Geopolitical tensions have increasingly impacted business operations in China, prompting multinational companies to adopt contingency strategies, including spin-offs or restructuring. These efforts present both challenges and opportunities, particularly when navigating government approvals, foreign exchange, merger control, and tax filing requirements in the People’s Republic of China (PRC). Understanding these factors is crucial for ensuring a smooth and compliant restructuring process.
This Insight outlines key considerations for companies considering business spin-offs in China.
Restructuring investments in China often require various government approvals. Companies must navigate a complex regulatory landscape to obtain the necessary permits and licenses.
If the transaction occurs at the offshore level, where the buyer acquires the offshore holding entity of the Chinese subsidiary, it is generally not subject to government approval in China for signing or closing the transaction, except for merger control filings if applicable. The Chinese subsidiary may need to file updates regarding its ultimate controller and changes to the Directors and Officers (D&O) slate with the Chinese regulator, typically post-closing.
Conversely, if the transaction takes place at the onshore level, involving a change in the direct shareholder of the Chinese subsidiary, the equity transfer must be registered with the State Administration for Market Regulation (SAMR), the company registry and administration authority in China, before it can be effected. If the spin-off of the China business is part of a global transaction, the closing in China must align with the global timetable.
Notably, in certain regulatory sectors, pre-approval from competent regulatory authorities is required for a change in ownership of the Chinese company to maintain the validity of its license following the spin-off transaction.
Managing foreign exchange is a crucial aspect of restructuring investments in China. The Chinese government enforces strict controls on foreign exchange transactions, which can affect the repatriation of profits and the financing of operations.
Generally, a spin-off transaction will require approval from a bank authorized by the State Administration of Foreign Exchange (SAFE) for the Chinese buyer to make outbound payments. SAFE may require supporting documents, particularly if there is a substantial premium compared to the original capital contribution by the seller.
Merger control regulations in China require careful consideration during business spin-offs. Companies must assess whether their restructuring plans trigger merger control filings and, if so, prepare the necessary documentation. Understanding the thresholds and criteria for merger control is essential to avoid potential penalties and ensure compliance.
According to China’s Anti-Monopoly Law (AML), parties involved in a cross-border merger and acquisition (M&A) transaction that results in a change of “control” must submit the transaction to the SAMR for review if they meet specific revenue thresholds. A change of “control” occurs when one or more parties gain the ability to exercise decisive influence over another party’s business activities, such as through acquiring shares, assets, contracts, or trusts. SAMR interprets a change of “control” broadly and may require parties to file even if they acquire only a minority stake with certain rights or influence.
A mandatory pre-closing filing in China is triggered if a transaction meets both of the following prongs:
The thresholds are calculated at the parent level, including the entire group, and SAMR does not require any nexus to China other than group revenues. Therefore, even if both buyer and seller are foreign companies, they may still need to file in China if they meet the thresholds, and the transaction involves a change of “control” of the seller’s China subsidiaries.
SAMR has a two-stage review process, consisting of a preliminary review and a further review. The preliminary review takes up to 30 calendar days, while the further review takes up to 90 calendar days. However, SAMR may extend the further review for up to an additional 60 calendar days in complex cases. SAMR may approve, prohibit, or impose conditions on the transaction based on its assessment of the impact on competition and other factors.
Failure to file or comply with SAMR’s decisions may lead to significant penalties. These can include a fine of up to RMB 5 million (approximately $714,000) for transactions without anticompetitive effects, or up to 10% of the acquirer's global revenues from the last fiscal year for transactions that adversely affect competition. Although uncommon in practice, SAMR has the authority to order the parties to unwind the transaction or revert to the pre-transaction status quo.
Tax implications are a significant consideration in restructuring investments in China. Companies must ensure compliance with PRC tax filing requirements to avoid potential liabilities. This involves understanding the tax treatment of spin-offs and any applicable exemptions or incentives.
For a direct transfer of equity interests in a Chinese subsidiary, the buyer is generally required to withhold and remit a withholding income tax of 10% on the gain recognized by the seller, if the seller is a non-resident enterprise, unless a tax treaty provides preferential treatment.
The tax implications become more complex in the case of an indirect change of equity interests in the Chinese subsidiary. Per the State Taxation Administration’s Announcement on Several Corporate Income Tax Issues Relating to Indirect Transfers of Assets by Non-resident Enterprises,[1] commonly known as “Bulletin 7,” the sale of the share capital in an offshore holding company that owns a Chinese institution (an “indirect transfer”) will be re-characterized as a direct transfer of the Chinese institution and will be subject to PRC tax if the tax authority determines that such indirect transfer lacks a “bona fide commercial purpose.”
Under Bulletin 7, factors for determining a “bona fide commercial purpose” include: (1) whether the value of the offshore holding company is primarily derived from the transfer of the Chinese company; (2) whether the assets of the offshore holding company mainly consist of investments in China; (3) whether the income of the offshore holding company is primarily sourced from China; (4) the duration of the shareholders, business model, and relevant organizational structure of the offshore company; and (5) whether foreign tax is paid on income derived from the indirect transfer of the Chinese company.
Bulletin 7 provides three safe harbors, including an open market transaction, a transaction exempted under an applicable tax treaty, and a transaction that is an intra-group reorganization. In each scenario, the transaction will be deemed to have a bona fide commercial purpose.
Certain indirect transfers of Chinese institutions shall be deemed to lack a reasonable commercial purpose per se if all of the following conditions are met, without going through the above-mentioned analysis of reasonable commercial purposes:
If these conditions are met, the transferee—whether a resident enterprise or not—is required to withhold tax on capital gains from an indirect transfer of equity interest in Chinese resident enterprises. In most indirect transfer transactions, the transferee acts as the payor; therefore, if the transaction is taxable, the transferee generally has the withholding obligation, while the seller is the taxpayer and bears the actual tax burden unless otherwise agreed. Neither party’s obligation may be changed via contractual agreements. Neither party’s obligations may be altered through contractual agreements.
Additionally, Bulletin 7 stipulates that the transferee may be partially or fully relieved from liabilities for failing to withhold taxes if the transferee reports the transaction information to the competent tax authorities in China within 30 days of executing the equity transfer agreement or its equivalent.
In practice, the responsibilities and liabilities related to PRC tax filing are commonly a key component of negotiations for transactions involving the transfer of equity interests in a Chinese subsidiary.
For joint ventures, cooperation between joint venture partners is crucial for successful restructuring. Companies must navigate the statutory right of first refusal and engage in open communication with partners to align interests and achieve mutually beneficial outcomes.
In addition to the contractual rights outlined in the shareholders’ agreement, each party, as a shareholder of a Chinese company, is protected by law, including the statutory right of first refusal. Practically, a party cannot finalize the sale of its equity interests in a joint venture to a third party without the cooperation of the other party, particularly concerning registration with the SAMR, irrespective of any provisions in the shareholders’ agreement.
Restructuring investment in China requires a comprehensive understanding of the regulatory landscape and strategic planning. By considering the factors outlined in this LawFlash, companies can position themselves for success in the dynamic Chinese market. Engaging experienced multijurisdictional professionals is essential in achieving successful restructuring outcomes.
If you have any questions or would like more information on the issues discussed in this Insight, please contact any of the following:
[1] (STA Announcement [2015] No. 7)