Due to the complicated political relationship between the People’s Republic of China (the “PRC”) and the Republic of China (“Taiwan”), Taiwan authorities subject investments from the PRC to requirements and restrictions different than those applicable to investments emanating from other jurisdictions. These requirements and restrictions have broad reach and the penalties for violations can be severe. We have seen a number of foreign investment transactions affected by Taiwan’s PRC investment regulations. Given that these regulations are likely to become more stringent in the near future, we felt it timely to set out for our clients and other readers the basic outline of these regulations and possible impacts on a planned investment transaction.
As mentioned above, the reach of Taiwan’s PRC investment regulations is broad. Regulated investments include those other than the direct purchase of a Taiwan enterprise by a PRC company. The Investment Commission (the “IC”) of Taiwan’s Ministry of Economic Affairs currently includes the following within its definition of “investment”:
- contributing capital to, or owning shares issued by, a Taiwan company (excluding investments that are less than ten (10%) of the outstanding shares of a listed company);
- establishing a branch, sole proprietorship, or partnership in Taiwan; or
- providing loans with maturity periods greater than one year to the enterprises described in items 1 and 2 above.
In August of this year, the IC announced a draft amendment to the Measures Governing Investment Permits to the People of the Mainland Area (the “Draft Amendment”) which, among other things, would expand the IC’s definition of “investment”. According to the changes proposed in the Draft Amendment, mergers and acquisitions with non-listed companies (including the acquisition of specific businesses and/or assets of a Taiwan company) would be considered investments in Taiwan as would any direct control of a Taiwan entity by a PRC entity through contract.
The PRC investment regulations are also broad in their definition of who is considered a PRC investor (and thus subject to regulation). We have seen a number of transactions in which the investor inaccurately determined that it was not a PRC investor, leading to transaction delays, additional costs, and potential criminal liability. A PRC investor is an individual, juristic person, organization, or any other institution from the PRC or its “third-area invested company”. It is the definition of “third-area invested company” that often causes confusion and difficulties. A PRC third-area invested company is any company in a third area (i.e., a jurisdiction other than the PRC or Taiwan) invested by an individual, juristic person, organization, or any other institution of the PRC which directly or indirectly holds more than thirty percent (30%) of the equity capital of such company or which otherwise has control of such company.
The Draft Amendment introduces a new calculation method for determining whether the thirty percent (30%) equity ownership threshold has been exceeded. The existing regulations calculate ownership by multiplying ownership percentages at each level of a shareholding structure. See Figure 1 below. Pursuant to the Draft Amendment, the calculation would be done on a “tier-by-tier” basis. If any enterprise in the shareholding structure were more than thirty percent (30%) owned by a PRC investor, such enterprise would be deemed to itself be a PRC investor and the thirty percent (30%) rule would be subsequently applied to the next tier in the ownership structure. See Figure 2 below.
Despite not meeting the direct equity ownership thresholds described above, a third-area company would be considered a PRC invested third-area company if a PRC investor otherwise maintained control power over such third-area company. The IC considers several factors when determining whether a PRC investor has such control, including whether the PRC entity has control (i) over the majority of voting power of the equity owners or the directors or over the appointment and discharge of a majority of directors; (ii) over the financial, operational, and/or human resource policies by law, regulation, or contract; or (iii) as defined in applicable accounting standards.
Having a PRC investor involved in a transaction can have substantial effects on the transaction and the persons involved. If a PRC investor is involved, only transactions in certain industries are permissible and may legally proceed. Any investments from a PRC investor into an industry that is not listed in the Positive List of Investments by People of the Mainland Area (the “Positive List”) set by the IC are prohibited. The current Positive List can be found here (Chinese language only).
Even if a proposed PRC investment is within the scope of permissible investments, application must be made to the IC to review and approve the proposed investment. According to the IC’s official website, the average processing time for PRC investment applications is twenty-five (25) to sixty (60) days. However, our team has routinely seen the process last a year or longer. The IC will strictly scrutinize and may place additional restrictions on, or completely prohibit, investments which it believes may (i) have an adverse effect on national security, (ii) be politically, socially, or culturally sensitive, or (iii) involve persons with a PRC military background or related business activities. Additional restrictions may include limiting investments to a maximum equity percentage.
On a practical note, it is important for PRC investors seeking to acquire Taiwan entities either directly or indirectly (e.g., in conjunction with an acquisition of a global or regional business) to take these investment prohibitions and the extended approval process into account at the outset of any transaction. In a bid-auction process, these investment prohibitions and extended timelines can put a PRC investor at a significant disadvantage to any non-PRC competitors. Even in a negotiated transaction, the indirect acquisition of a Taiwan subsidiary or business by a PRC investor could have serious consequences. In addition to affecting the transaction timeline, if the Taiwan business to be acquired operates in an industry not included in the Positive List, the Taiwan business would be required to divest itself of any operations and assets that were involved in the conduct of any and all businesses operating outside of the industries included in the Positive List. In a recent example, a consortium of PRC investors acquired Nexperia, a Dutch company. As a result of the acquisition, Nexperia’s Taiwan subsidiary became a PRC investment. As product design, research and development, and manufacturing of semiconductors, are not within the industries listed in the Positive List, Nexperia Taiwan was required to divest these businesses and was allowed to retain only its electronic component wholesale business in Taiwan.
In addition to divesting portions of the acquired Taiwan business, any investor violating the PRC investment laws and regulations may be ordered to cease or withdraw the investment altogether. Those found to have made an unauthorized PRC investment will also be fined an amount between NT$120,000 (~US$4,125) and NT$25 million (~US$858,560). Managers and directors of the Taiwan entity may also face financial and criminal liability if they approved the investment and knowingly misrepresented the investing entity as a non-PRC investor. Violators may be sentenced to imprisonment for up to three (3) years.
We expect regulation of PRC investment in Taiwan to become more stringent and enforcement more vigorous. Recently, we have been brought on to analyze PRC investment issues for a number of different teams involved in global acquisitions and securities offerings. We have assessed the consequences of such investments and where possible, provided creative structuring solutions to minimize the negative impact of Taiwan’s PRC investment regulations on the relevant transaction. Typically, many more structuring options are available at the planning stages of a transaction compared to the execution stage. If your transaction involves PRC investment into Taiwan, whether directly or indirectly, we highly encourage you to seek expert guidance on these issues as early in the transaction process as possible in order to prevent unintended, negative consequences to your business.
For more information on investment issues in Taiwan, please contact Greg Buxton at firstname.lastname@example.org.
 For the purposes of determining control, the third-area company’s board and its directors would be deemed to include not only the nominal board and directors but also any organization (e.g., committee or other group) with the power to control the company’s operations and the members of such committee or group.
 Ibid.Written September 29, 2020 By Gregory A. Buxton, Niki Chen, Yi-Kai Chen.