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Greater flexibility for financing and structuring foreign investment in China

Lewis Lu of KPMG explores the impact of new rules on equity investment in China.

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. 

An era of restraint

Up until recently, foreign invested enterprises in China (FIEs) were subject to severe restrictions on making investments in the equity of other enterprises in China. Where a FIE was set up as the Chinese subsidiary of a foreign enterprise, and it converted its foreign currency equity capital into RMB, it could only use this for expenditure associated with business operations, and not for investment in the equity of other enterprises in China. This was because only very limited categories of FIEs were allowed to include ‘equity investment’ as an activity within their approved business scope, registered with the Chinese authorities. Thus, in practice, such ‘standard FIEs’ could only invest in China enterprise equity by using their accumulated business profits.

There were a number of ‘specialised’ FIEs that were allowed to include equity investment in their scope of business. These limited categories of ‘approved investment enterprises’ included foreign invested venture capital investment enterprises (FIVCIEs) and qualified foreign limited partnerships (QFLPs), amongst others. There was also a regime for China holding companies (CHCs), but this had extremely high capital requirements that limited its usefulness. The net effect of these rules was that it was very difficult for most foreign enterprises to consolidate their various Chinese subsidiaries under an onshore holding company, and their ability to conduct restructuring and strategic M&A within China was restricted.

Breaking barriers

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.

Clarifications needed

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.


Lewis Lu
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