Flyingeagle PU Technical Corp

In October 2005, SAFE issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China, generally referred to as Circular 75, which required PRC residents to register with the competent local SAFE branch before establishing or acquiring control over an offshore special purpose company, or SPV, for the purpose of engaging in an equity financing outside of China on the strength of domestic PRC assets originally held by those residents. Internal implementing guidelines issued by SAFE, effective May 29, 2007 (known as Notice 106), expanded the reach of Circular 75 by (1) purporting to cover the establishment or acquisition of control by PRC residents of offshore entities which merely acquire “control” over domestic companies or assets, even in the absence of legal ownership; (2) adding requirements relating to the source of the PRC resident’s funds used to establish or acquire the offshore entity; (3) covering the use of existing offshore entities for offshore financings; (4) purporting to cover situations in which an offshore SPV establishes a new subsidiary in China or acquires an unrelated company or unrelated assets in China; and (5) making the domestic affiliate of the SPV responsible for the accuracy of certain documents which must be filed in connection with any such registration, notably, the business plan which describes the overseas financing and the use of proceeds. Amendments to registrations made under Circular 75 are required in connection with any increase or decrease of capital, transfer of shares, mergers and acquisitions, equity investment or creation of any security interest in any assets located in China to guarantee offshore obligations, and Notice 106 makes the offshore SPV jointly responsible for these filings. In the case of an SPV which was established, and which acquired a related domestic company or assets, before the implementation date of Circular 75, a retroactive SAFE registration was required to have been completed before March 31, 2006. This date was subsequently extended indefinitely by Notice 106, which also required that the registrant establish that all foreign exchange transactions undertaken by the SPV and its affiliates were in compliance with applicable laws and regulations. Failure to comply with the requirements of Circular 75, as applied by SAFE in accordance with Notice 106, may result in fines and other penalties under PRC laws for evasion of applicable foreign exchange restrictions. Any such failure could also result in the SPV’s affiliates being impeded or prevented from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the SPV, or from engaging in other transfers of funds into or out of China.

We have asked our shareholders, who are PRC residents as defined in Circular 75, to register with the relevant branch of SAFE as currently required in connection with their equity interests in us and our acquisitions of equity interests in our PRC subsidiary. However, we cannot provide any assurances that they can obtain the above SAFE registrations required by Circular 75 and Notice 106. Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies. For example, our present and prospective PRC subsidiaries’ ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with Circular 75 and Notice 106 by our PRC resident beneficial holders.

On April 22, 2009, the State Administration of Taxation issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of de facto Management Bodies, or the Notice, further interpreting the application of the EIT Law and its implementation against non-Chinese enterprise or group controlled offshore entities. Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) its substantial assets and properties, accounting books, corporate chops, board and shareholder minutes are kept in China; and (iv) at least half of its directors with voting rights or senior management often resident in China. A resident enterprise would be subject to an enterprise income tax rate of 25% on its worldwide income and its non-PRC shareholders would be subject to a withholding tax at a rate of 10% when dividends are paid to such non-PRC shareholders. However, it remains unclear as to whether the Notice is applicable to an offshore enterprise incorporated by a Chinese natural person. Nor are detailed measures on enforcement of PRC tax against non-domestically incorporated resident enterprises are available. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.

We face uncertainty from China’s Circular on Strengthening the Administration of Enterprise Income Tax on Nonresident Enterprises' Share Transfer, or Circular 698, that was released in December 2009 with retroactive effect from January 1, 2008.

The Chinese State Administration of Taxation, or SAT, released a circular on December 15, 2009 that addresses the transfer of shares by nonresident companies, generally referred to as Circular 698. Circular 698, which is effective retroactively to January 1, 2008, may have a significant impact on many companies that use offshore holding companies to invest in China. Circular 698, which provides parties with a short period of time to comply with its requirements, indirectly taxes foreign companies on gains derived from the indirect sale of a Chinese company. Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company, and the latter is located in a country or jurisdiction where the effective tax burden is less than 12.5% or where the offshore income of his, her, or its residents is not taxable, the foreign investor is required to provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers. Moreover, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through an abuse of form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided, the PRC tax authority will have the power to re-assess the nature of the equity transfer in accordance with PRC’s “substance-over-form” principle and deny the existence of the offshore holding company that is used for tax planning purposes. There is uncertainty as to the application of Circular 698. For example, while the term “indirectly transfer” is not defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. It is also unclear, in the event that an offshore holding company is treated as a domestically incorporated resident enterprise, whether Circular 698 would still be applicable to transfer of shares in such offshore holding company. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax in the country or jurisdiction and to what extent and the process of the disclosure to the tax authority in charge of that Chinese resident enterprise. In addition, there are not any formal declarations with regard to how to decide “abuse of form of organization” and “reasonable commercial purpose,” which can be utilized by us to balance if our Company complies with the Circular 698. If Circular 698 is determined to be applicable to us based on the facts and circumstances around such share transfers, we may become at risk of being taxed under Circular 698 and we may be required to expend valuable resources to comply with Circular 698 or to establish that we should not be taxed under Circular 698, which could have a material adverse effect on our financial condition and results of operations.

Although we believe that our current facilities is adequate and suitable to meet our existing demands, we currently utilize 100% of our current facilities. We intend to increase our production capacity primarily pursuant to certain a call option to acquire all of the outstanding shares of San Ming which has certain leasing rights to build manufacturing facilities in DaTian city, Fujian. We also entered into a call option agreement to acquire all of the shares of FFP which is attempting to acquire certain development rights to build a proposed manufacturing facility in Yong’an city. The development of the proposed manufacturing facility in Yong’an city by FFP was put on hold due to issues related to securing the land use rights, and the strategic decision to complete the build-up of the facility in DaTian city by San Ming before undergoing another construction project. The FFP call option expired on January 17, 2012. Construction on the facility in DaTian city by San Ming began in June 2010. There are three phases for the new PU leather factory. Phase 1 has been completed and consists of construction of the actual facilities that will house the production center and the purchases and installation of 3 wet process production lines, 2 dry process production lines and installation of recycling equipment to recapture and recycle chemicals used in the production process. Phase 1 has total cost of $20.0 to $21.0 million. Since Phase 1 has completed, the San Ming facility have the same production capacity as our current SFP facility. Phase 1 has completed with two wet production lines and three dry production lines which represents approximately 100% of Phase 1 capacity. The San Ming has been testing their machine and equipment for the past 5 months, except for a one month break during spring holiday. San Ming is currently in production and had sales in first quarter 2012. Phase 2 has not started yet; the timing is somewhat dependent on PU leather demand and the availability of capital resources. Phase 2 will consist of the expansion from 3 wet processing lines to 9 wet processing lines, from 2 dry process lines to 7 dry processing lines, and the addition of a resin plant and 5 base-cloth production lines. We intend to fund phase 2 from the sale of equity instruments and bank financing. After the construction of Phase 2, San Ming will decide how it wishes to proceed on Phase 3. Phase 3 consists of installing new wet and dry processing lines to product super-fiber PU leather, and the ability to produce PU leather for other industries at high capacity. As of December 31, 2011, the cost associated with the construction of phase 1 at San Ming was approximately $20.56 million of which SFP funded approximately $9.95 million.

At December 31, 2011 and 2010, we had a payable to Shishi Changsheng for $413,845 and $0, respectively. Shishi Changsheng is 100% owned by Mr. Ang, our director, executive officer and majority shareholder. Shishi Changsheng holds the land use rights for the land under the footwear factory. Pursuant to a lease dated December 21, 2007 with Shishi Changsheng, we lease 3,914.18 square meters of manufacturing space from Shishi Changsheng for an annual rent of $36,548 (RMB 234,851). We pay Shishi Changsheng rent under a four year agreement, which expires on December 31, 2011. We made a new lease agreement with Changsheng. It is 2 year lease agreement with annual payment of $14,760(RMB 93,940) For the years ended December 31, 2011 and 2010, we had rental expense of approximately $36,548 and $35,000, respectively, in accordance with the rental agreement. The receivable and payable is related to the payment of rent and transfers for cash flow purposes. As of December 31, 2011 and 2010, we had a receivable from Shishi Changsheng for $0 and $5,694,515, respectively, which was subsequently offset as part of entering into a call option agreement to acquire all of the outstanding shares of San Ming from Mr. Ang. On January 17, 2011, HK Weituo, our subsidiary, entered into a call option agreement to acquire all of the outstanding shares of San Ming from Mr. Ang. The $5,694,515 receivable from Shishi Changsheng due to SFP was transferred to Mr. Ang and later cancel in consideration of entering into the call option agreement to acquire Mr. Ang’s interest in San Ming. As additional consideration for entering into the call option agreement, a receivable in the amount of $83,490 due from San Ming to SFP and subsequently assigned to Mr. Ang was also cancelled as consideration for entering into the call option agreement. Therefore the total cost for the San Ming call option agreement to acquire all of the outstanding shares of San Ming was $5,778,005 which represented advances made by SFP to companies controlled by Mr. Ang that were subsequently transferred to Mr. Ang and cancelled.