Shanghai issues new local regulation on equity investment firms

24 October 2008

To support the development of equity investment, including private equity funds and venture capitalfunds, and to help Shanghai become a capital and asset management centre, the Shanghai Financial Service Office, the Shanghai Administration of Industry and Commerce, the Shanghai State Tax Bureau and the Shanghai Local Tax Bureau jointly issued the Circular on Matters Concerning the Industrial and Commercial Registration of Equity Investment Enterprises in Shanghai (the "Circular") in August 2008.

The Circular provides guidelines for equity investment enterprises (EIEs) and equity investment management enterprises (EIMEs) in Shanghai in relation to their establishment requirements, business registration and taxation. As the central government has yet to complete the national regulations clarifying the legal status and other relevant issues for private equity firms, most private equity firms have in the past established a presence in China via a consultancy company or representative office. Now, under the Circular, Shanghai allows qualified domestic and foreign investors to register EIEs and EIMEs in the city in the form of a company or partnership (including a limited liability partnership). EIEs are permitted to engage in equity investment business while EIMEs are permitted to manage equity investments as entrusted by EIEs.

With regard to set-up requirements, the minimum registered capital (or capital contribution) of an EIE is RMB 100 million and must be contributed in cash form. A subscription by a natural person shareholder (partner) shall be no less than RMB 5 million. An EIME in the form of limited liability company (LLC) must have a minimum paid-up capital of RMB 1 million and an EIME in the form of company limited by shares (CLS) must have a minimum registered capital of RMB 5 million.

The Circular also clarifies the taxation status of natural person partners of a limited liability partnership EIE or EIME. The business income and other income of such enterprise will be subject to the income tax payable by the partners only. Natural persons as general partners who manage the affairs of a limited partnership must pay individual income tax (IIT) under the category of "income of self-employed business" at the progressive tax rate of 5% to 35%. Natural person limited partners who do not manage the affairs of a limited partnership are subject to IIT under the category of "interests, dividends" at the rate of 20%.

The Shanghai Foreign Investment Commission (SFIC), the approval authority for all foreign-invested enterprises in Shanghai, has not participated in the formulation of the Circular. This has created some uncertainty as to whether the establishment of an EIE or EIME by foreign investors in Shanghai pursuant to the Circular will be subject to the approval by SFIC and if so, whether any additional requirements will be imposed for obtaining such approval.