Expanded opportunities

When it comes to investing in China, overseas companies have the option to establish a foreign-investment enterprise (FIE), wholly foreign-owned enterprise (WFOE), equity joint venture or co-operative joint venture.

From this month, investors should take into account the Provisional Measure for Merger and Acquisition of Domestic Enterprises by Foreign Investors. Introduced on April 12 by the Ministry of Foreign Trade and Economic Cooperation (Moftec), the State Administration of Taxation, the State Administration of Industry and Commerce and the State Administration of Foreign Exchange, the measure gives foreign investors more alternatives in structuring their China investment. It allows three types of transaction:

-acquisition of equity or share holding of a non-FIE enterprise by a foreign investor and a subsequent conversion of the target entity into an FIE;
-acquisition of assets of a non-FIE enterprise by an existing FIE; or
-acquisition of assets of a non-FIE enterprise by a foreign investor for the formation of a new FIE.

The first option is the most welcome as it provides foreign investors with the opportunity to acquire not only the assets of a non-FIE, but the integrated operation, including business networks and personnel. This equity/ share acquisition model can be effected either by means of a direct acquisition from the existing equity/share holders or by subscribing to the increased capital or newly issued shares of the target. However, the equity/share holding percentage calculations are slightly different. A direct acquisition from existing equity/share holders is more straightforward. Whatever the percentage holding an existing equity/share holder sold is what the foreign investor may acquire, re the increased capital to the original capital. The same treatment applies when the acquisition involves the acquisition of the existing equity/share holding and increased capital or newly issued shares.

The new measure does not exclude the possibility of a 100 percent acquisition of the equity/share holding and a subsequent conversion into a WFOE. However, as a general rule, the equity or share holding restrictions imposed by the Industry Catalogue for Foreign Investment need to be observed.

Apart from equity/share holding, debt-financing restriction would be considered. Certainly, the leverage requirement of the target enterprise post acquisition should comply with the following requirements:

After a business is acquired, its debts may be carried over to the surviving entity. In this regard, the new measure allows the restructuring of debts by mutual agreement between the foreign investor, target enterprise, debtors and other concerned parties, provided that the agreement does not infringe the interests of third parties or the public.

In line with the current trend to use yuan assets to invest in Mainland China, the new measure also permits the use of shares and yuan assets by foreign investors as investment considerations. However, prior approval from the State Administration of Foreign Exchange is necessary.

Foreign investors may be disappointed by the absence of special tax preferential treatment provided under the new measure; instead, the general tax rules and requirements should apply.

Although equity/share acquisition by a foreign investor may convert a domestic enterprise into an FIE, the converted FIE may not necessarily be able to enjoy tax incentives available to ordinary FIEs. Foreign investors must have a minimum 25 percent equity/share holding, and the operation and tax status before and after the acquisition will also affect the applicability of certain tax incentives.

Where assets are acquired by an existing FIE, tax incentives may be available.

Anti-trust implications
The new measure also has anti-trust implications, although the term itself is not used. Investors are required to report to Moftec (soon to be part of a future Ministry of Commerce) and the State Administration Bureau of Industry and Commerce and when they acquire equity/share or assets under the following conditions:

-turnover in China for the year of any party of the acquisition exceeds RMB1.5bn; or
-number of enterprises in related industries acquired in the year exceeds 10; or
-market share of any party of the acquisition reaches 20 percent; or
-market share of any party of the acquisition reaches 25 percent after the acquisition.

The authorities may prohibit acquisition if they believe it would create an obstacle to future market competition or would be harmful to consumers' interest.

Overall, the new measure provides fresh alternatives to foreign investors that plan to expand in China by mergers and acquisitions of domestic enterprises. Together with the recent relaxation in foreign involvement in merger and acquisition of state-owned assets, acquisition of state-owned shares and legal entity shares of listed enterprises, and as well as the acquisition of A shares and bonds by Qualified Financial Institutional Investors, there are now an increasing number of channels available for foreign investment in China.

Written by Becky Lai, partner of PricewaterhouseCoopers' Beijing office and Kelvin Lee, senior manager of its Hong Kong office.