Variable interest entity structure in China * Related international articles. Variable interest entity (VIE) structures in Chinaby Practical Law ChinaRelated ContentA note on the variable interest entity (VIE) structure that is commonly used for Chinese companies. A VIE is a legal business structure commonly used by mainland companies to establish ownership of a company through legal agreements, as opposed to direct share ownership. Awards. About the Editor. Qian Cheng (Chinese entity) owns 100% of Wuhan AdCo, which in turn owns 49% of Tech JV, the operating holding company for 51Job’s operating businesses. It establishes principles to create a more equal legal framework for foreign investors and to promote and protect foreign investment in China. Investors in Chinese companies soon encounter an obscure accounting term –the variable interest entity or VIE. There have been other actions taken by various governmental authorities that recognize the existence of the VIE structure in China. The note includes an analysis of the future of the VIE structure in the light of China's unified foreign … Financial markets have a habit of perpetually refactoring economic exposures until regulation intervenes. Those same policy rationales should also prompt reexamination of the disclosure being provided concerning, and associated governance risks posed by, the “variable interest entity” or “VIE” structures that are widely used by China-based firms (including Luckin) listed on U.S. exchanges. VIEs are a major input in China’s global economy creating jobs, tax revenues, innovation, global expansion and other economic benefits. Variable Interest Entities are a legal quagmire for investors to grapple with if they want exposure to the fast-growing internet enabled businesses in China. 51Job fully owns shares in 51net.com Inc, an entity registered in the British Virgin Islands, which in turn owns a 50% share in Tech JV. Capital inflows into the country would plunge as global investors speculate as to what other ways the Chinese government seek to destroy shareholder value. Renren and Baidu, for example, are variable interest entities. VIEs allow the public company to gain control of a private Chinese company and its assets through a series of contractual arrangements, rather than through a strict parent-subsidiary relationship or direct ownership of the … The VIE structure is entirely reliant on related-party transactions which are not at arms-length. By Carol Huang. The note explains the history and origins of the structure, the elements of the structure, the key contracts that make up the structure and the key clauses required in each contract to give effect to the structure. While the dispute was ultimately settled in 2011, it warns investors that their investment may be at risk if the owners of the domestic company are not carefully selected. 1. These companies use legal contracts to effectively own without owning shares in the underlying businesses; known as Variable Interest Entities (VIEs). A variable interest entity (VIE) refers to a legal business structure in which an investor has a controlling interest despite not having a majority of voting rights; or, it may refer to an accounting … Most of these businesses are listed offshore in more developed financial hubs … China is less likely to regulate the variable interest entity VIE structures of internet companies a relief for those that list overseas. China classifies their technology-platform businesses as value-added telecommunications businesses and limit foreign ownership to no more than 50%. The Chinese domestic company obtains the license to operate in the prohibited or restricted industry in China. The WFOE, in turn, provides capital through a loan to a VIE that conducts the operations in China and is wholly owned and operated by local Chinese investors. The China capital exchange controls would result in illiquid shares for foreign venture capitalists and other investors in an IPO exit in China. In 2011, after a series of public events, the variable interest entity (" VIE ") structure re-attracted a lot of attention and concerns from the PRC authorities, entrepreneurs, investors and other market participants. Variable interest entities have been used by non-Chinese investors to get financial control of companies in industries that limit foreign ownership, such as telecoms. In 2000, Sina Corporation made headlines by being the first Chinese business to list on the NASDAQ in New York using the 'Variable Interest Entity' ('VIE') structure, which uses contracts instead of shareholding to effect corporate control. Variable Interest Entities are a legal quagmire for investors to grapple with if they want exposure to the fast-growing internet enabled businesses in China. In a securities filing in July, Alibaba Group disclosed that executive chairman Jack Ma will be stepping away from the company’s variable interest entities. structure for its Chinese assets. In many areas, however, it provides only high level guidance, vague in some cases, and lacks detailed implementation provisions. U.S.-listed Chinese internet companies such as search giant Baidu and e-commerce giant Alibaba Group Holding utilize a corporate structure called a variable interest entity. In the years since, VIEs have become at once a buzzword amongst corporate lawyers and a headache for regulators in the People's Republic of China ('PRC'), the … Online Event – A Conversation on Enabling Startups in the US-India Corridor during India Global Week 2020, Online Event – Key Insights on Navigating the Fundraising Activity During a Pandemic, Panel Discussion with Crypto Valley on Institutional Investors in Crypto & Blockchain. It encourages technology collaboration between foreign investors and their Chinese counterparts on a fair and voluntary basis, and bars government officials from using administrative measures to force technology transfers. Alibaba Group Holding Inc., which conducted a $25 billion initial public offering (still the largest ever) on the … The economic right to the interest of the entity, as well as the ability to vote on how the company should be run. That’s it. Legal esoterica: what’s the difference between illegality and invalidity? 0 Comment. These American corporates never put the potential tax repatriation bill through their Income Statement arguably they would continue to hold the cash offshore, investing for growth. VIEs are used widely in China, particularly when a company that intends to list operates in a sector in which foreign investment is restricted, and are particularly common in the technology, telecommunications and media sectors. Should the Chinese government punitively treat foreign shareholders for the use of the VIE structure, they would be severely harming their reputation as a country to invest in. Extra taxation layers, involve a 10% withholding tax on the payment of dividends, when dividends flow from a domestic entity to any foreign non-resident enterprise investors. Much of this would be sitting in US pension funds and Australian superannuation funds. 1. It’s very hard to model out such a risk, in seemingly binary outcomes. 2015 The Accountant Power 50. These are companies many offshore investors want exposure to. VIEs are corporate structures usually set up to get around China’s not allowing WFOEs to participate in China’s internet sector. 51Job, Inc Entity Structure (2) Source: SEC filings. As of January 1, 2020, the FIL replaced and repealed the existing PRC Foreign Invested Enterprise Law, PRC Sino-Foreign Equity Joint Venture Law and PRC Sino-Foreign Cooperative Joint Venture Law (collectively, “FIE Laws”). Written By Ashford Bain. The WFOE exercises de facto control over the domestic company through a series of contractual arrangements entered between the WFOE and the domestic company. Updated:2019-10-10 18:30:57 Source:www.tannet-group.com Views:85. Alibaba is using a straightforward V.I.E. China’s Variable Interest Entity Structure Explained in 100 and 1,300 words. When the Chinese government tightened its regulations over online payment systems, Jack Ma, acting as the Chairman of Alibaba made the decision to transfer the assets of its online payment platform to a private company owned by him. An entity where an investor has a controlling interest that is not based on holding the majority of voting rights. The Negative List specifies administrative requirements for foreign investment access to certain business sectors. Invalid. Sitemap includes index to all articles. Consequently, the legal validity of VIEs … Those same policy rationales should also prompt reexamination of the disclosure being provided concerning, and associated governance risks posed by, the “variable interest entity” or “VIE” structures that are widely used by China-based firms (including Luckin) listed on U.S. exchanges. Chinese internet firms like Alibaba use contractual agreements between foreign-owned enterprises and locally owned-enterprises to replicate the economic interest of their domestic operations. Foreign investors will have national treatment consistent with domestic investment for sectors not included in the Negative List. 21 Cardozo J. Int'l & Comp. CSRC VIE Research Report Leaked to Media . The most well-known and severe example is the 2010 dispute between Alibaba and Yahoo and Softbank. China VIE Structure 2020 There doesn’t appear to be any transition process to restructure VIEs that would avoid serious financial chaos and disruption in the Chinese and global economy. For illustrative purposes I’ve excluded the other entities 51Job owns (Lagou Information Limited, 51net HR and 51Net Beijing) focusing on their main operations. Paul Gillis PhD CPA is Professor of Practice at Peking University's Guanghua School of Management. 28 Sep 2011 by Stan. China Accounting Blog does an excellent job explaining a typical VIE in its post, Explaining VIE Structures, which I urge you to read now. The most recent version of the Negative List was issued on June 30, 2019. Many of the largest and fastest growing technology businesses reside in China and present tremendous long-term opportunities to investors, benefitting from the same structural tailwinds as the FANG stocks. China is revising the laws that govern the variable interest entity, a complicated structure used by many companies to bypass foreign investment restrictions. A note on the variable interest entity (VIE) structure that is commonly used for Chinese companies. 51net.com Inc has in place a series of agreements with Qian Cheng, the actual owner of 50% of Tech JV, whereby Qian Cheng pass through all the economic risks and benefits back to 51net.com Inc. Legal esoterica: what’s the difference between illegality and invalidity? Some of the provisions in the FIL have been designed to reduce trade tensions with the United States. This proposal was not enacted but represented an existential risk to the VIE structure. To non-accountants, the VIE structure is a business structure that is widely used in certain business sectors in China that have prohibitions or restrictions on foreign investment under the 2019 Negative List such as telecommunications, e-commerce, education, and media. 13 Oct 2011 by Stan. 51Job, Inc (“51Job”), China’s leading online jobs classifieds website has been publicly listed on the NASDAQ since 2004 and despite significant volatility in the share price has delivered great shareholder returns over the long-term. Alibaba is using a straightforward V.I.E. Alibaba (China’s Amazon equivalent) and Baidu (China’s Google), among other listed American Depository Shares are exposed to a rarely discussed regulatory risk, relating to the holding structure of their domestic and foreign entities. Sitemap includes index to all articles. While VIEs remain in a grey area in China, capital markets have become accustomed to this status and this approach avoids the economic disruption that may result from new regulation of VIEs. 2014 Market Reformer of the Year. Many provisions will need to be clarified and interpreted in the future by supporting laws, administrative regulations or actions of the State Council. It entails a succession of contractual arrangements which hold the principal intention of circumventing the investment restrictions China has placed upon foreign ownership in particular sectors of the Chinese market. Article 23 of the FIL establishes obligations on administrative or other government officers not to disclose foreign investors’ and FIEs’ trade secrets to any third party. Many details need to be provided in supporting laws, regulations or by the State Council. 2020 Inventus Law. The scope of the definition of foreign investment and the national security review provisions, among others, need clarification. Charles Comey, Paul McKenzie, Sherry Yin and Michelle Yuan . Tech JV fully owns all of the operating subsidiaries for 51Job. These two articles are intended to protect foreign investors and FIEs from government interference. The Importance of Ownership of the Chinese Domestic Company. Until implementing regulations are issued, however, since the FIL contains broad and sometimes vague provisions, and repeals the existing legal framework for FIEs, there may be more confusion for foreign investors. The legal structure whereby contractual obligations pay the economic interest out to a foreign owned company is a circumnavigation of Chinese legislation. The National Development and Reform Commission will have the responsibility for national security review of foreign investments. An FIE is an enterprise incorporated under Chinese laws within China with all or part of its investment from a foreign investor. China law, business and economics commentary . All 11 of the companies were incorporated in the Cayman Islands. Detailed implementing laws, regulations or State Council action are expected in the near term. Since the FIL only prohibits the use of administrative means, there are still concerns that other methods could be used to force the transfer of technology. There have been few published cases and no implementing regulations or interpretations issued for the NSRS which will make it difficult in the short term to predict outcomes. China blinks on PCAOB; Kennedy Bill and MNCs; Sidebar. Most Influential People in Accounting. The founders, foreign investors, and other shareholders hold equity in the Caymans holding company, which in turn owns a 100% equity interest in the WFOE. It is a central government decision. Many of these businesses are listed on overseas exchanges, recording profits to shareholders as if they own 100% of the shares in their Chinese operations. Feb 24, 2020 | Fred Greguras. Several actions in the extremely sensitive education sector make it clear that there may not be foreign de facto control of any basic educational institutions in China. When you own shares in a business, you are owning two things. The note explains the history and origins of the structure, the elements of the structure, the key contracts that make up the structure and the key clauses required in each contract to give effect to the structure. The rate doubles to 20% for non-resident individual investors. Investors in … Accordingly, end-shareholders of VIE entities could be subject to far more taxation than would occur for otherwise “standard” investments. Renren and Baidu, for example, are variable interest entities. By . … Previously American entities like Apple were forced to pay the highest corporate tax rate from profits of international divisions if they wanted to repatriate their cash balances. It entails a succession of contractual arrangements which hold the principal intention of circumventing the investment restrictions China has placed upon foreign ownership in particular sectors of the Chinese market. 51Job, Inc Entity Structure (1) Source; SEC filings. Introduction The Variable Interest Entity (‘VIE’) is a well-established and widely utilised structure of investment employed in foreign investment in China. One additional risk factor in investing in Chinese companies is that the use of a reverse merger is often accompanied by the creation of a variable interest entity (“VIE”). Qian Cheng also directly owns 1% of Tech JV, in essence therefore owning 50% of Tech JV. These provisions may mitigate some of the political pressure China is currently facing to protect foreign IPR. For example, in a client matter, the founders were both foreign nationals and both domestic and foreign investors were involved. 13 Oct 2011 by Stan. The 42-provision FIL differs significantly from the more detailed 170-provision 2015 Draft. Consequently, the legal validity of VIEs has … The FIL contains general principles to consolidate the various laws and regulations on foreign investment in China, to promote and provide more equal treatment for foreign investment in China, to protect foreign investors by enhancing protections for intellectual property rights (IPR), to establish a national security review system and other provisions. The first well known VIE structure was that of Sina.com in its 2000 listing … The FIL is a positive step in support of foreign investment in China. About the Editor. The vaguer terms of China's new foreign investment law has made it less likely that VIE-structured companies will be regulated by the government - a relief to Alibaba and Tencent. Variable interest entities have been used by non-Chinese investors to get financial control of companies in industries that limit foreign ownership, such as telecoms. The VIE structure is also used by other types of Chinese businesses seeking foreign financing and a possible exit on an offshore equities exchange such as Nasdaq or the NYSE. Foreign investors must meet the requirements in the Negative list for any sector restricted by the Negative List. By undermining the confidence in capital markets, they would be threatening the flow of capital and causing as much harm to themselves as foreign investors. CSRC VIE Research Report Leaked to Media. Enron was masking their countless loss-making operations by recording these entities off-balance sheet. Where a wholly or partially foreign-owned entity enters into contracts with a Chinese company operating in PRC in the sector subject to foreign-investment restrictions or prohibitions, with the adequate business scope and licenses. Variable interest entity structure in China * Related international articles. Understanding the VIE Structure: necessary elements for success and the legal risks involved * - USA. Variable interest entity (VIE) Related Content. In September, 2019, also based on the passage of the FIL without the de facto control provision, the Hong Kong Stock Exchange revised its guidance to continue to permit VIE structures to be listed with certain requirements including “to the extent necessary to address any limits on foreign ownership stipulated by relevant PRC laws and regulations”. Awards. A variable interest entity (VIE) refers to a legal business structure in which an investor has a controlling interest despite not having a majority of voting rights. Invalid. It entails a succession of contractual arrangements which hold the principal intention of circumventing the investment restrictions China has placed upon foreign ownership in particular sectors of the Chinese market. Neither ministries nor local governments may specify restrictions on foreign investment. Rather than bring cash back home, American entities left it offshore for years, preferring to perpetually reinvest in low-yielding securities rather than pay taxes at 35%. A VIE … 2015 The Accountant Power 50. China blinks on PCAOB; Kennedy Bill and MNCs; Sidebar. Most variable interest entities are special purpose entities, which are legally structured entities which are created to serve a specific, predetermined, limited purpose. The structure is at odds with Chinese foreign investment legislation. gillis@gsm.pku.edu.cn. Last month, China’s Ministry of Commerce released a draft of the Foreign Investment Law, a new piece of legislation that attempts to integrate, update and replace the existing laws on foreign investment made more than a … ASU 2014-07, Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements, allows the reporting entity/lessee to elect not to apply VIE guidance to a lessor entity under common control. The review system implemented under the FIL will likely apply to all foreign investments as defined in Article 2. Over the last 18 years, an increasing number of Chinese companies have listed on U.S. exchanges relying heavily on a corporate structure called a variable interest entity (VIE). Instead, they will purchase shares in a Cayman Islands entity named Alibaba Group Holding Limited. Variable interest entity is a term used by the United States Financial Accounting Standards Board in FIN 46 to refer to an entity in which the investor holds a controlling interest that is not based on the majority of voting rights. The tax uncertainty here is reminiscent of the situation prior to the tax-reform from the 2017 Tax Cuts and Reform Act in the United States. As many of our readers are aware, the “variable interest entity” “VIE”) structure has proven popular over the past decade as a means to facilitate the offshore financing of PRC companies doing business in regulated sectors such as the Internet and value-added telecommunications. A VIE is an entity controlled by a company by means other than a majority of voting rights. Abstract In 2000, Sina Corporation made headlines by being the first Chinese business to list on the NASDAQ in New York using the 'Variable Interest Entity' ('VIE') structure, which uses contracts instead of shareholding to effect corporate control. For example, it is unclear whether any changes will be made to the 2001 Management Regulations on Technology Import-Export which specifies that a Chinese licensee of foreign technology owns any improvements it develops and prohibit a foreign licensor from restricting the licensee’s use such of improvements. Article 35 of the FIL states that foreign investment which harms or could harm national security is subject to a national security review and that a decision following such review is final and may not be reviewed again or appealed. Most of these businesses are listed offshore in more developed financial hubs like Hong Kong and New York. In addition, tell us how you addressed the disclosures in ASC 810-10- 50-9 related to the disclosure of the aggregation of VIEs. What Is a Variable Interest Entity - VIE? In July, 2019, S&P Global Ratings updated its risk assessment of Chinese companies using the VIE structure and concluded that the likelihood of regulatory action against such structures had diminished because of the passage of the FIL without the de facto control provision. The prospect of dividend payments for the medium term from many of these companies is cloudy at best. structure for its Chinese assets. They may also require companies that operate a so-called Variable Interest Entity -- a vehicle through … China VIEs: Recent Developments and Observations. Since around 1999, an incre The definition of foreign investment does not include the “de facto controller” concept which was in the 2015 Draft. 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