China offers VIE´s a way out - Paul Gillis

Paul Gillis

For decades foreign and Chinese companies used tax heavens like the Cayman Islands and Bermuda´s as a way to circumvent restrictions in China´s laws. Now the country is closing that loophole, but last week also offered a way out for those who feared to be in trouble, writes accounting professor Paul Gillis at his weblog, at least for online ventures.

Paul Gillis:

The new MIIT (Ministry of Industry and Information Technology) rule provides an escape valve. It appears limited to companies operating in online data processing and transaction processing (operating e-commerce). It is unclear to me how far that definition will stretch. 

Many foreign multinationals operate in China through the VIE structure. Only a few have disclosed this fact, since disclosure is only required when the VIE operations are material to the company as a whole. Amazon, CBS, and Pearson Education have disclosed the existence of Chinese VIEs. The new rule seems to help Amazon, and it is less clear whether CBS or Pearson Education will be able to take advantage of it. 

The law might also be used by some of the overseas listed Chinese companies that will have difficulty complying with the new foreign investment law. Tencent cannot put in place the control structure required because the Hong Kong Stock Exchange does not allow it. Ctrip does not have a dual class share structure or sufficient Chinese ownership to demonstrate Chinese control, and the new rule might provide an out for them. 

It is also unclear to what extent operations will have to be moved into the Shanghai Free Trade Zone in order to qualify for the new rule. Such is the nature of Chinese regulation; implementation details will take some time, even though the new rule is already effective. Many overseas listed Chinese companies are in the process of going private from the US exchanges with the intent to relist on China’s frothy boards. I believe this trend is less motivated by changes in VIE rules than the high valuations currently available on Chinese exchanges.

More at the ChinaAccountingBlog.

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´ request form.

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The end of VIE´s - Paul Gillis

Paul Gillis

China has announced new rules that reduce restrictions on foreign investments, for example in the internet. The traditional way to avoid those restrictions, VIE´s via Cayman islands and others, will be phased out fast, writes accounting professor Paul Gillis at his weblog.

Paul Gillis:

Steve Dickinson of the China Law Blog says that the proposed rules mean China VIEs are Dead and I Told You So. I think he is right that VIEs are dead. I believe that regulators are going to stop looking the other way on VIEs as they have for the last 15 years. 

For many of China’s internet companies and their investors, this is good news. They have been carrying the VIE structure around their necks like a millstone. Besides scaring off investors, VIEs proved to be an inefficient structure that made it difficult to manage taxes and move money around the group. While companies under Chinese control might continue to use existing VIE arrange-ments, I expect most will dump them, preferring instead to operate in wholly owned subsidiaries (WFOE). That will be a big win for shareholders, since they will finally own the assets that they think they own. 

There are a number of Chinese internet companies where the Cayman Islands parent company does not have the type of corporate governance arrangement that fits the proposed law. Hong Kong listed Tencent is one, since Hong Kong does not allow arrangements that keep founders in control. I expect these companies will restructure to meet the requirements of the proposed law, or will seek special permission to have foreign control. 

Some multinationals have used the VIE structure, and for them the future may be bleak. Some foreign companies, like Amazon and Pearson, have used VIEs to circumvent foreign investment restrictions. I have heard of a few situations where VIEs were used to circumvent investment approvals and to avoid taxes. The future for multinationals that are using the VIE is likely bleak. Steve Dickenson says that these VIEs will be required to either shut down or transfer their assets to Chinese entities. Those Chinese entities will have to be Chinese controlled, which likely leads to Chinese operations being deconsolid-ated. The various US chambers of Commerce have asked China to provide a 25-year grace period for existing VIEs or to grandfather them completely. I think that request will be ignored in the final law. This is a great opportunity for China to bring the internet more completely under Chinese control, and to favor Chinese companies in the process. I don’t see them passing it up.

  More at the WebAccountingBlog.

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´ request form.

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New foreign investment law: long overdue - Mark Schaub/Xu Ping

Xu Ping

Mark Schaub

The draft foreign investment law (FIL) is replacing the regulations from 1979. China has changed, and so a major overhaul of the law is long overdue, write lawyers Mark Schaub and Xu Ping in China Law Insight. They give an overview of the shortcomings of the current law, and the new features of the FIL. And it might only be the beginning.

Mark Schaub and Xu Ping:

The Foreign Investment Law, if promulgated in its current draft form, will fundamentally change the current foreign investment regulatory landscape. As such its implementation will rely on the formulation of relevant implementation rules as well as other complementary guidance, such as the Negative List, the national security review guidance and information reporting rules. While the circulation of the Draft FIL is an important first step in the context of the landmark reform, there is still a very long way to go in the establishment of a new foreign investment regime and the full implementation of the Foreign Investment Law. According to the Legislative Work Plan for the State Council in 2014, the amendment of the Three FIE Laws falls within the ‘research projects’ of 2014. MOFCOM, as the department responsible for drafting the Foreign Investment Law, has started to circulate the Draft FIL for public comments at the very start of 2015. This demonstrates the determination of the Chinese government to carry out reform. Upon expiration of the period soliciting public comments (approximately 1 month), MOFCOM will revise the Draft FIL on the basis of comments gathered from the public, and submit the revised draft to the standing meeting of the State Council for deliberation and then circulate an updated draft for the Standing Committee of the National People’s Congress to review. With the objective of establishing a “new open economy system” and along with the negotiation of Sino-US and Sino-EU bilateral investment agreements, we believe we are now at the dawn of the era of the new Foreign Investment Law.

More details on proposed institutional changes in China Law Insight.

Mark Schaub and Xu Ping are lawyers at King&Wood and Mallesons. They are also speakers at the China Speakers Bureau. Do you need them at your meeting or conference? Do get in touch or fill in our speakers´ request form.

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China might end VIE-structures, at last - Paul Gillis

+Paul Gillis 

The Cayman Islands and other offshore havens have been used by domestic and foreign companies to circumvent murky Chinese regulations, the VIE´s, in jargon. Accounting professor Paul Gillis has fighting against this practice, and see some light at the end of the tunnel.

Here he is quoted at the Business Spectator:

Paul Gillis, a visiting professor of accounting at Peking University’s Guanghua School of Management, says that reform is needed in the foreign investment rules. "If all they do is treat the VIE as an FIE [Foreign Invested Enterprise], it is a disaster” he said, "That means none of the VIEs in restricted sectors — nearly all of them — are legal."

Paul Gillis, in his weblog:

Today, January 19, 2015, the Ministry of Commerce (MOFCOM) released a draft of a new foreign investment law for public comments. What is notable about this new law is that it appears to introduce an actual control rule for determining when an enterprise has foreign investment and is thus subject to regulation as such. What that appears to mean is that a VIE that is controlled by an offshore company will be treated as a foreign invested enterprise (FIE). 

The nature of VIE arrangements in China is that they give control to an offshore company (typically the listed Cayman Islands company or its Chinese subsidiary (WFOE)), yet argue to Chinese regulators that the VIE is a local company owned by locals, and therefore not subject to foreign investment restrictions. The proposed law appears to change that interpretation. Instead, a VIE controlled by a foreign company will be treated as a foreign invested enterprise. 

Since foreign investment is restricted in the sectors favored by most US listed Chinese companies (internet and education), the ruling could have significant impact. If implemented, most overseas listed Chinese companies, including giants Alibaba, Baidu, and JD.com would appear to have a big problem with their VIEs. They would have prohibited foreign investment in the Internet sector, which could lead to loss of their Internet content provider licenses.

More at the ChinaAccountingblog.

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´ request form.

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