A look at land use rights treated as capital contributions in M&A deals

Pursuant to the Implementing Regulations for the Law Governing Land, the compensated use of state-owned land primarily consists of land assignment, land lease, as well as capital contributions or equity investment with valued land use rights. This method, including the contribution and valuation of land involved in merger and acquisition (M&A) deals, has been increasingly popular in recent commercial cases. The principal contributing parties are often state-owned enterprises (SOEs).

Types of equity investment

Equity investment with land use rights is generally divided into three types: i) the state makes equity investment with state-owned land use rights, which is defined as state shares (see article 3 of the Interim Provisions Governing the Allocation of Land Use Rights in the Reform of State-owned Enterprises); ii) enterprises as legal persons or other economic organisations make equity investment with land use rights acquired from land assignment, which is defined as corporate shares (see the Opinions of the Ministry of Land and Resources and the All-China Federation of Industry and Commerce on Further Encouraging and Guiding Private Capital to Invest in the Sector of Land and Resources); and iii) rural collective economic organisations make equity investment in setting up enterprises or joint ventures together with other units or individuals with the use rights to land for construction purposes defined in the general plan for the utilisation of land of townships. Such equity is defined as collective shares (see article 60 of the Land Administration Law).

If equity investment is made with the use rights of land authorised to operate or allocated by the state, it must be submitted to the competent land administration department for approval, and a land assignment fee must be paid. (See Certain Opinions of the Ministry of Land and Resources on Strengthening the Management of Land and Resources, and Promoting the Reform and Development of State-owned Enterprises).

Pursuant to the Reply of Civil Trial Chamber II of the Supreme People’s Court on Whether the Recovery of Land Upon Expiry of the Term Constitutes Shareholders’ Surreptitious Withdrawal of Capital Contributions if the Shareholders Use a Partial Term of Land Use Rights as an Equivalent Price for Capital Contributions, shareholders are also permitted to use a partial term of land use rights for capital contributions or equity investment.

The prerequisite for using land use rights for equity investment is that an investor must have complete land use rights, including but not limited to the related rights such as the lease, transfer and use of land use rights for capital contributions.

Evaluation methods

Pursuant to the Company Law, the value of any non-financial asset used as capital contribution must be assessed and verified, and must not be overestimated or underestimated. Therefore, the assessment is the basis for using land use rights as contributions.

Existing laws and regulations do not contain any explicit requirements for the methods employed for evaluating land use rights as capital contributions. There are three major evaluation methods: i) market comparison approach, which is to compare a piece of land to be evaluated with a similar piece of land in a recent transaction to generate a price for the piece of land to be evaluated by modifying the price of the land in the recent transaction; ii) income approach, which is to forecast the expected earnings to be generated by the land in the future and convert these expected earnings into a sum of present value at a certain capitalisation rate for determining the assessed value of the land; and iii) cost approach, which is to determine the price of land based on the sum of various expenses spent on the development of the land together with the profit, interest, taxes and land value-added income.

It should be noted that SOEs that make capital contributions in terms of non-monetary assets are required to comply with the special requirements for the disposal of land and resources by SOEs under the Notice of the Ministry of Land and Resources Regarding the Reform of Procedures for Confirming Land Valuation Findings and Approving Land Asset Disposals.

As a result of this notice, the original land valuation confirmation and approval system was revamped by setting up a land valuation reporting and filing system. If an enterprise tries to dispose of a piece of land that was used by the state as a capital contribution or equity investment, it may choose a land valuation agency independently to conduct land evaluation, but it must submit a land valuation report for the record as the approval of the disposal of the land asset is being processed by the competent land administrative department above the provincial level.

Accounting treatment

If a capital contribution is made with valued land use rights during the establishment of a limited liability company or a joint-stock company, the capital subscribed by investors is usually the same as the registered capital, and therefore the assessed value of the land use rights will be directly included in the registered capital and paid-up capital.

However, If the contribution is made with land use rights during an M&A deal, the appraised value of the land use rights may be partially included in the registered capital and paid-up capital, and partially included in the capital reserve; within the appraised value of the land use rights, the capital contribution amount calculated according to the investment proportion is included in the paid-up capital, while the excess is included in the capital reserve, i.e. capital premium.

Pursuant to article 28 of the Company Law, a shareholder making capital contribution with non-financial assets must carry out the transfer procedures for the relevant property rights in accordance with law. Pursuant to Chinese Registered Accountants Auditing Standards No. 1602 – Capital Verification, the transfer of the ownership of intellectual property rights, land use rights and other intangible assets as capital contributions should be verified. Upon completion of the transfer procedures, the value of these property rights must be verified as well.

The fulfilment of an investor’s obligations towards capital contributions with land use rights is marked by the completion of the procedures for the transfer of the ownership of these land use rights.