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How to Structure Your Business in China
Moderator:Angella Castille – Baker & Daniels LLP
Panelists:
Matt Rogers – Deloitte Tax LLPBing Wang – Baker & Daniels LLPJennifer Zhang- Deloitte Tax LLP
• General Considerations
• Entity Selection
• Common Structures
• Financing Strategies
• Repatriation Strategies
Agenda
China Entry Strategy Development
• 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
Legal
• International tax structuring
• Exit strategies (M&A, IPO)
• Capital requirements (LT/ST) Debt-to-equity 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
Tax/Finance
• 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
Real Estate
• 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
• 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
Business Processes
Tech Support
Business Strategy
HumanCapital
• Tech support tools
• Network security
• Data security\• Application
security• ERP approval• ERP
customization
• Business Objectives• Scope of business
options• Market Analysis
• Internal assessment
• High-level roadmap
• ROI
General Considerations for China Investment
● Business objectives / scope
● Industrial specialties and products
● Site selection issues
● Overall business model
● Entity selection
● IP ownership and protection
● Financing strategy
● International structure
● Foreign exchange control issues
● Unfamiliar tax issues (business tax, VAT, transfer pricing, etc.)
● Repatriation strategy
● Exit strategy
Bottom-up Planning Strategy
US Parent(US)
US Parent(US)
IntermediateHolding Co.(Offshore)
IntermediateHolding Co.(Offshore)
FIE(China)
FIE(China)
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
US
USCoUSCo USCoUSCo USCoUSCo USCoUSCoUSCoUSCoUSCoUSCo
Offshore HoldCo
Offshore HoldCo
OffshoreHoldCo
OffshoreHoldCo
Offshore HoldCo
Offshore HoldCoUS LLCUS LLC
ChinaSPV
ChinaSPV
China OpCo
China OpCo
ChinaHoldCo
ChinaHoldCo
ChinaOpCo
ChinaOpCo
China Branch
China Branch
China
ChinaOpCo
ChinaOpCo
ChinaOpCo
ChinaOpCo
ChinaOpCo
ChinaOpCo
Direct Investment
USCoUSCo
ChinaOpCoChinaOpCo
Considerations:
● 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 HoldCoConsiderations:
• Take advantage of treaty benefits
− 5% lower dividend withholding tax for certain jurisdictions
• 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 Anti-Avoidance Rule
• U.S. Subpart F Planning
USCoUSCo
Offshore HoldCo
Offshore HoldCo
China OpCo
China OpCo
Invest through a Chinese Holding CompanyConsiderations:• 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)
• Downsides− Significant investment (>= $30M)− Double reserve− Ability to repatriate depends on CHC’s overall P&L− Non-deductible investment expenses
• Suggest mixed holding structure− CHC owning 10% and Offshore HoldCo owning 90%
• US Subpart F planning
USCoUSCo
China HoldCoChina HoldCo
China OpCo
China OpCo
Offshore HoldCo
Offshore HoldCo
10% 90%
Comparison of Certain Chinese DTAsNon-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 DTAsCapital 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
• 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: Below-the-Line
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
• 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
Repatriation Strategies
Questions?
Break9:45 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 LLPRobert Kurek – KeyBankDavid 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
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08
3M LIBOR Fed Funds Target
Jan 1998 - present
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
SourceDervis LLC
Thinking Ahead : Asset/ Liability Management
48
RMB: Where Does It Go From Here?
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 priorto contract value and based on a central banks fixing at a specific fixing time.
• Contract Value: The day of cash settlement.• Exposure: 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: Corporation needs to cover 3-month exposure in the Chinese Yuan.Corporation needs to buy CNY 10 million. Today is February 12, 2008
• The NDF Contract: Spot rate =7.1835Fwd Equivalent = -.01358Contract 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 = $ 1,424,968• Contract value = CNY 10 million/7.0477 =- $1,418,902• Corporation receives = $ 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
53
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
Copyright © 2008 Deloitte Development LLC. All rights reserved.
54
Background
• China’s accession into WTO
• Need to conform accounting/reporting principles to encourage confidence in China’s capital markets
• International migration toward IFRS
Copyright © 2008 Deloitte Development LLC. All rights reserved.
55
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”)
Copyright © 2008 Deloitte Development LLC. All rights reserved.
56
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
Copyright © 2008 Deloitte Development LLC. All rights reserved.
57
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
Copyright © 2008 Deloitte Development LLC. All rights reserved.
58
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
Copyright © 2008 Deloitte Development LLC. All rights reserved.
59
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
Copyright © 2008 Deloitte Development LLC. All rights reserved.
60
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
Copyright © 2008 Deloitte Development LLC. All rights reserved.
61
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
Copyright © 2008 Deloitte Development LLC. All rights reserved.
62
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
Copyright © 2008 Deloitte Development LLC. All rights reserved.
Copyright © 2008 Deloitte Development LLC. All rights reserved.
About DeloitteDeloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, its member firms, and their respective subsidiaries and affiliates. Deloitte Touche Tohmatsu is an organization of member firms around the world devoted to excellence in providing professional services and advice, focused on client service through a global strategy executed locally in nearly 140 countries. With access to the deep intellectual capital of approximately 150,000 people worldwide, Deloitte delivers services in four professional areas — audit, tax, consulting, and financial advisory services — and serves more than 80 percent of the world’s largest companies, as well as large national enterprises, public institutions, locally important clients, and successful, fast-growing global companies. Services are not provided by the Deloitte Touche Tohmatsu Verein, and, for regulatory and other reasons, certain member firms do not provide services in all four professional areas.
As a Swiss Verein (association), neither Deloitte Touche Tohmatsu nor any of its member firms has any liability for each other’s acts or omissions. Each of the member firms is a separate and independent legal entity operating under the names “Deloitte,” “Deloitte & Touche,” “Deloitte Touche Tohmatsu,” or other related names.
In the United States, Deloitte & Touche USA LLP is the U.S. member firm of Deloitte Touche Tohmatsu and services are provided by the subsidiaries of Deloitte & Touche USA LLP (Deloitte & Touche LLP, Deloitte Consulting LLP, Deloitte Financial Advisory Services LLP, Deloitte Tax LLP, and their subsidiaries), and not by Deloitte & Touche USA LLP. The subsidiaries of the U.S. member firm are among the nation’s leading professional services firms, providing audit, tax, consulting, and financial advisory services through nearly 40,000 people in more than 90 cities. Known as employers of choice for innovative human resources programs, they are dedicated to helping their clients and their people excel. For more information, please visit the U.S. member firm’s Web site at www.deloitte.com
China Legislative Changes- Facing the New Enterprise Income Tax Era
Jennifer Zhang
Indianapolis
February 12, 2008
• Background
• Key Changes
• Transitional Rules
• Open Issues
• Planning Opportunities
Agenda
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 (two-year exemption followed by three-year half reduction from the first profitable year)
Removed
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 New Law
Tax refund on profits reinvestments
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 RulesCurrent Law New Law
FIEs which have started their tax holiday before the effective date of the new law (Jan. 1, 2008)
Continue to enjoy the remaining holiday
FIEs- 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
Tax holiday starts from 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
24%25%
2007 2008 and afterwards
15%-25% 24%-25%
25%2012
15%
18%
20%
22%
24%25%
Series1 15% 18% 20% 22% 24% 25%
2007 2008 2009 2010 2011 2012
• 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)
Transitional Rules (cont’d)
Summary of Selected Open IssuesOpen Issues Likely Development
“Related Party” definition for transfer pricing & Thin-Cap
The terms are loosely defined and require clarification and other guidance
“Control” of CFC/TP/Indirect Foreign Tax Credit
Equity Investment and safe-harbor ratios for Thin-Cap
Insufficient distribution of CFC
Encouraged Projects Detailed catalogue will be issued
Cost Sharing ArrangementsFurthering 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 IssuesOpen 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
China
Profile:• New investment into China, or has old
investment structure but w/o intermediate holdco yet
Steps:• 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 dividend to HoldCo may
only be subject to 5% WHT• May effectively insert Holdco tax-free• Possible new tax holiday?
Issue:• GAAR• Practical business issues
HoldCo
New WFOE
ParentCo
OpCo
• Business Transfer• Merger
Planning Opportunities - Holding Structure 2 Profile:
• 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)
Steps:• 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 residentBenefits:• OpCo dividends to SPV, which may be
tax free• SPV dividend to HoldCo, which may only
be subject to 5% WHTIssues:• GAAR• How to actual obtain tax registration for
SPV• FIN48 considerations
HoldCo
SPV
2. Become China tax resident
OpCo
China
ParentCo
1.Transfer share of SPV to HoldCo
Planning Opportunities - R&D Spin Off Profile:
• 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
ParentCo
HighTechManufacture
Co
China
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?
Lunch12:30 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
Source: Thomson Financial, EIU
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
3
0
5
10
15
20
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
US
$ B
illi
on
0
50
100
150
200
250
300
350
Nu
mb
er o
f D
eals
Disclosed Transaction ValueNumber of Deals
WTO Accession December 2001
*
* Preliminary analysis based on Thompson Financial data accessed on February 1, 2008
Largest Cross-Border M&A Deals into China in 2006 Deals with Disclosed Value, by Value
Date Announced & Status*
Acquirer Deal Size
(US$mm)
% Acquired /Sought**
Target Company Target Business
11/16 C Investor group led by Citigroup Inc.
3,100 85 Guangdong Development Bank
Banking
11/15 C 3Com Corp. 882 49 (100) Huawei-3Com Co. Ltd. Telecom equipment
01/23 C InBev NV 730 100 Fujian Sedrin Brewery Malt beverages
11/22 C Banco Bilbao Vizcaya Argentaria SA
648 5 China CITIC Bank Banking
05/20 W CVC Asia Pacific 624 30 Shandong Chenming Paper
Paper mills
01/04 C Hyundai Heavy Industries 527 20 Qinhuangdao Shouqin Metal
Primary metals
06/08 C Cathay Pacific Airlines 524 10 (20) Air China International Air transportation
01/24 C FedEx Corp. 400 50 (100) Federal Express-DTW Express delivery services
03/08 P China Resources Enterprises
and CDH China Fund
341 98 China Worldbest Group Pharmaceuticals and textiles
06/20 C Valspar Corporation 290 80 Huarun Paints Holdings
Paints
* C= Completed; P=Pending; W=Withdrawn **Numbers in parentheses indicate % owned after completion of deal, if different than % acquired Source: Thomson Financial
= Indicates deals with financial investor involvement 4
A Diversifying MarketplaceLargest Cross-Border M&A Deals into China in 2007 with Disclosed Value, by Value
Date Announcd &
Status*
Acquirer Deal Size
(US$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
Source: Thomson Financial
= Indicates deals with financial investor involvement
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&AHighlights From CSG Monthly Commentaries On Cross-Border InvestmentPrivate 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&AHighlights 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. DongBaker & Daniels [email protected]
China Issues: M&A SeriesCreating Lasting Value through M&A in China
• 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?
Five Questions Companies Should Ask
9
China Issues: M&A Series Volume IWar 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 ConsiderationsThe “Three Cs” of M&A Structuring• Contain: Insulate the investment from hidden or
contingent liabilities associated with previous operations or from potential liabilities created during the transaction itself
• Comply: Ensure that the terms of the deal and subsequent operations are in compliance with pertinent regulations from the outset, both in China and in the home country
• Compete: Create a sustainable business model that minimizes the net global tax position and maximizes the flexibility of cross-border capital deployment
• 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?
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 StructuringContain
• Common Mistakes – Contain:– Failure to detect legacy liabilities and
adjust structuring accordingly
– Failure to uncover improper related-party 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 DetailContain
• 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 StructuringComply
• 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 DetailComply
• 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 StructuringCompete
• Common Mistakes – Compete:– Failure to use an offshore intermediate
holding company or forming one in a sub-optimal 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 DetailCompete
• 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
WFOEGuangzhou
USCO
Netherlands HC
USCO
New WFOEGuangzhou
Offshore HC in better tax treaty
location
20
China Enterprise Income Tax ReformKey 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 ReformM&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
U.S. Co.
China Target
Hold Co.
China Enterprise Income Tax ReformRepatriation Planning
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:• Maximizes tax efficiency of profit
repatriation strategy post-M&A deal
Issues:• Potential GAAR implication
23
China Issues: M&A SeriesPeople 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 FirstTen Essential Elements for M&A Success in China
25
Before the DealUnderstand 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 deal-breakers 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 DealEstablish 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.
But more importantly, make sure you can trust your translator.
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?
27
After the DealTransform 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 ProcessMost acquirers are quite experienced with this process
EvaluateEvaluate InvestmentInvestment
OptionsOptions
EvaluateEvaluate InvestmentInvestment
OptionsOptions
Structure &Structure &NegotiateNegotiate
the the DealDeal
Structure &Structure &NegotiateNegotiate
the the DealDeal
Integrate & Integrate & ManageManage
on On-going on On-going BasisBasis
Integrate & Integrate & ManageManage
on On-going on On-going BasisBasis
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
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
Internal and External Approvals
Risk Management and Due Diligence
29
M&A Governance ProcessOnly the most successful have formalized this process
Boundary ConditionsDetermine “what not to do”
Cross-Border M&A StrategyLeverage & strengthen parenting advantages
Transaction ManagementFormal support structure for transactions
Performance ManagementEnsure attainment of M&A objectives
Market StrategyMarket Strategy1. 1. EvaluateEvaluateInvestmentInvestment
OptionsOptions
1. 1. EvaluateEvaluateInvestmentInvestment
OptionsOptions
2. 2. StructureStructureNegotiationNegotiation
Of The Of The DealDeal
2. 2. StructureStructureNegotiationNegotiation
Of The Of The DealDeal
3. 3. ManageManageInvestment Investment On Ongoing On Ongoing
BasisBasis
3. 3. ManageManageInvestment Investment On Ongoing On Ongoing
BasisBasis
ApprovalAuthorization
Investment Portfolio Review Process
Going Out Strategy
GeographicBusiness Case Parameters
Global Organization
Role of M&A
Potential Partners
Investment Types
Operations Plans
DealTeam
Performance Metrics
Scale of Investment
Domestic-International
synergy
Products & Services
FundingRequirements
Global Competitive Objectives
30
Deloitte’s Chinese Services GroupYour Connection to China
Contact Information:Clarence Kwan George Graham Jennifer [email protected] [email protected] [email protected]
M&A in China – Deal breakers and pricing challenges
The Board’s Changing Role in China Strategy
China Mergers & Acquisitions Playbook
Thank You
M&A in China – Structuring and Compliance Considerations
31
A member firm ofDeloitte Touche Tohmatsu
Questions?
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 TannerBaker & Daniels LLP
(317) [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. 2Product 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 products-
impossible 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 recallsIn 2006 there were 467 product recalls
In 2007 61 toy recallsIn 2006 40 toy recalls
In 2007 19 toy recalls were for lead paintIn 2006 3 toy recalls were for lead paint
Product Liability Reporter Vol. 36, No. 2
Dec. 2007 RecallsConsumer 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 RecallsConsumer 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 RecallsMotor 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 RecallsAutomotive Parts
• Goodyear Tires
• Service Brakes
• Graco SnugRide Car Seats
Product Liability Reporter Vol. 36, No. 2Product Liability Reporter Vol. 36, No. 2
How to Avoid Product Recall and What to Do When They
Happen.
Jackie SimmonsBaker & Daniels LLP
(317) [email protected]
179
Imagine Your Worst Nightmare
• Perhaps - concrete in hundreds of thousands of jars of baby food
180
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
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 TannerBaker & Daniels LLP
(317) [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/product-
by-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
205
Agenda
• Overview of Accounting Literature
• Is a Loss Probable?
• “Estimating” the Loss
• Other Considerations
• Example
206
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
207
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
208
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
209
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
210
“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
211
Other Considerations
• Inventory valuation issues
• Potential insurance recoveries
• Potential indemnification from manufacturer
• Future rebates, free product or other incentives offered to customers
212
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
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
215
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
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?
Reception4:45 p.m. – 5:30 p.m.