What is the VIE structure?
The China VIE Structure (Variable Interest Entities) is a contractual option. Where a wholly or partially foreign-owned entity enters into contracts with a Chinese company operating in PRC in the sector subject to foreign-investment restrictions or prohibitions, with the adequate business scope and licenses.
The interest for VIE structures came from the constraints imposed by the Chinese government regarding foreign investment structures. Indeed, in some sectors, it is made mandatory by the Foreign Investment Catalogue, Negative List and sector-specific regulations, to establish a business with a Chinese partner. Moreover, many joint ventures set up in the past faced many difficulties with their Chinese partners.
Therefore, where an investment is subject to restrictions, foreign investors have used a VIE structure to access to the Chinese market.
The VIE structure was adopted especially in the sectors of e-commerce. But also direct sales, and telecommunication that require certain approvals from authorities. Well-known listed companies are using a VIE structure. For exemple, as the online media company Sina Corp, or internet companies such as Alibaba (delisted from the HKEx in 2012), Baidu, Ctrip, Youku and Tencent.
The VIE structure might be considered as a “foreign investment enterprise”. In accordance with the New Foreign Investment Law promulgated on 15 March 2019. And consequently shall abide by the rules promulgated under the New Foreign Investment Law.
How is the China VIE structure organized?
The VIE structure is organized by three main elements:
- The domestic company with necessary licenses and adequate business scope to operate in China in the sector in which the foreign investment is restricted or prohibited;
- A consulting WFOE with the foreign investor as the sole shareholder;
- Contractual elements enabling the foreign investor to monitor the activities of the domestic company. Also allows to recover the profit made by the domestic company through the consulting WFOE. As well as to protect itself against any actions by which the nominee would try to get out of his purely passive role.
Examples of agreements granting effective control over the VIE: call option agreements, voting rights agreement or proxy, loan agreements.
-> This article may be of interest to you : Franchise in China : Contractual Options
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