China investment activity ‘on hold’

A member of the China Venture Capital Association has reportedly said that private equity deals in the country are on ‘on hold’ pending clarification from the government on the use of offshore vehicles.

Kathy Xu, a board member of the China Venture Capital Association has told the Wall Street Journal that private equity and venture capital funds are putting their investment activities in China “on hold” while they grapple with new regulations on offshore investing.

This year, Chinese authorities issued circulars intended to better track the use of special purpose vehicles by domestic and foreign investors. The new regulations are in response to worries that some of these investors are avoiding taxes and laundering money. The government is also worried about the new outflow of capital from the country, and sees special purpose vehicles as part of the problem.

Critics of the new policy argue that the regulations make it cumbersome to invest in Chinese startups and to pursue certain exits, such as listings on foreign stock exchanges.

According to the report, citing data service Zero2IPO, venture capital investment in China dropped 42 percent in the first quarter of this year.

Xu told the WSJ that she is “optimistic” that the issue will be resolved in the next one or two months.

In the meantime, private equity firms and their legal counsel are intensely lobbying the government for clarification and change to the new policy.

Elsewhere in Asia, the use of offshore investment vehicles is drawing government scrutiny. The Carlyle Group is being investigated by South Korean tax authorities, some of which paid a surprise visit to Carlyle offices in Seoul in late April, according to a source close to the situation. The source said the investigation involves a Korean law stating that private equity funds do not have to pay a gains tax, provided the funds are not domiciled in South Korea. The Carlyle Asia fund is reportedly based in the Cayman Islands.

Dallas-based Lone Star Funds was also reportedly targeted and paid two visits by Korean tax officials in the past month, possibly tied to a number of recent investments and exits in the region. In 2003, Lone Star acquired a majority stake in the Korea Exchange Bank for $1.2 billion. The firm recently sold Star Tower, a 45-story office building in Seoul, to the Government of Singapore for an undisclosed amount, which is reported to be around $1 billion.