The legal definition and core basis of equity contribution

Legal definition

       Equity contribution refers to the legal act where shareholders use the equity they hold in other companies as a form of contribution to transfer their equity to the target company and obtain the corresponding equity (shares) in exchange. Essentially, it is a capital operation mode of "equity for equity".

Three major legal bases

      Article 48 of the Company Law: Shareholders may contribute capital in the form of currency or in the form of non-monetary assets that can be valued in currency and legally transferred, such as physical objects, intellectual property rights, land use rights, equity, and creditor's rights. However, properties that are prohibited from being used as capital contributions by laws and administrative regulations are excluded. Non-monetary assets contributed as capital shall be appraised and valued, and the assets shall be verified. The valuation shall not be overestimated or underestimated. Where laws and administrative regulations provide for the assessment and valuation, such provisions shall prevail.

       Requirements: Assessable for valuation + transferable in accordance with the law + no rights defects.

       Key clause: "Non-monetary assets contributed as capital shall be appraised and valued, and the assets shall be verified. The valuation shall not be overestimated or underestimated."

       Article 7 of the "Implementation Measures for the Administration of Company Registration"

Equity contribution must meet the following requirements:

✓ Clear ownership and transferable

✓ No encumbrance of rights (such as pledge, freeze

✓ Completed actual payment (the equity used for capital contribution has been fully paid in by itself)

Property Rights Section of the Civil Code

       Equity as the legal attribute of property rights.

       The act of capital contribution constitutes the legal consequence of the transfer of property rights.

The "Triple Identity" of Equity Contribution (Newly Added from a Legal Perspective)

1.Accounting Perspective

Non-monetary asset contributions (subject to assessment and valuation).

Applicable to Accounting Standard for Business Enterprises No. 7 - Non-Monetary Asset Exchanges.

2.Legal Perspective

The act of transferring shareholders' equity (a written agreement must be signed).

Subject to the dual constraints of the Company Law and the articles of association.

3.Tax Perspective

Taxable acts deemed as equity transfer.

Trigger personal income tax/corporate income tax.

Standard Operating Procedures (New Legal Documents)

Assessment and pricing → Signing of equity contribution agreement → industrial and commercial change → Capital verification and audit → Accounting treatment

Core legal documents：

1.Resolution of the shareholders' meeting (approved by more than two-thirds of all shareholders)

2. Equity evaluation report (issued by a securities-qualified institution)

3. Proof of property transfer (Record of equity transfer of the target company

 Five Core Points to Note (Enhanced Legal Risks)

01The legal consequences of ownership defects

Real case: A shareholder of a certain technology company contributed equity that had been frozen by the court. After the industrial and commercial change, the original creditor filed a lawsuit, resulting in:

       The act of capital contribution is invalid.

       Shareholders are required to make up their capital contributions and compensate for the company's losses

02The key points of compliance for evaluating pricing

       Legal red line: If the assessed value is 30% lower than the actual value, it may be identified as "false capital contribution".

       Operation suggestion: Cross-validation should be conducted using more than two evaluation methods.

03A Comprehensive Analysis of Tax Traps

       The basis for individual income tax: Article 13 of the "Administrative Measures for Individual Income Tax on Gains from the Transfer of Equity"

       The basis for enterprise income tax: Article 25 of the Implementing Regulations of the Enterprise Income Tax Law

04The "three consistencies" principle for business registration

        The agreed price, assessed price and capital verification report price in the agreement must be consistent.

       Legal consequences: A price difference exceeding 20% May be regarded as capital withdrawal.

05Special restrictions of the company's articles of association

Key focus clauses

✓ Whether non-monetary contributions are allowed

✓ Maximum proportion limit for equity contribution

✓ Rules for exercising the preemptive right

 Core Tax and Financial Treatment: Accounting Rules for Equity Contributions

       According to Article 4 of Accounting Standard for Business Enterprises No. 2 - Long-term Equity Investments, when obtaining long-term equity investments through the issuance of equity securities, the fair value of the issued securities shall be taken as the initial investment cost, excluding the declared but not yet distributed cash dividends or profits that should be received from the investee.

       Where an investor acquires long-term equity investment by issuing equity securities (equity instruments), the fair value of the issued instruments shall be determined in accordance with relevant standards such as Accounting Standard for Business Enterprises No. 39 - Fair Value Measurement (hereinafter referred to as the "Fair Value Measurement Standard").

       When enterprises accept equity contributions, they need to recognize the assets at fair value or assessed value and make accounting treatments based on their different uses. The following are the accounting entries and key operational points of typical scenarios:

It is directly recorded as an asset

Example: [Example 3] When non-listed Company A was established, Company H contributed its long-term equity investment in Company B as capital to Company A. Company B is a listed company. It is agreed that the long-term equity investment made by Company H as the capital contribution is valued at 40 million yuan (this valuation is equivalent to its fair value). After the transaction was completed, the registered capital of Company A increased to 160 million yuan, among which Company H's shareholding ratio was 20%. After Company A acquires this long-term equity investment, it will be able to exert significant influence on Company B. Do not take into account the influence of other factors such as relevant taxes and fees. In this case, the long-term equity investment made by Company H to Company A has an active market quote, while the fair value of the equity instruments issued by Company A does not have an active market quote. Therefore, Company A should use the fair value of the equity in Company B to recognize the initial cost of the long-term equity investment.

The accounting treatment that Company A should undertake is:

Debit: Long-term equity investment - Investment cost 40,000,000

              Loan: Paid-in capital                                                                32,000,000

                          Capital reserve - Capital premium                         8,000,000

The case is from: "Application Guide of Accounting Standards for Business Enterprises"

Typical Case: The invalid Equity contribution case of a certain education Group

Case details: The founder contributed 5 million yuan worth of unpaid-in equity of a subsidiary as capital, and it was discovered after the industrial and commercial registration.

1.The equity contribution has not been fully paid in (in violation of Article 7 of the "Regulations on the Administration of Registration")

2. No written confirmation from other shareholders waiving their preemptive rights has been obtained

Consequence：

The industrial and commercial department revoked the change registration

The founder needs to make an additional cash contribution of 5 million yuan

Bear a penalty of 800,000 yuan for the partner

Three Legal Suggestions for Entrepreneurs

Three-step ownership verification method

Check the business archives (to confirm the actual payment situation)

Check court announcements (excluding judicial freezes)

Check the company's articles of association (verify the capital contribution qualifications)

List of essential terms for the agreement

The transfer time point of the voting rights/dividend rights corresponding to the contributed equity

The joint liability clause for capital contribution defects

Compensation mechanism for value deviation

Legal, fiscal and taxation linkage plan

It is recommended to consult a lawyer and an accountant simultaneously

It adopts a three-in-one design of "agreement terms + accounting treatment + tax planning"