Listed Companies: A Brief Discussion on Tax Implications of Stock Reductions by Limited Partnerships

The equity structure design of companies preparing for listing involves three primary types of shareholders: individual shareholders, corporate shareholders, and limited partnership shareholders. To effectively design such an equity structure, it is essential to thoroughly understand the tax types and relevant policies applicable to each shareholder type—before and after listing, as well as during share reduction and exit. This article focuses first on the tax treatment applicable to limited partnership shareholders. Tax Treatment of Limited Partnership Shareholders: 1. Share Restructuring Phase - Conversion of capital reserve into share capital: Current policy remains unclear; enforcement practices vary across regions. Such conversion is temporarily excluded from taxable income but does not increase the shareholder’s cost basis in the shares. - Conversion of surplus reserve or undistributed profits into share capital, or their transfer into capital reserve: Under current tax law, these are treated as profit distributions. When partners are individuals, profits are allocated according to their capital contribution ratios stipulated in the partnership agreement, subject to a 20% individual income tax. When partners are corporations, such amounts must be included in their taxable income. 2. Dividends and Bonus Shares - Dividends and bonus shares distributed before or after listing constitute profit distributions. For individual partners, profits are allocated per the partnership agreement’s contribution ratio and taxed at 20% as individual income tax. For corporate partners, such amounts must be included in their taxable income. 3. Share Capital Increase via Premium - Following share restructuring, share capital increases funded by capital premium remain subject to unclear policy guidance; such increases are temporarily excluded from taxable income and do not increase the cost basis of shares held. 4. Equity (Share) Transfer - Pre-listing: The net gain (after deducting related taxes and fees) from equity transfers is included in the limited partnership’s current-period profit. - Post-listing stock reduction: Per the State Taxation Administration’s Announcement on Several Tax Collection and Management Issues Regarding the Pilot VAT Reform, the net gain from stock sales is subject to VAT and associated surtaxes, as it constitutes financial commodity transfer. - After deducting taxes and fees, the net gain from share transfers is included in the limited partnership’s current-period profit and taxed under the ‘distribution-first, then-taxation’ principle for individual income tax. - The annual income of a limited partnership, after deducting costs, expenses, and losses, is taxed under the progressive individual income tax rates prescribed by the Individual Income Tax Law. At the local level, for equity-incentive investment partnerships transferring restricted shares, non-executive individual partners and executive individual partners are taxed separately: non-executives are taxed at 20% on property transfer income, while executives are taxed at 5%–35% on business operation income of self-employed individuals.

Tax Case Analysis: Corporate Partners in a Partnership Reducing Shares of a Listed Company

A corporate entity indirectly holds shares of a listed company through its interest in a partnership. The corporate entity determines when and how many shares the partnership should reduce. Upon reduction, the partnership distributes the net proceeds (after deducting related taxes and fees) to the corporate partner. Since the partnership was established primarily as a vehicle for the corporate entity to purchase and hold shares for profit—and because partnerships are treated as ‘transparent entities’ for tax purposes—some investors believe that, when the corporate entity receives investment returns from the partnership, it may deduct the original acquisition cost of the underlying shares. Others hold the opposing view, arguing that different tax layers must be considered and that the income must be classified either as business operation income or property transfer income. We explore below how a corporate entity calculates and pays enterprise income tax on gains from share transfers realized through a partnership, and how to interpret Article 3 of Cai Shui [2008] No. 159, which states that ‘partnership business operation income and other income shall be taxed following the principle of “distribution-first, then-taxation.”’ Case Background In 2017, Partnership A acquired a 5% equity stake (approximately 50 million shares) in Company B (unlisted) for RMB 200 million (approx. RMB 4 per share). In 2018, Company C Ltd. acquired an 80% interest in Partnership A from Partner D for RMB 320 million, thereby indirectly acquiring a 4% equity stake (approx. 40 million shares) in Company B (unlisted) at approx. RMB 8 per share. In May 2020, Company B officially listed, with an IPO price of RMB 5 per share. In October 2021, Partnership A reduced its holdings by 25 million shares of Company B, generating proceeds of RMB 250 million (approx. RMB 10 per share). After deducting related expenses of RMB 10 million, Partnership A distributed RMB 240 million in net proceeds to Company C Ltd., supported by a formal distribution resolution (as stipulated in the partnership agreement, all proceeds were allocated to the holder of the corresponding shares). Supporting Information 1. Partnership Agreement of Partnership A stipulates: ① Each limited partner may, by written notice to the general partner, direct the sale of part or all of the shares of Company B attributable to its interest in Partnership A, without requiring consent from other partners. Within five business days after successful sale, the resulting proceeds shall be distributed to the limited partner who initiated the reduction request, and all related taxes and fees shall be borne solely by that limited partner. If multiple limited partners simultaneously initiate and complete share sales, the resulting proceeds shall be allocated among them proportionally based on the number of shares each requested to sell, and the associated taxes and fees shall be borne by each initiating limited partner in proportion to their respective sale volumes.

Allworth Financial LP Reduces Stake in DuPont de Nemours

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Allworth Financial LP cut its DuPont de Nemours stake by 68.6% in Q2 to hold $789,000 worth of shares. Despite this reduction, other institutions increased positions, and analysts maintain a Moderate Buy rating with a $166.60 price target.

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