The ultimate goal of dismantling a red chip is to return the equity of the offshore listed entity to the domestic listed entity. At its core is an adjustment in the equity structure of one or more companies, and common ways of doing this include equity transfers, capital increases, share buybacks and exchanges.
An adjustment to the capital structure may involve ODI, FDI, capital increase of a foreign-invested enterprise, and capital transfer, among others. The critical question in assessing decommissioning compliance and the key point in an IPO review process is both whether the required approval procedures have been completed. In both scenarios, companies need to ensure that they address these issues in a timely manner.
While ensuring compliance, the design of legal procedures should give way to business benefits. That is, legal procedures must be appropriate to adhere to the principle of maximizing business benefits for the client – and it is with this mindset that a qualified business lawyer must operate.
Since dismantling a red chip does not bring direct economic benefits to a business, consideration of business benefits primarily means how costs are reasonably controlled. The main costs include finance, time, tax and the tax base. Only by planning a reasonable cash flow path in light of the actual project circumstances, after balancing the costs mentioned above, can the benefits to the client be maximized.
Financing costs. Typically, a business is required to pay the consideration for the transaction, making the cost of using funds one of the key factors to consider. Lawyers must take into account the funding capabilities and funding costs of the business when adjusting the design of the plan backwards. If a company has funds that can be used for decommissioning, it can reduce the costs of using the funds. For example, if the proceeds from a previous fundraising exercise have not been used, it can be used to pay a consideration and thus contribute to the flow.
Time costs. If the company does not have strict timing requirements, and provided that the flow of funds is a closed loop (its starting point and ending point are the same, and the amounts are essentially matched ), fundraising costs can be reduced by arranging for funds to flow multiple times. On the other hand, if there is a strict schedule, it can shorten the time required for the dismantling of the red chip by completing the flow of funds in one go, which is usually only achievable with a large bridging loan.
Tax costs. The transaction taxes at each stage are the central issues in the design of the plan. Transaction taxes are subject to many factors, such as net assets and historical transactions, which means transaction prices and tax costs vary across different plans. Special attention must be paid to these factors in each subsidiary of the company to formulate a transaction plan and thus reduce tax costs.
Loss of tax base. For a private company, when dismantling a red-chip structure, there are no mandatory laws or regulations that require it to have its own funds assessed when it returns to China, or whether they are assessed at such a level if an assessment took place. The business is free to set its own prices for transactions, but taxes on them must be paid based on the valuation determined by the tax administration. There may be a difference between the consideration paid and the valuation reported for tax purposes.
However, the problem that arises when a transaction is carried out at a price lower than the market price is the loss of tax base, in particular because the valuation is generally higher when investors enter in the last round of financing, so that, if a transaction is subsequently carried out at a low price, investors are likely to suffer a significant loss of tax base and incur higher tax costs in the future on the sale.
Planning of fund flows. As the execution of legal proceedings for the dismantling of a red chip is not conditioned on the realization of the flow of funds, the legal proceedings and the flow can be planned and implemented independently of each other.
The clearance of debts and liabilities should also be considered. Once a company has completed setting up a red chip structure, if the proceeds collected by the offshore listed entity are loaned to operational entities through offshore shareholder loans, clearance should be considered. timely receivables and liabilities relevant at the time of cash flow planning. Failure to do so will mean that offshore entities will continue to have claims against domestic operating entities – and cannot be written off and liquidated – after the red-chip structure is dismantled. This will also lead to the problem of the remaining related party transactions that were not fully ceded during the IPO application.
When designing a dreaded decommissioning plan, it is necessary – taking the curve of the flow of funds in a ‘closed loop’ as a guide – to design a set of appropriate legal steps and procedures to enable the company to make the payment in installments. or to flexibly select the currency of the bridging funds, in order to maximize the benefits for the client.
Designing a dreaded decommissioning plan is the art of balancing legal compliance with business benefits. It involves a series of tasks, such as designing legal procedures, planning the flow of funds, pricing transactions, estimating tax costs, clearing claims and liabilities. Each factor constrains and affects the others, so changing one condition will result in a substantial change in the plan as a whole. Lawyers must take into account the specific characteristics of the project itself and, in terms of compliance, reducing tax costs, avoiding loss of tax base, reducing funding pressures and ensuring the timing of the project. project, seek a point of equilibrium in accordance with the expectations of the client and the interests of investors and satisfies the time requirements of the request.
It should be noted that since SOEs must comply with regulations relating to state-owned assets, they have less flexibility than private companies in the design of schemes. Special attention is required and each project must be treated on a case-by-case basis.
Wei Pei is a senior partner at Jia Yuan Law Offices. He can be reached on +86 755 8278 9766 or by email at [email protected]
Ai Yongtao is an associate at Jia Yuan Law Offices. He can be contacted by email at [email protected]