Company Limited by Shares (CLS): A Powerful Legal Vehicle for Group Restructuring

Introducing Holding Companies

FIEs cannot sufficiently satisfy any of these needs. The PRC Company Law (中华人民共和国公司法)(first issued in 1993) made provision for a CLS structure. In 1995, the Certain Questions on the Establishment of Foreign-invested Companies Limited by Shares Tentative Provisions and Establishment of Companies of an Investment Nature by Foreign Investors Tentative Provisions were issued and intended to further address these issues.

The Holding Company (also known as a "foreign investment company") can hold shares in subsidiary FIEs and can provide centralized services for them, which resolves two of the concerns above. With certain qualifications and corporate planning it can also sell products of all FIEs within the multinational group. However, the Holding Company cannot satisfy other needs, namely, majority shareholder's control of an FIE, a general trading right to sell imported finished products, and the manufacturing of multiple types of products by one legal entity. In other words, the Holding Company only has service, investment and limited sales functions, but not a manufacturing function. Its high income tax rate (33%) and lack of tax holidays also make it unattractive to multinationals for group integration purposes.

The CLS Structure

To fill in the gap, the CLS was created and can now satisfy all the above needs except for a general trading right to sell imported finished products, which is more of a trade policy issue than a legal entity issue. A CLS also enjoys the same tax holidays as other manufacturing FIEs, which makes it an attractive legal vehicle for group integration.

In addition, a CLS has the following advantages compared to FIEs: (i) it has an indefinite life term and thus does not run the risk of re-negotiating among the shareholders or re-applying for government approval as must FIEs; (ii) the CLS usually can have a very broad business scope covering all products made by all FIEs within the group company, while an FIE's business scope is usually limited to one product line; (iii) a CLS can freely channel cash and balance the financing needs among branch operations that separate FIEs can not do; (iv) a CLS presents great opportunities for tax savings by utilizing the tax losses of loss-making branches to offset the profits of profit-making branches, which is impossible among separate legal entity FIEs; and (v) a CLS structure is a pre-condition for public listing.

Generally speaking a CLS has the advantages of both an FIE (manufacturing functions and tax holidays) and the advantages of a Holding Company (service, sales and investment functions). It also gives the multinational shareholder absolute control as long as the multinational shareholder holds more than two-thirds of the shares. Such control in turn enables the multinational investor to conduct future capital increases, mergers and acquisitions, and divestments in a more flexible way. For all of these reasons, a CLS has now become a powerful legal vehicle in China for group restructuring or integration.

A Closing Caveat

We should also note that there are difficulties and uncertainties in utilizing a CLS for group restructuring. These are mainly implementation difficulties and uncertainties, particularly in negotiations with partners and with various local government authorities that have jurisdiction over post-CLS mergers and acquisitions.

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