China Special Situations Insight(Volume 3, Issue 1)
Tax Issues regarding the Disposal of Real Property through Online Judicial Auctions
Online judicial auctions have become a very popular method for disposing of the collateral and assets of debtors. Online judicial auctions are the public disposal of assets by the courts through online bidding via Internet auction platforms.
A question often raised by NPL investors regarding online judicial auctions is how the burden of taxes and fees arising from the disposal of real property (collectively, “Taxes”) is borne and shifted between the parties. In this article, we introduce the rules and common practices of tax undertakings and highlight some of the risks for NPL investors.
To carry out an online judicial auction in accordance with the Provisions of the Supreme People's Court on Several Issues Concerning the Online Judicial Auction by the People's Courts (“Online Auction Provisions”, effective from 1 January 2017), the court shall identify the burden of Taxes arising from the disposal of real property under auction conditions (“Property”). They will also outline this information in an auction announcement published via the online judicial auction platform (“Auction Announcement”).
The Online Auction Provisions stipulate those taxes arising from an online judicial auction shall be borne by the buyer and seller respectively, pursuant to the laws and regulations. In the absence of any applicable provision or where such provision is unclear, the court may determine the amount and the party to undertake the tax liability, in accordance with the legal principles and the actual situation of the case. The Reply to Recommendation No. 8471 of the Third Session of the 13th National People's Congress (对十三届全国人大三次会议第8471 号建议的答复) issued by the Tax Bureau on 2 September 2020 reaffirmed these rules.
Taxes shall therefore be borne by the original owner of the Property (“Original Owner”) and the winning bidder of the online judicial auction (“Buyer”) respectively, according to the applicable laws and regulations. We have summarized the main categories of tax that may be incurred in the disposal of Property and the corresponding taxpayers.
In practice, however, different courts may provide different requirements on Taxes while making the Auction Announcements. These are some of the most common scenarios for reference:
(1) All Taxes shall be assumed by the Buyer (including but not limited to the tax incurred by the original owner for the disposal of the Property (“Original Owner Tax”)).
(2) The Taxes shall be assumed by the corresponding party in accordance with the relevant laws and regulations.
(3) The Taxes shall be assumed by the corresponding parties, while the Buyer is required to advance the Original Owner Tax and then be reimbursed from the auction proceeds.
We are also aware of some examples in Beijing, Shanghai and other cities:?
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(1) In Beijing, the courts normally do not require the Buyer to pay the Original Owner Tax before the Buyer can obtain the ownership certificate of the Property, if the purchase price and its taxes have been paid. Usually, when the court receives funds for the Property, it will distribute all the remaining proceeds to the creditor after deducting the appraisal fee, the auction fee and the enforcement fee, all of which are usually a relatively small amount.
(2) In Shanghai and some other major cities, the courts do not require the Buyer to pay the Original Owner Tax, but the Buyer must advance such tax first and then be reimbursed by the court. The court will withhold part of the disposal proceeds to reimburse the Buyer against the Original Owner Tax and then distribute all the remaining proceeds to the creditor after deducting the appraisal fee, the auction fee and the enforcement fee.
NPL investors may acquire non-performing loans secured by the Property and take on the role of the mortgagee (the “Mortgagee”) or acquire the Property through an online judicial auction and become the Buyer. The Mortgagee and the Buyer are advised to use different strategies and fully consider their options.
(1) From the Mortgagee’s perspective
In principle, the Original Owner Tax should be borne by the Original Owner but it is uncertain whether the courts will withhold part of the disposal proceeds for the Original Owner Tax (“Withhold the Tax”). If so, the investor will not be entitled to all the disposal proceeds of the Property as certain proceeds shall be applied to pay the Original Owner Tax.
According to the Law on the Administration of Tax Collection (税收征收管理法) (whereby taxes become payable before the taxpayer creates a mortgage or a pledge on its property or before the taxpayer's property is liened), taxes shall take precedence over the exercise of the right of the mortgage, pledge or lien.
Therefore, we tend to believe that the Original Owner Tax will not rank ahead of mortgages on the Property, since the Original Owner Tax occurs after the creation of the mortgage. We cannot, however, rule out the possibility that a court may Withhold the Tax.
In light of the above, Mortgagees are advised to investigate the Original Owner Tax and confirm if the court will Withhold the Tax. Also, investors may want to take such risks into account when evaluating the distressed loan.
(2) From the Buyer’s perspective
As stated above, some courts may require the buyer to assume all Original Owner Tax in relation to the Property in the Auction Announcement. In this event, the successful Buyer at auction will have to assume the tax.
Before attending an auction, it is important for Buyers to peruse the Auction Announcement, especially the sharing and reimbursement procedures (if any) of the Taxes. In some real estate registration centers, proof of the tax payment is a document required for the title transfer registration of the real property. Even though the court does not require the Buyer to undertake or advance the Original Owner Tax, the Buyer may not be able to complete the title transfer of the Property if the Original Owner does not pay such taxes in a timely manner. The Buyer should take such costs and risks into consideration when offering bids at auction.?
For further information, please contact Catherine Miao, Head of Special Situations and Alternative Investment at JunHe LLP: [email protected] or +86-21-22086350.