Tax Treatment Of Promised Compensation In Valuation Adjustment Mechanism

In the process of enterprise merger and reorganization, due to the obviousinformation asymmetry between investors and financiers, investors and financiersboth sides hardly agree on valuation to enterprise value, and then ValuationAdjustment Mechanism (VAM) arises at the historic moment. VAM is usually basedon enterprise operating performance in the future. When the enterprise operatingperformance achieves agreed goals, financiers pay investors equity or cash tocompensate for the losses suffered from the investors’ underestimating enterprisevalue. Otherwise, investors pay financiers equity or cash to compensate the lossessuffered from overrated enterprise value.In recent years, VAM is imported into China by international investors, and areused in the case of the Mengniu, Yongle, Taizinai. But in the legal framework of ourcountry, it has not been clearly defined; the operation of the VAM has legal risk.Recently, the first VAM of judicial precedent of the Supreme People’s Court–HaifuCompany in Suzhou vs. Shiheng Company in Gansu to make a final decision, theeffectiveness of the VAM finally is recognized. But the next question aroused wideattention in the field of taxation; How to deal with the tax of the payments due to theperformance of the VAM promised compensation?Based on the case analysis of Haifu Suzhou, analyze the legal nature of the VAM and the promised compensation, I think it is a price adjustment of the contract price,the both sides adjust the forecast price through the promised compensation of theVAM, in order to achieve the two sides recognized the fair value and promised thatthe compensation is actually a part of the consideration in the contract. Again from theAngle of practice, to analyze the tax treatment for the promised compensation, andput forward referred opinions to improve the VAM. In this paper, the main content isas follows:The first part introduces the basic facts of the Haifu case and its controversyabout taxes. Firstly, there is a detailed introduction of Haifu case. According to theSupreme Court decision, the VAM between shareholders is effective if it is not inviolation of prohibited provisions in laws and regulations which do not harm theinterests of the company and the creditors. Secondly, sum the controversy about taxtreatment of promises compensation. On the one hand, Whether the Haifu Company,as receiver of promised compensation, should pay tax? How to determine the income?How to determine the time of tax liability? On the other hand, the Diya Company, aspromised compensation expenses, is it can be deductions?The second part analyzes the legal nature of VAM and promised compensation.Firstly, make a summary to VAM, analyzes the concept, type, purpose, function, etc.Secondly, Introduce and briefly analyze the legal nature doctrine of the VAM, itmainly includes options theory, conditional contract theory, aleatory contract theory.The author agree with aleatory contract theory. Thirdly, introduce and briefly analyzethe opinion of the tax treatment about promised compensation. It mainly has donatedtheory, breach of contract theory, guarantee theory, derivatives theory, contractelements adjust theory, comprehensive view, the author agree with contract elementsadjust theory.The third part determines the nature of the VAM behavior and put forward adviceon tax treatment about promised compensation. Through determine the tradingbehavior of VAM, clearly define that the essence of the economic transactions is theoriginal deal contract price adjustment. To analyze tax treatment under differentconditions that the target company business performance reaches standards or not up to standards, propose the opinion of tax treatment in Haifu case.The fourth part puts forward opinions on consummating the tax treatment ofVAM. It mainly includes the tax treatment processing rules of the combination ofestablishing principle of legislation and specific tax treatment; establish a perfect taxprogram and build professional tax law enforcement team; to establish informationcommunication platform between the enterprises and the tax authorities.