26 January, 2013

A Welcome Development for Foreign and Local Investors Alike.

On 21 September 2012, the Ministry of Commerce of the People’s Republic of China issued the Ministry of Commerce Tentative Provisions on the Use of Equity Interests to Make Capital Contributions to Foreign-invested Enterprises (“Tentative Provisions“) which took effect on 22 October 2012. The Tentative Provisions allow both local PRC and foreign investors to use their existing equity interest holdings (“Equity Interests”):

• in foreign invested enterprises (“FIEs“) in the People’s Republic of China (“China” or the “PRC“) (whether in the form of joint ventures (both co-operative and equity joint ventures) or wholly-foreign owned enterprises);
• companies which are wholly owned by PRC nationals or entities (“Domestic Companies“); and
• companies listed in the PRC

as capital contributions to: 

• a newly-established ‘greenfield’ FIE; 
• an existing FIE; or 
• a Domestic Company which is converted into an FIE as a result of the capital contribution.

Furthermore, the Tentative Provisions also allow Equity Interests to be used as consideration for participation in private placements relating to PRC listed companie.

The Tentative Provisions will benefit both PRC and foreign investors who have difficulty raising the required amount of cash for their investments in China (or who would simply prefer not to tie up their cash in China) and/or those that do not have other hard assets such as industrial machinery, land use rights or even intellectual property rights to contribute.  

The Tentative Provisions apply to both acquisitions and greenfield projects.  The Tentative Provisions can also be used to facilitate group restructurings, for which tax benefits may be available.   

By allowing Equity Interests to be used as capital contributions and/or payment currency, the Tentative Provisions usher in new options in terms of structuring transactions in China, particularly from the point of view of structuring or restructuring new or existing investments in China and tax optimization.  However, they somewhat disappointingly do not provide an express legal basis for allowing unlisted overseas shares to be used as the means for funding a China acquisition or greenfield project. Furthermore, the processes and documentation requirements for the underlying M&A transactions implicit in using Equity Interests in this way have not been streamlined or simplified as a result of the Tentative Provisions, which simply refer back to the various existing rules governing such transactions. 

The full version of the client note will discuss the above and offers an in-depth analysis on the background to the issuance of the Tentative Provisions, including how they fit in with the existing legal framework on capital contributions and where they take us in terms of new structuring opportunities. It looks at the types of transactions and Equity Interests which can qualify as a capital contribution, and the processes and documentation involved. Finally, it also looks at the potential tax implications and the potential application of the Tentative Provisions in agroup restructuring scenario.

If you would like to read the full version please click here.