Foreign investment law in China guarantees a certain level of investment security and relaxed capital controls, but involves a complex set of compliance processes. These processes aim to protect China’s national security from anything it deems a threat, and involves correctly filing reports in order to ensure that nothing threatening to the country, or the stability of its government, is allowed into the country. In exchange, you are given “national treatment,” which means that you are entitled to both security of property and protected against discrimination, subject to a lot of exceptions. You can also qualify for a number of foreign investment preference programs, and favorable treatment when doing foreign exchange, as to capital controls.
The following content was translated from official Chinese government guidance on foreign investment using the User Centered Translation approach.
Contents
How China’s foreign investment regime works
Foreign Investment Legal Compliance
1. How China’s foreign investment regime works
The Foreign Investment Act came into effect in 2020, replacing a set of statutes known as the Foreign Ownership Laws; the traditional laws created a separate parallel corporate governance regime for foreign owned entities. Entities must obtain business registrar and commerce agency approval to transition to the new entity form by 2025.
The Foreign Investment Act equalizes corporate governance, such that, the Company Act and the Partnership Act governs the business structure, organizational structure, and activities of any foreign investor’s wholly-owned subsidiary or collaborative joint venture identically to domestic entities.
The Foreign Investment Act guarantees equality both before and after the investment is established in China, but investors may not invest in a field in the Foreign Investment Access Exceptions List. Foreign investors must take action to ensure they are in compliance with these requirements. The Supreme Court Rules provide further clarity that investment agreements are valid if not covered by the Exceptions List, but a transaction prohibited by the Exceptions List is invalid.
Under the Act, a foreign investor is anyone outside Mainland China, even residents of Taiwan and Hong Kong, and even PRC passport holders residing abroad. Foreign investment is defined to include both foreign direct investment and foreign indirect investment. Direct investment includes greenfield investment, M&A, and new projects. Indirect investment includes debt investment (i.e., bond subscriptions）, VIEs, custodianships, trusts, offshore transactions, and leases. Reinvestment in Chinese entities made by foreign owned entities formed pursuant to Chinese law is still considered foreign investment.
An investment by a Chinese-owned entity in a foreign jurisdiction, also known as a round-trip investment, is characterized as a foreign investment even if owned by people in China. Therefore, its investment access is subject to the Exceptions List.
Round-trip investments are also affected by the two following provisions:
Foreign Investment Act §14: “The state shall encourage and attract foreign investors to invest in specific industries, fields, and regions based on socioeconomic development needs. Foreign investors and foreign owned entities may be entitled to special treatment under applicable law, administrative regulations, or the State Council policies.”
Administrative Regulations §12: “Foreign investors and foreign owned entities may enjoy preferential treatment in government funding, taxes, financing and leasehold pursuant to law, administrative regulations, and State Council regulations.”
China determines foreign owned entity status based on the national origin of the capital contributions and not on the nationality of beneficial owners. Thus, if over 25% of the capital contributions are made by an offshore entity, it will be considered a foreign owned entity. Local governments are authorized to adjust this ratio.
2. Foreign Investment Legal Compliance
The Foreign Investment Act can invalidate some investment contracts. Specifically, contracts to invest in an industry contained in the Foreign Investment Access Exceptions list will be prohibited. The Exceptions List provides access to some industries subject to maximum shareholding ratios and requirements executives be Chinese. An administrative entitlement can also grant access to restricted industries. If not specifically prohibited by the Exceptions List or another law, foreign investment contracts are automatically valid.
The penalty for violation is that the appropriate agency with jurisdiction will issue a cease and desist order and reverse the effects of the transaction, including seizing illegal income.
Legal Compliance
A foreign owned entity must comply with the full range of Chinese law and regulatory oversight. Special attention must be given to the reporting system, anti-trust, and national security.
The foreign investor must submit investment information to the agency with jurisdiction over commerce in the business entity filing system and the national business entity credit lookup system, in addition to NDRC filings. This information will be shared with all relevant government agencies in China. Transactions over USD$300 million otherwise prohibited by the Exception List can be approved by the State Council. All investments over USD$2 billion must be filed with the State Council. Other investments are approved by local government.
During the information reporting process, the appropriate government agency will review the planned investment to see that it complies with the Investment Access Exceptions List. Special approval is required for sensitive industries, such as tobacco, publishing, schools, and securities brokerage.
Antitrust Reviews
The Antitrust Act and regulations in China require requesting a market concentration review if their control of an entity could affect market concentration. “Control” occurs for a foreign investment in the event of the following:
- Foreign investors owning over 50% of voting shares;
- Foreign investors having veto power over major corporate governance matters;
- The power to name executives;
- When businesses participating in the concentration have a combined global total gross revenues of over RMB 10 billion or a combined total gross revenues in China of over RMB 2 billion.
National Security Review
Any foreign investment that affects or may affect China’s national security will be subject to a security review. A national security review is required whenever:
- A foreign investor purchases assets or equity from a domestic business entity directly or indirectly involved with national defense and security.
- Foreign investors obtain actual control of a business entity in China through merger and acquisition even if there is no direct involvement with national security. This applies for domestic business entities in fields critical to economic security, such as agricultural products, energy, natural resources, infrastructure, transportation services, essential technologies, or heavy equipment.
Actual control exists if:
- A foreign investor, together with its controlling parent company and holding subsidiary own over 50% of the total shares through merger and acquisition.
- Over 50% of the total shares are held by multiple foreign investors through mergers and acquisitions.
- The voting power held by foreign investors owning less than 50% of the shares through merger and acquisition is sufficient enough to materially affect decisions during shareholders or board of directors meetings;
The National Development and Reform Commission and the Ministry of Commerce conduct joint national security reviews for mergers and acquisitions, and their decisions are final.
3. How China regulates foreign exchange for foreign investments
To obtain foreign exchange approval, you will need to provide your bank with your Business License, regulatory approvals, and a copy of the FDI registration. The bank will look at your corporate governance documents and good standing in the National Business Credit Lookup System.
To remain in good standing, you must submit an annual financial statement to the National Business Credit Lookup System. Copies of the filing will be shared with each of the several business regulators in China.
Corporate Transactions
Foreign exchange remittances of paid-in capital when forming a business entity is accomplished by opening a special purpose cost account during the pre-establishment phase of the investment. To complete he transaction, you will need to bring to the bank a copy of your business license issued by the market regulatory agency, and the foreign investment approval certificate issued by the commerce agency. During the pre-establishment phase, you may freely exchange foreign currency from your costs account for valid business transactions, without submitting a capital contribution registration form.
Once an entity is formed in China, when using foreign exchange to invest in a new venture through an existing legal entity, you will need to first file a foreign investment information report amendment. You can distribute net profit to foreign shareholders with a foreign exchange filing by providing your bank with financial statements showing profit and loss for the current and past years.
Tax payment documentation is required for foreign exchange arising from when a foreign investor sells their shares in a Chinese company; to do this, you can authorize your bank to access your tax payment records electronically from your local tax office. A China resident can receive payments for sales of shares paid through foreign exchange without opening a capital account or foreign currency capital account.
Any foreign owned entity even those not licensed for investment, may make equity investments in China if not otherwise prohibited by the Exceptions List, if for a significant and legal venture. To do so, you must complete domestic reinvestment filings and open a foreign currency account. No capital registrations are required if the transaction is totally in foreign currency. However, if foreign exchange is used, a foreign owned entity must complete domestic reinvestment registration and open a capital account to receive the funds.
After processing corporate dissolution of a foreign owned entity, you can process foreign exchange to remit fund proceeds from liquidation from China to overseas. You can do this by providing the bank with the business registrar’s acknowledgement of liquidation and tax office’s tax registration termination.
Two other issues often come up at banks:
- You cannot pledge funds in a security deposit account as security for a loan.
- Interest earned on a foreign exchange account can be transferred or withdrawn freely at the bank.
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Summary
In this set of three government guidance documents translated by CBL, we have seen that the foreign investment regime in China guarantees foreign investors equal national treatment to their own citizens
Sources
This guidance was consolidated from three related government publications explaining China’s foreign investment laws. The User Centered Translation approach has the same meaning as the original, but makes changes to grammar, word order, and semantics to be understandable. You can use machine translation on the original sources below to see a word-for-word version.
Guidance 1: https://www.cznd.gov.cn/html/cznd/2022/HFFPILLL_0207/466344.html
Guidance 2: http://www.cznd.gov.cn/html/cznd/2022/HFFPILLL_0215/466345.html
Guidance 3: https://fdi.swt.fujian.gov.cn/index.php?c=content&a=show&id=7543