An extract from The Acquisition and Leveraged Finance Review, 8th edition
Commercial banks are the primary source of debt finance in acquisition transactions. Trust companies and finance companies also play an important role in the debt financing market. Unsecured credit facility, secured facility, revolving facility for working capital purposes, bonds and convertible bonds are the most commonly used debt products. Mezzanine finance is commonly seen in China in innovative transaction. Hybrid debt-plus-securities instruments are also commonly arranged, under which companies can issue securities backed by the credit assets consisting of the debts arising out of a number of loans of multiple borrowers in the national inter-bank bond market or stock exchanges, and the qualified investors, thus, may be able to negotiate and trade these securities.
Private equity and venture capital (PE/VC) are other important sources of funding and are becoming more and more important in the acquisition market. However, PE/VC mainly provide equity finance since debt finance by PE/VC is limited in China.
Regulatory and tax matters
In China, an entity can only conduct lending business after obtaining the permit or approval from finance regulators, such as People's Bank of China, China Banking and Insurance Regulatory Commission (CBIRC) or finance regulation bureau of local government. Major market players in the debt financing industry are commercial banks, policy-oriented banks, trust companies, finance companies, lending companies and micro-lending companies, which should conduct business according to the applicable laws and regulations.i Acquisition finance
Commercial banks, policy-oriented banks, Chinese branches of foreign banks, finance companies of enterprise groups should comply with the Guidelines for Risk Management of Acquisition Financing by Commercial Banks (the Acquisition Finance Guidelines) promulgated by CBIRC in 2008 and amended in 2015. The Acquisition Finance Guidelines stipulate that the financing amount may not exceed 60 per cent of the total acquisition price of a transaction and the term of the loan may not exceed seven years.
According to the Acquisition Finance Guidelines, a lender conducting acquisition financing business must: (1) have sound risk management and an efficient internal control mechanism; (2) have a capital adequacy ratio of no less than 10 per cent; (3) meet applicable regulatory requirements in all of its other regulatory indices; and (4) have a professional team to conduct the due diligence and risk assessment of acquisition financing.
The Acquisition Finance Guidelines also set forth the requirements for the acquisition financier to maintain the internal control and risk management system, including:
- ensuring its aggregate outstanding amount of acquisition financing does not exceed its net tier-1 capital for the same period, and its aggregate outstanding amount of acquisition financing to a single borrower does not exceed 5 per cent of the net tier-1 capital for the same period;
- assessing the strategic, legal, regulatory, concentration, business, financial and regulatory risks of an acquisition transaction;
- reporting to the CBIRC the concentration limit on a per-borrower, group customer, industrial, national or jurisdictional basis;
- ascertaining the leveraged ratio of acquisition financing and ensuring reasonable funding by equity contribution;
- strengthening due diligence and post-lending loan management and supervision; and
- adding mandatory provisions in the facility agreement to protect the lender's right, such as the provisions on the lender's right to take risk control measures upon occurrence of material adverse change in the target group and the equity funding as a condition precedent to the disbursement of the acquisition financing.
The Guidelines for Syndicated Loan Business (the Syndication Guidelines), promulgated by CBIRC, stipulates the rights and responsibilities of the lead bank, agent bank and participating bank, form of syndication and documentation requirement. If a single bank acts as the lead bank, its commitments should not be less than 20 per cent of the total commitment, and the participating shares of the other members should not be less than 50 per cent of the total commitment.iii Anti-money laundering and anti-corruption compliance
As a member of the Financial Action Task Force, China is devoted to fighting against money laundering. The People's Bank of China (PBOC) is the key regulator of anti-money laundering. In addition to the Anti-Money Laundering Law, the Provisions on Anti-Money Laundering of Financial Institutions issued by the PBOC stipulates detailed requirements for financial institutions and certain non-financial institutions to comply with, including identifying a client's identity, preserving information about their clients and transactions, and reporting large transactions or suspicious transactions.
The Criminal Law establishes a criminal offence in relation to money laundering. The Supreme People's Court and the Supreme People's Procuratorate may issue guidelines on the application of criminal law to combat money laundering activities.
Anti-corruption is largely stipulated in the Criminal Law, Anti-unfair Competition Law and related regulations. There is no legislative guidance specifically applicable to financial institutions regarding the administration of anti-corruption matters.iv Tax
Interest on loans is taxable income, and unless otherwise stipulated by law, the taxable income of the enterprises is generally subject to 25 per cent of the corporate income tax in China. The overseas branch office (with no legal person status) of a Chinese resident bank is considered a resident of China for tax purposes. The income of the overseas branch office is taxable together with its head office, and no withholding tax is payable for the interest paid from a domestic institution to the overseas branch office, provided that, if the overseas branch collects the interest on behalf of a non-Chinese resident, the domestic enterprise is obligated to withhold income tax for the interest paid to the overseas branch. If the actual management organ of a Chinese enterprise's overseas subsidiary is located in China, the overseas subsidiary will be considered a Chinese resident as well.
Interest expenses are deductible against operating income of the borrower.
Unless otherwise stipulated in the tax treaties or other tax preferential treatment, a Chinese resident borrower should withhold corporate income tax at the rate of 10 per cent for the interest paid to the non-resident lender.
Financial institutions are subject to 6 per cent VAT for income accrued from the debt financing. A VAT exemption is granted if the loan is made to small or micro enterprises or self-employed households.
Parties to a loan agreement executed within the territory of China shall pay stamp tax at a rate of 0.005 per cent of the loan amount. If a loan agreement is executed outside China but will be used in China (e.g., for governmental registration or court enforcement), stamp duty will also be applicable.