Viewpoint | Don't Know the "Capital Provident Fund"

Published:

2022-11-30

Introduction Capital provident fund refers to the portion of shareholders' capital contribution in excess of registered capital (capital premium or equity premium), as well as gains and losses directly included in the owner's equity. The capital provident fund is not converted from the company's profits, it is essentially input capital. ① As China adopts the statutory registered capital system, the capital provident fund cannot be directly reflected as registered capital or as a separate industrial and commercial registration item, and there are few laws and regulations. The relevant provisions on the use of capital provident fund are mainly reflected in the accounting system standards, but in practice, the use of capital provident fund is special. This paper intends to sort out and analyze the relevant provisions of the capital provident fund, aiming to provide reference for relevant practical issues. Sources of formation of 1. capital provident fund Because the capital reserve fund is an integral part of the owner's equity, and it usually directly leads to the increase of the net assets of the enterprise, therefore, the capital reserve information is very important for the decision-making of investors, creditors and other accounting information users. In order to avoid inflating net assets and misleading decisions, it is necessary to identify the main sources of capital surplus formation. According to the Enterprise Accounting System, the sources of capital provident fund formation mainly include two types according to their purposes: One category is the capital provident fund that cannot be directly used to increase capital, which includes the preparation of donations to accept non-cash assets, the re-evaluation and appreciation of statutory property, and the preparation of equity investment. Among them, the preparation for accepting non-cash assets donation refers to the capital accumulation fund increased by the enterprise due to accepting the donation of non-cash assets; the legal property re-evaluation and appreciation refers to the difference between the confirmed value of the asset evaluation or the value agreed by both parties and the original net book value when the enterprise transfers out various assets due to foreign investment or when the enterprise needs to revalue the property due to merger and reorganization; the preparation for equity investment, when an enterprise adopts the equity method of accounting for its long-term equity investment in an investee, it increases its capital provident fund due to the acceptance of donations by the investee, resulting in an increase in the capital provident fund calculated by the investing enterprise in proportion to its shareholding or investment. One category is capital reserves that can be used directly to increase capital, which includes capital (or equity) premiums, cash donations received, transfer of appropriations, foreign currency capital translation differences and other capital reserves. Among them, the capital (or equity) premium refers to the part of the capital invested by corporate investors that exceeds their share of the registered capital, which is called equity premium in joint stock limited companies; accepting cash donations refers to the company's acceptance of cash donations The increased capital reserve; appropriation transfer refers to the completion of the appropriation projects allocated by the state for technological transformation and technological research, the part transferred to the capital provident fund according to regulations shall be recorded according to the transferred amount; the foreign currency capital conversion difference refers to the capital conversion difference caused by the different exchange rates adopted by the enterprise for foreign currency investment; other capital provident fund refers to the capital provident fund formed in addition to the above-mentioned capital provident fund and the amount transferred from various reserve items of the capital provident fund, including the debts exempted by creditors. Use of 2. Capital Provident Fund According to the provisions of Article 168 of the Company Law that "the company's provident fund shall be used to make up for the company's losses, expand the company's production and operation or to increase the company's capital. However, the capital provident fund shall not be used to make up for the company's losses", the capital provident fund has the following purposes: (I) to expand the company's production and operation The capital provident fund increases the asset base required for the company's operations, so the company can use the capital provident fund to expand the company's production and operation scale according to its own business needs without increasing capital, in order to enhance the company's operating strength. (II) to increase company capital Under normal circumstances, part of the company's capital reserve can be converted to increase the company's registered capital, but the conversion of the company's share capital needs to pay attention to the following important matters: 1. According to the provisions of the Enterprise Accounting System, the preparation items under the capital provident fund cannot, in principle, be transferred to capital (or equity). The preparation items include three items: preparation for accepting non-cash asset donations, revaluation and appreciation of statutory property, and preparation for equity investments. However, for companies that implement the Enterprise Accounting Standards, the capitalization of capital surplus includes the capital (equity) premium and the capital surplus of the realized portion of the capital surplus in addition to the capital surplus. 2. The transfer of the registered capital (or share capital) of the company from the capital accumulation fund shall be decided by the shareholders' meeting (general meeting of shareholders) or other similar authority. 3. If the capital accumulation fund is converted into share capital, income tax shall be paid in accordance with the provisions of the law and the relevant provisions of the Ministry of Finance and the State Administration of Taxation. Matters of concern in 3. practice (I) procedures for increasing registered capital Although article 168 of the Companies Act provides that the capital provident fund may be used to increase the capital of the company, the conditions that must be met for the conversion of capital from the provident fund and whether the capital must be increased to all shareholders in accordance with the original shareholding ratio are not stipulated by law. ② Article 43 of the "Company Law" stipulates that the method of discussion and voting procedures of the shareholders meeting shall be prescribed by the articles of association of the company, except as provided for in this law. Resolutions made at the shareholders' meeting to amend the articles of association of the company, increase or decrease the registered capital, as well as resolutions on the merger, division, dissolution or change of corporate form of the company must be passed by shareholders representing 2/3 or more voting rights. According to the above provisions, the shareholders of the company may, when convening a shareholders' meeting, determine whether the conditions for capital increase from provident fund have been met and whether to increase capital to all shareholders in accordance with the original shareholding ratio. If the articles of association do not provide for this, it shall be discussed and determined by the shareholders' meeting and implemented after being adopted by shareholders representing more than 2/3 voting rights. It is important to note that when only some shareholders are targeted to increase capital from the capital reserve, the resolution must be unanimously approved by all shareholders. The current company law does not prohibit the company from making targeted increases to some shareholders. However, since all shareholders enjoy the final rights and interests of the capital accumulation fund according to the proportion of equity, after the targeted increase, all the capital accumulation fund will be converted to the capital contribution of some shareholders, which may lead to the reduction of the interests of other shareholders. Therefore, the shareholders' meeting resolution of the company's targeted increase of registered capital can only be made with the unanimous consent of all shareholders. The (II) shall pay income tax on the acquisition of equity (shares) due to the transfer of capital reserves to increase capital (share capital). When capital surplus is transferred to capital (share capital), a corresponding change in legal form occurs, and the equity that originally belonged to the company is transformed into the share capital of the shareholders, and from the point of view of the change in legal form and control, it can be considered that the company has paid to the shareholders. Specifically, prior to the conversion, the capital provident fund represents the assets and interests of the company, while after the conversion, it is formally expressed as each shareholder's respective rights to the company, thus giving rise to the basis for taxation. However, it should be noted that, unlike other capital reserves, the capital reserves generated by the capital (equity) premium are not the income generated in the process of production and operation of the enterprise, in which the capital (equity) premium comes from the input of shareholders and should not be regarded as the income of the nature of "dividends and bonuses" obtained by shareholders, there is no need to pay corporate income tax (the standard rate is 25%) or personal income tax (the rate is 20%). At present, the income tax treatment of shareholders when an enterprise transfers capital from capital reserve is as follows: 1. Corporate shareholders The second paragraph of Article 4 of the notice of the State Administration of Taxation on the implementation of the enterprise income tax law (Guo Shui Han [2010] No. 79) stipulates that if the invested enterprise converts the capital reserve formed by the equity (ticket) premium into equity, it shall not be regarded as the dividend and dividend income of the investor enterprise, and the investor enterprise shall not increase the tax basis of the long-term investment. Therefore, for the shareholders of the enterprise, the capital accumulation formed by the equity premium or the stock premium of the invested enterprise will not lead to the tax liability of the shareholders. And at this time, do not distinguish between the nature of the invested enterprise, the invested enterprise with equity or stock premium formed by the capital accumulation to increase capital, are not subject to corporate income tax on its shareholders. 2. Individual shareholders Article 1 of the notice of the State Administration of Taxation on the exemption of individual income tax on the conversion of capital stock and the distribution of bonus shares by joint-stock enterprises (Guo Shui Fa [1997] No. 198) stipulates that the conversion of capital stock by joint-stock enterprises with capital accumulation fund does not belong to the distribution of dividends and dividends, and the amount of capital increase obtained by individuals is not regarded as personal income and individual income tax is not levied. The "Approval of the Original Urban Credit Cooperatives in the Process of Transforming into Urban Cooperative Banks to Pay Individual Income Tax on Income from Individual Share Appreciation" (Guo Shui Han [1998] No. 289) states that the "capital provident fund" described in Document No. 198 refers to the capital provident fund formed by the income from the premium issuance of shares of joint-stock enterprises. The second paragraph of Article 2 of the Circular of the State Administration of Taxation on Further Strengthening the Collection and Administration of individual income tax for High-income earners (Guo Shui Fa [2010] No. 54) stipulates that if capital reserves other than stock premium are transferred to increase registered capital and share capital, individual income tax shall be levied in accordance with the items of "income from interest, dividends and dividends" and in accordance with the current policies. That is to say, only the capital reserve formed by the stock premium issuance of joint-stock enterprises is not regarded as the personal income of shareholders when it is converted into share capital, and no personal income tax is levied; for the capital reserve formed by joint-stock enterprises that are not part of the stock issuance premium, and non-joint-stock enterprises that convert capital reserve into share capital (capital), there is no clear stipulation that individual shareholders' personal income tax is not levied. In practice, some local tax authorities will levy a 20% personal income tax on "interest, dividends and dividend income" on individual shareholders when limited liability companies and non-listed joint-stock enterprises increase their capital (share capital) at a capital (share capital) premium. Of course, there is still much controversy over the appropriateness of this provision, with opponents arguing that the nature of the enterprise should not affect the determination of the nature of capital, and that Document No. 79, which applies to the enterprise, likewise does not distinguish whether the shareholders of the enterprise are subject to corporate income tax by the nature of the enterprise. The (III) shall not arbitrarily withdraw the capital provident fund without legal procedures. Although the legal provisions are not clear, the relevant judicial cases are negative about the arbitrary direct or disguised withdrawal of capital reserves by shareholders. For example, in (2017) Shan 01 Minchu No. 1079 case, the court held that the withdrawal of capital contribution is not limited to the withdrawal of capital contribution that has been paid in the registered capital. In the case of capital increase of the company, the withdrawal of capital contribution (I .e. capital reserve) by shareholders that has not been registered by the industrial and commercial department but has become the legal person property of the company also belongs to the category of withdrawal of capital contribution and is prohibited by the company law. ③After the case was retried by the Shaanxi Provincial High Court and the Supreme People's Court, both supported the judgment of the court of first instance. In addition, the same view is held in (2013) Minti Zi No. 226 and (2013) Minshen Zi No. 326 cases. Moreover, the agreements between shareholders and between shareholders and the company on the retrieval of capital reserves are invalid. In the case of (2019) Su Minzong No. 1446, the court held that the content of the undertaking involved in the case was that Banghao Company returned the part of investment funds larger than the registered capital to Zhongnan Company, which violated the capital maintenance principle of the Company Law and damaged the legitimate rights and interests of Banghao Company and its creditors, and should be invalid, therefore, Zhongnan Company shall not be supported in requesting Banghao Company and other shareholders to return funds to it in accordance with the undertaking. ④ Not only that, the shareholders who withdraw their capital contributions usually make false financial accounting statements to increase profits for distribution, transfer the capital contribution through fictitious creditor's rights and debts, and transfer the capital contribution out by using related transactions. ⑤ Such acts are prohibited by the relevant jurisprudence. For example, in the Supreme Court (2013) Minti No. 226 case, the court found that the actual capital contribution of the shareholders is greater than the capital premium formed by the capital contribution payable, which belongs to the company's capital provident fund in nature and does not constitute a shareholder's loan to the company, and the shareholders use this as a loan claim and the company to repay the debt, constitute a disguised withdrawal of capital contribution. The court held that the board of directors of Jinhua Investment Company decided to use the real estate in this case to offset the principal and interest of Lin Jinpei's capital contribution, which was essentially to convert Lin Jinpei's capital contribution belonging to the capital accumulation fund into the company's loan to Lin Jinpei, and to return it in the form of debt repayment, resulting in Lin Jinpei's disguised withdrawal of capital contribution, violating the principle of capital enrichment of the company and the provisions of the above notice of the Company Law and the State Council, therefore, the resolution of the Board of Directors on the confirmation of Lin Jinpei's loan claims and the decision to offset the debt in kind should be deemed invalid. ⑥ Although the Company Law does not explicitly include capital surplus as a statutory contribution. However, allowing shareholders to withdraw their capital surplus at will would also materially undermine the principle of corporate capital maintenance. The path to the recovery of (IV) capital reserves-after the liquidation of the company. The company's capital provident fund belongs to the category of the company's capital, and the shareholders enjoy the shareholders' equity, not the ownership. According to Article 26 of the Accounting Standards for Enterprises, the owner's equity of an enterprise, also known as shareholders' equity, refers to the residual equity enjoyed by the owner after deducting liabilities from the assets of the enterprise. It is the economic interest of the company's shareholders in the remainder of the company's total assets after deducting liabilities (I. e., the company's net assets), as opposed to ownership. Therefore, for investments that have been included in the company's capital reserve, shareholders can claim owner's equity from the company in proportion to their capital contributions after the liquidation of the company. The reasons for the liquidation of a company generally include the dissolution of a shareholder resolution, the dissolution of an administrative order and the liquidation of bankruptcy. Among them, the reason for bankruptcy liquidation is that the company's assets are not enough to pay off all the debts or the obvious lack of solvency, at this time, the liabilities are greater than the assets, the owner's equity is negative, does not involve the distribution of capital reserves. Thus, the treatment of capital reserves may only be involved in the dissolution of a shareholder resolution or an executive order. According to the second paragraph of Article 186 of the Company Law, the remaining property after the company's property is paid for liquidation expenses, employees' wages, social insurance premiums and statutory compensation, the taxes owed, and the company's debts are paid off. The company is distributed in proportion to the capital contribution of shareholders, and the company limited by shares is distributed in proportion to the shares held by shareholders. The capital surplus on the company's books is distributed together with surplus and paid-in capital in proportion to the shareholders' capital contribution or shareholding. Also, income tax is still payable on the proceeds of liquidation. Conclusion As an important asset of the company, the fund provident fund can bring real benefits to the company and shareholders by recognizing it and making good use of it.

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