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The Next Cayman? Reflection On Offshore Finance And Offshore Company System Design In Hainan Free Trade Port

By Zhang Shiwei
As a free trade port with Chinese characteristics, the relevant system design of the Hainan free trade port cannot copy the offshore company law and offshore financial system of the traditional offshore jurisdiction. We may as well start from the local offshore and become the registered place of red chip offshore companies, so as to give full play to the location advantages relative to the traditional offshore jurisdiction, so as to play an important role in the overseas red chip private placement, listing and cross-border M & A of Chinese enterprises.
Recently, the Hainan Free Trade Port Law (Draft) was deliberated by the Standing Committee of the National People's Congress and solicited public opinions. As the first free trade port law to be born in China, the draft legalizes and institutionalizes the top-level design of the overall plan for the construction of the Hainan free trade port issued by the central government. It also explicitly grants the flexible legislative power to the free trade port for the first time and lays the basic legal foundation for the construction of the free trade port from the aspects of free trade and convenience, free investment and convenience, financial and tax system, etc.
After the law comes into effect, Hainan free trade port will implement Customs sealing operation, implement customs border management with the mainland, and achieve the free flow of personnel, capital, goods, data, technology, and other elements. This means that compared with the mainland, Hainan will not only be physical offshore, but also realize specific institutional offshore, so as to become a high-level free trade port based on China and facing the world, or the so-called "offshore island", "offshore jurisdiction", "offshore financial center", "offshore center", etc.
The traditional "offshore jurisdiction" and "offshore center" have all kinds of beautiful appellations: the " SOFTAROM " of venture capital, "beautiful turning point" of a different way to listing, "land of changing face" of eclectic, and "geomantic treasure land" of legal tax saving. No matter how it is called, it is characterized by the low tax rate (even zero tax rate in many aspects), free and convenient trade and investment, and free and convenient cross-border capital flow (mainly a high degree of freedom of foreign exchange and in and out under current account and capital account). 
Ranging from offshore banks, offshore funds, offshore trusts, offshore companies to other legal forms of offshore activities carrier or subject, of which the most important is undoubtedly the offshore company. According to incomplete statistics, there are millions of offshore companies in the world.
Whether it is a cross-border investment, financing, M & A, cross-border commodity trade, or cross-border intellectual property flow, it is mostly carried out through offshore companies. Whether we want to admit it or not, offshore companies have become an indispensable part of the effective operation of the world economic and financial system. In this regard, the common offshore characteristics of the offshore company law in the famous offshore jurisdictions such as the British Virgin Islands (BVI), the Cayman Islands, Bermuda Islands, and Delaware have great reference significance for the system design of offshore companies in Hainan free trade port.
Of course, considering that we are a free trade port with Chinese characteristics and pay special attention to the requirements of financial services for the real economy, the system design of offshore finance and offshore company related to free trade port can not completely copy the offshore financial system and offshore company law of these offshore jurisdictions, nor can we go back to race to the bottom competition in history. Hainan free trade port will not and should not become another virgin and Cayman.
Considering the fact that tens of thousands of overseas red chip enterprises (hundreds of which have been listed, most of which are also state-owned enterprises) in China are all offshore companies registered in virgin, Cayman, and other offshore jurisdictions, an expectable development goal is that Hainan Free Trade Port may start from the local offshore, become the registration place of China's red-chip offshore companies and play an important role in their overseas red-chip private placement and listed cross-border mergers and acquisitions, and then partially replace the relevant functional status of Virgin Cayman and other offshore jurisdictions in this respect.
Theoretically speaking, Hainan free trade port, backed by the mainland of China which is the world’s second-largest economy, is the bridgehead of the 21st century Maritime Silk Road and Pan South China Sea Economic Cooperation Zone, Compared with the traditional offshore legal domain location advantage is obvious. Under the new situation that the domestic capital market has been opened the red chip enterprises listed in China, the development prospect of Hainan free trade port in this aspect is even more worth looking forward to. Therefore, Hainan free trade port should timely introduce relevant institutional arrangements, such as re-domiciliation, so as to facilitate the re-domiciliation of offshore companies originally registered in Virgin and Cayman (red chips) and offshore funds (return).
At the same time, it should be noted that driven by the tide of anti-tax avoidance, anti-money laundering, and anti-terrorist financing in major global economies and regulatory pressure, the original characteristics of traditional offshore jurisdictions, such as excessive freedom, opacity, improper tax avoidance, and even tax evasion, are also changing. On the one hand, the relevant offshore jurisdictions have successively issued economic substance bills to distinguish different subjects and situations.
These bills require that the offshore companies and other related entities incorporated locally must pass the corresponding "economic substance" laws in the "substance" test, the relevant entities need to carry out the corresponding actual business in different situations, otherwise, they may face the risk of fines or even cancellation. On the other hand, the organization for economic cooperation and development (OECD) has formulated a common reporting standard for the automatic exchange of tax information ("CRS"). Through the automatic exchange mechanism of tax-related information of financial accounts under the CRS, the tax authorities of tax resident countries (regions) can fully grasp the rights and interests held by offshore companies of tax resident countries (regions) and other offshore financial assets, and it can effectively carry out the anti-tax avoidance work for tax resident offshore companies.
China has joined the CRS in 2017, and the new individual income tax law has also introduced anti-avoidance rules for individual income tax of offshore companies. According to the law, once the Chinese tax authorities have the relevant information and determine that the relevant offshore company is a controlled (individual) foreign enterprise under the law, they may regard the investment income collected but not distributed shall be regarded as the profit distribution obtained by the individual, and then require the individual to declare and pay personal income tax on such overseas income.
Generally speaking, improving transparency and strengthening compliance supervision have become the latest trend in the development of offshore finance and offshore companies. Under this trend, offshore entities are faced with three major changes: hollowing out to substantiation, offshore operations from offshore to onshore, offshore operations from concealment to transparency, and their compliance costs will be appropriately increased. This is the correction and call-back of the excessive laissez-faire of the original offshore finance and offshore companies due to the lack of supervision. Only if we can manage it, then we can really let it go. These are undoubtedly the specific system design of offshore finance and an offshore company of Hainan free trade port need to pay attention to.
In order to facilitate the offshore commercial activities of the relevant free trade port, the registration management, trading, financial services, and other infrastructure of the relevant commercial entities of Hainan free trade port need to be updated. According to the "general plan for the construction of Hainan free trade port" and "Hainan Free Trade Port Law (Draft)" and other relevant contents, after the closure operation of Hainan Island, different from the mainland outside the island, the people, property, material, and data inside the island will have offshore attributes. The identification of relevant attribution nature and transaction flow will be carried out according to the requirements of offshore laws and regulations, and the relevant subjects and their funds and accounts will be opened.
The system arrangement and infrastructure of revenue and expenditure, exchange, settlement, liquidation, trusteeship, registration, supervision and management, tax collection, and management must meet the needs of serving, supporting, and facilitating such offshore economic and financial activities. Now it is a new era of the digital economy. Undoubtedly, the relevant systems and infrastructure of free trade port should make good use of new technologies such as blockchain, big data, and artificial intelligence in the new era, so as to give full play to its late development advantages compared with the traditional offshore jurisdiction, and also consider the unique requirements of the new era. For example, in the context of free trade port, data storage, cross-border flow, and key infrastructure setting, which are the most important factors of production in the Internet information age, also need to consider the coordination with relevant rules such as civil code, network security law, and personal information protection law (Draft). When necessary, it may also need to use flexible legislative power for flexible treatment.
In fact, in addition to the highly free and convenient financial infrastructure, highly developed and highly respected offshore business practice requires a fair and efficient legal system and a mature legal service system, which is also the only way for the traditional offshore jurisdiction and its offshore companies to develop so far. "The rule of law is the best business environment. "In terms of rule of law construction, free trade port should undoubtedly aim at creating a world-class business-friendly, investment-friendly and ecological friendly rule of law environment. Since the founding of Hainan Province, we must learn from the historical lessons in this respect. Recently, Hainan Province reported six typical cases of damaging the business environment, which is a great warning sign.
The opinions of the Supreme People’s Court on Providing Judicial Services and guarantee for the construction of Hainan free trade port recently issued by the Supreme People’s court also promotes the construction of a legal system suitable for the construction of Hainan free trade port from eight aspects, including improving the reform of trial organization system, promoting the innovation of foreign-related civil and commercial trial mechanism, and promoting the construction of an international commercial dispute settlement center. The intellectual property court of Hainan free trade port has also been listed and officially accept and hear a case. Next, the establishment of the Hainan free trade port financial court should undoubtedly be put on the agenda. The vitality of the rule of law lies in practice.
We also hope that the relevant judicial practice will recognize, protect and respect the inherent laws and requirements of offshore companies, offshore finance, and other offshore commercial practices to the greatest extent, provide precedents and rules for offshore civil and commercial activities on the basis of a large number of offshore civil and commercial cases, enhance their certainty and predictability, and form a flexible, practical and unique offshore rule of law on this basis. Then it stands in the forest of rule of law in China and even in the world. In this regard, the goal of the Hainan free trade port should be the ocean, not just Cayman.
Source: Zhong Lun