Unilever, the European consumer group, and BYD, the Chinese carmaker backed by Warren Buffet, are among the issuers that have raised RMB funds in Hong Kong market through dim sum bonds since January.
While the sums involved are still small, the market's rapid growth - if maintained - could have big implications for how companies fund themselves, how investors access the renminbi, and ultimately for the future of the Chinese economy.
Dealmakers say dozens more companies are rushing to issue renminbi bonds in Hong Kong because the cost of funding there is ultra-cheap - hundreds of basic points lower than on the Chinese market. Beijing's strict capital controls mean that interest rates on renminbi debt, as well as the value of the renminbi against the dollar, can - and do - vary dramatically between the mainland and Hong Kong, a special administrative region open to international investors.
In the current financial environment in China, for many Chinese companies, there is a particular urgency to tap the offshore market, since interest rates have been rising on the mainland and banks have been told to rein in lending. The problem is that, mainland-incorporated companies are not allowed to issue dim sum bonds directly. So they have been structuring their deals in creative ways, typically using an offshore vehicle to issue the bonds while providing some form of guarantee from onshore to give comfort to investors.
Dacheng Law Firm Shanghai Office, with its team headed by its senior partner Wang Hanqi and acting as the PRC legal counsel of the Joint Lead Managers, recently successfully assisted Far East Horizon Limited, the issuer, an HKEx-listed company with its major business operations and subsidiaries based in China including Far East International Leasing Co., Ltd., in issuing RMB 1.25 billion of RMB dominated, 3.9 percent annually, 3-year bonds in Hong Kong. The proceeds are planned to be on-lent to the Issuer's PRC subsidiaries by way of intercompany loans.
There are several legal aspects regarding the above-mentioned deal structure, as popularly adopted in Dim Sum Bonds issued by mainland-incorporated companies, which are necessary to be addressed.
Necessary PRC Governmental Approval.
According to the Several Opinions of the General Office of the State Council on Providing Financial Support for Economic Development (Guo Ban Fa [2008] No.126) issued by the General Office of the State Council on 8 December, 2008, Hong Kong enterprises and financial institutions which have substantial business operations in mainland China, are permitted to issue RMB bonds in Hong Kong. Except for the aforesaid opinion, there is currently no other PRC laws or regulations specifically governing the issuance of RMB bonds in Hong Kong by Hong Kong enterprises.
Cross border remittance of RMB funds.
Under the current PRC foreign exchange system, foreign companies are allowed to remit funds in foreign currencies raised abroad to their PRC subsidiaries by way of shareholder's loan or capital contribution upon the approval of the PRC authorities. However, in terms of shareholder's loan in the currency of RMB by foreign companies to their PRC subsidiaries, there are currently no applicable PRC Laws. According to the Reply to the Instruction Request on Dealing with Loans from Foreign Non-financial Institutions by Domestic Industrial and Commercial Institutions (Yin Tiao Fa [1997] No.7) issued by the People's Bank of China ("PBOC"), loans from foreign companies by domestic enterprises, whether in renminbi or foreign currencies, will constitute external debts of the PRC, under which the loan and the interests thereof shall be approved in accordance with the relevant regulations. Therefore, the RMB loans between foreign companies and their PRC subsidiaries shall be approved by the relevant PRC authority. However, as mentioned previously, there are currently no applicable PRC laws as to the specific approval authority and approval procedure.
The current practice adopted by the PBOC regarding the above-mentioned approval is that the PBOC is empowered to review and approve such remittance of RMB inside and outside the PRC on a case-by-case and trial basis, and currently the necessary PRC governmental approvals in the above-mentioned case are the approval from the Clerical Office of the People's Bank of China to adopt renminbi to settle the shareholder loan from the proceeds of the bonds and the registration of the shareholder loan in the State's Administration of Foreign Exchange or its local branch. The Joint Lead Managers are all incorporated in Hong Kong and the bondholders of the bond are all Hong Kong or Singapore based institutional investors.
Taxation Issues.
PRC tax liabilities for the issuer incorporated in Hong Kong:
In the above mentioned case, the issuer has not been notified or informed by the PRC tax authorities that it is considered as a PRC tax resident enterprise for the purpose of Enterprise Income Tax Law, and the transaction documents (including the offering circular, the subscription agreement, the terms and conditions, and the fiscal agency agreement) are all executed in Hong Kong, therefore, no stamp or other issuance or transfer taxes or duties and no capital gains, income taxes or other taxes are payable to the PRC or to any political subdivision or tax authority thereof or therein by or on behalf of the issuer in connection with the creation, allotment and issuance of the bonds outside the PRC, the execution and delivery of the Transaction Documents, or the sale and delivery outside the PRC by the Joint Lead Managers of the Bonds to the initial purchasers.
However, pursuant to the new Enterprise Income Tax Law (the "EIT Law") and its implementation regulations, enterprises that are established under the laws of foreign countries and regions (including Hong Kong, Macau and Taiwan) but whose actual management organs are within the territory of China shall be PRC tax resident enterprises for the purpose of the EIT Law and they shall pay enterprise income tax at the rate of 25% in respect of their income sourced from both within and outside China. In the above-mentioned deal structure, there is a good chance that the issuer located in Hong Kong will be identified as PRC tax resident enterprises for the purpose of the EIT law if the actual management organs are within the territory of China. If the relevant PRC tax authorities decide, the issuer is a PRC tax resident enterprise for the purpose of the EIT Law and will be subject to enterprise income tax at the rate of 25% for its income sourced from both within and outside of PRC.
PRC tax liabilities for the non-PRC institutional bond holders of the bonds:
In the above mentioned case, the bondholders of the Bonds are all non-resident enterprises for the PRC EIT Law purposes, therefore such bondholders will not be subject to withholding tax, income tax or any other taxes or duties imposed by any of the PRC Government Agencies in respect of (i) any payments, including principal, premium, interests or other distributions made on the Bonds or (ii) gains made on sales of the Bonds between non-residents of the PRC consummated outside the PRC, unless the holder thereof is subject to such taxes in respect of such Bonds by reason of being connected with the PRC otherwise than by reason only of the holding of the Bonds or receiving payments in connection therewith as described in the Offering Circulars and the Transaction Documents.
By Wang Han Qi, Senior Partner at Dacheng Law Firm looks into the legal problems revolving around the offshore RMB-denominated bonds.
