By Eunice Ku, Rachel Xuan and Susan Kang
Oct. 6 – In 2003, the Chinese government first laid down in a single piece of M&A legislation the relevant principles, procedures and requirements allowing foreign investors to acquire Chinese limited companies. The most recent version, the “Rules on Acquisition and Merger of Domestic Enterprises by Foreign Investors (M&A Rules),” was promulgated in 2006 and revised in 2009.
These regulations provide investors with a basic framework and guidance on carrying out M&A activities in China, while giving the government ample discretion to examine and approve M&A activities that would potentially impact national and economic security.
Due to the recentness of China’s exposure to M&As, M&A culture in China is still in its infancy and the Chinese government is careful in weighing the benefits against the risks of acquisition of enterprises in China by foreign enterprises, especially in key sectors.
Acquisition of equity and assets requires the approval from the local Ministry of Commerce (MOFCOM) branch and registration with the local Administrative Bureau of Industry of Commerce.
In addition to anti-monopoly provisions, China reserves the right to review foreign acquisitions of Chinese companies and assets from a national economic and security perspective.
MOFCOM approval at the central level is required in the following M&A situations:
Below, we examine the provisions with which foreign investors who wish to carry out M&As in China have to comply.
The M&A Rules apply only to the merger and acquisition of domestic firms, and foreign investors seeking to acquire firms in China that already enjoy FIE status must adhere to a different set of regulations.
Matters concerning the reporting and approval of all changes in the equity structure of an FIE are governed by the Several Provisions on Changes in Equity Interest of Investors in Foreign-Invested Enterprises (“FIE Equity Interest Change Provisions”), published by the Ministry of Foreign Trade and Economic Cooperation in 1997. Matters not addressed by these provisions are handled “with reference” to the M&A Rules.
The M&A Rules apply when a foreign investor:
According to the M&A Rules, M&A of domestic enterprises by foreign investors must comply with the Foreign Investment Industrial Guidance Catalog (“Catalog”). This means that mergers or acquisitions may not result in foreign investors:
The M&A Rules stipulate time limits for foreign investors to pay in full the considerations for equity or asset transfer, or the capital increase to which they subscribed; the ratio between the registered capital and total investment; and the application procedures and documents required.
An equity acquisition will require the following documentation:
An asset acquisition will require the following documentation:
Many small to medium Chinese companies do not report their true revenue to the China tax office in order to lower the amount of tax they pay. In an equity acquisition, the foreign investor takes on the tax liabilities of the original domestic company. In an asset acquisition, such tax liability remains with the domestic company.
After a foreign investor purchases the equity rights of a domestic company, and the domestic company has been changed to an FIE, the FIE’s registered capital shall be the registered capital of the original domestic enterprise, and the investment contribution by the foreign investor shall be the proportion of the purchased equity in the original registered capital.
Additionally, when a foreign investor merges with a domestic enterprise by equity merger, Article 19 of the M&A Rules places upper limits on the total investment amount of the foreign-funded enterprise established after the merger. The upper limit on investment is determined by the total amount of registered capital as outlined in the table below.
Article 9 of the M&A Rules provides that, where the ratio of a foreign investors’ capital contribution to the registered capital of an FIE established as a result of M&A is less than 25 percent, the enterprise shall not be entitled to the treatment for FIEs.
All M&As between a foreign and domestic enterprise should determine the transaction price on the basis of the result of an evaluation conducted by an asset evaluation institution. The parties may choose the asset evaluation institution themselves, but it must be established within the territory of China in accordance with the law.
Article 14 of the M&A Rules further prohibit the transfer of equity interest or sale of assets at a price “obviously lower” than the evaluation result for the purpose of transferring the capital out of China in a disguised way.
Equity purchase agreement
The foreign investor and domestic enterprise are to conclude an equity purchase agreement, or in the case of foreign investors’ subscription to the capital increase of the target, a capital increase agreement. Article 22 of the M&A Rules provide that the agreement should contain the following:
The foreign investor should pay the full amount stated in the Equity Purchase Agreement within three months of the receipt of the FIE business license. Under special circumstances and subject to the approval of Ministry of Foreign Trade and Cooperation (MOFTEC) or the provincial examination and approval authority, the foreign investor can pay a minimum of 60 percent of the price within six months, with the full balance to be paid within one year of the issuance of the FIE business license.
If the foreign investor conducts the acquisition through subscription to the capital increase of a domestic enterprise, the foreign investor shall pay no less than 20 percent of the amount of registered capital to be increased at the time of application for FIE business license. The time limit for payment of remaining increased registered capital is subject to the provisions of Company Law of the People’s Republic of China, FIE laws and regulations, and regulations on the registration of companies.
Approval and registration
The MOFCOM will announce its acceptance or rejection of the application within 30 days of receipt of the necessary application documents. In the case that the MOFCOM accepts the application, it will present a certificate of approval.
Upon receipt of the approval certificate from the MOFCOM, the foreign enterprise has 30 days to register the acquired domestic enterprise as an FIE with the SAIC or its local sub-branches.
Content for this article was taken from the Sept. 2011 issue of China Briefing magazine titled “Reevaluating China Joint Ventures and M&As.” In it, we take a fresh look at joint ventures and M&As in China – the current market circumstances, the motivations and challenges faced – and provide a few practical insights into key issues such as forming a joint venture contract and finding an M&A partner.
Dezan Shira & Associates is a boutique professional services firm providing foreign direct investment business advisory, tax, accounting, payroll and due diligence services for multinational clients in China. In particular, the firm specializes in all matters relating to mergers and acquisitions in the country. For relevant advice, please email firstname.lastname@example.org, visit www.dezshira.com, or download the firm’s brochure here.
Mergers and Acquisitions in China (Second Edition)
This guide is a practical overview for the international business to understand the rules, regulations and management issues regarding mergers and acquisitions in China. It will help you to understand the implications of what can initially appear be a complicated and contradictory subject as well as points you at the structures you should use and some of the common pitfalls you may encounter.
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