1. law, govt and politics
2. legal issues
3. legislation
4. tax laws

How to Structure Your
Business in China
Moderator:
Angella Castille – Baker & Daniels LLP
Panelists:
Matt Rogers – Deloitte Tax LLP
Bing Wang – Baker & Daniels LLP
Jennifer Zhang- Deloitte Tax LLP
Agenda
•
•
•
•
•
General Considerations
Entity Selection
Common Structures
Financing Strategies
Repatriation Strategies
China Entry Strategy Development
Business Strategy
Tax/Finance
Legal
• International legal •
entity structure
• Business
•
scope/Trade
privileges
•
• U.S. export control
• Intellectual property
protection
•
• China labor law
•
• Foreign Corrupt
Practices Act
• Impact of WTO
• Land use rights
•
• Intercompany
•
agreements
•
International tax
structuring
Exit strategies
(M&A, IPO)
Capital requirements
(LT/ST) Debt-toequity ratio
Foreign exchange
control
Repatriation
strategies: license,
mgt. fee, loan,
dividends
Reinvestment
Tax considerations:
Import duties &
customs
• Transfer pricing
• Establish China
accounting
procedures, etc.
• Statutory audits
• Business Objectives
• Internal assessment
• Scope of business options • High-level roadmap
• Market Analysis
• ROI
Real Estate
• Choose economic zone •
• Infrastructure (telecom •
and utilities)
•
• Real estate market
• Development incentives •
• Timing
•
• Labor access
• Logistic needs
• Proximity to contract
management
• Attractiveness to
•
qualified HR
•
• Availability of local
•
incentives (tax, cash,
lease rates, grants)
•
• Use of capital-intensive
equipment
•
• Park & zone selection
• Location, location,
•
location
Human
Capital
Skill sets required
•
Number of staff required
•
Recruitment/
selection
•
Expatriate, local talent
requirements
•
Total rewards
- Compensation
•
- Benefits
- Equity/stock options
Training and development
Performance management•
On-boarding process and
implementation labor
Legal and tax
•
compliance
Establish China HR policy
and manual
Expatriate needs &
related tax issues
Business
Processes
Schedule field
service engineers
Interface with
customers
Manage invoices
and receivables
Manage logistics
networks
Services product
offerings, price
model, & channel
development
‘Free’ warranty vs.
‘For fee’ service
models
Internal Controls
Tech Support
• Tech support
tools
• Network security
• Data security\
• Application
security
• ERP approval
• ERP customization
General Considerations for China Investment
● Business objectives / scope
US Parent
(US)
● Industrial specialties and products
● Site selection issues
● Overall business model
Intermediate
Holding Co.
(Offshore)
● Entity selection
● IP ownership and protection
● Financing strategy
● International structure
FIE
(China)
Bottom-up Planning Strategy
● Foreign exchange control issues
● Unfamiliar tax issues (business tax,
VAT, transfer pricing, etc.)
● Repatriation strategy
● Exit strategy
Entity Selection for China Investment
● Business objectives drive decision
● Various Forms of Investment
– Representative office (“RO”)
– Equity Joint Venture (“EJV”) and Cooperative
Joint Venture (“CJV”)
– Wholly foreign owned enterprise (“WFOE”)
– Partnership
– Joint stock company
Common Structures for China Investment
USCo
USCo
USCo
US LLC
Offshore
HoldCo
USCo
USCo
USCo
Offshore
HoldCo
Offshore
HoldCo
US
China
SPV
China
China
OpCo
China
OpCo
China
OpCo
China
HoldCo
China
OpCo
China
Branch
China
OpCo
Direct Investment
Considerations:
USCo
China
OpCo
● 10% dividend withholding tax
● Disposition of shares in China
OpCo subject to 10% Chinese
withholding tax on capital gains
● Change in shareholder requires
notification and approval of
Chinese authorities
Invest through an Offshore HoldCo
Considerations:
USCo
•
Take advantage of treaty benefits
− 5% lower dividend withholding tax for
certain jurisdictions
•
Offshore
HoldCo
China
OpCo
Provides flexibility of exiting at the
Offshore HoldCo level:
− Shares in HoldCo may be transferred
without Chinese government approvals
− Shares in HoldCo may be transferred
without Chinese withholding tax on capital
gain
•
Beware of the new Chinese tax
residency concept and General AntiAvoidance Rule
•
U.S. Subpart F Planning
Invest through a Chinese Holding Company
Considerations:
USCo
•
Benefits
− Dividend from China OpCo to CHC exempt
from tax
− CHC can provide shared services to at
least 10% owned subsidiaries
− CHC has “super” borrowing capacity (4:1 or
6:1)
Offshore
HoldCo
•
− Significant investment (>= $30M)
− Double reserve
− Ability to repatriate depends on CHC’s
overall P&L
− Non-deductible investment expenses
China
HoldCo
10%
90%
•
China
OpCo
Downsides
Suggest mixed holding structure
− CHC owning 10% and Offshore HoldCo
owning 90%
•
US Subpart F planning
Comparison of Certain Chinese DTAs
Non-Treaty
Rate
Hong Kong
Singapore
Barbados
Mauritius
Dividend
10%
5% (if recipient
company holds at
least 25% of the
capital of the
payer company);
or 10% (in all other
cases)
5% (if recipient
company holds at
least 25% of the
capital of the
payer company);
or 10% (in all other
cases)
5%
5%
Interest
10%
Exempt (if interest
is received by the
government of
contracting party
or recognized
financial
institutions); or 7%
(in all other cases)
7% (if interest is
received by a bank
or financial
institution); or 10%
(in all other cases)
10%
10%
Royalties
10%
7%
6% for royalty on
leases for
industrial,
commercial or
scientific
equipment; 10%
(in all other cases)
10%
10%
Comparison of Certain Chinese DTAs
Capital Gains
Non-Treaty
Rate
Hong Kong
Singapore
Barbados
Mauritius
Property other than property
listed below
10%
Not taxable in PRC;
taxable only in
Hong Kong if the
source is in HK and
revenue in nature
Arising in PRC
may be taxed in
PRC
Taxable only
in Barbados
Taxable only
in Mauritius
Immovable property in PRC
and movable property business property or
property of fixed base (PRC
property)
10%
May be taxed in
PRC
May be taxed in
PRC
May be taxed
in PRC
May be
taxed in
PRC
Ships, Aircraft or Land
Transport Vehicles; or
related movable property
10%
Not taxable in PRC;
taxable only in HK if
the source is in
Hong Kong and
revenue in nature
Taxable only in
Singapore
Taxable only
in Barbados
Taxable only
in Mauritius
Shares in a company that
holds principally immovable
property in other jurisdiction
10%
May be taxed in
PRC
May be taxed in
PRC
Taxable only
in Barbados
May be
taxed in
PRC
Shares in a company
resident in other jurisdiction,
representing a 25% or more
interest (PRC companies)
10%
May be taxed in
PRC
May be taxed in
PRC
May be
taxed in
PRC
Comparison of Certain HoldCo Jurisdictions
HoldCo
Jurisdictions
Hong Kong
Singapore
Barbados
Mauritius
Foreign Dividend
Income at HoldCo
Exempt
Effectively
exempt
1%-2.5%,
effectively
1%
Effective
exempt
Outbound Dividend
WHT at HoldCo
Exempt
Exempt
Exempt
Exempt
Income Tax Rate
17.5%
18%
1%-2.5%
0-3%
effectively
Treaty Network
Limited
Extensive
Limited
Extensive
Common Legal Considerations for
Foreign HoldCos
• Investor and board meeting requirements
• Residency requirements for officers and
directors
• Fees for establishment and maintenance of
entity
• Requirements for annual audits and filings
• Expenses and time needed to dissolve
foreign HoldCo
• Interface of tax treaties both upstream and
downstream
Financing Strategies
• Minimum Capital Requirement
– N/A for a Representative Office
– RMB30,000 for a Limited Liability Company under Company Law
– Depend on the relevant foreign investment related regulations,
e.g. $30M for a Chinese Holding Company
– Should be supported by Business Plan for approval purpose
• Debt/Equity Ratios
– Borrowing capacity is generally limited to the difference between
total investment and registered capital
Total Investment (USD)
Minimum Registered Capital (USD)
0 – 3,000,000
70% of total investment
3,000,001 – 10,000,000
Higher of 2.1 million or 50% of total investment
10,000,001 – 30,000,000
Higher of 5 million or 40% of total investment
Over 30,000,000
Higher of 12 million or 33.3% of total investment
Repatriation Strategies: Below-the-Line
• Dividend Distribution
– Declared only when profitable and with sufficient cash
– Once a year after year-end audit and annual income tax filing
– After certain reserve contributions (e.g. 10% of after-tax profit, up
to 50% of registered capital)
– Documentation requirements
– 10% withholding tax (or lower under treaty provision) on dividend
to non-China residents
• Loan Repayment
– No withholding tax on payment of loan principal
– Proper loan documentation and registration
– Need to observe proper debt to equity ratio
• Capital Reduction
– Very difficult to do and requires pre-approval
Repatriation Strategies: Above-the-Line
• Interest Payments
– 10% withholding tax (or lower under treaty provision) based on
accrual
– Thin capitalization rule
• Royalty Payments
– 10% withholding tax (or lower under treaty provision)
– 5% business tax may be exempt for technology transfer
• Consulting Services Fee Payments
– In general, services entirely provided outside of China are exempted
from China taxes
– PE exposure / split of onshore vs. offshore services
– Watch out for foreign currency remittance issues
Repatriation Strategies
• All of the above-the-line repatriation strategies
should meet the transfer pricing standards of
China and the recipient country where applicable
• All of the repatriation payments need to be in
compliance with China foreign exchange control
requirements and obtain proper approvals
Questions?
Break
9:45 a.m. - 10:00 a.m.
China Legislative Changes
and
How Changes Will Affect U.S
Companies Doing Business in
China
Panelists:
Greg Coy - Deloitte & Touche LLP
Robert Kurek – KeyBank
David Renta – KeyBank
Jennifer Zhang – Deloitte Tax LLP
2008: Economic Update
David Renta, CTP
Indianapolis
February 12, 2008
Agenda
• Economic Updates
– US
– China
• How Can I Manage Currency Exposure ?
Historical 3M L & Fed Funds Target
Jan 1998 - present
7.00%
6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
3M LIBOR
Jan-03
Jan-04
Fed Funds Target
Jan-05
Jan-06
Jan-07
Jan-08
Source:
Bloomberg
Backdrop
Source Dervis LLC
Effect of US Rate Cuts on Reserve Holdings
Source DBS Research
Diversification of Reserves. More to Come ???
Source DBS Research
The Need for Monetary Reform…
Source HSBC Research
GDP Growth…
Source DBS Research
US: Current Account Problems
Source DBS Research
Current Account
Source DBS Research
Asia: Where is growth coming from ?
Source DBS Research
Passing the Baton…
Source DBS Research
Export Driven ?
Source DBS Research
Eurozone Trade Deficit
Source DBS Research
USD Depreciation: Cui Bono ? ?
Source DBS Research
Inflation…Reading the Tea Leaves
Source DBS Research
Tea Leaves… (cont)
Source DBS Research
Deposit Divergence.. Why ??
Source DBS Research
Answer: Negative Real Rates……
Inflation and The Central Bankers’ Balancing Act
Source DBS Research
Inflation
(Cont.)
Source GS Research
Fighting Inflation… The Monetary Tool Chest
Source DBS Research
Fighting Inflation… The Monetary Tool Chest
Source GS Research
Source GS Research
China & Dollar Reserves; They’re Huge, so What’s the Problem ?
•
China’s Foreign Reserves topped $1.53 T by year end 2007, up $462 B in one
year
China Investment Company
- Size of Coffers: At Least $ 200B
- Recent Investments
-$3 B in Blackstone Group
-$5 B in Morgan Stanley
Food For Thought: China could still
buy Ford, GM, Volkswagen & Honda
and still have money left over for Ice
Cream
Source THE NEW YORKER
Thinking Ahead : Asset/ Liability Management
SourceDervis LLC
RMB: Where Does It Go From Here?
48
How Can I Hedge ?
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
NON -DELIVERABLE FORWARD
A Non-Deliverable Forward (NDF) is a product that has evolved in order to provide the market a hedging mechanism for non-convertible
currencies. That is, countries whose currencies do not have forward capabilities or are restricted to certain types of transactions (invoicing)
and/or counterparts (non-financial institutions). It is an offshore way of hedging an onshore exposure. Restrictions are determined by
individual countries and differ on a case-by-case basis. (see appendix 1)
NDF’s are legally binding contracts that require cash (US Dollar) settlement instead of physical delivery of currencies. At maturity, the
difference between the contract rate and the prevailing spot rate is settled in a convertible currency. THERE IS NO EXCHANGE OF
PRINCIPLE. It is important to emphasize, when doing an NDF, the corporation will also need to enter into a separate spot transaction in
order to take physical delivery of the currency at the time of the NDF’s maturity. It is equally important to note that the spot transaction rate
will most likely differ from the official central bank fixing rate that the NDF contract was settled against because the fixing rate is set during
that central bank’s time zone. This does create an exposure for the corporation.
An NDF is not a perfect hedge but it offers the corporation a benchmark to work against. The following are the specific advantages and
disadvantages of an NDF contract.
NDF ADVANTAGES
No sovereign/convertibility risk.
No local balance sheet impact, that is no onshore balance sheet/tax consequences.
No dependence on local markets except for fixing.
Unlike spot markets, corporations can usually deal on both sides of the market.
NDF DISADVANTAGES
Corporation is “locked” into a contract.
Limited liquidity in this specialized product.
Not a perfect hedge against exposure.
Limited liquidity dictates minimum size requirements (usually $250,000) for pricing.
The key components of an NDF are as follows:
Spot:
The base for contract rate.
Forward Equivalent:
Typical to a convertible currencies forward rate in that it is determined largely
by interest rate differentials but amount marketability may lead to deeper price
discounting.
Date/Time of Setting:
NDF’s are “valued” based on a specific setting. Most settings are 2 days prior
to contract value and based on a central banks fixing at a specific fixing time.
Contract Value:
Exposure:
The day of cash settlement.
The time between the setting of the NDF value rate and when the corporation
covers the “real” spot exposure.
Managing Currency Risk
Non Deliverable Forwards
PBoC Fixing Page
How Can I Hedge (cont.)
•
Scenario:
•
The NDF Contract:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Corporation needs to cover 3-month exposure in the Chinese Yuan.
Corporation needs to buy CNY 10 million. Today is February 12, 2008
Spot rate =7.1835
Fwd Equivalent = -.01358
Contract Rate = 71835 - .1358 = 7.0477,
Settlement Date = Apr. 10, 2008, 5 PM Hong Kong time.
Central bank fixing posted on Reuters page SAEC.
Value Date = April 09, 2008
Corporation is “in the money”
Chinese Central Bank fixing = 7.0177 based on page SAEC 5 PM Hong Kong Time.
Contract settle = CNY 10 million/7.0177
Contract value = CNY 10 million/7.0477
Corporation receives =
= $ 1,424,968
=- $1,418,902
$ 6,066
B. Corporation is “out of the money”
Chinese Central Bank fixing = 7.0677 based on page SAEC 5 PM Hong Kong Time.
Contract value = CNY 10 million/7.0677 =- $1,414,887
Contract settle = CNY 10 million/7.0477 = $1,418,902
Corporation pays =
$ 6,066
Recall, regardless of the scenario, the corporation still needs to do a separate spot deal that will allow them to take physical
delivery of the currency. Any exposure involved with this transaction may be prevented by doing the spot component of the
deal early. Remember, most spot transactions in the non-convertible currencies are only on the US Dollar bid side . CNY
buyers and any sellers of non-convertible currencies need to take care of their business ONSHORE.
While NDF’s are legally binding contracts, there are ways to offset an NDF purchase. Should the corporation need to get out
of the deal, they would need to sell the offsetting contract. This would lock them into a spread. Should the corporation need to
change the date, the same action would occur but they would then purchase a new contract for the correct date. AT NO TIME
ARE NDF’s CANCELED.
In regard to pricing, orders may be the only way to execute an NDF. This would be the case for both extremely small and/or
extremely large deals. Remember, the market for this specialized product is highly illiquid. Deals are much easier to transact
during the morning. Prices may change quickly and dramatically.
CHINESE FINANICAL
ACCOUNTING & REPORTING
CHANGES
Greg Coy, Partner
Deloitte & Touche LLP
February 12, 2008
Agenda
• Background
• Overview of Applicable Standards
• Highlights of New Chinese Accounting
Standards
• Timeline for Convergence
• Major Changes from PRC GAAP
• Key Differences from IFRS
• Key US GAAP Differences
• Key Impact of Applying ASBEs
53
Copyright © 2008 Deloitte Development LLC. All rights reserved.
Background
• China’s accession into WTO
• Need to conform accounting/reporting
principles to encourage confidence in
China’s capital markets
• International migration toward IFRS
54
Copyright © 2008 Deloitte Development LLC. All rights reserved.
Overview of Applicable Standards
• People’s Republic of China GAAP (“PRC GAAP”)
• Accounting Standards for Business Enterprise
(“ASBEs” or “New Chinese GAAP”)
• International Financial Reporting Standards (“IFRS”)
• US Generally Accepted Accounting Principles (“US
GAAP”)
55
Copyright © 2008 Deloitte Development LLC. All rights reserved.
Highlights of New Chinese Accounting
Standards (“ASBEs”)
• Approved by the Ministry of Finance in
February 2006
• 38 Standards - Closely aligned with IFRS
• Changes both accounting and disclosure
standards
56
Copyright © 2008 Deloitte Development LLC. All rights reserved.
Timeline for Convergence
• February 2006 - Approved by the Ministry of
Finance
• January 1, 2007 - Mandatory for Chinese listed
companies
• 2008 – Central-level state owned enterprises
(“SOEs”) required to comply
• 2009 – Large and midscale enterprises
expected to comply
57
Copyright © 2008 Deloitte Development LLC. All rights reserved.
Major Changes from PRC GAAP
• Share Based Payments - Expense
• Business Combinations - Acquisition (fair
value) method
• Goodwill and Indefinite Lived Assets - No
longer amortized
• LIFO Method - Prohibited
• Non-Monetary Asset-Related Grants –
Treated as deferred income and recognized
over the life of the asset
• Development Costs - May be capitalized
58
Copyright © 2008 Deloitte Development LLC. All rights reserved.
Major Changes from PRC GAAP
(cont.)
• Borrowing Costs – Should generally be capitalized
• Investment Property - May be measured at fair value
• Employee Related Benefits - Accrue for certain
employee related benefits when service is provided
• Non-Monetary Transactions - Measured at fair value
if commercial substance
• Income Taxes - Tax effect accounting method should
be followed to account for temporary differences
• Equity/Liability Instruments - An instrument with both
equity and liability elements should be split and
accounted for separately
59
Copyright © 2008 Deloitte Development LLC. All rights reserved.
Key Differences from IFRS
• ASBE 4 and 6 – Allow only for the cost model for
measuring fixed assets and intangible assets
• ASBE 2 – Only allows for the equity method of
accounting for jointly controlled entities
• ASBE 8 – Prohibits the reversal of all impairment
losses
• ASBEs require expenses to be analyzed by function in
the income statement
• ASBEs require the direct method for cash flow
statements
• ASBEs require gross presentation for government
grants related to assets
60
Copyright © 2008 Deloitte Development LLC. All rights reserved.
Key US GAAP Differences
General
• US GAAP is generally more “rule-specific” than IFRS and ASBEs
• SEC Regulations may dictate form and content of financial
statement presentation
Specific
• LIFO inventory method is permitted for US GAAP
• Certain specific rules for revenue recognition
• Business combinations – treatment of contingent consideration
• Business combinations – treatment of fair value of net assets over
cost of acquisition
61
Copyright © 2008 Deloitte Development LLC. All rights reserved.
Key Impacts of Applying ASBEs
• Potential impact on share prices and credit
ratings
• Impact on key performance indicators
• Increased volatility in earnings
• Potential need for improved systems
• Training
62
Copyright © 2008 Deloitte Development LLC. All rights reserved.
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China Legislative Changes
- Facing the New Enterprise Income Tax Era
Jennifer Zhang
Indianapolis
February 12, 2008
Agenda
•
•
•
•
•
Background
Key Changes
Transitional Rules
Open Issues
Planning Opportunities
Background
• The new EIT law was enacted on March 16, 2007 and
effective from January 1, 2008
• The regulations, which provide for the detailed
implementation rules, were issued on December 11,
2007 and also became effective from January 1, 2008:
−
−
−
−
Basic framework and guidance only
Flexibility for policy change in the future
Reliance on notices to manage details
Provide some directional guidance but many unanswered
issues
• One of the key objectives is to unify the dual tax
system
Key Changes – Tax Rates
• 25% standard rate
– Effective rate for many FIEs would be increased due
to the elimination of the tax holidays and other
incentives
• 15% for high-tech companies
• 20% for small and thin-profit enterprises
Key Changes – Tax Rates (cont’d)
• 20% withholding tax (WHT) rate, reduced
to 10%
– Dividend payment
• 10% WHT for dividend payment to non-resident
• Inter-company dividend payment between two Chinese tax resident
corporations is generally tax free
– 12 months or longer holding period for publicly traded shares
• Timing for WHT based on when the dividend payment is declared
• Potential impact on foreign holding company in a country without tax
treaty protection
Key Changes – Tax Residency
• New “Tax Resident” Test
– “Effective management and control” test, as an
alternative to the current “place of incorporation” test
• Concept of “Tax Resident"
– Corporations are taxed differently based on their tax
residency status
– Effective Management is a key factor
• Substantial and “overall” management and control
–
–
–
–
Enterprise’s manufacturing and business operation,
Personnel,
Finance,
Properties and others
Key Changes – Tax Incentives
• Establish a new system of preferential tax
treatments
– The preferential tax treatments granted primarily to
encouraged industries and activities
– Most tax incentives currently made available
exclusively to FIEs removed
Key Changes – Tax Incentives (cont’d)
Comparison of Old and New Incentives (1)
Current Law
New Law
Tax holiday for manufacturing FIEs
Removed
(two-year exemption followed by threeyear half reduction from the first
profitable year)
Extended tax holiday for export
oriented FIEs
Removed
15%/24% reduced rates applicable to
FIEs in the specially designated
economic zones
Removed
15% tax rate applicable to high-tech
enterprises located in the state-level
high-tech zones
Expanded to nationwide
Key Changes – Tax Incentives (cont’d)
Comparison of Old and New Incentives (2)
Current Law
New Law
N/A
Bonus deduction for venture capital
engaged in start-up investments
N/A
Tax credit for investment in
equipment for environmental
friendly, energy-saving and
production safety projects
Tax incentives for investment in
infrastructure, agriculture,
forestry, livestock farming and
fishing
Preserved
Tax incentives for investments
in the central and western
regions
Retained
Key Changes – Tax Incentives (cont’d)
Comparison of Old and New Incentives (3)
Current Law
Tax refund on profits
reinvestments
New Law
No longer available
Key Changes – Tax Incentives (cont’d)
• Encouraged Projects
– May enjoy 3-3 tax holiday
– Infrastructure project and environment-friendly and
energy-saving project
• Small and Thin-Profit Enterprises
– May enjoy 20% tax rate
– Not engaging in restricted &prohibited industries, and
– For industrial co., taxable income ≤ RMB300,000; staff
≤100; assets ≤ RMB30,000,000, or
– For other co., taxable income ≤ RMB300,000; staff
≤80; assets ≤ RMB10,000,000
Key Changes – Tax Incentives (cont’d)
• High& New Technology (High-tech) Enterprises
– 15% tax rate
– No geographic restriction on location of the company
– Conditions:
– "Core" independent IP ownership requirement; and
– Requirement in the business scope, the percentage
of R&D expenses, high-tech product/service,
percentage of R&D staff, etc.
– The detailed rules of percentage required are to be
defined
– "Core" independent IP ownership is not defined
Key Changes – Tax Incentives (cont’d)
• Super-deduction for R&D expenses
– Amount of deduction
• 50% additional deduction/ amortization of the eligible
cost on eligible R&D activities
• The rules of deductible qualifying expenses and
qualifying activities are removed
– No IP ownership is required
Key Changes – Tax Avoidance
• Enhancing and strengthening anti-avoidance
rules
– Controlled Foreign Corporation (CFC) rules are
introduced
– Thin capitalization rules on related-party loans are
introduced
– General anti-avoidance rule (GAAR) is written into the
law for the first time
– Continued focus on transfer pricing (TP)
Key Changes – Other Issues
• Corporate Reorganization
– Article 75 suggests reorganization be conducted at
“transaction price” subject to exceptions to be prescribed
by SAT/MOF
– Government will likely continue some tax-free
reorganizations by issuing tax notice
– Cross-border transfer of shares to foreign entities may not
be tax-free any more
• Circular no. 207 may be phased out soon
• Transfer to a foreign entity at cost has to be done immediately
– Limitation on goodwill deduction
• Expenditures for purchasing goodwill cannot be deducted/amortized
until the transfer of entire assets or upon liquidation
Transitional Rules
Current Law
FIEs which have started their tax
holiday before the effective date of
the new law (Jan. 1, 2008)
New Law
Continue to enjoy the remaining
holiday
FIEs
Tax holiday starts from the
effective date of the new law
- Which are established before the
announcement date of the new law
(March 16, 2007);
- Would otherwise be qualified for the
tax holiday under the old law; and
- Have not started the holiday before
the effective date of the new law
Transitional Rules (cont’d)
• Enterprises subject to 15% tax rate: ratcheting to 18%, 20%,
22%, 24% and 25% in five years starting from 2008
• Enterprises subject to 24% tax rate: 25% in 2008
25%
2012
24%
25%
25%
24%
22%
20%
18%
15%
Series1
2007
2008
2009
2010
2011
2012
15%
18%
20%
22%
24%
25%
15%-25%
2007
2008 and afterwards
24%-25%
Transitional Rules (cont’d)
• Grandfathering of Tax Incentives (Guo Fa[2007] No.39)
–
–
–
The business registration completed prior to March 16, 2007; and
Fall within the scope of tax incentives eligible for the transitional rules
When both existing and new incentives are applicable, company can
make election
• Transitional Tax Incentives－5＋1 Special Zones New Policy
(Guo Fa [2007] No.40 )
–
–
State-encouraged high-new technology enterprises which complete
business registration on or after January 1, 2008
Established in Shenzhen, Zhuhai, Shantou, Xiamen, Hainan Special
Economic Zones or Shanghai Pudong New Area
• The preferential tax treatment for the development of the
Western Regions will continue to be effective (Guo Fa [2007]
No.40)
Summary of Selected Open Issues
Open Issues
Likely Development
“Related Party” definition for
transfer pricing & Thin-Cap
“Control” of CFC/TP/Indirect
Foreign Tax Credit
Equity Investment and safe-harbor
ratios for Thin-Cap
The terms are loosely defined and require
clarification and other guidance
Insufficient distribution of CFC
Encouraged Projects
Detailed catalogue will be issued
Cost Sharing Arrangements
Furthering circulars on matching of expenses and
benefits, required documentation/timing
Corp Reorganizations
Expect general rule that transactions will be taxable;
further circular to address exceptions for certain
debt restructurings, mergers, splits and exchanges
High-tech Enterprise
Catalog of products/industries to be issued along
with percentages for criteria in Rules
Summary of Selected Open Issues
Open Issues
Likely Development
Documentation
rules of TP
A more detailed disclosure form to include with the tax
filing and the specific documentation requirements that
must be contemporaneously prepared may be adopted
soon
IP ownership of
High-tech Co
Economic ownership may be considered
LP and foreign
partnerships
More guidance on foreign partner participation and on the
taxation of these vehicles is expected
GAAR
Rules are silent at this moment. Guidance is expected
Planning Opportunities
- Holding Structure 1
Profile:
•
ParentCo
New investment into China, or has
old investment structure but w/o
intermediate holdco yet
Steps:
•
HoldCo
•
•
China
•
Incorporate HoldCo in a treaty
country with 5% withholding tax on
dividend
Establish New WFOE
Migrate OpCo assets or people to
New WFOE and liquidate OpCo
Or merge OpCo to New WFOE
Benefits:
New WFOE
OpCo
• Business Transfer
• Merger
•
•
•
New WFOE dividend to HoldCo may
only be subject to 5% WHT
May effectively insert Holdco tax-free
Possible new tax holiday?
•
•
GAAR
Practical business issues
Issue:
Planning Opportunities
- Holding Structure 2
Profile:
•
ParentCo
1.Transfer share of SPV to
HoldCo
Steps:
•
HoldCo
•
•
China
SPV
2. Become China tax resident
OpCo
A SPV which was incorporated in a
country without any tax treaty with
China to hold an FIE and the potential
WHT for the dividend could be 10%
(long-term planning)
Incorporate HoldCo in a treaty Country
with 5% withholding tax on dividend
Transfer ownership of SPV to HoldCo
Take steps to ensure SPV become a
Chinese tax resident
Benefits:
•
•
OpCo dividends to SPV, which may be
tax free
SPV dividend to HoldCo, which may
only be subject to 5% WHT
Issues:
•
•
•
GAAR
How to actual obtain tax registration for
SPV
FIN48 considerations
Planning Opportunities
- R&D Spin Off
Profile:
•
•
ParentCo
•
China
HighTech
Manufacture
Co
Chinese operation model is under a license manufacturing
arrangement (ManufactureCo).
However, the royalty rate may be subject to a cap by the
registration authority (it is an unofficial and unwritten
administration policy)
ManufactureCo has significant amount of profits in China and
cannot be paid out by way of royalty payments (long-term
planning)
Steps:
•
•
•
Incorporate a separate high-tech company (Hightech) in China
Use Hightech to perform R&D related activities for IP
localisation work
Hightech charges ManufactureCo a royalty fee or technical
services fee to allow the use of local IP/ Technologies
Benefits:
•
•
Royalty can be repatriated through high-tech Co
Reduce the overall tax burden of Chinese operation
Issues:
•
•
•
Uncertainty regarding high-tech incentives rules
May need approval by local government
May be subject to new GAAR provision
China Banking Update
Robert S. Kurek
Indianapolis
February 12, 2008
Agenda
•
•
•
•
•
Overview
Risk and Ratings Drivers
Structure
Regulatory Environment
Reforms
Overview
• Fourth largest world & largest developing
economy
• Population: 1.3 Billion +
• Per capita GDP: US$2,390 (2007 est.)
•
•
•
•
•
Largely state-owned banking system
Recapitalizations
Reforms
Market orientation
Foreign participation
Financial System Risk & Ratings
• Strengths
– Real economic growth: 7.5% to 8% medium term
– Sector reforms: economic and financial sector
– Enhanced capital, asset quality, profitability
• Challenges
–
–
–
–
Dependence on investments and exports
Corporate sector exposure
Credit culture
Governance and controls
Financial Sector Challenges
• Fragmented
• 19,000 financial institutions
• High risk profile
• System Non-Performing Loans (“NPLs”)
– Reported: 7.1% (YE 2006) vs. 25% (YE 2004)
• Total Problem Assets (incl. undisclosed NPLs)
– 15% -20% of total loans (S&P estimate)
Financial Sector Tiering
• Tier 1: Mega banks (55% market share)
–
–
–
–
–
Industrial and Commercial Bank of China
Agricultural Bank
Bank of China
China Construction Bank
Bank of Communications
• Tier 2: Policy banks (8% market share)
– China Development Bank
– Export-Import Bank of China
– Agricultural Development Bank of china
Financial Sector Tiering
• Tier 3: Joint-Stock Commercial Banks
“JSCBs” (12% market share)
– 11 banks
– ownership: local governments, corporate investors,
the public
Financial Sector Tiering
• The Joint-Stock Commercial Banks
–
–
–
–
–
–
–
–
–
–
–
China Merchants Bank
China Minsheng Banking Corp
China CITIC Bank
Shanghai Pudong Development Bank
Industrial Bank Co
China Everbright Bank
Hua Xia Bank Co
Shenzhen Development Bank Co
Evergrowing Bank Co
China Zheshang Bank
China Bohai Bank
Financial Sector Tiering
• Tier 4: Other financial institutions
(25% market share)
–
–
–
–
–
–
–
–
19,300 + rural credit cooperatives
113 city commercial banks
80 rural credit banks
70 finance companies
54 trust & investment companies (TICs)
74 foreign banking institutions
13 rural commercial banks
Countrywide postal savings sector
Regulatory Environment
• Banking Oversight
– People’s Bank of China (“PBOC”)
•
•
•
•
Primary supervisor (pre-2003)
Set benchmark rates
Administer inter-bank market
Maintain financial system stability
– China Banking Regulatory Commission (“CBRC”)
• Post-2003 role as banking regulator
• Focus: independence and enforcement
Other Regulatory Oversight
• Capital Markets
• China Securities Regulatory Commission
• Insurance
• China Insurance Regulatory Commission
• Foreign Exchange
• State Administration of Foreign Exchange
• Audit (state-owned banks)
• National Audit Office
Regulatory Reform
• Commercial Banking Law
• Effective 1995 / revised 2003
•
•
•
•
•
•
•
•
Quality & enforcement
Public-sector financial support for banks
Recapitalizations
Risk management practices
Credit allocation
Move to market orientation
Foreign shareholding
No deposit insurance system / implied state
guarantee of deposits
Questions?
Lunch
12:30 p.m. - 1:30 p.m.
Priming for M&A
Success in China
Clarence Kwan, George Graham,
Zack Dong, Jennifer Zhang
February 12, 2008
By the Lunar Calendar, February 8, 2008 marks
the Chinese New Year 4706 – Year of the Rat
Agenda
•
•
•
•
Overview of Cross Border M&A
M&A Regulatory Framework
Five Key Questions
Putting People First
Cross-Border M&A into China (1997-2007)
• In 2007, the total value of completed cross-border deals with a
disclosed value exceeded US$12.6 billion
• Average deal size was US$58.6 million
Disclosed Transaction Value
Number of Deals
15
350
WTO Accession
December 2001
300
250
200
10
150
100
5
50
0
Number of Deals
US$ Billion
20
0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007*
Source: Thomson Financial, EIU
* Preliminary analysis based on Thompson Financial data accessed on February 1, 2008
3
Largest Cross-Border M&A Deals into China in 2006
Deals with Disclosed Value, by Value
Date
Announced
& Status*
Acquirer
Deal Size
(US$mm)
%
Acquired
/Sought**
3,100
85
11/16
C
Investor group led by
Citigroup Inc.
11/15
C
3Com Corp.
882
01/23
C
InBev NV
11/22
C
05/20
Target Company
Target Business
Guangdong
Development Bank
Banking
49 (100)
Huawei-3Com Co. Ltd.
Telecom
equipment
730
100
Fujian Sedrin Brewery
Malt beverages
Banco Bilbao Vizcaya
Argentaria SA
648
5
China CITIC Bank
Banking
W
CVC Asia Pacific
624
30
Shandong Chenming
Paper
Paper mills
01/04
C
Hyundai Heavy Industries
527
20
Qinhuangdao Shouqin
Metal
Primary metals
06/08
C
Cathay Pacific Airlines
524
10 (20)
Air China International
Air transportation
01/24
C
FedEx Corp.
400
50 (100)
Federal Express-DTW
Express delivery
services
03/08
P
China Resources Enterprises
and CDH China Fund
341
98
China Worldbest Group
Pharmaceuticals
and textiles
06/20
C
Valspar Corporation
290
80
Huarun Paints Holdings
Paints
* C= Completed; P=Pending; W=Withdrawn
Source: Thomson Financial
**Numbers in parentheses indicate % owned after completion of deal, if different than % acquired
= Indicates deals with financial investor involvement
4
A Diversifying Marketplace
Largest Cross-Border M&A Deals into China in 2007 with Disclosed Value, by Value
Date
Announcd &
Status*
Acquirer
Deal Size
(US$mm)
% Acquired
Target Company
Target Business
02/17
C
GuocoLand Ltd.
752
90
Beijing Chengjian Donghua
Real Estate Development
Co. Ltd.
Real estate
development
09/10
P
Blackstone Group LP
600
20
China National Bluestar
Group Corp.
Chemicals
manufacturer
09/25
P
Morgan Stanley
533
33
China Fortune Securities
Co. Ltd.
Securities brokerage
01/28
C
Investor Group
400
8
Guangzhou Hengda
Industrial Group Co. Ltd.
Investment holding
company
02/13
P
Beiersdorf AG
381
85
C-BONS Hair Care
Personal care
products
12/12
P
Iomega Corp.
323
100
ExcelStor Ltd.
Computers and
peripherals
05/17
P
Chia Tai Enterprises
International Ltd.
288
100
Shanghai Lotus
Supermarket
Grocery store
owner/operator
10/11
P
Raffles Education Corp. Ltd.
267
100
Oriental University City
Development Co. Ltd.
Educational assets
owner/operator
10/25
P
Hong Leong Bank Berhad
261
20
Chengdu City Commercial
Bank
Bank
03/22
C
Asia Bottles Co. Ltd.
225
29
Zhuhai Zhongfu Enterprise
Co. Ltd.
Packaging and
Containers
* C= Completed; P=Pending; W=Withdrawn
= Indicates deals with financial investor involvement
Source: Thomson Financial
5
Drivers of Long-Term M&A Growth in China
• Opportunity to by-pass major China
headaches
– Buy-out JV partners or jump start operations by
acquiring existing assets & relationships
• Improving regulatory transparency
• Growing pool of attractive targets
– WTO-mandated deregulation is expanding
number of sectors open to foreign investors
(wholesale/retail, logistics, banking, etc…)
– On-going restructuring of SOEs & emergence of
more and better-managed privately-held
companies in China
• Expanding activity of financial investors,
particularly global PE firms
6
Emerging Trends in China M&A
Highlights From CSG Monthly Commentaries On Cross-Border Investment
Private Equity Meets the Chinese Consumer (April)
Rising income and increased retail spending are attracting global
PE firms to China’s fast-growing consumer markets:
• Targeted sectors include food processing, beverages, retail
chains, etc.
• Implications for strategic investors?
– Short-term – rising valuations for assets
– Long-term – more attractive targets as PE firms seek to exit via
trade sales
Learning the China Two-Step — Multi-stage
Acquisitions in China (July/August)
Foreign investors are increasingly acquiring controlling interests in
Chinese companies over several stages. Three main reasons:
•
To assess opportunities on an exclusive basis
•
To gain time to acclimate to China’s unique business culture
•
To position themselves to expand when further liberalization
occurs
7
Emerging Trends in China M&A
Highlights From Our Monthly Commentaries On Cross-Border Investment
Industry Consolidation in China Opportunity and Risk (October)
Foreign investors can either participate in the
roll-up of China’s fragmented industries, or
watch from the sidelines as their competitors do:
• Challenge – to time investments to achieve
critical mass more efficiently
- Too early? – waste resources buying-up
undersized companies
- Too late? – targets become formidable
competitors in China (and overseas)
• Capacity (people & processes) needs to be in
place to monitor industry dynamics closely
8
M&A Regulatory Framework
• Must comply with general foreign investment
policy:
– Restrictions may impact M&A transactions
•
•
•
•
“Encouraged”
“Permitted”
“Restricted”
“Prohibited”
• Regulations on Acquisition of Domestic
Enterprises by Foreign Investors
– Came into effect September 8, 2006 to replace
the 2003 Interim Regulations
M&A Regulatory Framework
• Acquisition Structures
– Equity purchase
• Indirect/offshore
• Direct
• Acquisition by FIE
– Asset purchase
• Acquisition vehicle required
– Merger
M&A Regulatory Framework
• Changes under the new regulations:
– offer new protections for key Chinese industries
and well-known brands
– specifically permit stock-for-stock transactions
– provide rules for “special-purpose” vehicles
– preserve the anti-trust filing and review
requirement with minor adjustments
M&A Regulatory Framework
• Acquisition of Domestic Entities
– Private companies
• FIEs
– State-owned enterprises (privatization)
• pre-approval required
– Listed companies
• pre-approval required
M&A Regulatory Framework
• Subject to FDI Regulation:
– Minimum investment required to qualify as FIE
– Debt/equity ratio
– Other stakeholder(s)’ statutory rights
• May not bypass FDI restrictions
– e.g., prohibited, JV only, subject to Chinese
party’s majority control
M&A Regulatory Framework
• M&A Verification and Approval
– MOFCOM/SDRC vs. local authority – largely
depends on
• Total amount of investment
• Project category (encouraged/permitted or restricted)
• Industry sector
– Approval authority decision final, but not involved
in negotiations
– Post-approval registration
M&A Regulatory Framework
• Anti-trust review required if certain
thresholds are crossed
– Onshore acquisitions
• thresholds
• at the request of relevant domestic parties
– Offshore/indirect acquisition
• thresholds
Zack Z. Dong
Baker & Daniels LLP
317-569-4831
[email protected]
China Issues: M&A Series
Creating Lasting Value through M&A in China
Five Questions Companies
Should Ask
• At what point should we
walk away from a deal?
• What is an acceptable price
to both parties?
• How should the deal be
structured?
• Does the deal present a
compliance risk?
• How can the acquisition be
integrated in to the global
organization?
9
China Issues: M&A Series Volume I
War Stories from Our Colleagues on the Ground in China
• Potential Deal-Breakers?
– Lack of integrity on the part of target’s
management
– Disagreements over management
control
– Inability to establish clear title to assets
– Diverging expectations over price
– Conflicting stakeholder obligations
At what point should we
walk away from a deal?
• What is an acceptable
price to both parties?
• How should the deal be
structured?
• Does the deal present a
compliance risk?
• How can the acquisition
be integrated in to the
global organization?
10
One Example in Detail
Potential Deal-Breakers
• Disagreements over management control
– It is difficult to convince company owners to relinquish
management control in any market
– Owners and/or managers of growing companies in China are
increasingly hesitant/unwilling to handover reins of the company
• Case: A major U.S. auto parts manufacturer attempted to assume
management control of a large Chinese company, but hit a snag
– The target was fully confident in its own management capacities and was
merely seeking access to financing and technology
– The acquirer, on the other hand, was looking to exert management control
– The two firms were unable to resolve control-oriented differences through
negotiation
11
China Issues: M&A Series Volume I
War Stories from Our Colleagues on the Ground in China
• Pricing Considerations?
– Availability of basic financial
information
– Conflicting valuation
procedures/methodologies
– Contingent/hidden liabilities
– Redundancies and non-core assets
– Sustainability of sales
• At what point should we
walk away from a deal?
What is an acceptable
price to both parties?
• How should the deal be
structured?
• Does the deal present a
compliance risk?
• How can the acquisition
be integrated in to the
global organization?
12
One Example in Detail
Pricing Considerations
• Availability and quality of basic financial
information
– Chinese companies often place less emphasis on
clear, transparent control and reporting
• Case: A European food company
encountered serious difficulties during the
financial due diligence process
– The target kept two sets of books, maintained
poor accounting records, had a high volume of
off-book sales, and made little distinction
between corporate and personal funds
13
China Issues: M&A Series Volume II
Structuring and Compliance Considerations
The “Three Cs” of M&A Structuring
• Contain: Insulate the investment from hidden or
•
•
• At what point should we
walk away from a deal?
contingent liabilities associated with previous operations
or from potential liabilities created during the transaction • What is an acceptable
price to both parties?
itself
How should the deal be
Comply: Ensure that the terms of the deal and
structured?
subsequent operations are in compliance with pertinent Does the deal present a
regulations from the outset, both in China and in the
compliance risk?
home country
• How can the acquisition
be integrated in to the
Compete: Create a sustainable business model that
global organization?
minimizes the net global tax position and maximizes the
flexibility of cross-border capital deployment
Now let’s look at some of the most common mistakes made by
foreign acquirers in each of these three areas…
14
The “Three Cs” of M&A Structuring
Contain
• Common Mistakes – Contain:
– Failure to detect legacy liabilities and
adjust structuring accordingly
– Failure to uncover improper relatedparty transactions
– Assuming unnecessary risk in a seller’s
market
– Over-reliance on personal relationships
– Failure to assess the consequences of
offshore payments
• At what point should we
walk away from a deal?
• What is an acceptable
price to both parties?
How should the deal be
structured?
Does the deal present a
compliance risk?
• How can the acquisition
be integrated in to the
global organization?
15
One Common Mistake in Detail
Contain
• Failure to detect legacy liabilities and adjust structuring
accordingly
– Legacy liabilities can arise from a wide variety of sources in China,
and extensive due diligence is required to identify any and all such
liabilities, after which an appropriate acquisition structure can be
settled upon
• Case: A U.S. firm purchasing a majority stake in a Chinese
consulting company was pleased with the three years of financial
data presented by the seller, but due diligence advisers found the
virtually flawless financial statements suspicious and
recommended searching further in the past
– It was revealed that the seller had enhanced the most recent accounts
and buried significant unpaid taxes in the preceding years
– The buyer avoided the tax liability by executing an asset deal rather
than an equity deal
16
The “Three Cs” of M&A Structuring
Comply
• Common Mistakes – Comply:
– Following common business practices without
a full understanding of their legal basis
– Failure to recognize the potential for
inconsistent regulatory interpretation between
local and state-level officials
– Failure to anticipate and adapt to changes in
the regulatory environment
– Ignoring industry-specific regulations
– Violation of foreign exchange rules
– Misunderstanding of circumstances under
which a license can or cannot be transferred
• At what point should we
walk away from a deal?
• What is an acceptable
price to both parties?
How should the deal be
structured?
Does the deal present a
compliance risk?
• How can the acquisition
be integrated in to the
global organization?
17
One Common Mistake in Detail
Comply
• Following common business practices without a full understanding of
their legal basis
– Foreign investors sometimes conclude that because a practice is firmly
rooted in the local business culture, it is either legal or too widespread to
attract scrutiny. However, regulatory crackdowns can be swift and severe in
China.
• Case: A U.S. buyer of a Chinese pharmaceutical company discovered
that the target’s sales force consisted of independent individuals paid on
a commission basis, who regularly expensed transportation and hotel
costs in violation of their contract terms. The target was also claiming
tax deductions on business expenses incurred by these individuals,
although they were not employees of the company.
– The buyer devised a two-prong strategy. An asset deal was structured to
minimize the buyer’s exposure to the target’s accumulated tax liability.
Second, a new and independent legal entity was established for the sales
force.
18
The “Three Cs” of M&A Structuring
Compete
• Common Mistakes – Compete:
– Failure to use an offshore intermediate
holding company or forming one in a suboptimal jurisdiction
– Giving insufficient consideration to exit
strategies
– Using legal entities that are incompatible
with the business model
– Failure to capture specific tax incentives
– Failure to correctly estimate the long-term
capital needs of the China operation
– Inability to repatriate cash in excess of
dividend capacity
• At what point should we
walk away from a deal?
• What is an acceptable
price to both parties?
How should the deal be
structured?
Does the deal present a
compliance risk?
• How can the acquisition
be integrated in to the
global organization?
19
One Common Mistake in Detail
Compete
• Failure to use an offshore intermediate holding company or forming one
in a sub-optimal jurisdiction
– Opting to establish an offshore intermediate holding company can have a
very real impact on the investment’s internal rate of return
– China has signed bilateral tax treaties with over 80 countries, each with
different implications from a tax optimization perspective
Case Study
USCO
USCO
Netherlands HC
Offshore HC in
better tax treaty
location
WFOE
Guangzhou
New WFOE
Guangzhou
20
China Enterprise Income Tax Reform
Key Provisions
• Tax Rates – 25% standard rate, 15% for high-tech enterprises, 20%
for small and thin-profit enterprises
• Tax Incentives – elimination of most tax incentives available
exclusively for FIEs, replaced with incentives for encouraged
industries and activities
• Withholding Tax (WHT) – 10% imposed on dividend payments to
non-residents
• New Tax Residency Concept - effective management and control
• Transitional Rules – five-year transition period, applicable only to
state/national incentives
• Enhancing and Strengthening Anti-avoidance Rules:
–
–
–
–
Controlled Foreign Corporation (CFC) rules introduced
Thin-Capitalization Rules on related-party loans introduced
General Anti-Avoidance Rules (GAAR) introduced
Continued focus on Transfer Pricing
21
China Enterprise Income Tax Reform
M&A Considerations
Changes
Impact
Tax Rate and Tax Incentive
Scheme
− Deal evaluation based on the applicable tax rates
and current tax incentives (including grandfathering
rules) and availability of tax incentives under the
new law
New tax residency concept and
General Anti-Avoidance Rule
− Care needs to be exercised when structuring the
legal holding and organizational structures
Thin-capitalization rules
− Financing structure and repatriation method
− Balance the cash flow needs while minimizing cash
trapped position and maximizing tax efficiency on
interest deduction
Transfer-pricing rules
− Post-M&A structuring of inter-company transactions
and documentation
Corporate reorganization
− Cross-border transfer of shares to foreign entities
may not be tax-free any more
− Limitation on goodwill deduction
Increase in dividend withholding
tax
− Repatriation strategy
22
China Enterprise Income Tax Reform
Repatriation Planning
U.S. Co.
Hold Co.
Steps:
• Incorporate an intermediate holding
company in a jurisdiction with a 5% lower
WHT on dividends, such as Hong Kong
• Use the holding company to acquire
China targets
Benefits:
China
Target
• Maximizes tax efficiency of profit
repatriation strategy post-M&A deal
Issues:
• Potential GAAR implication
23
China Issues: M&A Series
People Issues Dominate the List of Transaction Headaches
• Potential Deal-Breakers?
– Lack of integrity on the part of
target’s management
– Disagreements over management
control
– Inability to establish clear title to
assets
– Diverging expectations over price
– Conflicting stakeholder obligations
• Pricing Considerations?
– Availability of basic financial
information
– Conflicting valuation
procedures/methodologies
– Contingent/hidden liabilities
– Redundancies and non-core assets
– Sustainability of sales
• Structuring and Compliance?
– Failure to uncover improper
related-party transactions
– Over-reliance on personal
relationships
– Following common business
practices without a full
understanding of their legal basis
– Failure to recognize the potential
for inconsistent regulatory
interpretation between local and
state-level officials
– Violation of foreign exchange
rules
– Misunderstanding of
circumstances under which a
license can or cannot be
transferred
24
Putting People First
Ten Essential Elements for M&A Success in China
25
Before the Deal
Understand the Stakeholder Environment
1. Find out not only
who can make the
deal but who can
break it.
In China, these
individuals can be both
inside and outside the
company.
2. Learn everything
you can about the
stakeholders in
advance.
Lack of management
integrity is one of the
most frequent dealbreakers in China.
3. Secure a firm
mandate from your
top management,
including clear
“go/no go” decision
points.
This will help you to
negotiate with
confidence in China’s
unpredictable and less
than transparent M&A
environment.
 At what point should we
walk away from a deal?
 What is an acceptable
price to both parties?
• How should the deal be
structured?
• Does the deal present a
compliance risk?
• How can the acquisition
be integrated in to the
global organization?
26
During the Deal
Establish Trusting Relationships
4. Negotiating in China
is not just about
getting the best deal
possible but also
building lasting
relationships.
Strong-arm tactics can
be effective but should
be applied judiciously.
5. Trust takes time but
once you have it,
nothing moves a
deal forward faster.
If they trust you, you will
get the information
needed to support your
decisions.
6. You do not need to
be Chinese to get
what you want in
China.
Be creative – Look for
occasions where acting
like an American
advances your cause.
7. Better to
communicate too
much than too little.
0
• At what point should we
walk away from a deal?
• What is an acceptable
price to both parties?
 How should the deal be
structured?
 Does the deal present a
compliance risk?
• How can the acquisition
be integrated in to the
global organization?
But more importantly,
make sure you can trust
your translator.
27
After the Deal
Transform Relationships into Lasting China Value
8.Signing the
contract is often
just the beginning
of real negotiations
in China.
Use the relationships
you have established to
protect your China
value.
9.Loyalties in China
are more often to
individuals than to
companies.
The best way to retain
critical employees,
customers and
suppliers is to retain
key leaders.
10.Anything is
possible in China,
but nothing is easy.
Without the right
people, nothing is
possible.
• At what point should we
walk away from a deal?
• What is an acceptable
price to both parties?
• How should the deal be
structured?
• Does the deal present a
compliance risk?
 How can the acquisition
be integrated in to the
global organization?
28
The M&A Transaction Process
Most acquirers are quite experienced with this process
Evaluate
Investment
Options
Structure &
Negotiate
the
Deal
Integrate &
Manage
on On-going
Basis
Risk Management and Due Diligence
Internal and External Approvals
The transaction process can be unique to each transaction. While each deal is different, the key
steps involved in assessing each transaction are similar and should be subject to the same
systematic decision-making process. Advantages of this approach include:

Efficient — Inappropriate investment opportunities are quickly evaluated and rejected at minimum total cost

Effective — Appropriate investments are correctly implemented with all major risk categories managed
29
M&A Governance Process
Only the most successful have formalized this process
Cross-Border M&A Strategy
Performance Management
Leverage & strengthen parenting
advantages
Ensure attainment of M&A objectives
Investment
Portfolio
Review
Process
Global Competitive
Objectives
Going Out Strategy
Role of M&A
Performance
Metrics
DomesticInternational
synergy
Operations
Plans
1. Evaluate
Investment
Options
2. Structure
Negotiation
Of The
Deal
Global
Organization
3. Manage
Investment
On Ongoing
Basis
Market Strategy
Funding
Requirements
Products &
Services
Business Case
Parameters
Geographic
Investment Types
Approval
Authorization
Transaction Management
Formal support structure for transactions
Scale of Investment
Deal
Team
Potential Partners
Boundary Conditions
Determine “what not to do”
30
Deloitte’s Chinese Services Group
Your Connection to China
Thank You
M&A in China – Deal breakers and
pricing challenges
M&A in China – Structuring and
Compliance Considerations
The Board’s Changing
Role in China Strategy
China Mergers &
Acquisitions Playbook
Contact Information:
Clarence Kwan
[email protected]
George Graham
[email protected]
Jennifer Zhang
[email protected]
31
Questions?
A member firm of
Deloitte Touche Tohmatsu
How To Avoid Product Recalls
And What To Do
When They Happen
Panelists:
Greg Coy – Deloitte & Touche LLP
Jackie Simmons - Baker & Daniels LLP
Joe Tanner - Baker & Daniels LLP
How to Avoid Product Recall
and What to Do When They
Happen.
J. Joseph Tanner
Baker & Daniels LLP
(317) 237-1251
[email protected]
Our Litigious “Society”
• Proliferation of media encouraging lawsuits
• Increasing sophistication of trial attorneys
• Increasing scrutiny from federal
organizations and agencies
• Consumer expectations
Changing Consumer Expectations
“Ladies and
Gentleman of the
jury, I ask that you
find my client’s
parents liable – his
knees must have
been defective
because they did
not last his
lifetime!”
Who Is At Risk?
•
•
•
•
Manufacturer
Component supplier
Importer
Wholesaler/retailer
Importer Of All Or Part Of Product
•
•
•
•
•
Often has imported prior products
Not involved in design
Not involved in manufacture
Not involved in warnings
Not matter
Types of Defects
• Manufacturing
– Product does not conform to specifications
• Design
– Product unreasonably dangerous/unsafe for
intended use due to way it was designed
• Warnings
– Product itself not defective, but does not have
adequate warnings/instructions on how to use
properly or safely
Types Warnings Defects
• On package for an iron:
– “Do not iron clothes on body.”
• On Nytol sleep aid:
– “Warning – May Cause Drowsiness.”
• On bag of peanuts:
– “Warning – Contains nuts.”
• On Swedish chainsaw:
– “Do not attempt to stop chain with your hands.”
• On child’s Superman costume:
– “This garment does not enable you to fly.”
How Do You Avoid
Product Recall/Liability Risk?
• Employing risk-management practices in
research and design
• Controlling and monitoring product
manufacturing and inspection
• Appropriate warning labels and instructions
• Effective warranty and contract language
• Avoiding "smoking gun" documents
• Product liability and recall insurance
• Controlling the message
• Being prepared for recalls
Risk Management Practices Select Qualified Partners
•
•
•
•
In person visits
References
Review quality management systems
Discuss government regulations (do
they know them?)
• Financially sound?
• Insurance/Indemnity/Enforcement
• Negotiate sound contract
Risk Management Practices –
Research And Design
• Design the product to be without hazards
• Safeguard the hazard through appropriate
controls if the hazard cannot be eliminated
• Include product traceability in designs
Risk Management Practices –
Design Considerations
• Make it difficult to alter or modify the
product
• Develop procedures for the design
process and for documenting the
design process
• Develop procedures for testing the
design and document testing
Risk Management Practices –
Controls During Product Manufacturing
• Develop and insist on quality controls
with suppliers and distributors
• Develop documenting procedure and
confirm it is followed
• Conduct regular product liability audits
• Inventory and distribution control
Traceability
• “Information systems necessary to provide
the history of a product or a process from
origin to the point of sale.” Supply Chain
Management, 3, 127-133.
• “The ability to trace the history, application or
location of an entity by means of recorded
identifications.” International Organization
For Standardization (ISO).
Traceability During
•
•
•
•
•
•
Development
Production
Processing
Handling
Distribution
Retailing
Warnings
• Purpose: Communicate the hazard to the
user, if the hazard cannot be safeguarded
through the use of labels and/or written
instructions or directions
• Products without warnings are presumed to
be without danger of causing injury during
foreseeable use
• The warning often is the last effort in the
product design process
Warnings
• Develop warnings during product
hazard analysis
• Consult regulatory agencies and
appropriate regulations
• Consider agency guidelines - American
National Standard For Product Safety
Signs And Labels
Warnings
• Document a procedure for developing
warnings
• Test the warnings
• Document the results of testing
• Revise warnings based on user testing
• Ensure product warnings are
consistent in form and message
• Periodically retest the warning
Instructions
•
•
•
•
Consider your audience
Test instructions
Check translations
Periodically audit instructions
Contractual Protections
•
•
•
•
•
•
•
•
•
All of the above
Certificates of insurance
Waivers of subrogation
Hold harmless agreements
Indemnity language
Arbitration clause
Confirm correct party
Forms and shortcuts
Translations
Warranty Language
• Ensure warranties are targeted and
appropriate
• Disclaim implied warranties
• Disclaim misuse or alteration
Employ Document Controls For:
• Design and Development
• Testing
• Manufacturing
• Quality and Regulatory
– Monitoring quality slippage
• Marketing and Sales
Types Of Problem Records
•
•
•
•
•
•
Inaccurate records
Incomplete records
Unnecessary records
Self-serving records
Imprecise records
Records containing exaggeration or
hyperbole
Why Does This Matter?
Our Litigious “Society”
• Proliferation of media encouraging lawsuits
• Increasing sophistication of trial attorneys
• Increasing scrutiny from federal
organizations and agencies
• Consumer expectations
Consumer Product Safety Commission
• CPSC Reform Legislation
• CPSC Actions
CPSC Reform Legislation
• Increased Civil Penalties (2007 max. $1.825 million)
– House – To $10 million
– Senate – To $100 million
• Increased Criminal Penalties
• Empowers State Attorneys General
– Seek injunctive relief under CPSA
• Increased Funding
– House - $100 million by 2011
– Senate - $141 million by 2015
• Confidentiality
– CPSC to give 15 days notice before release information
• House – Even if manufacturer claims inaccurate
• Senate – Manufacturer has appeal rights
CPSC Reform Legislation
• Ban on lead paint in children’s products
– House – Under 12 years old
– Senate – Under 7 years old
• Tracking labels for children’s products
– Registration cards for nursery products
• Third-party testing for children’s products
• Cautions on ads for toys, games, balloons
etc.
CPSC Actions
• Programs to
– Require testing certification of all imported
toys,
– Target surveillance of suspect imports at
key U.S. ports
– Create early warning system to more
quickly identify hazardous children’s
products
• CPSC patrols of retail stores and internet for
products that violate standards
Product Liability Reporter Vol. 36, No. 2
The China Initiative
• Agreement between CPSC and China
entered in summer 2007
• China pledged to:
– Increase pre-export inspections
– Improve compliance with mandatory and
consensus standards
– Crack down on repeat violators of U.S.
Safety Standards (primarily for lead paint)
Product Liability Reporter Vol. 36, No. 2
Have To Be Proactive
• Can’t rely on government
– Number and volume of productsimpossible to pre-approve all products
– Can’t inspect all shipments
– Can’t test all products
The Problem Is Not Just China’s Problem
It is up to U.S. companies to not only
ensure products they order and import
meet U.S. safety standards but also to
test the items to ensure they meet
standards before placing them on the
market.
Nancy Nord, CPSC Acting Chair
2007 Consumer Product Recalls
In 2007 there were 472 product recalls
In 2006 there were 467 product recalls
In 2007 61 toy recalls
In 2006 40 toy recalls
In 2007 19 toy recalls were for lead paint
In 2006 3 toy recalls were for lead paint
Product Liability Reporter Vol. 36, No. 2
Dec. 2007 Recalls
Consumer Products
•
•
•
•
•
•
•
•
•
•
•
•
Entertainment Centers
Built-in Wall/Microwave Ovens
Infrawave Toasters
Inversion Benches
Fleece-Lined Boys’ Jackets
Horseshoe Magnets
Honda Lawn Mowers
Christmas Candle Sets
DEWALT Cordless Drills
Soldier Bear Toys
Walk-behind Lawn Mowers
Full-body Safety Harnesses
•
•
•
•
•
•
•
•
•
•
•
•
Bicycle Helmets
Heat-Recovery Ventilators
Infantino Lion Teethers
Booster Cables
Toys (300,000)
Children’s Metal Jewelry
Bunk Beds
Fishing Games
MultiVac Outdoor Vacuums
SCUBA Regulators
Elliptical Trainers
Ceramic Hairstyling Irons
Product Liability Reporter Vol. 36, No. 2
Dec. 2007 Recalls
Consumer Products
• Children’s Sunglasses
• Starbucks Fusion
Coffee Mugs
• Holiday Figurines
• Boys’ Hooded
Sweatshirts
• Infant Reclining
Feeding Seats
• Potty Seats
• Sweaters
• Girls’ Clothing Sets
• TKS Children’s Pants
• Oscillating Ceramic
Heaters
• Baby Strollers
• Collectible Mini-Helmets
• Silver Teething Rings
• Pressure Cookers
• Girls’ Hooded Sweatshirts
• Covered Warmer Dishes
• Boy’s Jackets
• Counterfeit Circuit
Breakers
• Tot Tower Toy Blocks
Product Liability Reporter Vol. 36, No. 2
Dec. 2007 Recalls
Motor Vehicles
• Nissan, Altima,
Sentra Vehicles
• Nissan Xterra Suvs
• Lexus Cars
• Ford Super Duty
Trucks
• Chrysler Vans,
Pickups
• Honda Acura Cars
•
•
•
•
•
•
•
•
Suzuki Vitara Vehicles
Volvo SUVs
Volvo XC70 Cars
Thomas Built School
Buses
Triumph Motorcycles
Honda Motorcycles
Toyota Tundra Pickups
Big Dog Motorcycles
Product Liability Reporter Vol. 36, No. 2
Dec. 2007 Recalls
Automotive Parts
• Goodyear Tires
• Service Brakes
• Graco SnugRide Car Seats
Product Liability Reporter Vol. 36, No. 2
How to Avoid Product Recall
and What to Do When They
Happen.
Jackie Simmons
Baker & Daniels LLP
(317) 237-1013
[email protected]
Imagine Your Worst Nightmare
• Perhaps - concrete in hundreds of thousands
of jars of baby food
179
Imagine Your Worst Nightmare
Consequences
– ABC, NBC, CBS carry the story
and interview mothers
– No one thinks concrete is a good
way to introduce fiber to the
baby’s diet
– The client’s customer has to recall
its baby food and potentially loses
valuable store shelf space in the
future
180
What Could Have Been Done To
Prevent This Recall?
• Quality Assurance Testing
– What if the shipment arrives before the
test results?
– What if the supplier’s testing is only done
on some % of the product?
– What if the supplier’s test results always
look remarkably the same?
Establishing Your Own Testing
• Could be done in China before the
product leaves
• Test results are certain to be available
before product reaches the US
• Need to use qualified
labs with EPA/ FDA
qualifications
Audits of Your Suppliers
• Even ISO certified suppliers should be
periodically audited
• In this case, even a simple plant visit would
have spotted the problem – corrosive materials
in the vitamins had caused concrete to chip
• Hiring the right auditor can save your company
many trips to China
• How frequently to audit your supplier depends
on the product and the history of your
relationship with the supplier
What To Do When Products Are
OFF Spec
• Do NOT ship the products back to
China
• Too many “resourceful” people who will
recycle the off spec product by selling it
again (with your name brand on it)
• Always destroy the product – and only
enter into contracts that permit you to
do so
How to Avoid Product Recall
and What to Do When They
Happen.
J. Joseph Tanner
Baker & Daniels LLP
(317) 237-1251
[email protected]
Goals For Product Recalls
• Protect the customer from bodily injury or
property damage
• Remove the product from the market
• Comply with state and federal requirements
• Protect company assets
• Effective communication
• Recoup costs
To Recall Or Not To Recall
• Is it required by law or regulation?
– Product not comply with safety standard
– Product contains defect that creates
substantial hazard or risk of serious injury
• If not, a recall is not “required”
But. . . .
Non-Mandated Recall
• Must conduct the recall with reasonable care
• What is “reasonable” varies case-by-case/productby-product – But will be scrutinized
• If manufacturer knows or easily can determiner
owner, direct contact to owner should be made
• If manufacturer not know owner (e.g. because
product is fairly common or there were a large
number of units sold), it may be reasonable to
contact dealers or distributors and provide public
notice
• The more severe/likely the danger, the more steps
manufacturer must take to provide notice
“Voluntary” or Mandated
Government Recalls
• Request for information
– Confidential?
• Noncompliance report to agency
– 5 working days of determination by
manufacturer of noncompliance (NHTSA)
– By U.S. company
– The problem; recall population; summary;
remedy; recall schedule
“Voluntary” or Mandated
Government Recalls
• Notice to manufacturer – Secure agreement:
– To recall
– To taking the lead
– To payment
• Develop remedy
– Repair
– Replacement (Make it right!)
– Refund
• Execution of remedy
– How, when, where – return and get replacement?
“Voluntary” or Mandated
Government Recalls
• Notice of recall
– Direct notice
– Public notice
– Toll free numbers
– Web based
• Recall monitoring
• Quarterly reports
• Communication strategy
Recall Costs
• The recall
• New product
–
–
–
–
•
•
•
•
Design
Manufacture
Test
Ship
Storage
Return product
Penalties
Publicity and customer relations
Who Pays The Costs – “They Do”
•
•
•
•
•
•
Enforceable insurance
Enforceable indemnity
Letter of credit
Post bond
Escrow funds
Pledge U.S. assets
Arbitration vs. Litigation
• New York Convention 9 U.S.C §§ 201-201
• Agreement to arbitrate (product liability and
recall)
• Exclusivity
• Finality
• Interest
• Currency/exchange rate
• Translation of award
• Costs
• Enforceability
Effectively Addressing
Product Recalls
• Preparation - develop a recall plan in
advance
– Avoids direct and indirect costs
– Alerts company of need to consider recall
– Designate a recall coordinator
• Patience – don’t panic
• Isolate internal product
Effectively Addressing
Product Recalls
• Contact legal counsel
• Request representative samples in the
stream of commerce
• Inspect and test representative
samples
• Identify the number of products in the
marketplace, number returned, and
severity of the hazard
Effectively Addressing
Product Recalls
• Identify peer group to analyze results
of testing and inspection
• Document decision making and testing
process
Effectively Addressing
Product Recalls
• Analyze company records to identify
hazards - sources of information:
–
–
–
–
–
–
Field service records
Customer complaint records
Warranty records
Feedback from distributors and dealers
Testing and inspection records
Product liability claims
Effectively Addressing
Product Recalls
• Freeze relevant documents
• Identify employees with knowledge
• Ensure accurate fact pattern exists
Effectively Addressing
Product Recalls
• Consider whether something other
than a product recall will achieve the
same result
– Is there a fix?
– Would a market withdrawal serve the
same purpose?
– Is a recall required?
Effectively Addressing
Product Recalls
• Determine information needed from
consumers
–
–
–
–
Specific nature of problem
Name, serial number, model number, etc.
Name, address, phone number of customer
Date and time product received, and date and
time of problem and injuries
– Resolution of problem
Effectively Addressing
Product Recalls
• Develop an effective communication strategy
– Consider retaining a communications consultant
– Identify a single source for the message
– Develop a single message – Jetblue “We
Learned From Our Mistakes”
– Stay on message in communications with the
public and the press
– Remember that premature or incorrect
communication can create unwarranted
problems
– Address both internal and external
communications
Effectively Addressing
Product Recalls
• Act in a timely fashion
• Refund, repair, replace, or retrofit
product
• Stay current – the rules are changing
Product Recalls – Accounting &
Reporting Considerations
Greg Coy
Indianapolis
February 12, 2008
Agenda
•
•
•
•
•
Overview of Accounting Literature
Is a Loss Probable?
“Estimating” the Loss
Other Considerations
Example
205
Overview of Accounting Literature
• US GAAP
– SFAS 5, Accounting for Contingencies
• IFRS
– IAS 37, Provisions, Contingent Liabilities and
Contingent Assets
• ASBEs
– ASBE 13, Contingencies
Accounting and recognition criteria are generally
consistent for all 3 standards
206
Overview of Accounting Literature
• Recognize an estimated loss contingency in
earnings if “both” of the following are met:
– Probable that an asset has been impaired or a
liability has been incurred
– Loss can be reasonably estimated
• It is implicit in recognizing a loss that there will
be a future event(s) that will confirm the loss
207
Is a Loss “Probable”?
• When is a loss deemed “Probable” in a
product recall situation?
– Triggering event – Announcement of a product
recall campaign
– Voluntary announcement
– Mandated by regulators
• Generally no legal obligation until
announcement
208
Is a Loss “Probable”?
• Other Related Product Issues;
– Product Warranty (contractual or implied)
– Product Defects (health, safety hazards)
– Product Liability (injuries or damage)
• Generally record an obligation if probable
and estimable
209
“Estimating” the Loss
• “Estimating” the loss associated with a
product recall:
– Terms of the recall – cash, repair kit, returns,
new product, etc.
– Estimating the customer response
– Consideration of the recall period
– Continue to evaluate the estimated loss
based on actual experience
210
Other Considerations
• Inventory valuation issues
• Potential insurance recoveries
• Potential indemnification from
manufacturer
• Future rebates, free product or other
incentives offered to customers
211
Example
• Facts / Assumptions
– Company A announces a product recall campaign for a defect
in baby strollers
– Company A is offering end users of the baby stroller the option
of receiving a repair kit or a new stroller free of charge
– Company A has requested its retail customers to immediately
return or dispose of all strollers that are currently in retail
inventories
– Company A is seeking indemnification for product
manufacturing defects from its manufacturer located in China –
this will likely result in litigation
– Company A has stroller inventory totaling $5 million
212
Questions?
Protecting your Intellectual
Property in China
Moderator:
Angella Castille – Baker & Daniels LLP
Panelists:
J.Q. Liu – Baker & Daniels LLP
Susan Anthony – U.S. Patent & Trademark Office
Strategies for Protecting your
Intellectual Property in China
• Registration of IP in the U.S. and in
China
• Contractual protection
• Monitoring of infringers and contract
breach
• Administrative action, law suits, seizures
and self-help
• U.S. and Chinese government assistance
215
Traditional Methods of Protection
• Registration of patents, trademarks
and copyrights
• Scope of protection
• Enforcement of IP rights in China
• Enforcement in the U.S.
• The role of courts, customs and
administrative agencies in both
systems
Contractual Protections
Confidentiality, non-compete,
manufacturing and technology
agreements
Injunctive relief
Civil damages
Criminal sanctions
Practical limits
Non-Traditional Methods
•
•
•
•
•
Government relations
Trade and industry associations
Relationships with the Party
Investigators
Self-help
The Internet – New Frontiers of
Infringement
•
•
•
•
Protection of domain names
Common scams
Monitoring
Remedies
Final Words of Advice
• Evaluate existing IP and control access
• Register, maintain and monitor compliance
with IP filings
• Regularly evaluate, monitor and defend
existing IP agreements
• Where necessary, train enforcement
personnel – in-house, administrative
agencies, investigators
• Spend your budget strategically
Questions?
Reception
4:45 p.m. – 5:30 p.m.