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. It is not known if national security reviews will be expanded to sectors other than those currently specified. CSRC VIE Research Report Leaked to 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. Importantly, Article 4 and Article 28 clarify that the Negative List will be released by or with the approval of the State Council. The financial statements of the Cayman holding company are consolidated with the WFOE and VIE which makes the holding company financeable. By not getting explicitly mentioned, the VIE structure have been left out of the spotlight for regulatory scrutiny, albeit not given the green light on their activities. … China Accounting Blog does an excellent job explaining a typical VIE in its post, Explaining VIE Structures, which I urge you to read now. 2014 Market Reformer of the Year. They may also require companies that operate a so-called Variable Interest Entity -- a vehicle through … 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. 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 … Financial markets have a habit of perpetually refactoring economic exposures until regulation intervenes. All rights reserved. Much of this would be sitting in US pension funds and Australian superannuation funds. 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 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. 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. When it comes to VIEs and related contracts, the distinction is important. 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. The 40-item restricted/prohibited industry list was much shorter than previous versions but did not ease the restrictions in any material way. VIEs were of questionable validity under PRC law and drafts of the new … Similarly, the withholding tax is acting as a deterrent to paying distributions out of China and into the pockets of shareholders. In many areas, however, it provides only high level guidance, vague in some cases, and lacks detailed implementation provisions. Variable Interest Entities (VIE) have been used to control businesses in China in industries in which there are foreign ownership restrictions. The primary beneficiary of … The operating … 21 Cardozo J. Int'l & Comp. The FIL has several broad provisions for promoting foreign investment by creating a more equal (national treatment) legal framework for foreign investors and to promote and protect foreign investment. The scope of the definition of foreign investment and the national security review provisions, among others, need clarification. Variable interest entity structure in China * Related international articles. Charles Comey, Paul McKenzie, Sherry Yin and Michelle Yuan . 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. China VIE Structure 2020 The economic right to the interest of the entity, as well as the ability to vote on how the company should be run. It establishes principles to create a more equal legal framework for foreign investors and to promote and protect foreign investment in China. The Chinese domestic company obtains the license to operate in the prohibited or restricted industry in China. I’ll email when new articles are published. A note on the variable interest entity (VIE) structure that is commonly used for Chinese companies. 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. Take “variable interest entities” (VIEs), a kind of corporate architecture used mainly by China’s tech firms, including two superstars, Alibaba and Tencent. The great majority of VIE holding companies are domiciled in the Cayman Islands, where no tax-treaty with China occurs. Awards. 2015 The Accountant Power 50. There have been other actions taken by various governmental authorities that recognize the existence of the VIE structure in China. 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. 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. China law, business and economics commentary . VIEs are corporate structures usually set up to get around China’s not allowing WFOEs to participate in China’s internet sector. 46 out of response to the Enron scandal, closing off what were ridiculous accounting loopholes. The SEC filings for recent IPOs contain the current state-of-the-art set of control agreements. gillis@gsm.pku.edu.cn. The FIL is a positive step in support of foreign investment in China. FASB’s 2003 interpretation (yet to be updated since), cleaned up this oversight and required the consolidation of financial reporting when: An entity can be controlled through voting rights or similar rights, There is an obligation to absorb losses of entity, There is right to receive residual returns of entity. Article 2 defines foreign investment as investment activities, directly or indirectly, by foreign individuals, corporations, or other organizations in China, including the establishment of foreign-invested enterprises (“FIEs“), acquisition of shares, equity, assets and other similar interests in China enterprises, investment in new projects in China independently or jointly with other investors, and other forms of foreign investment as specified in laws, regulations or by the State Council. 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 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. Variable interest entity (VIE) Related Content. For illustrative purposes I’ve excluded the other entities 51Job owns (Lagou Information Limited, 51net HR and 51Net Beijing) focusing on their main operations. twitter @profgillis. 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. 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. Many details need to be provided in supporting laws, regulations or by the State Council. This total includes 15 IPOs … 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”. 13 Oct 2011 by Stan. Articles 22 and 23 could reduce forced technology transfers in JVs and cause faster government action to amend the patent and other IPR laws. China could punitively restrict the VIE structure, yes. 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. VIEs present risks to investors as the Chinese government could clampdown on this loophole. 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. These companies use legal contracts to effectively own without owning shares in the underlying businesses; known as Variable Interest Entities (VIEs). The most well-known and severe example is the 2010 dispute between Alibaba and Yahoo and Softbank. That’s it. It’s very hard to model out such a risk, in seemingly binary outcomes. 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. Article 2 doesn’t define what constitutes an ‘indirect investment’. 2016] CHINA’S VARIABLE INTEREST ENTITY PROBLEM 543 saw the value of their shares plummet when it came to light that the company’s Chinese VIE had issued a $16.4 million bond off the books and engaged in fraudulent retail practices.19 In both the Gigamedia and FAB Universal incidents, the U.S. investors were unable to en-force their rights in Chinese courts due to the illegal status of the VIE … China’s antitrust watchdog is seeking feedback on a raft of regulations that establish a framework for curbing anti-competitive behavior such as colluding on sharing sensitive consumer data, alliances that squeeze out smaller rivals and subsidizing services at below cost to eliminate competitors. As indicated above, all of the 11 Chinese IPOs in the US in the 3 months ending January 31, 2020 were incorporated in the Cayman Islands. An FIE is an enterprise incorporated under Chinese laws within China with all or part of its investment from a foreign investor. Investors in the United States offering will not be buying shares in Alibaba China. A VIE is a company that is included in consolidated financial statements because it is controlled through contracts, rather than the more conventional control that is obtained through ownership. Almost all investor issues relating to VIEs have been when the shareholders of the domestic company fail to comply with the controlling contracts rather than from actions taken by Chinese regulators. China law, business and economics commentary . Furthermore, legislation provides scope for withholding tax to be paid on the capital gain for investors, similarly at 10 or 20%, as the Chinese government considers capital gains as income sourced within the PRC. exchanges relying heavily on a corporate structure called a variable interest entity (VIE). About the Editor. Understanding the VIE Structure: necessary elements for success and the legal risks involved * - USA. 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 … This business structure, called a variable-interest entity, became common among Chinese companies because Beijing restricts foreign investment in certain sectors, such as the internet. Investors in Chinese companies soon encounter an obscure accounting term –the variable interest entity or VIE. 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