Yes.  Foreign investors may establish a foreign-invested RMB Fund as a foreign-invested venture capital enterprise ("FIVCE") under the 2003 Measures on the Administration of Foreign-invested Venture Capital Enterprises ("FIVCE Rules").  Additionally, it is possible to establish a foreign-invested RMB Fund as a foreign-invested partnership ("FIP") under the recently promulgated Measures on the Establishment of Partnership Enterprises of Foreign Individuals (the "FIP Measures") and the Regulations for the Administration of the Registration of Foreign-invested Partnership (the "FIP Registration Measures", and together with the FIP Measures, the "FIP Rules"). 

However, with respect to a RMB Fund formed as a FIP, additional implementing regulations and regulatory guidance will be needed before FIPs become a practical vehicle for RMB Funds.  Among other things, the FIP Rules do not provide any regulations regarding a FIP RMB Fund's downstream investments, including whether the fund would be subject to the 2007 Catalogue Guiding Foreign Investment (the "2007 Catalog") (although we believe it will be), and if so, what approvals or filings would be necessary to make such investments.  Further regulations will hopefully clarify these and other issues.

In addition, foreign investors have been able to establish RMB Funds in Tianjin under the so-called "Tianjin Model", whereby a wholly foreign owned enterprise ("WFOE") may act as a partner (general or limited) in a RMB Fund.  The resulting RMB Fund is a domestic partnership established under the 2007 Amended Partnership Enterprise Law (the "PRC Partnership Law") and is afforded a certain level of "national treatment" (i.e., generally is not subject to the 2007 Catalog).  Such funds have been permitted to invest in traditionally restricted or prohibited categories, such as real estate (but with certain carve-outs for sensitive industrial sectors, such as those related to military and defense), on the same footing as a purely domestic RMB Fund; i.e., without the approval regime that would normally apply to foreign investments. 

However, the RMB Funds established under the Tianjin Model have primarily been with the foreign investor acting as the general partner, typically donating services or using onshore RMB profits to fund its general partner commitment to the fund (due to the restrictions of SAFE Circular 142 on the conversion of foreign currency — please see the discussion below).  Reportedly, in one recent case, a WFOE was also allowed to use its onshore RMB profits to fund its obligations as a limited partner under this model.

- Morrison Foerster -

The establishment of a FIVCE of less than USD100 million of registered capital may be approved by the provincial level counterpart of the Ministry of Commerce ("MOFCOM").  A FIVCE of USD100 million or more of registered capital requires central level MOFCOM approval.

The major requirements for a FIVCE are as follows:

• 2-50 investors with at least one requisite investor
• The requisite investor must have:
• Venture capital investment as its principal business
• At least 3 investment professionals with at least 3 years of experience in venture capital investment
• Investment track record (for a foreign requisite investor — minimum USD100 million under management with no less than USD50 million invested in venture capital enterprises; for a PRC requisite investor — minimum RMB100 million under management with no less than RMB50 million invested in venture capital enterprises)
• No history of sanctions

Other basic establishment requirements for a FIVCE include:

	Corporate FIVCE	Non-Legal Person FIVCE
Minimum Registered Capital	USD5 million	USD10 million
Requisite Investor's Minimum Investment	30% of total committed capital	1% of total committed capital
Other Investors' Minimum Investment	USD1 million each	USD1 million each
Nationality of Investors (Requisite or Other Investors)	May be wholly foreign or have foreign and PRC investors (requisite or other investors)	Must have at least one PRC investor (requisite or other investor)
Capital Contribution Term	2 years	Within 5 years
Tax	PRC Enterprise Income Tax ("EIT")	Pass-through taxation
Liability	Limited to the amount of each investor's capital contribution	Investor(s) and requisite investor(s) bear joint and severally liability; alternatively, the investors may agree that each investor's liability is limited to the amount of its capital contribution and that the requisite investor bears unlimited liability

A FIP RMB Fund is established through registration with and the approval of the provincial level counterpart of the Administration for Industry and Commerce ("AIC").  The FIP Registration Measures provide that AIC may consult with other appropriate governmental departments in order to determine whether an approval is warranted. 

With respect to the establishment of a FIP RMB Fund, the Shanghai Financial Services Office ("Shanghai FSO") has undertaken this role in Shanghai.  For the establishment of Carlyle/Fosun's FIP RMB Fund, Shanghai AIC sought an opinion from Shanghai FSO prior to registering this FIP.  However, it is uncertain at this time whether any other any financial services regulators (e.g., the National Development and Reform Commission ("NDRC"), MOFCOM or the China Securities Regulatory Commission) will be involved in approving FIP RMB Funds in the future.

There are no statutory requirements with respect to minimum registered capital, professional experience, timing of capital contributions, among others, for the establishment of a FIP.  However, the relevant approval authorities may have the discretion to, and future regulations (please see the discussion on the Trial Plan below) may, impose additional requirements.

- Morrison Foerster -

Yes.  With respect to a FIVCE, a non-legal person FIVCE comes closest to such characteristics.  A non-legal person FIVCE must fund its registered capital (i.e., the amount of the fund) within 5 years.  However, the schedule for the capitalization of a non-legal person FIVCE can be a negotiated point with MOFCOM, and thus implementing a "just-in-time" capital call funding schedule can be challenging.  With respect to taxes, non-legal person FIVCEs have in practice been able to obtain pass-through taxation treatment.  It is important for investors to consult early with experienced tax advisors to ensure integrated legal and tax planning when structuring a FIVCE.

In contrast, a corporate FIVCE must fund its capital contributions within 2 years of formation (since the FIVCE is in corporate form it is subject to the PRC Company Law regarding timing of capitalization).  Significantly, a corporate FIVCE is subject to PRC taxes, in particular enterprise income tax at the rate of 25%. 

The FIP Rules do not expressly address capitalization and tax issues, and by their terms are not comprehensive and should be read in conjunction with the PRC Partnership Law and other applicable PRC law.  The PRC Partnership Law does not provide statutory requirements for the timing or any minimum amount of capitalization and relegates those issues to the relevant partnership agreement.  Thus, in principle, capital call funding should be available to a domestic partnership and, by analogy, to a FIP.

Similarly, the PRC Partnership Law clearly provides for pass-through taxation for a domestic partnership.  However, what PRC taxes would apply to a foreign partner in a FIP (e.g., withholding tax versus EIT) remains to be clarified by the PRC tax authorities.

- Morrison Foerster -

Yes.  Foreign investors may participate in a FIVCE as the requisite investor or an investor.  In a non-legal person FIVCE, the requisite investor shares many of the characteristic of a general partner, including assumption of unlimited liability for the FIVCE's obligations.  In contrast, an investor (i.e., other than the requisite investor) in a non-legal person FIVCE is akin in many ways to a limited partner. In a corporate FIVCE, the requisite partner is much like the managing partner in a general partnership, with the other investor(s) being the "silent" or financial partner(s).

The FIP regime contemplates that foreign investors may serve as either a limited partner and/or a general partner.  A FIP may be wholly made up of foreign investors.  However, as noted above, further FIP regulations are expected to provide details with respect to foreign participation in RMB Funds formed as a FIP. 

This situation is further complicated by the fact that the State Administration for Foreign Exchange ("SAFE") presently will not allow the conversion of foreign currency into RMB to fund a foreign partner's obligations to a FIP RMB Fund.  Specifically, SAFE Circular 142 imposes general restrictions on the conversion of foreign currency into RMB in order to make investments in the equity of PRC companies (see discussion below).  This seems to reflect a policy on the part of the PRC authorities to encourage foreign fund managers to bring their expertise onshore but to control the flow of additional foreign capital onshore.

Additionally, reports indicate that a QFII-type scheme might be adopted under which certain licensed foreign fund sponsors (reportedly, six have currently been designated in Shanghai) will be permitted to raise a limited amount of foreign capital to be invested into FIP RMB Funds.  The Trial Plan for the Participation of Foreign Investment in RMB Equity Investment Funds (the "Trial Plan") was approved by the Shanghai government on March 15, 2010 but has not been officially promulgated.  As such, it remains subject to further consideration and revision by NDRC, MOFCOM and SAFE.  It remains unclear when the Trial Plan might be implemented what, if any quotas for "permitted" foreign capital will be included therein.

The Trial Plan reportedly intends to establish a qualified foreign limited partner mechanism ("QFLP") similar to the QFII system whereby, subject to approval by SAFE, a quota would be established and allocated to qualifying foreign investors to permit foreign-invested general partners and limited partners to convert foreign exchange into RMB to fund their obligations in FIP RMB Funds.  The Trial Plan contemplates the following major requirements:

• Foreign investor must have no less than USD500 million in capital and USD5 billion under management
• RMB Fund must be established in the Pudong New District of Shanghai
• General partner/management company should be established in Shanghai in principle
• USD100 million maximum foreign exchange quota per fund
• Maximum general partner contribution is 5% of fund size
• Investments by resulting RMB Fund still considered a "foreign investment" and subject to the 2007 Catalog
• No investments in public companies or real estate permitted

Beijing and Tianjin are reportedly also seeking QFLP quotas.  If a QFLP mechanism were adopted, it is unclear whether foreign investors would be restricted to this avenue, other than FIVCEs, in order to participate in RMB Funds.  We anticipate further clarification on the Trial Plan and its particulars.

- Morrison Foerster -

Yes.  The FIVCE Rules expressly provide, and the FIP Rules contemplate, that a foreign-invested RMB Fund is permitted to have PRC investors.

- Morrison Foerster -

Yes.  Both a foreign entity and a PRC foreign-invested entity may serve as the manager of a RMB Fund.  PRC law does not prohibit a RMB Fund from contracting with an offshore foreign entity to act as the fund's advisor or manager. However, the offshore advisor or manager would need to establish an affiliate entity in China to conduct activities in the PRC on an ongoing basis and avoid permanent establishment tax issues for itself.

Currently, the only form of foreign-invested enterprise ("FIE") that may undertake fund management activities in the PRC (i.e., for funds other than its own) is a foreign-invested investment  management enterprise ("FIME").  The Interim Measures for the Establishment of Foreign-invested Equity Management Enterprises in Shanghai Pudong New District (promulgated June 2, 2009) were the first regulations to authorize the establishment of FIMEs.  Although initially restricted only to Pudong, FIMEs may now be established in other jurisdictions including Beijing and Tianjin and other districts of Shanghai.  The major requirements for a FIME are as follows:

• The FIME's equity holder or its affiliate must have a business scope which includes equity investment or equity investment management
• At least 2 senior management officers, each of whom have at least 2 years experience in equity investment or equity investment management and at least 2 years experience in a senior management position
• Minimum USD2 million of registered capital

A FIME may be established in any corporate or non-legal person form (including a FIP) available under PRC law.  Note, however, that as a PRC entity a FIME is subject to the full range of PRC taxes on its revenues, although tax incentives have been granted in certain areas (e.g., the Pudong New District) to encourage qualified parties to establish FIMEs in their districts.

- Morrison Foerster -

A FIVCE is mandated to make investments "primarily" in "high technology" or "new technology" private companies.  In practice, this has been broadly interpreted to permit investments in private companies where foreign investment is allowed.  A FIVCE may not invest in publicly traded companies (other than selling the equity of its portfolio companies that have subsequently listed), real estate (other than for self-use) or companies in sectors where foreign investment is prohibited (as provided in the 2007 Catalog).  An FIVCE may also not receive or provide debt financing.

A FIVCE is only required to make a notice filing with the local counterpart of MOFCOM for investments in encouraged or permitted categories (as provided in the 2007 Catalog) regardless of the amount of total investment.  A FIVCE's investment in a restricted category requires the approval of provincial level MOFCOM, again regardless of the amount of total investment.  In contrast, an investment by a foreign party exceeding (i) USD100 million total investment in a encouraged or permitted category, or (ii) USD50 million total investment in a restricted category requires central level MOFCOM approval (generally, central level approvals are much more difficult and time-consuming to obtain).  In either case, other government approvals for investments in restricted categories (e.g., industry specific approvals) may be required in addition to MOFCOM approvals, depending on the particulars of the specific investment.

Other than a general statement that FIPs are subject to the laws and regulations applicable to FIEs, no specific regulations regarding portfolio investment by a FIP RMB fund have yet been promulgated.  We expect the 2007 Catalog's unaudited foreign ownership's levels to apply to any portfolio investment made by a FIP RMB Fund.

- Morrison Foerster -

As referenced above in our discussion of the Trial Plan, SAFE Circular 142 prohibits the conversion of foreign currency into RMB for the purposes of purchasing equity in PRC companies, unless otherwise permitted by law.  Since the FIVCE Rules clearly provide a regulatory basis for the purchase of equity in PRC companies, a FIVCE is within the safe harbor of the exception to SAFE Circular 142.  Thus, a FIVCE may convert foreign currency into RMB in order to make equity investments in PRC companies.

Currently, however, we understand from PRC officials that it is not possible for foreign investors to convert foreign currency into RMB to settle obligations as a partner (limited or general) in a FIP RMB Fund due to the restrictions of SAFE Circular 142.  Officials seem to take the position that the current FIP rules are insufficient to overcome SAFE Circular 142's restrictions on the conversion of funds to purchase equity in PRC companies.  However, we anticipate that this issue will be resolved once additional clarifications are issued with respect to RMB Funds established as a FIP, as well to the Trial Plan discussed above.

- Morrison Foerster -

In addition to the Trial Plan, there have been reports that NDRC is in the process of drafting national-level legislation regulating investment funds (the Provisional Measures for the Management of Equity Investment Funds).  Although no details regarding the measures have been made public, we expect that such legislation, if promulgated,  will provide further clarity on the establishment and permitted activities of investment funds, including foreign-invested RMB Funds.

- Morrison Foerster -

Although a non-legal person FIVCE shares some of the characteristics of a FIP, no rules have been promulgated which would allow the restructuring or establishment of a FIVCE as a FIP.  The establishment of a FIVCE requires MOFCOM approval, while in contrast, the establishment or the restructuring of an entity as a FIP only requires AIC approval (although AIC may consult other departments, including MOFCOM, in granting such approval).  Therefore, a level of cooperation and coordination between the relevant offices of MOFCOM and AIC would seemingly be required in order to restructure an FIVCE as a FIP.  We do not expect that it will be possible in practice to convert an existing FIVCE to a FIP.  Similarly, the regulatory regime for FIP RMB Funds is still unclear, as is the extent to which such funds would be subject to the FIVCE Rules and regime with respect to, among other things, restrictions on downstream investments and the related approvals/filings.

- Morrison Foerster -

By way of general comment, funds that are regarded as carrying on business in Hong Kong and are neither authorised under the Securities and Futures Ordinance, nor widely held and regulated by an acceptable overseas regulatory regime, will be taxable on their Hong Kong sourced profits. Funds that do not carry on business in Hong Kong or do not derive Hong Kong sourced profits are not taxable in Hong Kong. Similarly, profits which can be regarded as 'capital' in nature are taxable in Hong Kong, although in the context of venture capital investments involving the purchase of shares principally for resale at a profit it may not always be possible to support the position that such profits are 'capital' in nature.

Hong Kong also has an offshore fund exemption regime for funds which have their central management and control situated outside Hong Kong, although this regime generally does not apply to investments in private companies unless an exit by way of IPO is undertaken. Therefore, many venture capital and private equity groups with operations in Hong Kong look to carefully manage their activities to support the position that investment gains and carry payments are not taxable in Hong Kong. Whilst such arrangements do involve the use of offshore investment vehicles, such structures do require decision making and certain deal execution activities to be undertaken outside Hong Kong. The nature and location of the activities of the investment committee and deal team members therefore need to be carefully managed to support the position either that offshore investment vehicles do not carry on business in Hong Kong or that their profits are non-Hong Kong sourced.

Applicable Nov 2010
KPMG