In recent years the Chinese government has been steadily reducing restrictions on foreign investment in China. The number of industries that are off limits to foreign investment have been reduced. The remaining prohibited or restricted sectors are detailed in a Foreign Investment Negative List, while investment in restricted sectors can still go ahead with special approvals. The requirements for foreign investors to co-invest with Chinese joint venture partners are also being scrapped for many sectors.
China’s new Foreign Investment Law went into effect on January 1 2020. The new law notably provides that foreign investors can use the same forms of a Chinese legal entity as used by Chinese investors, while also improving intellectual property protection. In parallel with these developments, China’s State Administration of Foreign Exchange (SAFE) recently rolled out new measures that give foreign investors greater flexibility in how they finance and structure their China investments and operations, as detailed below.
Starting in July 2019, SAFE pilot programs in Shanghai and Shenzhen started to dismantle these restrictions, such that standard FIEs could use their registered capital to make equity investments in Chinese enterprises regardless of the terms of their registered business scope. Criteria were established that the investment must ‘genuine’ and ‘reasonable’ and comply with the Foreign Investment Negative List. Effective from October 2019, SAFE Circular 28 takes this treatment nationwide. The benefits of this change are multi-fold:
- Going forward, foreign investors have much more flexibility to establish their China operations under onshore holding companies, restructure operations, and conduct M&A activity.
- Red chip structures can also benefit. These are Chinese companies with a Hong Kong or Cayman top company as listing entity. Such enterprises can now can inject the foreign capital, raised overseas, into their onshore controlled entities, which can then make onward domestic equity investments.
- Standard FIEs may now offer an alternative structure for making domestic equity investments, alongside QFLP, FIVCIEs, and the other specially approved investment enterprises. Indeed, the tax rules are clearer for FIEs than for other investment platforms such as QFLP. FIEs can also benefit from the tax incentive in Circular 102 (2018) which defers the application of withholding tax (WHT) on dividends where profits are reinvested in China.
A number of matters do remain to be clarified, including the meaning of ‘genuine’ and ‘reasonable’ investments. It also remains to be clarified whether the reduced national restrictions will cover debt raised overseas for making domestic equity investments, in the same way as now done for equity raised overseas. Debt use is facilitated in this manner under the Shanghai and Shenzhen pilot schemes but this is not yet explicitly the case for the national rules.
There are also procedural matters to be clarified around permissible cash flow and registration processes for domestic investments. Nonetheless, the new rules significantly raise the flexibility that foreign enterprises have for financing and structuring their China operations.
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