PRC laws do not leave door open for a foreign investor when determining the purchase consideration in a M&A transaction. When foreign investors acquire a purely domestic company in China, they should comply with the requirement of Rules on Acquisition of Domestic Company by Foreign Investors(“M&A Rules”) on purchase consideration.
Article 14 of M&A Rules says the parties to an acquisition shall determine the transaction price on the basis of the value of the to-be-transferred equity or the value of the to-be-sold assets to as appraised by an asset appraisal institution. The parties to the acquisition may agree on an asset appraisal institution lawfully established in China. The asset appraisal shall be conducted in accordance with common international appraisal methods. The use of a price markedly lower than the appraisal results to transfer equity, sell assets or to transfer capital overseas in a disguised manner is prohibited.
In light of the foregoing, the foreign investors have no much flexibility in determining purchase price when acquiring a purely domestic company. However, if foreign investors acquire a foreign-invested enterprise (“FIE”), the aforesaid Article 14 should not be triggered.
According to PRC laws, M&A Rules should not govern a M&A transaction in which foreign investors acquire a FIE in China, and, other regulations, which cover equity transfer matter in a FIE, also do not put off-limits on the determination of purchase consideration. Thus, the parties to such kind of acquisition may, technically, determine the purchase consideration based on their negotiation result, other than the appraisal result.
However, if parties to acquisition determine purchase consideration as USD 1, it would be challenged by local authority. Based on our experience in M&A transaction in China, we would like to point out that in practice, local authorities, which are in charge of examine and approve equity transfer in a FIE, will review the balance sheet and profit and loss statement of target company, and, if the consideration(such as USD 1 as purchase consideration) is markedly lower than the value of to-be-transferred equity as stated in the balance sheet and profit and loss statement of target company, some local authorities might request the parties to the acquisition to adjust the consideration to the extent that the consideration is in line with the value of f to-be-transferred equity as stated in financial statements of target company.
We have several precedents where the local authority requested our client to adjust purchase consideration while acquiring a FIE, and, even if the examination and approval authority gave a green light to our client for the original purchase consideration, the local tax authority request our client to adjust purchase price because they hold view that USD 1 of consideration will understate tax exposure and therefore violate pricing policy in China.
Thus, foreign investors should be very careful in dealing with purchase consideration issue. They should consult with an experienced lawyer so that they would not have a cloud hanging over their head.
By Adam Li