Mergers and acquisItions in the people’s republic of china
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Table of Contents
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1. Introduction
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2. PRC Government Role in M&A Transactions
6
3. Structuring the Transaction
10
4. PRC Domestic Targets
16
5. Acquisition of Listed PRC Companies
20
6. Recent Changes and Developments
26
7. Standard Documentation
30
8. Conclusion
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Mergers and Acquisitions in the People’s Republic of China
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Hong Kong Overview
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Introduction
The PRC’s economic reforms and robust growth have accelerated the growth of different types of M&A activities
Merger and acquisition (“M&A”) activities in the People’s Republic of China (“PRC”) have increased dramatically over the last few years. While such transactions were virtually unknown a decade ago, they are now becoming increasingly common and important in the PRC economic landscape. The M&A route now offers foreign investors practical and viable means of entering the PRC market. The PRC’s economic reforms and robust growth have accelerated the growth of different types of M&A activities. The PRC’s accession to the World Trade Organisation (“WTO”) has opened previously restricted industry sectors to foreign investment and the PRC is now gradually relaxing previous operational restrictions imposed on foreign investment, permitting greater access to the PRC’s domestic market. With the continued strong growth of the Chinese economy, M&A transactions offering immediate market access are becoming increasingly attractive as an alternative to “green field” investments.
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Consequently, a large number of State-Owned enterprises are being made available for restructuring ...
Concurrent with these market reforms, the PRC has been restructuring State-Owned asset holdings. In certain industrial sectors, the State is encouraging State-Owned enterprises to consolidate into large integrated conglomerates, which are intended to be global leaders in their respective fields, while in some other sectors, the State is actively seeking to reduce the level of its equity holding. Consequently, a large number of State-Owned enterprises are being made available for restructuring or for partnership with foreign entities. These new potential targets again offer foreign investors greater and more varied market entry options. Oldham, Li and Nie is able to provide clients with a broad overview of the current status of M&A practice in the PRC and with practical solutions, including the regulatory framework, structuring options, target types and recent regulatory developments.
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Hong Kong Overview
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PRC Government Role in M&A Transactions
There is a higher level of Government participation in M&A transactions in the PRC than in other jurisdictions.
The PRC Government plays an important role in all PRC M&A transactions. There is a higher level of Government participation in M&A transactions in the PRC than in other jurisdictions. Despite the recent relaxation of foreign investment restrictions, case by case approval requirements remain a distinctive feature of any PRC M&A transaction. In these transactions, the respective PRC government departments and/or bureaus do not merely act as anti-trust or competition regulators and their concerns are not limited to the economic consequences of a transaction. They play a much broader role in reviewing and approving deal specific arrangements. In many M&A transactions, PRC government departments and/or bureaus will act as regulators and possibly also as “vendor”, and will have concerns that extend well beyond the commercial aspects of the transaction. The approvals required for an M&A transaction are NOT mere formalities, but may take considerable effort to obtain. Understanding the applicable regulatory framework and the PRC Government’s role in the acquisition process is therefore important to successfully conclude any M&A transaction in the PRC. Key PRC Government Departments and/or Bureaus A few PRC government departments and/or bureaus play key roles in M&A transactions.
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Newly Built National Theatre of China in Beijing (Summer of 2007)
The nature of the PRC “target” company may also lead to the involvement of other PRC regulators.
The Ministry of Commerce (“MOC”) and the National Development and Reform Commission (“NDRC”) are the PRC government bureaus with primary responsibility for supervising foreign related M&A transactions. The MOC is the principal foreign investment regulator and has general supervisory and approval authority over M&A transactions. The NDRC is responsible for approving the foreign investment project applications and supervising the restructuring of State-Owned enterprises. These two bureaus will be involved in most M&A transactions. The nature of the PRC “target” company may also lead to the involvement of other PRC regulators. The State-Owned Assets Supervision and Administration Commission (“SASAC”), which has supervisory authority over State-Owned assets, plays a significant role in transactions targeting State-Owned enterprises. It will participate in approving the transactions, and may also act as the vendor through one of its designated agencies or companies. The China Securities Regulatory Commission (“CSRC”), which is responsible for monitoring and regulating the PRC capital markets, will also be involved in transactions targeting listed companies. Other industry specific and specialised administrative bureaus may be involved depending on the nature of the transaction and the industry sector of the target company. For example, the approval of the Ministry of Information Industry may be
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PRC Government Role in M&A Transactions
required for certain acquisitions targeting companies in the consumer electronics business. The approval of the State Administration of Foreign Exchange (“SAFE”) will be required where the consideration to be paid is in currencies other than RMB. In dealing with these PRC bureaus, it is important to remember that different PRC bureaus have different agendas and constituencies. The support of one bureau does not necessarily imply the support of another, and national and local authorities may hold divergent views on the same issue. It is important to proactively monitor the entire process. Foreign Investment Regulations in the PRC The general regulatory framework applicable to foreign investment in the PRC is also applicable to foreign related M&A transactions. A foreign company is not permitted to directly operate a business in the PRC. It must do so through a foreign investment enterprise (“FIE”). There are currently four types of FIE in the PRC: • Sino-foreign equity joint ventures, • Sino-foreign cooperative joint ventures, • wholly foreign-owned enterprises; and • foreign investment enterprises limited by shares.
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Mergers and Acquisitions in the People’s Republic of China
Although each type of FIE has its own distinctive features, FIEs share many common characteristics and are generally limited liability companies. The Catalogue for the Guidance of Foreign Investment classifies investment projects by industry sector as “encouraged”, “permitted”, “restricted” or “prohibited”. The catalogue classification impacts on both the investment approval process and the permissible level of foreign equity holding. Majority Chinese equity is required in certain restricted industries, while in other industries, wholly foreign-owned enterprises are prohibited. A preliminary step in any M&A transaction or PRC investment project is to confirm whether such industry permits foreign investments pursuant to the above catalogue Regulatory Framework for M&A Transactions Over the past few years, PRC has enacted a preliminary regulatory framework for M&A transactions. This framework, though not complete, does provide guidance for foreign investors engaging in M&A transactions and standardises practices that may have previously developed on an “ad hoc” basis. Under the PRC’s civil law legal system, even a basic type of business transaction may be governed by detailed regulations. The new regulations establish the basis for using conventional acquisition methods to acquire most
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PRC Government Role in M&A Transactions
types of enterprises in the PRC. Regulations now permit foreign investors to engage in asset or equity acquisitions of FIEs, domestic enterprises, State-Owned enterprises and or listed companies. The range of permissible targets has been vastly expanded, but distinct regulatory regimes still apply to the acquisition of different types of entity. Approvals for M&A Transactions The specific approvals required for an M&A transaction will depend on the individual deal structure, the target type, and the transaction value. As a general rule, transactions involving encouraged or permitted projects with a total investment amount of US$100 million or more typically require the approval of both the MOC and the NDRC, whereas encouraged or permitted projects with a total investment amount of under US$100 million can generally be approved by the Ministries’ provincial or lower level branches. Restricted projects with a total investment amount of US$50 million or more require national level approval from the MOC and the NDRC, while smaller restricted projects may be approved by provincial level offices of the Ministries. There may be exceptions to these general rules depending on the particular nature of the project, and may require a higher level of approval to be obtained in some cases. Until very recently, MOC and NDRC approvals were required for most projects with a total
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Shanghai skyline at night
Until very recently, MOC and NDRC approvals are required for most projects with a total investment amount exceeding US$30 million
investment amount exceeding US$30 million. Larger “encouraged” category projects could be approved locally. Depending on the industry sector, the approval of other specialised administrative bureaus may also be required. If the target company is a State-Owned enterprise, the transaction will generally require the approval of the MOC, the NDRC and the SASAC. A variety of registrations will be required after the completion of the transaction.
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Hong Kong Overview
3 Foreign investors intending to conclude an M&A transaction in the PRC can choose among the traditional acquisition structures, equity purchases, asset acquisitions ...
Structuring the Transaction
Foreign investors intending to conclude an M&A transaction in the PRC can choose among the traditional acquisition structures, equity purchases, asset acquisitions and a statutory merger, which are all recognised under PRC law. The preferred acquisition method will however depend on a number of considerations like the financial condition of the M&A target entity, the required PRC Governmental approvals, the transferability of the assets and the tax consequences of any existing or proposed structure. Equity Purchases A foreign investor may choose to directly or indirectly acquire equity interests in the target company from the existing investors of the target company. This acquisition is generally the simplest and quickest to complete because the legal nature of the target company generally does not change, but just the ownership. Equity acquisitions by a foreign investor may be carried out through an indirect offshore acquisition or a direct acquisition. Indirect Equity Acquisitions If the target interest is a foreign party’s equity interest in an FIE, an indirect offshore acquisition is possible and a foreign investor may simply acquire the shares in the FIE’s offshore investor. This is generally the preferred acquisition method, especially if the target equity is held by a special purpose vehicle without other assets. In this way, PRC government approvals are not required, since the FIE’s registered equity holder will not be changed. Also, this form of transaction will not trigger any statutory pre-emption rights of other investors (if any).
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Hong Kong Overview The bridge on Yangtze river
Direct Equity Acquisitions The foreign investor will acquire equity in an FIE or PRC domestic enterprise from their existing equity holder(s) by entering into an equity acquisition agreement with the then current equity holder(s) or through subscription for new equity in the target. If the target is an FIE, this will require the approval of the same PRC approval authority that originally approved the formation of the FIE. However, other investors in the target FIE will have a statutory pre-emption right to acquire the interest which is intended to be transferred. If the equity of a purely PRC domestic enterprise is acquired by a foreign investor, conversion of the PRC enterprise into an FIE is needed and the approval process for the establishment of an FIE is applicable. This changes the legal nature of the target, and the regulations governing the operations of FIEs will then become applicable to the target. Consequently after the acquisition, the target will be subject to different operating rules, a fact which should always be considered when assessing the transaction. Equity Acquisitions by FIEs Operating FIEs are now permitted to invest in other enterprises. The Interim Provisions on Domestic Investment by Foreign Investment Enterprises provides a basis for such subsidiary investments. The invested entity may either be another FIE or a domestic PRC enterprise. Sector restrictions on foreign investment are still applicable to such investments. The investing www.oln-law.com
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Structuring the Transaction
FIE must also satisfy certain criteria. For nonholding company FIEs, the investment amount may not exceed 50% of its net assets. The FIE’s registered capital must have been fully paid up. The FIE must also be profitable and have no record of unlawful activities. A formal registration and approval process is applicable to such investments. For investments in “encouraged” and “permitted” industries, the PRC domestic company registration procedure may be used to validate the investment. This is a simpler and less time consuming process than obtaining MOC approval. For investments in “restricted” industies, MOC approval is still required. Asset Acquisitions It is also possible to structure an M&A transaction through asset acquisition where the investor acquires key assets (and or liabilities) of the target. Hence, the investor may have the opportunity to carve out unwanted assets and/or liabilities. After the acquisition, the target continues to maintain a separate legal existence. Although an asset acquisition may be time consuming, this method may be attractive to foreign investors in view of the fact that it is often difficult to identify with certainty, all the liabilities of any PRC entity. As a foreign company may not operate assets directly in the PRC, a PRC acquisition vehicle is typically established simultaneously with the acquisition. The capital contributions made for the establishment of the acquisition vehicle are often used as consideration for the acquisition of the target assets. Considerable government liaison work may be necessary for this type of transaction and agreements with creditors are usually required. Arrangements with the target’s workers will normally be examined during the approval
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process. In some cases, formal consultation with the target’s workers on their settlement arrangement may be required. While the worker settlement issues are the responsibility of the target, the way that they are being dealt with may impact the progress of the transaction. Approval from the customs authority and the payment of supplemental duty like import tariffs may be required if the acquired assets fall under customs supervision. Mergers Previously, mergers took place largely on an ad hoc basis through liaison with PRC local approval authorities. Pursuant to the Provisions on the Merger and Division of Foreign Investment Enterprises, mergers between FIEs and domestic enterprises now have a legal basis and statutory mergers are subject to the sanctions of PRC law. In a statutory merger, the acquiring entity inherits all of the assets and liabilities of the target by operation of law, while the existing investors’ equity is transformed into merger consideration. A merger under PRC law may be structured in various ways. The target may be merged into the acquirer or a new entity being created can absorb both entities. A merger is subject to a number of conditions. The merger agreement must address certain statutorily required items. The merger candidates’ registered capital must have been fully paid. Parties to a merger must also make arrangements for the employment of the original employees. Creditors are required to be notified and have the statutory right to require debt repayment or the provision of adequate security as a condition to the consumption of the merger. The foreign investor in the merged company is required to hold a minimum of 25% of the postmerger company’s registered capital in order for it to enjoy FIE tax and customs benefits. www.oln-law.com
Structuring the Transaction
A merger is subject to a multi-step approval process. Preliminary approvals must be obtained from both the surviving and the dissolving entities’ establishment approval authorities. A final approval is required from the surviving entity’s establishment approval authority. Any
existing subsidiaries of the merged entities must satisfy the applicable post-merger regulatory requirements. The chart below summarises the relevant procedures.
Execution of the merger agreement
Corporate approvals of the parties Dissolution approval of the absorbed company Preliminary approval of the merger by relevant PRC authorities
Notice to the creditors; public announcement
Final approval of the merger by relevant PRC authorities
State Administration of Industry and Commerce: deregistration of the absorbed company; registration of the post-merger FIE
Establishment of the post-merger FIE
Notice to the creditors; public announcement; deregistration/ registration with tax/foreign exchange authorities
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Hong Kong Overview
Megacity Highway, Shanghai, China
The merger may also result in a change of ownership of land use rights and buildings 14
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Structuring the Transaction
Taxation Issues A merger will potentially trigger a number of complex tax and accounting issues. For instance, it is the practice in the PRC that the post-merger FIE calculates all its assets, liabilities and shareholders’ equity interests at the book value of historical costs of the pre-merger parties. The book value calculated on the basis of the valuation result that has been conducted for the particular purpose of the merger is disregarded. As regards to previous losses, during the remainder of the fiveyear period, the operating losses of each pre-merger party that have not been covered may be carried over to the next tax year on a continuous year-by-year basis by the post-merger company. There are also issues relating to the reduced/exempted tax. If the foreign capital of the pre-merger FIE is transferred to domestic investors during the merger, the already reduced or exempted enterprise income tax (“EIT”) can be clawed back. However, there is also a situation that the already reduced or exempted EIT cannot be clawed back, if the foreign capital of the pre-merger FIE has been consolidated into the post-merger company in the deal where an FIE is absorbed when its actual period of operation is less than ten years. The merger may also result in a change of the ownership of land use rights and buildings. In this regard, the three to five per cent deed tax that would otherwise be levied over the purchaser on the title transfer is exempted.
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Hong Kong Overview
4 The new M&A regulations do not provide additional guidance on M&A activities targeting FIEs, but are still addressed in other regulations
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PRC Domestic Targets
New M&A regulations have expanded the range of permissible targets providing greater regulatory guidance on acquisitions involving PRC domestic companies and State-Owned enterprises. However, these new general M&A regulations are not applicable to acquisitions targeting listed companies, which are covered by separate regulations based on share classification. These new regulations do not provide additional guidance on M&A activities targeting FIEs, but are still addressed in other regulations. Acquiring Domestic PRC Companies The Interim Provisions on the Acquisition of Domestic Enterprises for Foreign Investors has established a mechanism for the acquisition of domestic equity or assets by foreign investors. A foreign investor may acquire equity in a PRC domestic company from an existing domestic shareholder, or may subscribe for new shares of a domestic company as a result of increasing its capital. In either event, the domestic enterprise shall be transformed into an FIE. These transactions are subject to discretionary PRC government approval, which should be granted within thirty (30) days of the submission of transaction documents. The investments resulting from such transactions must comply with the PRC’s industrial policies for foreign investment.
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Offices buildings in Beijing, China
Acquiring Non-listed State-Owned Companies The acquisition of non-listed State-Owned companies is also addressed in the new regulations. The Interim Provisions on the Utilisation of Foreign Investment to Restructure State-Owned Enterprises establishes a framework for foreign investors to acquire State-Owned enterprises and for their transformation into FIEs. A foreign investor may acquire an interest in a State-Owned company by acquiring an existing equity interest, converting existing debt or acquiring the assets of the State-Owned company. A foreign investor may also subscribe to the registered capital as increased of a State-Owned company. The resolution of employee related issues is an important aspect of the acquisition process. The PRC government pays particular attention to plans for the handling of existing employees. Worker settlement arrangements are typically required in connection with such transactions. The application for reorganisation using foreign investment requires SASAC approval. The reorganised enterprise must then handle approval procedures related to the establishment of an FIE.
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Hong Kong Overview
Ruiguang Ta (Pagoda), dating from the 3rd Century AD, Suzhou, China
A foreign investor may acquire an interest in a State-Owned company by acquiring an existing equity interest, converting existing debt or acquiring the assets of the State-Owned company. 18
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PRC Domestic Targets
The chart below summarises the procedures of equity acquisition of domestic companies by foreign investors and converting it into a FIE in the PRC.
Execution of the acquisition agreement
Corporate approval of the parties
Approval by provincial or national office of Ministry of Commerce to obtain the FIE Approval Certificate
• •
Registration of shareholding change with the SAIC FIE Business Licence issued to the target company
Registration with SAFE to obtain the Foreign Exchange Registration Certificate
Registration with the State Administration of Taxation to obtain the FIE Tax Registration Certificate
Payment within specified time limit Payment verification with local SAFE
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Hong Kong Overview
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Acquisition of Listed PRC Companies Foreign acquisitions of shares in listed companies are regulated with reference to the nature of the shares acquired. Most shares in the PRC are NOT freely transferable. Shares are classified according to the entities authorised to hold them. Listed A shares, which are denominated in Renminbi, may generally only be held by PRC nationals, while listed B shares, which are denominated in a foreign currency, may generally only be held by foreign nationals. There are a few exceptions in each case. State-Owned shares are held directly by the State or government entities. Legal person shares are held by government authorised entities. The capital structure of PRC listed companies generally consists of a minority of tradable listed shares and a majority of non-tradable State-Owned and legal person shares. This complex share ownership system has limited share acquisition opportunities. Recent changes made to the regulatory framework, however, have expanded the range of permissible foreign share acquisitions. Acquisition of Listed Companies Foreign M&A transactions targeting PRC listed companies are not common. Foreign investment in listed companies has traditionally taken the form of negotiated minority stakes, and has been for the purpose of establishing a strategic relationship or making a financial investment rather than for obtaining operational control. The Administrative Measures on the Acquisition of Listed Companies, however, now provides a framework for the acquisition of listed PRC companies by foreign investors. Recent regulations address
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Door leading to the Forbidden City, Beijing
State-Owned shares are held directly by the State or government entities
the takeover of listed companies, which is defined as the acquisition of 30% of a listed company’s issued shares rather than listed shares. A takeover may be undertaken by agreement, public tender offer or market acquisitions on the stock exchange. The regulations permit the use of non-cash consideration in a takeover, allowing more complex structuring arrangements involving equity consideration. CSRC approval is required for a takeover by agreement. A public tender offer to all shareholders is statutorily required after the 30% interest is acquired. It is unclear how the tender offer requirement will typically work in practice since foreign investors are prohibited from acquiring certain classes of shares. The interaction between the general offer requirements and the share class ownership restrictions requires further clarification. The CSRC may waive the general offer requirement in its discretion. Acquisition of Legal Person and State-Owned Shares The foreign acquisition of legal person shares in PRC listed companies had been prohibited since 1995. The restriction, however, was lifted in 2003 pursuant to the Notice on Relevant Issues Regarding the Transfer of State-Owned Shares and Legal Person Shares of Listed Companies to Foreign Investors. The Notice outlines a regulatory framework for the transfer of nonlisted shares to foreign investors. The approval procedure for such transactions involving State-Owned shares was further clarified by
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Acquisition of Listed PRC Companies
the Notice on Issues Concerning the Application Procedures for the Transfer of State-Owned Shares in Listed Companies to Foreign Investors and Foreign Investment Enterprises, which was issued in 2004. A foreign investor wishing to acquire legal person shares or State-Owned shares in a listed company must satisfy certain investor qualifications to demonstrate the benefits of its investment. The acquisition is subject to PRC government approval. The purchase price must generally be paid with either convertible foreign currency or renminbi profits generated by other investments in the PRC. Conversion into an FIE may also be required in connection with such acquisition, although the target will not enjoy the benefits typically available to FIEs.
A foreign investor wishing to acquire legal person shares or State-Owned shares in a listed company must satisfy certain investor qualifications to demonstrate the benefits of its investment
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Mergers and Acquisitions in the People’s Republic of China
Acquisitions of A Shares Pursuant to the Interim Provisions on the Administration of Security and Investment in China by Qualified Foreign Institutional Investors, the A share market is slightly open to foreign financial investors. The Provisions establish a framework for permitting limited foreign investment in the A share market. Foreign institutional investors that satisfy certain stringent criteria are classified as Qualified Foreign Institutional Investors (“QFII”) and are permitted to make limited investments in A shares. A QFII is not permitted to hold more than 10% of the outstanding shares of any particular listed company, and the combined holdings of QFIIs in a company cannot exceed 20% of its listed A shares. Taxes Arising from Acquisition Transactions Pursuant to the PRC tax laws, parties to the acquisition transactions are liable to pay certain PRC taxes and are subject to the supervision of PRC tax authorities. The table on the following page sketches out the specific tax levied in an acquisition transaction in accordance with the current PRC tax laws, which however may vary by transactions.
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Acquisition of Listed PRC Companies
Tax Category
Tax Rates
Taxable Items
Responsible Party
Acquisition of Equity from Corporate Vendor
Enterprise Income Tax
Stamp Tax
1. 2.
Foreign vendor: 10%; Domestic vendor, 33% prior to 2008/01/01; 25% after 1 January 2008
0.05%
Gains on transfer
Vendor
Execution of contractual document
Vendor and Purchaser
Acquisition of Assets from Corporate Vendor Business Tax
5%
Transfer of immovable properties or intangible assets
Vendor
Deed Tax
3-5%
Transfer of land-use rights or real estate property
Purchaser
Land Appreciation Tax 30%-60%
Gains on disposal of landuse rights and buildings
Vendor
Value-added Tax
Transfer of inventory
Vendor
Transfer of used fixed asset
Vendor
Gains on transfer
Vendor
0.03%
Execution of contractual document for inventory
Vendor and purchaser
0.05%
Execution of contractual document for other asset
Vendor and Purchaser
17% 2%
Enterprise Income Tax
Stamp Tax
1. 2.
Foreign vendor: 10%; Domestic vendor, 33% prior to 2008/01/01; 25% after 1 January 2008
Acquisition of Equity or Assets from Individual Vendor Income Tax
20%
Gains on transfer
Domestic individual Vendor
Withholding Tax
20%
Gains on transfer
Foreign individual Vendor
Execution of contractual document
Vendor and Purchaser
Stamp Tax
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Acquisition of Listed PRC Companies
Tax Implications The consideration or price payable on an acquisition can often be affected by a number of tax issues and the transaction itself may affect the continuity of the existing tax incentives or the availability of new tax incentives. Therefore, before entering into an acquisition transaction, it is prudent for both vendor and purchaser to consider the tax implications of the transaction, which may include: 1. Tax credits due to previous losses Tax credits due to losses prior to the acquisition in an acquisition for equity may continue to be carried forward by the post-acquisition FIE for no more than five years. Therefore, the purchaser in an acquisition transaction may benefit from the tax credits of the target company.
carry forward their respective tax credits, which cannot be transferred to the other party through the acquisition. In this circumstance, the benefit of the tax credit due to the losses incurred by the target company will remain with the vendor. 2. Tax deduction In an acquisition for equity, neither the purchase price nor any amortization for goodwill resulting from the acquisition will entitle the purchaser to any credits for tax deduction; the acquisition expenses incurred by the purchaser cannot be transferred to the target company. However, in an acquisition for assets, it is possible for the purchaser to gain tax credits, so the purchase price can be depreciated or amortized.
In an acquisition for assets only, however, the vendor and purchaser can only retain and
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Acquisition of Listed PRC Companies
Panorama of Pudong seen from Shanghai
3. Claw-back of tax incentives The importation of certain equipment into the PRC can enjoy certain tax concessions, including the reduction of or exemption from customs tariffs and the value-added tax. To enjoy such tax concessions, however, the equipment is subject to a supervision period by the PRC Customs Authority. Transfer of such imported equipment which has already enjoyed tax incentives will require the consent by the Customs Authority. In reality, however, the Custom Authority would usually allow the transfer of such imported equipment only if the vendor makes up all the previously exempted or reduced customs tariffs and value-added tax in connection with the import of such equipment. Also, pursuant to the new EIT Law, an enterprise may enjoy certain tax offset if it acquires certain
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special facilities for environmental protection, energy and water conservation, work safety, etc, if such special facilities are those acquired for actual self-use. However, if the vendor sells such special facilities within the next 5 years, the vendor has to make up all the offset tax it has enjoyed. In addition, for an acquisition of assets, if the target company is an existing FIE and would be terminated and liquidated as a result of the sale of its operating assets and the termination is made within ten years of the target company’s establishment, and the FIE has enjoyed certain tax holidays, then the FIE may be required to make up the previously reduced or exempted tax before its termination or liquidation. Therefore, the vendor may increase the selling price of the assets concerned to offset the potential tax liability.
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Hong Kong Overview
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Recent Changes and Developments There have been many recent changes to the prevailing practices in the PRC, some of which now offer greater flexibility, while others close perceived loopholes in current practice. Minimum Foreign Investment The NEW regulations clarify the treatment of foreign investments of less than 25% of a domestic enterprise’s equity. Applicable law previously provided for a minimum foreign investment of 25% in the equity of a Sino-foreign joint venture. The regulations did not address the permissibility or handling of smaller investments. Smaller investments were dealt with locally on an ad hoc basis. The new regulations now permit smaller investments. Investments of less than 25%, however, still require adherence to the foreign investment approval procedure, although such invested enterprises shall not be eligible for the benefits typically granted to FIEs. This change has clarified a grey area of current practice. Consideration The new regulations permit the use of a greater range of acquisition consideration, which now includes convertible foreign currency, in-kind assets, intangible assets, and lawfully earned Renminbi, as well as shares over which the investor has a disposal right. This wider range of consideration permits greater deal structuring flexibility. The possibility of using share consideration is another major development, although SAFE approval is required for the use of such consideration.
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Metal roof construction, airport of Hangzhou, China
Chinese nationals are generally prohibited from holding equity in an FIE
Statutory time frames for the payment of consideration have also been established with payments generally required within three months to one year of the transfer of the assets. Valuation Asset valuation is now required for all acquisitions of PRC domestic assets, not simply for State-Owned assets. The valuation must be undertaken by a licensed valuation organisation, and there is separate regulations governing the valuation procedure. The valuation report will establish the reference price for the transaction. While the actual purchase price may vary from the valuation, if the variance is too large, PRC government confirmation of the purchase price may be required. Chinese Domestic Shareholders Chinese nationals are generally prohibited from holding equity in an FIE. Recent regulations, however, permit individual PRC shareholders, who have held their shares for a year, to retain their interests, subject to government approval, following a foreign acquisition. This change will permit greater continuity within target enterprises. This change may also be a first step in providing a basis for employee share incentive schemes within FIEs.
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Recent Changes and Developments
Further Developments The following legal developments in the PRC, may also affect a proposed acquisition of interests in an FIE: 1. “Amendments to the Law of the PRC on Sino-Foreign Cooperative Joint Venture Enterprises” and “Amendments to the Law of the PRC on Wholly Foreign-Owned Enterprises” passed by the Standing Committee of the National People’s Congress, and “Amendments to the Law of the PRC on Sino Foreign Equity Joint Venture Enterprises” passed by the National People’s Congress FIEs can now purchase raw materials, fuel and other materials that they need from either inside or outside the PRC subject to the principles of fairness and reasonableness. The FIEs are no longer necessary to give preference to purchasing such supplies inside the PRC, and CJVs or WFOEs are also not required to balance their foreign exchange receipts and expenditure. With such amendments, the obligation of EJVs and WFOEs to file their production and business plans with the authorities has also been removed.
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Previously, there was a mandatory requirement that a WFOE can be established
Mergers and Acquisitions in the People’s Republic of China
only if it were to utilise advanced technology and equipment, or to export all or most of its products. But the requirement has been relaxed. In general, this means that a WFOE is not required to export all of its products or to utilise advanced technology. As a result, foreign investors which entered into joint ventures with PRC parties due to the mandatory requirements in the past can now consider buying out their PRC partners’ interests and converting the joint ventures into WFOEs. 2. “Tentative Provisions on Investment by Foreign Investment Enterprises Within the PRC” promulgated by Ministry of Foreign Trade and Economic Cooperation (“MOFTEC”, now known as Ministry of Commerce) and State Administration of Industry and Commerce (“SAIC”) Pursuant to these Provisions which came into effect on 1 September 2000, a FIE investing in another enterprise within the PRC must fulfill certain requirements including (but are not limited to) the following: • the FIE’s registered capital has been fully paid up; • the FIE has started to generate profits; • the FIE is and has been operating lawfully; and • the aggregate amount invested in the
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other PRC enterprise should not exceed 50% of the FIE’s net assets, excluding for such purposes, the capitalization of profits generated by the other PRC enterprise.
But it should be noted that the FIE is not permitted to invest in any areas of sectors in which a foreign investment is prohibited. Despite these Provisions, there are still rooms that foreign investors can still restructure their existing investments in the prohibited areas in the PRC in order to comply with the requirements of the Provisions.
3. “Provisions on Merger and Division of Foreign Investment Enterprises” promulgated by MOFTEC and SAIC Pursuant to these Provisions which came into effect towards the end of 1999 to supplement the stipulations of the “Company Law of the PRC”, the rules for acquisition of an FIE by another FIE through a merger have been set up to sanction the following two forms of merger: • “merger by absorption” – means the absorption of one FIE by another in which the latter FIE survives the merger; and • “merger by new establishment” – means the merger of two or more FIEs into a new FIE so that the old FIEs are dissolved and a new FIE is established.
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4. “Supplemental Provisions to the Tentative Provisions on Establishment of Companies of an Investment Nature by Foreign Investors” promulgated by MOFTEC Under the “Tentative Provisions on Establishment of Companies of an Investment Nature”, an investment company may be established either in the form of an EJV or a WFOE in order to hold and or invest in other enterprises, and to undertake certain business activities which in principal include the following: • establishing scientific research and development centres in the PRC in order to engage in the research and development of new products and advanced or new technology, to transfer the resulting achievements and to provide technical services; • undertaking the business of a sales agent or distributor both within and outside the PRC for products produced by enterprises; • providing transportation, warehousing and other services to enterprises in which it has made a stipulated amount of investment; and • purchasing and exporting from the PRC goods which are not subject to export quotas or export licensing.
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7 In an acquisition, an agreement for transfer of equity interests in a FIE will be made between the investor and the transferor of such interest
Standard Documentation
Letter of Intent/Memorandum of Understanding A Letter of Intent or Memorandum of Understanding may be entered into by the parties to a proposed acquisition in order to record their intentions regarding the acquisition. The parties may indicate certain commitment in such documents, including the requirements for the acquisition that the purchaser of the equity interest is allowed to carry out due diligence on the target company or companies. Direct Acquisition of Equity Interest of a FIE: Agreement for Equity Transfer and Amendments to Joint Venture Documents In an acquisition, an agreement for transfer of equity interest in a FIE will be made between the investor and the transferor of such interest. In these circumstances, the existing joint venture contract and articles of association of the FIE will have to be amended in order to reveal the fact that the investor is a new party to the FIE and the rights and obligations of the parties of the FIE will be re-defined accordingly. Such documents are subject to examination and approval by the original establishment approval authority of the FIE.
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Night view of Shanghai, China
A shareholders’ agreement is also normally entered into between the shareholders of the target company to govern their relationship in the target company
Indirect Acquisition of Equity Interest of a FIE: Share Sale and Purchase Agreement, and Shareholders’ Agreement In an indirect acquisition of equity interest in a FIE, a share sale and purchase agreement will be entered into between the purchaser and the vendor of shares in the target company. If the purchaser is not the only shareholder in the target company, a shareholders’ agreement is also normally entered into between the shareholders of the target company to govern their relationship in the target company. If a shareholders’ agreement already exists between the current shareholders, it may have to be amended to reflect the necessary changes in shareholding of the FIE. If it is necessary to amend any joint venture contract and or the articles of association of the FIE as a result of the indirect acquisition, such amendments to the documents are subject to examination and approval by the original approval authority of the FIE.
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8
Conclusion
• The PRC has committed to further open up its economy following its accession to the WTO and indeed the PRC has made considerable advances in the last few years in developing a regulatory framework for M&A transactions. • This framework has broadened the scope of permissible acquisitions by FIEs. With the practical enactments of such regulations, both the range of targets and acquisition methods have been expanded. Emerging market practices have also been standardised and validated.
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• More detailed implementing regulations to complement the recently enacted general provisions will be issued in future. Given the further expansion of the PRC economy, the PRC’s market will continue to attract the interest of foreign investors and certainly, M&A transactions should become an increasingly viable method for foreign investors to access PRC markets.
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Economic Center of China – Night View of Shanghai
If you require additional advice on the above, or on any PRC employment or other legal or regulatory issue, please contact: Chris Hooley Partner Tel (852) 2868 0696 E-mail chooley@oln-law.com
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The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although every effort has been made to ensure that the information is accurate and timely, there can be no assurance or guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice as to the specific circumstances of any particular situation, individual, entity or transaction. The law is stated as at 2011 | © OLDHAM, LI & NIE LAWYERS
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