Typical due diligence issues

Due diligence investigations remain an essential tool for assessing and reducing the risks inherent in a merger and acquisition transaction in Hong Kong. In the absence of complete knowledge of the operations, the scope of assets and extent of liabilities of the target, due diligence investigations give the prospective buyer an opportunity to assess the target's legal and financial state of affairs. They also facilitate the consideration of structuring issues. Accordingly, thorough due diligence is vital in most merger and acquisition transactions in Hong Kong.

Pricing and payment

There are no requirements to carry out a valuation or follow a particular valuation model for determining the purchase price for companies or assets in Hong Kong. However, particularly where the transaction is made between related parties, it is advisable to ensure that the transaction is conducted on arm's length terms to manage any potential transfer pricing and other legal issues, such as those related to a transfer at an undervalue. In practice, commonly used valuation methods include using a debt-free, cash-free basis (representing the enterprise value of the business) and using a locked box structure in secondary buyouts and competitive auction processes (particularly where the sale process is run by a financial sponsor). The parties may also agree on an adjustment to the purchase price based on any shortfall or excess of the target's actual working capital against a target working capital.

Hong Kong applies no controls on the movement of foreign exchange. Similarly, there are no restrictions on investment or repatriation of capital or remittance of profits or dividends to or from a Hong Kong company and its shareholders.

Signing/closing

Is a deposit required?

The payment of deposits is not common practice in Hong Kong, except in the real estate sector. However, the buyer may be required to provide proof of funding. For financial sponsors, equity commitment letters are common.

Is simultaneous signing/closing common?

It is common for signing and closing to occur simultaneously in Hong Kong, and a seller may typically require simultaneous signing and closing. However, a split signing and closing is also not uncommon, particularly where it is necessary to obtain certain regulatory or other consents or approvals before closing, or for the buyer to complete further due diligence after signing the agreement.

Foreign investment restrictions

Hong Kong has a mandatory and suspensory foreign investment screening procedure, which means that transactions that meet the relevant criteria need to be notified to the relevant authority and cleared before they can be completed.

The foreign investment review regime is targeted at foreign direct investments in the following sector: the broadcasting and telecommunication sector, and specifically in relation to the influence and control of the Domestic Free TV Licensee and Sound Broadcasting Licensee. For further information and definitions of Domestic Free TV Licensee and Sound Broadcasting Licensee, see the more detailed section on "Foreign investment restrictions".

Antitrust/merger control

Merger control in Hong Kong is limited to mergers involving an undertaking with a telecommunications carrier license. Parties can seek informal advice, or, subject to certain criteria, apply for a decision on whether a merger should be excluded from the regime. There are no specific deadlines for these processes, but the competition authority must start investigating completed mergers within 30 days of becoming aware of them. The law also includes two "safe harbor" thresholds for assessing potential competition concerns. For further information, see the more detailed section on "Antitrust/merger control".

Other regulatory or government approvals

For certain sectors, such as banking, insurance, financial services and broadcasting, consent is required from the relevant regulatory body for: (i) a change of ownership; (ii) the acquisition of even a minority interest; or (iii) the disposal or amalgamation of the regulated business. With only a few exceptions, these merger approvals apply equally to foreign and local investors.

In the broadcasting industry, approval is required under the Broadcasting Ordinance if foreign ownership of a domestic free television program service licensee is to exceed certain thresholds (5%, 10% and 15%).

Foreign ownership of a radio broadcasting company must not exceed 49% as regulated under the Telecommunications Ordinance. Certain telecommunications licenses may only be issued to Hong Kong companies (although there are no restrictions on foreign ownership of such companies).

Where a transaction takes the form of an acquisition of shares in a company with employees, the process is simpler (than in respect of a transfer of assets), as the underlying employment contract (and employee benefits generally) between the target and its employees will usually be unaffected by the change in control. The contracts of key senior personnel should be checked, in particular, for any change of control provisions. Due diligence should be undertaken to ensure that potential liability for past acts and omissions is known.

The position is a little more complex in a transfer of the assets comprising a business, as the contracts of the business's employees are not automatically transferred to the buyer. Existing employment contracts must be terminated and new contracts should be entered into with the buyer. Technically, the employees will be made redundant by the transfer and it is important from the seller's perspective to take steps, to the extent possible, to minimize the existing employer's potential liability to make payments to employees in this situation.

To avoid liability to pay statutory severance to employees on the transfer of a business, the offer of new employment must be given by the buyer at least seven days before the date of the employees' transfer. In addition, the new terms of employment must either be identical to those under the employees' existing employment or constitute an offer of suitable employment on terms no less favorable to the employees than those under which they were previously employed. The new employer must agree to recognize the employees' previous period of service. It is common practice for the termination and offer of new employment to be combined in a joint letter sent by both seller and buyer or to be made in separate letters from the seller and buyer but given to employees at the same time. Typically, a clause requesting the employee's consent to a shorter contractual notice for the transfer will also be contained in the transfer letter. The notice period cannot, however, be shorter than seven days.

If on a transfer of assets or business, the employees are provided with due notice and all the mandatory details they should receive (as above), but the employees decide not to accept the offer from the buyer, and their employment is terminated by the seller, the legal exposure of the seller will, in normal circumstances, be limited to just a long-service payment (if applicable) plus accrued wages and untaken annual leave. If the employees are entitled to a contractual bonus, a pro-rata portion may also be payable.

Transfers of shares in Hong Kong companies are subject to stamp duty. Stamp duty is currently calculated at a rate of 0.2% of the value of the shares or the purchase price paid, whichever is greater (plus a fixed duty of HKD 5). The seller and buyer are currently each liable to pay stamp duty at 0.1% (hence the aggregate of 0.2%). However, the parties may contractually agree that the overall stamp duty shall be shared between them on a different basis. 

The transfer of assets in Hong Kong may be subject to Hong Kong profits tax depending on the nature of the assets being transferred and the source of the disposal gains.

Gains on the disposal of a capital asset are exempt from profits tax. A limited exception can apply where the gains are deemed to be Hong Kong sourced income by virtue of the refined foreign sourced income tax exemption (also known as the "refined FSIE regime"), discussed further below. However, to the extent that the capital asset is a depreciable asset, any income arising from the claw-back of depreciation or capital allowances may be assessable.

Hong Kong sourced income arising from the disposal of inventories or assets held for trade, in the course of a business carried on in Hong Kong is assessable. Whether a profit is Hong Kong-sourced will be determined on the basis of the location of the operations generating profit.

Effective from 1 January 2023, foreign sourced gains derived from the disposal of equity interests  that are accrued and received in Hong Kong (or deemed to be received in Hong Kong), by a member of a MNE Group (as defined under the Inland Revenue Ordinance (Cap. 112)) carrying on a trade, profession or business in Hong Kong, can be deemed to be Hong Kong-sourced income so as to be taxable in Hong Kong, unless the economic substance requirement is met or specific exemption or exclusion applies. The capital asset exemption does not apply where the gain is deemed to be Hong Kong-sourced income under the refined FSIE regime.

From 1 January 2024, the refined FSIE regime will expand to include foreign sourced gains derived from the disposal of any type of asset (whether capital or trading in nature). The extension covers foreign-sourced gains derived from the disposal of intellectual properties. Such foreign-sourced gains will be taxable unless the intellectual property is a patent (or equivalent assets) or copyright subsisting in software and the nexus requirement is met.

OECD's Two Pillar Solution

The OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting has put forward a so-called Two-Pillar Solution to address the tax challenges arising from the digitalization of the economy. Pillar Two is intended to introduce a global minimum effective rate of tax of 15% for large businesses in each jurisdiction where they operate and will lead to fundamental changes in the international tax system. It is currently being implemented in a large number of jurisdictions.

Groups will need to consider how the Pillar Two rules could impact on the life cycle of M&A transactions from the pre-acquisition phase (including transaction planning (such as the choice of acquisition structure and financing) and due diligence of the target group), the acquisition phase (such as contractual risk allocation around Pillar Two) to the post-acquisition phase and the impact of Pillar Two on any post-acquisition integration.

For information on post-acquisition integration matters, please see our Post-acquisition Integration Handbook.