Foreign investors are permitted to invest in the stocks of publicly traded companies in China. The applicable regulation under which this occurs is the Foreign Investor Public Company Strategic Investment Administrative Procedures, and the latest procedures became effective in 2024. The rules follow the Foreign Investment Act principles, in particular imposing significant reporting requirements with regulators. The rules also require a long lock-up period for investments and minimum shareholder requirements. Additionally, general business law principles unique to China must be followed for these kinds of investments, especially where state owned enterprises are involved. Stock swaps involving a foreign stock for a Chinese stock will implicate international tax treatment, which can create significant tax risks if the transaction is not structured strategically. All of these legal issues will be covered in this article.
Contents
China’s regulatory system for investment into A Shares
Regulatory agency transparency requirements
General business law compliance requirements
Lock-up periods for investments
Minimum shareholding and broker requirements
How stock in publicly traded Chinese companies is be taxed
China’s regulatory system for investment into A Shares
The current public company foreign investment regime is based on the China Foreign Investment Act of 2019, which establishes legal principles for how foreign direct investment into China is governed. Previously, China used a patchwork of regulations centered around the 2005 Foreign Investor Public Company Strategic Investment Administrative Procedures, which were further amended in 2015, and again in 2018 via a circular. This patchwork of regulations created confusion about foreign investor participation in China’s capital markets. Thus, the Ministry of Commerce as the lead agency drafted the Foreign Investor Public Company Strategic Investment Administrative Procedures with an effective date of December 2, 2024. You can get an overview of China’s general foreign investment landscape at CBL’s foreign investment FAQ here.
Built on the foundation of the Foreign Investment Act, the current Administrative Procedures are applicable to foreign business entities, individuals, and organizations that invest in Chinese A-shares or over the counter stocks on the new “third board” in China through new share issuance, purchase and sale, and tender offer. The rules are specifically applicable to China’s Qualified Foreign Institutional Investor (QFII) plans and its renminbi-denominated variant (RQFII), and A share purchases made through one of the several online “stock connect” platforms. Private equity placements made prior to a listing and employee stock ownership plans with foreign participants are also subject to the Administrative Procedures.
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The Administrative Procedures have varying requirements based on the nature of the investment into China, and generally are focused on investor capability and compliance.
China’s investment capability rules seek to ensure the investor has financial health, credit, and financial management aptitude. An individual investor must have good risk management ability and a net worth of over $50 million USD, or alternatively be responsible for assets under management over $300 million. An investor that becomes the controlling shareholder of a public company in China must have net worth over $100 million USD, or alternatively be responsible for assets under management over $500 million USD. The minimum net worth and asset under management requirements are waived if the investor acquires a 100% stake in the entity.
The Administrative Procedures compliance requirements focus on lawful business organization, effective governance structure, and internal controls; thus, it automatically excludes any party that has been subject to a criminal penalty or major regulatory penalty within the past three years. The Administrative Procedures require cross-border stock swaps to result in lawful ownership of an interest in the foreign jurisdiction entity; such entity must also be legally compliant and in good standing under the business organization laws of its jurisdiction. Any major regulatory penalty in its home jurisdiction on a manager of the entity itself within the past three years will disqualify the transaction.
Regulatory agencies require transparency from all market actors
A foreign investor’s participation in a public Chinese company must be fully transparent to regulatory agencies. The Administrative Procedures require that foreign investors in China declare the number of shares and percentage of interest held in a business entity; shares in possession of a broker or other third party for the beneficial owner must be added up to a single total number of shares and percentage interest for each beneficial owner in the organization. These third parties are defined to include a Qualified Foreign Institutional Investor (QFLI or RQFLI), and platforms such as the several “stock connect” platforms available in China.
The financial capability requirements under the Administrative Procedures can be waived for a foreign investor that acquires a 100% stake, provided they meet the other requirements. When filing for this waiver, the foreign investor must covenant to assume full joint and several liability for all matters in connection with the investment.
These rules can cause some confusion if you aren’t familiar with the China Foreign Investment Act of 2019. A key fact under the Act is that it eliminated commerce regulatory agency authority over foreign owned entity formation approval and filings.
Notably, that the commerce agency is not involved with approving these investments. China’s current foreign investment regime, foreign investors are required to file accurate and complete information disclosures about their investments. There are now lower barriers to making cross-border stock swaps, because prior approval from the Ministry of Commerce for a foreign investor acquisition is not required.
General business law compliance for foreign investment into public companies
An investment by a foreign investor into China is subject to domestic corporate law, securities law, and several regulatory processes such as information disclosure and declaring change in ownership.
In particular, the Foreign Investment Act regime totally prohibits investment in any areas falling under the Foreign Investment Access Exceptions List, and regulators may impose a national security review of the investment, and possibly an anti-trust review. Chinese corporate law has special rules for acquiring an interest in a publicly listed state-owned enterprise. The investor must also follow foreign exchange procedures including filing, cancellation, account opening, settlements, and cross border funds flow reports, in addition to tax requirements. Business registrar filings may be required in some cases. Special regulations may also apply to certain industries, for example there are specific requirements for shareholding in a financial institution.
Traditionally, there have not been clear rules governing how cross-border share swaps work in China. Before 2024, the Foreign Investor Mergers & Acquisitions Rules governing equity swaps contemplated only that stocks in a foreign publicly traded company could be exchanged.
The current Administrative Procedures now permit exchanging shares of a private foreign company for stock in a public Chinese company without needing Ministry of Commerce approval, merely requiring foreign investment reporting to be completed.
Lock-up periods for investments
The Administrative Procedures require a 12-month lock-up period for foreign investment into Chinese A Shares. More stringent lock-up penalties also apply to an investor who is in violation of the law. For example, a foreign investor that violates the law by making misrepresentation in the course of making an investment in a public company in China, is subject to several penalties. They may not assign, transfer, gift, or pledge their shares, and are ineligible for dividends or exercise of voting rights. The penalties apply during a window covering the 12 months before and after penalty conditions existed.
Other regulations may impose a stricter lock-up period than the Administrative Procedures, in which case the longer period applies. For example, an 18-month lock-up period applies to public companies acquired by foreign investors, or for private placement completed through agreement with the board of directors. Major shareholders in commercial banks have a lock-up period of 5 years.
Lock-up period arrangements for indirect transfers. If the party making the investment in China does not meet the financial capability requirements under the Administrative Procedures, they can obtain an exemption by making a 100% acquisition of an entity, provided that they meet the other requirements, including lock-up period requirements. During the lock-up period, the investor is not allowed to exit the investment at all. Additionally, the investor will be responsible for all of the previous investor’s obligations, and will have to make all investment disclosures, especially those provided under the Foreign Investment Act.
The Administrative Procedures are not retroactive, so investments made before December 2, 2024, will continue to be subject to the 3-year lock-up period.
Minimum shareholding and broker requirements
Traditionally, a 10% minimum shareholding requirement has been imposed for foreign investment in a public company in China. Under the current Administrative Procedures, there is no minimum shareholding requirement when making a private placement in a public company. Specifically, the investor must reach an agreement with the board of directors of the public company to issue new shares subject to a private placement agreement.
Where a share purchase agreement or tender offer is used to acquire stocks in a public company by a foreign investor, a 5% minimum stake is required. The Administrative Procedures require that when purchasing shares of a public company, a foreign investor must hire a financial advisor, underwriter, or law firm organized and in good standing under China law to serve as broker or representative in the transaction. This representative must prepare a formal opinion about the investor’s qualifications, specifically as to qualification to be an investor under the Administrative Procedures and ability to maintain the investment during the lock-up period, Foreign Investment Act compliance, and national security review.
During a private placement issuance to a foreign investor, the public company itself in China must retain its own counsel to perform a due diligence review for compliance with the China Foreign Investment Act and a national security impact assessment. On the other hand, if the foreign investor completes the investment through a share purchase agreement or a tender offer, the foreign investor is the party responsible for hiring its own counsel to complete this due diligence review for compliance. A securities registrar must refuse recording any stock transfers if it sees the due diligence review results show that the investment does not satisfy the requirements of the Administrative Procedures.
Taxation of foreign investment in Chinese public companies is governed primarily by the National Tax Administration Circular No. 9 (2018), which addresses beneficial ownership determinations under international tax treaties. Under the Circular, a beneficial owner is defines as the person who own and controls the proceeds or property which proceeds may be derived.
This rule implies the management of a company investing directly in China must be able to show that it has control over the proceeds of its investments in China. However, foreign investors will typically be making investments into China through several layers of legal entities, and the entity making the investment directly will usually not have a core management team. The beneficial ownership procedures also impose restrictions on the flow of funds and exit from the investment. Overall, these rules in the context of general taxation principles will affect how public company stock investments by foreign investors are taxed in China. These rules can be very complex, so let’s look at them in different common investment contexts.
Let’s take a look at the basics of how share swaps are taxed under the current rules for foreign investment into public companies. Under the Administrative Procedures for tax purposes, a stock swap is characterized as assignment of shares in a first for cash consideration, in which case that cash is used as consideration for the purchase or acquisition of shares in a second company. Even if no actual cash transactions are made parties are nonetheless subject to China taxation; this is because China tax law considers a cash transaction to have been constructively made, even if no cash exchange takes place. Consider these two hypotheticals representative of common transaction structures:
- Foreign investor Alpha owns shares in a foreign company Omega, and makes a deal with Beta to do a stock swap for shares in a Chinese company Zeta that Beta owns. In this case, Beta must pay personal income tax, value added tax, and stamp tax in China when selling the Zeta shares. Investor Alpha’s sale of Omega shares will not implicate Chinese tax law, but instead will be subject to tax in the foreign jurisdiction.
- A foreign investor Charlie offers his shares in the foreign Bravo Corporation as consideration for the private placement purchase of newly issued shares in the Chinese public company Foxtrot. The newly issued shares in the Chinese public company does not implicate income tax or value added tax, and the taxation of Charlie’s shares in Bravo Corporation are subject to the foreign jurisdiction’s taxation.
In either of these transaction types, #1 or #2, the foreign investor exits the investment, they must make a China tax filing (in the examples, both Alpha and Charlie must make the filing). A cross-border stock swap will complicate how the China individual income tax liability is calculated, as typically it by uses the cost of acquiring shares in the Chinese public company as the tax base when calculating gains.
How institutional investors are taxed
When an institutional investor purchases stock with cash consideration, that number will be assigned as the tax base. However, a stock swap that does not involve a cash exchange makes determining the tax base difficult especially since the foreign stock transaction, as noted above, may not have been included in a China tax filing. There is therefore significant uncertainty about what tax base the China tax administration will recognize. To mitigate this risk, the parties should make a written agreement as to the transaction price when doing a share swap, and retain records of the basis for the share price valuation.
A foreign investor’s stock purchase in a Chinese foreign company may result in the company being designated as having a Chinese-Foreign ownership structure, which means that business profits will be subject to a 25% business income tax. One strategy for this kind of transactional risk is to use an offshore equity holding structure for assets located outside China, for example holding the equity through a Singapore entity. This approach can defer taxation of offshore capital gains. Holding offshore assets through an offshore holding company makes it possible to make a direct stock swap of what is now foreign equity, which can avoid implicating Chinese income tax.
How foreign individuals living outside China are taxed
Typically, the foreign investor in Chinese A shares making a strategic investment will be someone who has not established Chinese tax domicile. The foreign investor in this case is liable for tax on income arising in China, thus a strategic investment under the Administrative Procedures is subject to a 20% China individual income tax.
During exit from the investment, a foreign investor holding less than 25% of the equity in the entity may be exempt from Chinese individual income tax. Whereas if the investor holds more than 25% of the equity in the entity, they may be entitled to a reduction an income tax burden of 10%. Individual taxpayers who are not a China tax domiciliary do not need to pass the beneficial owner test. Individuals selling public company stocks do not need to pay China income tax.
Conclusion
China’s updated rules on foreign investor participation in publicly listed companies integrates with the Foreign Investment Act of 2019 and as a result, significantly lowers barriers to invest in capital markets. However, China’s rules on foreign investment and public company investment nonetheless impose complex compliance requirements that should be taken into account, particularly for national security reviews and lock-up periods. Having a solid understanding of China’s foreign investment law regime can ensure you are well-positioned to make smart investment decisions.
FURTHER READING
Get authoritative insights about Chinese foreign investment law from official government guidance in translation:
For a general overview of this topic, see also CBL’s Foreign Investment FAQ.