Chinese Firms Access Foreign Capital in International Tax Havens

Tax havens are increasingly the avenue for emerging market countries, particularly China, to raise money from foreign investors. Many Chinese companies use financing subsidiaries and shell companies located in the tax havens, which makes them hard to trace. The firms involved range from Chinese tech giants to state-owned enterprises.

In China in Tax Havens (NBER Working Paper 30865), Christopher Clayton, Antonio Coppola, Amanda Dos Santos, Matteo Maggiori, and Jesse Schreger draw on subsidiary-parent information from several commercial datasets, along with data from the International Monetary Fund, to link securities offerings in tax havens with the ultimate country of origin for the issuer as well as the domicile of the holder.

In 2020, Chinese companies accounted for more than 60 percent of the outstanding value of equities issued by firms resident in tax havens.

In the past 20 years, Chinese companies have gone from negligible participation in securities issuance in tax havens to representing more than 60 percent of the equity outstanding by firms domiciled in these countries in 2020. Roughly 70 percent of foreign portfolio equity investment to China flowed through this channel, especially through the Cayman Islands. Chinese companies also account for about one-fifth of the corporate bonds issued in tax havens, and offshore entities also account for most foreign bond investment in China. Since 2016, however, foreign investment in Chinese government bonds onshore has also risen rapidly, diminishing the relative importance of offshore bond investments.

The use of tax havens for equity investments is more aimed at skirting Chinese law than tax considerations per se. Foreign investors are not permitted to own equity in Chinese firms in strategic industries, which include the technology industry. To abide by the letter of Chinese law and still attract foreign investment, some Chinese firms set up shell companies in tax havens and list them on global exchanges including the New York Stock Exchange.

The offshore shell companies create bilateral contracts with the Chinese operating companies and their owners. These are not formal equity contracts, but they are designed to give shell company shareholders control and a claim to the residual profits of the operating companies in China. International accounting standards regard these contracts as equivalent to equity. Meanwhile, the companies operating in China report to local regulators that they are fully owned by residents of China.

Giant tech-sector enterprises including Alibaba, Tencent, and Baidu get the vast majority of their portfolio equity investment from developed country investors through offshore shell companies. For bond issuance, large firms in other industries including state-owned enterprises, such as State Grid Corporation of China, China National Offshore Oil Corporation (CNOOC), and Sinopec, raise large amounts of offshore financing via the British Virgin Islands as well as the Caymans.

Offshore investments raise a number of uncertainties. The central question is whether stock holdings via tax-haven entities, known as variable interest entity (VIE) structures, are legal and enforceable. For corporate bonds, what happens if the Chinese company goes bankrupt? The US Senate and regulators have stepped up scrutiny of these entities if they are listed on a US stock exchange. China, too, has repeatedly warned it might increase and change its oversight of Chinese VIEs.

—Laurent Belsie