china variable interest entity

About the Editor. These companies use legal contracts to effectively own without owning shares in the underlying businesses; known as Variable Interest Entities (VIEs). 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. China relies on external capital to fund their continued development. Understanding the VIE Structure: necessary elements for success and the legal risks involved * - USA. 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. Most investors prefer not to deal with regulatory risk. Essentially, under a VIE, foreign companies or individuals obtain the rights and financial benefits of ownership through contractual arrangements with a PRC domestic company. 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. Alibaba is using a straightforward V.I.E. The variable interest entity ("VIE") has long been a popular structure for foreign parties to invest in sectors which are restricted by China’s industrial policy to foreign investment. We believe the vaguer terms of the FIL as compared to the 2015 Draft was a practical decision that benefits the Chinese economy and has made it less likely that VIEs will be prohibited by the government in the near future. The importance of such VIEs to China’s GDP continues to increase. The legislation was initially circulated for public consultation in January 2015 (“2015 Draft”). The most well-known and severe example is the 2010 dispute between Alibaba and Yahoo and Softbank. 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. Paul Gillis PhD CPA is Professor of Practice at Peking University's Guanghua School of Management. VIEs present risks to investors as the Chinese government could clampdown on this loophole. The China capital exchange controls would result in illiquid shares for foreign venture capitalists and other investors in an IPO exit in China. Variable Interest Entities: A Regulatory Work-Around All of China’s major Internet companies that list on U.S. exchanges use the VIE structure as a means of circumventing Chinese restrictions on their access to foreign capital. 51Job, Inc Entity Structure (2) Source: SEC filings. twitter @profgillis. China’s Variable Interest Entity Structure Explained in 100 and 1,300 words. The accounting definition of “variable interest entity” (VIE) is an entity in which an investor holds a controlling interest based on contractual arrangements … Investors in the United States offering will not be buying shares in Alibaba China. 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%. The China VIE Structure (Variable Interest Entities) is a contractual option. 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. 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 … 13 Oct 2011 by Stan. By Carol Huang. 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. 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. 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. 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 … China blinks on PCAOB; Kennedy Bill and MNCs; Sidebar. A legal loophole used by Enron allows these companies to bypass regulatory restrictions. 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. Renren and Baidu, for example, are variable interest entities. 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. The variable interest entity ("VIE") has long been a popular structure for foreign parties to invest in sectors which are restricted by China’s industrial policy to foreign investment. Alibaba is using a straightforward V.I.E. The simplest VIE structure includes a foreign holding company which is often an exempt limited company in the Cayman Islands, a China wholly foreign-owned enterprise (WFOE) and a China domestic company owned only by Chinese nationals. 0 Comment. … There are well over 100 companies in China with VIE structures in restricted or prohibited industries including BAT: Baidu, Alibaba and Tencent. 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. Enron was masking their countless loss-making operations by recording these entities off-balance sheet. It’s very hard to model out such a risk, in seemingly binary outcomes. The economic right to the interest of the entity, as well as the ability to vote on how the company should be run. In essence contractual arrangements such as those employed by 51Job and Alibaba would be considered equity ownership and mean these companies were breaching proposed regulations. 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. A 10-20% withholding tax isn’t a make-or-break for potential investments, as with American entities prior to the tax reform, but it does mean a greater margin of safety is required to justify owning the shares. January 2015 – China’s Ministry of Commerce (MOFCOM) drafted legislation preventing contractual obligations from dodging foreign-ownership laws. In many areas, however, it provides only high level guidance, vague in some cases, and lacks detailed implementation provisions. Many details need to be provided in supporting laws, regulations or by the State Council. VIEs are a major input in China’s global economy creating jobs, tax revenues, innovation, global expansion and other economic benefits. 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. Since around 1999, an incre By . China’s need for foreign direct investment renders a strict clampdown unlikely. Due Diligence. Some of the provisions in the FIL have been designed to reduce trade tensions with the United States. 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. This total includes 15 IPOs … Article 2 doesn’t define what constitutes an ‘indirect investment’. China VIE Structure 2020 Financial markets have a habit of perpetually refactoring economic exposures until regulation intervenes. The VIE structure is currently the only way that foreigners may have an economic interest in such businesses. All rights reserved. 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. The review system implemented under the FIL will likely apply to all foreign investments as defined in Article 2. 46 out of response to the Enron scandal, closing off what were ridiculous accounting loopholes. The definition of foreign investment does not include the “de facto controller” concept which was in the 2015 Draft. To mitigate the risk of a decision independent of the business interests of the holding company, the economic interest of the owner of the domestic company was aligned with the owners of the holding company by stock ownership in the Caymans entity. The Cayman Islands, where no tax-treaty with China occurs nor local may... 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