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Draft foreign investment law aims to clarify status of VIE

Reprinted from Chinadaily

On Jan 19, the draft of China's Foreign Investment Law was released for a public comment period that runs until Feb 17. An official explanation was also released that highlights the key points for interpretation.

 

One of the most significant changes in the draft legislation is the adoption of a de facto review of the variable interest entity, or VIE, structure of corporate ownership. This is a workaround structure that is used by foreign and Chinese investors in many industries where foreign direct investment is restricted or prohibited in China.

 

The current draft legislation states that domestic entities controlled by foreign investors must be engaged in non-prohibited industries. Previously, VIE structures were used to enable foreign investors to invest in almost any industry, even prohibited ones.

 

The VIE structure is also called the Sina Structure, because it became well-known after Sina Corp's 2000 listing. Under a VIE structure, a Chinese entity holding all the necessary licenses to operate a business in a restricted or prohibited industry is de facto controlled by a wholly foreign owned enterprise through contractual arrangements.

 

The profits of the domestic entity flow back to the controlling WFOE or joint venture. This arrangement enables foreign investors to engage in Chinese industries that they would otherwise be excluded from by law.

 

The VIE structure was never expressly prohibited or sanctioned under Chinese law. However, it has been widely used by foreign investors despite its ambiguous legal status. There has never been an express prohibition or any other legislation seeking to regulate the VIE structure until the draft Foreign Investment Law was released.

 

The draft law tries to address this legal ambiguity by requiring the identification of the de facto owner of the domestic entity engaging in the business operations for the VIE. Contractual or trust arrangements and other VIE structure arrangements are prohibited to circumvent relevant foreign investment restrictions.

 

Under Article 158 of the Draft Legislation and Section (iii) of Chapter 3 of the Draft Explanation, current VIE structure arrangements are subject to review by foreign investment authorities. The nature of control and who receives beneficial interests are factors in the final assessment of the identity of the de facto investor behind the VIE.

 

Different approaches are provided in different scenarios. For example, the VIE structure can be kept intact without interfering with its normal operation if the de facto investor is (or is determined to be) a domestic Chinese party.

 



 
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