Alibaba and the disappearing VIE | China Accounting Blog | Paul Gillis

Alibaba and the disappearing VIE

Alibaba Group Ltd (Alibaba) and its shareholder Yahoo are in a very public spat over Alibaba’s alleged transfer of Alipay to a company controlled by Jack Ma and Xie Shihuang, the founders of Alibaba.  It is alleged that Alibaba transferred 70% of the online payment service in June, 2009 for $22.4 million to Zhejiang Alibaba E-commerce Company (Zhejiang Alibaba) which is owned by Ma and Xie. The remaining 30% was transferred in August 2010 for RMB 164.9 million. Yahoo claims it did not learn about the transaction until March 31, 2011, despite having board representation. 

Alibaba is a private company (not to be confused with Alibaba.com, the Hong Kong traded B2B company it also controls), so financial statements are not available.  I have attempted to piece together the structure and the issues presented from press reports and from public filings of Alibaba.com. There is no assurance I have figured out the structure correctly. 

It appears Alipay was operated through Zhejiang Alipay Network Technology Co. Ltd and Alipay Software (Shanghai) Co. Ltd., both second or third tier wholly owned subsidiaries of Alibaba, and wholly foreign owned enterprises (WFOE) in China.   

China restricts foreign ownership of companies operating in certain sectors, including internet related businesses.  It is common for overseas listed Chinese companies to use variable interest entities (VIE) to hold operations that are restricted from foreign ownership.  Alibaba.com uses a VIE called Alibaba Hangzhou to run its B2B business in compliance with Chinese laws.  Alibaba Hangzhou is owned by Jack Ma and Simon Xie, founders and PRC nationals.  A series of contracts between Alibaba Hangzhou and Alibaba.com allow Alibaba.com to consolidate Alibaba Hangzhou even though it does not own it.  Although the VIE rules and the term come from U.S. GAAP, you can reach the same result under IFRS, which Alibaba.com uses. 

Alibaba also appears to have a VIE, Zhejiang Alibaba.  Whether they used this VIE for other parts of  Alibaba  (like Taobao) is not known. Since Yahoo indicates that Alipay was consolidated until the first quarter of 2011, there must have been VIE agreements in place between Jack Ma, Simon Xie and Alibaba that give Alibaba  control of Zhejiang Alibaba.  

There is nothing particularly alarming about the transfer of Alipay to the VIE. The People's Bank of China issued rules in June 2010 requiring operating licenses for non-banks operating third party payment systems.  Foreign owned institutions are subject to tougher requirements, including review by the central bank and approval from the State Council.   It appears that Alibaba transferred 70% of Alipay to the VIE hoping this would be sufficient to get the license, but later decided it would be easier if they just transferred the whole thing.  The ending situation is not much different than most overseas listed Chinese e-commerce companies - at least as long as the VIE agreements stay in place. 

Yahoo alleges that Alipay was deconsolidated from Alibaba  in the first quarter of 2011.  That implies that the VIE type agreements between Alibaba and Zhejiang Alibaba were modified or terminated in a way that prevented consolidation under VIE type rules.  Or the Alipay companies could have been transferred out from under Zhejiang Alibaba to Jack Ma and Simon Xie. 

There are reports that Alipay is worth $5 billion.  Since the transfer seems to have been made for only about $46 million, it looks like Alibaba Group may have to explain to the Chinese tax authorities why they don't owe 20% tax on the other $4.95 billion of value.  This could become the transfer pricing case of the year - no, make that century.  

Yahoo's beef with Alibaba Group would appear to be valid if the economic value of the Alipay companies was actually transferred out.  That appears to be what would happen if the companies needed to be de-consolidated.  The whole mess points to the risks of VIE arrangements where the company does not actually own its operations. 

Update:

A good analysis of some source documents is here.

 

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