VIE Problems? Shanghai’s Free Trade Zone is the Answer
Recent media coverage over the Chinese Government’s clampdown on Variable Interest Entities (VIE) has indicated foreign companies, and especially those from Silicon Valley in the e-commerce area, will suffer due to this positioning. China being horrible to foreign investors is becoming a recurring theme, yet long-term China observers will recognize that it simply does not work like that in the PRC. The country continues to relax regulations concerning FDI and has long indicated its discomfort with VIE investments. These investments have proven popular as a legal ‘solution’ in the past to enable foreign companies to gain effective control of a Chinese limited company. This is done in order to get around restrictions on foreign ownership laws, especially in the e-commerce field.
This is achieved by placing contracts in position between the Chinese directors/shareholders and the foreign entity, handing all effective control to the foreign party. Once that is in place, overseas funding is then dropped in to what on paper remains a Chinese entity. China-based profits are then later stripped out through the use of a variety of ‘service’ contracts, minimizing profit tax liabilities and maximizing profits that can be sent overseas to the foreign investors – who often sit in companies registered in jurisdictions such as the British Virgin Islands and so on.
Beijing has long indicated that it is unhappy with such arrangements, and has now indicated it will close this loophole via changes to China’s foreign investment law. This has long been on the cards, and VIEs are as a result considered unstable platforms from which to enter China’s e-commerce market.
However, in actual fact, the Chinese Government has already provided a solution and a far more transparent mechanism for foreign investors to access the China e-commerce market. Since January this year, foreign investors have been allowed to set up under a ‘pilot’ scheme (China’s way of testing what usually later become fully rolled out regulatory guidelines) 100 percent foreign owned companies in the same industry. We wrote about this in some detail in this article here.
This is typical China legal evolution in place. While the media may pick up on the ‘negative’ aspect of foreign companies being banned from using VIEs in the future, a solution has already been found. E-commerce investors need not worry about the demise of the VIE. Shanghai’s Free Trade Zone is quietly getting on with the business of providing well thought-out and state supported alternatives, and ones that carry far more transparency than VIEs ever did.
Chris can be followed on Twitter at @CDE_Asia.
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