A Brief Analysis of Relevant Legal Issues of Overseas Direct Investment: Taking the Acquisition of a Certain Overseas Enterprise Project as an Example

Background introduction

Suppose the target company is a limited company registered in Hong Kong, with actual business operations in Hong Kong and a net profit of approximately 20 million yuan. It has not conducted business or established branches in the Chinese mainland (for the purposes of this article, excluding Hong Kong, Macao and Taiwan). Its shareholder (hereinafter referred to as "the seller") is a Chinese natural person. When establishing the target company, the obligation of foreign exchange registration was not fulfilled. The start-up capital is approximately 30 million yuan of foreign currency legally held by it abroad. The buyer is a domestic enterprise with sufficient RMB cash flow and intends to acquire 100% equity of the target company in cash.

The buyer's objective:To legally acquire high-quality overseas assets and hold them for the long term to balance their asset allocation both domestically and overseas. For the avoidance of ambiguity, the buyer has no listing plan based on the target company as a platform and will not establish a domestic WFOE based on the target company in the future.

The seller's purpose: To eventually receive RMB within the territory and use it for new investments and operations within the territory in the future.

Based on the background of the above assumptions, this paper hopes to explore the feasibility and potential risks of acquiring an overseas enterprise that failed to fulfill the obligation of foreign exchange registration at the time of establishment.

01.Concerns of both buyers and Sellers

(1) Buyer's Focus

1.The process of funds leaving the country and obtaining overseas equity assets is legal, and the time cost and complexity should be appropriately considered.

(I) From the perspective of compliance, Overseas Direct Investment (hereinafter referred to as "ODI") is an official and legal outbound capital route endorsed by the National Development and Reform Commission, the Ministry of Commerce, and the State Administration of Foreign Exchange. The flow of funds is fully traceable throughout the process and can avoid the legal risks of virtual currencies, underground banks, or split foreign exchange purchases. And after the future transaction is completed, the buyer's act of holding overseas equity will be legal for a long time.

(Ⅱ) In terms of time cost, when all the materials are complete, professional agencies have a high approval rate after optimizing the materials (such as feasibility reports and proof of the source of funds), and the process can be shortened to 1-2 months at the fastest.

(Ⅲ) In terms of the review content, ODI filing mainly involves formal review. Only legal opinions, equity penetration diagrams, and statements on the legality of the source of funds need to be submitted, without the need for substantive review of the transaction content.

2. Flexibility in the acquisition, subsequent holding and disposal of overseas equity assets this time.

(Ⅰ) Retain the structure of the Special Purpose Vehicle (SPV for short) in Hong Kong. When applying for an ODI, only the newly established company in Hong Kong can be disclosed, and there is no need to disclose the subsequent real transactions with the seller.

(Ⅱ) The buyer indirectly holds overseas assets through the newly established Hong Kong SPV. In the future, they can freely transfer them externally without paying capital gains tax. The final gains can be legally repatriated to the mainland if necessary.

(2) Seller's Concerns

1. Safe return of overseas funds

The seller needs to ensure that overseas funds can flow back to the domestic market through compliant channels to avoid having the bank's account frozen due to suspected foreign exchange evasion or money laundering. Therefore, the seller should handle the registration under Document No. 37 to set up a red-chip structure. After the transaction is completed, the seller can legally invest the transaction proceeds into a domestic WFOE or transfer the funds back to the domestic market through borrowing.

2. Risk isolation of historical foreign exchange registration flaws

As the seller did not complete the foreign exchange registration when establishing the target company, the possibility of re-completing the foreign exchange registration procedures for the historical establishment of the target company at present is extremely low, the process is cumbersome and costly, and there is a relatively high risk of being punished. In short, there is no completely compliant solution to the historical issue that the seller has not registered for foreign exchange. Moreover, for the compliance of subsequent transactions, the seller should handle the new registration under Document No. 37 to set up a red-chip structure and hold shares in the target company through Cayman Company to ensure that the funds can be legally remitted into the country in the future.

02 Feasible Solutions

(1) Basic Transaction Process

1. Seller's side

(Ⅰ) The seller registers under Document No. 37 and sets up a small red chip return framework: Seller -BVI-Cayman-HK-WFOE (the entire process takes approximately 3 to 4 months).

(Ⅱ) Cayman Company acquires the target company directly held by the seller.

The risk lies in that: As it involves equity transfer, the seller is required to file tax returns according to the regulations of Hong Kong. Since the seller is a Chinese natural person, there is a certain probability that the Inland Revenue Department of Hong Kong will report the transaction situation to the domestic tax authorities. If the domestic tax bureau becomes aware of it, it may synchronize the information to the State Administration of Foreign Exchange while levying taxes. The current situation where Chinese natural person shareholders hold equity in Hong Kong companies without completing the foreign exchange registration may be noticed and punished by the State Administration of Foreign Exchange.

2. Buyer's side

(Ⅰ) The buyer establishes a new SPV in Hong Kong through ODI, and the funds are transferred out of the country to Hong Kong.

(Ⅱ) Then, use a Hong Kong SPV to acquire the equity of the target company from Cayman Company. [1]

The purpose of the buyer setting up a Hong Kong SPV is that when the buyer transfers the equity of the target company to the outside in the future, it does not need to pay the capital gains tax in Hong Kong.

3. The subsequent transaction proceeds will be returned to the domestic market

After the transaction is completed, Cayman Company receives the transaction price, and Cayman Company can invest the transaction price in WFOE. Since the process of investing in a WFOE is overly long, it is also possible to consider repatriating the funds to the domestic market by lending to the seller.

(2) The main filing and registration procedures are as follows

1. Filing of overseas investment projects with the National Development and Reform Commission

Article 4 of the "Measures for the Administration of Overseas Investment by Enterprises" stipulates: "When an investment entity conducts overseas investment, it shall go through the procedures for approval and filing of overseas investment projects, report relevant information, and cooperate with supervision and inspection." Article 14 stipulates: "The scope of record-filing management is non-sensitive projects directly carried out by the investment entity, that is, non-sensitive projects involving assets, rights and interests directly invested by the investment entity or providing financing or guarantees." For projects subject to the filing management system, if the investment entity is a centrally-administered enterprise (including centrally-administered financial enterprises and enterprises directly managed by The State Council or its affiliated institutions, hereinafter the same), the filing authority is the National Development and Reform Commission. If the investment entity is a local enterprise and the Chinese investment amount is 300 million US dollars or more, the filing authority is the National Development and Reform Commission. If the investment entity is a local enterprise and the Chinese investment amount is less than 300 million US dollars, the filing authority is the development and reform department of the provincial government where the investment entity is registered.

2. Filed with the competent department of commerce

Article 6 of the "Measures for the Administration of Overseas Investment" stipulates: "The Ministry of Commerce and the provincial-level commerce authorities shall, in accordance with the different circumstances of enterprises' overseas investment, respectively implement the filing and approval management." For enterprises' overseas investment involving sensitive countries and regions and sensitive industries, approval management shall be implemented. The overseas investment of enterprises in other circumstances shall be subject to filing management. Article 9 stipulates: "For overseas investments that fall under the circumstances of filing, central enterprises shall file with the Ministry of Commerce." Local enterprises shall file with the provincial-level competent department of commerce where they are located.

3. Foreign exchange registration process

According to the "Notice of the State Administration of Foreign Exchange on Further Simplifying and Improving Foreign Exchange Administration Policies for Direct Investment" (Hui Fa [2015] No. 13) issued by the State Administration of Foreign Exchange, as of June 1, 2015, the foreign exchange registration for domestic enterprises' overseas direct investment has been changed to the model of "bank handling and foreign exchange supervision". Domestic enterprises can independently choose the banks at their place of registration to handle foreign exchange registration for direct investment, account opening, fund conversion and other business. The banks will complete the relevant foreign exchange registration procedures for the enterprises' overseas direct investment on behalf of the national foreign exchange administrative department.

(3) Advantages

It complies with China's foreign exchange management regulations and does not affect the buyer's future transfer of dividends and other funds of the target company back to the domestic market after the transaction is completed.

(4) Points to Note

The situation where the existing shareholders of the target company have not completed foreign exchange registration may be noticed by the foreign exchange regulatory authorities, and there is a risk of being punished. [2]

2. The filing process with the two committees and the foreign exchange registration take a relatively long time, usually 2 to 3 months.

3. If the seller needs overseas financing to set up the return framework and handle the registration under Document No. 37, it should be taken into account in the process.

4. There are certain requirements for the legality and compliance of the buyer's source of funds and the business they operate. A lawyer is needed to conduct due diligence and issue an opinion.

5. Depending on the actual processing location, the overall process is conservatively estimated to take about 4 to 6 months.

Footnote:

[1] If the buyer directly acquires the equity of the target company through ODI, it involves the issue of the seller paying taxes in China.

[2] Article 39 of the Regulations on Foreign Exchange Administration stipulates that any act of evading foreign exchange, such as transferring domestic foreign exchange abroad in violation of regulations or transferring domestic capital abroad by deceptive means, shall be ordered by the foreign exchange administration authority to return the foreign exchange within a prescribed time limit and be subject to a fine of not more than 30% of the amount evaded. If the circumstances are serious, a fine of not less than 30% but not more than the equivalent amount of the evaded foreign exchange shall be imposed. If a crime is constituted, criminal responsibility shall be pursued in accordance with the law.