Recently, I had the privilege of attending the 9th Tax Judicial Theory and Practice Forum. In the forum, the author and numerous experts in tax theory and practice discussed the issue of whether tax authorities should refund taxes after a failed bet on the case of "Wang and Shanghai Taxation Bureau not refunding taxes" through their evaluation. Here, the author summarizes his personal views and opinions on the issue of "whether tax refunds can be issued for gambling failures", and lists the enforcement practices of tax authorities in various regions for readers' reference.

1、 Basic Case - Wang and Shanghai Taxation Bureau's Refusal to Refund Taxes Case

Case number: (2023) Hu 7101 Hang Chu 518, (2024) Hu 03 Hang Zhong 133

From December 2015 to June 2016, investor A company signed agreements with financing party Wang and external party Yuan, including the "Agreement on Issuing Shares and Paying Cash to Purchase Assets", "Agreement on Profit Forecast Compensation for Issuing Shares and Paying Cash to Purchase Assets", and supplementary agreements. It was agreed that investor A company would purchase 100% equity of target company B held by Wang and external party Yuan, with a total transaction price of RMB 1.15 billion. Company A would pay in a combination of cash payment and issuing stocks. Wang holds 50% equity of Company B and received a total of RMB 250 million in cash consideration and RMB 325 million in stock consideration (issued by Company A), totaling RMB 575 million. Both parties also agreed that if the target company B fails to achieve the promised net profit amount in the future (2016-2019), Company A shall repurchase its shares issued to Mr. Wang at a total price of RMB 1.

Due to B Company's failure to meet the net profit targets for 2018 and 2019, Wang fulfilled the "Compensation Agreement" and compensated A Company's shares in two installments, with a total repurchase price of 1 yuan. On October 11, 2022, Wang claimed that the price of his equity transfer transaction had been reduced, resulting in an overpayment of personal income tax of 53744652.18 yuan. Therefore, he applied to Q Tax Bureau for a refund of the tax. After the Q tax bureau made the decision not to refund the tax, the case was reviewed by the Shanghai tax bureau, and the first and second instance final procedures were carried out. The taxpayer Wang's tax refund application was not supported by the tax authorities and the court.

The second instance court held that: 1. The performance of the obligation to compensate for shares is a compensation for the operational risks of Company B, rather than an adjustment to the total consideration of 1.15 billion yuan for the equity transfer transaction involved in the case. The fulfillment of Wang's obligation to compensate for shares does not change the income from equity transfer in the sense of tax administration. 2. Although the actual benefits of Wang's equity transfer will ultimately be determined with the completion of a package of agreements such as the Asset Purchase Agreement and the Profit Forecast Compensation Agreement. However, in the field of taxation, there is currently no specialized tax collection and management arrangement designed for such transaction models. Therefore, no tax refund will be granted.

2、 Case evaluation

After seeing the above two statements of the second instance court, the author believes that there is a conflict between the above viewpoints. If it is determined that the fulfillment of the obligation to compensate for shares does not change the transaction consideration, then no tax refund will be granted and there will be no issues; But in the second paragraph, the court also acknowledged the fact that the actual benefits of Wang's equity transfer had changed, which means that the transaction consideration had changed. So there are contradictions in the two paragraphs of the judgment.

The core issues that have sparked multi-party discussions in this case are: "Can a tax refund be issued if a bet fails?" and "How should the court make a judgment if there is no arrangement for tax collection and management of a certain transaction model in the tax field

（1） This case does not involve the "equity repurchase" as described in State Taxation Letter (2005) No. 130

One viewpoint holds that Company A's repurchase of shares held by Mr. Wang at a total price of 1 yuan falls under the circumstances of Article 1 of State Taxation Letter (2005) No. 130 and should not be subject to tax refund. This viewpoint raises the issue of legal application errors. According to Article 1 of the Reply of the State Administration of Taxation on the Issue of Taxpayers Withdrawing and Levying Personal Income Tax on Transferred Equity, Guoshuihan (2005) No. 130, "If the equity transfer contract has been fulfilled, the equity has been registered for change, and the income has been realized, the transferor shall pay personal income tax on the equity transfer income obtained in accordance with the law. After the transfer is completed, both parties shall sign and execute an agreement to terminate the original equity transfer contract and return the equity, which is another equity transfer, and the personal income tax levied on the previous transfer shall not be refunded." According to this provision, Guoshuihan (2005) No. 130 is applicable to "equity repurchase of the same company. But in this case, Wang transferred the equity of Company B, and Company A repurchased the equity of Company A paid to Wang (with a partial refund of the transaction consideration). Therefore, this case does not apply to State Taxation Letter (2005) No. 130.

（2） The betting agreement is a valuation adjustment agreement, and the equity repurchase is a non independent "secondary transaction"

Taxation arises from the trading activities of market economy entities. Therefore, the establishment of the tax system is also related to the arrangement and purpose of transactions. The Notice of the Supreme People's Court on Issuing the Minutes of the National Conference on Civil and Commercial Trial Work of Courts (Law [2019] No. 254) provides a clear definition of "betting agreement". "A betting agreement, also known as a valuation adjustment agreement, refers to an agreement designed by the investor and the financing party to address the uncertainty, information asymmetry, and agency costs of the target company's future development when reaching an equity financing agreement. It includes equity repurchase, monetary compensation, and other adjustments to the valuation of the target company in the future." Therefore, stock repurchase or monetary compensation arising from performance failure should not exist in isolation. However, in the practice of tax treatment, except for the cases of "Li Julian" from Guangzhou Taxation Bureau and "Silver Jubilee Technology" from Dongguan Taxation Bureau, which involved returning personal income tax after a failed bet, tax authorities mostly consider equity repurchases and monetary compensation due to underperformance as independent transactions and do not affect the determination of the initial equity transfer price.

In this case, the court also determined that the actual benefits of Wang's equity transfer were ultimately determined with the completion of a package of agreements such as the Asset Purchase Agreement and the Profit Forecast Compensation Agreement. The author believes that based on this assumption, the price of equity transfer transactions should also be determined after the overall performance of the package agreement. After considering the true commercial purposes of both parties under the civil legal relationship, the adjustment of the transaction consideration by both parties should be respected, and the taxable income should be recalculated.

（3） The court should use penetrating judicial thinking to respond to disputes involved in the case

The Notice of the Supreme People's Court on Issuing the Minutes of the National Conference on Civil and Commercial Trial Work of Courts (Law [2019] No. 254) clarifies that judicial judgments should use "penetrating trial thinking", that is, "pay attention to handling the relationship between civil and commercial trials and administrative supervision, through penetrating trial thinking, identify the true intentions of the parties, and explore the true legal relationship. I believe that when the tax system is unclear, tax refunds should be given from a perspective that benefits taxpayers. After all, Article 1 of the Tax Collection and Administration Law has already clarified the principle of protecting taxpayers' rights and interests.

3、 Enforcement practices of tax authorities in various regions

Based on the announcement of a listed company, publicly available cases, and responses from tax service centers in various regions, we will understand the handling situation of different tax authorities.

（1） Dongguan Taxation: Tax refund allowed

In June 2016, Guangdong Silver Jubilee Technology Co., Ltd. (hereinafter referred to as "Silver Jubilee Technology") signed the "Performance Commitment Compensation Agreement between Guangdong Silver Jubilee Technology Co., Ltd. and the subscriber" (hereinafter referred to as "Performance Commitment Compensation Agreement") with Hu Enci, Chen Zhiyong, Xu Liming, and Gao Bingyi, former shareholders of Xingke Electronics Technology Co., Ltd. (hereinafter referred to as "Xingke Electronics"). The Performance Commitment Compensation Agreement stipulates that Hu Enci, Chen Zhiyong, Xu Liming, and Gao Bingyi, as performance compensation obligors, undertake that Xingke Electronics' net profit (after deducting non recurring gains and losses) for the years 2016-2018 shall not be less than RMB 200 million, RMB 240 million, and RMB 290 million, and agree to compensate Xingke Electronics Technology for the shortfall in actual net profit compared to the committed net profit. Due to Xingke Electronics' cumulative net profit after deducting non recurring gains and losses from 2016 to 2018 being -56.09 million yuan, and Xingke Electronics' cumulative committed performance from 2016 to 2018 being 730 million yuan, Xingke Electronics Technology's performance commitment completion rate is 0%.

According to the Performance Commitment Compensation Agreement, Hu Enzi, Chen Zhiyong, Xu Liming, and Gao Bingyi are required to provide performance compensation to the company (i.e. share and cash compensation and refund of dividends already received from the company). In July 2019, Silver Jubilee Technology submitted a personal income tax refund application to the Dongguan Taxation Bureau. Based on the stocks compensated by Hu Enci, Xu Liming, and Gao Bingyi, the original shareholders of Xingke Electronics, the company applied for a refund of 112550463.36 yuan.

After receiving the tax refund application, the Dongguan Tax Bureau granted the refund.

（2） Guangzhou Taxation: Approval to Adjust Transaction Consideration

The Announcement on Service of Tax Documents (Li Julian Tax Processing Decision) No. 91 of 2020 issued by the Third Inspection Bureau of Guangzhou Taxation Bureau shows that:

In May 2014, Huawen Media acquired 100% equity of Guangzhou Bangfu Software held by Li Julian and three others, with a total transaction price including cash of 201.6 million yuan and stock of 518.4 million yuan. At the same time, performance compensation clauses were agreed upon. Due to Guangzhou Bangfu Software's failure to fulfill its performance commitments, Li Julian and three others were required to provide performance compensation, with Li Julian compensating 1038644.00 shares of the company's stock.

Due to Li Julian's failure to fully declare and pay personal income tax on the above-mentioned equity transfer, the inspection bureau requires Li Julian to make up for the personal income tax. When calculating the amount of tax that Li Julian should make up, the inspection bureau deducted the value corresponding to 1038644.00 shares of compensation for Huawen Media (calculated based on the initial issue price).

（3） Hainan Taxation: The profit compensation obtained can be regarded as an adjustment to the pricing of the acquired equity

Reply on Issues Related to Enterprise Income Tax on Profit Compensation of Gambling Agreements (Qiongdi Tax Letter (2014) No. 198)

Hainan Airlines Co., Ltd.:

We have received your company's request regarding the issue of corporate income tax on profit compensation for gambling agreements (Qionghangcai [2014] No. 237). After research, our response is as follows:

According to the relevant provisions of the Enterprise Income Tax Law of the People's Republic of China and the Implementation Regulations of the Enterprise Income Tax Law of the People's Republic of China regarding investment assets, the profit compensation obtained by your company in this bet agreement can be regarded as a pricing adjustment for the initial equity acquisition, that is, adjusting the initial investment cost of the corresponding long-term equity investment in the year when the profit compensation is received.

Hereby reply.

Hainan Provincial Local Taxation Bureau

May 5, 2014

（4） Sichuan Taxation: Promoting the Implementation of Relevant Policies

Letter from the State Administration of Taxation and the Sichuan Provincial Taxation Bureau on Responding to Proposal No. 0427 of the Third Meeting of the 12th Sichuan Provincial Committee of the Chinese People's Political Consultative Conference

We have received your suggestion regarding the tax confirmation of gambling agreements in equity transfer. Our response is as follows:

In recent years, frequent restructuring of China's capital market has promoted the widespread application of betting agreements, which in turn has propelled the prosperous development of the capital market. The treatment of income tax on gambling agreements has always been a theoretical and practical challenge in the field of tax law. Even in countries with relatively complete income tax systems such as Europe and America, due to the complexity of transactions and the diversity of consideration methods, it has been constantly developing. At present, there is no direct and clear document regulation for the tax treatment of gambling agreements in China's corporate income tax; The current policy basis for personal income tax is the "Measures for the Administration of Personal Income Tax on Equity Transfer Income (Trial)" (Announcement No. 67 of the State Administration of Taxation in 2014), which clarifies the basic policies in principle, but further refinement is needed for specific operations.

In 2019, our bureau conducted research and discussions on relevant issues, formed opinions and suggestions for dealing with the problem, and made a special report to the Income Tax Department of the State Administration of Taxation. After receiving your proposal and suggestions, as the provincial tax bureau does not have the power to interpret policies, our bureau conducted a special study on the issue and once again reported to the State Administration of Taxation in writing, requesting that the State Administration of Taxation consult with the Ministry of Finance to study and issue policy documents. Next, our bureau will adhere to the principle of not levying or omitting taxes, and handling taxes in a consistent manner. We will continue to follow up on and implement the relevant work requirements of the proposal, and promote the early resolution of tax issues related to the gambling agreement.

Thank you sincerely for your valuable feedback on tax work. Please continue to care about and support tax work.

State Administration of Taxation Sichuan Provincial Taxation Bureau

July 27, 2020

（5） Fujian Taxation: No Tax Refund

Message content: In January 2020, Zhang San purchased 100% equity of Company A from Li Si. Li Si's investment cost in Company A was 1 million yuan, and Zhang San purchased Company A for 2 million yuan, a premium of 1 million yuan. Li Si has already paid a personal income tax of 200000 yuan on the proceeds of the equity transfer. In the transfer agreement, Li Si promised to compensate Zhang San with 500000 yuan if the net profit of Company A in 2020 is less than 500000 yuan. In April 2020, Company A's audited net profit amount was 350000 yuan, which did not meet the promised profit target. Therefore, Li Si needs to compensate Zhang San with 500000 yuan.

May I ask: 1. After Li Si pays a compensation of 500000 yuan, can he apply to the tax authority for a refund of the personal income tax on the 100000 yuan equity transfer? 2. Does Zhang San need to pay personal income tax after receiving the compensation of 500000 yuan? Is it necessary to pay a personal income tax of 20% based on accidental income?

Reply department: Tax Service Center of Fujian Provincial Taxation Bureau

Reply time: June 7th, 2021

Reply content: According to Article 6 of the Personal Income Tax Law of the People's Republic of China, for income from property transfer, the taxable income shall be the balance after deducting the original value of the property and reasonable expenses from the income from the transfer of property. There is no relevant policy for refunding personal income tax in the situation you described. Accidental income refers to personal gains from winning awards, prizes, lottery winnings, and other accidental sources. As you mentioned, 'Zhang San received this compensation of 500000 yuan' is not accidental income and does not pay personal income tax.

（6） Ningbo Taxation: The profit compensation obtained cannot be regarded as adjusting the pricing of the acquired equity

Message content: Company A has acquired 100% equity of the target company from its counterparty and signed a bet agreement, stipulating that the target company should achieve a certain profit operating target within three years, otherwise the counterparty should pay compensation to Company A. Due to the target company's failure to achieve its profit management target, the counterparty has actually paid compensation to Company A. May I ask how to confirm this compensation and whether it is possible to adjust the initial investment cost of the corresponding long-term equity investment? On May 5, 2014, the Hainan tax authorities issued a reply letter (Qiongdi Tax Letter [2014] No. 198) regarding the issue of enterprise income tax on profit compensation for gambling agreements. It was clarified that "according to the relevant provisions of the Enterprise Income Tax Law and its Implementation Regulations on investment assets, the profit compensation obtained in the gambling agreement can be regarded as a pricing adjustment for the initially acquired equity, that is, adjusting the initial investment cost of the corresponding long-term equity investment in the year when the profit compensation is received." May I ask if this provision can be implemented accordingly?

Reply department: Ningbo Taxation Bureau

Reply time: March 16, 2020

Reply content: Article 56 of the Implementation Regulations of the Enterprise Income Tax Law of the People's Republic of China stipulates that all assets of an enterprise, including fixed assets, biological assets, intangible assets, long-term deferred expenses, investment assets, inventory, etc., shall be taxed based on historical cost.

The historical cost referred to in the preceding paragraph refers to the actual expenses incurred by the enterprise when acquiring the asset.

Ningbo does not implement it.

（7） Xiamen Taxation: The profit compensation obtained cannot be regarded as adjusting the pricing of the acquired equity

Question content: Hello, our company is a venture capital partnership enterprise that invests in Company B and signs a betting agreement with the company. If the profit does not meet the standard during the agreed period, Company B will provide performance compensation (cash compensation) to our company. May I ask if the cash compensation obtained as agreed in the betting agreement can be regarded as a pricing adjustment to the initial equity acquisition, that is, adjusting the initial investment cost of the corresponding long-term equity investment in the year of receiving the cash compensation and not including it in the investment income of the current year? On May 5, 2014, the Hainan tax authorities issued a reply letter (Qiongdi Tax Letter [2014] No. 198) regarding the issue of enterprise income tax on profit compensation for gambling agreements. It was clarified that "according to the relevant provisions of the Enterprise Income Tax Law and its Implementation Regulations on investment assets, the profit compensation obtained in the gambling agreement can be regarded as a pricing adjustment for the initially acquired equity, that is, adjusting the initial investment cost of the corresponding long-term equity investment in the year when the profit compensation is received". Can this provision be implemented accordingly? Thank you

Reply department: Xiamen Taxation Bureau

Reply time: March 8, 2021

Reply content: Dear taxpayer (withholding agent, payer), hello! We have received your online message and inquiry. Our response is as follows: Article 56 of the Implementation Regulations of the Enterprise Income Tax Law of the People's Republic of China stipulates that all assets of an enterprise, including fixed assets, biological assets, intangible assets, long-term deferred expenses, investment assets, inventory, etc., are taxed based on historical cost. The historical cost referred to in the preceding paragraph refers to the actual expenses incurred by the enterprise when acquiring the asset. During the period when an enterprise holds various assets, if the assets increase in value or decrease in value, the tax base of the assets shall not be adjusted except for those that can be recognized as gains or losses by the financial and tax authorities of the State Council. Please follow and execute accordingly.

summarize

Although the dust has settled on the case of Wang and Shanghai Taxation Bureau's refusal to refund taxes, the focus of the dispute involved in this case - the failed bet - can a tax refund be granted? It is still a common controversy in current practice. We hope that the relevant departments can clarify this issue as soon as possible to reduce tax disputes.