PRINT THIS PAGE China: Recent legal updates and decisions26/10/2005. Source: Baker & McKenzie.
Baker & McKenzie look at recent developments which may impact venture capital and private equity firms operating in China, including the Chinese inquiry system for IPOs and the new Forex rules on acquisitions. Notice on Trial Implementation of Inquiry System for IPO
China Securities Regulatory Commission (CSRC) issued the Notice on Several Issues Concerning the Trial Implementation of an Inquiry System for Initial Public Offerings of Shares, effective 1 January 2005. The Notice provides that companies undertaking IPOs and their sponsors have to determine the price of share offerings through inquiries with ‘inquiry recipients’, which could be securities investment fund management companies, securities companies, trust and investment companies, finance companies, insurance institutional investors, or qualified foreign institutional investor (QFII) that complies with the conditions specified by the CSRC. The inquiry should be done after the offer application has been verified by CSRC.
The issuer and its sponsor(s) are required to make the preliminary inquiry with not less than 20 inquiry recipients (or 50 if the number of shares offered to the public is not less than 400 million). A cumulative tendered inquiry to determine the offer price will be required after the offer price range has been determined. The issuer and its sponsor(s) have to offer shares by a rights issue (of 20% of the total number of shares offered or less, or 50% or less if the number of shares to be offered to the public is less than 400 million) to those inquiry recipients who participated in the cumulative tendered inquiry. The trial inquiry system adds transparency and allows market forces to play a greater role in IPO activities in PRC.
New Forex Rules on Acquisitions
State Administration of Foreign Exchange (SAFE) issued the Notice on Several Issues Concerning the Improvement of the Administration of Foreign Exchange in Acquisitions Effected with Foreign Capital on 24 January 2005. The Notice targets PRC nationals who establish or control offshore enterprises directly or indirectly. Approval and registration are required for such transactions, and also the transfer of shares in PRC companies by PRC nationals in exchange for equity holding or other property rights in offshore enterprises. When the relevant authorities are handling foreign exchange registration of foreign invested enterprises established by acquisitions effected with foreign capital, the Notice requires them to pay special attention to the involvement of PRC nationals. At this stage, it is not clear if the tax benefits available to PRC companies established by PRC nationals through offshore are the two franchising models allowed by the Measures.
Only enterprises can be franchisors or franchisees. Among other conditions, the franchisor must own at least two directly operated stores in PRC with an operational history of more than one year. The franchisor cannot force the franchisee to accept its supply of goods unless a) the goods concerned are ‘exclusive merchandise’, or b) the goods concerned must be supplied by the franchisor or its designated suppliers in order to control the quality of the franchise. A franchisee must possess capital, fixed sites, staff, etc. suitable for the franchise operation.
The Measures impose an obligation on franchisors to disclose information including number, distribution, and budgets of outlets of existing franchisees, information about the registration, licensing and litigation of the franchisor’s trademarks etc. to potential franchisees before execution of the franchise agreement. The term of a franchise should generally not be less than three years. Franchisors are also required to submit an annual report on franchise agreements entered into during the previous year.
Export VAT Refund Rate Raised for Certain IT Products
The Ministry of Finance and State Administration of Taxation (SAT) issued a notice increasing the export VAT refund rate from 13% to 17% for certain listed information technology (IT) products, retroactively taking effect from 1 November 2004. The relevant IT products involve five categories including integrated circuits, semiconductor discrete devices, mobile communication equipment (such as base station, Ethernet exchanger, router, mobile phone), computer and peripheral products (such as LCD, hard drive), and digital control machine tools. The increase of export VAT refund rate will reduce the costs of producers and increase their market competitiveness.
After the Corporations Law comes into effect, it will no longer be possible to incorporate a YK. In addition, transitional provisions will enterprises will be affected. More significant is the impact of this Notice on proposed IPOs involving such onshore-offshore asset exchange.
New Rules on Leasing Activities
MOFCOM also promulgated the Measures for the Administration of Foreign-invested Leasing Business, effective 5 March 2005. The Measures remove all foreign equity restrictions on leasing companies. Foreign companies are permitted to establish wholly-owned enterprises in China for leasing business. The Measures distinguish between financial leasing companies and non-financial leasing companies. The foreign investor must have total assets of at least US$5 million for investing in either kind of company, but the minimum registered capital of a financial leasing company (US$10 million) is higher than that of a non-financial leasing (RMB100,000).
Financial leasing companies must also have appropriate management personnel with the required professional qualifications and experience. For the leasing business, various equipment, transportation vehicles, and their related software and technologies could be leased. Both types of leasing companies can engage in operational leasing i.e. purchasing, repairing, maintaining, and transferring (for residual value) the property leased. A financial leasing company can additionally engage in financial leasing, consultancy services and guarantees for leasing transactions.
New Rules on Franchising
The PRC Ministry of Commerce (MOFCOM) promulgated the Measures for the Administration of Commercial Franchise Operations, effective February 1, 2005. Franchising is defined in the Measures as an arrangement whereby a franchisor, by contract, authorizes a franchisee to use its operational resources (e.g., trademark, trade name, business system, etc.); and where the franchisee conducts business according to the franchisor’s standardized business system and pays franchise fees in accordance with a franchise agreement.
Direct franchising and sub-franchising automatically convert existing YKs into kabushiki kaisha (KKs) but allow them to continue to trade under the YK name for the time being. KKs do not have pass-through status for US tax purposes and so it is possible that YKs that convert into KKs when the Corporations Law comes into effect will lose their pass-through status for US tax purposes.
Andrew Tan (Hong Kong)
Tel: +852 2846 1910
andrew.tan@bakernet.com
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