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1、Why Establish an RMB Fund?,Presentation to Lei Fuby OMelveny&Myers LLPSeptember 5,2007,2,Doing Deals from Offshore is Getting Harder and Harder,Political/Nationalist SensitivitiesAversion to more foreign capital investmentoverheatingRMB issuesCompetition from Domestic Investors,huge domestic liquidi
2、ty,3,China is pushing deals onshore,Chinese government wants more“control”over domestic Chinese companiesOffshore holding company structures can mean loss of tax revenues,loss of control of FXGovernment wants to develop a domestic financial services industry and deal flow,4,Chinese Government Takes
3、Policy Stepsto Increase Onshore Deals,M&A regulationsSAFE 75 and related measuresRamps up domestic stock marketsPushes smaller H-Share offerings onshore as A-Share offerings or dual listings,5,What do the M&A Regulations Do?,Before M&A Regulations:As part of financings,domestic companies would be re
4、structured so that all shareholders,including new investors,would hold shares in an offshore holdco(usually Cayman)which held Chinese WFOEFor smaller deals,usually only provincial approvals were required.,6,What do the M&A Regulations Do?(continued),Under the new M&A Regulations:Central MOFCOM appro
5、val is required for all deals where domestic persons acquire an affiliated domestic company through an offshore company they established or control.Central MOFCOM approvals are hard to get,and we are not aware of any that have been issued yet for such“round-trip”investments.Effect:Stoppage of invers
6、ion transactions,7,What does SAFE 75 do?,Local SAFE registrations are required for PRC residents to set up or control Offshore SPVs for the purpose of financing operations in China Non-compliance impacts not only the PRC resident investors,but also the Offshore SPV and its onshore subsidiaries,by pr
7、ohibiting payment of dividends or distributions offshore,liquidations,share transfers,decreases of investment,etc.Recent SAFE 75 Implementing Rules indicate that:the onshore subsidiaries may need to have an operating history for at least three yearsformation or control of an Offshore SPV by a Chines
8、e enterprise(as opposed to individuals)requires approval from central SAFEemployee option plans must be registered collectively through an“entrustment arrangement.”if PRC residents who had used offshore funds to set up offshore companies to invest in China without first establishing onshore companie
9、s,the offshore companies must have been in existence for at least two years,8,No Impact on Pure Cash Deals,Inversion transactions are needed as a means to provide equity to Chinese founders or other Chinese shareholders in an offshore SPVAcquisitions not involving an offshore SPV in which Chinese pa
10、rties hold equity do not trigger SAFE 75 RulesThus,all cash deals are executed without SAFE 75 complicationsHowever,all cash deals will still trigger M&A Rules relevant to approval and other deal execution matters,9,What are some workarounds?,Use existing FIE(not established for this purpose)to purc
11、hase the business assets of targetonly requires local approval if not too big,and not in sensitive industryInvest directly in domestic company,making it a JV(but you still need to worry about later restructuring and exit)Set up WFOE to buy key asset(but not“business”)and set up contractual arrangeme
12、nts to pull out economic benefitsSet up RMB Fund,10,What is an RMB Fund?,The primary type is a Foreign-invested Venture Capital Enterprise(FIVCE),specifically authorized by RegulationForeign investors permitted to invest in this type of RMB denominated domestic investment fundRequires central MOFCOM
13、 approval to set up,but not difficultCan be a JV between foreign investors and Chinese domestic investors,or can be wholly foreign-owned,11,What are the Advantages of an RMB Fund?,In theory,no prior government approvals for investments in non-sensitive sectors you can move fastCan take in Chinese RM
14、B investors An RMB fund can look more like a domestic investorIf properly structured,tax pass-through treatment for the fund and tax treaties can be used to reduce or eliminate Chinese taxes on exitsRepatriation of capital and profits upon sale of individual investmentsForeign-Invested Limited Partn
15、ership Regulations are still in a draft.Further,the current draft is silent on the following matters that are key for foreign VC/PE to decide whether FIP is an appropriate investment vehicle:whether government approval is required for each portfolio investmentwhether an FIP can be a pure investment
16、company such as the RMB fundwhether the GP of the FIP can be a limited liability companywhether repatriation of capital and profits upon sale of individual investments is allowed,12,What are the disadvantages of an RMB Fund?,Must primarily invest in private hi-tech(although it may be possible to get
17、 special dispensation)so to do a buyout fund would need special approvalsHarder to invest offshoreOnshore exits not established;offshore listing exit very hardPotential conflicts between RMB fund and offshore fundAll amendments and changes in investors require approvalsLegal structure,documentation
18、and enforceability of onshore deals not well established under Chinese lawLack of familiarity in all localities and“educational”issues with respect to the conversion of portfolios into FIEs or companies limited by shares,13,How does the basic tax structure work?,BackgroundNo partnership tax law in C
19、hina(yet)Most onshore vehicles are taxed once at the corporate level,followed by a potential second level of tax at the shareholder level depending on how profits are distributedMany purely domestic RMB funds are structured as corporate vehicles for tax purposesA 70%preferential tax benefit for corp
20、orate RMB funds was introduced in early 2007 but has questionable value The Present“Non-legal person cooperative joint venture”is closest thing to a partnership for tax purposes in ChinaSpecial circular allows flow-thru tax treatment,i.e,only the funds investors,not the fund itself,are subject to Ch
21、inese taxesFund investors pay Chinese taxes based on their own individual situationThe FutureRevised Partnership Law expected to call for a new tax regime in China for full partnership tax treatment ushering in more types of structures that are similar to traditional private equity structures,14,How
22、 does the tax treaty structuring work?,First,need to meet all the requirements of the flow-thru tax treatment circular:Must be“non-legal person cooperative joint venture”As a CJV,need at least one Chinese investor,investing at least$1 millionCannot have its own office in China;must be managed by an
23、onshore management company(which can be wholly owned by the GP)similar to how an offshore fund would be structuredTax treaty structuring enhancements:Certain tax treaties with China exempt investors from Chinese tax on capital gainsE.g.,An Irish holding structure could be used to access the Irish ta
24、x treaty If properly structured,treaty protects against Chinese taxes on capital gains but does not attract additional taxes in Ireland,depending on the shareholding structure,15,Basic Tax Structure,Requisite Investor(Barbados),FIVCIE,Fund ManagerWFOE,Fund Management Contract,SPV(Hong Kong),China,Of
25、fshore,Limited Investor(Ireland),Carried Interest,Share of Profits,Management Fees,Dividends&Service/Secondment Fees,Nominal CJVPartner,16,What are some of the other key requirements for an FIVCE?,Need at least one GP-equivalent investor meeting certain prudential requirementsEstablish an FIE manage
26、ment company and management contract approved by MOFCOMPost investment filings with MOFCOMAll investment commitments must be made within five years,17,What about a Domestic RMB Fund,Very active pilot program supported by NDRCTianjin has a concentration of activityNo foreign capitalForeign managers c
27、arried interest taxed at high rates,18,Potential Exit Routes,M&A sale to domestic or foreign buyersDomestic IPOFirst convert to company limited by sharesMeet listing requirements,including three years of profitsWait in queue and get government approvals to listOne year statutory lockupOffshore listings difficult because of need to restructure or do H-share offering,19,The End,
