how to structure your business in china moderator: angella castille – baker & daniels llp...

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 Mauritius

Shares in a company that holds principally immovable property in other jurisdiction


May be taxed in PRC


May be taxed in PRC

Shares in a company resident in other jurisdiction, representing a 25% or more interest (PRC companies)


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


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”)


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


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


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


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


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


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


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



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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


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


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


• Tier 3: Joint-Stock Commercial Banks “JSCBs” (12% market share)

– 11 banks– ownership: local governments, corporate investors,

the public


• 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


• 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


• Acquisition Structures– Equity purchase

• Indirect/offshore• Direct• Acquisition by FIE

– Asset purchase• Acquisition vehicle required

– Merger


• 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


• Acquisition of Domestic Entities– Private companies

• FIEs

– State-owned enterprises (privatization)• pre-approval required

– Listed companies• pre-approval required


• 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 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


• 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?





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


What is an acceptable price to both parties?




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



How should the deal be structured?

Does the deal present a compliance risk?


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






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






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






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?




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






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.





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


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


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


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


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


Happen.

Jackie SimmonsBaker & Daniels LLP


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


Happen.

J. Joseph TannerBaker & Daniels LLP


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


• 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


• Identify peer group to analyze results of testing and inspection

• Document decision making and testing process


• 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


• 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?


• 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.

how to structure your business in china moderator: angella castille – baker & daniels llp...

Documents

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