Variable Interest Entities: A Regulatory Work-Around All of China’s major Internet companies that list on U.S. exchanges use the VIE structure as a means of circumventing Chinese restrictions on their access to foreign capital. Several actions in the extremely sensitive education sector make it clear that there may not be foreign de facto control of any basic educational institutions in China. Now that you understand VIE … Legal esoterica: what’s the difference between illegality and invalidity? By not getting explicitly mentioned, the VIE structure have been left out of the spotlight for regulatory scrutiny, albeit not given the green light on their activities. This business structure, called a variable-interest entity, became common among Chinese companies because Beijing restricts foreign investment in certain sectors, such as the internet. Essentially, under a VIE, foreign companies or individuals obtain the rights and financial benefits of ownership through contractual arrangements with a PRC domestic company. To non-accountants, the VIE structure is a business structure that is widely used in certain business sectors in China that have prohibitions or restrictions on foreign investment under the 2019 Negative List such as telecommunications, e-commerce, education, and media. A note on the variable interest entity (VIE) structure that is commonly used for Chinese companies. There is no foolproof way to prevent such a dispute but practical measures for avoiding a conflict include selecting a trusted person for being the owner(s) and aligning the economic interests of the owner with the interests of the holding company. July 22, 2019. Alibaba (China’s Amazon equivalent) and Baidu (China’s Google), among other listed American Depository Shares are exposed to a rarely discussed regulatory risk, relating to the holding structure of their domestic and foreign entities. Introduction The Variable Interest Entity (‘VIE’) is a well-established and widely utilised structure of investment employed in foreign investment in China. The 40-item restricted/prohibited industry list was much shorter than previous versions but did not ease the restrictions in any material way. A variable interest entity (VIE) refers to a legal business structure in which an investor has a controlling interest despite not having a majority of voting rights. The 42-provision FIL differs significantly from the more detailed 170-provision 2015 Draft. First, I am going to briefly discuss Variable Interest Entities (VIE) and how they are typically used in China. There have been few published cases and no implementing regulations or interpretations issued for the NSRS which will make it difficult in the short term to predict outcomes. Updated：2019-10-10 18:30:57 Source：www.tannet-group.com Views：85. Many of the largest and fastest growing technology businesses reside in China and present tremendous long-term opportunities to investors, benefitting from the same structural tailwinds as the FANG stocks. Most variable interest entities are special purpose entities, which are legally structured entities which are created to serve a specific, predetermined, limited purpose. CSRC VIE Research Report Leaked to Media . twitter @profgillis. 2016] CHINA’S VARIABLE INTEREST ENTITY PROBLEM 543 saw the value of their shares plummet when it came to light that the company’s Chinese VIE had issued a $16.4 million bond off the books and engaged in fraudulent retail practices.19 In both the Gigamedia and FAB Universal incidents, the U.S. investors were unable to en-force their rights in Chinese courts due to the illegal status of the VIE … Understanding the VIE Structure: necessary elements for success and the legal risks involved * - USA. 21 Cardozo J. Int'l & Comp. What Is a Variable Interest Entity - VIE? Enron was masking their countless loss-making operations by recording these entities off-balance sheet. Charles Comey, Paul McKenzie, Sherry Yin and Michelle Yuan . It’s very hard to model out such a risk, in seemingly binary outcomes. These provisions may mitigate some of the political pressure China is currently facing to protect foreign IPR. In 2000, Sina Corporation made headlines by being the first Chinese business to list on the NASDAQ in New York using the 'Variable Interest Entity' ('VIE') structure, which uses contracts instead of shareholding to effect corporate control. China’s need for foreign direct investment renders a strict clampdown unlikely. By . The definition of foreign investment does not include the “de facto controller” concept which was in the 2015 Draft. Ownership of the domestic operating company is very important since a contract which avoids the requirements of Chinese law is void and the court will not enforce it. They may also require companies that operate a so-called Variable Interest Entity -- a vehicle through … It encourages technology collaboration between foreign investors and their Chinese counterparts on a fair and voluntary basis, and bars government officials from using administrative measures to force technology transfers. Articles 22 and 23 could reduce forced technology transfers in JVs and cause faster government action to amend the patent and other IPR laws. It entails a succession of contractual arrangements which hold the principal intention of circumventing the investment restrictions China has placed upon foreign ownership in particular sectors of the Chinese market. 1. The majority of industries growth-orientated investors would want to invest in have some kind of foreign ownership restriction. China blinks on PCAOB; Kennedy Bill and MNCs; Sidebar. … Through December 7, a total of 20 Chinese companies using VIE structures conducted or filed for initial public offerings (IPOs) on U.S. exchanges in 2017, a resurgence compared with the previous two years. 51Job, Inc Entity Structure (2) Source: SEC filings. A legal loophole used by Enron allows these companies to bypass regulatory restrictions. By undermining the confidence in capital markets, they would be threatening the flow of capital and causing as much harm to themselves as foreign investors. Renren and Baidu, for example, are variable interest entities. A note on the variable interest entity (VIE) structure that is commonly used for Chinese companies. … Paul Gillis PhD CPA is Professor of Practice at Peking University's Guanghua School of Management. See more: http://prodygia.com/video_interviews/199-what-you-need-to-know-about-the-variable-interest-entity-vie-structure The WFOE exercises de facto control over the domestic company through a series of contractual arrangements entered between the WFOE and the domestic company. Renren and Baidu, for example, are variable interest entities. The variable interest entity ("VIE") has long been a popular structure for foreign parties to invest in sectors which are restricted by China’s industrial policy to foreign investment. The note includes an analysis of the future of the VIE structure in the light of China's unified foreign … It’s very hard to model out such a risk, in seemingly binary outcomes. Consequently, the legal validity of VIEs has … Similarly, the withholding tax is acting as a deterrent to paying distributions out of China and into the pockets of shareholders. exchanges relying heavily on a corporate structure called a variable interest entity (VIE). When the Chinese government tightened its regulations over online payment systems, Jack Ma, acting as the Chairman of Alibaba made the decision to transfer the assets of its online payment platform to a private company owned by him. Variable interest entity is a term used by the United States Financial Accounting Standards Board in FIN 46 to refer to an entity in which the investor holds a controlling interest that is not based on the majority of voting rights. Most of Alibaba’s Chinese assets will be owned by Mr. Ma and another … Previously American entities like Apple were forced to pay the highest corporate tax rate from profits of international divisions if they wanted to repatriate their cash balances. VIEs present risks to investors as the Chinese government could clampdown on this loophole. About the Editor. In accordance with FASB Interpretation 46, 51Job is obligated to consolidate the financials associated with Tech JV, thereby presenting to investors what looks like full ownership of the operating businesses. In many areas, however, it provides only high level guidance, vague in some cases, and lacks detailed implementation provisions. In September, 2019, also based on the passage of the FIL without the de facto control provision, the Hong Kong Stock Exchange revised its guidance to continue to permit VIE structures to be listed with certain requirements including “to the extent necessary to address any limits on foreign ownership stipulated by relevant PRC laws and regulations”. Those same policy rationales should also prompt reexamination of the disclosure being provided concerning, and associated governance risks posed by, the “variable interest entity” or “VIE” structures that are widely used by China-based firms (including Luckin) listed on U.S. exchanges. Variable interest entity (VIE) Related Content. China is less likely to regulate the variable interest entity VIE structures of internet companies a relief for those that list overseas. China’s antitrust watchdog is seeking feedback on a raft of regulations that establish a framework for curbing anti-competitive behavior such as colluding on sharing sensitive consumer data, alliances that squeeze out smaller rivals and subsidizing services at below cost to eliminate competitors. China VIE Structure 2020 Foreign investors may not invest in any sector prohibited for foreign investment by the Negative List. The prospect of dividend payments for the medium term from many of these companies is cloudy at best. 51Job, Inc (“51Job”), China’s leading online jobs classifieds website has been publicly listed on the NASDAQ since 2004 and despite significant volatility in the share price has delivered great shareholder returns over the long-term. Variable Interest Entities (VIE) have been used to control businesses in China in industries in which there are foreign ownership restrictions. By . So far, 50% of the earnings are attributable to equity ownership. 50% of the real business through equity ownership; and, 100% of a contact which says Qian Cheng will pass through their 50% share of residual profits back to 51Job, 51Job, Inc Entity Structure (3) Source: SEC filings. There have been other actions taken by various governmental authorities that recognize the existence of the VIE structure in China. We believe the vaguer terms of the FIL as compared to the 2015 Draft was a practical decision that benefits the Chinese economy and has made it less likely that VIEs will be prohibited by the government in the near future. Many details need to be provided in supporting laws, regulations or by the State Council. Most Influential People in Accounting. 0 Comment. Variable Interest Entities: A Regulatory Work-Around All of China’s major Internet companies that list on U.S. exchanges use the VIE structure as a means of circumventing Chinese restrictions on their access to foreign capital. 2014 Market Reformer of the Year. As indicated above, all of the 11 Chinese IPOs in the US in the 3 months ending January 31, 2020 were incorporated in the Cayman Islands. Qian Cheng also directly owns 1% of Tech JV, in essence therefore owning 50% of Tech JV. An FIE is an enterprise incorporated under Chinese laws within China with all or part of its investment from a foreign investor. About the Editor. As many of our readers are aware, the “variable interest entity” “VIE”) structure has proven popular over the past decade as a means to facilitate the offshore financing of PRC companies doing business in regulated sectors such as the Internet and value-added telecommunications. Rather than bring cash back home, American entities left it offshore for years, preferring to perpetually reinvest in low-yielding securities rather than pay taxes at 35%. In addition, tell us how you addressed the disclosures in ASC 810-10- 50-9 related to the disclosure of the aggregation of VIEs. An entity where an investor has a controlling interest that is not based on holding the majority of voting rights. structure for its Chinese assets. Most of these businesses are listed offshore in more developed financial hubs … These American corporates never put the potential tax repatriation bill through their Income Statement arguably they would continue to hold the cash offshore, investing for growth. China law, business and economics commentary . China’s Corporate Income Tax (CIT) law gives regulators the ability to adjust the tax for entities if there is non-compliance with the arms-length principle, as such tax positions are uncertain, rendering the ending economic value to foreign shareholder ambiguous. When it comes to VIEs and related contracts, the distinction is important. The financial statements of the Cayman holding company are consolidated with the WFOE and VIE which makes the holding company financeable. Article 2 defines foreign investment as investment activities, directly or indirectly, by foreign individuals, corporations, or other organizations in China, including the establishment of foreign-invested enterprises (“FIEs“), acquisition of shares, equity, assets and other similar interests in China enterprises, investment in new projects in China independently or jointly with other investors, and other forms of foreign investment as specified in laws, regulations or by the State Council. The FIL has several broad provisions for promoting foreign investment by creating a more equal (national treatment) legal framework for foreign investors and to promote and protect foreign investment. Introduction The Variable Interest Entity (‘VIE’) is a well-established and widely utilised structure of investment employed in foreign investment in China. The simplest VIE structure includes a foreign holding company which is often an exempt limited company in the Cayman Islands, a China wholly foreign-owned enterprise (WFOE) and a China domestic company owned only by Chinese nationals. For investors who take a long-term view and are focused on growth, the structure might be good enough for now. | Website Designed By Blue Astral, Online Event: ‘Term Sheet Analytics: Anatomy of a Term Sheet. China VIEs: Recent Developments and Observations. 2015 The Accountant Power 50. One additional risk factor in investing in Chinese companies is that the use of a reverse merger is often accompanied by the creation of a variable interest entity (“VIE”). For VIE structures the regulatory loophole allows the economic interest to be transferred to foreign shareholders, however the value of those contractual obligations can meaningfully differ depending on the tax treatment adopted by the PRC. 51Job conveniently doesn’t have to deal with this problem “since we intend to permanently reinvest earnings to further expand our business” according to their 2018 20-F Report. China is revising the laws that govern the variable interest entity, a complicated structure used by many companies to bypass foreign investment restrictions. Financial markets have a habit of perpetually refactoring economic exposures until regulation intervenes. Variable Interest Entities are a legal quagmire for investors to grapple with if they want exposure to the fast-growing internet enabled businesses in China. gillis@gsm.pku.edu.cn. Legal esoterica: what’s the difference between illegality and invalidity? It entails a succession of contractual arrangements which hold the principal intention of circumventing the investment restrictions China has placed upon foreign ownership in particular sectors of the Chinese market. ASU 2014-07, Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements, allows the reporting entity/lessee to elect not to apply VIE guidance to a lessor entity under common control. The legal structure whereby contractual obligations pay the economic interest out to a foreign owned company is a circumnavigation of Chinese legislation. Since around 1999, an incre It entails a succession of contractual arrangements which hold the principal intention of circumventing the investment restrictions China has placed upon foreign ownership in particular sectors of the Chinese market. A VIE is an entity controlled by a company by means other than a majority of voting rights. Home; Profile; Tag Archives: variable interest entity The VIE Meta-Narrative: Illegal vs. Promotion of and National Treatment for Foreign Investment. An entity where an investor has a controlling interest that is not based on holding the majority of voting rights. Until implementing regulations are issued, however, since the FIL contains broad and sometimes vague provisions, and repeals the existing legal framework for FIEs, there may be more confusion for foreign investors. In July, 2019, S&P Global Ratings updated its risk assessment of Chinese companies using the VIE structure and concluded that the likelihood of regulatory action against such structures had diminished because of the passage of the FIL without the de facto control provision. While the dispute was ultimately settled in 2011, it warns investors that their investment may be at risk if the owners of the domestic company are not carefully selected. As of January 1, 2020, the FIL replaced and repealed the existing PRC Foreign Invested Enterprise Law, PRC Sino-Foreign Equity Joint Venture Law and PRC Sino-Foreign Cooperative Joint Venture Law (collectively, “FIE Laws”). In the years since, VIEs have become at once a buzzword amongst corporate lawyers and a headache for regulators in the People's Republic of China ('PRC'), the … The VIE structure is also used by other types of Chinese businesses seeking foreign financing and a possible exit on an offshore equities exchange such as Nasdaq or the NYSE. The great majority of VIE holding companies are domiciled in the Cayman Islands, where no tax-treaty with China occurs. 13 Oct 2011 by Stan. 51Job, Inc Entity Structure (1) Source; SEC filings. The accounting definition of “variable interest entity” (VIE) is an entity in which an investor holds a controlling interest based on contractual arrangements … All 11 of the companies were incorporated in the Cayman Islands. To mitigate the risk of a decision independent of the business interests of the holding company, the economic interest of the owner of the domestic company was aligned with the owners of the holding company by stock ownership in the Caymans entity. Where a wholly or partially foreign-owned entity enters into contracts with a Chinese company operating in PRC in the sector subject to foreign-investment restrictions or prohibitions, with the adequate business scope and licenses. 0 Comment. Should the Chinese government punitively treat foreign shareholders for the use of the VIE structure, they would be severely harming their reputation as a country to invest in. Those same policy rationales should also prompt reexamination of the disclosure being provided concerning, and associated governance risks posed by, the “variable interest entity” or “VIE” structures that are widely used by China-based firms (including Luckin) listed on U.S. exchanges. A VIE is a legal business structure commonly used by mainland companies to establish ownership of a company through legal agreements, as opposed to direct share ownership. Invalid. March 2019, PRC approved legislation effective January 2020 which has alleviated the near-term risk for shareholders in VIE companies, through an updated definition of what foreign investment is considered. The primary beneficiary of … Some of the provisions in the FIL have been designed to reduce trade tensions with the United States. 2015 The Accountant Power 50. Variable interest entities have been used by non-Chinese investors to get financial control of companies in industries that limit foreign ownership, such as telecoms. Last month, China’s Ministry of Commerce released a draft of the Foreign Investment Law, a new piece of legislation that attempts to integrate, update and replace the existing laws on foreign investment made more than a … The owner of the China domestic company is a close relative of one of the founders of the Caymans holding company, someone who is trusted. Many of the largest and fastest growing technology businesses reside in China and present tremendous long-term opportunities to investors, benefitting from the same structural tailwinds as the FANG stocks. China could punitively restrict the VIE structure, yes. Home; Profile; Tag Archives: variable interest entity The VIE Meta-Narrative: Illegal vs. It is a central government decision. The FIL contains general principles to consolidate the various laws and regulations on foreign investment in China, to promote and provide more equal treatment for foreign investment in China, to protect foreign investors by enhancing protections for intellectual property rights (IPR), to establish a national security review system and other provisions. VIEs are corporate structures usually set up to get around China’s not allowing WFOEs to participate in China’s internet sector. A 10-20% withholding tax isn’t a make-or-break for potential investments, as with American entities prior to the tax reform, but it does mean a greater margin of safety is required to justify owning the shares. The Negative List specifies administrative requirements for foreign investment access to certain business sectors. Variable interest entity (VIE) structures in Chinaby Practical Law ChinaRelated ContentA note on the variable interest entity (VIE) structure that is commonly used for Chinese companies. See more: http://prodygia.com/video_interviews/199-what-you-need-to-know-about-the-variable-interest-entity-vie-structure China law, business and economics commentary . China Accounting Blog does an excellent job explaining a typical VIE in its post, Explaining VIE Structures, which I urge you to read now. 4 Feb. Almost all investor issues relating to VIEs have been when the shareholders of the domestic company fail to comply with the controlling contracts rather than from actions taken by Chinese regulators. On the basis of economic self-interest, the VIE structure looks safe for now. The Variable Interest Entity (‘VIE’) is a well-established and widely utilised structure of investment employed in foreign investment in China. 1. The economic right to the interest of the entity, as well as the ability to vote on how the company should be run. The FIL is a positive step in support of foreign investment in China. Many provisions will need to be clarified and interpreted in the future by supporting laws, administrative regulations or actions of the State Council. Variable interest entities have been used by non-Chinese investors to get financial control of companies in industries that limit foreign ownership, such as telecoms. All rights reserved. … Capital inflows into the country would plunge as global investors speculate as to what other ways the Chinese government seek to destroy shareholder value. The variable interest entity ("VIE") has long been a popular structure for foreign parties to invest in sectors which are restricted by China’s industrial policy to foreign investment. Alibaba is using a straightforward V.I.E. U.S.-listed Chinese internet companies such as search giant Baidu and e-commerce giant Alibaba Group Holding utilize a corporate structure called a variable interest entity. In essence contractual arrangements such as those employed by 51Job and Alibaba would be considered equity ownership and mean these companies were breaching proposed regulations. Rather than providing clear commentary on the VIE structure the legislation simply doesn’t mention them. The note explains the history and origins of the structure, the elements of the structure, the key contracts that make up the structure and the key clauses required in each contract to give effect to the structure. This proposal was not enacted but represented an existential risk to the VIE structure. The collective valuation of VIEs listed via the Cayman Islands exceeded US $1.5 trillion in 2017 and has surely grown since then. A variable interest entity (VIE) refers to a legal business structure in which an investor has a controlling interest despite not having a majority of voting rights; or, it may refer to an accounting … There are well over 100 companies in China with VIE structures in restricted or prohibited industries including BAT: Baidu, Alibaba and Tencent. The most recent version of the Negative List was issued on June 30, 2019. It establishes principles to create a more equal legal framework for foreign investors and to promote and protect foreign investment in China. January 2015 – China’s Ministry of Commerce (MOFCOM) drafted legislation preventing contractual obligations from dodging foreign-ownership laws. Since the FIL only prohibits the use of administrative means, there are still concerns that other methods could be used to force the transfer of technology. The vaguer terms of China's new foreign investment law has made it less likely that VIE-structured companies will be regulated by the government - a relief to Alibaba and Tencent. Awards. Alibaba Group Holding Inc., which conducted a $25 billion initial public offering (still the largest ever) on the … Alibaba is using a straightforward V.I.E. The structure is at odds with Chinese foreign investment legislation. Yahoo and Softbank then complained about the transfer, claiming that they were not notified nor approved the transfer. The review system implemented under the FIL will likely apply to all foreign investments as defined in Article 2. The tax uncertainty here is reminiscent of the situation prior to the tax-reform from the 2017 Tax Cuts and Reform Act in the United States. The importance of such VIEs to China’s GDP continues to increase. Investors in … 1 When it comes to VIEs and related contracts, the distinction is important. The Importance of Ownership of the Chinese Domestic Company. Online Event – A Conversation on Enabling Startups in the US-India Corridor during India Global Week 2020, Online Event – Key Insights on Navigating the Fundraising Activity During a Pandemic, Panel Discussion with Crypto Valley on Institutional Investors in Crypto & Blockchain. M&A is included in the scope of foreign investment. For example, it is unclear whether any changes will be made to the 2001 Management Regulations on Technology Import-Export which specifies that a Chinese licensee of foreign technology owns any improvements it develops and prohibit a foreign licensor from restricting the licensee’s use such of improvements. First, I am going to briefly discuss Variable Interest Entities (VIE) and how they are typically used in China. 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