Mergers & acquisitions support in China.

M&A is a major component of the new wave of foreign investments recently flowing into China. There are two essential choices for foreign companies interested in investing in M&A with domestic companies: direct and indirect M&A.

The indirect method is self-explanatory, and occurs when a foreign investor invests in another company outside of China, using that company to own parts of a Chinese firm. Most deals are done in an indirect M&A method; however, this method has many disadvantages. While indirect investment may be suitable for foreign companies who have already had a considerable presence in the Chinese market, it may be inapplicable for companies who have not entered the market yet, and want to maintain a market share for only a short period of time.

A foreign company owned by foreign investors could purchase the equity of shareholders of non-foreign investment enterprises in China or subscribe to additional capital of domestic companies to convert such domestic companies into foreign investment enterprises. This process is called equity acquisition. Another method is that a foreign company could purchase the assets of domestic companies by foreign investors through an agreement and invest such assets to provide foreign enterprises for operation of such assets, which is defined as assets acquisition. These two methods are direct M&A, which are able to enter the market in a short period of time. Currently, there are extremely strict laws and rules for its permit in China.

There are eight major supporting legal documents for M&A through FIEs:

1. Provisions on Merger and Acquisition of Domestic Enterprises by Foreign Investors (2009)
2. Anti-monopoly Law (2008)
3. Measures for Strategic Investment by Foreign Investors upon Listed Companies (2005)
4. Using Foreign Investment to Reorganise State-owned Enterprises Tentative Provisions (2003)
5. Issues Relevant to the Transfer of State-owned Shares and Legal Person Shares in Listed Companies to Foreign Investors Circular (2002)
6. Interim Rules on the Domestic Investment by FIEs (2000)
7. Rules on Merger and Division of FIEs (1999)
8. Regulations on Changing Investor’s Shares Right in the FIEs (1997)

Mergers & acquisitions deals may take the form of either;

1. The purchase of equity or assets of an existing company.
2. Share swaps
3. A merger of two or more business entities by way of cash or shares, or
4. A combination of (i), (ii) and (iii).

This would depend on many factors. For example, if a foreign investor already has a reliable business associate in China, the foreign investor may wish to consider entering into a merger with the existing entity. The advantages of a merger with a local counterpart are, among others, ready local knowledge and channels to penetrate the local market and the comfort of having one less competitor in the market while the existing business continues.

In some instances, the foreign investor may worry about the hidden liabilities in the target company. Under these circumstances, the foreign investor may be reluctant to enter into a merger with the target company but wish to purchase only the assets of the target company. Therefore, the foreign investor may form a separate entity and thereafter acquire the assets of the local company through the newly formed entity. An asset deal enables the foreign investor to acquire only the viable assets without having to take over the accumulated debts and liabilities of the local entity.

According to the Notice of the Ministry of Finance and the State Administration of Taxation on Enterprise Income Tax Treatment of Enterprise Reorganisation Caishui [2009] No.59, as a general proposition, the relevant tax treatments of merger are as follows:

1. The merging enterprise shall determine the tax basis of assets and liabilities received from the merged enterprise(s) in accordance with the fair market value.
2. The merged enterprise and its shareholders shall follow the enterprise income tax treatment of liquidation.
3. The tax losses of the merged enterprise shall not be carried over to or be utilised by the merging enterprise.