Abstract: In enterprise merger and acquisition transactions, the tax, labor, litigation, arbitration, and administrative penalties related to the target company are routine verification items and essential verification steps in legal due diligence.

 

1、 Taxation

 

1. Verification methods and documents

The main verification methods for the tax department of the target company include document review, online verification, verification with other intermediary agencies, verification with local tax authorities, interviews, etc. The main verification documents include a written explanation of the target company's tax categories, tax rates, and tax situation, proof of the tax preferential policies enjoyed by the target company, tax declaration documents, audit reports, etc.

 

2. Issues to pay attention to

In this section, due diligence needs to verify the applicable taxes and tax rates of the target company, the tax declaration and payment status of the target company, the situation of enjoying tax benefits, and the relevant situations of administrative penalties in tax matters. Here are a few examples to illustrate.

 

(1) Inconsistency between tax declaration form and audited financial statements

In small and medium-sized private enterprises in China, there are generally two sets of accounts, internal and external, as well as two sets of accounts for taxation and finance. During the due diligence process, similar issues may be discovered by reviewing the tax declaration forms, financial statements, and audit reports provided by the target company.

 

For example, in a certain project handled by the author, the operating income recorded in the tax declaration form submitted by the target company to the tax department in 2018 is inconsistent with the 2018 operating income recorded in the audit report issued by the accountant responsible for financial audit of the project, and there is a significant difference. We believe that according to Article 63 of the Law of the People's Republic of China on the Administration of Tax Collection, if the target company is deemed to have made false declarations and constituted tax evasion, it may face the risk of being pursued and fined by the tax authorities. If the circumstances are serious, it may also constitute a criminal offense.

 

(2) Changes in tax preferential policies

In a certain project, after reviewing the "Investment Agreement" and related "Supplementary Agreements" signed between the target company and the Investment Promotion Bureau of the High tech Industrial Development Zone in a certain city, we found that the target company was one of the enterprises attracting investment from the local government in 2008. According to the relevant agreements, from the second year after the target company completes the investment project, as long as the target company meets the agreed tax targets, The China Merchants Bureau provides a certain proportion of the local retained portion of the target company's actual payment of value-added tax, corporate income tax, and business tax as a project operation subsidy every year. These preferential policies are valid for ten years.

 

In 2017, when we conducted a project due diligence investigation, we consulted the local China Merchants Bureau regarding this issue. The bureau's response was that the issue could only be determined after a new leadership team meeting to study it. Due to the expiration of the validity period of the "Investment Agreement" and "Supplementary Agreement" on which the target company enjoys these tax preferential policies, and the local investment promotion department has not provided accurate information on the relevant policies after the expiration of the validity period, we believe that the tax preferential policies enjoyed by the target company are easily affected by the local investment promotion policies, and there is significant uncertainty whether the target company can continue to enjoy these preferential policies.

 

2、 Labor employment

 

1. Verification methods and documents

The main verification methods for labor related matters include document review, visiting relevant departments for verification, and interviews. The main verification documents include employee rosters, written labor contracts and related agreements, social insurance, proof of provident fund payment, and judicial documents related to labor disputes.

 

2. Legal issues to pay attention to

In the verification of labor related matters, the issues that need to be paid attention to and verified include the number of employees of the target company, the signing status of labor contracts, the payment status of social insurance and housing provident fund, and whether the target company has labor disputes. Here are a few examples to illustrate.

 

(1) The target company did not sign a written labor contract/open-ended labor contract with employees in accordance with the law

In China's private enterprises, there are a large number of situations where written labor contracts are not signed with workers in accordance with the law, or open-ended labor contracts are not signed with employees who meet the conditions. Such situations are also frequently encountered in the labor verification process of merger and acquisition projects. We believe that signing a written labor contract with employees or signing an open-ended labor contract with employees who meet legal conditions is a legal obligation of the employer. If the target company fails to fulfill the above-mentioned legal obligations in a timely manner, it may lead to labor disputes and may therefore face the risk of paying twice the monthly salary to employees who have not signed written labor contracts or open-ended labor contracts in accordance with the law.

 

① Article 10 of the Labor Contract Law of the People's Republic of China stipulates that in order to establish a labor relationship, a written labor contract shall be signed. If a labor relationship has been established but a written labor contract has not been signed at the same time, a written labor contract shall be signed within one month from the date of employment. If the employer and the employee sign a labor contract before employment, the labor relationship shall be established from the date of employment.

 

Article 14: An open-ended labor contract refers to a labor contract where the employer and the employee agree on an indefinite termination time. Employers and workers can enter into open-ended labor contracts through consultation and agreement. If a worker proposes or agrees to renew or enter into a labor contract under any of the following circumstances, in addition to the worker proposing to enter into a fixed term labor contract, an open-ended labor contract shall be concluded: (1) If the worker has worked continuously with the employer for at least ten years; （2） When an employer implements the labor contract system for the first time or when a state-owned enterprise restructures and signs a new labor contract, the employee has worked continuously for the employer for at least ten years and is less than ten years from the statutory retirement age; （3） Continuously concluding two fixed term labor contracts, and the employee does not have the circumstances stipulated in Article 39 and Article 40 (1) and (2) of this Law to renew the labor contract. If an employer fails to sign a written labor contract with the employee for one year from the date of employment, it shall be deemed that the employer and the employee have signed an open-ended labor contract.

 

② Article 82 of the Labor Contract Law of the People's Republic of China: If an employer fails to sign a written labor contract with the employee for more than one month but less than one year from the date of employment, it shall pay twice the monthly salary to the employee.

 

If an employer violates the provisions of this Law by not signing an open-ended labor contract with a worker, it shall pay twice the monthly salary to the worker from the date of signing the open-ended labor contract.

 

(2) The target company failed to timely and fully pay social insurance for all employees

According to Article 60 of the Social Insurance Law of the People's Republic of China, it is the legal obligation of employers to declare, pay and withhold social insurance premiums on time and in full. If the target company fails to pay social insurance premiums in full and on time, it may be ordered by the social insurance premium collection agency to pay or make up within a specified time limit, and an additional late fee of 0.05% per day shall be imposed from the day of default; If the overdue payment is still not made, the relevant administrative department shall impose a fine of not less than twice but not more than three times the amount owed.

 

3、 Litigation, arbitration, and administrative penalties

 

1. Verification methods and documents

The main verification methods for matters related to litigation, arbitration, and administrative penalties of the target company include online verification, document review, and interviews. The documents reviewed mainly include legal documents related to litigation, arbitration, and administrative penalties issued by courts, arbitration institutions, and government agencies, as well as written reports, analyses, and explanations from the target company regarding such litigation, arbitration, or administrative penalties.

 

2. Legal issues to pay attention to

In this section, we need to pay attention to and verify the issues, including the basic situation of relevant litigation, arbitration or administrative penalties, the legal procedures and stages involved, the target company's response measures, potential legal risks, and the impact on project transactions. It should be noted that when the target company is involved in litigation or arbitration cases that may lead to an increase in the target company's debt, it can be considered to combine with the target company's debt and creditor's rights for verification, in order to comprehensively reflect the target company's debt situation.