1. THE PRIVATE EQUITY INTERNATIONAL CFOs AND COOs FORUM Structuring a Private Equity Investment in China Presented by: Jay Bakst, Partner, EisnerAmper LLPJanuary 20, 2011

2. Personal Message from the Author This presentation is intended to provide an overview of selected tax considerations for structuring private equity investments in the PRC. It uses a hypothetical structure for illustration, but this is not to imply that this is the only way to structure an investment in the PRC. This presentation is not intended to provide exhaustive, comprehensive treatment of the material. I am indebted for advice on PRC aspects of this presentation to the following people: John Forry, EisnerAmper, LLP Paley Chan & David Leong, PKF-Hong Kong Stephen Nelson, DLA Piper, Beijing You are invited and encouraged to contact me directly with any questions or clarifications you may have. My contact information is listed below. Jay Bakst, CPA Tax Partner EisnerAmper, LLP (212) 891-4236 jay.bakst@eisneramper.com Any tax advice contained in this presentation is not intended or written to be used, and cannot be used, for the purpose of (a) avoiding or reducing penalties that may be imposed by the Internal Revenue Service or any other governmental authority, or (b) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

3. Executive Summary What are the key structuring objectives? Obtain 15% U.S. tax rate for U.S. taxable investors in PE Fund for dividends from PRC Target and long-term capital gain from disposition of PRC Target. Minimize PRC withholding tax on dividends from, and disposition of, PRC Target shares. Obtain a full U.S. foreign tax credit in respect of PRC withholding tax for U.S. taxable investors Avoid UBIT (unrelated business income tax) for U.S. tax-exempt investors in PE fund. Offset PRC Target profits with interest on third-party debt used to finance the acquisition so as to reduce PRC Enterprise Income Tax (25%). Facilitate investment in PRC by foreign investors who are often subject to various restrictions, prohibitions, and time-consuming regulatory compliance.

4. Foreign Taxable Investors Bank debt PRC Operating Company (Target) HK Limited BVI CO Cayman Limited PE Fund – Cayman L.P. Foreign Tax-Exempt Investors U.S. Taxable Investors U.S. Tax- Exempt Investors Equity ownership Partnership Corporation under local law, partnership or disregarded for U.S. tax purposes PE Fund Investor

5. Executive Summary What are the key drivers for the structure? Unlike the U.S. and many other countries, PRC imposes a withholding tax of 10% on capital gains realized by a PRC- nonresident from disposition of shares of a PRC resident company. This withholding tax often cannot be reduced by treaty. A similar 10% withholding tax is imposed on interest and dividends paid by a PRC resident company. A U.S. foreign tax credit (“FTC”) is available for U.S. taxable investors in respect of the PRC withholding tax on dividends. The FTC is also available for U.S. taxable investors in respect of the PRC withholding tax on capital gains; Article 22 (3) of the U.S. – PRC income tax treaty provides that the capital gain will be treated as foreign source (thereby facilitating use of the FTC). In order for U.S. investors in PE Fund to access the FTC, all of the entities in the structure above PRC Target (paying the dividend or whose shares will ultimately be sold at a gain) must be transparent for U.S. tax purposes; otherwise for most the FTC will be “blocked”.

6. Executive Summary What are the key drivers for the structure? cont’d Besides FTC considerations, it is necessary (or highly facilitative) for all entities in the structure above PRC Target be tax-transparent so that (a)Dividends from PRC Target, which is a corporation that would be eligible for benefits under the U.S.- PRC income tax treaty, be treated as “qualified” (and therefore subject to a 15% U.S. tax rate, instead of the U.S. ordinary income tax rate of 35%). If any of the entities above PRC, which are organized in non-treaty countries, is treated as a corporation for U.S. tax purposes, dividend distributions to the PE Fund investors will generally be treated as non-qualified. (b)It will generally be easier to structure a partial exit (if it were to be at a level below Cayman Limited) as a long-term capital gain subject to the 15% tax rate, rather than as a nonqualified dividend.

7. Executive Summary What are the key drivers for the structure? cont’d Third-party debt should be (if possible) at the PRC Target level so that (a)U.S. tax-exempt investors will not incur unrelated business income tax (UBIT; generally a (maximum) 35% tax imposed on otherwise tax-exempt organizations who have debt-financed income). Accordingly, debt must be “blocked” by an entity that is treated as a corporation for U.S. tax purposes. (b) PRC Target will (hopefully) be able to reduce its income which is subject to the 25% PRC Enterprise Income Tax (EIT) by the interest paid or accrued on the third-party debt. A Hong Kong (HK) company is used to directly acquire and hold PRC Target shares. Since HK is part of the PRC, there are generally advantages, tax and nontax, to using a HK company to invest in the PRC. However, these advantages might be limited if the PRC tax authorities view the HK entity as not having substance.

8. The Acquisition Buying the shares of PRC Target –As a threshold issue, PE Fund must ascertain if the business area in which it plans to invest (i.e. PRC Target’s business) is open to foreign investment and, if so, how open. The PRC government forbids, restricts, or encourages foreign investment in various industries. The PRC and Hong Kong have signed the Mainland and Hong Kong Closer Economic Partnership Arrangement (“CEPA”)”, under which certain industries which are prohibited or restricted to foreign investment are open to HK investors (e.g. HK company) who meet certain requirements (e.g. industry operating experience). 14 Industries open to HK investors by CEPA including medical services, tourism, construction, audiovisual services, securities, technical testing, analysis and product testing services, air transport, and added value services to telecommunication, etc. For example, a HK company that is wholly owned by foreign persons can engage in an audiovisual services business, whereas a (non-HK) foreign investor is only allowed to own such a business by investing in a PRC cooperative company with the majority owned by a PRC resident. However, a HK company that merely acts as an investment holding company will probably not be able to enjoy CEPA entry advantages. If a PE fund is considering use of a HK company (that is treated as transparent for U.S. tax purposes) to do more than simply act as a holding company (so as to obtain certain PRC privileges), it should consider UBTI implications. In general, UBTI is income from an activity that constitutes a trade or business which is regularly carried on for the production of income (e.g. the performance of services). –Foreign investors must file notarized incorporation documents as part of the process of registering the shares of a PRC company. For HK companies, it usually takes only 7 working days to complete the notarization process. However, for the companies incorporated outside HK, the notarization has to be done at the PRC Embassy of the country in which the foreign buyer is organized. takes about 1 to 2 months to complete.

9. The Acquisition Financing the acquisition –PE Fund will typically finance part of the investment with capital calls from its own investors and obtain third-party bank financing for the rest. –If PE Fund were to invest part, or substantially all, of its portion of the purchase price in the form of a loan to PRC Target, then PE taxable investors would realize interest income on an annual basis, whether or not this interest were paid up the chain to the investors. Furthermore, interest income would be subject to U.S. taxable investors at ordinary rates (up to 35%). It would generally be much more tax- efficient for U.S. investors to receive qualified dividends or capital gains at a rate of 15%. Accordingly, PE’s investment down the chain of companies into PRC is generally structured in the form of equity. –As for the third-party bank financing, the following may be considered: (a)PE Fund (or the holding companies) can negotiate with an offshore bank with a branch in PRC to make an RMB loan to PRC Target. Since the loan would be in RMB, it should not need to be registered with, or approved by, the PRC Foreign Exchange Bureau. PE Fund should be careful not to guarantee the loan with any assets other than PRC Target stock; otherwise the U.S. IRS might argue that the Fund (or one of the tax transparent holding companies) is the real borrower for U.S. tax purposes with the result that any income from this investment would constitute UBTI to the extent of the third-party bank debt. (b)PRC Target could borrow from an offshore bank, or overseas direct/indirect shareholders, however this loan is required to be approved by, and registered with, the PRC Foreign Exchange Bureau. In addition, the amount of the loan cannot exceed the difference between the total investment (made by HK) and the registered capital of PRC Target. Furthermore, such difference between the total investment and registered capital is subject to certain ratio limitations. For example, if the total investment is over $30M USD, then registered capital must be at least the greater of $12M or 1/3 of the total investment. In addition, if there is onshore debt also, related party debt interest deductions may be subject to scrutiny if the thin cap ratios(5:1 for financing business, 2:1 for others) are exceeded.

10. Tax Implications During the Holding Period Dividends paid by PRC Target to HK –Generally subject to 10% PRC withholding tax. –The PRC-HK income tax treaty provides that the PRC withholding rate is reduced to 5% for dividends paid to HK resident companies that own at least 25% of the PRC company paying the dividend. –However, the Chinese State Administration of Taxation (“SAT”) issued GuoShuiHan [2009] No.601which provides guidance for the determination of “beneficial ownership” for purpose of claiming treaty benefits for passive types of income. The guidance provides for a facts and circumstances analysis using a “substance over form” approach. There are various factors which are considered unfavorable such as where the treaty resident (i.e. HK) (a) is required to distribute its income within a prescribed time frame of receipt, (b) has no other business activity other than ownership of the asset, etc., (c) has a relatively small amount of assets, employees, and operations that are not commensurate with its income, and (d) the treaty country (HK) exempts the income or taxes it at a low rate. Accordingly, it would appear likely that the HK holding company is at-risk of being considered a “conduit company” without substantive business activity and might be denied treaty benefits. In practice, the SAT has delegated the evaluation of whether a recipient of PRC dividend income is the beneficial owner to the local level tax bureaus. Enforcement at the local level is inconsistent, but we understand that there is a concerted effort to examine HK holding companies.

11. Tax Implications During the Holding Period Dividends paid by PRC Target to HK Limited– cont’d –HK tax implications-There is no tax on dividends in HK. Distributions made by HK of these dividends will not be subject to HK withholding tax. –U.S. tax implications to U.S. taxable investors As PRC Target should generally qualify for benefits under the U.S.- PRC income tax treaty, dividends that it pays should constitute “qualified dividends” subject to a U.S. tax rate of 15% (through 2012). As all entities in the structure above PRC Target are tax transparent (for U.S. tax purposes), a FTC, dollar for dollar, should generally be available. Accordingly, there should not be any tax leakage in the structure for these investors on account of PRC withholding tax.

12. Tax Implications to the Exit Sale by HK Limited of PRC shares –PRC withholding tax of 10% on capital gains & stamp duty of.05% on total consideration –HK will not tax capital gains –U.S. taxable investors (individuals and trusts) will be taxed at a rate of 15% if PRC shares were held for more than one year. –As all entities in the structure above PRC Target are tax transparent (for U.S. tax purposes), a FTC, dollar for dollar, should generally be available in respect to the income tax withholding. Article 22 (3) of the U.S. – PRC income tax treaty provides that the capital gain will be treated as foreign source (thereby facilitating use of the FTC). –Accordingly, there should not be any tax leakage in the structure for these investors on account of PRC income tax withholding tax.

13. Tax Implications to the Exit IPO at Cayman Limited level –Non-Tax Considerations Several countries will allow a Cayman company to be listed, but not a BVI company (note: the HK stock exchange recently began allowing the listing of BVI companies). An IPO at the HK Limited level would incur a capital duty at the rate of HK$1 per HK $1,000 of capital increase (maximum of HK$30K) immediately prior to listing & stamp duty of.1% of consideration for value of every share transferred. Using Cayman Limited as the IPO vehicle avoids this cost. Note: a private buyer might prefer a BVI company since the annual maintenance for a BVI company is a fraction of that for a Cayman company. Also, unlisted Cayman companies are required to appoint a Cayman resident director and company secretary. This is a reason for having a BVI company in the structure, i.e. to provide for additional exit options that might be more attractive to a buyer.

14. Tax Implications to the Exit IPO or private sale at Cayman Limited level –Tax Considerations PRC Tax Consequences- –Guoshuihan No. 698 and SAT Bulletin [2010] No.4 – Circular 698 and Bulletin 4 require reporting to China local tax bureau on sale of an offshore intermediary holding company owning a Chinese resident enterprise, if the intermediary holding company enjoys a low income tax rate. Depending on the local tax bureau’s review of the report, capital gains tax may be imposed on the sale of the offshore intermediary holding company owning a Chinese resident enterprise. –Since the holding company whose shares are sold is not subject to a tax in its jurisdiction of organization (i.e. Cayman), Cayman Limited is required to submit all relevant documentation on the equity transfer and the relationship between HK Limited and Cayman Limited to the Chinese tax authorities within 30 days. –Using a substance-over-form analysis, the Chinese authorities may disregard the existence of the offshore intermediary company (and require 10% PRC withholding tax on the gain) if it lacks business objectives and was established for the purpose of avoiding tax. –There may be question whether the PRC government has the right to tax foreign companies or require them to submit information that may or may not be relevant to Chinese enterprises. It is also unclear how these requirements may be enforced.