Introduction of the Pilot QFLP Programme in Qingdao: RMB funds invest in domestic market

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1 PwC Tax Insights China Asset Management Tax News Flash Introduction of the Pilot QFLP Programme in Qingdao: RMB funds invest in domestic market July 2015 In brief As the first comprehensive financial reform pilot area with the theme of wealth management, the Qingdao Municipal Finance Service Office and other principal government authorities jointly promulgated the Implementation Measures on the Pilot Programme for Qualified Foreign Limited Partnership (QFLP) (the Pilot Measures ) on 9 February Under the Pilot Measures, foreign investment institutions are allowed to set up a RMB private investment fund ( RMB Fund Enterprise ) with lenient restrictions. The restrictions on registered capitals of a Fund Management Company ( FMC ) and the investors investment amounts have both been relaxed, and the investment scope of the RMB Fund Enterprise has been modestly expanded a breakthrough in the fund industry in China. The Pilot Measures became effective 30 days after its issuance date, i.e. 9 March In detail Introduction of the Pilot Measures This is the first time the requirements and procedures for the setting up a RMB Fund Enterprise in Qingdao are clearly outlined. At the same time, the Pilot Measures have made significant breakthroughs by introducing the qualified foreign investor ( QFI ) system, lessening the restrictions on foreign exchange settlement when FMCs invest in a RMB Fund Enterprise, and relaxing the foreign investment scope limitations imposed on a RMB Fund Enterprise in which a FMC has invested. Under the Pilot Measures, the RMB Fund Enterprise can be limited partnership, and the FMC can either be established in the form of a corporation or a To illustrate the impact of the Pilot Measures, we illustrate a typical investment operation diagram under the structure of the Pilot Measures for QFLPs in Appendix 1. Establishment of a RMB Fund Enterprise The Pilot Measures confirms that a foreign invested RMB Fund Enterprise can be Foreign investors may make contributions with convertible currency, offshore RMB, legitimate RMB revenues or earnings generated in China, or the legitimate onshore RMB. In comparison, Chinese investors may only use RMB to make capital contributions. The use of offshore RMB and legitimate onshore RMB for RMB Fund investments as set out in the Qingdao Pilot Measures represent significant breakthroughs in China. In addition, the Pilot Measures require that each RMB Fund Enterprise must engage a qualified custodian bank in China to supervise its funding. Industry restrictions on RMB Fund Enterprise s portfolio investment The Pilot Measures stipulate that the RMB Fund Enterprise can use its self-owned capital to invest in domestic unlisted enterprises, non-publicly traded equity of listed enterprises, convertible bonds, sector funds, and other programmes that are permitted by related laws and regulations with the approval of Qingdao Cross-border Wealth Management Working Group ( the Working Group ). The scope of investment is also one of the most important differences between Qingdao and other cities where the similar pilot measures have been implemented.

2 Establishment of a FMC In addition to carrying on a fund management and investment advisory business, a FMC established in Qingdao can now carry out establishing a fund investment enterprise (i.e. as a promoter of a RMB Fund Enterprise) activities under the Pilot Measures. In particular, there are no specific limitations on the amount of registered capital or timeline of capital injection in Qingdao. The Pilot Measures also gives FMCs the flexibility to be established either in the form of a corporation or a Relaxation of foreign currency conversion for Qualified Pilot FMC or Qualified Pilot FMC RMB Fund Enterprise A pilot programme is launched under the Pilot Measures whereby a Qualified Pilot FMC or Qualified Pilot RMB Fund Enterprise is entitled to enjoy certain preferential treatments. For a FMC, one of the primary benefits is the relaxation of the foreign currency exchange policy, which applies to a Qualified Pilot FMC in Qingdao in relation to its capital contribution to a RMB Fund Enterprise. Before the Pilot Measure was introduced in Qingdao, in other cities, equity investments and management enterprises are allowed to use their own foreign currency to contribute as equity and establish equity investment enterprises. However, the ratio between the foreign currency used and the total subscribed capital is limited; for instance, the Pilot Measures in Shanghai allows a maximum foreign currency limit of 5% of the total subscribed capital in the RMB Fund Enterprise. The Qingdao Pilot Measures allows the qualified Pilot FMCs to use their own foreign currency to contribute to a RMB Fund Enterprise that they established, and does not set any limitations on the amount of the capital invested. Moreover, this capital can be converted to RMB for future investments in onshore entities. However, whether or not that foreign currency capital would affect the original nature of that RMB Fund Enterprise, and whether or not that foreign currency capital would be affected by the foreign investment industry policy is unclear. Introduction of a qualified foreign investor ( QFI ) The Pilot Measures also introduces the QFI system. When a RMB Fund Enterprise is approved as a Pilot RMB Fund Enterprise by the Working Group, it can have foreign currency investment with convertible currency, offshore RMB or domestically obtained RMB profits, legitimate RMB revenues or earnings generated in China, and legitimate onshore RMB subscribed by QFIs. Those QFIs may include sovereign wealth funds, pension funds, endowment funds, charitable funds, fund of funds (FOFs), insurance companies, banks, securities companies and other foreign institutional investors approved by the Working Group. From our observation, the Qingdao Pilot Measures do not impose limitations on the minimum investment of qualified investors. In contrast, similar QFLP schemes in other cities have certain restrictions on the minimum investment amount for both domestic and foreign investors. The takeaway Comparison of the Pilot Measures between Qingdao and Shanghai At the end of 2010, in order to implement the aim to build an international financial centre, Shanghai introduced The Implementation Measures on the Pilot Program for Foreign-invested Equity Investment Enterprises (the Shanghai Pilot Measures ). After an interval of four years, in light of the only Financial Comprehensive Reform Pilot Area with the subject of financial management in China, Qingdao issued the Pilot Measures for QFLPs as well. Similar to the Shanghai Pilot Measures, Qingdao s also require the foreign investors of the Pilot FMC and RMB Fund Enterprise to meet certain requirements on creditability, performance, and qualifications of the management personnel. At the same time, pilot enterprises should authorise qualified domestic custodian banks to manage the funds. Compared with the Shanghai Pilot Measures, the Qingdao Pilot Measures are more lenient on the registered capitals of FMC, and the investors investment capitals. In addition to the equity investment of a listed company, the Qingdao Pilot Measures in allows foreign investment funds to invest in non-publicly traded equity of listed companies, convertible bonds, and sector funds. It has greatly broadened the investment scope of foreign investment funds. The Qingdao Pilot Measures have different foreign currency conversion requirements from Shanghai. Further details are set out in Appendix 2 Comparison of the Pilot Measures between Qingdao and Shanghai. Practically, Shanghai requires that not only the registered address, but also the operating activities of a pilot enterprise should be in Shanghai. This has significantly influenced the operating activities and decision making of a pilot enterprise. However, according to our communications with Qingdao Municipal Finance Service Office, pilot enterprises under the Qingdao Pilot Measures should be registered in Qingdao without any restrictions on where to conduct their operating activities. All in all, in comparing the Shanghai Pilot Measures, the Qingdao Pilot Measures have more lenient rules for foreign investors, the FMC, and the RMB fund Enterprise. What is good? To an extent, the Pilot Measures represents significant improvements over the existing rules for FMCs and RMB Fund Enterprises in Qingdao. We are delighted to see that the Pilot Measures has incorporated the following desirable features: A FMC set up in Qingdao can now engage in capital raising and establishing a fund investment enterprise under the Pilot Measures. A FMC is allowed to be limited partnership (including foreign invested partnership ( FIP )) in Qingdao. It also provides a more flexible and tax efficient investment structure since the tax flow-through treatment could apply to FIP, but subject to further clarification in the Chinese tax rules. The Pilot Measures also relax the foreign currency conversion, and foreign investors could make investments directly with overseas RMB, which has long been a major obstacle for foreign investors looking to set up a RMB Fund Enterprise with foreign investors. 2 PwC

3 What is uncertain? The impact foreign currency capital contribution would make on the RMB Fund Enterprise: The Qingdao Pilot Measures do not impose any restrictions on how FMC use their own foreign currency to invest in the RMB Fund Enterprise. Therefore, once the foreign currency contribution exceeds a certain amount, problems of whether or not it will affect the original nature of the RMB Fund as well as the investment directions still remain uncertain. The tax treatment of the RMB Fund Enterprise in the form of a limited partnership since the tax rules for FIP have not yet been issued, many tax issues remain unclear. To name a few: how a foreign limited partner could make tax payments, whether or not the nature of income derived by the FIP flows through to the foreign partner, is carried interest allocated to the general partner treated as compensation or dividends. Tax authorities in different regions may have different practices. We will closely monitor how the tax authorities in Qingdao intend to deal with these issues. At the same time, we also suggest the relevant enterprises keep close communications with local tax authorities. The Pilot Measures for QFLPs, as part of the 35 approved policies requiring support from the national level, is one that attracts financial resources and promotes the development of crossborder wealth management in Qingdao. After the introduction of the Pilot Measures, Qingdao will keep promoting the financial reform of wealth management while encouraging foreign investors to participate in the establishment of RMB Fund Enterprises. Simultaneously, Qingdao will also proactively attract financial institutions, financial consultant companies, and private equity fund managers. Of note, three family offices were established in Qingdao at the beginning of 2015, to provide comprehensive and high-end wealth management for the high net wealth family clients with senior professionals. This demonstrates Qingdao s innovative and openminded attitude on the wealth management experiment. As the Pilot Measures and other supporting policies have been implemented, Qingdao is expected to become another attractive place for foreign fund investors in China. Fund investors should also consider the uncertainties of the different types of tax treatment and carefully plan the structures and operations for their RMB Fund Enterprise investments upon making investment in China. 3 PwC

4 Appendix 1: Typical Investment Operation Diagram under the Pilot Measures of QFLPs in Qingdao Overseas Foreign limited partners Foreign general partners China FMC Domestic limited partners Portfolio companies Appendix 2: Comparison of the Pilot Measures between Qingdao and Shanghai Limitations on registered capital of FMC Limitations on investment amount of qualified investors Criteria for foreign investors Restrictions on investment currency Investment scope Foreign exchange restrictions on FMC Pilot Measures of Qingdao No minimum requirement on registered capital. No minimum requirement on investment amount. More lenient restrictions on the scale of self-owned asset/portfolio One fiscal year before application, the selfowned assets of the foreign investors should be no less than USD 100 million or the portfolio managed should be no less than USD 200 million. Relaxation on contribution currency. The foreign investors of the Pilot enterprise are allowed to use freely exchanged currency, offshore RMB or the RMB profits they have legitimately obtained in China, legitimate RMB profits from conversion or liquidation, or legitimate onshore RMB for investment. Broaden investment scope The investment scope is extended to unlisted enterprises, non-publicly traded equity of listed enterprises, convertible bonds, sector funds, and the other investment scopes and other programmes that are permitted by related laws and regulations with the approval of the Working Group. No minimum restrictions on foreign exchange investment amount. Pilot Measures of Shanghai The registered capital for management enterprises should be no less than USD 2 million, which is limited to the form of monetary contribution. At least 20% of the registered capitals should be injected within 3 months after the issue date of business license and the remaining amount should be in place within 2 years. Foreign-invested enterprises that engaged in equity investment should subscribe capital contribution of at least USD 15 million, which is limited to the form of monetary contribution. Partners should invest in their own names. In addition, the general partners, each of other limited partners should invest no less than USD 1 million. One fiscal year before application, the self-owned assets of the foreign investors should be no less than USD 500 million dollars million or the portfolio managed should be no less USD 1 billion. Foreign investors have to use freely exchanged currency or legally RMB profits from conversion or liquidation that they have legitimately obtained in China for investment. Foreign investors can make equity investment in unlisted enterprises. Qualified foreign FMC may use foreign exchange for investment. The investment amount of foreign currency may not exceed 5% of the total investment amount. The foreign capital contribution will not change the nature of the invested enterprises. 4 PwC

5 Let s talk To further discuss how this new development might affect your business, please contact a member of PwC s Qingdao QFLP key contacts or your usual PwC advisor: Qingdao QFLP Key Contacts: Helen Zhang +86 (532) helen.h.zhang@cn.pwc.com Kenny Lam +86 (21) kenny.lam@cn.pwc.com Matthew Wong +86 (21) matthew.mf.wong@cn.pwc.com We have a dedicated Corporate Tax team specialised in providing services to clients in the Financial Services sector. This team of experienced tax professionals have in-depth understanding of the business issues of the sector, including issues relating to crossborder financial transactions, permanent establishment exposure, transfer pricing, etc. They work closely with our strong PwC international network to provide seamless solution to our clients for their current business operations as well as their future needs PricewaterhouseCoopers Consultants (Shenzhen) Ltd. All rights reserved. In this document, PwC refers to PricewaterhouseCoopers Consultants (Shenzhen) Ltd. which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.