Due Diligence Guidelines –
15.1.1 The Listing Rules require the inclusion of an income statement as part of an accountants’ report to be included in a listing document, and such income statement must disclose, among other things, profit (or loss) before taxation and taxation on profits. [Listing Rule 4.05 and Appendix 16 to the Listing Rules]
15.1.2 In respect of mineral companies, (i) Listing Rule 18.03 provides that such listing applicant must disclose, among others, an estimate of cash operating costs including the costs associated with non-income taxes, royalties and other governmental charges and (ii) Listing Rule 18.05 requires that such company include any relevant and material disclosure on compliance with host country laws, regulations and permits, and payments made to host country government in respect of tax, royalties and other significant payments on a country by country basis.
15.1.3 Paragraph 12(b)(iii) of Practice Note 21 provides that typical due diligence inquiries in relation to the new applicant’s qualifications for listing include reviewing material financial information, including tax certificates and supporting documents to tax certificates for the trading record period.
15.1.4 For listing applicants whose primary operations are conducted through PRC incorporated entities, as part of Stock Exchange Form M 104 (“Additional Information To Be Submitted with the Form A1”), the sponsor must at time of A1 filing provide a summary of the material findings of the sponsor and the Reporting Accountant in assessing whether the underlying financial information of the applicant group’s PRC companies used for the preparation of the Accountants’ Report is consistent with:
(i) all the relevant regulatory filings or reports filed with the appropriate competent government authorities; and
(ii) where applicable, the information on related party transactions as shown in the financial statements of the relevant related parties.
For this purpose, the relevant filings and government authorities include all relevant PRC tax filings and competent tax authorites.
15.2.1 Tax is a specialist technical area.
15.2.2 The sponsor is not expected to be an expert on tax.
15.2.3 The sponsor’s due diligence enquiries are primarily aimed at ascertaining:
(a) Whether all categories of material tax liability have been suitably identified and addressed by the listing applicant?
(b) Whether taxes due for payment have been paid?
(c) Whether future and deferred tax payments have been suitably reserved or provided for?
(d) That the listing applicant’s tax position has been fairly disclosed in the listing document.
15.2.4 This normally involves routine enquiries of the listing applicant’s senior financial officers and external auditor (and specialist tax adviser, if any) aimed to identify any material issues meriting specific further enquiry.
15.2.5 A higher standard of routine investigation is customary for PRC enterprises (as indicated below).
15.2.6 Any significant tax concerns arising from the applicable due diligence enquiries should be suitably addressed. (See section 12 “Red Flags and Similar Irregularities” below).
15.3 Recommended Steps (General)
15.3.1 Initial documentary information requests (as to which see section 4 above “Financial Review Process (Overview)”) should normally include requests for copies of the following in respect of the listing applicant and each group entity:
(a) All submitted tax returns or other tax filing documents for the latest three financial years;
(b) List of tax years open (and a description of any claim made, pending or known in relation to each open year);
(c) Any tax audit or investigation reports within the latest three financial years;
(d) A list detailing any dispute (actual or pending) with any relevant taxation authorities;
(e) A list detailing any fines, penalties or other administrative sanctions imposed within the latest three financial years;
(f) All tax reduction, preference or exemption documentation for the latest three financial years;
(g) All assessments made together with certificates and receipts for payment including PRC tax certificates;
(h) Any tax sharing agreement to which any relevant entity is party.
15.3.2 It is not normal for the sponsor to conduct a detailed review of the listing applicant’s tax returns or correspondence files, except if this is appropriate as part of any additional follow-up diligence resulting from material issues arising. However, due diligence practices specific to PRC enterprises should include consideration of consistency between tax filings and the listing applicant’s audited financial statements (and underlying financial statements of applicable group entities). As noted (see paragraph 15.1.4 above), Stock Exchange Form M 104 (“Additional Information To Be Submitted with the Form A1”), requires the sponsor at time of A1 filing provide a summary of the material findings of the sponsor and the Reporting Accountant in this regard. See further section 15.4 below.
(a) Discussing with management as to the tax policies and procedures in place if any; and
(b) Reviewing the most recent tax filings and assessments for compliance.
15.3.4 Discussion with management (as part of the sponsor’s overall financial review process) should commonly include the areas identified in Part 1 of Appendix II.
15.3.5 The sponsor should seek to arrange meeting(s) to discuss the listing applicant’s tax position and its tax accounting with (i) the Reporting Accountant and (ii) any Tax Advisers having a current or prior engagement of material relevance.
15.3.6 In relation to tax matters, the discussion with the Reporting Accountant should normally encompass questions on the matters identified in Part 2 of Appendix II.
15.3.7 For discussions with the Reporting Accountant with respect to PRC enterprises see further below (“Steps to Take (PRC Tax)”).
15.3.8 As with accounting and audit interviews, the nature and degree of the Reporting Accountant’s participation in due diligence interviews will normally be governed by its terms of engagement consistent with prevailing industry practices. See sections 7 (“Accounting Review Process”) and 8 (“Audit Review Process”) above, and .
15.3.9 Again, effective interaction with the Reporting Accountant is generally regarded as an important component of due diligence, but an area where the sponsor is significantly dependent upon the Reporting Accountant’s preparedness to embrace the process.
15.3.10 Where the listing applicant has engaged external Tax Advisers, the sponsor should:
(a) Enquire as to the scope of work;
(b) Obtain copies of all advice issued in writing; and
(c) Depending on the nature and scope of any such assignment, consider arranging interviews with each relevant Tax Adviser to discuss any significant structures or arrangements implemented (or uncertainties examined, or resulting from any such structures or arrangements).
15.3.11 An interview with a Tax Adviser might usefully be framed by an agenda / set of questions formulated as indicated in Part 4 of Appendix II.
15.3.12 Depending on the overall level of certainty or uncertainty resulting from such enquiries or discussions (and the materiality of any tax issues considered or arising), the sponsor should consider appointing (or requesting the listing applicant to appoint) a tax consultant for relevant purposes in connection with the listing application.
15.4 Steps to Take (PRC Tax)
15.4.1 Certain due diligence practices have developed which are specific to PRC enterprises.
15.4.2 The sponsor should seek to ascertain the categories of taxation to which each PRC enterprise is subjected, for example:
(a) Enterprise Income Tax;
(b) Value Added Tax;
(c) Business Tax;
(d) Consumption Tax;
(e) Land Use Tax;
(f) City Maintenance & Construction Tax;
(g) Land Appreciation Tax;
(h) Resource Tax;
(i) Social Security and Housing Fund Contributions;
(j) Customs Duties;
(k) Stamp Duty; and
15.4.3 The sponsor should further seek to ascertain the tax rates applicable to each such category.
15.4.4 The sponsor should (where possible) arrange to obtain copies of all applicable PRC tax certificates from relevant state and local level tax bureaus. As and where applicable these should include:
(a) State level tax certificates;
(b) Local level tax certificates; and
(c) Applicable certificates from social security and housing fund administrators.
15.4.5 Applicable sources may include:
(a) AIC (Administration for Industry and Commerce);
(b) State Administration of Taxation, and local state tax bureaus;
(c) Local tax bureaus;
(d) Customs authorities.
15.4.6 The sponsor should ensure that chopped official copies of tax filings have (where possible) been obtained independently from applicable official sources. This may be achieved directly by the sponsor, or via lawyers or the Reporting Accountant independently of the listing applicant. Where available, filings may be reviewed from tax authority websites.
15.4.7 The Listing Rules require the Reporting Accountant to have reviewed filings for consistency with the listing applicant’s audited financial statements (and the underlying financial statements of group entities). The sponsor should discuss this review (including any questions or areas of uncertainty) with the Reporting Accountant. (See paragraphs 15.1.4 and 15.3.2 above, and further below).
15.4.8 With respect to PRC customs duties, the sponsor should make enquiries aimed at establishing that appropriate duties have been and are being paid. This may include:
(a) Obtaining customs compliance certificates; and
(b) Opinion(s) from PRC lawyers.
15.4.9 In relation to PRC tax matters, the discussion with the Reporting Accountant should normally encompass questions on the matters identified in Part 3 of Appendix II.
15.4.10 The sponsor should consider arranging interview meetings with PRC tax authorities. Such meetings are not always essential, and the importance of these meetings will vary depending on the extent to which the listing applicant depends on or benefits from materially favourable tax treatment and/or material tax rulings.
15.4.11 Depending on the overall level of certainty or uncertainty resulting from such enquiries (and the materiality of any tax issues considered or arising), the sponsor should consider appointing a PRC tax consultant.
15.5 Steps to Take on Group Structure
15.5.1 The sponsor should enquire what evaluation has been undertaken, and what advice obtained, by the listing applicant to determine the tax implications of remittances between group entities (including up-stream dividends and other remittances from subsidiaries).
15.5.2 The sponsor (together with its lawyers) may consider obtaining opinions on withholding taxes as part of the legal due diligence conducted in relation to material subsidiaries.
15.6 Steps to Take on Re-Organisation(s)
15.6.1 The sponsor should ascertain what evaluation has been undertaken, and what advice obtained, by the listing applicant to determine the tax implications of any re-organisation undertaken in preparation for the IPO.
15.6.2 Enquiries should be made of the listing applicant’s management, the Reporting Accountant and any relevant Tax Adviser.
15.7 Tax Disclosure in the Listing Document
15.7.1 Depending on scope and relative materiality, the sponsor should consider engaging (or ensuring that the listing applicant engages) the tax department of the Reporting Accountant, or another appropriate expert, to provide a formal letter in support of the general tax disclosure normally included (usually by way of discrete appendix) in the listing document.
15.7.2 The legal verification notes will normally address (among other things) specific tax disclosure within the body of the listing document on an itemised basis.
HKCFEF Limited and the contributing law firms, accountants and sponsors are not offering these due diligence guidelines as legal, financial or professional advice or services and they should not be relied upon as such. These due diligence guidelines should not be used as a sole basis for any decision, action or inaction and are not meant to serve as a substitute for the advice of qualified professionals. See here for the full terms and conditions.