In recent years, venture capital funds have witnessed rapid growth in China and become one of the key financing channels for numerous innovative micro and small enterprises. Compared with other private investment funds, venture capital funds enjoy more benefits in terms of tax policies, divestment, shareholding reduction and lockup policies.
Tax policies. Pursuant to relevant provisions of the Notice on Tax Policies Relevant to Venture Capital Enterprises and Individual Angel Investors (document No. 55), once the investment of a venture capital fund that satisfies specific investment requirements in a high-tech enterprise that is in its seed stage or infant stage reaches two years, 70% of its investment may be deducted against taxable income by the venture capital firm or its investors. With the issuance of document No. 55, the scope of application of the above-mentioned tax break has expanded from pilot zones specified in the previous document, document No. 38, to the entire country. Document No. 55 expressly specifies that the term “venture capital firm” includes both “venture capital funds” recorded with the Asset Management Association of China (AMAC) and “venture capital enterprises” recorded with the National Development and Reform Commission (NDRC).
For a long time there has been a debate as to whether the 20% tax rate applies to individual limited partners of funds organized as limited partnerships. The State Administration of Taxation (SAT) has stated on multiple occasions that individual limited partners are required to calculate their individual income tax at a 5%-35% progressive tax rate. On 12 December 2018, a new tax calculation method for venture capital firms was proposed at an executive meeting of the State Council, pointing out that, on the basis of the tax breaks specified in document No. 55, beginning from 1 January 2019, venture capital firms that have carried out recordal in accordance with the law may opt to make the calculation as for a single investment fund, in which case the individual partners of that fund pay individual income tax on the equity transfer and dividend income derived from the fund at the rate of 20%. Alternatively, they make the calculation based on the entirety of the venture capital fund’s income for the year, in which case the individual partners calculate individual income tax on their income from the firm at a 5%-35% progressive tax rate.
The period for the implementation of this policy is provisionally set at five years. Given that the individual income tax break determined at the above-mentioned meeting is grounded on the basis of the tax breaks in document No. 55, it would be reasonable to assume that its scope of application would include both venture capital funds recorded with the AMAC and venture capital enterprises recorded with the NDRC, but further clarification will have to await the issuance of detailed rules.
Divestment, shareholding reduction and lockup policies. Pursuant to Several Provisions for the Reduction of Their Shareholdings by the Shareholders, Directors, Supervisors and Senior Management Personnel of Listed Companies (announcement No. 9 of the China Securities Regulatory Commission (CSRC)) and the detailed rules for implementing such provisions issued by the Shanghai and Shenzhen stock exchanges, where a shareholder holding at least 5% of the shares of a listed company proposes to reduce its shareholding by centralised bid trading or block trading in any continuous 90-day period, the total number of shares reduced may not exceed 1%-2%, respectively, of the company’s total number of shares. In other words, the most it can reduce its shareholding through centralised bid trading in one year is by 4%, and by block trading 8%.
Pursuant to the Special Provisions for the Reduction of Their Shareholdings by Venture Capital Fund Shareholders of Listed Companies, and the detailed implementing rules issued therefor by the Shanghai and Shenzhen stock exchanges, with respect to a venture capital fund that is recorded as a venture capital fund with AMAC, and satisfies the conditions, depending on the term of its investment in the listed company and the shareholding in which it proposes to reduce, the most it can reduce its shareholding by centralised bid trading in one year is 4%-12%, and by block trading 8%-24%. Compared with other shareholders, the speed at which venture capital fund shareholders can reduce their shareholdings is greatly accelerated.
A venture capital fund as a shareholder of an enterprise without an actual controller that is making an initial public offering is also eligible for preferential treatment in the lockup period. Where an issuer does not have an actual controller, or the same is difficult to determine, the CSRC requires the shareholders of the issuer to undertake, in order from the largest to the smallest shareholding percentage, that the shares held by them be locked up for 36 months from the date of the listing until the total number of locked shares is not less than 51% of the total number of shares before the offering.
Based on two regulatory question-and-answer documents issued by the CSRC on 2 June 2017, where an issuer does not have an actual controller, the lockup period that satisfies certain conditions and falls within the ranks of those whose shareholdings, from high to low, total 51% is one year. Recordal as a venture capital fund with AMAC is a basic requirement for this lockup period preferential treatment and, for the same, the submission of a written application to the sponsor is required. Once the sponsor’s and issuer’s lawyers check the same and deem it satisfies the above-mentioned criterion, the sponsor will submit a written application to the offering review department of the CSRC.
To date, AMAC has yet to issue clear criteria for differentiating funds recorded as venture capital funds and equity investment funds. Until these criteria are issued, the authors recommend that fund managers elect to record newly established private funds as venture capital funds, so as to secure the opportunity and possibility to be eligible for preferential policies.
It is the authors’ understanding that at the moment, the AMAC does not permit funds currently recorded as private equity investment funds, or other types of investment funds, to convert into venture capital funds. If a fund satisfies the conditions for recordal with the NDRC as a venture capital enterprise, it may alternatively, for the purpose of being eligible for tax breaks, opt to file for recordal as a venture capital enterprise with the NDRC.
Catherine Chen is a partner and Sha Yuedi is an associate at Zhong Lun Law Firm