Country snapshot

Trends and climate
What is the current state of the M&A market in your jurisdiction?

China has an active M&A market. According to a September 2015 Thomson Reuters report, despite a slowdown in the third quarter the value of announced M&A involving Chinese companies reached a record high of $477.2 billion, surpassing that for 2014. According to an EY report, M&A involving companies in mainland China generated a total deal value of $247.6 billion in the first half of 2015 – the highest in 10 years – equivalent to an 88% year-on-year increase. Inbound M&A transactions were up 211% to $25 billion in the first half of 2015.

Have any significant economic or political developments affected the M&A market in your jurisdiction over the past 12 months?

In the past 12 months, the Chinese government has worked towards economic restructuring and reforms to confront the negative effects of economic slowdown, including Chinese state-owned enterprise reform, the ‘belt and road’ initiative, the ‘go out’ policy for Chinese enterprises, the establishment of free trade zones, monetary policy easing, renminbi internationalisation and exchange rate liberalisation, and the anti-corruption campaign. Many of these initiatives have had a positive effect on M&A and cross-border investment activity.

For example, recent Ministry of Commerce statistics show that in the first 10 months of 2015, overseas direct investment in 49 nations through the ‘belt and road’ initiative totalled $13.17 billion – up 36.7% year on year. The top investment destinations were Singapore, Kazakhstan, Laos, Indonesia and Russia. Meanwhile, new foreign-contracted projects in 60 countries along the route rose to $64.55 billion, up 21.6% from last year and accounting for 43.3% of China's overseas projects. At the same time, the Chinese government is also promoting the Asian Infrastructure Investment Bank, so-called ‘silk road’ funds and other financial institutions to support the global expansion of Chinese infrastructure projects, which also has had a positive impact on China’s outbound M&A market.

Another source of growth has been the establishment of the free trade zones. The eastern regions of China saw combined foreign investment of $88.41 billion in the first 10 months of 2015, an annual growth of 10.1%, as reforms deepened in China's free trade zones, according to the Ministry of Commerce. A total of 9,859 foreign-invested enterprises were set up along the Yangtze River economic belt, an annual growth of 7.8%. These companies constituted 47% of newly established foreign-invested enterprises in China.

Are any sectors experiencing significant M&A activity?

According to a September 2015 Thomson Reuters report, the high technology sector captured a majority of China's deal-making activity in 2015, with a 17.9% market share worth $85.3 billion, up 143.4% on the previous year and the highest first nine months ever in terms of value for high-tech M&A involving China.

Are there any proposals for legal reform in your jurisdiction?

On January 19 2015 the Ministry of Commerce released a draft of the new Foreign Investment Law for public comment. The draft law is intended to replace the existing laws governing foreign invested enterprises – if passed, it will mark a historic step in China’s reform and liberalisation. The draft law aims to establish a framework for the regulation and monitoring of foreign investment in the areas of market entry and ongoing compliance, while leaving the corporate form and governance issues to other legislation, such as the Company Law. Compared to the current regime, the draft law adopts a much broader definition of ‘foreign investment’ based on the ‘substance over form’ principle. In addition, it proposes a complete overhaul of the current pre-establishment approval regime governing foreign investment by replacing it with a market-entry review and an information-reporting regime. A negative list replicating the current practice in the China (Shanghai) pilot free trade zone would replace the decades-old case-by-case examination and approval system. An investor would only be required to obtain market-entry approval if the investment is in a sector on the negative list. Otherwise, the investor could simply report the establishment of or investment in the foreign invested enterprise. Another notable development is the codification of national security reviews as formal law. Many hurdles need to be cleared and a consensus built before the draft law can be presented to the Chinese legislature for its first formal legislative review. The whole process is likely to take at least two years.

Legal framework

What legislation governs M&A in your jurisdiction?

The primary governing legislation under the Chinese regulatory framework for private M&A involving foreign investors is the Regulations on the Merger and Acquisition of Domestic Enterprises by Foreign Investors, which was last revised in June 2009. In addition, the Provisions for Change of Investors’ Equities in Foreign Investment Enterprises apply if the target company is a foreign invested enterprise. The primary legislation involving public companies is the Company Law and the Securities Law, while key administrative rules include the Administrative Measures for the Takeover of Listed Companies and the Administrative Measures on Strategic Investment in Listed Companies by Foreign Investors. The merger control provisions of the Anti-monopoly Law and its related rules – such as the Provisions on the Reporting Threshold for Concentrations of Business Operators – which set out the thresholds that trigger merger notification requirements, are also relevant.

How is the M&A market regulated?

The procedures whereby a foreign investor can acquire a target in the People's Republic of China will vary depending on the location and the ownership structure of the Chinese party. In general, the acquisition will have to be approved by the Ministry of Commerce or its local counterpart depending on the target’s size and business, and other factors. For project-based targets such as manufacturing enterprises, verification by the National Development and Reform Commission or its local counterpart is additionally required before ministry approval. After approval, the transaction must be registered with the local bureau of the State Administration for Industry and Commerce within one month. The rules describing general approval authority vary in particular cases. The central government has promulgated a number of individual regulations, notices and policies with special rules for determining and delegating the approval authority for projects and transactions in certain sectors or industries. For example, sector-specific authorities (eg, the China Banking Regulatory Commission and the China Securities Regulatory Commission) are the primary regulator for their respective industries. Local authorities often publish individual rules to further refine delegation of approval powers within their localities. Accordingly, the precise approval authority for any given project, company or transaction can be determined only after careful consultation of all the relevant rules. Where applicable merger control thresholds are met, merger control filing and review requirements also apply. In addition, an acquisition of a target in certain industries may be subject to national security review requirements. Finally, special regulatory requirements apply to acquisitions of interests in or assets of state-owned enterprises.

For an indirect acquisition conducted offshore by acquiring equity in an offshore entity, the Chinese authorities generally have no jurisdiction over the transaction and it will, by and large, require no approval, except for the antitrust review and national security review procedures.

Are there specific rules for particular sectors?

Sector-specific authorities (eg, the China Banking Regulatory Commission and the China Securities Regulatory Commission) are the primary regulator for their respective industries.

Types of acquisition
What are the different ways to acquire a company in your jurisdiction?

A foreign investor wishing to acquire or increase its equity in a Chinese target would commonly do so through:

  • direct acquisition, where the foreign investor buys all or part of the equity of the Chinese target or directly subscribes for an increase in the target’s capital;
  • offshore/indirect acquisition, where the foreign investor acquires or increases equity of the Chinese target via the offshore purchase of or subscription for an increase in equity in the target’s foreign parent(s); or
  • asset acquisition, where a foreign investor, using a new foreign invested enterprise or an existing foreign invested enterprise as the acquiring vehicle, directly buys some or all of the Chinese target’s business and assets.

Western-style mergers between two or more companies are possible, but are rarely seen among foreign investors in China. Current Chinese statutory mechanisms recognise two means of merger: a merger by absorption and a merger by new establishment. A merger by absorption involves one company absorbing another, after which the absorbed company is dissolved and its registered capital and assets are merged into the surviving entity. In a merger by new establishment, both pre-merger companies are dissolved and a new company is established, holding an aggregate of the pre-merger companies’ assets and registered capital. Generally, the post-merger entity will be a complete successor to the pre-merger entities – that is, it will assume all rights and liabilities of those pre-merger entities. However, creditors of the participating companies may opt to have their claims repaid in full before the completion of the merger.

Cross-border mergers are currently unavailable under Chinese law – it is not possible to merge a foreign entity and a domestic company directly (including foreign invested enterprises). For foreign investors, the only permissible forms of mergers in China are between foreign invested enterprises and foreign invested enterprises, or between foreign invested enterprises and domestic companies.


Due diligence requirements
What due diligence is necessary for buyers?

Due diligence investigations remain an essential tool for assessing and reducing the risks inherent in M&A transactions in China. In the absence of complete knowledge of the operations, the scope of the assets and the extent of the liabilities of the target, due diligence investigations give the prospective buyer an opportunity to assess the target’s legal and financial affairs. They also facilitate consideration of structuring issues. Accordingly, thorough due diligence is vital in most M&As in China.

What information is available to buyers?

The concept of due diligence is relatively new to many Chinese targets. Many Chinese companies do not keep proper corporate or accounting books and records, and are used to concluding transactions without any pre-acquisition documentary review of target companies. As a result, foreign buyers may still find some Chinese parties reluctant to fully disclose information about the target. There have also been cases of lawyers, accountants and other business professionals being accused of violating China’s vague state secrets regime because they were closely inspecting certain financial and management records of Chinese state-owned enterprises. Document forgery can also be an issue when dealing with some Chinese parties. Generally, foreign investors and their advisers need a high level of patience, experience and diplomacy to carry out due diligence investigations up to international standards.

Parties should be careful of ‘gun-jumping’ restrictions under anti-monopoly laws, as underlined by the principle that business operators which are competitors should continue to act as such until the transaction completes. The extent to which this restriction applies will depend on the anti-monopoly laws applicable to the transaction.

The ability to do public searches on real property title, litigation, credit history or bankruptcy is quite limited in China, as the country is still developing national, searchable databases of such information. Intellectual property registrations are generally searchable.

What information can and cannot be disclosed when dealing with a public company?

Under the Securities Law, any person with non-public information that concerns the business operations or financial condition of a company or that may have a significant influence on the market price must not disclose it. In addition, the Administrative Measures for the Takeover of Listed Companies contain detailed reporting and announcement requirements.

How is stakebuilding regulated?

Under the Administrative Measures for the Takeover of Listed Companies, an investor whose shareholding reaches 5% or more of a listed company’s issued shares must make a written report to the securities regulator and the stock exchange, notify the listed company and make a public announcement within three days of acquiring that shareholding. During this period, the investor may not continue to buy or sell shares in the listed company. The investor must follow similar reporting and announcement procedures for each 5% increase or decrease in its shareholding in the listed company.


Preliminary agreements
What preliminary agreements are commonly drafted?

The initial phase of M&A transactions will ordinarily involve discussions between the seller and the buyer on the commercial and legal parameters for the transaction. Often, these parameters will be recorded in a heads of agreement, letter of intent or memorandum of understanding, which may or may not be legally binding.

Even if not expressed as legally binding, it is common for a period for exclusive negotiation to be agreed; and for the buyer to undertake confidentiality obligations (either as part of the letter of intent, or as a separate non-disclosure agreement) with respect to the information it will receive on the target.

Principal documentation
What documents are required?

Parties to a direct equity transfer transaction must enter into an agreement to transfer or subscribe for the target’s registered capital. The target’s articles of association (and the joint venture contract or shareholders’ agreement, in the case of a joint venture) will have to be amended or restated to reflect the changes. Where the transaction converts the target into a joint venture, a new joint venture contract or shareholders’ agreement is needed. The amendments or new corporate documents are reviewed by the approval authority along with the equity transfer or subscription agreement.

Other documentation required generally includes a unanimous board resolution of the target, consent from existing co-investors in the target and waiver of their pre-emptive rights to buy the equity transferred, or a unanimous shareholders’ resolution in case of acquisition of a domestic limited liability company. The approval authority may also require the parties to submit other documents for its review, such as bank letters evidencing the buyer’s financial soundness, board resolutions of the parties approving the equity sale, constitutional documents of the parties or other contracts or documents referred to in the transaction documents.

Under applicable rules and prevailing practice, all documents submitted for review and approval need to be in Chinese (with translations of essential documents from other jurisdictions). Officials can refuse to review documents not available in Chinese, delaying the approval process. The Regulations on the Merger and Acquisition of Domestic Enterprises by Foreign Investors require copies of the foreign investor’s constituent documents to be legalised or authenticated, and this may also be required for other documents.

Which side normally prepares the first drafts?

While there is no predominant trend, the buyer (and its legal counsel) will often prepare the first draft.

What are the substantive clauses that comprise an acquisition agreement?

According to the Regulations on the Merger and Acquisition of Domestic Enterprises by Foreign Investors, the equity purchase agreement shall consist primarily of:

  • information about the parties to the agreements (eg, their names and domiciles and the names, positions and nationalities of their legal representatives);
  • amount and price of equity purchase or capital increase subscription;
  • term and method of performance under such agreements;
  • rights and obligations of the parties;
  • liability for breach, and dispute resolution; and
  • time and place of such agreements.

Where a foreign investor is a party to the acquisition, it is commonplace to have an international style acquisition agreement, with comprehensive representations and warranties and other buyer protections.

What provisions are made for deal protection?

Deal protection provisions are not common. Exclusivity provisions are sometimes included in a memorandum of understanding, but these do not usually specify penalties for breach. Break fees are not common.

Closing documentation
What documents are normally executed at signing and closing?

The following documents are typically executed at signing:

  • the equity or asset purchase agreement;
  • amendments to the articles of association; and
  • shareholder or joint venture agreements.

The completion or closing requirements depend on the nature and structure of the transaction. For example, in a direct equity acquisition, transfer of the target’s registered capital is legally completed only after the relevant approval authority issues formal approval and requires registration with the local Administration for Industry and Commerce. Due to the timing required to complete these government approval and registration procedures, formal closing is rare in such deals. However, this requirement does not apply in an indirect equity acquisition or asset acquisition. In the case of state-owned equity transfers, the transaction will have to be completed at a property rights exchange. Subject to any applicable legal restrictions (eg, full payment of the purchase price within certain periods under the Regulations on the Merger and Acquisition of Domestic Enterprises by Foreign Investors), the parties are generally free to decide the appropriate milestones for closing or completion of the transaction

Are there formalities for the execution of documents by foreign companies?

For the purpose of government applications and filings, the foreign company must appoint an authorised representative, usually through a board resolution which may need to be notarised and legalised by the Chinese consulate in the local jurisdiction. The authorities will accept only documents signed by such designated representatives.

Are digital signatures binding and enforceable?

Yes, provided that they meet relevant requirements. They are not accepted for government applications and filings.

Foreign law and ownership

Foreign law
Can agreements provide for a foreign governing law?

The Regulations on the Merger and Acquisition of Domestic Enterprises by Foreign Investors require that Chinese law govern any equity or asset purchase agreement or capital increase subscription agreement relating to a Chinese target. The position is less clear with respect to the transfer of equity in a wholly foreign-owned enterprise between two foreign investors, but many practitioners take the view that Chinese law must also govern the transfer agreement. In the case of an indirect transfer conducted offshore by acquiring equity in an offshore entity, foreign law can govern the agreement.

Foreign ownership
What provisions and/or restrictions are there for foreign ownership?

The PRC Regulations for Guiding the Direction of Foreign Investment and the Catalogue for Guiding Foreign Investment in Industries serve as general indicators of current policy governing foreign investment in various industries. The catalogue is revised every few years to embody changes in Chinese foreign investment policy.

These documents provide certain policy incentives or disincentives depending on whether a project is deemed ‘encouraged’, ‘permitted’, ‘restricted’ or ‘prohibited’. An enterprise in the encouraged businesses category, for example, may qualify for local (and generally more lenient) approval processes. An enterprise conducting restricted activities, on the other hand, may be subject to additional scrutiny by higher approval authorities during the establishment process. A foreign investor cannot directly acquire a target that falls within the prohibited category. Foreign shareholdings are also limited in certain sectors and require foreign investors to establish a joint venture with a Chinese party, in some cases with the Chinese party holding a controlling share.

While Chinese government policies continue to restrict or prohibit foreign investment in many industries, there are now more encouraged industries and fewer restricted and prohibited industries than in the past. The Chinese government is also starting to remove many of the existing restrictions on foreign investment in the free trade zones that recently have been established in several cities. The liberalisation of these sectors will occur on a nationwide basis in due course.

Valuation and consideration

How are companies valued?

Most types of transaction require that the purchase price must, in principle, comply with the results of a valuation by qualified appraisers. With respect to acquisitions by foreign investors, if the target is not an existing foreign-invested enterprise, the parties must generally have the value of the equity appraised before the transfer. Internationally accepted valuation methods may be used, but prices manifestly lower than the appraisal result are prohibited.

If the acquisition involves a transfer of state-owned equity, whether the target is an existing foreign invested enterprise or not, the seller must appoint an asset appraisal institution. The appraisal results must be approved or registered by the state asset administration authorities and the transaction price must be based on those appraisal results. In general, the transaction price and the appraisal may not differ by more than 10%.

What types of consideration can be offered?

Depending on the type of transaction, the foreign investor may pay the purchase price in various forms, including currency and certain types of asset or property right.


General tips
What issues must be considered when preparing a company for sale?

Government approvals, first refusal rights of other shareholders and third-party consents (if applicable) should be considered. It is also advisable for sellers to conduct seller due diligence to identify any liabilities that must be disclosed or which may arise after closing and for which the seller may be liable.  Employee relations and communications should also be considered and handled carefully, as employee protests can hinder a deal in practice. The parties should also consider whether the transaction should be structured as a transfer of equity or assets in the company.

What tips would you give when negotiating a deal?

A company should make an effort to understand the motivations of its Chinese counterparty. State-owned entities may be driven by non-commercial factors (eg, policy and politics) and Chinese parties often have very different perspectives on pricing, creating a valuation gap between the parties. It is important to identify and cultivate direct channels to the ultimate decision makers, as the chief negotiator may not be the ultimate decision maker. 

Hostile takeovers
Are hostile takeovers permitted and what are the possible strategies for the target?

Hostile takeover bids are permitted in China. However, the ownership of most Chinese public companies is often controlled by small groups of shareholders, which can appoint and remove members of the company’s board of directors. Most companies are therefore unlikely to be subject to a hostile takeover bid and hostile takeovers remain rare in China.

Warranties and indemnities

Scope of warranties
What do warranties and indemnities typically cover and how should they be negotiated?

In private M&A transactions, warranties are typically quite comprehensive and extensive indemnities are sought in respect of liabilities found in due diligence. They are typically negotiated quite extensively.

Chinese targets and sellers sometimes resist these clauses, predominantly because they are not used to lengthy western-style representations and warranties.

The buyer’s own expectations as to the appropriate amount of representations and warranties will also affect these negotiations: buyers from common law jurisdictions typically want comprehensive and explicit representations and warranties, while buyers from civil law jurisdictions may rely more on statutory protections under Chinese law and demand fewer explicit representations and warranties.

Limitations and remedies
Are there limitations on warranties?

Limitations on warranties are common, including materiality and knowledge qualifiers, as well as limitations on liability for breach of warranties.

What are the remedies for a breach of warranty?

Under the Contract Law, if a party fails to perform its contractual obligations or its performance does not comply with the agreement of the parties, it shall be liable for breach – for example:

  • continued performance;
  • taking remedial measures; or
  • paying damages.

Typically, indemnity obligations and contractual damage claims are contemplated for breach of warranty.

Are there time limits or restrictions for bringing claims under warranties?

Time limits or restrictions for bringing claims under warranties are common, but these are negotiated on a case-by-case basis.

Tax and fees

Considerations and rates
What are the tax considerations (including any applicable rates)?

The seller in a share acquisition will be subject to enterprise income tax on capital gains at the applicable domestic rate, normally 25% if it is a resident enterprise or 10% if it is a non-resident enterprise and the gain is not connected with a permanent establishment in China. Each party is also subject to stamp duty at 0.05% of the contract value of the acquisition agreement.

If a foreign seller sells a Chinese company, real property situated in China or property owned by an establishment or place situated in China through an indirect share acquisition (ie, by selling the shares of the Chinese target’s overseas holding company), the seller of the shares may be subject to enterprise income tax in China on capital gains based on China’s indirect transfer rules through Bulletin 7. These rules have been effective since February 3 2015 and apply to indirect transfers that occur after February 3 2015 or that occurred before February 3 2015 where a tax determination has not yet been made. An indirect transfer generally will be recharacterised as a direct transfer if it lacks reasonable commercial purpose and does not fall within any safe harbours, and the buyer should be the withholding agent. If neither the withholding agent nor the offshore seller withholds or pays the taxes due, the Chinese tax authorities may impose a penalty, ranging from 50% to three times the amount of the unpaid tax, on the withholding agent.

The taxation of an asset acquisition is more complicated. The foreign investor needs to establish a Chinese company as the buyer of the assets from the Chinese seller (or use an existing Chinese company). The seller is subject to enterprise income tax on capital gains at its applicable rate (normally 25%) and may be subject to various transfer taxes (eg, value added tax (VAT), business tax and/or land appreciation tax) depending on the nature of the assets transferred. For general VAT taxpayers, the sale of tangible and moveable assets is generally subject to 17% VAT with input credit available, while the sale of used fixed assets purchased before January 1 2009 is subject to 2% VAT without input VAT credit. Under the VAT pilot programme, the sale of intangible assets is normally subject to VAT at a reduced rate of 6%, while the transfer of technology (ie, patents and know-how) is VAT exempt. For small-scale VAT taxpayers, VAT will be collected at the rate of 3% without input VAT credit. Transfer of immovable properties is subject to business tax at the rate of 5% on the gross proceeds. Land appreciation tax is levied on gains realised from real property transactions at progressive rates from 30% to 60%, based on the land value appreciation amount, which is the excess of the consideration received from the transfer or disposition of real property over the total deductible amount, which mainly consists of the original cost of the land and the cost of improvements. The buyer is subject to deed tax at a rate of 3% to 5% if it acquires real property. Both parties may also have to pay stamp duty at either 0.03% or 0.05%, depending on the type of dutiable instruments.

Exemptions and mitigation
Are any tax exemptions or reliefs available?

Notice 59 special tax treatment
Notice 59 (2009) offers special tax treatment (ie, without triggering enterprise income tax liability) to corporate reorganisations provided that all the following conditions are met:

  • the reorganisation has reasonable commercial purposes and the reduction, exemption or deferral of taxes is not its main purpose;
  • at least 50% of the total assets or shares of the target is transferred;
  • the key business activities remain unchanged within 12 months of the reorganisation;
  • at least 85% of the total consideration is paid in equity; and
  • the original main shareholder receiving the equity consideration does not transfer the equity interest within 12 months of the reorganisation.

In order for a cross-border share or asset acquisition to qualify for the special tax treatment, one of the following scenarios must exist:

  • a non-resident enterprise transfers shares of a resident enterprise to another non-resident enterprise over which the transferor has direct 100% share control, this transfer does not change the withholding tax burden on capital gains to be derived from the transferred shares in the future and the transferor undertakes in writing to the competent tax bureau that it will not transfer the shares of the transferee that it receives as consideration within three years of the reorganisation;
  • a non-resident enterprise transfers shares of a resident enterprise to another resident enterprise over which the transferor has direct 100% share control; or
  • a resident enterprise invests assets or shares in a non-resident enterprise over which it has direct 100% share control.

Tax-free internal transfers
Aside from Notice 59, tax-free treatment is available for the internal transfer of equity or assets between two Chinese resident enterprises under Notice 109 (2014) and State Administration of Taxation Bulletin 40 (2015). The following four types of tax-free internal transfer are covered by Notice 109 and Bulletin 40:

  • The transfer of equity or assets by a parent company to a directly 100%-owned subsidiary where the parent receives from the subsidiary equity consideration equal to the net book value of the transferred equity or assets (ie, the parent's long-term equity investment in the subsidiary is increased by the net book value of the transferred equity or assets while the subsidiary's paid-in capital, including capital surplus, is increased by the net book value of the transferred equity or assets, and the parent's tax basis for the equity received from the subsidiary is determined by the original tax basis of the transferred equity or assets).
  • The transfer of equity or assets by a parent company to a directly 100%-owned subsidiary where the parent receives neither equity nor non-equity consideration (ie, the parent's paid-in capital, including capital surplus, is decreased by the net book value of the transferred equity or assets, while the subsidiary's paid-in capital, including capital surplus, is increased by the net book value of the transferred equity or assets).
  • The transfer of equity or assets by a directly 100%-owned subsidiary to its parent company, where the subsidiary receives neither equity nor non-equity consideration (ie, the parent's long-term equity investment in the subsidiary is decreased by the net book value of the transferred equity or assets, while the subsidiary's paid-in capital, including capital surplus, is decreased by the net book value of the transferred equity or assets, and the parent's tax basis for the long-term investment in the subsidiary is decreased by the net book value of the transferred equity or assets).
  • The transfer of equity or assets between two subsidiaries that are directly 100%-owned by the same Chinese parent company or companies in which the transferor receives neither equity nor non-equity consideration (ie, the owner's equity in the transferor's accounting books is decreased by the net book value of the transferred equity or assets while the transferee's paid-in capital, including capital surplus, is increased by the net book value of the transferred equity or assets).

Due to corporate law considerations, a tax-free internal transfer must be conducted via corresponding capital increase, capital reduction, distribution or a combination thereof. In addition, the scope of Notice 109 and Bulletin 40 is limited and applies only to internal restructurings conducted between Chinese resident enterprises. 

Safe harbours for indirect share acquisitions
For indirect share acquisitions, several safe harbours are available, under which no liability for Chinese enterprise income tax should arise.

The internal restructuring safe harbour applies if all the following conditions are met:

  • the transferor directly or indirectly holds at least 80% shares in the transferee or vice versa, or another party directly or indirectly holds more than 80% shares in both of them (the threshold will increase to 100% if the target is a land-rich company);
  • the Chinese tax burden on any subsequent indirect transfer would not be less than that on the same or a similar indirect transfer if it were conducted before the indirect transfer in question; and
  • the transferee pays all consideration in equities (exclusive of equities in listed enterprises) of the transferee itself or its controlled enterprises.

In addition to the internal restructuring safe harbour, there are two other safe harbours – namely, the treaty safe harbour and the open market trading safe harbour. Under the treaty safe harbour, no Chinese tax liability should arise if the relevant direct transfer would be exempt from Chinese tax under an applicable tax treaty. Under the open market trading safe harbour, if the non-resident enterprise buys and then sells, in the same public securities market, the equity interests in a single foreign listed company, such indirect transfer should not give rise to Chinese tax liability.

What are the common methods used to mitigate tax liability?

Previously, an offshore share acquisition was a common method to mitigate Chinese tax liability. Until 2008 such acquisitions did not trigger Chinese tax liabilities. However, the indirect transfer rules, issued under Notice 698 in December 2009 with retroactive effect from January 1 2008, have significantly changed the situation. Notice 698 has been replaced with Bulletin 7, with effect from February 3 2015, but it applies to indirect transfers that occurred before February 3 2015 where a tax determination has not been made.

Since 2008 an offshore share acquisition would be typically subject to 10% Chinese withholding tax if the offshore companies have little to no substance.

What fees are likely to be involved?

No fees apply other than any legal fees.

Management and directors

Management buy-outs
What are the rules on management buy-outs?

The Administrative Measures for the Takeover of Listed Companies contains provisions in respect of management buy-outs. In addition, the State-Owned Assets Supervision and Administration Commission and the Ministry of Finance issued the Interim Provisions on the Transfer of Enterprises’ State-Owned Property Rights to the Management Stratum in 2005.

Directors’ duties
What duties do directors have in relation to M&A?

The Administrative Measures for the Takeover of Listed Companies requires that the directors, supervisors and senior management personnel of a listed target are loyal and diligent towards the company and treat all acquirers that take over the company fairly. The decision made by the board of directors of the target in respect of a takeover shall be beneficial to the safeguarding of the interests of the company and its shareholders. The board shall not:

  • abuse its official powers to create inappropriate obstacles for a takeover;
  • use company resources to provide any form of financial assistance to the acquirer; and
  • undermine the legitimate rights and interests of the company and its shareholders.


Consultation and transfer
How are employees involved in the process?

Consultation with the union
The company should consult the labour union if the employees’ immediate interests will be affected by management decisions taken as part of the transaction. These consultation requirements are vaguely worded, with no details provided regarding the timing or procedures of such consultations. More importantly, no penalties are specified in any of the relevant laws and regulations, so in practice private enterprises rarely, if ever, follow the consultation requirements. There is a theoretical possibility that any decision taken without following the necessary consultation procedures can be challenged and invalidated, although in practice this has never occurred.

Consultation with the employee
In an asset deal, another issue that a seller may face is how to handle an employee who is not transferred to the purchaser, either because the purchaser does not wish to hire him or her or because he or she refuses to transfer. The seller must decide whether it wishes to retain and potentially redeploy the employee within the company, or to terminate him or her.

The seller generally has only two options if it wishes to terminate the employee or he or she refuses to take an alternative position at the seller: mutual termination or unilateral termination.

Before an employer can unilaterally terminate an employee based on a major change in circumstances, the seller must consult with the employee about amending the employment contract in order to continue the employment relationship. Sellers frequently overlook this step, but termination on this basis is unlawful unless such consultations fail to produce an agreement.

Unfortunately, there is no national guidance as to how long the consultations must last or the form that they should take. Employers must check whether the relevant local regulations offer any guidance. For example, in Beijing, an employer wishing to amend an employment contract based on a major change in objective circumstances must send the affected employee a written notice of request to amend the current employment contract terms. The employee has 15 days in which to respond, and if he or she fails to do, the amendment request is deemed to have been refused.

If the seller wishes to lay off 20 or more employees, or the number to be laid off is less than 20 but accounts for 10% or more of the total workforce, a separate termination ground with its own procedures applies. The seller shall explain the situation to the labour union or to all employees 30 days in advance and after soliciting the labour union or employees' opinions should submit the lay-off plan to the local labour bureau (the labour bureau's requirements may vary by locality, and the record of consultation with the union or the employees may need to be submitted).

What rules govern the transfer of employees to a buyer?

The rules on employee transfers and their ramifications vary depending on whether the transaction is a merger or an acquisition, and on the nature of the target.

Equity acquisition
As a Chinese legal matter, equity acquisitions do not trigger transfers of employees as there are no changes to the target’s (ie, the employer’s) structure. However, in practice, many acquisitions are followed by further corporate restructurings, which may lead to employee transfers or terminations.

Asset acquisition
Based on the existing legal framework, a transfer of assets carries no obligation to transfer any employees. If the parties to an asset acquisition wish to transfer relevant employees to the buyer, the existing employment relationship must first be terminated (either by employee resignation or mutual agreement), and the employee must then sign a new employment contract with the buyer. In other words, there is no automatic or direct transfer of employees between two separate entities, and employees may be transferred only through termination and rehire. In an asset acquisition a transferred employee is entitled to severance pay as a result of the termination of his or her employment with the seller if the termination is done by way of mutual agreement. In practice, most employees are willing to waive their right to severance if the buyer agrees to count the transferred employee’s previous years of service with the seller when calculating severance pay for any subsequent termination.

In a merger, all employees’ employment contracts will automatically be transferred to the post-merger entity and employee consent would not be necessary provided that they keep working under the existing employment contract terms. Provided that the employees continue to work for the post-merger entity, the merger does not trigger a severance payment liability.

In general, employee consent would be required to amend or renew employment contracts after the merger (if and when any proposal to renew or amend is raised). However, under certain circumstances, the post-merger entity may be able to terminate certain redundant employees unilaterally following a merger. In that case, the post-merger entity will have to make severance payments.

Special rules for state-owned enterprises
Special rules apply to state-owned enterprise equity and asset acquisitions. When a foreign investor acquires a controlling interest in a state-owned enterprise and this is reorganised as a foreign-invested enterprise, or the foreign investor acquires a state-owned enterprise’s main business assets and uses them to establish a foreign-invested enterprise, an employee resettlement plan must be prepared and approved by the state-owned enterprise’s employee representative council. The plan must also be submitted to the approval authorities and included in the transfer agreement. The state-owned enterprise must use its existing assets to pay outstanding wages, non-refunded pooled contributions and unpaid social insurance premiums.

It must also pay severance payments to employees who are not retained and must make lump-sum payments of the required social insurance premiums for employees who are transferred to the local social insurance authority. The funds for these payments are to be deducted from the net assets of the state-owned enterprise or on a priority basis from the proceeds of the sale.

What are the rules in relation to company pension rights in the event of an acquisition?

In China, pensions are one of the five mandatory types of social insurance (the others are medical insurance, maternity insurance, work-related insurance and unemployment insurance). In an asset acquisition, when the employee's employment relationship with the seller is terminated, the seller should transfer the employees' social insurance account to the new entity that hires the employee within 15 days of termination. More specific requirements will vary by locality. In some cities the transfer would be done online and the seller need only delete the terminated employee from the company's social insurance account.

There are no mandatory rules for dealing with the seller’s commercial (non-mandatory) insurance for its employees on termination; therefore, it is subject to the agreement reached by the employees, the seller and the buyer.

Other relevant considerations

What legislation governs competition issues relating to M&A?

The 2008 Anti-monopoly Law and its related legislation govern competition issues relating to M&A.   

Are any anti-bribery provisions in force?

Yes, the primary pieces of legislation include:

  • the Criminal Law (1979, as amended);
  • the Anti-unfair Competition Law (1993); and
  • the Interim Provisions on the Prohibition against Commercial Bribery Acts (1996).

What happens if the company being bought is in receivership or bankrupt?

With respect to a company undergoing restructuring as a result of bankruptcy, during the restructuring period the company's directors, supervisors and senior management personnel may not transfer the equity of the company held by them to a third party, unless this is consented to by the court.