Star Plus Legend Holdings Limited - Proxy Solicitation & Information Statement 2005

THIS DOCUMENT IS IMPORTANT AND REQUIRES YOUR IMMEDIATE ATTENTION

If you are in any doubt as to any aspect of this circular or as to the action to be taken, you should consult your licensed securities dealer, bank manager, solicitor, professional accountant or other professional adviser.

If you have sold or transferred all your shares in AviChina Industry & Technology Company Limited, you should at once hand this circular and the enclosed proxy form to the purchaser or the transferee or to the bank, licensed securities dealer or other agent through whom the sale or transfer was effected for transmission to the purchaser or the transferee.

The Stock Exchange of Hong Kong Limited takes no responsibility for the contents of this circular, makes no representation as to its accuracy or completeness and expressly disclaims any liability whatsoever for any loss howsoever arising from or in reliance upon the whole or any part of the contents of this circular.

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AviChina Industry & Technology Company Limited*

(A joint stock limited company incorporated in the People’s Republic of China with limited liability)

(Stock Code: 2357)

CONTINUING CONNECTED TRANSACTIONS

Independent financial adviser to the Independent Board Committee and Independent Shareholders

SOMERLEY LIMITED

A letter from the Independent Board Committee is set out on page 37 of this circular. A letter from Somerley to the Independent Board Committee and Independent Shareholders is set out on pages 38 to 53 of this circular.

A notice convening an Extraordinary General Meeting of AviChina Industry & Technology Company Limited to be held at 9 a.m. on Monday, 19 December 2005 at Kang Ming Hotel, No. 18 Meishuguan Hou Jie, Dong Cheng Qu, Beijing, the People’s Republic of China is set out on pages 59 to 63 of this circular.

If you intend to attend the Extraordinary General Meeting, please complete and return the enclosed reply slip in accordance with the instructions printed thereon as soon as possible and in any event by 5 p.m. on Tuesday, 29 November 2005.

Whether or not you are able to attend the Extraordinary General Meeting in person, you are requested to complete and return the enclosed the form of proxy in accordance with the instructions printed thereon as soon as possible and in any event no later than 24 hours before the time appointed for the holding of Extraordinary General Meeting. Completion and delivery of the form of proxy will not preclude you from attending and voting at the Extraordinary General Meeting or any adjournment thereof should you wish.

* For identification purposes only

2 November 2005

	Page
Expected timetable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	1
Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	2
Letter from the Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	6
1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	6
2. Continuing Connected Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	7
3. General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	35
4. Extraordinary General Meeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	36
5. Recommendation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	36
6. Further information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	36
Letter from the Independent Board Committee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	37
Letter from Somerley . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	38
Appendix I — General information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	54
Appendix II — Procedures for demanding a poll . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	58
Notice of Extraordinary General Meeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	59

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EXPECTED TIMETABLE

Deadline for returning the reply	slip
for the Extraordinary General	Meeting . . . . . . . . . . . . . . .5 p.m. on Tuesday, 29 November 2005
Deadline for returning the proxy	forms
for the Extraordinary General	Meeting . . . . . . . . . . . . . . . .9 a.m. on Sunday, 18 December 2005
Extraordinary General Meeting	. . . . . . . . . . . . . . . . . . . . . .9 a.m. on Monday, 19 December 2005

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DEFINITIONS

In this circular, unless the context requires otherwise, the following terms and expressions shall have the following meanings:

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|||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|“Agusta|Agreement”|the Agusta|agreement|dated|2|June|2005|entered|into|between|
|Changhe|Industry|Company|and|Agusta|S.p.A.|
|“AVIC|II”|(China|Aviation|Industry|Corporation|
|II),|the|controlling|shareholder|of|the|Company|
|“AVIC|II|Group”|AVIC|II|and|its|associates|(as|defined|under|the|Listing|Rules)|
|(excluding|the|Group)|
|“Board”|or|“Board|of|Directors”|the|board|of|Directors|of|the|Company|
|“Cap(s)”|the|respective|proposed|annual|caps|for|each|of|the|
|Continuing|Connected|Transactions|for|the|three|financial|
|years|ending|31|December|2008|
|“CATIC”|(China|National|Aero-Technology|
|Import|and|Export|Corporation),|a|state-owned|enterprise|
|held|as|to|50%|by|AVIC|II|and|50%|by|China|Aviation|
|Industry|Corporation|I|
|“Changhe|Agusta”|(Jiangxi|Changhe-Agusta|
|Helicopter|Co.,|Ltd.),|a|sino-foreign|joint|venture|held|as|to|
|60%|by|Changhe|Industry|Company|and|40%|by|Agusta|
|S.p.A.|
|“Changhe|Industry|Company”|(Jiangxi|Changhe|Aviation|Industry|
|Company|Limited),|a|wholly-owned|subsidiary|of|the|
|Company|
|“Changhe|Suzuki”|(Jiangxi|Changhe|Suzuki|
|Automobile|Co.,|Ltd.),|a|sino-foreign|joint|venture|held|as|to|
|41%|by|Jiangxi|Changhe|Automobile|Co.,|Ltd|which|is|a|
|subsidiary|of|the|Company,|10%|by|Changhe|Industry|
|Company,|26.1%|by|Suzuki,|19.3%|by|Suzuki|(China)|
|Investment|Limited|(|)|and|3.6%|by|
|OKAYA|&|Co.|Ltd.|respectively|
|“CKD”|completely|knock|down,|the|parts|and|components|for|
|manufacturing|of|vehicles,|vehicle|engines|and|gearboxes|
|which|were|completely|knocked|down|when|imported|into|the|
|PRC|
|“Company”|(AviChina|Industry|&|Technology|
|Company|Limited),|a|joint|stock|limited|company|established|
|in|the|PRC|with|limited|liability|on|30|April|2003|

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DEFINITIONS

“Comprehensive Services	(the comprehensive services agreement) dated 2
Agreement” October 2003 entered into between the Company and AVIC II
“Continuing Connected the transactions, the details of which are set out in the
Transactions” paragraph headed “Continuing Connected Transactions” of
the letter from the Board in this circular.
“Directors” the director(s) of the Company “Dongan Engine” (Harbin Dongan Automotive
Engine Manufacturing Co., Ltd.), a sino-foreign joint venture
held as to 36% by Dongan Motor, 15% by Hafei Industry
Company, 19% by Dongan Group, 15.3% by Mitsubishi, 9%
by MCIC Holdings Sdn. Bhn. and 5.7% by Mitsubishi
Corporation “Dongan Group” (Harbin Dongan Engine (Group)
Co., Ltd.), a wholly-owned subsidiary of AVIC II “Dongan Motor” (Harbin Dongan Auto Engine
Co., Ltd.), a joint stock limited company whose shares are
listed on the Shanghai Stock Exchange with 70.01% of its
interest being held by the Company and the rest are held by
the public
“EGM” or “Extraordinary extraordinary general meeting of the Company to be held to
General Meeting” approve, inter alia, the Continuing Connected Transactions
and the proposed annual Caps
“Group” the Company and its subsidiaries “Hafei Auto” (Hafei Motor Co., Ltd.), a joint stock
limited liability company with foreign investment which is
held as to 74.81% by Hafei Industry Company, 25% by China
Aero (382) Limited which is ultimately wholly-owned by
CATIC, 0.1% by Dongan Group, 0.06% by CATIC and 0.03%
by Shenzhen Shenhang Avionics Co., Ltd., which is held as to
34% and 33% respectively by CATIC and Hafei Industry
Company “Hafei Industry Company” (Harbin Aviation Industry (Group)
Co., Ltd.), a wholly-owned subsidiary of the Company
“Independent Board Committee” an independent board committee comprising independent
non-executive Directors, namely, Dr. The Hon. Li Kwok-Po,
David, Mr. Guo Chongqing and Mr. Li Xianzong
“Independent Shareholders” Shareholders other than AVIC II, Mitsubishi, Suzuki, Agusta
S.p.A. and their respective associate(s), if any

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DEFINITIONS

“Internal CT Agreement”
(the internal connected transactions
agreement) dated 2 October 2003 entered into between the Company and various subsidiaries of the Company
“K Series Engine Licence Agreement”
K (the K series engine licence agreement) dated 24 December 2003 entered into between Changhe Suzuki and Suzuki
“Land Use Rights Leasing (the land use rights leasing agreement) Agreement” dated 2 October 2003 entered into between the Company and AVIC II
“Latest Practicable Date”
28 October 2005 being the latest practicable date before the printing of this circular for ascertaining certain information in this circular
“Liana Licence Agreement”
Liana (the Liana licence agreement) dated 24 December 2003 entered into between Changhe Suzuki and Suzuki
“Listing”

the listing of the H Shares on the Stock Exchange

“Listing Rules”
the Rules Governing the Listing of Securities on the Stock Exchange (as amended from time to time)
“Mitsubishi”
Mitsubishi Motor Corporation ( ), a substantial shareholder of Dongan Engine
“Mitsubishi CKD Agreement”
CKD (the CKD supply agreement) dated 30 June 1999 entered into between Dongan Engine and Mitsubishi
“Mitsubishi Hafei CKD Agreement”
- (the Mitsubishi Hafei CKD
agreement) dated 8 August 2005 entered into between Hafei Auto and Mitsubishi
“Mitsubishi Joint Development Agreement”
(the Mitsubishi joint development
agreement) dated 8 August 2005 entered into between Hafei Auto and Mitsubishi
“Mitsubishi Technology Transfer Agreement”
(the Mitsubishi technology transfer
agreement) dated 30 June 1999 entered into between Dongan Engine and Mitsubishi
“Mutual Supply Agreement”

(the products and ancillary services mutual supply agreement) dated 2 October 2003 entered into between the Company and AVIC II

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DEFINITIONS

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||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
|“New|Series|Automobile|Licence|(the|new|series|automobile|licence|
|Agreement”|agreement)|dated|21|March|2005|entered|into|between|
|Changhe|Suzuki|and|Suzuki|
|“PRC”|the|People’s|Republic|of|China|
|“Properties|Leasing|Agreement”|(the|properties|leasing|agreement)|dated|2|
|October|2003|entered|into|between|the|Company|and AVIC|II|
|“RMB”|or|“Renminbi”|the|lawful|currency|of|the|PRC|
|“SFO”|Securities|&|Futures|Ordinance|(Chapter|571|of|the|Laws|of|
|Hong|Kong)|
|“Shares”|Domestic|Shares|and|H|Shares|
|“Shareholders”|the|holder(s)|of|shares|of|RMB1.00|each|in|the|capital|of|the|
|Company|
|“Stock|Exchange”|The|Stock|Exchange|of|Hong|Kong|Limited|
|“Somerley”|Somerley|Limited,|a|corporation|licensed|under|the|SFO|to|
|conduct|types|1|(dealing|in|securities),|4|(advising|on|
|securities),|6|(advising|on|corporate|finance)|and|9|(asset|
|management)|regulated|activities|and|is|the|independent|
|financial|adviser|to|the|Independent|Board|Committee|and|the|
|Independent|Shareholders|
|“Suzuki”|Suzuki|Motor|Corporation,|a|joint|venture|partner|of|the|
|Company|which|holds|a|26.1%|equity|interest|in|Changhe|
|Suzuki|
|“Technology|Cooperation|(the|technology|cooperation|framework|
|Agreement”|agreement)|dated|2|October|2003|entered|into|between|the|
|Company|and|AVIC|II|
|“USD”|the|lawful|curreny|of|the|United|States|of|America|
|“Vigers”|Vigers|Appraisal|&|Consulting|Limited|

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In this circular, all amounts denominated in RMB and USD have been converted into HK$ using an exchange rate of HK$1.00: RMB1.04 and USD 1: HK$7.80, for the purpose of illustration only, and does not constitute a representation that any amount has been, could have been, or may otherwise be exchanged or converted at this or any other rate.

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LETTER FROM THE BOARD

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AviChina Industry & Technology Company Limited*

(A joint stock limited company incorporated in the People’s Republic of China with limited liability) (Stock Code: 2357)

Executive Directors:

Mr. Zhang Hongbiao Mr. Wu Xiandong

Non-executive Directors:

Registered Address:

No. 16, Hong Da Bei Lu Beijing Economical Technological Development Area Beijing, PRC

Mr. Liang Zhenhe

Mr. Song Jingang

Mr. Tan Ruisong
Mr. Wang Bin
Mr. Chen Huaiqiu

Principal Place of Business in Hong Kong:

Unit B, 15/F, United Center Queensway 95, Hong Kong

Mr. Tian Min

Mr. Wang Yong

Mr. Maurice Savart

Independent non-executive Directors:

Dr. The Hon. Li Kwok-Po, David

Mr. Guo Chongqing

Mr. Li Xianzong

2 November 2005

To the Shareholders

Dear Sir or Madam,

CONTINUING CONNECTED TRANSACTIONS

1. INTRODUCTION

As disclosed in the announcement of the Company dated 30 September 2005, the caps set for the three financial years ending 31 December 2005 and some of the agreements governing certain continuing connected transactions of the Company (with details set out in the prospectus of the Company dated 21 October 2003) will expire on 31 December 2005, accordingly the Company had on

* For identification purposes only

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LETTER FROM THE BOARD

26 August 2005 entered into various supplemental agreements with AVIC II, the controlling shareholder of the Company, for the purpose of extending the terms of these agreements to 31 December 2008. Moreover, the Group has also entered into certain new agreements with its joint venture partners, who are also connected persons of the Company as each of them holds more than 10% interests in the relevant joint venture of the Company, in respect of the provision of goods and/or services on a continuing basis. As the parties to the transactions are connected persons of the Company as defined under the Listing Rules, these transactions constitute non-exempted continuing connected transactions of the Company under Chapter 14A of the Listing Rules. Accordingly, the Continuing Connected Transactions together with the proposed annual Caps are subject to approval by the Independent Shareholders at the EGM by way of poll.

AVIC II, Mitsubishi, Suzuki, Agusta S.p.A. and their respective associate(s), if any, are connected persons of the Company as defined under the Listing Rules will abstain from voting on the ordinary resolutions to be proposed to consider the Continuing Connected Transactions and the proposed annual Caps, which will be taken by way of poll at the EGM as required under the Listing Rules.

The purpose of this circular is (i) to provide you with further information on the Continuing Connected Transactions and the proposed annual Caps as described below; (ii) to set out the opinions and recommendations of the Independent Board Committee and Somerley in relation to the Continuing Connected Transactions and the proposed annual Caps; and (iii) to give you notice of the EGM at which the resolutions set out therein will be proposed.

An Independent Board Committee, comprising the independent non-executive Directors Dr. The Hon, Li Kwok Po, David, Messrs. Guo Chongqing and Li Xianzong, has been established to advise the Independent Shareholders as to (i) the terms of the Continuing Connected Transactions contained therein and (ii) the proposed annual Caps for the three financial years ending 31 December 2008. The recommendation of the Independent Board Committee to the Independent Shareholders is set out on page 37 of this circular.

Somerley Limited has been appointed as an independent financial adviser to advise the Independent Board Committee and the Independent Shareholders on the fairness and reasonableness of (i) the terms of the Continuing Connected Transactions contained therein and (ii) the proposed annual Caps for the three financial years ending 31 December 2008 and (iii) the reasons for certain agreements governing the Continuing Connected Transactions with terms of more than 3 years. The recommendation letter of the independent financial adviser is set out on pages 38 to 53 of this circular.

2. CONTINUING CONNECTED TRANSACTIONS

2.1 Background

Shares of the Company are listed on the Stock Exchange since October 2003. As part of the reorganization carried out for the purpose of facilitating listing of the Company’s shares, AVIC II, together with three other promoters, established the Company by injecting most of the assets and equity interests relating to the development and manufacturing of aviation products, vehicles and

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LETTER FROM THE BOARD

vehicle engines into the Company. AVIC II retained interest in enterprises which are primarily engaged in the production of military aviation products, aviation and vehicle parts and components and other general machinery and equipment; one export and import enterprise specializing in trading of aviation products and related business namely CATIC; four research and design institutes; and 23 general trading, consultants, advertisement and financial service enterprises, as well as non-profit-making social and community service entities, education entities and overseas establishments. The enterprises which have not been injected into the Group are principally engaged in businesses which are not part of the core business of the Group. In addition, the Group also purchases certain raw materials, parts and components from independent suppliers through the AVIC II Group so as to benefit from increased negotiation power for bulk orders. As a result, there are certain continuing transactions between the Group and the AVIC II Group subsequent to the reorganization. As AVIC II is the controlling shareholder of the Company, these transactions constitute continuing connected transactions of the Company under the Listing Rules.

Besides those continuing connected transactions with the AVIC II Group, the Group has also been conducting, on a recurring basis, transactions with its joint venture partners (which are connected persons of the Company as they hold at least 10% interest in the subsidiaries of the Company), and non-wholly owned subsidiaries of the Company (which are connected persons of the Company because AVIC II or its associates has not less than 10% interest in them). The Company has been conducting these continuing connected transactions subject to caps set for the three financial years ending 31 December 2005 (details are set out in the prospectus of the Company dated 21 October 2003). As some of the agreements relating to these continuing connected transactions and/or the caps will expire on 31 December 2005, the Company has entered into various supplemental agreements for the purpose of extending the term of some of the existing agreements in relation to these continuing connected transactions to 31 December 2008. Moreover, the Group has also entered into certain new agreements with its joint venture partners (which are connected persons of the Company as they hold at least 10% interest in the subsidiaries of the Company) in respect of provision of goods and/or services on a continuing basis. Details of the Continuing Connected Transactions are set out below:

2.2 Mutual Supply Agreement

On 26 August 2005, the Company entered into a supplemental agreement with AVIC II to renew the term of the Mutual Supply Agreement for a further term of three years expiring on 31 December 2008. Save for such extension of the term of the Mutual Supply Agreement and the amendment of the definitions of “associates” of the AVIC II Group and “subsidiaries” of the Company in order to bring these terms in line with the Listing Rules as amended with effect from 31 March 2004, the other terms and conditions of the Mutual Supply Agreement remain unchanged. This supplemental agreement and the proposed annual Caps for the three financial years ending 31 December 2008 are subject to approval being obtained from the Independent Shareholders at the EGM.

Pursuant to the Mutual Supply Agreement, the AVIC II Group agrees to provide the following products and services to the Group:

Products: supply of parts and components for manufacturing aviation products, supply of raw materials for manufacturing automobile engines, supply of axles, air conditioners and chairs for automobiles, auxiliary parts, procurement of tools and moulds

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LETTER FROM THE BOARD

Services: production power supply, provision of import/export agency services, labour services, construction works services, transportation services, trial flying services, information technology and quality control services

Others: provision of loan guarantees, leasing of equipment

In respect of the guarantees provided by the AVIC II Group in favor of the Group, on the basis that the Company has not provided any security in respect of such guarantees, such guarantees fall within Rule 14A.65(4) of the Listing Rules and are therefore exempted from reporting, announcement and independent shareholders’ approval requirements applicable to continuing connected transactions. The Directors consider such guarantees provided by the AVIC II Group are on normal commercial terms. As at 31 December 2004, the amount of outstanding bank borrowings covered by the guarantees provided by the AVIC II Group in favor of the Group amounted to approximately RMB 946 million (equivalent to approximately HK$909.6 million). As mentioned in the 2004 annual report of the Company, the Directors have confirmed that all remaining guarantees will be gradually released or withdrawn.

According to the Mutual Supply Agreement, the Group agrees to provide the following products and services to the AVIC II Group:

Products: supply of parts and components for manufacturing aeroengines and moulds for the aviation parts and components, parts and components for military aircraft, processing of accessories, sales of aircraft and automobiles, supply of raw materials, supply of automobile engines and moulds for the parts and components of automobiles

Services: production power supply, labor services and comprehensive production management services

Term

Subject to approval being obtained from the Independent Shareholders at the EGM, the Mutual Supply Agreement will be renewed as from 1 January 2006 for a term of three years.

Pricing

The above products and services shall be provided according to the following pricing policies:

(i) according to government-prescribed price;
(ii) where there is no government-prescribed price but where there is a government guidance price, then according to the government guidance price;
(iii) where there is neither a government-prescribed price nor a government guidance price, then according to the market price. The market price is defined as the price at which the same type of products or services are provided by independent third parties in their ordinary course of business; or

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LETTER FROM THE BOARD

(iv) where none of the above is applicable, the price is to be agreed between the relevant parties for the provision of the above products or services, which shall be the reasonable cost incurred in providing the same plus not more than 8% profit of such cost (reasonable cost means the cost confirmed by both parties after negotiations and in accordance with the financial accounting standards of the PRC).

The profit margin charged by the Group and the AVIC II Group as per the pricing policy (iv) above is determined after arm’s length negotiation between the Group and the AVIC II Group. In determining the profit margin charged by the Group for the provision of the above products and services to the AVIC II Group, the Group has taken into account the profit margin required by the Group in conducting such business. In negotiating the profit margin charged by the AVIC II Group for the above mentioned products and services provided by the AVIC II Group, the Group has also taken into account the profit margin of these products and services of the Group after paying such amount of expense to the AVIC II Group and the profit margin required by the AVIC II Group in providing such products and services.

Historical figures

The total expenditures incurred by the Group for the purchase of products and services from the AVIC II Group for each of the financial years ended 31 December 2003 and 2004 and the six months ended 30 June 2005 were approximately RMB 2,498 million (equivalent to approximately HK$2,401.9 million), RMB 2,446 million (equivalent to approximately HK$2,351.9 million) and RMB 1,044 million (equivalent to approximately HK$1,003.8 million) respectively. The total revenues received by the Group for the provision of products and services to the AVIC II Group for each of the financial years ended 31 December 2003 and 2004 and the six months ended 30 June 2005 amounted to approximately RMB 2,395 million (equivalent to approximately HK$2,302.9 million), RMB 2,528 million (equivalent to approximately HK$2,430.8 million) and RMB 1,293 million (equivalent to approximately HK$1,243.3 million) respectively.

Annual Caps

The Directors expect that the total expenditures to be incurred by the Group for the purchase of products and services from the AVIC II Group for the three financial years ending 31 December 2008 would not exceed RMB 3,000 million (equivalent to approximately HK$2,884.6 million), RMB 3,500 million (equivalent to approximately HK$3,365.4 million) and RMB 4,000 million (equivalent to approximately HK$3,846.2 million) respectively, while the total revenues to be received by the Group for the provision of products and services to the AVIC II Group for the three financial years ending 31 December 2008 would not exceed RMB5,400 million (equivalent to approximately HK$5,192.3 million), RMB7,000 million (equivalent to approximately HK$6,730.8 million) and RMB8,500 million (equivalent to approximately HK$8,173.1 million) respectively. Accordingly, the Company would like to seek approval from the Independent Shareholders of the aforesaid amounts as the proposed annual Caps for the continuing connected transactions to be conducted pursuant to the Mutual Supply Agreement (as amended).

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LETTER FROM THE BOARD

The above proposed annual Caps for the total revenues of the Group for the provision of products and services to the AVIC II Group are determined with reference to the projected growth in turnover attributable to these activities in 2006-2008. Historically, turnover attributable to transactions carried out pursuant to the Mutual Supply Agreement mainly came from sales of aviation products to the AVIC II Group for the latter’s fulfillment of the government orders or to CATIC for export overseas. The Directors expect that the production and sales of aviation products will increase substantially in the next few years due to the substantial increase in purchase orders as indicated by the AVIC II Group.

The proposed annual Caps for the total expenditures to be incurred by the Group for the purchase of products and services from the AVIC II Group are determined with reference to the following factors:

(i) the expected increase in the Group’s sales of aviation products to the AVIC II Group will require an increase in the purchase of aviation parts and components from the AVIC II Group, and hence the transaction volume under the Mutual Supply Agreement will also increase;
(ii) the Group plans to use more imported parts and components for manufacturing aviation products as per clients’ specification, such specification from client also occurred in the past. As a result, the expected growth rate for the total expenditures of the Group to be incurred under the Mutual Supply Agreement would be much lower than that for the total revenues of the Group arising from the provision of products and services to the AVIC II Group pursuant to the Mutual Supply Agreement; and
(iii) the Group expects a growth in sales of vehicles to independent buyers. It is expected that there would be a more than 10% annual growth in the low-end consumer car market in the PRC which is less affected by foreign competition. Such estimation is in line with the market outlook on the low-end consumer car market in the PRC prepared by certain reputable investment banks. Increase in car sales would lead to an increase in purchase of vehicle parts and components from the AVIC II Group.

In determining the above proposed annual Caps for the total expenditures and total revenue to be recorded by the Group pursuant to the Mutual Supply Agreement, the Directors have made reference to the historical transaction amounts and consider that these historical transaction amounts and growth rates are not the key assumptions in deriving the above proposed annual Caps.

2.3 Comprehensive Services Agreement

On 26 August 2005, the Company entered into a supplemental agreement with AVIC II to renew the term of the Comprehensive Services Agreement for a further term of three years expiring on 31 December 2008. Save for such extension of the term of the Comprehensive Services Agreement and the amendment of the definitions of “associates” of the AVIC II Group and “subsidiaries” of the Company in order to bring these terms in line with the Listing Rules as amended with effect from 31

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LETTER FROM THE BOARD

March 2004, the other terms and conditions of the Comprehensive Services Agreement remain unchanged. This supplemental agreement and the proposed annual Caps for the three financial years ending 31 December 2008 are subject to approval being obtained from the Independent Shareholders at the EGM.

Pursuant to the Comprehensive Services Agreement entered into between the Company and AVIC II, the AVIC II Group agrees to provide certain social welfare and supporting services to the Group including:

(i) cultural, educational and hygiene services, including staff training, staff publicity services, recreational services and medical services; and
(ii) social welfare services including withholding and payment for social welfare funds and housing provident funds, management services for retired staff, fire safety, security and greenery services, staff housing area management, nursery and children education services and provision of public utilities, transportation and communication services and other supporting services.

Term

Subject to approval being obtained from the Independent Shareholders at the EGM, the Comprehensive Services Agreement will be renewed as from 1 January 2006 for a term of three years.

Pricing

The services under the Comprehensive Services Agreement will be provided in accordance with the same pricing basis as set out in the Mutual Supply Agreement, except that if the price is to be agreed between the relevant parties, such price shall be the reasonable cost incurred in providing the relevant services plus not more than 3% of such cost as profit (reasonable cost means the cost confirmed by both parties after negotiations and in accordance with the financial accounting standards of the PRC). Such profit margin charged by the AVIC II Group is determined after arm’s length negotiation between the Group and the AVIC II Group. In negotiating the profit margin charged by the AVIC II Group for the aforesaid services provided by the AVIC II Group, the Group has also taken into account the overall profit margin of the Group after paying such amount of expense to the AVIC II Group and the profit margin required by the AVIC II Group in providing such services.

Historical figures

The total expenditures paid by the Group in relation to the social welfare and supporting services provided by the AVIC II Group for each of the financial years ended 31 December 2003 and 2004 and the six months ended 30 June 2005 were approximately RMB 131 million (equivalent to approximately HK$126.0 million), RMB 150 million (equivalent to approximately HK$144.2 million) and RMB 49 million (equivalent to approximately HK$47.1 million) respectively. Payment to the AVIC II Group for the social welfare and supporting services is mostly made in the latter half of the year.

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LETTER FROM THE BOARD

Annual Caps

Taking into account (i) the expansion of the Group’s business in future as a result of the expected economic growth and (ii) the increase in wage caused partly by inflation, the Directors expect that the total expenditures to be incurred by the Group in relation to the social welfare and supporting services sourced from the AVIC II Group for the three financial years ending 31 December 2008 would increase steadily and would not exceed RMB180 million (equivalent to approximately HK$173.1 million), RMB200 million (equivalent to approximately HK$192.3 million) and RMB220 million (equivalent to approximately HK$211.5 million) respectively.

In determining the above proposed annual Caps for the total expenditures to be incurred by the Group pursuant to the Comprehensive Services Agreement, the Directors have made reference to the historical transaction amounts and consider that these historical transaction amounts and growth rates are not the key assumptions in deriving the above proposed annual Caps.

2.4 Land Use Rights Leasing Agreement and Properties Leasing Agreement

2.4.1 Land Use Rights Leasing Agreement

On 2 October 2003, the Company entered into the Land Use Rights Leasing Agreement with AVIC II whereby the AVIC II Group agreed to lease to the Group 48 pieces of lands, with an aggregate area of approximately 2.9 million square meters (“Leased Lands”) at an annual rent of approximately RMB37.6 million (equivalent to approximately HK$36.2 million). Pursuant to the terms of the Land Use Rights Leasing Agreement, the annual rental is to be adjusted every three years and any such revised rent shall not be higher than the prevailing market rent as confirmed by an independent valuer, provided that the rent may be reduced at any time as the parties may agree. In accordance with the Land Use Rights Leasing Agreement, the annual rent is due to be adjusted on 1 January 2006. The Leased Lands are used by the Group as workshops, warehouses, administrative office and ancillary facilities.

Term

The Land Use Rights Leasing Agreement has a term of 20 years commencing from 30 April 2003.

Historical figures

The annual rentals paid by the Group to the AVIC II Group for the Leased Lands for each of the financial years ended 31 December 2003 and 2004 and the six months ended 30 June 2005 were approximately RMB 37.6 million (equivalent to approximately HK$36.2 million), RMB 37.6 million (equivalent to approximately HK$36.2 million) and RMB 18.8 million (equivalent to approximately HK$18.1 million) respectively.

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LETTER FROM THE BOARD

Annual Caps

The annual rentals payable by the Group to the AVIC II Group for the Leased Lands as agreed by the Company and AVIC II for the three financial years ending 31 December 2008 will remain at approximately RMB 37.6 million (equivalent to approximately HK$36.2 million), which are not higher than the market rent as at 31 July 2005 assessed by Vigers, the Company’s independent property valuer.

2.4.2 Properties Leasing Agreement

On 2 October 2003, the Company entered into the Properties Leasing Agreement with AVIC II whereby the AVIC II Group agreed to lease to the Group 54 buildings with an aggregate gross floor area of approximately 110,508 square meters (“Former Rented Properties”) at an annual rent of approximately RMB 24 million (equivalent to approximately HK$23.1 million). Similarly, the Group agreed to lease to the AVIC II Group certain properties with an aggregate gross floor area of approximately 36,835 square meters (“Former Leased Properties”) at an annual rent of approximately RMB1.1 million (equivalent to approximately HK$1.06 million).

Pursuant to the Properties Leasing Agreement, the annual rentals for the Former Rented Properties and the Former Leased Properties are to be adjusted every three years and any such revised rents shall not be higher than the prevailing market rents as confirmed by an independent valuer. The next rental adjustment date pursuant to the Properties Leasing Agreement is 1 January 2006. On 26 August 2005, the Company entered into a supplemental agreement with AVIC II whereby it is agreed that the AVIC II Group will lease certain properties to the Group with an aggregate gross floor area of approximately 111,000 square meters (“Rented Properties”) at an annual rental of approximately RMB24 million (equivalent to approximately HK$23.1 million) and the Group will lease certain properties to the AVIC II Group with an aggregate gross floor area of approximately 36,000 square meters (“Leased Properties”) at an annual rental of approximately RMB1.1 million (equivalent to approximately HK$1.06 million). Save for the above leasing arrangements and the amendment of the definitions of “associates” of the AVIC II Group and “subsidiaries” of the Company in order to bring these terms in line with the Listing Rules as amended with effect from 31 March 2004, the other terms and conditions of the Properties Leasing Agreement remain unchanged. This supplemental agreement and the proposed annual Caps for the three financial years ending 31 December 2008 are subject to approval being obtained from the Independent Shareholders at the EGM.

The Rented Properties are used by the Group as workshops, warehouses and ancillary facilities which are built on the Leased Lands. The Leased Properties are used by the AVIC II Group as workshops, warehouses and ancillary facilities.

Term

The Properties Leasing Agreement has a term of 10 years commencing from 30 April 2003.

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LETTER FROM THE BOARD

Historical figures

The annual rentals for the Former Rented Properties paid by the Group for each of the financial years ended 31 December 2003 and 2004 and the six months ended 30 June 2005 were approximately RMB24 million (equivalent to approximately HK$23.1 million), RMB24 million (equivalent to approximately HK$23.1 million) and RMB12 million (equivalent to approximately HK$11.5 million) respectively, while the annual rentals for the Former Leased Properties received by the Group for each of the financial years ended 31 December 2003 and 2004 and the six months ended 30 June 2005 were approximately RMB1.1 million (equivalent to approximately HK$1.06 million), RMB1.1 million (equivalent to approximately HK$1.06 million) and RMB0.55 million (equivalent to approximately HK$0.53 million) respectively.

Annual Caps

The annual rentals for the Rented Properties and the Leased Properties as agreed by the Company and AVIC II for the three financial years ending 31 December 2008 will be approximately RMB 24 million (equivalent to approximately HK$23.1 million) and approximately RMB 1.1 million (equivalent to approximately HK$1.06 million) respectively, which are not higher than the market rent as at 31 July 2005 as assessed by Vigers, the Company’s independent property valuer.

Reasons for the term of the Land Use Rights Leasing Agreement and the Properties Leasing Agreement being more than three years

The Land Use Rights Leasing Agreement and the Properties Leasing Agreement have an unexpired term longer than three years. The land use rights for the Leased Lands and the Rented Properties were not injected into the Group as part of the reorganization carried out at the time of Listing because such injection by way of investment would require payment of certain fees and taxes by the Group under the applicable PRC law and regulations and State policy. In the circumstances, the Board considers that it is more cost efficient to secure the Group’s long-term right to use the Leased Lands and the Rented Properties by entering into the long-term Land Use Rights Leasing Agreement and the Properties Leasing Agreement. Given that the Land Use Rights Leasing Agreement and the Properties Leasing Agreement contain the term that the rentals will be adjusted to not higher than the then prevailing market rents every three years, interests of the Company and the Independent Shareholders would not be prejudiced even though the term of the agreements are longer than three years.

The recommendation letters from the independent financial adviser to the Independent Board Committee and the Independent Shareholders explaining, among other things, the long-term nature of these transactions and confirming that it is normal business practice for contracts of these types to be of such duration is set out in pages 38 to 53 of this circular.

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LETTER FROM THE BOARD

2.5 Technology Cooperation Agreement

On 26 August 2005, the Company entered into a supplemental agreement with AVIC II to renew the term of the Technology Cooperation Agreement for a further term of three years expiring on 31 December 2008. Save for such extension of the term of the Technology Cooperation Agreement and the amendment of the definitions of “associates” of the AVIC II Group and “subsidiaries” of the Company in order to bring these terms in line with the Listing Rules amended with effect from 31 March 2004, the other terms and conditions of the Technology Cooperation Agreement remain unchanged. This supplemental agreement and the proposed annual Caps for the three financial years ending 31 December 2008 are subject to approval being obtained from the Independent Shareholders at the EGM.

Pursuant to the Technology Cooperation Agreement, the AVIC II Group:

(i) has transferred or granted exclusive licences to the Group to use certain technologies of the AVIC II Group which is required for the business of the Group in connection with the production of aviation products and automobiles at nil consideration;
(ii) agrees that any improvement made to the transferred technologies shall belong to the Group (whether such improvement is made by the Group or the AVIC II Group). The AVIC II Group may however use such improvement at no consideration with the Group’s consent. Any improvement to the licenced technologies shall belong to the parties making the improvement, and the other parties shall be entitled to use such improved technologies free of charge;
(iii) agrees to develop new technologies jointly with the Group. The results of those jointly developed technologies shall be enjoyed by the AVIC II Group and the Group. The AVIC II Group and the Group were entitled to apply for patent registration and software registration jointly, while any improvement made to these new technologies shall be jointly owned by the AVIC II Group and the Group;
(iv) agrees that the Group may appoint the AVIC II Group to develop new technologies for the Group’s business and the results of such development shall belong to the Group;
(v) also agrees that they may appoint the Group to develop new technologies, in which case the funding of such development shall be provided by the AVIC II Group and the results of such development shall belong to the AVIC II Group except otherwise agreed; and
(vi) agrees with the Group that for any improvement made to the new technologies which one party appointed the other to develop, if such improvement is made by the AVIC II Group, the AVIC II Group shall grant a licence to the Group to use such improvement free of charge. If such improvement is made by the Group, the AVIC II Group may use such improvement free of charge only with the Group’s consent and provided that such usage by the AVIC II Group will not constitute competition with the business of the Group.

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LETTER FROM THE BOARD

Term

Subject to approval being obtained from the Independent Shareholders at the EGM, the Technology Cooperation Agreement will be renewed as from 1 January 2006 for a term of three years.

Pricing

Pursuant to the Technology Cooperation Agreement,

(i) the Group may develop new technologies jointly with the AVIC II Group. It is expected that in the case of jointly developed project, funding will be contributed in proportion to the two parties’ agreed percentage of ownership of the new technologies;
(ii) if the Group appoints the AVIC II Group to develop new technologies for the Group’s business, the Group will provide the funding for the development; and
(iii) if the Group is appointed by the AVIC II Group to develop new technologies, the AVIC II Group will provide funding for such development.

Historical figures

The amounts spent by the Group on the development of new technologies under the Technology Cooperation Agreement for each of the financial years ended 31 December 2003 and 2004 and the six months ended 30 June 2005 were approximately RMB 33 million (equivalent to approximately HK$31.7 million), RMB18 million (equivalent to approximately HK$17.3 million) and RMB5 million (equivalent to approximately HK$4.8 million) respectively and the amounts received by the Group for developing new technologies for the AVIC II Group pursuant to the Technology Cooperation Agreement for the same years or period were approximately RMB46 million (equivalent to approximately HK$44.2 million), nil and nil respectively. Because of market development of the aviation products and automobiles, some of the research projects planned to be carried out in 2003 to 2005 had been delayed or cancelled. As a result, the total amounts of expenditures incurred and revenues received by the Group pursuant to the Technology Cooperation Agreement decreased significantly in 2004 and 2005.

Annual Caps

The Directors expect that the total expenditures to be spent by the Group on the development of technologies under the Technology Cooperation Agreement for the three financial years ending 31 December 2008 would not exceed RMB33 million (equivalent to approximately HK$31.7 million), RMB36 million (equivalent to approximately HK$34.6 million) and RMB40 million (equivalent to approximately HK$38.5 million) respectively, and the total revenue to be received by the Group for developing new technologies for the AVIC II Group under the Technology Cooperation Agreement for the same years would not exceed RMB22 million (equivalent to approximately HK$21.2 million), RMB24 million (equivalent to approximately HK$23.1 million) and RMB27 million (equivalent to approximately HK$26.0 million) respectively.

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LETTER FROM THE BOARD

The above proposed annual Caps for the transactions to be conducted under the Technology Cooperation Agreement are determined after taking into account the planned research projects involving the joint development with the AVIC II Group of the advanced utility helicopters, the modified model of Z-9 series helicopters and the advance jet trainers and the Group’s development of some composite materials for the AVIC II Group.

The research projects for the development of the advanced utility helicopters and the advance jet trainers have commenced in 2005, while the rest of the research projects are expected to be launched in 2006. The above proposed annual Caps are the current estimation of the aggregate transaction amounts to be incurred for these research projects. The amount of expenditures to be incurred for each project may deviate from the current estimation depending on the development of these projects.

As the above proposed annual Caps are based on the planned research projects to be conducted in the future, the Directors consider that the historical transaction amounts and growth rates are not the key assumptions in deriving the above proposed annual Caps.

2.6 Mitsubishi Technology Transfer Agreement & Mitsubishi CKD Agreement

2.6.1 Mitsubishi Technology Transfer Agreement

Pursuant to the Mitsubishi Technology Transfer Agreement, Mitsubishi:

(i) has granted certain licences to Dongan Engine to use the industrial properties rights, patent and technology documents relating to engines, gearboxes and the respective assemblies, parts and components;
(ii) agrees to assist Dongan Engine to establish research and development centre, and provide technical training and technology instructions;
(iii) agrees to provide Dongan Engine with all technology documents pursuant to the Mitsubishi Technology Transfer Agreement;
(iv) agrees to provide technical services in relation to quality control, product technology, production, sales and after-sales services, purchase and management of materials of Dongan Engine; and
(v) agrees to provide special assistance to Dongan Engine as agreed between Mitsubishi and Dongan Engine.

Since Dongan Engine is a subsidiary of the Company and Mitsubishi is a substantial shareholder of Dongan Engine (i.e. a connected person of the Company as defined under the Listing Rules), the transactions contemplated under the Mitsubishi Technology Transfer Agreement constitute continuing connected transactions of the Company.

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LETTER FROM THE BOARD

Term

The Mitsubishi Technology Transfer Agreement has a term of 10 years commencing from 22 October 1999.

Pricing

Pursuant to the Mitsubishi Technology Transfer Agreement, Dongan Engine will pay Mitsubishi royalty fee charged in respect of each engine and gearbox produced by Dongan Engine using Mitsubishi’s technology. The amount of royalty fee is agreed between Dongan Engine and Mitsubishi after arm’s length negotiation. In negotiating the royalty fee with Mitsubishi, the Directors have taken into account:

(i) the overall operation and development of the vehicle engines and gearboxes business of the Group;
(ii) the fact that the royalty fees are charged in proportion to the production of engines and gearboxes produced by Dongan Engine using Mitsubishi’s technology; and
(iii) that the expected gross profit margins of the engines and gearboxes to be produced by Dongan Engine using Mitsubishi’s technology during commercial production will not be lower than that of other engines and gearboxes produced by the Group even after taking into account the royalty fees payable to Mitsubishi.

Having considered all the above factors, the Directors consider that the royalty fees charged by Mitsubishi are fair and reasonable to the Company and the Shareholders as a whole.

Historical figures

The amounts of royalty fees paid by the Group for the engines and gearboxes using Mitsubishi’s technology for each of the financial years ended 31 December 2003 and 2004 and the six months ended 30 June 2005 were approximately RMB 5 million (equivalent to approximately HK$4.8 million), RMB 4 million (equivalent to approximately HK$3.8 million) and RMB 3 million (equivalent to approximately HK$2.9 million) respectively.

Annual Caps

The Directors estimate that the total expenditures to be incurred by the Group under Mitsubishi Technology Transfer Agreement for the three financial years ending 31 December 2008 would not exceed RMB 8 million (equivalent to approximately HK$7.7 million), RMB 14 million (equivalent to approximately HK$13.5 million) and RMB17 million (equivalent to approximately HK$16.3 million) respectively. Accordingly, the Company would like to seek approval from the Independent Shareholders of the aforesaid amounts as the proposed annual Caps for this type of continuing connected transactions for the three financial years ending 31 December 2008. The basis in respect of the proposed annual Caps for this type of continuing connected transactions has been summarized under the paragraph headed “Annual Caps” under the Mitsubishi CKD Agreement below.

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LETTER FROM THE BOARD

2.6.2 Mitsubishi CKD Agreement

Pursuant to the Mitsubishi CKD Agreement, Dongan Engine agrees to purchase CKD spare parts and components from Mitsubishi.

Term

The Mitsubishi CKD Agreement took effect from 22 October 1999 and would remain effective until the expiry of the joint venture contract of Dongan Engine. However, it is expected that no transaction will be conducted under the Mitsubishi CKD Agreement after the expiry of the Mitsubishi Technology Transfer Agreement since both are required for producing the types of engines and gearboxes that are being manufactured by Dongan Engine. Accordingly, the Mitsubishi CKD Agreement effectively has a term of 10 years commencing from 22 October 1999 which coincides with the Mitsubishi Technology Transfer Agreement.

Pricing

Pursuant to the Mitsubishi CKD Agreement, the prices payable for the CKD spare parts and components are fixed for a term of four and a half years commencing from the placement of the first order by the Company on 23 November 2000. The prices were fixed after arm’s length negotiation between Dongan Engine and Mitsubishi based on market price. Dongan Engine would continue to purchase these parts and components from Mitsubishi at the same prices for the period ending 31 December 2007.

Historical figures

The total expenditures paid by the Group for the purchase of the CKD spare parts and components from Mitsubishi, being the subject matter of the Mitsubishi CKD Agreement, for each of the financial years ended 31 December 2003 and 2004 and the six months ended 30 June 2005 were approximately RMB 486 million (equivalent to approximately HK$467.3 million), RMB 204 million (equivalent to approximately HK$196.2 million) and RMB 11 million (equivalent to approximately HK$10.6 million) respectively. The decrease in purchase of CKD spare parts and components was mainly due to implementation of the localization process which significantly reduced Dongan Engine’s demand for imported CKD spare parts and components from Mitsubishi in its production process.

Annual Caps

The Directors estimate that the total expenditures to be incurred by the Group under the Mitsubishi CKD Agreement for the two financial years ending 31 December 2007 would not exceed RMB36 million (equivalent to approximately HK$34.6 million) and RMB86 million (equivalent to approximately HK$82.7 million) respectively. Accordingly, the Company would like to seek approval from the Independent Shareholders of the aforesaid amounts as the proposed annual Caps for this type of continuing connected transactions for the two financial years ending 31 December 2007. The Company would not seek a cap for the Mitsubishi CKD Agreement for the financial year ending 31 December 2008 as the Company expects that localization of parts and components would have been completed by the end of 2007.

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LETTER FROM THE BOARD

The above proposed annual Caps for the transactions to be conducted under the Mitsubishi Technology Transfer Agreement and the Mitsubishi CKD Agreement are determined after taking into account:

(i) the expected more than 10% growth in the low-end consumer car market which is less affected by foreign competition;
(ii) the increased demand from third party buyer. Dongan Engine has been supplying to certain new independent customers since the latter half of 2005. It is expected that the transaction volumes with independent customers would grow in the future;
(iii) the increase in demand for parts and components from Mitsubishi following the expected increase in sales of Dongan Engine’s products. It is believed that Dongan Engine’s sales will grow with the gradual localization of its products’ parts and components which will make Dongan Engine’s products increasingly price competitive; and
(iv) the plans to launch the upgraded models of the engines and gearboxes newly developed by Dongan Engine in 2006. The Directors expect that the production of engines and gearboxes by Dongan Engine will increase substantially in 2007 since the upgraded models of the engines and gearboxes will be launched in the market in 2006 and hence the total expenditure to be incurred by the Group under Mitsubishi Technology Transfer Agreement is expected to increase substantially in 2007;
(v) the expected increase in purchase of CKD spare parts and components from Mitsubishi as a result of the requirement for parts and components for the upgraded models of the engines and gearboxes newly developed by Dongan Engine.

In determining the above proposed annual Caps for the transactions to be conducted under the Mitsubishi Technology Transfer Agreement and the Mitsubishi CKD Agreement, the Directors have made reference to the historical transaction amounts and consider that these historical transaction amounts and growth rates are not the key assumptions in deriving the above proposed annual Caps.

Reasons for the term of the Mitsubishi Technology Transfer Agreement and the Mitsubishi CKD Agreement being more than three years

The Mitsubishi Technology Transfer Agreement and the Mitsubishi CKD Agreement have an unexpired term longer than three years. Dongan Engine is a joint venture established between the Group and Mitsubishi. The principal business of Dongan Engine is to manufacture and assemble vehicle engines and gearboxes and related parts and components. To manufacture and assemble the types of vehicle engines and gearboxes that are being produced by Dongan Engine, Dongan Engine has to purchase CKD spare parts and components from Mitsubishi and use the related licences and technology owned by Mitsubishi. The Directors therefore consider that entering into the Mitsubishi Technology Transfer Agreement and the Mitsubishi CKD Agreement for a term exceeding three years will enable Dongan Engine to continue its operation smoothly.

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LETTER FROM THE BOARD

2.7 Internal CT Agreement

On 26 August 2005, the Company entered into a supplemental agreement with its subsidiaries to renew the term of the Internal CT Agreement for a further term of three years expiring on 31 December 2008. Save for such extension of the term of the Internal CT Agreement, the other terms and conditions of the Internal CT Agreement remain unchanged. This supplemental agreement and the proposed annual Caps for the three financial years ending 31 December 2008 are subject to approval being obtained from the Independent Shareholders at the EGM.

The purpose of the Internal CT Agreement is to govern the transactions entered into between the Company (or its wholly owned subsidiaries) and the non-wholly owned subsidiaries of the Company and transactions between the non-wholly-owned subsidiaries of the Company. Dongan Engine and Hafei Auto are two of the parties to the transactions carried out pursuant to the Internal CT Agreement.

Dongan Engine, a subsidiary of the Company, has certain continuing transactions with other subsidiaries of the Company. Since Dongan Group is an associate of AVIC II and a substantial shareholder of Dongan Engine, Dongan Engine is a connected person of the Company as defined under the Listing Rules. As a result, the transactions between Dongan Engine and the other subsidiaries of the Company constitute continuing connected transactions of the Company under the Listing Rules.

Similarly, another non-wholly-owned subsidiary of the Company, Hafei Auto, is currently a connected person of the Company because China Aero (382) Limited (an associate of AVIC II within the meaning of the Listing Rules) holds 25% of the equity interest in Hafei Auto. Therefore, the transactions between Hafei Auto and the other subsidiaries of the Company constitute continuing connected transactions of the Company under the Listing Rules.

In addition, Hafei Industry Company (a wholly-owned subsidiary of the Company) has been giving guarantees in favor of Hafei Auto. For the reasons stated above, such grant of guarantees constitutes continuing connected transactions of the Company under Rule 14A.63 of the Listing Rules.

As disclosed in the announcement and the circular of the Company dated 30 December 2004 and 1 February 2005 respectively in relation to the acquisition of the entire equity interest of Hafei Auto by Dongan Motor (the “Acquisition”), upon completion of the Acquisition, the legal status of Hafei Auto will be cancelled and all the assets, rights and liabilities of Hafei Auto will be assumed by Dongan Motor. As a result, Hafei Auto will cease to be a connected person of the Company following completion of the Acquisition. As at the Latest Practicable Date, the Acquisition is yet to be completed and the transactions conducted between Hafei Auto and members of the Group continue to constitute continuing connected transactions of the Company.

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LETTER FROM THE BOARD

Term

Subject to approval being obtained from the Independent Shareholders at the EGM, the Internal CT Agreement will be renewed as from 1 January 2006 for a term of three years.

Pricing

The transactions that fall under the Internal CT Agreement are carried out in accordance with the same pricing policies as that of the Mutual Supply Agreement.

Historical figures

The annual expenditure spent by Dongan Engine and Hafei Auto in relation to the products and services purchased from the subsidiaries of the Company for each of the financial years ended 31 December 2003 and 2004 and the six months ended 30 June 2005 were approximately RMB 1,501 million (equivalent to approximately HK$1,443.3 million), RMB 1,863 million (equivalent to approximately HK$1,791.3 million) and RMB 1,126 million (equivalent to approximately HK$1,082.7 million) respectively. The annual revenue received by Dongan Engine and Hafei Auto in relation to the products and services provided to the subsidiaries of the Company for each of the financial years ended 31 December 2003 and 2004 and the six months ended 30 June 2005 were approximately RMB 486 million (equivalent to approximately HK$467.3 million), RMB 296 million (equivalent to approximately HK$284.6 million) and RMB 195 million (equivalent to approximately HK$187.5 million) respectively. The decrease in revenue in 2004 was mainly due to decrease in sales of cars manufactured by Hafei Auto using the engines produced by Dongan Engine, and hence leading to a decrease in purchase of engines by Hafei Auto from Dongan Engine. The purchase of engines by Hafei Auto from Dongan Engine has been picking up in 2005 as reflected by the increase in revenue contributed by transactions conducted pursuant to the Internal CT Agreement with the launch of a new car model by Hafei Auto using the engine manufactured by Dongan Engine.

The amount of outstanding bank borrowings covered by the guarantees provided by Hafei Industry Company in favor of Hafei Auto for each of the financial years ended 31 December 2003 and 2004 and the six months ended 30 June 2005 were approximately RMB 2,516 million (equivalent to approximately HK$2,419.2 million), RMB 1,784 million (equivalent to approximately HK$1,715.4 million) and RMB 1,544 million (equivalent to approximately HK$1,484.6 million) respectively. The current maximum amount of guarantees given by Hafei Industry Company in relation to the debts of Hafei Auto is approximately RMB2,000 million (equivalent to approximately HK$1,923.1 million).

Annual Caps

The total expenditures spent by Dongan Engine and Hafei Auto pursuant to the Internal CT Agreement are mainly attributable to the total expenditures spent by Hafei Auto in relation to the purchase of engines from Dongan Motor which is a subsidiary of the Company, while the total revenues received by Dongan Engine and Hafei Auto pursuant to the Internal CT Agreement are mainly attributable to the sales of vehicle engines and gearboxes by Dongan Engine to Hafei Auto.

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LETTER FROM THE BOARD

Based on the expected increase in demand for car engines and the associated parts and components arising from the expected more than 10% growth in the low-end consumer car market in the PRC as mentioned above, the Directors expect that the purchase of engines by Hafei Auto from Dongan Motor and the sales of vehicles engines and gearboxes by Dongan Engine to Hafei Auto will increase accordingly. Based on the above, the Directors expect that the total expenditures to be spent by Dongan Engine and Hafei Auto relating to products and services purchased from other subsidiaries of the Company for the three financial years ending 31 December 2008 would not exceed RMB2,700 million (equivalent to approximately HK$2,596.2 million), RMB3,200 million (equivalent to approximately HK$3,076.9 million) and RMB3,800 million (equivalent to approximately HK$3,653.8 million) respectively; while the total revenues to be received by Dongan Engine and Hafei Auto for the products and services sold to other subsidiaries of the Company for the three financial years ending 31 December 2008 would not exceed RMB500 million (equivalent to approximately HK$480.8 million), RMB550 million (equivalent to approximately HK$528.8 million) and RMB600 million (equivalent to approximately HK$576.9 million) respectively. However, as the Directors expect that the sales of vehicle engines and gearboxes by Dongan Engine to independent customers will increase in the next few years, the expected percentage increase in the annual revenue to be received by Dongan Engine and Hafei Auto (which is approximately 10%) is lower than the expected percentage increase in the annual expenditure to be spent by Dongan Engine and Hafei Auto (which is approximately 15%).

Based on the current maximum amount of guarantees provided by Hafei Industry Company in favor of Hafei Auto, the Company would like to seek approval from the Independent Shareholders of setting RMB 2,000 million (equivalent to approximately HK$1,923.1 million) as the proposed annual Caps for this type of continuing connected transactions for the three financial years ending 31 December 2008.

In determining the above proposed annual Caps for the transactions to be conducted under the Internal CT Agreement, the Directors have made reference to the historical transaction amounts and consider that these historical transaction amounts and growth rates are not the key assumptions in deriving the above proposed annual Caps.

2.8 Agusta Agreement

On 2 June 2005, the Group entered into the Agusta Agreement with Agusta S.p.A.. Pursuant to the Agusta Agreement, Agusta S.p.A. agrees to supply the parts and components for manufacturing helicopters to Changhe Agusta, a joint venture established between the Group and Agusta S.p.A., and to provide assistance to Changhe Agusta for manufacturing, assembling and sales of the helicopters. Commercial production of the helicopters is expected to start in 2006.

Since Changhe Agusta is a subsidiary of the Company and Agusta S.p.A. is a substantial shareholder of Changhe Agusta (i.e. a connected person of the Company as defined under the Listing Rules), the transactions to be conducted under the Agusta Agreement would constitute continuing connected transactions of the Company. Agusta S.p.A. is an international helicopter manufacturer.

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LETTER FROM THE BOARD

Term

The Agusta Agreement has a term of 20 years commencing from 2 June 2005.

Pricing

The prices payable by Changhe Agusta for the helicopter parts and components to be purchased from Agusta S.p.A. for the manufacturing of helicopters pursuant to the Agusta Agreement will be determined after arm’s length negotiation between Changhe Agusta and Agusta S.p.A. based on market price.

Annual Caps

The Directors estimate that the total expenditures to be incurred by the Group for the purchase of helicopter parts and components from Agusta S.p.A. for the three financial years ending 31 December 2008 would not exceed RMB 78 million (equivalent to approximately HK$75.0 million), RMB 117 million (equivalent to approximately HK$112.5 million) and RMB 117 million (equivalent to approximately HK$112.5 million) respectively. Accordingly, the Company would like to seek approval from the Independent Shareholders of the aforesaid amounts as the proposed annual Caps for this type of continuing connected transactions for the three financial years ending 31 December 2008. As at the Latest Practicable Date, no transaction has been conducted pursuant to the Agusta Agreement.

The above proposed annual Caps for the transactions to be conducted under the Agusta Agreement are determined on the following basis:

(i) the proposed annual Cap for 2006 is determined with reference to the purchase orders as indicated by various government departments; and
(ii) the proposed annual Caps for 2007 and 2008 are determined with reference to the management’s expectation on the potential demand for these helicopters by various government departments and the Directors’ knowledge and outlook on the market.

Since the helicopters produced by Changhe Agusta using the parts and components provided by Agusta S.p.A. are expected to be launched in 2006, the Directors estimate that the demand for these helicopters will increase in 2007 and remain steady in 2008.

Reasons for the term of the Agusta Agreement being more than three years

The Agusta Agreement has a term of 20 years commencing from 2 June 2005. Changhe Agusta is a joint venture established between the Group and Agusta S.p.A.. The principal business of Changhe Agusta is to manufacture helicopters using parts and components supplied by Agusta S.p.A.. To manufacture and assemble the helicopter, Changhe Agusta has to purchase the helicopter parts and components from Agusta S.p.A.. The Directors therefore consider that entering into the Agusta Agreement for a term exceeding three years is essential for the continuity of the business of Changhe Agusta.

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LETTER FROM THE BOARD

The recommendation letters from the independent financial adviser to the Independent Board Committee and the Independent Shareholders explaining, among other things, the long-term nature of this transaction and confirming that it is normal business practice for contracts of this type to be of such duration is set out in pages 38 to 53 of this circular.

2.9 Liana Licence Agreement, New Series Automobile Licence Agreement and K Series Engine Licence Agreement

On 24 December 2003, 21 March 2005 and 24 December 2003, Changhe Suzuki and Suzuki entered into three licence agreements, namely the Liana Licence Agreement, the New Series Automobile Licence Agreement and the K Series Engine Licence Agreement.

Pursuant to the Liana Licence Agreement, Suzuki:

(i) agrees to allow Changhe Suzuki to manufacture, assemble and market the Liana automobiles and their parts and components using Suzuki’s technology;
(ii) agrees to grant licences to Changhe Suzuki to use certain trademarks and patents relating to the Liana automobiles and their parts and components;
(iii) agrees to provide assistance to Changhe Suzuki for the manufacturing and assembling of the Liana automobiles; and
(iv) agrees to supply the related parts and components to Changhe Suzuki.
It is expected that the Liana automobiles will be launched in the last quarter of 2005.

Pursuant to the New Series Automobile Licence Agreement, Suzuki:

(i) agrees to allow Changhe Suzuki to manufacture, assemble and market the new series automobiles and their parts and components using Suzuki’s technology;
(ii) agrees to grant licences to Changhe Suzuki to use certain trademarks and patents relating to the new series automobiles and their parts and components;
(iii) agrees to provide assistance to Changhe Suzuki for the manufacturing and assembling of the new series automobiles; and
(iv) agrees to supply the related parts and components to Changhe Suzuki.
It is expected that commercial production of the new series automobile will begin in 2006.

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LETTER FROM THE BOARD

Pursuant to the K Series Engine Licence Agreement, Suzuki:

(i) agrees to allow Changhe Suzuki to manufacture, assemble and market the K series engines and gearboxes and the related parts and components;
(ii) agrees to grant licences to Changhe Suzuki to use certain trademarks and patents relating to the K series engines and gearboxes and the related parts and components;
(iii) agrees to provide assistance to Changhe Suzuki for the manufacturing and assembling of the K series engines and gearboxes; and
(iv) agrees to supply the related parts and components to Changhe Suzuki.

It is expected that the K series engines and gearboxes will be launched in the last quarter of 2005.

Since Changhe Suzuki is a subsidiary of the Company and Suzuki is a substantial shareholder of Changhe Suzuki, the transactions contemplated under the Liana Licence Agreement, the New Series Automobile Licence Agreement and the K Series Engine Licence Agreement will constitute continuing connected transactions of the Company.

Term

The Liana Licence Agreement and the K Series Engine Licence Agreement have a term of 8 years commencing from obtaining the relevant PRC authority approval on 18 May 2005. The New Series Automobile Licence Agreement also has a term of 8 years commencing from the effective date of the agreement. As at the Latest Practicable Date, the New Series Automobile Licence Agreement is yet to become effective, pending the necessary approval being obtained from the relevant PRC authority. It is expected that this agreement would become effective in 2006.

Pricing

Pursuant to the Liana Licence Agreement, the New Series Automobile Licence Agreement and the K Series Engine Licence Agreement, Changhe Suzuki will pay Suzuki royalty fees charged in respect of each Liana automobile, new series automobile and K series engine and gearbox produced by Changhe Suzuki using Suzuki’s technology. Such royalty fees are calculated as a percentage of the adjusted sales price. Adjustment includes, among others, deduction of the value added tax and the price of imported parts and components. Pursuant to the K Series Engine Licence Agreement, the aggregate amount of royalty fees charged by Suzuki for the three years’ period commencing from the production of the K series engines and gearboxes is subject to a prescribed minimum amount of USD650,000 (equivalent to approximately HK$5.0 million).

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LETTER FROM THE BOARD

In addition to the royalty fees, Suzuki also charged Changhe Suzuki one-off fees, payable by Changhe Suzuki at different stages of production, for the licences granted by Suzuki under the Liana Licence Agreement, the New Series Automobile Licence Agreement and the K Series Engine Licence Agreement. The one-off fees and the royalty fees are agreed between Changhe Suzuki and Suzuki after arm’s length negotiation. In negotiating the one-off fees and the royalty fees with Suzuki, the Directors have taken into account:

(i) the recent development of the automobiles market in the PRC; the Directors consider that it is in the interests of the Company and the Shareholders as a whole to have an immediate access to the advanced technologies in manufacturing automobiles, vehicle engines and gearboxes possessed by Suzuki, one of the international automobiles manufacturers, through entering into the above mentioned agreements and paying the one-off fees to Suzuki;
(ii) the overall operation and development of the automobiles, vehicle engines and gearboxes businesses of the Group;
(iii) that the licensing of such technologies from Suzuki is more cost and time effective to the Group than developing such technologies by the Group itself;
(iv) the fact that the royalty fees are charged in proportion to the production of the Liana automobiles, the new series automobiles and the K series engines and gearboxes manufactured by Changhe Suzuki using Suzuki’s technology; and
(v) that the expected gross profit margins of the Liana automobiles, the new series automobiles and the K series engines and gearboxes to be manufactured by Changhe Suzuki during commercial production will not be lower than that of other automobiles, engines and gearboxes produced by the Group even after taking into account the royalty fees payable to Suzuki.

Having considered all the above factors, the Directors consider that the one-off fees and the royalty fees charged by Suzuki are fair and reasonable to the Company and the Shareholders as a whole.

It is expected that subject to the approval being obtained from the Independent Shareholders, the Group will pay Suzuki in 2005 an aggregate amount of not more than RMB 45 million (equivalent to approximately HK$43.3 million) representing a portion of the one-off fees in accordance with the Liana Licence Agreement, the New Series Automobile Licence Agreement and the K Series Engine Licence Agreement.

The prices payable by Changhe Suzuki for the parts and components purchased from Suzuki for the manufacturing of the Liana automobiles, the new series automobiles and the K series engines and gearboxes pursuant to the Liana Licence Agreement, the New Series Automobile Licence Agreement and the K Series Engine Licence Agreement will be determined after arm’s length negotiation between Changhe Suzuki and Suzuki based on market price.

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LETTER FROM THE BOARD

It is expected that subject to the approval being obtained from the Independent Shareholders of the Liana Licence Agreement, the New Series Automobile Licence Agreement and the K Series Engine Licence Agreement, the total purchases of parts and components from Suzuki in 2005 pursuant to the aforesaid agreements would amount to not more than 2.5% of the assets, revenue and consideration ratios (as defined in the Listing Rules) pursuant to the agreements. Therefore, these transactions are only subject to the reporting and announcement requirements under rules 14A.34 of the Listing Rules.

Annual Caps

Based on the planned production of the Liana automobiles, the new series automobiles and the K series engines and gearboxes, the Directors estimate that the total expenditures to be spent by the Group in relation to the royalty fees and one-off fees and purchases of parts and components under the Liana Licence Agreement, the New Series Automobile Licence Agreement and the K Series Engine Licence Agreement for the three financial years ending 31 December 2008 would not exceed RMB1,105 million (equivalent to approximately HK$1,062.5 million), RMB2,070 million (equivalent to approximately HK$1,990.4 million) and RMB2,121 million (equivalent to approximately HK$2,039.4 million) respectively. Accordingly, the Company would like to seek approval from the Independent Shareholders of the aforesaid amounts as the proposed annual Caps for these type of continuing connected transactions for the three financial years ending 31 December 2008.

Taking into account (i) the management’s experience in launching new models of vehicles in the market that the demand for those vehicles will increase nearly by 100% during the second year of commercial production, (ii) the expected more than 10% growth in the low-end consumer car market in the PRC as mentioned above and (iii) the Directors’ knowledge and outlook on the market, the Directors expect that the demand for the Liana automobiles and the new series automobiles would increase substantially in 2007 and remain relatively steady in the subsequent year.

Based on the expected more than 10% growth in the low-end consumer car market in the PRC as mentioned above and the Director’s knowledge and outlook on the market demand for the K series engines and gearboxes, the Directors estimate that the demand for the K series engines and gearboxes would increase moderately during the three financial years ending 31 December 2008.

Reasons for the term of Liana Licence Agreement, the New Series Automobile Licence Agreement and the K Series Engine Licence Agreement being more than three years

Each of the Liana Licence Agreement, the New Series Automobile Licence Agreement and the K Series Engine Licence Agreement has a term longer than three years. Changhe Suzuki is a joint venture established between the Group and Suzuki. The principal business of Changhe Suzuki is to manufacture and assemble different series automobiles and vehicle engines and gearboxes using Suzuki’s technology. The related licences and technology are owned by Suzuki. The Directors therefore consider that entering into the Liana Licence Agreement, the New Series Automobile Licence Agreement and the K Series Engine Licence Agreement for a term exceeding three years is essential for the continuity of the business of Changhe Suzuki.

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LETTER FROM THE BOARD

2.10 Mitsubishi Joint Development Agreement and Mitsubishi Hafei CKD Agreement

2.10.1 Mitsubishi Joint Development Agreement

Pursuant to the Mitsubishi Joint Development Agreement, Mitsubishi agrees to assist Hafei Auto (or Dongan Motor after completion of the Acquisition and upon obtaining consent from Mitsubishi) to develop certain automobiles using Mitsubishi’s technology. Mitsubishi also agrees to grant licences to Hafei Auto to use the technology, information and patents relating to certain automobiles developed by Mitsubishi.

Since Hafei Auto is a subsidiary of the Company and Mitsubishi is a substantial shareholder of Dongan Engine (i.e. a connected person of the Company as defined under the Listing Rules), the transactions contemplated under the Mitsubishi Joint Development Agreement would constitute continuing connected transactions of the Company.

Term

The Mitsubishi Joint Development Agreement has a term of 10 years commencing from 8 August 2005.

Pricing

Pursuant to the Mitsubishi Joint Development Agreement, Hafei Auto will pay Mitsubishi royalty fee charged in respect of each automobile produced and sold by Hafei Auto using Mitsubishi’s technology.

In addition to the royalty fees, Mitsubishi also charges Hafei Auto an one-off fee for the licences granted. The one-off fee is payable by Hafei Auto within one year from the effective date of the Mitsubishi Joint Development Agreement.

The one-off fee and the royalty fee payable to Mitsubishi are agreed between Hafei Auto and Mitsubishi after arm’s length negotiation. In negotiating the one-off fee and the royalty fee with Mitsubishi, the Directors have taken into account:

(i) the recent development of the automobiles market in the PRC; the Directors consider that it is in the interests of the Company and the Shareholders as a whole to have an immediate access to the advanced technologies in manufacturing automobiles possessed by Mitsubishi, one of the international automobiles manufacturers, through entering into the Mitsubishi Joint Development Agreement and paying the one-off fee to Mitsubishi;
(ii) the overall operation and development of the automobiles business of the Group;

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LETTER FROM THE BOARD

(iii) that the licensing of such technologies from Mitsubishi is more cost and time effective to the Group than developing such technologies by the Group itself;
(iv) the fact that the royalty fees are charged in proportion to the production of automobiles produced by Hafei Auto using Mitsubishi’s technology; and
(v) the expected gross profit margin of the automobiles to be produced by Hafei Auto using Mitsubishi’s technology during commercial production will not be lower than that of other automobiles produced by the Group even after taking into account the royalty fee charged by Mitsubishi.

Having considered all the above factors, the Directors consider that the one-off fee and the royalty fee charged by Mitsubishi are fair and reasonable to the Company and the Shareholders as a whole.

Annual Caps

Based on the planned production of automobiles to be manufactured by Hafei Auto using Mitsubishi’s technology, the Directors estimate that the total expenditures to be spent by the Group pursuant to the Mitsubishi Joint Development Agreement for the three financial years ending 31 December 2008 would not exceed RMB 41 million (equivalent to approximately HK$39.4 million), RMB 38 million (equivalent to approximately HK$36.5 million) and RMB53 million (equivalent to approximately HK$51.0 million) respectively. Accordingly, the Company would like to seek approval from the Independent Shareholders of the aforesaid amounts as the proposed annual Caps for this type of continuing connected transactions for the three financial years ending 31 December 2008.

2.10.2 Mitsubishi Hafei CKD Agreement

Pursuant to the Mitsubishi Hafei CKD Agreement, Hafei Auto agrees to purchase CKD spare parts and components from Mitsubishi for manufacturing certain automobiles using Mitsubishi’s technology.

Term

The Mitsubishi Hafei CKD Agreement took effect from 8 August 2005. It is expected that no transaction will be carried out under the Mitsubishi Hafei CKD Agreement after expiry of the Mitsubishi Joint Development Agreement since both are required for the subject operation as contemplated under the Mitsubishi Joint Development Agreement. Accordingly, the Mitsubishi Hafei CKD Agreement effectively has a term of 10 years commencing from 8 August 2005 which coincides with the Mitsubishi Joint Development Agreement.

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LETTER FROM THE BOARD

Pricing

Pursuant to the Mitsubishi Hafei CKD Agreement, the prices payable by Hafei Auto for the CKD spare parts and components will be fixed for a term of 3 years, commencing from the placement of the first order. The Company expects that the price payable for the CKD spare parts and components will be determined after arm’s length negotiation between Hafei Auto and Mitsubishi based on market price.

Annual Caps

Based on the planned production of automobiles manufactured by Hafei Auto using Mitsubishi’s technology which will increase the purchase of CKD spare parts and components from Mitsubishi, the Directors estimate that the total expenditures to be incurred by the Group pursuant to the Mitsubishi Hafei CKD Agreement for the three financial years ending 31 December 2008 would not exceed RMB 30 million (equivalent to approximately HK$28.8 million), RMB 95 million (equivalent to approximately HK$91.3 million) and RMB 135 million (equivalent to approximately HK$129.8 million) respectively. Accordingly, the Company would like to seek approval from the Independent Shareholders of the aforesaid amounts as the proposed annual Caps for this type of continuing connected transactions for the three financial years ending 31 December 2008.

The above proposed annual Caps for the transactions to be conducted under the Mitsubishi Joint Development Agreement and the Mitsubishi Hafei CKD Agreement are based on the planned production of automobiles to be manufactured by Hafei Auto using Mitsubishi’s technology which is determined after taking into account:

(i) the expected more than 10% growth in the low-end consumer car market in the PRC as mentioned above;
(ii) the expected substantial increase in demand for the automobiles to be manufactured by Hafei Auto using Mitsubishi’s Technology during the second year of commercial production and the expected moderate increase of such demand in the subsequent year which is based on the management’s past experience in launching new models of vehicles to the market;
(iii) the plan to launch a new model of vehicles by Hafei Auto using Mitsubishi’s technology in 2007; and
(iv) the expected requirement for CKD spare parts and components for the new model of vehicles to be launched by Hafei Auto using Mitsubishi’s technology in 2007.

Based on the above-mentioned factors, the Directors expect that the planned production of the automobiles to be manufactured by Hafei Auto using Mitsubishi’s Technology will increase substantially in 2007 and 2008 and accordingly, the total expenditures to be spent by the Group in respect of the royalty fees payable to Mitsubishi and the purchases of CKD spare parts and components from Mitsubishi under the Mitsubishi Joint Development Agreement and the Mitsubishi Hafei CKD Agreement will increase substantially in 2007 and 2008. The Directors expect that the expected percentage increase in total expenditures to be spent by the Group in 2007 for the purchase

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LETTER FROM THE BOARD

of CKD spare parts and components from Mitsubishi will be higher than that of the royalty fees payable to Mitsubishi since the Directors expect that the requirement for CKD spare parts and components for the new model of vehicles to be launched by Hafei Auto using Mitsubishi’s technology in 2007 will increase the purchases of CKD spare parts and components from Mitsubishi. However, the Directors also expect that the expected percentage increase in total expenditures to be spent by the Group in 2008 for the purchases of CKD spare parts and components from Mitsubishi will coincide with that of the royalty fees payable to Mitsubishi with the full localization of these CKD spare parts and components in 2008.

Reasons for the term of Mitsubishi Joint Development Agreement and Mitsubishi Hafei CKD Agreement being more than three years

Each of the Mitsubishi Joint Development Agreement and the Mitsubishi Hafei CKD Agreement has a term longer than three years. Hafei Auto plans to manufacture various series of automobiles using Mitsubishi’s technology. To this end, Hafei Auto has entered into the Mitsubishi Joint Development Agreement and the Mitsubishi Hafei CKD Agreement with Mitsubishi. The Directors therefore consider that entering into the Mitsubishi Joint Development Agreement and the Mitsubishi Hafei CKD Agreement for a term exceeding three years is essential for conducting this new project by Hafei Auto.

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LETTER FROM THE BOARD

2.11 Summary of the Continuing Connected Transactions and the proposed annual Caps

		Historical figures	Historical figures	Historical figures	Historical figures		Estimated amount	Estimated amount
		(in RMB		million)			(in RMB million)
						For the
		For the financial			6	months
		year ended				ended	For the	financial year ending
		31 December				30 June		31 December
	Agreements	2003		2004		2005	2006	2007	2008
1	Mutual Supply Agreement
	(a) Annual expenditure of the Group	2,498	2,446			1,044	3,000	3,500	4,000
	(b) Annual revenue of the the Group	2,395	2,528			1,293	5,400	7,000	8,500
2	Comprehensive Services Agreement
	Annual expenditure of the Group	131		150		49	180	200	220
3	Land Use Rights Leasing
	Agreement
	Annual expenditure of the Group	38			38	18.8	38	38	38
	Properties Leasing Agreement
	(a) Annual expenditure of the Group	24			24	12	24	24	24
	(b) Annual revenue of the the Group	1.1			1.1	0.55	1.1	1.1	1.1
4	Technology Cooperation Agreement
	(a) Annual expenditure of the Group	33			18	5	33	36	40
	(b) Annual revenue of the the Group	46			—	—	22	24	27
5	Mitsubishi Technology Transfer
	Agreement
	Annual expenditure of the Group	5			4	3	8	14	17
	Mitsubishi CKD Agreement
	Annual expenditure of the Group	486		204		11	36	86	0
6	Internal CT Agreement
	(i) Annual expenditure of Dongan
	Engine and Hafei Auto	1,501	1,863			1,126	2,700	3,200	3,800
	(ii) Annual revenue of Dongan
	Engine and Hafei Auto	486		296		195	500	550	600
	(iii) Annual amount of gurantees
	provided by subsidiary of the
	Group to Hafei Auto	2,516	1,784			1,544	2,000	2,000	2,000
7	Agusta Agreement
	Annual expenditure of the Group	—			—	—	78	117	117

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LETTER FROM THE BOARD

		Historical figures	Historical figures	Historical figures		Estimated amount	Estimated amount
		(in RMB	million)			(in RMB million)
					For the
		For the financial		6	months
		year ended			ended	For the	financial year ending
		31 December			30 June		31 December
	Agreements	2003	2004		2005	2006	2007	2008
8	Liana Licence Agreement, New
	Series Automobile Licence
	Agreement and K Series Engine
	Licence Agreement
	Annual expenditure of the Group	—		—	—	1,105	2,070	2,121
9	Mitsubishi Joint Development
	Agreement
	Annual expenditure of the Group	—		—	—	41	38	53
	Mitsubishi Hafei CKD Agreement
	Annual expenditure of the Group	—		—	—	30	95	135

3. GENERAL

Based on the information described above, the Board is of the view that the Continuing Connected Transactions are on fair and reasonable and normal commercial terms and that they are entered into in the ordinary and usual course of business and in the interests of the Company and the Shareholders as a whole.

As the Continuing Connected Transactions constitute non-exempt continuing connected transactions of the Company under Rule 14A.35 of the Listing Rules, they will be subject to the reporting requirements under Rules 14A.45 and 14A.46 of the Listing Rules, the annual review requirement under Rules 14A.37 to 14A.41 of the Listing Rules and are subject to independent shareholders’ approval at general meeting by way of poll under Rule 14A.35(4) of the Listing Rules. The Company will seek approval from the Independent Shareholders of the Continuing Connected Transactions and the proposed annual Caps for the three financial years ending 31 December 2008.

In respect of each of the Continuing Connected Transactions, the proposed annual Caps represent the maximum aggregate annual value of consideration payable or receivable under the relevant transactions. If any annual cap is exceeded, the Company will be required to re-comply with the applicable continuing connected transactions regulatory requirements under Chapter 14A of the Listing Rules.

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LETTER FROM THE BOARD

4. EXTRAORDINARY GENERAL MEETING

The notice of The EGM to be held at Kang Ming Hotel, No. 18 Meishuguan Hou Jie, Dong Cheng Qu, Beijing, the PRC, on Monday, 19 December 2005 at 9 a.m. is set out on pages 59 to 63 of this circular, at which an ordinary resolutions will be proposed to approve (i) the Continuing Connected Transactions contained therein and (ii) the proposed annual Caps for the three financial years ending 31 December 2008. A reply slip is also enclosed.

A form of proxy for use at the EGM is enclosed herewith. Whether or not you are able to attend the EGM in person, you are requested to complete and return the form of proxy in accordance with the instructions printed thereon as soon as possible and in any event no later than 24 hours before the time appointed for the holding of EGM. Completion and return of the form of proxy will not preclude you from attending and voting at the EGM or any adjournment thereof should you wish.

AVIC II, Mitsubishi, Suzuki, Agusta S.p.A. and their respective associate(s), if any, are connected persons of the Company as defined under the Listing Rules and they will abstain from voting at the EGM in respect of the ordinary resolutions regarding the transactions in which they are respectively interested. The procedures for demanding a poll are set out in Appendix II to this circular. The Company will announce the results of the poll in accordance with the Listing Rules following the EGM.

5. RECOMMENDATION

Your attention is drawn to the letter from the Independent Board Committee which is set out on page 37 of this circular. The Independent Board Committee, having taken into account the advice of Somerley, considers that the terms of the Continuing Connected Transactions and the proposed annual Caps are fair and reasonable and entering into the Continuing Connected Transactions is in the interests of the Company and the Shareholders as a whole. Accordingly, the Independent Board Committee recommends the Independent Shareholders to vote in favour of ordinary resolutions to be proposed at the EGM.

6. FURTHER INFORMATION

Your attention is also drawn to the additional information set out in the Appendices to this circular.

Yours faithfully, By order of the Board Zhang Hongbiao Chairman

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LETTER FROM THE INDEPENDENT BOARD COMMITTEE

==> picture [265 x 78] intentionally omitted <==

AviChina Industry & Technology Company Limited (A joint stock limited company incorporated in the People’s Republic of China with limited liability) (Stock Code: 2357)*

2 November 2005

To the Independent Shareholders

Dear Sir or Madam,

We refer to the circular (the “Circular”) dated 2 November 2005 despatched to the Shareholders of which this letter forms a part. Unless the context requires otherwise, terms and expressions defined in the Circular shall have the same meanings in this letter.

We have been appointed to advise the Independent Shareholders on whether the terms of the Continuing Connected Transactions and the proposed annual Caps are fair and reasonable and the entering into of the Continuing Connected Transactions is in the interests of the Company and the Shareholders as a whole. Somerley has been appointed to advise the Independent Board Committee and Independent Shareholders in respect of the terms of the Continuing Connected Transactions and the proposed annual Caps.

We wish to draw your attention to the letter from the Board set out on pages 6 to 36 of the Circular and the letter from Somerley set out on pages 38 to 53 of the Circular.

Having considered the advice given by Somerley, we are of the opinion that the terms of the Continuing Connected Transactions and the proposed annual Caps are fair and reasonable and the entering into of the Continuing Connected Transactions is in the interests of the Company and the Shareholders as a whole. Accordingly, we recommend the Independent Shareholders to vote in favour of the ordinary resolutions to be proposed at the EGM.

Yours faithfully,

For and on behalf of the Independent Board Committee

Li Kwok-Po, David

Independent non-executive Director

Guo Chongqing

Independent non-executive Director

Li Xianzong

Independent non-executive Director

* For identification purposes only

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LETTER FROM SOMERLEY

The following is the text of the letter of advice to the Independent Board Committee and the Independent Shareholders of the Company from Somerley in relation to the Continuing Connected Transactions for the purpose of incorporation in this circular.

Somerley Limited Suite 2201, 22nd Floor Two International Finance Centre 8 Finance Street Central Hong Kong

2 November 2005

To: The Independent Board Committee and the Independent Shareholders

Dear Sirs,

CONTINUING CONNECTED TRANSACTIONS

INTRODUCTION

We refer to our appointment to advise the Independent Board Committee and the Independent Shareholders in respect of the terms of the Continuing Connected Transactions and the respective proposed annual Caps for the three financial years ending 31 December 2008. Details of the Continuing Connected Transactions are contained in the circular of the Company to the Shareholders dated 2 November 2005 (the “Circular”), of which this letter forms a part. Unless otherwise defined, terms used in this letter shall have the same meanings as defined in the Circular.

The Independent Board Committee, comprising the three independent non-executive Directors namely Dr. The Hon, Li Kwok Po, David, Mr. Guo Chongqing and Mr. Li Xianzong, has been formed to consider the terms of the Continuing Connected Transactions and the proposed annual Caps and to make a recommendation to the Independent Shareholders on how to vote. We, Somerley Limited, have been appointed as the independent financial adviser to advise the Independent Board Committee and the Independent Shareholders in this regard.

In formulating our advice and recommendation, we have relied on the information and facts supplied, and the opinions expressed, by the Directors and management of the Company, which we have assumed to be true, accurate and complete. We have reviewed, among others, the agreements relating to the Continuing Connected Transactions and the key assumptions and basis made by the Company to derive the proposed annual Caps for the three financial years ending 31 December 2008.

We have sought and received confirmation from the Directors that all material relevant information has been supplied to us and to the best knowledge of the Directors, no material facts have been omitted which would make any statements made misleading. We consider that the information we have received is sufficient for us to reach our advice and recommendation as set out in this letter

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LETTER FROM SOMERLEY

and to justify our relying on such information and we have no reason to doubt that the information provided to us is true and accurate or that any material information has been omitted or withheld. However, we have not conducted any independent investigation into the business and affairs of the Group. We have assumed that all representations contained or referred to in the Circular are true at the date of the Circular and will continue to be true up to the date of the EGM.

Executive Summary

The Continuing Connected Transactions relate to the following three categories of connected persons of the Company:

(i) the AVIC II Group

AVIC II is the controlling shareholder of the Company. Prior to the reorganisation (the “Reorganisation”) carried out for the purpose of facilitating the Listing in October 2003, the businesses of the Group were carried out by the AVIC II Group. As part of the Reorganisation, AVIC II, together with three other promoters, established the Company by injecting most of the assets and equity interests relating to the development and manufacturing of civilian aviation products, vehicles and vehicle engines into the Company. AVIC II retained enterprises which are primarily engaged in, among other things, the production of military aviation products. Despite this general business delineation, there is cross-provision of materials and services and common use of land and properties between the Group and the AVIC II Group which is not unusual in our experience for a business which was spun off from a much bigger group. This type of transactions includes transactions carried out pursuant to the Mutual Supply Agreement, the Comprehensive Services Agreement, the Land Use Rights Leasing Agreement, the Properties Leasing Agreement and the Technology Cooperation Agreement, which were being carried out between the Group and the AVIC II Group prior to the Reorganisation.

(ii) intra-group transactions

This refers to transactions conducted among members of the Group, including Dongan Engine and Hafei Auto which fall into the definition of connected persons of the Company under the Listing Rules. They are conducted pursuant to the terms of the Internal CT Agreement and include sale and purchase of raw materials and components such as vehicle engines and gearboxes. Again, intra-group transactions are common for a group where each group subsidiary has its own business specialisation and have been carried out since the Reorganisation.

(iii) with joint venture partners

Besides developing its own technology, the Group also develops vehicles, vehicle engines and gearboxes and helicopters using technology developed by international automobile or aviation product manufacturers. Usually a joint venture is formed between the Group and such technology provider, which becomes a connected person of the Company under certain circumstances. Transactions of this type include those conducted (a) with Mitsubishi pursuant to the Mitsubishi Technology Transfer Agreement, the Mitsubishi CKD Agreement, the Mitsubishi Joint Development Agreement and the Mitsubishi Hafei CKD Agreement; (b) with Suzuki pursuant to the Liana Licence Agreement, the New

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LETTER FROM SOMERLEY

Series Automobile Licence Agreement and the K Series Engine Licence Agreement; (c) with Agusta S.p.A. pursuant to the Agusta Agreement. Agusta S.p.A. is a new joint venture partner of the Group while Mitsubishi and Suzuki have had business relationships with the Group prior to the Listing. Transactions under the Mitsubishi Technology Transfer Agreement and the Mitsubishi CKD Agreement were being carried out between the Group and the AVIC II Group prior to the Reorganisation. The other agreements were entered in 2003 or 2005.

PRINCIPAL FACTORS AND REASONS CONSIDERED

In arriving at our opinion on the terms of the Continuing Connected Transactions and the proposed annual Caps, we have taken into consideration the following principal factors and reasons:-

Pricing basis for the Continuing Connected Transactions
(I) Mutual Supply Agreement, Comprehensive Services Agreement and Internal CT Agreement

Transactions conducted under the Mutual Supply Agreement, the Comprehensive Services Agreement and the Internal CT Agreement would be charged:

(i) according to government prescribed price;
(ii) according to the government guidance price where there is no government prescribed price but there is a government guidance price;
(iii) according to the market price where there is neither a government prescribed price nor a government guidance price. The market price means the price at which the same type of products or services are provided by independent third parties in their ordinary course of businesses; or
(iv) where none of the above is available, the price as agreed between the transacting parties on a cost plus basis. The margin is 8% (in case of the Mutual Supply Agreement and the Internal CT Agreement) or 3% (in case of the Comprehensive Services Agreement) of the reasonable cost (which means the cost confirmed by both transacting parties after negotiations and in accordance with the financial accounting standards of the PRC) incurred for providing the relevant products or services.

The 3% or 8% profit margins were determined after arm’s length negotiation between the Group and the AVIC II Group or among members of the Group. The basic principle that the management of the Group follows in negotiating the margin is that a reasonable spread of margin is required for the type of activity. As a result, a lower ceiling of 3% margin is agreed for the Comprehensive Services Agreement which involves provision of social welfare and supporting services by the AVIC II Group and are cost items to the Group. A higher ceiling of 8% margin is agreed for the Mutual Supply Agreement and the Internal CT Agreement which involves cross-provision of materials and services between the Group and the AVIC II Group or among members of the Group and both parties are charged on a reciprocal basis which we consider fair.

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LETTER FROM SOMERLEY

We understand from the management of the Group that the Mutual Supply Agreement mainly involves sale or purchase of aviation or automobile products or services which are largely priced in accordance with the pricing policies (i) to (iii) above. The Comprehensive Services Agreement, which mainly involves provision of certain social welfare and supporting services, may be priced in accordance with pricing policy (iv) above, but the amount of each transaction is relatively small. The management of the Group considers it more cost efficient to sub-contract out small-value services to the AVIC II Group at a pricing basis as stipulated in the Comprehensive Services Agreement. We also understand from the management of the Group that the intra-group transactions conducted under the Internal CT Agreement are largely priced in accordance with the pricing policy (iv) above.

(II) Land Use Rights Leasing Agreement and Properties Leasing Agreement

Pursuant to the terms of the Land Use Rights Leasing Agreement and the Properties Leasing Agreement, the annual rentals for the land and properties rented to or leased from the AVIC II Group are to be adjusted every three years and any such revised rents shall not be higher than the prevailing market rents as confirmed by an independent valuer. The new rentals which shall prevail over the three financial years ending 31st December 2008 are not higher than the market rents as at 31st July, 2005 as assessed by Vigers, the Company’s independent property valuer.

(III) Technology Cooperation Agreement

The pricing policy of the Technology Cooperation Agreement is as follows:

(a) in the case of jointly developed projects, funding will be contributed in proportion to the two parties’ agreed percentage of ownership of the new technology;
(b) if the Group appoints the AVIC II Group to develop new technologies for the Group’s business, the Group will provide the funding for the development; and
(c) if the Group is appointed by the AVIC II Group to develop new technologies, the AVIC II Group will provide funding for such development.

As illustrated above, the pricing policy is cost based and applies reciprocally.

(IV) Mitsubishi Technology Transfer Agreement, Mitsubishi CKD Agreement, Agusta Agreement, Liana Licence Agreement, New Series Automobile Licence Agreement, K Series Engine Licence Agreement, Mitsubishi Joint Development Agreement and Mitsubishi Hafei CKD Agreement (collectively “Licensing Agreements”)

As mentioned above, besides developing its own technology, the Group also licenses technology from technology experts in the areas of automobile or aviation product manufacturing. Details of the pricing policy and basis for each of the Licensing Agreements are set out in the letter from the Board contained in the Circular.

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LETTER FROM SOMERLEY

The following is a summary of the pricing policies for the various Licensing Agreements that the Group has entered into:

			Technology
		Agreement	provider	Nature of transaction		Pricing policy
(a)	(i)	Mitsubishi	Mitsubishi	●	Licence to use patents	●	One-off fee (paid in
		Technology			and technology to		2002); and
		Transfer			manufacture vehicle	●	Royalty fee: A fixed
		Agreement			engines and		amount for every
					gearboxes and		engine or gearbox
					technology support		produced
	(ii)	Mitsubishi CKD	Mitsubishi	●	Supply CKD spare	●	Agreed based on
		Agreement			parts and components		market price
					for manufacturing
					vehicle engines and
					gearboxes
(b)	(i)	Mitsubishi Joint	Mitsubishi	●	Licence to use patents	●	One-off fee; and
		Development			and technology to	●	Royalty fee: A fixed
		Agreement			manufacture vehicles		amount for every
					and technology		product sold
					support
	(ii)	Mitsubishi Hafei	Mitsubishi	●	Supply related parts	●	Agreed based on
		CKD Agreement			and components		market price
(c)	(i)	Liana Licence	Suzuki	●	Licence to use	●	One-off fee; and
		Agreement			patents, trademarks	●	Royalty fee: A fixed
					and technology to		percentage of the
		And			manufacture vehicles		sales price, after
					and technology		deducting, among
		New Series			support		others, the value
		Automobile					added tax and the
		Licence					price of imported
		Agreement					parts and components,
							for every product
							produced
				●	Supply related parts	●	Agreed based on
					and components		market price

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LETTER FROM SOMERLEY

			Technology
		Agreement	provider	Nature of transaction		Pricing policy
(d)	(i)	K Series Engine	Suzuki	●	Licence to use	●	One-off fee; and
		Licence			patents, trademarks	●	Royalty fee: A fixed
		Agreement			and technology to		percentage of the
					manufacture vehicle		sales price, after
					engines and		deducting, among
					gearboxes		others, the value
							added tax and the
							price of imported
							parts and components,
							for every product
							produced
				●	Supply related parts	●	Agreed based on
					and components		market price
(e)	(i)	Agusta	Agusta	●	Supply parts and	●	Agreed based on
		Agreement	S.p.A.		components for		market price
					manufacturing
					helicopters

As illustrated above, the pricing for the parts and components is based on market price. The relevant technology licensing fees include an one-off payment and a variable royalty fee charged as a percentage of sales price or a fixed amount for every unit of products produced or sold which is a common formula observed in the tables of the HK Comparables and the PRC Comparables set out below.

In assessing the pricing basis for the Licensing Agreements, we are unable to find comparable transactions in the same industries announced by companies listed on the Stock Exchange. Alternatively, we have reviewed a number of technology transfer and licence agreements and supply agreements involving other industries as announced by companies listed on the Stock Exchange (the “HK Comparables”). We have also made reference to the technology transfer agreement and joint development agreement as announced by companies listed in the PRC which is engaged in manufacturing and sales of automobiles (the “PRC Comparables”).

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LETTER FROM SOMERLEY

The table below summarizes the terms of the relevant agreements entered into by the HK Comparables and the PRC Comparables:

Details of the HK Comparables:

Parties	Nature of transaction	Nature of transaction	Pricing basis	Pricing basis	Date of circular
TCL Multimedia	●	Licence to use	●	A fixed rate for every	31 May 2004
Technology Holdings		certain patents to		television receiver
Limited		manufacture		produced
(stock code:1070)		television receiver
and
Thomson S.A.
	●	Supply of	●	Market price
		components by
		Thomson S.A.
China Resources	●	Licence to use	●	2% of the net sales	28 July 2004
Logic Limited		certain technologies		for the first six
(stock code: 1193)		to manufacture		months; and 3% of
and		compressor products		net sales for the
Sanyo Electric Co., Ltd		used for air-		remaining term
		conditioners
Culturecom	●	Licence to use	●	One-off fee of US$10	30 September
Holdings Limited		certain technology to		million; and	2005
(Stock code: 343)		manufacture	●	a fixed percentage of
and		microprocessors used		the net sales
Transmeta Corporation		for computers
COSCO International	●	Transfer the	●	One-off fee; and	15 June 2005
Holdings Limited		technology and	●	0.5% of net sales for
(stock code: 517)		know-how for the		2003 to 2007; and
and		manufacturing of		0.75% of the net
Kansai Paint Co., Ltd.		different coatings to		sales for the
		a joint venture in		remaining term
		Shanghai
	●	Transfer the	●	One-off fee; and
		technology and	●	0.5% of the net sales
		know-how for the
		manufacturing of
		different coatings to
		a joint venture in
		Tianjian
	●	Supply of raw	●	No less favourable
		materials		terms than those
				quoted by
				independent suppliers

Sources: The circulars of the respective companies.

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LETTER FROM SOMERLEY

Details of the PRC Comparables:

				Year of annual/
Parties	Nature of Transaction	Pricing basis		interim report
Tianjin Faw Xiali	Licence to use certain	●	One-off fee:	2001
Automobile Co., Limited	technology to		US$500,000 (which
(stock code: 000927)	manufacture automobiles		is equivalent to
and			approximately RMB4
Toyota Motor			million); and
Corporation		●	US$200 for each car
			sold (which is
			equivalent to
			approximately RMB
			1,600)
Jiangling Motors Co.,	Jointly develop certain	●	1.8% of net sales	2005
Limited	vehicle models
(stock code:000550)
and
Ford Motor Company

Sources: The annual/ interim report of the respective companies.

As illustrated in the above table, licensing fees are commonly charged as a fixed amount or percentage of unit sales price and one-off fee. While this pricing methodology is common, it is difficult to make a direct comparison between the pricing basis under the Licensing Agreements entered into by the Group and that of the HK Comparables and the PRC Comparables which may or may not involve payment of one-off fee. We have “amortised” the one-off fees payable pursuant to the Licensing Agreements entered into by the Group to the planned units of production of the respective products in years 2006-2008 and find that, even after incorporating the amortised one-off fee with the royalty fee, the adjusted royalty fees for the Licensing Agreements are within the range of 0.5% to 3% of the net sales as indicated by the HK Comparables and the PRC Comparables (to the extent information regarding the amounts of royalty fee of the above comparables is available).

We also have referred to the expected margin for the models of cars or helicopters developed or to be developed during commercial production under the respective Licensing Agreements entered into by the Group, which the management of the Group has estimated after taking into account the licensing fees, both fixed and variable, and the cost for the imported parts and components. The management of the Group estimates that the expected gross profit margins of these products after taking into account the licensing fees would not be lower than that of other similar products produced by the Group. In addition, in our opinion, the entering into of the Licensing Agreements would also give the Group intangible benefits of immediate access to advanced technology developed by international companies in the relevant industry.

In conclusion, based on the above analysis, we consider a fair and reasonable pricing basis has been established for each type of the Continuing Connected Transactions.

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LETTER FROM SOMERLEY

2. The proposed annual Caps for the Continuing Connected Transactions

The following is a summary of the historical transaction amounts for each type of the Continuing Connected Transactions for the two financial years ended 31 December 2004 and 6 months ended 30 June 2005 as well as the respective proposed annual Caps for each of the three financial years ending 31 December 2008:

			Historical	Historical	figures	figures	figures	Estimated amount	Estimated amount
			(in	RMB million)				(in RMB million)
							For the 6
			For the	financial			months
			year	ended			ended	For the financial		year
		Products/	31 December				30 June	ending 31 December
	Agreements	services	2003	2004			2005	2006	2007	2008
1	Mutual Supply Agreement	Aviation and
	(a) Annual expenditure of the	automobile
	Group	products	2,498	2,446			1,044	3,000	3,500	4,000
	(b) Annual revenue of the the
	Group		2,395	2,528			1,293	5,400	7,000	8,500
2	Comprehensive Services	Supporting
	Agreement	services
	Annual expenditure of the
	Group		131	150			49	180	200	220
3	Land Use Rights Leasing	Land use
	Agreement	rights
	Annual expenditure of the	leasing
	Group		38			38	18.8	38	38		38
	Properties Leasing Agreement	Properties
	(a) Annual expenditure of the	leasing
	Group		24			24	12	24	24		24
	(b) Annual revenue of the the
	Group		1.1		1.1		0.55	1.1	1.1	1.1
4	Technology Cooperation	Technologies
	Agreement	research and
	(a) Annual expenditure of the	development
	Group	projects	33			18	5	33	36		40
	(b) Annual revenue of the the
	Group		46			—	—	22	24		27
5	Mitsubishi Technology	Automobile
	Transfer Agreement	products
	Annual expenditure of the
	Group		5			4	3	8	14		17
	Mitsubishi CKD Agreement	Automobile
	Annual expenditure of the	products
	Group		486	204			11	36	86		0

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LETTER FROM SOMERLEY

			Historical figures	Historical figures	Historical figures	Historical figures	Estimated amount	Estimated amount
			(in	RMB million)			(in RMB million)
						For the 6
			For the	financial		months
			year	ended		ended	For the financial		year
		Products/	31 December			30 June	ending 31 December
	Agreements	services	2003	2004		2005	2006	2007	2008
6	Internal CT Agreement	Automobile
	(i) Annual expenditure of	products
	Dongan Engine and Hafei
	Auto		1,501	1,863		1,126	2,700	3,200	3,800
	(ii) Annual revenue of Dongan
	Engine and Hafei Auto		486	296		195	500	550	600
	(iii) Annual amount of
	gurantees provided by a
	subsidiary of the Group to
	Hafei Auto		2,516	1,784		1,544	2,000	2,000	2,000
7	Agusta Agreement	Aviation
	Annual expenditure of the	products
	Group		—		—	—	78	117	117
8	Liana Licence Agreement,	Automobile
	New Series Automobile	products
	Licence Agreement and
	K Series Engine Licence
	Agreement
	Annual expenditure of the
	Group		—		—	—	1,105	2,070	2,121
9	Mitsubishi Joint Development	Automobile
	Agreement	products
	Annual expenditure of the
	Group		—		—	—	41	38		53
	Mitsubishi Hafei CKD	Automobile
	Agreement	products
	Annual expenditure of the
	Group		—		—	—	30	95	135

According to the management of the Group, the historical annual caps for the three financial years ending 31 December 2005 for those Continuing Connected Transactions in respect of aviation and automobile products already taking place were in general set based on estimated production and intention of purchases. In determining the proposal annual Caps for the three financial years ending 31 December 2008, we understand from the management of the Group that the basis for setting the proposed annual Caps can be summarised as follows:

(I) based on agreements or existing guarantees

Caps for the Land Use Rights Leasing Agreement and the Properties Leasing Agreement represent the annual rentals as agreed under the respective agreements.

Caps for the provision of guarantees under the Internal CT Agreement are based on the current amount of guarantees outstanding.

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LETTER FROM SOMERLEY

(II) Business projections

(a) Aviation products

The Group’s aviation products are mainly sold to the AVIC II Group for fulfilment of orders from the PRC Government or to CATIC for export overseas. In respect of the purchases of aviation parts and components from the AVIC II Group for the Group’s production of aviation products, the management of the Group expects that the growth will not be as significant as that of its sales to the AVIC II Group because more imported parts and components will be used in its production in accordance with the clients’ specification. The Group has recently set up a joint venture with Agusta S.p.A. to manufacture helicopters chiefly for sale to the PRC government departments and the joint venture would need to purchase parts and components from Agusta S.p.A.. The proposed annual Caps under the Mutual Supply Agreement and the Agusta Agreement involving aviation products are determined mainly based on the indicative purchase orders directly received from the PRC Government or through the AVIC II Group.

(b) Automobile products

The basis for setting the proposed annual Caps under the Mutual Supply Agreement, the Mitsubishi Technology Transfer Agreement, the Mitsubishi CKD Agreement, the Internal CT Agreement, the Liana Licence Agreement, the New Series Automobile Licence Agreement, the K Series Engine Licence Agreement, the Mitsubishi Joint Development Agreement and the Mitsubishi Hafei CKD Agreement involving automobile products can be summarised as follows:

(i) the historical amounts of transaction volume in the case of the Continuing Connected Transactions already taking place;
(ii) it is expected that there would be a more than 10% annual growth in the low-end consumer car market in the PRC which is less affected by foreign competition. Such estimation is in line with the market outlook on the low-end consumer car market in the PRC prepared by reputable investment banks. Increase in car sales would lead to an increase in purchase of vehicle parts and components;
(iii) the estimated business volume brought about by factors newly emerged, such as the expansion of clientele in the case of Dongan Engine; the launch of upgraded models as discussed in the letter from the Board in this circular under the paragraph headed “Mitsubishi Technology Transfer Agreement and Mitsubishi CKD Agreement” and “Mitsubishi Joint Development Agreement and Mitsubishi Hafei CKD Agreement”;
(iv) the localisation process for the Group’s parts and components. It is the Group’s business strategy to license overseas technology and use imported parts and components in the initial stage of product development. In order to make the product more price competitive, the Group aims to produce the required parts and components locally in due course; and
(v) the expected growth rate in business volume for new models based on management’s experience in launching new models to the market. In management’s experience, sales normally double in the second year of launch and growth would stabilise thereafter.

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LETTER FROM SOMERLEY

(III) Technology development projects

The proposed annual Caps under the Technology Cooperation Agreement are determined based on the estimated expenditure and revenue to be generated from the research projects planned for years 2006-2008.

(IV) Social welfare and supporting services

The proposed annual Caps under the Comprehensive Services Agreement are determined based on the estimated social welfare and supporting services to be provided by the AVIC II Group for years 2006-2008.

Generally speaking, in our opinion, it is in the interest of the Group for the proposed annual Caps to be as accommodating to the Group as possible (within reason). Provided that the pricing for the Continuing Connected Transactions is fair and reasonable and the conduct of those transactions would be subject to annual review by the independent non-executive Directors and auditors of the Company (as discussed below) as required under the Listing Rules, the Group would have flexibility in conducting its businesses if the proposed annual Caps are tailored to future business growth. This is particular so for transactions conducted with the AVIC II Group involving aviation products as it is unlikely that the Group can secure purchase orders of this type directly from the PRC Government. Flexibility in conducting transactions under the various Licensing Agreements is also important to the Group as it enables the Group to gain access to overseas advanced technology to develop new products and maintain competitiveness in the market. In assessing the reasonableness of the proposed annual Caps, we have reviewed industry reports in respect of the future prospects of the low-end consumer car market in the PRC, and have discussed with the management of the Group their projected volume which we consider reasonable. Based on the above analysis, we are of the view that the proposed annual Caps for each of the Continuing Connected Transactions have been determined by the Board with due care and are fair and reasonable and approval of the same is in the interests of the Company and the Shareholders as a whole.

Shareholders should note that the proposed annual Caps should not be construed as an assurance or forecast by the Company of the future revenue of the Group.

3. Reasons for terms of Continuing Connected Transactions in excess of three years

(I) Land Use Rights Leasing Agreement and the Properties Leasing Agreement

At the time of the Reorganisation, certain land and properties used by the Group were not injected into the Group because title transfer would require payment of significant fees and taxes by the Group under the applicable PRC law and regulations and State policy. Portions of the properties that have been injected into the Group as part of the Reorganisation continue to be occupied by the AVIC II Group subsequent to the Reorganisation. As a result, leasing agreements with terms of 10-20 years were entered into between the Group and the AVIC II Group at the time of the Reorganisation so that both parties can have continued use of the areas that they have been occupying prior to the Reorganisation. Rentals for those land and buildings are revised every three years with reference to market rents as assessed by an independent valuer. We consider it in the mutual interest of the Group

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LETTER FROM SOMERLEY

and the AVIC II Group if both parties can have long-term continuous use of the properties and land to ensure smooth operation of their businesses. We also note that it is common for a listing applicant to enter into such kind of long-term leasing contracts if the land or properties are not injected into the listed group as part of the reorganization carried out to facilitate listing.

The following is a list of the long-term leasing agreements for land and properties entered into by Hong Kong listed companies with their parent companies that we have reviewed:

					Date of prospectus/
Parties	Nature of transaction		Term		circulars
China Shenhua Energy	●	Lease of land	●	20 years	2 June 2005
Company Limited
(stock code: 1088)	●	Lease of	●	10 years
		properties
China Petroleum &	●	Lease of land	●	50 years for	31 October 2003
Chemical Corporation				industrial land;
(stock code: 386)				and 40 years for
				land for
				commercial use
	●	Lease of	●	20 years
		properties
Petrochina Company	●	Lease of land	●	50 years	22 September 2005
Limited
(stock code: 857)	●	Lease of	●	20 years
		properties
Shanghai Electric	●	Lease of land	●	20 years	18 April 2005
Group Company
Limited (stock code:2727)	●	Lease of properties	●	20 years

Sources: The prospectus and circulars of the respective companies.

Based on the above table which includes several lease periods of 20 years and over, we are of the view that it is normal practice for such land and properties leasing arrangements to be of a duration of longer than three years.

(II) Licensing Agreements

We understand from the management of the Group that in order to maintain competitiveness in the market, the Group needs to tap into advanced technology developed by international automobile or aviation product manufacturers. To this end, the Group has entered into long-term licensing agreements and supply contracts with its technology partners to ensure continuous technology support or supply of imported parts and components that are required for the production of the Group.

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LETTER FROM SOMERLEY

We have reviewed a number of the long-term technology supply agreements entered into by the HK Comparables, as detailed below:

Parties	Nature of transaction	Nature of transaction	Term	Term	Date of circular
TCL Multimedia	●	Licence to use	●	5 years and	31 May 2004
Technology Holdings		certain patents to		automatically
Limited		manufacture the		renewed for a
(stock code:1070)		television receiver		further 5 years
and
Thomson S.A.	●	Supply of	●	a maximum of 15
		components by		years
		Thomson
China Resources Logic	●	Licence to use	●	10 years	28 July 2004
Limited		certain
(stock code: 1193)		technologies to
and		manufacture
Sanyo Electric		various types of
Co., Ltd		compressor
		products used for
		air-conditioners
Culturecom Holdings	●	Licence to use	●	no fixed term	30 September 2005
Limited		certain technology
(Stock code: 343)		to manufacture
and		different
Transmeta Corporation		microprocessors
		used for
		computers
COSCO International	●	Transfer the	●	19 years for the	15 June 2005
Holdings Limited		technology and		joint venture in
(stock code: 517)		know-how for the		Shanghai; and 16
and		manufacturing of		years for the joint
Kansai Paint Co., Ltd.		different coatings		venture in Tianjian
		to a joint venture
		in Shanghai and
		Tianjian
	●	Supply of raw	●	3 years
		materials

Sources: The circulars of the respective companies.

Based on the above table, we are of the view that it is normal business practice for agreements with technology partners to be for periods in excess of three years.

4. Annual review of the Continuing Connected Transactions

The procedures to be put in place for the annual review of the Continuing Connected Transactions as set out in the Listing Rules are as follows:

(i) the independent non-executive Directors will review the Continuing Connected Transactions and comment in the annual report and accounts of the Company;

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LETTER FROM SOMERLEY

(ii) the auditors of the Company will review the Continuing Connected Transactions and issue a confirmation letter to the Board;
(iii) the Board will state in the annual report whether the auditors have made such confirmation in relation to the Continuing Connected Transactions; and
(iv) the Company will promptly notify the Stock Exchange and publish an announcement if it believes that the independent non-executive Directors and/or the auditors will not be able to issue the aforesaid confirmation.

The independent non-executive Directors and the auditors of the Company have reviewed the continuing connected transactions of the Group conducted during the two years ended 31st December, 2004 and have provided the relevant confirmation as required under the Listing Rules, as set out in detail in the Company’s annual reports for the years of 2003 and 2004.

In light of the above, in particular, (i) the restriction of the value of the Continuing Connected Transactions by way of the proposed annual Caps and (ii) the ongoing review by the independent non-executive Directors and auditors of the terms of the Continuing Connected Transactions and the proposed annual Caps not being exceeded, we are of the view that there exist appropriate measures to govern the conduct of the Continuing Connected Transactions and safeguard the interests of the Independent Shareholders.

DISCUSSION AND ANALYSIS

The Company’s shares were listed on the Stock Exchange in October, 2003. Prior to that, the Company’s businesses were substantially integrated with those of the AVIC II Group. On Listing, the businesses, assets and contractual arrangements were separated as far as possible, but inevitably some connections and areas of overlap remained. We consider this is the normal situation when a relatively integrated business is spun-off from its parent. There are also transactions among members of the Group, which is common where each group subsidiary has its own business specialisation. These result in continuing connected transactions of the types summarised above. We consider a fair and reasonable basis for pricing and other terms of the agreements has been established, as discussed above.

In addition, as the Group requires access to international technology in its industries, various joint ventures have been established with international companies. Transactions between the Group and certain joint venture partners are also classified as continuing connected transactions. In our opinion, an objective and reasonable basis has been established for the pricing and other terms for such transactions.

Caps have been established for the Continuing Connected Transactions. As we consider the transactions themselves are on fair terms and benefit the development of the Group, we concur with the proposed annual Caps, which are set based on contracted amounts or reasonable projections to allow the Group a reasonable degree of flexibility in managing its businesses.

Where agreements are for longer than 3 years, we consider these terms are in line with the terms of comparable agreements we have researched and are necessary for the consistent development of the Group’s businesses.

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LETTER FROM SOMERLEY

RECOMMENDATION

Based on the above principal factors and reasons and taking these factors and reasons as a whole as described in this letter and summarised in the section above headed “Discussion and Analysis”, we consider the terms of the agreements relating to the Continuing Connected Transactions and their respective proposed annual Caps are fair and reasonable to the Independent Shareholders and the entering into of the Continuing Connected Transactions is in the ordinary and usual course of business, on normal commercial terms and in the interests of the Company and the Shareholders as a whole. We therefore advise the Independent Board Committee to recommend the Independent Shareholders, and we ourselves advise the Independent Shareholders, to vote in favour of the resolutions in relation to the Continuing Connected Transactions and the proposed annual Caps to be proposed at the EGM.

Yours faithfully, for and on behalf of SOMERLEY LIMITED M.N. Sabine Chairman

— 53 —

GENERAL INFORMATION

APPENDIX I

1. RESPONSIBILITY STATEMENT

This circular includes particulars given in compliance with the Listing Rules for the purpose of giving information with regard to the Group. The Directors collectively and individually accept full responsibility for the accuracy of the information contained in this circular and confirm, having made all reasonable enquiries, that to the best of their knowledge and belief, there are no other facts the omission of which would make any statement contained herein misleading.

2. DIRECTORS’ AND CHIEF EXECUTIVE’S DISCLOSURE OF INTERESTS

As at the Latest Practicable Date, the interests and short positions of Directors and chief executive of the Company in the Shares, underlying Shares and debentures of the Company or any of its associated corporations (within the meaning of Part XV of the SFO) which were required to be notified to the Company and the Stock Exchange pursuant to Divisions 7 and 8 of Part XV of the SFO (including interests and short positions which they were taken or deemed to have under such provisions of the SFO) or which were required, pursuant to Section 352 of the SFO, to be entered in the register keep by the Company, or were required pursuant to the Model Code for Securities Transactions by Directors of Listed Companies of the Listing Rules to be notified to the Company and the Stock Exchange were as follows:

					Approximate
Name of	Name of				percentage of
company or its	Director/		Capacity	Type of	shareholding in
associated	Supervisor/	Number and class	in holding	interests	the same
corporation	chief executive	of securities held	interest	held	securities
AviChina	David Li Kwok-Po	2,000,000	Beneficial	Long	0.12%
		H Shares	owner	positions
Dongan Motor	Tan Ruisong	5,070 A Shares	Beneficial	Long	0.0011%
			owner	positions

As at the Latest Practicable Date, no option in the securities or debentures of the Company’s share capital had been granted to its Directors, supervisors and senior management or their spouse or children under 18.

Save as disclosed herein, as at the Latest Practicable Date, none of the Directors and chief executive of the Company has any interests and short positions in the Shares, underlying Shares and debentures of the Company or any of its associated corporations (within the meaning of Part XV of the SFO) which were required to be notified to the Company and the Stock Exchange pursuant to Divisions 7 and 8 of Part XV of the SFO (including interests and short positions which they were taken or deemed to have under such provisions of the SFO) or which were required, pursuant to Section 352 of the SFO, to be entered in the register keep by the Company, or which were required pursuant to the Model Code for Securities Transactions by Directors of Listed Companies of the Listing Rules to be notified to the Company and the Stock Exchange.

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GENERAL INFORMATION

APPENDIX I

3. SUBSTANTIAL SHAREHOLDERS’ DISCLOSURE OF INTERESTS

As at the Latest Practicable Date, so far as is known to any Directors or chief executive of the Company, the following persons (not being a Director or chief executive of the Company) had interests or short positions in the Shares and underlying Shares of the Company which would fall to be disclosed to the Company under the provisions of the Divisions 2 and 3 of Part XV of the SFO, or, who was, directly or indirectly, interested in 10% or more of the nominal value of any class of share capital carrying rights to vote in all circumstances at general meetings of any other member of the Group.

			Approximate	Approximate
			percentage of	percentage of
			shareholdings	shareholdings
Name of	Class of	Number of	to the same	to share capital	Nature of
shareholders	shares	shares	class of shares	in issue	shares held
AVIC II	Domestic	2,835,305,636	95.66%	61.06%	Long positions
	shares
European Aeronautic	H Shares	232,180,425	13.82%	5%	Long positions
Defence and Space
Company
EADS N.V.

4. SERVICE CONTRACTS

As at the Latest Practicable Date, none of the Directors had any existing or proposed service contract with any member of the Group which will not expire or is not determinable by the Group within one year without payment of compensation (other than statutory compensation).

5. MATERIAL LITIGATION

As at the Latest Practicable Date, so far as known to the Directors, there is no litigation or claim of material importance pending or threatened against any member of the Group.

6. DIRECTORS’ INTERESTS IN ASSETS AND/OR CONTRACTS AND OTHER INTERESTS

As at the Latest Practicable Date, none of the Directors had any direct or indirect interest in any asset which had been, since 31 December 2004, being the date to which the latest published audited accounts of the Company were made up, acquired or disposed of by or leased to, or were proposed to be acquired or disposed of by or leased to, any member of the Group.

As at the Latest Practicable Date, none of the Directors was materially interested in any contract or arrangement entered into by any member of the Group which was subsisting as at the Latest Practicable Date and which was significant in relation to the business of the Group.

— 55 —

GENERAL INFORMATION

APPENDIX I

7. DISCLOSURE OF INTEREST, CONSENT AND QUALIFICATION OF EXPERT

Each of Somerley and Vigers has given its opinion in this circular and whose names are included in this circular. Somerley is a corporation licensed under the SFO to conduct types 1, 4, 6 and 9 regulated activities. Vigers is a qualified property valuer.

As at the Latest Practicable Date, neither Somerley nor Vigers has any shareholding interest in any member of the Group nor any right to subscribe for or to nominate persons to subscribe for securities in any member of the Group.

As at the Latest Practicable Date, neither Somerley nor Vigers has any direct or indirect interest in any assets which has been, since 31 December 2004, being the date to which the latest published audited accounts of the Company were made up, acquired or disposed of by or leased to, or were proposed to be acquired or disposed of by or leased to, any member of the Group.

Each of Somerley and Vigers has given and has not withdrawn its written consent to the issue of this circular with the inclusion of its letter and references to its name included in this circular in the form and context in which they respectively included.

8. COMPETING INTERESTS

As at the Latest Practicable Date, none of the Directors and their respective associates have any interests in a business which competes or may compete with the business of the Group.

9. NO MATERIAL ADVERSE CHANGE

Since 31 December 2004, being the date to which the latest published audited accounts of the Company have been made up, there have been no material adverse changes in the financial and trading position of the Group.

10. MISCELLANEOUS

(a) Mr. Yan Lingxi and Mr. Ip Kun Wan, Kiril are the company secretaries of the Company. Mr. Ip Kun Wan, Kiril is a solicitor of the High Court of Hong Kong.
(b) Reference is made to the announcement of the Company dated 18 May 2005 (the “Announcement”). Since Mr. Li Yao (“Mr. Li”), a Vice President and the Chief Financial Officer of the Company, is able to meet all requirements as set out in Rule 3.24 save for being a fellow or associate member of the Hong Kong Society of Accountants (now known as Hong Kong Institute of Certified Public Accountants) (“HKICPA”) or a similar body of accountants recognized by HKICPA for the purpose of granting exemptions from the examination requirement for membership of HKICPA, the Company has arranged Mr. Barry Wong (“Mr. Wong”), who is a member of the Association of Chartered Certified Accountants which is recognized by HKICPA for the purpose of granting exemptions from the examination requirement for membership of HKICPA to assist Mr. Li in discharging his duty as the qualified accountant of the Company for a term of three years.

— 56 —

GENERAL INFORMATION

APPENDIX I

As set out in the Announcement, the Stock Exchange had agreed to grant to the Company a conditional waiver from the strict requirement of Rule 3.24 of the Listing Rules for a term of three years from 13 May 2005.

As at the Latest Practicable Date, Mr. Wong still assists Mr. Li in discharging his duty as the qualified accountant of the Company.

(c) The registered address of the Company is situated at No. 16, Hong Da Bei Lu, Beijing Economic — Technological Development Area, Beijing, PRC. The registrar of the Company is Computershare Hong Kong Investor Services Limited, whose address is at Room 1712-1716, 17th Floor, Hopewell Centre, 183 Queen’s Road East, Hong Kong.
(d) The principal place of business of the Company in Hong Kong is at Unit B, 15/F, United Center, Queensway 95, Hong Kong.
(e) The English text of this circular and the proxy form shall prevail over their respective Chinese text in the case of inconsistency.

11. DOCUMENTS AVAILABLE FOR INSPECTION

Copies of the following documents are available for inspection during normal business hours at the principal place of business of the Company up to and including Monday, 19 December 2005:

(a) the articles of association of the Company;
(b) the agreements governing the Continuing Connected Transactions.
(c) the letter dated 2 November 2005 from the Independent Board Committee to the Independent Shareholders, the text of which is set out on page 37 of this circular;
(d) the letter of advice dated 2 November 2005 from Somerley to the Independent Board Committee and the Independent Shareholders, the text of which is set out on pages 38 to 53 of this circular;
(e) the valuation report prepared by Vigers; and
(f) the written consent of Somerley and Vigers referred to in paragraph 7 of this Appendix.

— 57 —

PROCEDURES FOR DEMANDING A POLL

APPENDIX II

According to Article 66 of the Articles and subject to the rules prescribed by the Stock Exchange or any relevant stock exchange from time to time, at any shareholders’ general meeting a resolution shall be decided on a show of hands unless a poll is (before or after any vote by show of hands) demanded:

(i) by the chairman of the meeting;
(ii) by at least two shareholders or proxies entitled to vote; or
(iii) by one or more shareholders (including proxy of shareholder) alone or jointly representing 10 percent or more (inclusive) of all Shares carrying the right to vote at such meeting.

Unless a poll is demanded otherwise, the declaration of the results on a show of hands by the chairman of the meeting on the approval of the resolution proposed and recorded in the minutes of the meeting will be final, without inclusion of evidences on the votes as to the proportion for or against the resolution proposed in such meeting. The demand for a poll may be withdrawn by the party who has made such demand.

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NOTICE OF EXTRAORDINARY GENERAL MEETING

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AviChina Industry & Technology Company Limited*

(A joint stock limited company incorporated in the People’s Republic of China with limited liability)

(Stock Code: 2357)

NOTICE OF EXTRAORDINARY GENERAL MEETING

Notice is hereby given that an extraordinary general meeting of AviChina Industry & Technology Company Limited (“Company”) will be held at 9 a.m. on Monday, 19 December 2005 at Kang Ming Hotel, No. 18 Meishuguan Hou Jie, Dong Cheng Qu, Beijing, the People’s Republic of China for the purpose of considering and passing the following resolutions as ordinary resolutions of the Company:

“ THAT the supplemental agreement dated 26 August 2005 entered into between the Company and AVIC II (as defined in the Company’s circular dated 2 November 2005 (“Circular”)) in relation to certain amendments of the Mutual Supply Agreement (as defined in the Circular), a copy of which has been initialed by the Chairman and for the purposes of identification marked “A” be and is hereby approved, ratified and confirmed and any one director of the Company be and he is hereby authorized to do all such further acts and things and execute such further documents or supplemental agreements or deeds on behalf of the Company and take all such steps which in his opinion may be necessary, desirable or expedient to implement and/or give effect to the terms of the said supplemental agreement and to make and agree with such changes in the terms of the said supplemental agreement as he may in his discretion consider necessary, desirable and expedient and in the interest of the Company, that the continuing connected transactions under the Mutual Supply Agreement, which the Company expects to be conducted on normal commercial terms, be and are hereby generally approved and that the proposed annual Caps in respect of the Mutual Supply Agreement as set out in the Circular be and are hereby approved, ratified and confirmed.”
“ THAT the supplemental agreement dated 26 August 2005 entered into between the Company and AVIC II in relation to certain amendments of the Comprehensive Services Agreement (as defined in the Circular), a copy of which has been initialed by the Chairman and for the purposes of identification marked “B” be and is hereby approved, ratified and confirmed and any one director of the Company be and he is hereby authorized to do all such further acts and things and execute such further documents or supplemental agreements or deeds on behalf of the Company and take all such steps which in his opinion may be necessary, desirable or expedient to implement and/or give effect to the terms of the said supplemental agreement and to make and agree with such changes in the terms of the said supplemental agreement as he may in his discretion consider necessary, desirable and expedient and in the interest of the Company, that the continuing connected transactions under the Comprehensive Services Agreement, which the Company expects to be conducted on normal commercial terms, be and are hereby generally approved and that the proposed annual Caps in respect of the Comprehensive Services Agreement as set out in the Circular be and are hereby approved, ratified and confirmed.”

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NOTICE OF EXTRAORDINARY GENERAL MEETING

“ THAT the supplemental agreement dated 26 August 2005 entered into between the Company and AVIC II in relation to certain amendments of the Technology Cooperation Agreement (as defined in the Circular), a copy of which has been initialed by the Chairman and for the purposes of identification marked “C” be and is hereby approved, ratified and confirmed and any one director of the Company be and he is hereby authorized to do all such further acts and things and execute such further documents or supplemental agreements or deeds on behalf of the Company and take all such steps which in his opinion may be necessary, desirable or expedient to implement and/or give effect to the terms of the said supplemental agreement and to make and agree with such changes in the terms of the said supplemental agreement as he may in his discretion consider necessary, desirable and expedient and in the interest of the Company, that the continuing connected transactions under the Technology Cooperation Agreement, which the Company expects to be conducted on normal commercial terms, be and are hereby generally approved and that the proposed annual Caps in respect of the Technology Cooperation Agreement as set out in the Circular be and are hereby approved, ratified and confirmed.”
“ THAT the supplemental agreement dated 26 August 2005 entered into between the Company and AVIC II in relation to certain amendments of the Properties Leasing Agreement (as defined in the Circular), a copy of which has been initialed by the Chairman and for the purposes of identification marked “D” be and is hereby approved, ratified and confirmed and any one director of the Company be and he is hereby authorized to do all such further acts and things and execute such further documents or supplemental agreements or deeds on behalf of the Company and take all such steps which in his opinion may be necessary, desirable or expedient to implement and/or give effect to the terms of the said supplemental agreement and to make and agree with such changes in the terms of the said supplemental agreement as he may in his discretion consider necessary, desirable and expedient and in the interest of the Company, that the continuing connected transactions under the Properties Leasing Agreement, which the Company expects to be conducted on normal commercial terms, be and are hereby generally approved and that the proposed annual Caps in respect of the Properties Leasing Agreement as set out in the Circular be and are hereby approved, ratified and confirmed.”
“ THAT the supplemental agreement dated 26 August 2005 entered into between the Company and AVIC II in relation to certain amendments of the Internal CT Agreement (as defined in the Circular), a copy of which has been initialed by the Chairman and for the purposes of identification marked “E” be and is hereby approved, ratified and confirmed and any one director of the Company be and he is hereby authorized to do all such further acts and things and execute such further documents or supplemental agreements or deeds on behalf of the Company and take all such steps which in his opinion may be necessary, desirable or expedient to implement and/or give effect to the terms of the said supplemental agreement and to make and agree with such changes in the terms of the said supplemental agreement as he may in his discretion consider necessary, desirable and expedient and in the interest of the Company, that the continuing connected transactions under the Internal CT Agreement, which the Company expects to be conducted on normal commercial terms, be and are hereby generally approved and that the proposed annual Caps in respect of the Internal CT Agreement as set out in the Circular be and are hereby approved, ratified and confirmed.”

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NOTICE OF EXTRAORDINARY GENERAL MEETING

“ THAT the continuing connected transactions under the Land Use Rights Leasing Agreement (as defined in the Circular), which the Company expects to be conducted on normal commercial terms, be and are hereby generally approved and that the proposed annual Caps of the continuing connected transactions under the Land Use Rights Leasing Agreement as set out in the Circular be and are hereby approved, ratified and confirmed.”
“ THAT the continuing connected transactions under the Mitsubishi Technology Transfer Agreement (as defined in the Circular), which the Company expects to be conducted on normal commercial terms, be and are hereby generally approved and that the proposed annual Caps of the continuing connected transactions under the Mitsubishi Technology Transfer Agreement as set out in the Circular be and are hereby approved, ratified and confirmed.”
“ THAT the continuing connected transactions under the Mitsubishi CKD Agreement (as defined in the Circular), which the Company expects to be conducted on normal commercial terms, be and are hereby generally approved and that the proposed annual Caps of the continuing connected transactions under the Mitsubishi CKD Agreement as set out in the Circular be and are hereby approved, ratified and confirmed.”
“ THAT the continuing connected transactions under the Agusta Agreement (as defined in the Circular), which the Company expects to be conducted on normal commercial terms, be and are hereby generally approved and that the proposed annual Caps of the continuing connected transactions under the Agusta Agreement as set out in the Circular be and are hereby approved, ratified and confirmed.”
“ THAT the continuing connected transactions under the Liana Licence Agreement, the New Series Automobile Licence Agreement and the K Series Engine Agreement (as such terms are defined in the Circular), which the Company expects to be conducted on normal commercial terms, be and are hereby generally approved and that the proposed annual Caps of the continuing connected transactions under the Liana Licence Agreement, the New Series Automobile Licence Agreement and the K Series Engine Licence Agreement as set out in the Circular be and are hereby approved, ratified and confirmed.”
“ THAT the continuing connected transactions under the Mitsubishi Joint Development Agreement (as defined in the Circular), which the Company expects to be conducted on normal commercial terms, be and are hereby generally approved and that the proposed annual Caps of the continuing connected transactions under the Mitsubishi Joint Development Agreement as set out in the Circular be and are hereby approved, ratified and confirmed.”

— 61 —

NOTICE OF EXTRAORDINARY GENERAL MEETING

“ THAT the continuing connected transactions under the Mitsubishi Hafei CKD Agreement (as defined in the Circular), which the Company expects to be conducted on normal commercial terms, be and are hereby generally approved and that the proposed annual Caps of the continuing connected transactions under the Mitsubishi Hafei CKD Agreement as set out in the Circular be and are hereby approved, ratified and confirmed.”

By order of the Board AviChina Industry & Technology Company Limited Yan Lingxi

Company Secretary

Hong Kong, 2 November 2005

Notes:

Closure of register of members and eligibility to attend the extraordinary general meeting of the Company (“EGM”)

Pursuant to Article 38 of the Articles of Association of the Company, the H Share register of the Company will be closed between Friday, 18 November 2005 and Monday, 19 December 2005 (both days inclusive), during which no transfer of H Shares will be effected. Holders of the Company’s H Shares and Domestic Shares whose names appear on the Company’s Register of Members on Monday, 19 December 2005 are entitled to attend the EGM.

In order to attend the EGM, holders of the Company’s H Shares shall lodge all transfers together with the relevant share certificates to Computershare Hong Kong Investor Services Limited, the Company’s H Shares Registrar, not later than 4:00 p.m. on Thursday, 17 November 2005 at Rooms 1712-1716, 17th Floor, Hopewell Centre, 183 Queen’s Road East, Wanchai, Hong Kong.

Registration procedures for attending the EGM
a. The shareholder or its proxies shall produce his identification proof.
b. Holders of H Shares or Domestic Shares who wish to attend the EGM must complete the reply slip to confirm the attendance, and return the same to the correspondence address designated by the Company not later than 20 days before the date of the EGM, i.e. no later than 5 p.m. on Tuesday, 29 November 2005.
c. Shareholders may deliver the reply slip by post or facsimile to the correspondence address designated by the Company.
Proxies
a. Any shareholder who is entitled to attend and vote at the EGM is entitled to appoint one or more proxies to attend and vote on his behalf at the EGM. A proxy need not be a shareholder of the Company. Any shareholder who wishes to appoint a proxy should first review the form of proxy for use in the EGM.
b. For any shareholder who has appointed more than one proxy, such proxies shall only vote on a poll.

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NOTICE OF EXTRAORDINARY GENERAL MEETING

c. Any shareholder shall appoint its proxy in writing. The instrument appointing a proxy must be in writing signed under the hand of the appointor or his attorney duly authorized in writing. If the appointor is a legal person, the instrument shall be signed by its directors or attorney duly authorized with the seal of the legal person affixed. If the instrument is signed by an attorney of the appointor, the power of attorney authorizing that attorney to sign or other documents of authorization must be notarially certified. In order to be valid, the form of proxy, and a notarially certified copy of the power of attorney or other documents of authorization, where appropriate, must be delivered in the case of holders of domestic shares, to the correspondence address designated by the Company, and in the case of holders of H Shares, to Computershare Hong Kong Investor Services Limited at the address stated in note 1 above not less than 24 hours before the time for holding the EGM and return of a form of proxy will not preclude a shareholder from attending in person and voting at the EGM if he or she so wishes.
The EGM is expected to last for half a day. Shareholders attending the meeting are responsible for their own transportation and accommodation expenses.

Designated address of the Company: P. O. Box 1655, Beijing, the PRC (Postal code: 100009) Telephone No.: 86-10-64094835 Facsimile No.: 86-10-64094826 Attention: Xu Bin

The ordinary resolutions will be voted by poll by the Independent Shareholders.

— 63 —

AI assistant

Star Plus Legend Holdings Limited — Proxy Solicitation & Information Statement 2005

51032_rns_2005-11-02_12f11c74-aba5-4852-a4d5-acf0b1b041ac.pdf

THIS DOCUMENT IS IMPORTANT AND REQUIRES YOUR IMMEDIATE ATTENTION

AviChina Industry & Technology Company Limited*

CONTINUING CONNECTED TRANSACTIONS

Independent financial adviser to the Independent Board Committee and Independent Shareholders

SOMERLEY LIMITED

TABLE OF CONTENTS

EXPECTED TIMETABLE

DEFINITIONS

DEFINITIONS

DEFINITIONS

DEFINITIONS

AviChina Industry & Technology Company Limited*

Executive Directors:

Non-executive Directors:

CONTINUING CONNECTED TRANSACTIONS

1. INTRODUCTION

LETTER FROM THE BOARD

2. CONTINUING CONNECTED TRANSACTIONS

2.1 Background

LETTER FROM THE BOARD

2.2 Mutual Supply Agreement

Term

Pricing

LETTER FROM THE BOARD

Historical figures

Annual Caps

LETTER FROM THE BOARD

2.3 Comprehensive Services Agreement

LETTER FROM THE BOARD

Term

Pricing

Historical figures

LETTER FROM THE BOARD

2.4 Land Use Rights Leasing Agreement and Properties Leasing Agreement

2.4.1 Land Use Rights Leasing Agreement

Term

Historical figures

LETTER FROM THE BOARD

Annual Caps

2.4.2 Properties Leasing Agreement

LETTER FROM THE BOARD

Historical figures

Annual Caps

LETTER FROM THE BOARD

2.5 Technology Cooperation Agreement

LETTER FROM THE BOARD

Pricing

Historical figures

Annual Caps

LETTER FROM THE BOARD

2.6 Mitsubishi Technology Transfer Agreement & Mitsubishi CKD Agreement

2.6.1 Mitsubishi Technology Transfer Agreement

LETTER FROM THE BOARD

Pricing

Historical figures

Annual Caps

LETTER FROM THE BOARD

2.6.2 Mitsubishi CKD Agreement

Term

Pricing

Historical figures

Annual Caps

LETTER FROM THE BOARD

LETTER FROM THE BOARD

2.7 Internal CT Agreement

LETTER FROM THE BOARD

Term

Pricing

Historical figures

Annual Caps

LETTER FROM THE BOARD

2.8 Agusta Agreement

LETTER FROM THE BOARD

Pricing

Annual Caps

Reasons for the term of the Agusta Agreement being more than three years

LETTER FROM THE BOARD

Star Plus Legend Holdings Limited Proxy Solicitation & Information Statement 2005