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Insights and Commentary from Dentons

On March 31, 2013, three pre-eminent law firms—Salans, Fraser Milner Casgrain, and SNR Denton—combined to form Dentons, a Top 10 global law firm with more than 2,500 lawyers and professionals worldwide.

This document was authored by representatives of one of the founding firms prior to our combination launch, and it continues to be o ered to provide our clientsG withro thewing information with they need to do business in an increasingly complex, interconnected and competitive marketplace.

The role of government has never been more critical

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Note from the Editors

Introduction to Focus on Asia Contents There are many issues common to the Onto the magazine, where we have opted for a investment environment in China with the CIS balanced look at China – catering to those Note from the Editors ...... 03 and Central and Eastern Europe, where Salans investing into the market as well as those Chinese has been a leading presence for many years. As companies looking to raise capital outside of the Welcome to this first edition of Focus on Asia. As a firm renowned for our extensive coverage of Europe (both societies undergo the transformation from borders of the mainland. Chinese companies are West and East) and the CIS region, the concept of a Salans magazine focused on Asia might seem a little out of Distressed Asset ...... 04 planned to market economies, their legal systems increasingly looking to IPOs to raise capital, and the blue. But, like you, we have been keeping our eye on Asia and making progress in establishing a fully-serviced Investments must also change. This can result in a lack of our main feature looks at the rules and presence there. predictability and transparency, and can delay or regulations in three of the most popular markets Buyer Beware: Tenants’ Right ...... 08 frustrate investors' objectives. China is no different – Hong Kong, London and Frankfurt. Since 2003, Salans has been in Shanghai, China and in the last five years, has recognised that the same skills and of First Refusal in this respect. The government is taking steps to foresight which took us so successfully into the CIS in the early 1990’s – the ability to combine our legal expertise ensure the investment environment in China can There are a number of new tax laws coming into in established markets and financial centres with the needs and developments of emerging or fast-growing When does the first sale ...... 10 keep up with both domestic and foreign demand. force in China, and we look at these but also at Of course, in this rush, there are many pitfalls and the follow-on effect they have in the area of economies – had a place in Asia. Just as our clients have gone truly global and embraced Asia, we saw the take place when importing Dr Bernd Stucken John Flanigan this creates the demand for experienced legal advanced pricing arrangements. We also look at opportunity to partner our clients in navigating a new frontier. With regulations, legislation and market conditions goods into the US? Co-Managing Partner, Co-Managing Partner, changing regularly, a focused Asia strategy meant we were able to ensure that wherever our clients needed to go, Salans China region advisers to steer their clients onto the right path. non-performing loans (NPLs) – touted as the Salans China region we were already taking a few steps in front to help pave a path. vehicle to enter China for some foreign Frankfurt Funding? ...... 12 Built on one of the first international law practices companies – and consider a different approach to As a result, we have made significant progress in the last few years - our association agreements in the Gulf, our to be licensed in Shanghai, our office in the new NPLs: corporate restructuring. new presence in Qatar, and our developments into India with an association recently established with a firm of Enter the Dragon ...... 14 Park Place Office Tower consists of over 25 over 70 lawyers based in Mumbai but with additional locations in Bangalore, Pune and Goa, who share our vision professional staff including four partners, making There is a need for China to grow in a sustainable us one of the largest international law firms in manner, and Salans worldwide is committed to of entrepreneurship, prudence and at the same time, innovation. London (Capital) Calling ...... 16 the city. ensuring a responsible progress of client interests This first issue of Focus on Asia looks at China. In many respects, we consider China no longer an emerging market. balanced with the economic and social needs of Making the new Enterprise ...... 18 We have also announced plans for further the countries in which we operate. It has emerged, and its potential as the economic powerhouse of the future is there for all to see. Yet still many Income Tax laws work expansion into China: a new office in Hong Kong, companies have not yet mastered how to maximise the opportunities of China. Western-based thinking and in association with Andrew Lui, will open and we As such, we are proud to note that this magazine management models cannot simply be replicated in these markets. What is needed is an on-the-ground presence Advanced Pricing Arrangements 21 will also open in Beijing, where the Olympic is prepared and printed with environmentally- which can bring best practice approaches in techniques and methodology from international operations and tailor legacy has given the city an energised government friendly inks and materials and that in lieu of a them at local level. Salans has this in place with Dr Bernd Stucken and John Flanigan, the leadership team in China. and business environment. large print run, the firm will use surplus budget for Salans News ...... 22 Bernd has lived in China for almost 20 years advising domestic and foreign subsidiary clients across a range of this project to channel into community projects sectors, and this is John’s tenth year with Salans as a leading corporate/M&A lawyer.Together, they lead this edition around China. in looking at changing, challenging China. About the Authors ...... 24

Stephen Finch, Chairman Asia Contacts Worldwide ...... 26 Salans Salans Worldwide ...... 27

www.salans.com 4 5 Distressed Asset Investments COULD CORPORATE RESTRUCTURING BE THE WAY INTO CHINA?

2008 is a difficult year for China in many (IPO), Beijing established four Asset Management • Only the holder of the NPL itself has the Experience from End of the road? restructuring is relatively less restricted. Strategic respects. The manufacturing sector is Companies (AMC), namely Huarong, Great Wall, right to collect outstanding debts under the or longer-term investors have invested in this experiencing shrinking margins caused by China Orient and Cinda, to take over the NPLs loan agreements. No debt servicing companies strategic investors So if NPLs are not the promised path in reality, way for some time also, giving increasing spiralling raw material prices and increasing from the Big Four. To date, the AMCs have for the collection of third party debts can shows that any foreign what else for foreign investors? Many NPL predictability in what could occur with the solid salaries. In addition, the increasing value of the acquired more than USD $325 billion in NPLs. be established. investors are now actively seeking alternative on-the-ground know-how of investing in Yuan and the sharply reduced possibilities for investment into China investments including investments in: single loans distressed debt. As a result, typical M&A processes VAT reimbursement, is eroding China’s position AMCs are currently the only authorised large • The loans are frequently secured with assets of distressed debtors (though this is a difficult are increasingly understood by Chinese sellers, as a low cost production base. Distress is scale sellers of distressed assets in China. Most which cannot be enforced (eg. only ‘granted’, should be one of a business model to run in China); high-yield lending government agencies and the management of looming over many Chinese enterprises. NPL portfolios were auctioned off but up to now, and not ‘allocated’, land use rights can be sold hands-on nature more (not entirely possible under PBOC lending target companies. Investment banks and hedge funds have started less than USD $100 billion worth of NPLs have off and assigned in an enforcement action). provisions); equity investments in real estate (a building distressed debt teams in Hong Kong to been sold. In 2001, the AMCs began focusing on so than hands-off. prohibitive 50% in equity financing is required, This experience has given rise to a clear(er) legal get ready for the big hunt. Dr Bernd Stucken bulk sales to foreign investors. A recent estimate • Loan workouts rely on a robust insolvency with only onshore debt financing possible); and framework, though investors still need to be investigates the opportunities. attributed sales of only USD $12 billion (face regime. The new PRC Bankruptcy Law came equity investments in Chinese companies. prepared for Chinese bureaucracy and lengthy value) to foreign investors. It seems there are only into effect last year, but it still remains to be approval processes. In addition, poor levels of A traditional approach in distressed assets a few investors left who remain interested in seen whether it can be used as a tool to A new opportunity – corporate documentation require investigative due diligence, markets is to buy non-performing loans (NPLs) investing in Chinese NPLs. recover NPLs. There have been a number of restructuring adding further time to the process. On top of all and use them inside or outside of bankruptcy bankruptcy proceedings but only very few In this minefield of opportunity and caution, being of this, remember that the government’s approval proceedings to force the distressed debtor into There are a number of reasons why NPL restructurings under the new provisions. thrown in equal measure to foreign companies, a of the transaction, not closing as per the purchase financial but sometimes also operational investments in China are not attractive: possible route is corporate restructuring. Whilst contract, determines when the deal is done. restructurings. Almost a decade ago, investors there are still restrictions for equity investments in were watching China where the banking sector - • AMCs set portfolios for auctions at prices distressed Chinese companies (both in terms of Finding target companies led by four (originally state-owned) banks known which are close to the ultimate recovery stockholding ratio as well as industry/sector When sourcing the right target company for an collectively as the ‘Big Four’: Bank of China, value of the underlying loans. So there restrictions eg. media ownership), corporate Industrial and Commercial Bank of China, China is little room for investors to achieve equity investment, consider the company’s Construction Bank and the Agricultural Bank of acceptable returns. business model. State-Owned Enterprises (SOE) China - was famous for a rapidly growing amount can be a challenge, because of the obvious of NPLs. These banks were not driven by profit, • It may take months to get the approvals for change in culture within the company that would and often provided ‘policy loans’, namely loans the establishment of the investment vehicle be required. Similarly, but perhaps not as daunting, made on non-market terms, often to unprofitable necessary to acquire the loan portfolio. private enterprises can be difficult to turn around, state enterprises to stave off bankruptcy for the especially with the former owners still involved, as enterprise and unemployment for their workers. • It is difficult to service purchased loans they may struggle to relinquish control of the According to conservative estimates, this left as many portfolios have a poor level company. A poorly-managed listed company in China with a legacy of USD $400 billion in NPLs. of documentation. China could be an option but take note the In an effort to clean up the banks’ balance sheets overvaluations which can exist in China. and prepare them for Initial Public Offerings

www.salans.com Focus on Asia 6 7

Chinese management is often not focused but rather opportunity-driven.

Private equity funds are often a good source of in China. They have to know the business and the Chinese management teams are renowned for Selecting the right exit strategy • IPOs on Chinese markets can be difficult for distressed assets for sale, a legacy of any stakeholders, seek board representation and following far-reaching and long-term (though companies with a component of foreign Key challenges for unsuccessful investments. It can also be a actively get involved in the management of the fuzzy) visions. When revitalising companies in With so much of the proverbial blood, sweat and investment. Consider, however an overseas Recommended Reads turnaround investors secondary market for investments which have not portfolio companies. It is important to demand China it is important to restate an existing or tears going into a corporate restructuring IPO eg. in London or Frankfurt, two of the into China yet emerged. Foreign companies could also regular financial and operational information from implement a new vision. Chinese management is investment in China, some forget that at the core more popular destinations for Chinese • Read some of the 1990’s horror stories approach AMCs, under the condition that they various managers and stakeholders, but this still often not focused but rather opportunity-driven. of turnaround management is to keep an eye on companies. Liquidity may have dried out for of doing business in China in • Find the right target companies. are prepared to arrange a debt-equity swap does not replace an active presence on site. It is Without guiding and energising goals, the getting out. the time being, but Chinese companies still Mr. China (Tim Clissold) regarding their NPLs. While debt-equity swaps are essential to constantly meet and talk to the senior management and employees can get lost in the have an attractive investment story to offer. • Develop turnaround concepts that are known to the authorities, it is likely they would management and perform regular formal or ocean of opportunities and threats. Some exit strategies worth considering include: Inside this edition, you can find our feature on • Understand the Chinese style of suitable for China, and work in China. management in Made in China: only support strong Chinese debt-holders like the informal audits. If these basic rules are not • Undertaking a trade sale to late-moving taking Chinese companies to market in London, What Western Managers Can Learn AMCs to swap any acquired NPLS into equity. respected, it is more than likely that the Culture in a company is of paramount strategic investors. Recent experience shows Frankfurt and Hong Kong. • Find turnaround managers who can from Trailblazing Chinese Entrepreneurs Foreigners rarely manage to get into such a investment will not take care of itself and in some importance, in particular in companies which tend that these investors recently started to focus successfully implement the turnaround (Donald N. Sull). position. Investors in search of underperforming circles, it is regarded as an invitation to burn money. to organise themselves more around relationships on building distribution networks with Chinese concepts in Chinese enterprises. enterprises may also knock at the doors of the than by processes. People will follow leaders and characteristics, as well as Chinese brands. • Learn more about the differences in State Assets Supervision and Administration Chinese companies in many aspects are managed the culture they represent and not systems Roll-up strategies in fragmented industries • Decide on appropriate exit strategies. Asian and Western thinking in business Commission (SASAC) or its local branches which differently from Western companies. This results in of management. are emerging. In addition, investments in in The Geography of Thought are typically holding the shares of state-owned certain strengths and weaknesses which will the service industry will be attractive for (Richard E. Nisbett.) enterprises (SOEs) influence the turnaround process. Restructuring It is clear that any distressed debt acquisition strategic buyers. teams must understand the Chinese ‘geography of cannot simply be ‘re-engineered’, either in strategy Understanding the Chinese thought’ and the resulting management approaches or process because the Chinese will expect a • Investigate the viability of Management Buy approach to turnaround (holistic thinking vs. sequential thinking). holistic approach to be applied to the situation, and Outs (MBO) – Chinese managers are management not merely a segmented tackling of problem areas. entrepreneurs at heart and will be willing to hear the proposition, yet it will be important The real challenge will be to turn around a to identify at an early stage the bank(s) willing Chinese company in distress. Experience from to finance an MBO which will ordinarily have strategic investors shows that any foreign to be leveraged. investment into China should be one of a hands- on nature more so than hands-off. Investors must take an active approach to its portfolio companies

Focus on Asia www.salans.com 8 • The term sale, albeit undefined, is generally The grey area SCC Opinions do not address. Under Chinese Additionally, a potential buyer may demand a Go into negotiations with 9 understood in a conventional sense, so it is Chinese law has a reputation for being law, a property lease must be duly registered with ‘breakup’ fee and open-ended expense eyes wide open generally agreed that ROFR will not be ambiguous, which is not always deserved though the relevant housing authorities, although the reimbursement. In China, tenants have ROFR conferred by the law triggered where the legal title to the property in this case, there is some truth as there is a lack lease agreement will nonetheless be legal and with respect to the conveyance of property. This is assigned by way of inheritance, bequest, of clear guidance in many respects. valid if they do not. Consider the scenario where Landlords are not left defenceless though. As can be expressly contracted out. And we have devise, donation or gift. However, SCC clarifies a buyer purchases a property without being already mentioned, ROFRs can be negotiated examined how the existence, validity and possible that sale will include a judicial sale. To begin with, the law does not define any aware of the existence of a lease (and the burden away. In China, it is not uncommon for standard infringement of ROFR is always fact- and case- Consequently, ROFR also applies where the of ROFR), has paid normal consideration, and the Buyer Beware: standard terms and conditions (STCs). The form leases used by landlords over multiple specific. A landlord who has possibly infringed the landlord's property is being sold by a receiver legal title has been duly transferred to the buyer. prevailing view is that STCs refer to the major properties to contain a clause effectively stating tenant’s ROFR risks being sued by the tenant and in bankruptcy. Could the tenant apply for a declaration that the terms and conditions of the proposed sale, that the tenant waives their ROFR and the also by the buyer for losses arising from negotiating Tenants’ Right of First Refusal said agreement is null and void, particularly when including but not limited to the price for the sale, usually-required notice periods on the part of and executing the property sale and purchase • The issues of ROFR arise only when the the lease has not been registered with the payment period and financing contingencies. If an landlord. But landlords must carefully draft any agreement. Potential buyers (including mortgagee underlying leased real estate is to be sold. relevant housing bureau and therefore the buyer offer has been provided to the tenant and waiver clauses so as not to fall foul of the laws lenders) need to be aware that this could not only probably had no of knowing that it existed? While restricting the use of standard form contracts. This Chinese law confers a right of first refusal tenancy or with vacant possession, or whether the • ROFR operates by default. Unless a waiver rejected, and then altered, it must be resubmitted involve unexpected and lengthy court proceedings the Property Rights Law (“PLR”), effective since means bringing the clause(s) to the special (“ROFR”) on tenants, where a landlord who property is residential, commercial or otherwise. has been granted expressly by the tenant for the tenant’s consideration. but also the invalidation of the purchase agreement. October 2007, expressly recognises that the attention of the tenant, and making sure the wants to sell a rental property and who has either in the lease or separately after the reached agreement with a potential buyer on ROFR can be differentiated from a right of first The law also seems unclear with respect to the interests of a bona fide purchaser of real estate tenant fully understands the legal implications of execution of the lease, the tenant automatically may prevail under certain circumstances, it the sale terms, must first offer the property to offer which gives the tenant the first option of enjoys such a right against the leased property. following issues: such waivers before agreeing to the clause. the tenant on these terms. But all is not as buying or leasing occupied property if the owner provides no clear-cut answers to such a question. In addition to waivers, there are some other ways a simple as it first sounds, as Salans’ Head of decides to sell or lease. Unlike an option to • The ROFR will be infringed either when (i) (i) if ROFR also applies to a sub-tenant; China Real Estate Jeff Wenhai Cai discusses. purchase, a ROFR does not entitle the holder of the landlord has not given the tenant a proper It has been decided in some cases that where the landlord can mitigate the impact of a ROFR: the right to compel the other party to sell the notice to exercise such ROFR; or (ii) the (ii) the timeline for which tenants can landlord offers to sell a larger tract of land that • Prices are set by the landlord and need not In the above scenario, landlords must give three property. It is thus not a means of forcing a landlord has disposed of the property in exercise ROFR. In judicial practice, the includes the leased property and the tenant agrees be assessed by a property valuer or similar (3) months’ notice to the tenant before the landlord to convey his legal title to the property. question prior to the expiry of the time limits. tenant is generally allowed three (3) to buy only the leased area, the landlord is not In China, an option to purchase or a right of first body. Since the landlord can dictate terms of proposed sale, pursuant to Article 118 of the A tenant who has been denied the ROFR can months (unless agreed otherwise in the liable. Once again, however, the specific facts of each offer is not a statutory right. case including actual and/or permitted functions of sale, the terms can be structured in a way that Tentative Opinions on Certain Matters pursue their rights of remedy even if the new lease) to exercise the right; concerning the Application of the General landlord sells the property to another. the leased premises and the gross floor area (GFA) meets the requirements of the potential buyer It is also worth mentioning that under PRC law, a ratio of the leased property to that of the larger whilst also making it difficult for the tenant to Principles of Civil Law (“SCC Opinions”) issued According to Article 118 of the SCC (iii) whether a ROFR can be triggered by an co-owner of a property also has a ROFR where tract, must be carefully considered. A prudent buyer exercise ROFR, if even at all eg. landlords may by the Supreme Court of China (“SCC”), as well Opinions, where the landlord has sold the real offer on a larger piece of land which the other co-owner wishes to sell the property. will not rely on general principles without analysing offer for sale a much larger tract, including the The issue of ROFR as local regulations. The law does not specify that property in contravention of the tenant’s includes the property in question. If so, If the validity of a ROFR is not challenged before notice must be given in writing. However, the facts that these principles are based upon, leased property, for which the tenant does not a buyer proceeds with the property purchase, the comes up irrespective Tenants’ ROFR has been the subject of frequent ROFR, the tenant may apply to the court for a can the ROFR holder purchase the landlords give oral notice at their own risk particularly given the non-binding nature of decided want to buy or cannot afford. buyer must make sure that the ROFR has either legal disputes and numerous court decisions, declaration that the sale of real property is null burdened property alone, or the entire because the onus is on them to prove service. court cases in China. been validly waived or that the tenant has failed of whether the landlord which is testament to the importance of and void. land parcel; and • By ordinary circumstance, tenants lose their Presumably, these time limits can be extended, or to exercise their rights within the stipulated time is prepared to sell comprehending the perils and pitfalls involved and • In case of a competition between co-owner ROFR when leases expire or terminate. possibly shortened, as long as the test of (iv) whether a landlord’s proposed exchange limits. This requires careful and professional analysis the difficulties in managing them effectively. and tenant, co-owner rights will prevail. Room to manoeuvre Therefore, landlords may be tempted to reasonableness is satisfied. of real estate, or use of the leased of the issues involved. Given the uncertainty with tenancy or with for landlords terminate a lease early in the hope of surrounding many aspects of the rules as they Key Points of the ROFR property to make contributions to the eliminating the ROFR and being able to sell Landlords must also inform tenants a reasonable Unlike some jurisdictions, in China the landlord currently stand, the old adage of “buyer beware” vacant possession, or registered capital of a company (as Clearly, a ROFR has a dampening effect on the the property at will. Any landlords doing this time before the proposed sale that the tenant has does not commit a criminal offence for violating seems appropriate for the Chinese property • The ROFR is based on the assumption that permitted under Chinese company marketability of a property. Potential buyers often do so at their own risk, with the early whether the property is the right to buy the property on the same terms market. there is a legally binding formal lease. There will the ROFR and will generally not be subjected to legislation), constitutes a sale for the hate investing time, money and energy to conduct termination possibly challenged in court. residential, commercial and conditions (STCs) as the proposed sale, be no ROFR where the lease itself is found to any penalties by the government. purposes of ROFR. due diligence and enter into serious negotiations pursuant to Article 230 of the Contract Law. be null and void, or is validly terminated. Also, with the owner, only to find that an existing • If a buyer acquires 100% equity interest in a Note: this article refers to the Mainland China or otherwise. a holdover tenant or an occupier has no tenant ultimately steps in and reaps the benefits company that directly owns the property in property market and associated laws and The issue of ROFR comes up irrespective of ROFR although they have to pay usage fees on A more perplexing issue is bona fide purchaser of such negotiations. More often than not, this can question, ROFR no longer applies. regulations. It expressly excludes Hong Kong, Macau whether the landlord is prepared to sell with the premises in an amount similar to rent. vs. tenant, which both the Contract Law and the result in a lower purchase price or lower rent. and Taiwan.

Focus on Asia www.salans.com 10 11

The manoeuvring of US Customs has When does the first sale take place some interesting political significance. when importing goods into the US? CUSTOMS PROPOSES TO CHANGE THE RULES OF PLAY

A recent proposal by US Customs that will regulations and qualify for first-sale appraisement order with the middleman for a shipment of the The facts from the Nissho Iwai case illustrate the government officials have been waiting for the telling comment came from Senator Charles require importers to pay duties based on the while utilising first sale valuation as a means of merchandise. Under this scenario, the transaction logic and benefits of the first sale rule. The US opportunity to reintroduce appraisement “based Schumer, the Senior Senator from the State of last sale price of goods before entry into the providing US customers with lower landed duty- between the middleman and the factory is for importer in the case, the New York City only on the last sale occurring prior to the New York, who “questioned the Administration’s US, poses not only a challenge to players of paid costs without adversely affecting vendors’ goods sold for export to the US. Of course, the Metropolitan Transportation Authority (“MTA”), introduction of the goods into the US.” This is judgment in imposing what essentially amounts to the critical US-China trade game but also to profit margins. transaction between the importer and had placed an order with Nissho Iwai, a vendor, for precisely what Customs’ recent proposal on a tax increase on consumers and businesses at a the resilience of the US economy. Rob Smits middleman is also for goods sold for export to built-to-specification merchandise, namely train adjusting interpretation achieves: to undo the ruling time when we are seeking to stimulate the and Liza Schaeffer in Salans’ New York Legal Foundation of the the US. However, a US importer will generally carriages for New York’s underground transport in the Nissho Iwai case. economy to avoid an extended or deep 2. office investigate. First Sale Rule prefer to declare the value of the merchandise network. Nissho Iwai was able to source the recession.” based on the first sale – that is, without the carriages at a price of approximately The proposed interpretation is premised on an Under current law, US importers utilising The first sale rule stems from US valuation laws. middleman’s markup – when entering the USD $800 000 per unit from a Japanese producer advisory commentary that was issued by a In total, over 150 comments responding to middlemen or trading companies are permitted to By federal statute, Customs is required to collect merchandise into the US. and resell them to the MTA at approximately technical committee of the World Customs Customs' proposal were filed by manufacturers, use the 'first sale' in a tiered transaction as the duties on the ‘transaction value’ of merchandise, USD $844 500 per unit. Customs attempted to Organisation (“WCO”) in July 2007 1. Though the importers, trade associations and congressmen. In basis for calculating duties payable on merchandise which is defined as “the price actually paid or While not explicitly articulated in law, the first sale asses duties on the basis of the sale between commentary is a non-binding document which response, Congress has enjoined Customs from upon its entry into the US, provided the payable for the merchandise when sold for rule was unambiguously adopted by the Court of Nissho Iwai and the MTA, resulting in an increased carries little legal authority in the US, the WCO eliminating the first sale rule before January 1 importers can demonstrate that the first sale was exportation to the United States” plus certain Appeals for the Federal Circuit (“CAFC”) in the duty payment of about USD $3 500 per carriage, document reflects the valuation laws of many, 2011 and, until then, has implemented a reporting a bona fide arm's length transaction and that the specified amounts. The first sale rule is rooted in Nissho Iwai American Corp. v. United States, 982 or a 5% increase on the landed duty paid cost of indeed perhaps most, WCO member states. US requirement at entry to collect information on merchandise was destined for exportation to the the notion that, in tiered transactions, there are F.2d 505 (Fed. Cir. 1992) case, which provided: the carriages for the MTA. However, the Federal Customs is now using this document and, the prevalence of the first sale rule. US at the time of sale. two sales when exporting goods to the US – one “… once it is determined that both the Circuit Court held that Customs’ reasoning was conveniently, the opinion of the world community, Members of the textile and apparel industry in between the factory and the middleman, and one manufacturer's price and the middleman's price “legally unsound” and found that Customs should to support its not-so-new crusade against the first 1. The US valuation laws, including the definition of transaction Asia and, in particular, China have benefited from between the middleman and the importer. are statutorily viable transaction values, the rule is have looked at the sale between the Japanese sale rule. producer and Nissho Iwai to determine the value value, were created as a result of the General Agreement on this first sale rule, as the rule has historically In practice, tiered transactions are very common. straightforward: the manufacturer's price, rather Tariffs and Trade (“GATT”) which, among other objectives, of the train carriages assessable for customs duties. The manoeuvring of US Customs has some enabled them to offset high tariff rates and the A US importer initiates a sale by contacting a than the price from the middleman to the attempted to develop harmonised customs regulations globally, interesting political significance. From a legal cost of quota to remain competitive with middleman (or trading company) and providing purchaser, is used as the basis for determining to facilitate trade. perspective, it is not quite clear that an suppliers in other regions for their US client base. specific information as to the merchandise the transaction value.” International Influences administrative agency such as Customs has the 2. See Document ID no. USCBP-2007-0083-0073, available at In fact, manufacturers throughout South-East Asia importer is looking to purchase. The middleman Nissho Iwai American Corp., 982 F.2d at 509. While Nissho Iwai was not the first case to stand legal authority to overturn, by regulation, well- http://www.regulations.gov including Hong Kong, Macau, China, Vietnam, then works with a factory to develop a for the first sale rule, the court’s opinion was entirely accepted judicial precedent. The timing of Philippines and Malaysia have tailored their production sample for the US importer’s approval dispositive and frustrated many in the US Customs’ proposal has also raised many corporate environments to satisfy existing and, once obtained, the US importer places an administration who viewed Customs’ mission, rightly, eyebrows, as noted in several public comments as a protector of revenue. Indeed, certain which were filed in response to the proposal. A

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Frankfurt Funding? LISTING A CHINESE COMPANY ON GERMANY’S STOCK EXCHANGE

The first two initial public offerings (IPOs) of for Chinese companies. Most importantly, Under current Chinese law, a Chinese company M&A provisions at the end of 2006 requiring accounting standards. Issuers in the General Chinese companies occurred on the Frankfurt however, listing costs at the FSE are considerably has to obtain prior approval from the Chinese Chinese issuers to seek prior approval from the Standard, on the other hand, must meet more Stock Exchange (FSE) in 2007. With the lower than at other large Western exchanges. authorities for a direct listing on a foreign stock Chinese authorities for any IPO on a foreign stock stringent requirements such as preparing financial ZhongDe Waste Technology and Asian Bamboo According to data published by the FSE, the exchange (option 1). In practice though, approval exchange. To date, no such approval appears to statements according to IFRS, publishing interim listings being 13 and 15 times oversubscribed overall costs for an IPO in Frankfurt (calculated as tends to be given only to large state-owned have been given and it is to be expected that only reports after the first half of the fiscal year and respectively, it looks as though this may be the a percentage of total proceeds) is, on average, enterprises, effectively making this option state-owned enterprises, if any, will be able to complying with numerous disclosure obligations start of a concerted level of interest by the several percentage points below the costs for a inaccessible for private Chinese companies. obtain the necessary approval in the future. under German law, to name a few. Those issuers German investment community in China. Salans listing on other major exchanges such as the The Depositary Receipts mechanism (option 2) Nevertheless, the new rules do not apply to listed in the Prime Standard segment must meet lawyer Benjamin Kroymann uses his experience London Stock Exchange. allows for an indirect listing of shares – the shares of Chinese companies which had a holding structure the requirements of the General Standard as well as part of the advisory team on both IPOs to the Chinese company are not listed abroad, rather in place before the M&A provisions took effect in as publish quarterly reports and hold annual When it comes to choosing the offering structure look at the features of listing in Frankfurt. Depositary Receipts representing those shares. September 2006. analyst conferences. for listing on the FSE, a Chinese issuer may However, as in the case of option 1, prior approval by From a Chinese company’s perspective, there are choose among different options. It can decide on There is a possibility that companies lacking the For large and medium-sized Chinese companies, the Chinese authorities is needed if the Depositary a number of reasons for considering a listing on the type of securities it intends to offer as well as necessary holding structure could work around the conducting an IPO in the Prime Standard segment Under current Chinese Receipts represent shares listed on a Mainland the FSE. To begin with, going public on a Mainland select the market segment in which it plans to approval requirements set out by the M&A will mostly be the preferred option – due to its Chinese stock exchange. And as in the case of a law, a Chinese Chinese exchange is currently not an option for offer such securities. regulations. Several models have been devised to high level of transparency, the Prime Standard has direct listing abroad, such approval is generally only most Chinese entrepreneurs – a long waiting list blunt the applicability of the M&A provisions, albeit proven to be particularly attractive to international company has to obtain available for large state-owned enterprises. as well as preferential treatment of large state- none of them have been tested in practice. Whether investors. Smaller Chinese companies, on the other Types of securities issued on In this context, ZhongDe and Asian Bamboo prior approval from the owned enterprises deter many smaller and such models will prove effective in circumventing the hand, may prefer to seek a listing in the Entry the FSE unsurprisingly utilised the third option ie. shares of medium-sized private enterprises from approval requirements remains to be seen. Standard segment as it stipulates much lower In theory, a Chinese issuer has three options as to a newly established German holding company Chinese authorities for considering an IPO in Shanghai or Shenzhen. admission criteria and no additional requirements the types of securities offered on a foreign stock were listed on the FSE. The respective German Moreover, a listing abroad provides Chinese Market segment selection on with respect to accounting standards. a direct listing on a exchange: stock corporations held shares in an offshore companies with direct access to international holding company serving as the parent company the FSE foreign stock exchange investors and helps improve the respective brand (1) its Chinese shares by way of a direct listing of the Chinese issuer. The main advantage of this Market segments at the FSE include the Prime The future name on the domestic Chinese market. abroad; option is that it puts investors in a position where and General Standard as EU-regulated markets as (2) so-called Depositary Receipts representing its As demonstrated by last year’s successful IPOs of they can buy shares of a familiar legal entity which well as the Entry Standard as part of the so-called But why choose Frankfurt? Compared to other Chinese shares; or ZhongDe and Asian Bamboo, going public in is governed by German corporate governance Open Market. international stock exchanges, the FSE provides of (3) shares of a newly set-up holding company Germany is an alternative worth considering for standards and hence by well-known rules. a number of advantages. As evidenced by the holding (all) shares in the Chinese issuer (or The lowest benchmarks in terms of admission Chinese companies intending to raise capital abroad. Not all Chinese issuers are eligible for this option, listings of ZhongDe and Asian Bamboo, IPOs by in an offshore holding company acting as the criteria and follow-up obligations are to be found Given the number of factors to consider for a however. The Chinese government issued new Chinese issuers receive broad media coverage in parent company of the Chinese issuer). in the Entry Standard. Issuers in this segment may, company planning to list outside of Mainland China, Germany. Moreover, Germany is China's largest among others, continue to prepare their annual a prospective Chinese issuer should engage with its trading partner in Europe and thus a key market statements pursuant to respective national German and Chinese advisers as early as possible to discuss the feasibility of different IPO models.

Focus on Asia www.salans.com 14 15

Enter the Dragon The company and its business must, in the opinion of the HKEX, be suitable for listing. LISTING PRC COMPANIES ON THE HONG KONG STOCK EXCHANGE

The listing of PRC companies on the HKEX has LISTING REQUIREMENTS income or loss of the issuer (or its group) In all three tests, listing applicants are also • enhancing both profile and reputation of • using all reasonable endeavours to address Hong Kong Legal Counsel been occurring since the early 1990s and with generated by activities outside the ordinary and required to have: the company; and matters raised by the HKEX in connection the increased appetite for PRC companies Suitability for Listing usual course of its business. with the listing application. Lawyers acting for the issuer on an H-share issue amongst investors, listing applications continued The company and its business must, in the (i) a trading record of not less than • applying positive pressure on the will play a crucial role in the listing process. They their rise into this decade. Ronny Wong and opinion of the HKEX, be suitable for listing. This 2. Market Capitalisation / Revenue / 3 financial years; management of the Chinese issuing Underwriters will inevitably have to rely primarily on the Andrew Lui look at the main features. means, for example, that the nature of the Cash Flow Test (ii) management continuity for at least the 3 company to recognise and adhere to The underwriters, as a group, do not play a preparatory work of the issuer’s Chinese counsel preceding financial years; and international standards in terms of significant role in the H-Shares offer until towards in relation to the reorganisation and company's business and its management must be This test states listing applicants must have: Traditionally, in accordance with the Rules in keeping with the standards of integrity which (iii) ownership continuity and control for corporate governance, providing, inter alia, a the end of the transaction. Their main role is to establishment of the company but will, as a matter Governing the Listing of Securities on the Stock the HKEX endeavours to uphold and that there • market capitalisation of at least HK $2 at least the most recent audited higher level of transparency and protection market the new issue and underwrite the risk of practice, be expected to have reviewed and in Exchange of Hong Kong Limited (“Listing Rules”), will be sufficient public interest in the business of billion at the time of listing; financial year. of minority shareholders. of under-subscription. It is a requirement of some cases drafted, with the assistance of joint stock companies incorporated in China can the company and in its shares. • revenues of at least HK $500 million for the Listing Rules that a new issue must be Chinese counsel, contracts to be entered into by list directly on the HKEX, with the Hong Kong- the most recent audited financial year; and BENEFITS OF LISTING INTERMEDIARIES fully underwritten. the issuer and other parties in China. listed shares of these companies known as Financial Requirement and Management and • positive cash flow from operating activities Underwriters’ Legal Counsel ‘H- Shares’. Ownership Continuity carried out by listing applicants or their For Chinese companies, the benefits of listing on Sponsor Reporting Accountants The underwriters’ counsel are principally For Main Board listings, companies must have an groups, that are to be listed of at least HK the HKEX include: Under the Listing Rules, a prospective Chinese The reporting accountants will primarily focus on: concerned with safeguarding the interests MAIN BOARD VS GROWTH adequate trading record under a substantial $100 million in aggregate for the three issuer is required to appoint one or more • access to international funds. Hong Kong • preparing the accountants’ report to be of the underwriters. Accordingly, their ENTERPRISE MARKET (GEM) proportion of the same management team and preceding financial years. sponsors to assist with its initial listing application. has no foreign exchange control, is a included in the listing document; and responsibilities include: ownership, whilst also meeting certain financial The sponsor will usually be a merchant bank and • reporting any profit forecasts to be made 3. Market Capitalisation / Revenue Test regional and international financial centre There are two Markets on the HKEX for listing – standards. This allows investors to make an is often the global coordinator of the by the issuer. • conducting due diligence in relation to the informed assessment of the management's ability as well as a base for some of the world's underwriting syndicate, the party responsible for the Main Board and the GEM. In what could be This test applies to listing applicants with a market issuer and its subsidiaries; to manage the business and therefore, its likely most successful fund managers; coordinating the issue and the underwriting of the likened to the Alternative Investment Market capitalisation of at least HK $4 billion at the time Chinese Legal Counsel of the Issuer • reviewing the listing document and performance in the future. H-shares. The role of sponsor is important, (AIM) in the UK, the GEM in Hong Kong is the of listing, and revenues of at least HK $500 million • active post-listing trading which facilitates The primary responsibility of the issuing conducting verification; and carrying a number of substantial and significant secondary market. Whilst the process for for the most recent audited financial year. This test subsequent fundraising. This is attributable company’s Chinese legal counsel is to issue a • drafting the underwriting agreement, All Main Board listing applicants are required to obligations including: companies listing on either the Main Board or is for larger companies who have a proven ability to an active interest in, and more in-depth Chinese Law opinion on: agreement amongst underwriters and satisfy one of the following three tests: GEM in Hong Kong market is similar, the listing to generate substantial revenue and can understanding of, the Chinese market due related documentation. • close involvement in preparing the • the incorporation of the issuer; requirements for GEM are far less stringent. demonstrate that they command significant to geographical and cultural proximity, a 1. Profit Test listing document; • the reorganisation; Perhaps the most important difference is that investor interest (applicants should have at least high concentration of analysts focused on Other Parties • the obtaining of all necessary approvals for GEM applicant companies do not require a 1000 shareholders at the time of listing). China as well as the separate Hang Seng Other parties to a listing project would proven “profit-making track record”, as is required In the three financial years immediately preceding Chinese Enterprise Index (tracking the • conducting reasonable due diligence the reorganisation, establishment of the normally include: for Main Board applicants. the listing, the company must have achieved performance of large H-share companies); inquiries; company and the H share issue; and Trading activities on GEM have been rather certain profit figures. The profits, in respect of the • the transfer of land use rights and other • valuers; stagnant as compared to its Main Board most recent year, must be not less than HK $20 • securing the interest and confidence of • submitting the listing application with all land title. • public relations consultants; counterpart in Hong Kong in recent years, so million and, in respect of the two preceding years, international investors who are familiar supporting documents and acting as • receiving banks; new listings are somewhat scarce. the profits must be, in aggregate, not less than HK with the standards of regulation in principal channel of communication with • share registrars; and $30 million. Such profit should exclude any Hong Kong; the approving authorities on behalf of the • printers. applicant; and

www.salans.com Focus on Asia 16 17

London (Capital) Calling MAIN MARKET AIM The London Stock Shares 25% of the class of shares to be No requirement Exchange (LSE) allows listed must be in public ownership The rise of London to be a serious contender wherever possible and that the company at the • accountants; and no later than the time of admission as the world’s financial capital has only top of a group must be a type of company able • PR consultants to manage the brand companies to raise strengthened in recent years, with the to be admitted to a public market. and reputation of the company during capital from its two Accounts Companies must have filed audited No trading record requirement depreciation of the US dollar destabilising New the process. accounts covering at least three York’s claim to the title. But it is more than that Compliance with AIM Rules, Listing Rules and principal markets - the years – the two-market approach has ensured that Prospectus Rules Publication of prospectus / admission document capital-raising companies of all sizes find a If a company chooses to float on AIM, it will be One of the principal tasks of the advisory team Main Market and the Value Expected aggregate market value AIM Rules do not impose a of all shares to be listed must be at minimum market capitalisation receptive market in the UK. Paul Salmon and subject to the LSE’s AIM Rules for Companies will be to prepare the prospectus or admission Alternative Investment least GBP £700 000 requirement, though the costs Alican Babalioglu give an overview of the and, depending on whether there is a public offer, document. This can be a lengthy process, involving involved in the IPO process dictate process involved. the Prospectus Rules. Conversely, if a company large amounts of due diligence. As a general rule, Market (AIM). Investors a company should be worth several decides to float on the Main Market, security the less well-known the jurisdiction in which the may raise capital in millions of pounds in order to be The London Stock Exchange (LSE) allows listings will be subject to the UKLA’s Listing Rules business is located, the more thorough the Broker cost effective companies to raise capital from its two principal as well as the Prospectus Rules. will require the due diligence to be in order to these markets through markets - the Main Market and the Alternative optimise investor interest. It is when the Prospectus Prospectus must be approved by Provided it is not an offer to the Investment Market (AIM). Investors may raise Appointment of advisers prospectus is published that the IPO will be live. listing shares, debt or the UKLA public, admission documents do not capital in these markets through listing shares, After deciding to float, the next critical decision is depositary receipts. need approval from either the debt or depositary receipts. appointing good quality corporate advisers. Any Corporate and Capital Considerations UKLA or the LSE, but will need to company considering a listing should appoint its One thing to consider at an early stage is be vetted by the Nomad Initial Legal Considerations team of advisers at an early stage. whether the company's corporate and capital structure is suitable for a listing. If changes need Listing suitability The typical make-up of an advisory team to be made to the company's structure, these Directors of the company need to take an will include: must be resolved very early in the IPO process. It Management will be critical to a successful IPO, as Financial Services Authority. A central feature of such as the need for funds, current corporate activity, The huge amount of work for management to do objective look and analyse its suitability for a is commonplace to incorporate a holding investors will want to be assured that the business the AIM regulatory system is the delegation of valuation, the financial reporting timetable and the in the lead-up to an IPO can often distract from listing, including how a listing aligns with the • a corporate finance specialist, possibly an company which would own the shares in the is in capable hands. Therefore, companies should responsibility to Nomads for assessing the availability of management. From a market the day-to-day running of the company in company’s future ambitions. Given the cost and investment bank to act as sponsor or lead company proposed for listing. The jurisdiction of consider whether the current management team suitability of AIM entrants and monitoring their perspective, it will be considering current market question. It can be near to impossible for an amount of management time associated with an manager; the holding company would depend largely on is the right one to take the business forward into compliance with AIM Rules going forward. There conditions, market outlook, industry trends and existing management team to tend to all their initial public offering (IPO), companies need to be • if going to AIM, a Nominated Adviser tax considerations. a listing. Other factors need considering here also, are differences between the Main Market and investors’ appetite for new issues. management duties at the same time as preparing very thorough at this stage. There are many (often referred to as ‘Nomad’), who will be including the remuneration and incentive AIM so far as the eligibility criteria for admission, the Company for listing. There is a real risk that entrepreneurs who are successful at running a responsible for managing the IPO process The structure of the company should comply structure of the company. and these are highlighted in Table 1. When seeking a listing on the Main Market, three to even the most successful IPOs are followed by a private enterprise but entirely unsuited to the and coordinating all other advisers; with relevant corporate governance provisions four months prior to admission date, the company’s profit warning, due to management losing public arena. • a broker, who will advise the company of because if it does not, it will struggle to attract Main Market vs. AIM Timetable advisers will begin consulting with the UKLA and the operational focus during the period prior to listing. the market conditions and market the investment from UK institutions. This is why when Contrary to popular belief amongst its detractors, There is no standard timetable for an IPO. The LSE, with certain draft documents likely to be submitted Corporate Structure shares to investors. Note that a Nomad or commencing the listing process, it is AIM is not the unregulated ‘wild west’ of stock Sponsor or Nomad will advise the company on to the UKLA for comment and approval. Ideally, the The company must be a single group structure, sponsor often acts as broker; recommended to appoint independent non- markets. It is an exchange-regulated market run timing based on its individual circumstances. prospectus should be submitted about two months ensuring that any minority interests are eliminated • legal specialists; executive directors. by the LSE, which in turn is regulated by the UK Companies are likely to be concerned with issues before the expected date of admission.

www.salans.com Focus on Asia 18 19

Legally, subsidies to private enterprises do not qualify for a general EIT exemption.

Taxable Income of Foreign- Deduction of Expenses to the joint development or receipt of intangible M&A and Enterprise Invested Enterprises assets or the joint provision or acceptance of Restructuring Making the new Enterprise Directly Related to Income labour services. The rules require that the Gross Income The EIT Law allows enterprises to deduct proportion and amount of allocated costs shall be Although M&A and enterprise restructuring is not The implementing rules of the EIT Law expanded “related” and “reasonable” expenses. Related fixed by agreement, and that the allocation shall mentioned in the EIT Law, there have been Income Tax laws work match the respective ownership rights to use and the meaning of the term “Gross Income” to expenses are those incurred which are directly indications that there will be a unification of include all types of receipts including “deemed related to income generation. The term to benefit. Any allocations not associated with restructuring taxation on FIEs and domestic sales” and subsidies. “reasonable expenses” is not further defined. As arm’s length transactions, or that lack a reasonable enterprises; as such, huge changes are expected in commercial purpose or economic substance, will The new Enterprise Income Tax (EIT) regime tax planning, although it will also be necessary to this is a principle-based rule, taxpayers and the this area in the future. Taxability of Foreign not be permissible deductions for the purpose of affects Foreign-Invested Enterprises (FIEs) keep an eye on newly introduced anti-avoidance Deemed sales are where an enterprise engages in Chinese tax authorities may each take their own Enterprises calculating an FIE’s taxable income. The concept and foreign Enterprises in relation to how they rules (see section below). a barter trade or uses its stock, assets or services stance on what may be regarded as deductible Recognition of Assets’ Income of Advanced Pricing Agreements (“APA”) as and their income streams are taxed, as well as for donations, fundraising, advertising, samples, staff expenses. It is likely that such different The implementing rules reiterate the general rule Withholding Tax on Dividends applicable to transfer pricing may also be used in their M&A, restructuring and liquidation activity. Effective Management Organisation welfare or profit distribution. Tax authorities now interpretation will lead to tax audit challenges. for M&A that any gain or loss from restructuring Under the EIT Law, dividends issued by an FIE regard to the cost allocation. See our separate Yun Wei and Fang Liu look in detail at the lose their exempt status and become subject to a Under the EIT Law, the global income of an consider that the products have been sold or the shall be recognised for tax purposes. As a result, Deductions with Percentage Limitation article on APAs. implementing rules. 10% withholding tax. It has been made clear that enterprise incorporated outside China that has services provided for commercial purposes; the preferential policies provided by the its “effective management organisation” inside therefore, any related incomes will be taxable. Commonweal Donations were fully deductible Temporary Stipulations on the Income Tax the 10% withholding tax will only apply to Management Fees The new Enterprise Income Tax Law (“EIT Law”), China is taxable in China. The term “effective Although a similar deemed sales provision under the FEIT Law, but will be capped at a rate Treatment of Restructuring Business of FIEs such dividends on profits earned from 2008 onwards, Management fees paid to related parties were implemented in March 2007, provided the management organisation” refers to the internal currently exists in the Value-Added Tax regime, it of 12% of an FIE’s annual gross profit under the as Merger, Split, Share Transfer and Assets Transfer and the dividends on profits earned in previous not deductible under the FEIT Law. This created a The EIT Law foundation for a unified corporate tax law, which organisation which exercises the essential is important to keep in mind the additional EIT Law. In addition, while advertising expenses (Guo Shui Fa [1997] No. 71) to foreign-invested years - even remitted in 2008 or later - will still constant headache for foreign investors who are came into effect this year. It replaced the tax laws management functions of, and exerts control over, income tax impact and increased complexity in are currently fully deductible, they will be capped enterprises may have come to an end. For be exempt from EIT. required by their home tax authorities to charge has introduced a governing foreign-invested enterprises and foreign the enterprise as a whole. This new stipulation, in complying with these new provisions. at a rate of 15% of an FIE’s annual sales income. example, under this old circular, mergers and splits Deductions for business entertainment expenses, such fees to their PRC subsidiaries. The enterprises, previously covered in the Income Tax The reintroduction of the dividend withholding line with general principles of international of FIEs can take place at book values and do not number of changes as which may currently be as high as 0.3% or 0.5% of implementing rules still do not allow for the Law for Foreign-invested Enterprises and Foreign tax re-establishes the importance of certain tax taxation, may affect off-shore holding companies "Governmental funding" which qualifies for give rise to enterprise income taxes. The tax annual sales, are modified so that only 60% of deduction of management fees. a general framework, Enterprises (“FEIT Law”). treaties, including an Arrangement between in Hong Kong or other tax havens. If such entities exemption from taxation under the EIT Law is neutral basis prescribed by the implementing rules are managed by a PRC subsidiary, they may now limited to funding for public services, units and business entertainment expenses with a limit of may remove this exemption. Moreover, there may Mainland China and Hong Kong which limits the Depreciation of Fixed Assets supplemented by the The EIT Law has introduced a number of changes come within the scope of the EIT. Hence, a social organisations under the governmental 0.5% of annual sales will be deductible. In addition, no longer be a tax free treatment for a cross- withholding tax rate to 5% for those beneficiaries The implementing rules will no longer require as a general framework, supplemented by the restructuring of such arrangements may budget management. Legally, subsidies to private the deduction limitation on employee education border share restructuring transaction, where a implementing rules in who own no less than 25% of the capital in an that the depreciation of fixed assets be limited to implementing rules in December 2007. The become necessary. enterprises do not qualify for a general EIT expenses has been increased from 1.5% to 2.5% 100% shareholding relationship exists between FIE. In addition, an Agreement between China a residual value of 10%. The useful life of December 2007. implementation rules do not go into great detail exemption. Although the Ministry of Finance and of the total employees’ salary amount. the transferor and the transferee. and Barbados provides that a dividend electronic equipment has been shortened from but provides an indication of what changes may withholding tax may not exceed 5% when the State Administration for Taxation has the right to Cost Allocation five to three years, and the useful life of be expected and serves as a starting point for tax recipient is the “beneficial owner” of the dividends. adopt further special regulations in this regard, no Amortisation of Acquired Goodwill For the first time, allocated costs are tax transportation vehicles other than train, plane and planning to manage changes ahead. It is expected that such treaties and agreements such regulations have been adopted so far. A remarkable outcome of the implementing rules deductible. However, under the implementing ship has been shortened from five to four years will increase in importance in future international is that they do not allow the amortisation of rules, deductibility is limited to costs attributable accordingly. acquired goodwill for tax purposes until the

Focus on Asia www.salans.com 20 acquiring enterprise disposes of its entire business Anti-Avoidance international context, considerable local gearing 21 or is liquidated. This deviates from previous tax under the new thin capitalisation rules may result treatment for FIEs in similar situations (generally, The EIT Law provides for a general anti-avoidance in the elimination of interest expenses as a Advanced Pricing Arrangements Preparatory Meetings allowing amortisation of goodwill over ten years). rule which allows all transactions to be adjusted permissible deduction. Taxpayer (company or enterprise) submits by the tax authorities if their main purpose is to ADVANCED PRICING ARRANGEMENTS ARE A TOOL TO DETERMINE TRANSFER PRICES, WITHOUT written request to apply for an APA with Significant tax timing differences may result from reduce, exempt or delay tax payment without Preferential Tax Treatment VIOLATING TRANSFER PRICING REGULATIONS. HOW IS THIS APPLIED UNDER CHINA’S NEW the relevant tax authority. Both parties hold preparatory meetings, and discuss the this, since the gains arising from taxable business reasonable commercial reasons. In addition to ENTERPRISE INCOME TAX LAW AND HOW ARE THEY ARRANGED? MATTHIAS MUELLER AND feasibility of the APA. Taxpayer is required to restructurings of the transferor will be taxed the general anti-avoidance rule, the following The new EIT Law repeals most of the existing tax meet a number of documentation upfront, whereas the acquirer may not claim incentives for FIEs. New preferential tax FANG LIU TAKE A LOOK AT THE NEW PROCESS. principles are put forward under the new regime: requirements at this stage. amortisation of acquired goodwill until those treatments such as reduced tax rates or special critical events occur. In addition, it is not clear Transfer Pricing deductions are now provided for both FIEs and whether FIEs which previously acquired The EIT Law encourages companies to adopt domestic enterprises, as well as investors in the In China, as in most other countries, transaction Forms of APA and Legal Basis APAs run from two to four years, usually renewable at expiration. The relevant tax businesses with goodwill can continue amortising Advanced Pricing Arrangements (“APA”). The EIT following industries: prices between parties must be at market prices authority will ensure the APA is being correctly Written Authorisation Notice their goodwill for tax purposes under the new Law provides that tax authorities are allowed to for tax purposes. This so-called ‘arm’s length’ An APA can be binding between the Chinese tax implemented with periodic checks, and applicants Tax authority issues written notification to regime. To date, however, there has been no adjust taxes in case an incorrect transfer price is • high & new tech enterprises; principle as applied in China means that each authority and a company, or between the Chinese are required to keep complete records and taxpayer within 15 days of agreeing to disclosed rejection from the tax authorities. used. Two new methods – the transactional net • initial investment enterprises which invest company has to document its transfer prices, tax authority and the tax authority of one or documentation. An annual APA Implementation authorise a formal application for an APA. margin method and profit-split method – have in non-listed small and medium high & new but tax authorities may adjust these amounts if more other countries. Report is due to the authorities within four Offshore Share Transfer tech enterprises; they are not satisfied with their determination. been introduced to adjust the taxation of months of year-end. If any material changes occur The share transfer between foreign enterprises is • enterprises in the agriculture, forestry, The legal basis for concluding an APA in China is transactions by tax authorities. The during the term of an APA, companies must captured by the EIT if the share is in a Chinese animal husbandry or fishing industries; An Advanced Pricing Arrangement (APA) allows the PRC Implementing Rules for Advance Pricing implementation rules require taxpayers in related report these to the relevant tax authority within Formal Application enterprise, unless there is a double tax treaty in party transactions to capture information on • enterprises which undertake a company to eliminate the risk that its transfer Arrangements for Business Dealings between prices will not be accepted by the tax authority 15 days of its occurrence. Within 3 months of receipt of the written place to provide relief. pricing/expense determinations, calculation environmental protection projects; and Related Enterprises (for Trial Implementation) notice, taxpayer is expected to submit a upon audit. APAs fix the method for determining methods and explanations and submit them upon • enterprises which undertake public which came into effect in September 2004. APAs and the new Enterprise written formal application for an APA, with Liquidation request from the tax authorities. infrastructure projects supported by transfer prices of a particular company with its These rules state that an APA is applicable to the: relevant supporting documents. The formula for calculating liquidation income has related parties, for a specified time, with the Income Tax (EIT) Law the State. • purchase, sale and use of tangible assets; been completely changed under the Controlled Foreign Corporation (“CFC”) express approval of the relevant tax authority. • assignment and use of intangible assets; The new Enterprise Income Tax (EIT) Law (see implementing rules. While the old calculation The EIT Law stipulates that if a CFC (which was The EIT Law indicates that FIEs established prior • provision of labor services; and separate article), in effect since the start of the method looked to the difference between net established where the effective tax rate is to the implementation of the law may continue • financing between a taxpayer and its year, encourages the use of APAs by prescribing Review and Evaluation assets and equity, the new method uses the significantly lower than the EIT rate) does not to enjoy certain tax incentives eg. tax holidays related party. that, under certain circumstances, APAs can be Within 5 months (term may be extended liquidation period as an operating period and distribute profits or distributes fewer profits than it for a transitional period of five years. The entered into retrospectively for previous years. by 3 months, if necessary) of receipt of adopts a profit and loss approach to the should without a reasonable commercial basis, the grandfathering provisions have been defined Application and Term Further to this, cost allocation between related formal and complete application, tax calculation. Although the tax consequences undistributed profits will be included when as follows: parties has, for the first time, become tax authority reviews and reaches a decision. appear to be similar with regard to direct calculating the enterprise’s taxable income in the An application for an APA is usually made with deductible (within certain boundaries), making an enterprise income taxation, taxation on the current period. • companies which had a reduced tax rate of the relevant international tax administration at or APA an attractive instrument for use in this regard. distribution of liquidation proceeds is likely to 15% before 2008 will get a tax rate above China’s provincial levels. Multinationals, become stricter. Proceeds distributed to investors increase phased in over time i.e. 18% for Thin Capitalisation Rules however, are able to apply for an APA across their Negotiation as undistributed profits or reserve funds will be 2008, 20% for 2009, 22% for 2010, 24% for The implementation rules do not provide detailed subsidiaries (even if these are located in more Within 30 days of its decision, tax authority taxed as dividends and consequently may result in definitions on debt to equity ratios, but this is 2011 and 25% for 2012. than one province) with a direct approach to the commences negotiation of relevant terms additional withholding taxes for foreign investors; expected to be detailed in a later tax circular. • companies which were entitled to tax State Administration of Taxation in Beijing. and conditions with taxpayer. the balance of the liquidation proceeds may be However, PRC foreign investment laws have set holiday before 2008 will continue their tax Once agreed, taxpayer and tax authorities taxed as capital gains which, again for a foreign certain debt and equity standards for FIEs which holidays until tax holidays expire, however, compile a draft APA. investor, may result in withholding taxes. This will in practice are only enforced in the context of the tax holiday has to start no later not be welcomed by most foreign investors since foreign exchange loans. Whilst this is not than 2008. most tax treaties with China follow the UN- expected to attract any tax repercussions in an model and permit China to tax capital gains. Conclusion Within 30 days of agreeing a draft APA, both parties expected to formally conclude the APA.

Focus on Asia www.salans.com 22 23

Andrew Lui joins Salans to run its Salans NEWS Hong Kong office

Major strategic expansion Head of China Real Estate Head of Hong Kong Office Shanghai office wins Salans recognised as leading The news comes on the back of two eminent in China announced appointed prestigious award International Law Firm legal practitioners in the Gulf joining the Salans Salans recently announced that on the back of its Jeff Wenhai Cai joins Salans as Head of China Real Andrew Lui, former head of Pinsent Masons’ Asian-Counsel magazine awarded its “Firm of the The Lawyer, one of the UK's leading legal Gulf team: Dr Ali Busedrah (Consultant - expansion in Shanghai last year and moving into Estate as part of the firm's ongoing expansion in corporate practice in China, is joining Salans to Year 2007” accolade to the Salans Shanghai office, publications, has recognised Salans' international General Counsel of the Abu Dhabi Ministry of new premises in March, new offices will be China. He will be joining one of the strongest real run its Hong Kong office, through an association recognising its tax practice as one of the top two standing once again with the firm placing second Economy and Planning) and Dr Ahcene opened in are to be opened in Beijing and estate teams among international law firms, with with Andrew Lui & Co. in China. in its International Law Firm of the Year category. Boulesbaa (Consultant - General Counsel of Hong Kong. over 200 real estate and property finance specialists. This is the second year in a row the firm was Dubai Customs). Andrew has worked in Hong Kong and Mainland The award is based on a comprehensive survey nominated; last year it placed third. Salans is the The practice focus for Salans’ Hong Kong Jeff joins Salans from Fried Frank in Hong Kong, China for more than a decade in the fields of of in-house counsel across Asia, who were asked only firm from last year’s nominees – including the operation will be corporate, capital markets and and is qualified in the People’s Republic of China, M&A, public offerings and private equity work. to identify what factors they considered most winner – to be recognised again. New association agreement Salans celebrates its institutional real estate transactions. It will capitalise Hong Kong and New York State (USA). Resident His client focus is on investment banks, venture important when recruiting and working with 2007 was quite a year for the firm - with law firm in India 30-year anniversary on the firm’s relationships with leading global real in Hong Kong, Cai will lead Salans’ award-winning capitalists and listed companies in both Hong external counsel. unprecedented cross-border collaboration with India plays a key role in Salans' plans to assist This year, Salans is celebrating its 30th anniversary. estate investors, private equity houses and Global Real Estate Practice in China. Cai’s career Kong and the PRC. Andrew speaks Cantonese, 84% of top 250 client revenue generated from clients in Asia. To support our clients on projects Founded in 1978 by Carl Salans, Jeffrey Hertzfeld Jeff Wenhai Cai joins Salans as Head of China Real Estate investment banks. Salans’ team in Hong Kong will has been in PRC-focused real estate and his Mandarin and English. “We’re delighted that the high calibre advice work spread across more than one office, a 37% involving India, Salans has established an and Eliane Heilbronn, the firm opened in Paris also provide the conduit for financing and practice includes foreign acquisition of PRC provided by our tax team is being recognised by growth in revenue, opening in Madrid and association with an Indian law firm, Hariani & Co. and has since grown to more than 750 lawyers executing corporate and real estate transactions properties, real estate finance, property John Flanigan, co-managing partner of Salans the marketplace,” said Bernd Stucken, co- Barcelona, doubling in size in Istanbul, adding new globally operating from 20 offices. in Mainland China, and form a hub for the firm’s development and other complex real estate China region said, “This appointment is indicative managing partner of the Shanghai office with over real estate teams in Moscow and Paris, and The Hariani law firm is very well-established in growth in Asia, outside China. transactions. He will divide his time primarily of the investment we are making to build our 18 years of experience in China. “Since the award forming new association agreements in the Gulf, India. Its main areas of practice include: banking Salans has built a leading reputation in emerging between Hong Kong and Mainland China. China practice. We are fortunate to add is based on surveys of in-house counsel and their Georgia and Southern Poland. and finance; capital markets and securities; markets and is consistently recognised as a firm Salans’ Beijing office will serve clients with regional someone with the background and calibre of votes, this is an indication that our clients are corporate/M&A; real estate; intellectual property; which successfully combines prudent judgement headquarters in the Chinese capital and will Eric Rosedale, Co-Chairman of Global Real Estate at Andrew to our team.” pleased with the level of service the Shanghai technology, media and communications; dispute with a streak of entrepreneurialism, as witnessed by provide the base for Salans to develop its Foreign Salans said, “We have been looking to expand from office provides,” added John Flanigan, co-managing Salans obtains licence to resolution; and shipping. Hariani's principal office this year’s extensive expansion programme in Asia. Direct Investment and M&A business in our emerging markets platform into Asia for some Andrew added, “It was essential for Salans to be partner of the Shanghai office. independently operate in Qatar is in Mumbai and the firm also has offices in Northeast China. The office will also provide a time. Jeff Cai provides an excellent opportunity to present in one of Asia’s leading financial hubs. The Salans has received a licence from the Qatar Bangalore, Pune and Goa. focal point for serving the growing number of build on our successes in representing international challenge of building a new gateway into China is Dariusz Oleszczuk, Salans’ Global Managing Financial Authority to operate independently of clients in the Salans global network who are real estate investors in China.” extremely compelling from a personal and Partner, went on to say, “After making a substantial any local sponsorship and is now situated at the Stephen Finch, Salans Chairman, commented, “We investing in China. professional stand point.” investment in Shanghai which saw us almost triple Qatar Financial Centre in the West Bay, Doha. are delighted to be associated with the Hariani Cai added, “I am extremely excited to join Salans. in size last year, this award is another Salans will continue to work alongside the firm’s firm. Their partners share our values, and are like- The three locations across China will give Salans Salans has a leading reputation in emerging demonstration of the progress our China practice long-standing cooperation agreement with The minded – they focus on service to clients and extensive coverage in one of the world’s fastest markets and a blue-chip real estate client base. is making in the marketplace.” Qatar International Law Firm. they are professional, entrepreneurial, and growing markets. Many of our real estate clients are very active enthusiastic. The association enables both firms to throughout Asia, particularly in Mainland China. serve their clients more effectively.” This provides a unique opportunity for me to be part of this success story.”

Focus on Asia www.salans.com 24 About the AUTHORS 25

Alican Babalioglu is an associate in the London John Flanigan is the co-managing partner of the Benjamin Kroymann is an associate in the Fang Liu is a tax manager in the Shanghai office Paul Salmon is a partner in the London office Dr Bernd Stucken is the co-managing partner Rob Smits is the Managing Partner of the New Ronny Wong is a senior associate in the Office. He concentrates on cross-border mergers Shanghai office. He specialises in mergers and Berlin office of Salans LLP. His practice focuses on and has worked for more than five years in the and head of the London Corporate Group. of the Shanghai office. He has lived and worked in York office and practices primarily in the areas of Shanghai office. He has experience in acting for & acquisitions, privatisations, corporate finance and acquisitions and corporate finance, including mergers & acquisitions, equity capital markets and PRC tax area and has extensive experience in He has over 25 years extensive experience in China for over 18 years and has extensive mergers & acquisitions, venture capital and private both sponsors and companies in IPOs in both the telecommunications. Some of his recent leveraged acquisitions, securities offerings and general corporate transactions. He advised advising on the PRC tax implications in foreign acting for public and private companies and experience advising on foreign direct investment equity financing. Rob has represented public and Main Board and Growth Enterprise Market of the experience includes advising the NOMAD and venture capital investments. He has published Chinese companies on the first two IPOs by direct investment (FDI), mergers and acquisitions concentrates on mergers and acquisitions, (FDI), mergers and acquisitions and joint venture private companies in the acquisition and sale of Hong Kong Stock Exchange. He has also acted as broker in connection with the admission of the numerous articles on corporate and securities law Chinese issuers in the Prime Standard segment of as well as during the operation of Foreign company and business disposals, takeovers, restructuring including strategic business and tax businesses, venture capital and private equity the Head of Legal for a blue-chip group listed in enlarged share capital of an AIM-trading company, issues, in particular regarding mergers and the Frankfurt Stock Exchange. Investment Enterprises (FIE). flotation's, issues of securities and joint ventures. aspects. Bernd is a former chairman of the funds, and issuers of securities in private Hong Kong with a market capitalisation of over and advising on the acquisition of a leading acquisitions, public offerings of securities and He is a specialist in IPOs for overseas companies Shanghai chapter of the German Chamber of placement transactions. HKD 100 billion. In addition to IPOs, Ronny's Ukranian dairy products business. corporate governance. and has lectured on the AIM Market in London Commerce and is a frequent speaker and writer practice covers private equity investment, mergers and overseas. on Chinese legal and business topics. and acquisitions and takeovers.

Matthias Müller is a partner and will become Jeff Wenhai Cai is a partner and the head of Andrew Lui is a partner and head of the Hong Liza Schaeffer is an associate in the New York Yun Wei is a senior associate in the Shanghai Managing Partner of the Beijing office once open. Salans' China Real Estate Practice. Before joining Kong office. He specialises in corporate, office and is part of the Corporate and office. She is qualified as a Chinese lawyer and He specialises in all aspects of corporate Salans, Jeff practiced with several leading commercial and corporate finance transactions in Intellectual Property groups. Liza has advised CPA. Yun specialises in finance, mergers & law and foreign direct investment, including international law firms in Hong Kong. He has Hong Kong and Mainland China as well as cross- clients, including major US and international acquisitions and real estate, including business mergers and acquisitions and restructuring of extensive experience in virtually all aspects of border regional transactions including advising on fashion houses, on a wide variety of international restructuring and tax consultancy. Some of her foreign invested enterprises. His work focuses on PRC-related real estate transactions, including listings, mergers and acquisitions, restructurings trade compliance issues such as import/export recent experience includes advising a world- private companies and on the approach of property development and construction, sales, and reorganisations and private equity regulations, intellectual property management, leading leasing company on establishing a wholly corporate governance in industries still restricted leasing and management, acquisitions and investments. Andrew's experience also includes advertising arrangements and consumer owned subisidiary in China and advising several on foreign investment in China. dispositions, financing and distressed real estate, as advising companies on their corporate, protection laws. venture capital funds on their private placement well as related tax planning, corporate and debt employment, regulatory and operational needs in with a leading manufacturer and subsequent listing restructurings and dispute resolution. Hong Kong and Mainland China. on the Hong Kong Stock Exchange.

Focus on Asia www.salans.com 26 27

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