Expectations and Preparations for Forthcoming New Foreign Investment Regime in China

Expectations and Preparations for Forthcoming New Foreign Investment Regime in China

At the beginning of this year, the Draft of Foreign Investment Law (外国投资法草案征求意见稿) (the « Draft ») released by Ministry of Commerce (« MOFCOM ») made a huge splash in public. There were a lot of voices that the Draft would herald a revolution to Chinese Foreign Investment Regime, which may substantially affect current and future investment made by foreign investors.

What are the signals sent out by the Draft that should be concerned? Is it necessary to analyze the Draft in detail expecting to prepare in advance for the upcoming new foreign investment regime? Or is it more practical to wait until the enactment of the finalized law and react in a hurry?

The Chinese government knows well that an unstable and unpredictable legal environment is a significant constraint to attract foreign investment, which is undoubtedly the last they would like to see by releasing the Draft. In order to erase unnecessary worries among foreign investors, Chinese government launches a bottom-up reform to current foreign investment regime from the access to daily supervision and from the substantial thresholds to procedural ones right before and after sending out signals in the Draft, which is believed to aim at exploring and experimenting a practical scheme for the future foreign investment regime to be established by the future Foreign Investment Law.

Therefore, it is much wiser to focus on series of amendments and adjustments made by the Chinese government right before and subsequent to the Draft for the preparation of a new era of foreign investment in China.

This article describes the new amendments to come and gives some highlights on the future face of foreign investment in China.

I. Expectations indicated in the Draft of Foreign Investment Law

Chinese foreign investment regime underwent a dramatic reform in 2014 which reached its peak when the Draft of Foreign Investment Law (外国投资法草案征求意见稿) (the « Draft ») was issued by Ministry of Commerce (« MOFCOM ») on January 19, 2015[1].

One of reasons that the draft has made a big splash is that once enacted, it will replace Law on Sino-foreign Equity Joint Ventures (中外合资经营企业法) and Law on Wholly Foreign-owned Enterprises (外资企业法)[2] (« Laws on Foreign Invested Enterprises »), which have been served as the basic of China’s foreign investment regime for more than 30 years. However, it would not be as eye-catching as it is, without the following highlights which to some extent also demonstrate the expectations of more liberalization for foreign investment.

1. The Evolved Definition of Foreign Investment

The « Foreign » in the Draft is not only defined by the nationality of an investor but also the nationality of the investor’s controller[3]. Though there are already several standards to identify the control in China’s legal regime, such as the definition of actual controller in Company Law (公司法)[4], the circumstances to be deemed as having control over a listed company in Administrative Measures on Takeover of Listed Companies (Amended in 2014) (上市公司收购管理办法)[5], and the determinants for the scope of consolidation in Accounting Standards for Business Enterprises No. 33 – Consolidated Financial Statements (企业会计准则第33号——合并财务报表)[6],it is indeed the first time that a clear definition of control has been given[7].

The Draft specifies that the investment not only includes greenfield investments or establishment of legal entities, but also includes mergers and acquisitions, real property transactions, financing for more than one year, concessions for the exploration and development of natural resources, concessions for the construction and operation of infrastructures, contractual / fiduciary control and other investment methods[8].

2. Pre-access National Treatment Plus Negative List

The Draft adopts « negative list » mode which is internationally popular in the access management of foreign investment and experimenting in Shanghai Free Trade Zone. Except for the industries in the negative list, no pre-approvals, licenses, etc. will be needed for foreign investors as the same with purely domestic companies.

3. National Security Review

The Draft elevates the national security review from departmental regulations[9] to official law and improves the review factors and procedures. In addition, a national security decision cannot be challenged either through administrative means or through the courts[10].

4. Information Reporting System

On one hand, the Draft eases the access to China’s market by limiting pre-establishment approval to certain industries in the negative list. On the other hand, obligation of information reports is required after establishment, including the investment implementation report, the investment amendment report, the annual report and the quarterly report.

Nevertheless, no matter what significant differences the Draft will make to current foreign investment regime, we are unable to say how many of them or to what extent and when they will be enacted for the time being.

First, as stated by the Draft, the Foreign Investment Law is intended to be the basic law for regulating foreign investment and revoke current Laws on Foreign Invested Enterprises. So the future Foreign Investment Law must be at least equivalent to Laws on Foreign Invested Enterprises in terms of legal hierarchy, which means it shall be enacted and amended by National People’s Congress (the « Congress »). In accordance with Legislation Law (立法法), the legislative bills to be deliberated by the Congress may be submitted by the presidium of the Congress, the Standing Committee of the National People’s Congress, the State Council, the Central Military Commission, the Supreme People’s Court, the Supreme People’s Procuratorate and the special commissions of the National People’s Congress. As specified in the Notes of Ministry of Commerce to the Foreign Investment Law (Draft for Comment) released along with the Draft, the Draft was made according to Legislation Program of the Standing Committee of the 12th National People’s Congress and 2014 Legislation Plan of the State Council. However, when we resort to the former one, it seems that the amendments to Laws on Foreign Invested Enterprises was classified into the second class which is supposed to be submitted for deliberation by State Council under the mature conditions.[11] And when it comes to the State Council Legislation Plan of 2014 (国务院2014年立法工作计划[12], the amendments to Laws of Foreign Invested Enterprises are classified into the third and last class of legislative projects in order of priority which are projects in research. Therefore, it will be a fairly long time before the Draft is submitted by State Council to the Congress for deliberation as a mature legislative bill.

Second, as far as the details of the Draft are concerned, there are several pending issues to be solved before the finalization of the Draft. For instance, the Catalogue of Special Administrative Measures shall be uniformly formulated and promulgated by State Council[13]; the foreign investment regulatory authorities under the State Council shall develop and release the guide to the national security review of foreign investments[14]. Thus, series of supporting regulations or normative documents should be enacted simultaneously, otherwise, it may cause new obstacles and confusions in practice, which is opposite to the intension to create a more transparent and predictable legal environment by the Foreign Investment Law. In addition, the Draft is largely a picture designed by MOFCOM, the foreign investment regulatory authority in the Draft, expecting to play a more active role in foreign investment regulation. However, to be a basic law for foreign investment administration, it is indispensable to involve the authority of other supervisors. For instance, the information report system may overlap the publicity of corporate information which is under the authority of administration industry and commerce (the « AIC ») according to Interim Regulations for the Publicity of Corporate Information (the « Publicity Interim Regulations ») (企业信息公示暂行条例). So the Draft will have to coordinate the authorities of different supervisors in order to avoid overloading foreign investment with post-establishment obligations.

II. Preparations for forthcoming new foreign investment regime

The Draft can be regarded as the government’s assumption for the future administration and supervision regime of foreign investment. However, on one hand, the assumption requires a dramatic adjustment and coordination among various governmental authorities involved; one the other hand, once being enacted, the Draft will be superior to various current laws and regulations as a law of highest level in the field of foreign investment., therefore, in order to avoid later conflicts and chaos in the implementation, the central government is believed to demonstrate practicable scheme for the potential Foreign Investment Law by a bottom-up approach, which has been reflected in series of reforms and amendments to current regimes before and after the Draft and which can also be relied on to prepare for a new era of foreign investment in China.

1. More industries opened up to foreign investment

The Catalogue of Industries for Guidance of Foreign Investment is regarded as the basic legal document that is always relied on to judge the feasibility of specific potential foreign investment project. The new version came into force on April 10, 2015 opens up more industries to foreign investment by such amendments as cancelling the requirement for share proportions of foreign investment in most manufacturing industries permitted for foreign investment and reducing number of restricted industries for foreign investment from 79 to 38.[15]

2. Streamline government administration and simplify the formalities for access

(1) Facilitate formalities before registration

The intension of the Draft to substantially cancel administrative examination and approval before registration has already been demonstrated and confirmed by the Administration Measures for Approval and Record-filing of Foreign Investment Projects (the « Project Approval Measures ») (关于改进外资审核管理工作的通知) which came into force on June 17, 2014. Accordingly, only the projects involving fixed assets with total investment amount above the thresholds which depend on how the industry of project is categorized in the Catalogue of Industries for Guiding Foreign Investment (revised in 2015) (外商投资产业指导目录(2015年版)) needs approval from either National Development and Reform Commission (« NDRC ») or local Development and Reform Commission (« LDRC ») before filing for establishment approval in commerce bureaus comparing with the requirement of approval for all projects involving fixed assets prior to the Project Approval Measures. As of February 24, 2015, current thresholds are:

Screen Shot 2018-01-15 at 12.25.25 PM

Furthermore, under the « Negative List Mode » first implemented in Shanghai Pilot Free Trade Zone and later extended to the other 3 Pilot Free Trade Zones covering designated areas in Tianjin, Fujian and Guangdong by Special Administrative Measures for the Access of Foreign Investment in Pilot Free Trade Zones on May 8, 2015[16], the foreign invested projects in industries out of the Negative List will not been approved but recorded unless the approval is required for domestically invested projects of the same kind according to effective laws and regulations, that is, the project proposals, joint venture contracts and articles of association are no need to be examined and approved, and the approval certificate for foreign-invested enterprises will not be issued anymore while the approval certificate is still applicable for foreign investment in any industries either encouraged and permitted or restricted out of the said Pilot Free Trade Zones.

What deserves to be noted is that the Negative List is not applicable to the merger and acquisition of domestic enterprises by foreign investors, the foreign investment in public listed companies and the capital contribution made by transferring shares of domestic companies held by foreign investors.

(2) Uniform business registration system for Foreign invested companies and domestic companies

A. Regarding the substantial requirement

The Circular of the Ministry of Commerce on Improving Foreign Investment Review Administration (商务部关于改进外资审核管理工作的通知) (the « Circular ») promulgated on June 17, 2014 classifies that the registration system under new Company Law which came into force on March 1, 2014 will also apply to the registration of foreign invested companies, which could be regarded as a first step of the national treatment, one of principles that the Draft intends to establish.

According to the Circular, the restrictions and provisions on the ratio of initial capital contribution, the ratio of monetary capital contribution, and the period of capital contribution to foreign-invested are cancelled. The investors (shareholders or promoters) of a company may independently agree with each other on the amount of capital contribution subscribed, and the method and period of capital contribution. The restriction on the minimum registered capital is cancelled, unless otherwise stipulated by laws, administrative regulations or the decisions of the State Council on the minimum registered capital in particular industries.

However, it is worth noting that:

(i) the ratio of the registered capital to the total investment of a company shall still be in compliance with the Interim Provisions of the State Administration for Industry and Commerce on the Ratio of the Registered Capital to the Total Investment of a Sino-Foreign Equity Joint Venture (关于中外合资经营企业注册资本与投资总额比例的暂行规定).
(ii) The timeframe and method to pay in the registered capital agreed upon in the articles of association shall still be followed.
(iii) It does not encourage to subscribe the registered capital as low as possible since business operation requires certain capital (such as for renting premise, purchasing office devices and engaging employees). If the capital is directly put in by investor in manners other than the registered capital, it will probably be regarded as mixing of property of company and shareholder, and lead to « piercing the corporate veil » under the circumstance of insolvency when the shareholder will no longer be protected by limited liability and required to take the liability of company’s debts with shareholder’s property.
(iv) The requirements on paid-in capital for particular industries, types of companies, etc. will still be applied.

B. Regarding the procedural requirement

As of June 23, 2015, the reform of combining three certificates (ie, business license, organization code certificate and tax registration certificate) (« Three into one ») has been gradually carried out throughout China. Meanwhile, uniform registration conditions, registration procedures and standards for registration application documents shall be implemented.

In practice, the above-mentioned registration scheme has encountered some obstacles in some special areas because that the foresaid three certificates may fall into the authorities of different levels. Take Shanghai for instance, the business license for certain industries such as steel shall be issued by municipality AIC whereas the organization code certificate and tax registration certificate will be issued by the district authorities. Therefore, enterprise belonging to such industries cannot for the time being enjoy the facility of the registration scheme of « Three into one ». Local government has already launched research on the solution which we believe will be released soon.

C. Simplify formalities for post-registration

On February 13,2015, State Administration of Foreign Exchange (« SAFE ») released the Circular on Further Simplifying and Improving the Direct Investment-related Foreign Exchange Administration Policies (the « Circular »), with effect as of June 1, 2015.[17]

Under the Circular, the requirement for capital accounts under direct investments to be subject to foreign exchange registration approval is cancelled, whereby foreign investment may directly go through the relevant foreign exchange registration formalities for their capital accounts under direct investments with competent banks; the requirement for foreign investors to register their non-monetary contributions and those made by acquiring stock shares of Chinese parties for confirmation of their capital contributions is cancelled, adjusting the foreign investors’ monetary capital contribution confirmation registrations into registrations for recording the receipt of monetary capital contributions in the capital account with competent banks.

For the time being, the intention to facilitate the foreign exchange registration has been discounted by the uncertainty of the time schedule for banks to perform such new responsibility due to their excessive prudency over supervisory risks on banks’ side. It remains to be seen whether the improvement on the relevant inner system and the proficiency in the business of banks can finally achieve the targeted effect of the Circular.

3. More emphasis on daily legal compliance

(1) Regular information disclosure

Though the market access has dramatically eased, it does not result in deregulation by the authority. Instead, the focus of the regulation will be shifted to the post establishment and stimulate more attention of enterprises to legal compliance, which is clearly indicated either by proposed information reporting system in the Draft or the information publicity administered by AIC.

Either in current information publicity system or in the future information reporting system, the enterprise should pay attention to following points:

A. Strengthen the legal compliance and avoid administrative penalty as far as possible

Under the circumstance of information publicity, business reputation is critical or even life-to-death to an enterprise. Previously, administrative penalty is usually not available to the public awareness unless disclosed by media exposure or legal investigation. However, pursuant to requirements of current information publicity, the administrative penalties are required to be publicized by relevant authorities including tax bureau, environmental protection bureau, customs bureau, food and drug administration, quality supervision bureau, etc., which for the purpose of establishing credit system and in turn urge higher legal compliance by enterprises.

B. Publicize required information authentically and timely

(i) The basic information about registered address, business premises and correspondence address shall be authentic and accurate. According to the Interim Measures for the Administration of Enterprises with Abnormal Operation (企业经营异常名录管理暂行办法) (the « Interim Measures »), AIC may contact an enterprise through posting special letters, and if such special letters are sent twice by post to the registered address or business premise but are not signed and received by the enterprises, the targeted enterprises will be put into the « blacklist of abnormal operation »[18]. So the inconsistency between office address and registered address shall be timely corrected.
(ii) Though the annual report of last year is required to be submitted in the publicity system prior to June 30, it would be better to start the preparation of annual report 2 or 3 months earlier since it will take some time to collect, verify and fill in relevant information especially the audited financial data. Furthermore, the inconsistency between the real financial data and those in the financial data submitted shall not happen anymore as it may be the case in previous annual inspection since the AIC may entrust the professional agencies to verify the authenticity.
(iii) The amount of paid-in capital publicized must authentic, otherwise creditors are entitled to hold the shareholder liable for fraud capital contribution.
(iv) Keep careful about the information disclosed on the website. The enterprise website address is necessary information in the annual report pursuant to Publicity Interim Regulations[19]. Therefore, apart from the authenticity and accuracy of the website address, the information disclosed on the website may trigger legal problems concerning misleading propaganda, intellectual property, domain name, etc.

(2) Tax compliance

As of February 3, 2015, it has been impracticable for any scheme about indirect transfer of any equity interests in resident enterprise in China without reasonable commercial purpose and intended to avoid the enterprise income tax liability of non-resident enterprises according to the Announcement on Several Issues concerning the Enterprise Income Tax on the Indirect Transfers of Properties by Non-resident Enterprises[20]. Such indirect transfer is identified as a direct transfer of equity interests in Chinese resident enterprises and other properties under current Enterprise Income Tax Law.

Contracts between Chinese enterprises and related parties overseas have been under the scrutiny by tax authorities based on the arm’s length principle as of March 18, 2015 pursuant to the Announcement on Issues concerning the Enterprise Income Tax on Payments of Fees Made by Enterprises to Related Parties Overseas.[21]

Retrospect adjustments will be made to any payment of fees to related parties overseas falling into the following four scenario: (i) payment without corresponding services or functions; (ii) payment for unbeneficial services; (iii) payment of royalty for intangible assets where the related parties overseas have not contributed to the creation of value; (iv) payment of royalties to related parties overseas for incidental interest arising from listing-related financing activities.

Conclusion

Generally speaking, Chinese legal regime for foreign investment is cautiously moving to liberalization which of course is signaled in various legal documents without limitation to the above-mentioned. On the other side, there are increasing penalties for violation of laws in daily operation along with the barrier reduction to business. In a word, more business will be allowed to be conducted in more responsible ways.

[1] http://tfs.mofcom.gov.cn/article/as/201501/20150100871010.shtml
[2] Article 170 of the Draft
[3] Article 11 of the Draft
[4] Article 216(3) of the Company Law
[5] Article 84 of Administrative Measures on Takeover of Listed Companies
[6] Chapter 2 of Accounting Standards for Business Enterprises No. 33 – Consolidated Financial Statements
[7] Article 18 of the Draft
[8] Article 15 of the Draft
[9] Notice of the General Office of State Council on Establishment of Security Review System Pertaining to Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (关于建立外国投资者并购境内企业安全审查制度的通知)
[10] Article 73 of the Draft
[11] http://www.npc.gov.cn/npc/zgrdzz/2013-12/12/content_1816288.htm
[12] http://www.zffz.yn.gov.cn/ynsfzxxw/1946680938930896896/20140327/255675.html
Unfortunately, we do not find the original document in the official website of the State Council but in the website of Yunnan government.
[13] Article 23 of the Draft
[14] Article 68 of the Draft
[15] http://www.sdpc.gov.cn/zcfb/zcfbl/201503/t20150313_667332.html
[16] http://www.gov.cn/zhengce/content/2015-04/20/content_9627.htm
[17] http://www.safe.gov.cn/resources/wcmpages/wps/wcm/connect/safe_web_store/safe_web/zcfg/zbxmwhgl/zjtzwhg
l/node_zcfg_zbxm_kjtz_store/ecb2730047782024852fa73b4795588d/
[18] Article 9 of the Interim Measures
[19] Article 9 of the Publicity Interim Regulations
[20] http://www.chinatax.gov.cn/n810341/n810755/c1491377/content.html
[21] http://www.chinatax.gov.cn/n810341/n810755/c1519231/content.html