Our China lawyers have assisted many M&A clients requiring transfers of shares in China companies. When we work on these projects, one of the most common issues our client’s encounter is that it is difficult to accurately determine the value of the shares, this makes it almost impossible to determine a fair market value. It is important to price the shares at a fair value to discourage the tax office coming around later and imposing additional taxes according to that the tax office determines is a “fair” value. To do so, our firm works with the client to determine a reasonable fair value.
There are a few different methods to determine the fair value, depending on the nature of the company, it’s current assets, and expected business opportunity going forward.
The parties may simply negotiate and reach a fair price as agreed and determined by all parties. Such a method fully complies with the principle of contractual freedom, but its usage as a practical matter is limited, not only because of disagreements between the parties, but because of the difficulty in proving to tax authorities at a later date that the price paid is indeed fair. Such a method is most commonly used where the parties have closely associated interests or have a close affiliate relationship with each other.
The parties may also look to the registered capital contribution of the current shareholder as registered with the local administration of industry and commerce. Such price, as being registered specifically, is easy to be confirmed and calculated. As there are many factors such as the market environment and management’s decision may affect on companies operations, parties concerned should note that the real value of the capital may become higher or lower than the amount contributed by the shareholder previously for registration purposes.
The parties may calculate the price based on the company’s net asset value, as per a recent official audit report or asset evaluation report. This is the most commonly used method. It is particularly useful as the asset valuation report provides clear evidence to show the tax office that a fair price (and all attendant taxes) was paid. One flaw of this method is that it only addresses specific recorded financial information related to the the company. It cannot speak as to other operational indexes such as overall cash flow or the non-performing loan ratio of company or the actual operational status of the company.
If you wish to sell your China company but do not have a certain potential buyer in mind, it is possible to pursue a sale by auction. The auction works as you might expect, with potential buyers submitting bids for purchase of the company. Due to the public and competitive nature of the auction, there is a reasonably high chance that the final sales price obtained is a reasonable fair market price.
Whether we recommend our clients to use one of the above options or another is highly dependent on not only the condition of the company, but the client’s goals as to the final sales price, and expected timeline for closing and securing payment.