On August 11, 2008, the Financial Services Office of Shanghai Municipality, the Shanghai Administration for Industry and Commerce, the State Taxation Bureau of Shanghai Municipality and the Local Taxation Bureau of Shanghai Municipality jointly issued a Circular on Business Registration of Equity Investment Firms in Shanghai (the “Circular”). The Circular grants for the first time legal status to foreign private equity firms in Shanghai; no regulations on business registration for equity investment firms existed previously. This measure is a significant part of the Shanghai Municipality’s efforts to attract equity investment into Shanghai and build the municipality into an equity investment industry center and international financial hub. Beijing and Tianjin municipalities also aim to be China’s key equity investment industry center, thereby forming a three-pronged competitive pattern for the country’s equity investment industry.

The Circular’s main provisions define the principles and objectives for developing equity investment firms, and specify the qualifications, business registration requirements and tax treatment for equity investment and equity investment management firms in Shanghai. The Circular defines an “equity investment firm” as a legally established firm that principally engages in equity investments and defines an “equity investment management firm” as a firm that principally engages in the management of equity investments as entrusted by equity investment firms.

If firms with equity investment business have registered with the Shanghai Industrial and Commercial Authority before the Circular’s release, those firms may apply for changes in compliance with the Circular.

The Circular requires equity investment firms and equity investment management firms to pay taxes as required by the Enterprise Income Tax Law and the Individual Income Tax Law. For equity investment firms and equity investment management firms that are established in the form of limited partnerships, partners must pay income tax on their operating profits and other profits, respectively, in accordance with laws and regulations. A general partner who is a natural person and the executive of the limited partnership must pay individual income tax under the taxable item “income from production or business operation conducted by self-employed industrial and commercial households” on a progressive tax rate scale that ranges from 5 to 35 percent. A limited partner who is a natural person but not an executive of the limited partnership firm must pay individual income tax under the taxable item “interest, dividends and bonuses” at a rate of 20 percent for the equity investment gains. Shanghai’s Vice Mayor, Tu Guangshao, indicated that these tax treatments are preliminary incentives aimed at attracting equity investment, and that the government will further amend and improve the Circular’s tax and other measures going forward.

With China’s rapid economic and capital market growth, demand for private equity funds has increased significantly; however, a lack of nationwide regulations on business registration has posed substantial regulatory hurdles for equity investment firms’ business operations and deterred further capital market development. With the Circular in place, the Shanghai government will grant legal status to equity investment firms, especially those foreign firms which formerly had only a consultancy service or representative office in China. The move will help create an enabling environment for the growth of equity investment in Shanghai and widen financial channels for small and medium-sized enterprises. In the long-term, it will also promote Shanghai’s transition to an equity investment industry center and an international financial hub for China and Asia.