoff of losses carried forward in the amalgamated company or from the amalgamating company) and the amalgamated company will generally be treated as far as possible as if it is the continuation of and the same person as the amalgamating company for the purposes of the Inland Revenue Ordinance.

Amalgamation with sale of assets of the amalgamating company

If the court free amalgamation is structured with a sale of assets on an arm’s length basis, the provisions relating to sale of assets will be applied to such amalgamation to assess any deemed trading receipts and to make balancing adjustments.

Amalgamation without sale of assets of the amalgamating company

The amalgamating company is treated for profits tax purpose on the day immediately before the amalgamation as having:

ceased to carry on its trade, profession or business; and
realized its trading stock in the open market.

The amalgamated company is treated for profits tax purpose on the date of amalgamation as having:

continued to carry on the trade, profession or business of the amalgamating company by way of succession;
qualified for annual allowances in respect of commercial/industrial buildings or structures by way of its entitlement to the relevant interests subject to balancing charges on disposal not exceeding the aggregate of the allowances made to it and the amalgamating company;
qualified for annual allowances in respect of machinery or plant by reference to reducing values still unallowed subject to balancing charges on disposal not exceeding the aggregate of allowances made to it and the amalgamating company;
qualified for any allowances/deductions under sections 16B, 16E, 16EA, 16F, 16G and 16I that the amalgamating company would have been allowed but for the amalgamation, subject to the assessment of proceeds as trading receipts on sale;
been entitled to deductions that the amalgamating company would have been allowed but for the amalgamation; and
earned the amount that would have been income or trading receipt of the amalgamating company but for the amalgamation.

The amalgamated company will be granted in the year of assessment in which the amalgamation takes place, annual allowances in respect of the commercial/industrial buildings or structures, and machinery or plant, and allowances/deductions under sections 16B, 16E, 16EA, 16F, 16G, and 16I. Such allowances and deductions will not be granted to the amalgamating company in the same year of assessment.

Tax losses

Tax losses are specific to a company and cannot be transferred to other group companies. Group loss relief and deduction for acquired losses through court-free amalgamation procedure are not to be allowed.

10.

Tax losses brought forward in the amalgamated company can be used to set off against profits derived from the trade or business succeeded from the amalgamating company if:

the amalgamated company has adequate financial resources (excluding intra-group loans) to purchase the trade or business of the amalgamating company other than through amalgamation (financial resources test);
the amalgamated company was carrying on a trade or business until the amalgamation (trade continuation test); and
such losses were incurred after the amalgamating company and the amalgamated company had become wholly owned subsidiaries of the same group (post entry test).

If not all the conditions are met, the tax losses can only be used to set off against the profits derived by the amalgamated company from its own trade or business.

11.

The term “financial resources” is broad and would include capital, liquid assets and cash. In applying the financial resources test, it may be necessary to consider the ability of the amalgamated company to raise funds from independent third parties having regard to its own credit rating.

12.

Tax losses brought forward from the amalgamating company can only be used to set off against the profits of the amalgamated company derived from the same trade or business succeeded from the amalgamating company (same trade test).

13.

The meaning of the word “same” in the phrase “same trade or business” imports identity and not similarity. It means an identical trade or business. The ultimate analysis will be a question of fact. Reference can be made to the judgement of Walton J in Rolls-Royce Motors Ltd v Bamford [1976] STC 162. In applying the same trade test, it is necessary to compare the trade or business actually carried on by the amalgamating company in the years of assessment in which it was making the tax losses in question and the trade or business carried on by the amalgamated company the profits derived therefrom are to be set off by such tax losses.

Example 1

Company-1 and Company-2, incorporated in Hong Kong, are both wholly-owned subsidiary companies of Holding Company. Company-1 owned and operated a high-end restaurant located in Central, which served a distinctive style of Japanese cuisine. The name of the restaurant reflected the style of the cuisine and was a registered tradename of Company-1. Company-2 owned and operated a low-end Italian restaurant in Wanchai with a registered tradename. Company-1 made losses. Company-1 and Company-2 amalgamated in accordance with section 681 of the Companies Ordinance and Company-2 became the amalgamated company.

If immediately after the amalgamation, Company-2 converted the premises where the Japanese restaurant was located into a restaurant serving Italian food and using the same tradename of the Italian restaurant, the same trade test would not be met. The answer to the question of whether the business carried on after the amalgamation was the same as that carried on immediately before the amalgamation, depends, in practical result, on the extent to which the business of the second restaurant resembles the business of the first restaurant. Opening an Italian restaurant would not ordinarily be regarded as an expansion of a Japanese restaurant business. Assuming the second restaurant is an equal part of the business, it would be difficult to describe the business, in the year in which a set-off is claimed, as the same but expanded business carried on before the amalgamation.

If immediately after the amalgamation, Company-2 continued to own and operate the Japanese restaurant with the same tradename as before, but converted half of the premises into a restaurant serving Italian food with the same tradename as its own Italian restaurant, the same trade test would be accepted as having been met. The tax losses brought forward from Company-1 could be used to set off against the profits of Company-2 derived from the Japanese restaurant succeeded from Company-1, but not the profits derived from the two Italian restaurants.

Example 2

Company-3 and Company-4, incorporated in Hong Kong, were both wholly-owned subsidiary companies of Holding Company in the United States. Company-3 and Company-4 were trading in the same products but with different customer bases. Company-3 was trading with customers in the Greater China Region whereas Company-4 was trading with customers in the ASEAN member countries. Company-4 incurred losses. Company-3 and Company-4 amalgamated in accordance with section 681 of the Companies Ordinance. Company-3 became the amalgamated company.

Since Company-3 and Company-4 sold the same products, the same trade test would be accepted as having been met if there were no significant differences in their mode of operations. Sales to customers in the Greater China Region after the amalgamation would be treated as an expanded part of the business of Company-4 as a result of its organic growth. The losses brought forward from Company-4 could be used to set off against the assessable profits of Company-3 after the amalgamation.

Example 3

Company-5, a wholly-owned subsidiary of Holding Company, was a special purpose vehicle incorporated in Hong Kong for the purpose of acquiring and developing a residential site in Kowloon for sale. Company-6, another wholly-owned subsidiary of Holding Company, was a special purpose vehicle incorporated in Hong Kong for the purpose of acquiring and developing a residential site in Kowloon for leasing. Company-5 incurred heavy losses after completing the sale of all the apartment units on the residential blocks constructed on the residential site. Company-5 and Company-6 were then amalgamated and Company-6 became the amalgamated company. The amalgamation was carried out in accordance with section 681 of the Companies Ordinance. When the amalgamation was completed, Company-6 constructed a block of building on the residential site and leased out the units therein for earning rental income.

The same trade test would not be satisfied. The development and holding of a residential building for earning lease rental was a business different from that of deriving selling profits from the construction and sale of residential units. Losses carried forward in Company-5 on sale of residential apartment units cannot be set off against the assessable profits of Company-6 after the amalgamation.

14.

The amalgamating company and the amalgamated company should seriously consider applying for an advance ruling under section 88A if tax losses available for set off on amalgamation are material in quantum or the application of the same trade test or the financial resources test is not so clear cut in the circumstances of the case.

Profits tax return

15.

The amalgamated company should inform the Commissioner in writing of the amalgamation within one month from the date of the amalgamation and submit a profits tax return for each amalgamating company for the year of assessment in which the date the amalgamating company is regarded as having ceased its business falls, together with certified management accounts covering the period from the day immediately following the end of the previous accounting year up to the day before the amalgamation.

Rights and obligations

16.

The amalgamated company should undertake all obligations imposed on the amalgamating company, in particular record keeping requirement, return filing requirement and provision of information requirement, and shall assume all its tax liabilities, certain or contingent, in respect of the year of assessment in which the amalgamating company is regarded as having ceased its business and all prior years of assessment.

(For Advance Ruling cases on Court-free Company Amalgamations, please click here.)