For start-up enterprises, debt investment is a flexible way of resource integration. If not handled properly, it can easily lead to financial chaos, tax risks and even legal disputes. Exclusive Easy Finance and Taxation sorting out the core legal basis, definitions, processes and risk points, guiding you step by step to avoid common minefields, helping entrepreneurs operate in compliance, and mastering the essential finance and taxation survival guide - save money and comply!

Debt Contribution: Definition and Legal Definition

The definition of debt contribution

       It refers to the act of shareholders (or initiators) of a company converting their legally held claims (receivables) against the company into equity contributions to the company (increasing registered capital or share capital) through legal procedures. In simple terms, it means that shareholders turn the "money the company owes you" into "the money you have invested in the company (equity)".

Legal basis and nature

       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."

Legal effect：

For the company: Debt (liabilities) decreases, and owner's equity (paid-in capital/capital reserve) increases

To shareholders: The creditor's rights (assets) are extinguished, and the corresponding equity (interests) are obtained.

Common understanding:

Suppose you (Shareholder A) previously lent the company 500,000 yuan for turnover (forming a liability of the company to you - "Other Payables"). Now, you and the other shareholders of the company have agreed to directly count this 500,000 yuan "IOU" as your additional 500,000 yuan investment in the company. So, the company no longer owes you 500,000 yuan, but your shareholding ratio in the company has increased accordingly.

Five-step Process Standardization (Legal, Accounting Standards and Audit Perspectives)

1.Creditor's rights confirmation and evaluation

       Clear ownership and legal validity: This is the core of legal compliance. It is necessary to prove that the creditor's rights truly exist, are legal and valid, and have no disputes with third parties. The original chain of evidence (such as loan contracts/agreements, supplementary agreements, bank transfer vouchers, proof of goods/service delivery, statements of account, receipts, etc.) must be provided. Key audit verification points.

       Fair value assessment (statutory requirement) : According to the Company Law and its supporting regulations, when non-monetary property is contributed as capital, it should be appraised and valued, and the property verified. The valuation shall not be overestimated or underestimated. The fair value of the creditor's rights must be determined by an assessment report issued by a qualified asset evaluation institution. This is a necessary document for business registration and capital verification.

2.Resolution of the shareholders' (general) meeting (legal Procedure)

It must be approved by shareholders representing more than two-thirds of the voting rights (the specific proportion depends on the company's articles of association, but usually a higher proportion is required for capital increase and major matters). The resolution must be clear:

Agree that a certain shareholder contributes debt as capital.

The amount and assessed value of the creditor's rights.

The specific amount of equity converted (how many yuan of registered capital) and the corresponding equity ratio.

Amend the relevant provisions of the company's articles of association (such as registered capital, register of shareholders, contribution methods, etc.).

3.Sign a debt-to-equity swap agreement (legal guarantee)

The company and the contributing shareholders should sign a formal "Debt-to-Equity Agreement", clearly defining key terms such as the rights and obligations of both parties, details of the creditor's rights, the amount of equity to be converted, the equity ratio, settlement, and tax and fee assumption. This is an important legal document.

4.Capital Verification and Accounting Treatment (Core of Accounting Compliance

Capital verification report: Hire an accounting firm to conduct the capital verification. Accountants verify the authenticity, legality and availability of capital contributions (whether they comply with the "Auditing Standards for Certified Public Accountants of China") based on assessment reports, shareholders' resolutions, debt-to-equity swap agreements, original creditor's rights certificates, etc. The capital verification report is a key document for industrial and commercial changes.

Accounting entries (application of accounting standards - such as Accounting Standard for Business Enterprises No. 22 - Recognition and Measurement of Financial Instruments, etc.) :

Debit: Other Payables - XX Shareholder (or other corresponding liability account, original debt book value)

Credit: Paid-in capital - XX shareholders (the amount agreed to be included in the registered capital)

Credit: Capital reserve - Capital premium (the difference, usually the portion where the assessed value is higher than the agreed capital contribution or the original book value)

5.Business change registration (Legal effectiveness requirements)

With the resolution of the shareholders' meeting, the revised articles of association, the debt-to-equity swap agreement, the assessment report, the capital verification report and other documents, apply to the market supervision and administration department for the change registration of matters such as registered capital, shareholders and contribution methods. After the registration is completed, the act of contributing creditor's rights as capital will have full legal effect externally.

Key Risk Points: Legal Compliance and Tax "Hidden reefs"

01Legal compliance risk

       The creditor's rights are untrue, invalid or defective: such as fictitious creditor's rights, the creditor's rights have exceeded the statute of limitations, the creditor's rights are pledged or frozen, and the corresponding obligations of the creditor's rights have not been fully fulfilled, etc. This will result in the invalidation of the capital contribution, requiring shareholders to make up the capital contribution and even bear legal responsibility (risks of false capital contribution and capital withdrawal).

       Procedural flaws: Failure to conduct an assessment, failure to obtain a valid shareholders' resolution, failure to handle industrial and commercial changes in a timely manner, etc., may lead to the invalidity of the capital contribution behavior or pose significant legal risks.

      Harm to the interests of other creditors: In specific circumstances (such as when a company is insolvent), an improper debt-to-equity swap may be determined to harm the interests of other creditors of the company and there is a risk of being revoked.

02Personal income tax (at the individual shareholder level

       Core policy: Document No. 41 of the Ministry of Finance and the State Taxation Administration [2015], "Notice on Personal Income Tax Policies Concerning Personal Non-Monetary Asset Investment", clearly stipulates that individuals invest in non-monetary assets (including creditor's rights!) Investment refers to the simultaneous occurrence of an individual's transfer of non-monetary assets and investment. For the income from the transfer of non-monetary assets by individuals, individual income tax should be calculated and paid in accordance with the "Income from the Transfer of Property" item in accordance with the law.

Tax payment logic

Taxable income = Fair value (assessed value) of the claim - original value (tax basis) of the claim - reasonable taxes and fees

Tax rate: 20%

Case: In a certain technology start-up company, shareholder Li once invested 800,000 yuan in the company in the form of a personal loan (recorded in the company's books as "Other Payables - Li"). One year later, when the company increased its capital, the shareholders' meeting agreed that Li could directly convert the 800,000 yuan debt into equity. Li believed that "transferring from one hand to the other" did not require tax payment, so he neither conducted an assessment nor filed a tax return.

Consequences of falling into a trap

1.Tax inspection determined that this behavior constitutes an individual's investment with non-monetary assets (debts), and is subject to Document No. 41 of the Ministry of Finance and the State Taxation Administration [2015].

2. As there is no assessment report, the tax authority has the right to determine the fair value of the creditor's rights. Based on the company's current operating conditions and future development expectations, the fair value of this claim is determined to be 1 million yuan.

3. Li Mou needs to pay additional individual income tax: (1 million - 800,000) × 20% = 40,000 yuan.

4.At the same time, a huge late fee (calculated at 0.05% per day) and a fine (usually 0.5 to 5 times the tax) must be paid.

5. The company was fined for its books failing to truly reflect the essence of transactions (failing to show assessed value gains and deemed sales).

Lesson: Ignoring the legal mandatory assessment requirements will inevitably trigger tax risks! The non-cash transaction of "debt-to-equity swap" does not represent tax exemption. Individual shareholders must attach great importance to the assessment process and the individual income tax liabilities it brings.

03Corporate income tax (at the shareholder level of enterprises

       When a corporate legal person shareholder contributes a debt as capital, it is also regarded as the transfer of the debt. Need to confirm

       Transfer gains = fair value of the claim - tax basis of the claim

       This income should be included in the current taxable income of the enterprise and subject to enterprise income tax at the applicable income tax rate for the enterprise (generally 25%, with preferential treatment for small and micro enterprises that meet the conditions).

04Stamp duty

       The increase in the amount of "paid-in capital" and "capital reserve" due to capital increase shall be subject to stamp duty under the "Business Account Book" tax item.

       Tax rate: 0.025%.

       Preferential treatment: Small-scale taxpayers, small and low-profit enterprises, etc. can enjoy a 50% reduction in the levy.

Thoughtful Advice for Entrepreneurs: 

Tax planning early and fund preparation early:

      The creditor's rights are guaranteed to be genuine, legal, valid and flawless. Establish and retain a complete chain of evidence for creditor's rights.

     Strictly abide by the legal procedures: assessment, shareholders' resolutions, agreements, capital verification, and industrial and commercial changes, none of which can be omitted. Where the articles of association of a company have special provisions, they must be abided by.

       Assessment is indispensable: This is a mandatory requirement of the Company Law and also the cornerstone of tax calculation. No matter how large the amount of the creditor's rights is or how "certain" it seems, a qualified assessment agency must be hired to issue a report.

Tax planning early and fund preparation early:

     Before making an investment, it is essential to consult professional legal and financial advisors. Especially for individual shareholders, it is necessary to accurately calculate the potential individual income tax burden (based on the assessed value). A tax of 40,000 yuan, along with late payment penalties and fines, could be a heavy blow to a start-up.

      Find out if there are policies such as installment payment applicable (Document No. 41 of the Ministry of Finance and the State Taxation Administration [2015] allows installment payment within five years, but it needs to be filed), and make good cash flow arrangements.

      The documents are complete and can stand up to scrutiny: The system archives a full set of legal and fiscal and tax documents, including loan agreements, transfer records, assessment reports, shareholders' meeting resolutions, debt-to-equity swap agreements, capital verification reports, industrial and commercial change notices, tax payment certificates, etc.

      Seeking professional team support: Debt contribution involves the intersection of multiple fields such as the Company Law, Tax Law, Accounting Law, and Asset Appraisal Law. The collaborative cooperation between professional financial and tax advisors and legal advisors is of vital importance. They can help you design a legal, compliant and tax-burden optimized plan to avoid legal risks and tax audits.