By Alex Liu

In the recently published CCP Central Committee Decision Concerning Certain Major Issues in Comprehensively Deepening Reform, China decides to "establish and complete foreign debt and capital flow control systems under prudential macro-level management framework, accelerate the realization of the convertibility of Renminbi capital accounts."

Actually, since late 2012, the Chinese foreign exchange control authority, the State Administration of Foreign Exchange (the "SAFE") has released some important rules to streamline and further improve the foreign exchange control systems. Among those are the followings in regard to "capital accounts" under foreign investments:

  >   SAFE Circular on Publishing the Provisions on Foreign Exchange Control on Domestic Direct Investment by Foreign Investors and the Operating Guidelines, effective as of May 13, 2013 ("SAFE Circular 21"); and

  >   SAFE Circular on Further Improving and Adjusting the Foreign Exchange Control Policy on Direct Investment, effective as of December 17, 2012 ("SAFE Circular 59").

Such rules aim to streamline the foreign exchange control systems over foreign investments in China. They bring a lot of important changes to the former control systems. It is thus helpful to have a survey of the key requirements and changes under such new rules. To be more clearer and easier to understand Chinese complicated foreign exchange control systems, the survey below will follow a step-by-step style in line with the common foreign investment procedures.

 

 

Briefly, the following flow chart indicates the common procedures of inbound investment in China:

 

 

 

 

1. Step One: Upfront Expenses

Upfront expenses may occur before the foreign investor sets up a foreign invested enterprise ("FIE"). Early ten years ago, China has already allowed foreign investors to open a foreign exchange account for such upfront expenses (the "Upfront Expense Account"). The SAFE Circular 59 further facilitates the procedures in the following aspects:

 

 

Upfront Expense Account
Matter	Before	Current
Rules	SAFE Circular [2003] 30	SAFE Circular 59; SAFE Circular 21, Forms 1.1 & 2.1
Accounts Type	Special Accounts (Investment; Acquisition; Expense; or Guarantee)	Upfront Expense Account
Account Opening	Prior SAFE approval required	SAFE registration suffices
Inflow Quota	USD100,000	USD300,000; Higher quota possible if approved by local authority on a case-by-case basis
RMB Conversion	Prior SAFE approval required	Directly with the bank
Transfer to the FIE Capital Account	Prior SAFE approval required	Directly with the bank
Balance Repatriation	Prior SAFE approval required	Directly with the bank
Validity	3 months	6 months, or12 months at most

 

2. Step Two: FIE Set-up

2.1 Set-up by Incorporation

From the perspective of foreign exchange control, the procedures involved in setting up a new FIE may be illustrated as below:

①  Newly Set-up FIE Basic Information Registration (Form 1.2)

FIE shall handle this registration with the local SAFE of where its registered domicile is located. Form 1.2 of SAFE Circular 21 provides for the details of this registration.

One key change is that upon registration, the FIE will be issued with the Matter Registration Voucher (业务登记凭证) with local SAFE's stamp thereon. The formerly used Foreign Exchange Registration Certificate or IC Card ceased to be used since May 2013. To get the aforesaid Matter Registration Voucher, the FIE shall fill in the Application Form for the Domestic Direct Investment Basic Information Registration Matter.

②  FIE's Opening of Forex Capital Account (Form 2.2)

Like the Upfront Expense Account, SAFE Circular 59 abolishes the precedent SAFE approval requirement for the opening of the FIE's Forex Capital Account. The FIE can now proceed directly with the bank to open its Forex Capital Account, on strength of the aforesaid Matter Registration Voucher for the FIE Basic Information Registration. Form 2.2 of SAFE Circular 21 provides for the details for this account opening matter.

Another important change is that the FIE is now permitted to open two or more Forex Capital Accounts in different banks, including the bank outside of the FIE's registered domicile location.

③  Foreign Capital Remittance (Form 2.2)

To remit foreign capital into the FIE's Forex Capital Account, the foreign investor shall follow the guidance specified in Form 2.2 of SAFE Circular 21.

Of mention, where the FIE opens more than one Forex Capital Accounts, there is now no quota restriction on the amount that can be remitted into one single Account, provided however that the aggregate amount remitted into all the Accounts of the same FIE is below the quota granted to that FIE (that is, the foreign registered capital of that FIE).

In addition, due to the exchange inflation or other reasons, the foreign capital remitted may exceed the foreign capital quota (or the balance thereof) of the FIE. Such excess foreign capital may be remitted in if it is an amount of USD30,000 or below.

④ Foreign Investor's Capital Contribution Confirmation Registration (Forms 1.7, 1.8)

Upon the remittance of the foreign capital, the FIE shall handle the Capital Contribution Confirmation Registration with local SAFE for its foreign shareholder, which will be done via the accounting firm that handles capital verification for the FIE. One change of mention is that, the accounting firm may now handle this procedure directly through the SAFE's online system, without having to submit the written application as before. Forms 1.7 and 1.8 of SAFE Circular 21 provide for the details of this Confirmation Registration respectively for the cash contribution and non-cash contribution.

Of notice, without the abovementioned Capital Contribution Confirmation Registration, the FIE cannot convert the foreign capital in its Forex Capital Account into RMB, transfer it outward or otherwise use it, and foreign shareholder of the FIE cannot remit its earnings in or of the FIE (such as dividends or equity transfer consideration) outside of China.

⑤  RMB Conversion of Foreign Capital (Form 2.6)

Form 2.6 of SAFE Circular 21 specifies the requirements and procedures for the conversion into RMB of the foreign capital received in the FIE's Forex Capital Account.

Unfortunately, it seems that the SAFE does not intend to relax the control over the RMB conversion of the foreign capital in the FIE's Forex Capital Account, which control was strengthened since August 2008 when the SAFE issued the well-known Circular 142.

Nevertheless, it is to mention that the SAFE Circular 59 cancels the prior record-filing requirement with local SAFE for special cases of foreign exchange settlement. With regard to FIE's payment need for which lack of clear guidance under existing regulations but which need is in line with the FIE's self-use purpose within its permitted business scope and conforms the principles of authenticity, it now allows the concerned bank to directly handle the foreign exchange settlement procedures upon duly examination, and go through the record-filing procedures through the SAFE's online system on an item-by-item basis. It can be expected that the practice may vary depending on banks' different attitudes and most banks will still follow a relatively prudent manner in this regard, especially in light of the SAFE's stringent control over the foreign capital settlement.

2.2 Set-up through Acquisition from Domestic Seller

 

 

In a cross-border acquisition deal, the foreign exchange procedures involved may be illustrated as below:

 

 

① FIE Basic Information Registration for Domestic Target's Acquisition (Form 1.3)

Form 1.3 of SAFE Circular 21 provides for the details of this registration.

Upon registration, the FIE (transformed from the domestic target of the acquisition deal) should provide its Matter Registration Voucher of the FIE Basic Information Registration to the domestic seller, which may then continue to open a special account to receive the purchaser's consideration payment.

② Seller's Opening of Onshore Asset Realization Account (ARA) (Form 2.3)

SAFE has been for a time requiring that the domestic seller must open a special foreign exchange account for the asset realization resulted from the foreign purchaser's consideration payment.

What is changed under the SAFE Circular 59 is that the opening of this ARA does not require prior SAFE approval any more. Now, upon receipt of the FIE's Matter Registration Voucher of the FIE Basic Information Registration, the domestic seller may directly go to the bank to open the onshore ARA.

Of notice, the ARA must be opened in the domestic seller's own name; and, unlike the FIE's Forex Capital Account, the domestic seller can only open one single ARA in a given transaction, although it may open this account in a city outside of its domicile. Form 2.3 of SAFE Circular 21 specifies the details for the onshore ARA's opening.

③  Consideration Payment into ARA (Form 2.3)

Form 2.3 of SAFE Circular 21 also provides guidance for the consideration payment into the onshore ARA. One important change of mention here is that, the ARA's receipt of the foreign purchaser's consideration payment is not subject to the prior SAFE approval requirement any more (which previously may take 20 days or more).

④ Foreign Investor's Capital Contribution Confirmation Registration (Form 1.9)

Similarly to the RMB conversion of the foreign capital in the FIE's Forex Capital Account, the domestic seller's RMB conversion of the payment it receives in the onshore ARA is also subject to the foreign investor's Capital Contribution Confirmation Registration. Form 1.9 of SAFE Circular 21 specifies the details of this Capital Contribution Confirmation Registration for a cross-border acquisition deal.

Once upon payment, the foreign purchaser should entrust the FIE (i.e. the domestic target it acquires) to handle the Foreign Investor's Capital Contribution Confirmation Registration procedures with local SAFE for the consideration payment in an acquisition deal, which procedures are in turn:

a)    foreign purchaser's payment into the ARA;
b)    notice of the payment to the domestic seller;
c)    domestic seller's provision of the ARA bank receipt to the FIE;
d)    FIE's handling of the Capital Contribution Confirmation Registration with local SAFE; and
e)    domestic seller's RMB settlement.
Of notice, one change made under the SAFE Circular 59 is that, where the payment is made in cash, once upon the bank's online record-filing with the SAFE of the ARA's receipt of the consideration payment, the SAFE's online system will automatically complete the Foreign Investor's Capital Contribution Confirmation Registration for the consideration payment. Only where the payment is made in kind or other non-cash assets, does the FIE (via its accounting firm) have to go to the local SAFE to handle this Registration.

⑤ Seller's RMB Conversion of the Paid Consideration (Form 2.6)

Form 2.6 of SAFE Circular 21 also provides guidance on the RMB conversion of the consideration received in the domestic seller's onshore ARA.

It is a general rule that the RMB conversion of the foreign capital in an onshore ARA should be handled following similar rules as those regarding the RMB conversion in the FIE's Forex Captial Account. One key change made in this regard is that, in the acquisition deal, the SAFE Circular 21 differentiates between an entity ARA account owner and an individual person ARA account owner. Specifically, the individual person ARA account owner is not required to submit to the bank for review his/her specific plan on how to spend the RMB funds settled from the ARA. In contrast, the entity ARA account owner remains have to submit documentary proof confirming the use of proceeds (like purchase contract or services contract) and justify each disbursement by Fapiao issued by the goods or service vendor. 

3. Step Three: Domestic Re-investment with Earnings in China

3.1 Foreign Investor's Re-investment with Earnings from FIE

One significant improvement is that the SAFE Circular 59 abolishes the prior SAFE approval requirement on the foreign investor's re-investment in China in the following respects:

  >   FIE's capital increase with the capital reserve, surplus reserve or undistributed profits that are attributable to its foreign shareholder;

  >   FIE's capital increase with its foreign shareholder loan (interests thereon as well) that has been registered with the competent SAFE; and

  >   foreign investor's domestic re-investment with its returns in China such as those derived from the FIE's dividends or those resulted from the equity transfer, capital decrease or liquidation in or of the FIE.

3.2    Investment FIE's Re-investment in China

Another important change brought by the SAFE Circular 59 is that the capital flows (especially in foreign currency) between an Investment FIE (such as a holding, PE or VC FIE whose main business is investment other than manufacturing or services) and its portfolio companies are much simplified. SAFE Circular 59 significantly facilitates the procedures for such capital flows in the following respects:

  >   the portfolio company of the Investment FIE is not required to do the Forex registration with local SAFE;

  >   prior SAFE approval is cancelled regarding the funds transfer from the Investment FIE to its portfolio company;

  >   prior SAFE approval is cancelled regarding the portfolio company's remittance in foreign capital of its profits or dividends to the Investment FIE; and

  >   the Investment FIE is no longer required to go through the capital verification procedures with local SAFE for its investment in the portfolio company.

The underlying point is that, before, the Investment FIE itself (though an onshore company incorporated in China) is deemed as a foreign investor, and thus its portfolio company (just like a typical FIE incorporated by offshore investors) had been required to do the Forex registration, its investment in the portfolio company had to go through the capital confirmation or verification procedures with local SAFE, and the capital flow from the Investment FIE to its portfolio company or the vice versa was subjected to prior SAFE approval. Now, at least from the point of the foreign exchange control, the Investment FIE is deemed as a Chinese shareholder, hence the aforesaid SAFE approval or procedures cease to apply.

Of notice, where the portfolio company's shareholders include not only an Investment FIE but also an offshore shareholder, then this portfolio company still has to do the Forex registration or go through certain other SAFE procedures in regard to the offshore shareholder's investment (just like those discussed in Sections 2.1 or 2.2 above).

3.3 Foreign Capital Flow under Re-investment in China

As just discussed, SAFE procedures on an Investment FIE is much simplified. Nevertheless, where the Investment FIE re-invests in China with foreign capital, certain SAFE procedures still have to be gone through, which include the followings:

 

Of notice, where other onshore parties (other than the Investment FIE) re-invest in China with foreign capital, or where in an acquisition deal the onshore party (either the Investment FIE, typical FIE or other onshore parties) pays the consideration in foreign capital to a domestic seller, similar SAFE procedures should be followed.

4. Step Four: Foreign Investor's Exit

Generally, the foreign investor may exit from an FIE through the ways of equity transfer, capital decrease of the FIE or the FIE's liquidation. So far as the SAFE procedures are concerned, the following developments are of mention:

  >   foreign currency's purchase and payment, prior SAFE approval is no longer required where the FIE needs to purchase foreign currency to pay its foreign shareholder in a capital decrease or liquidation transaction, or where domestic buyers need to pay the consideration in foreign capital to the foreign seller;

  >   shares sale in a Chinese ListCo, if below 5%, no prior MOFCOM approval is required, the clearing house's shareholding change certificate suffices for the handling of relevant SAFE procedures.

In any event, SAFE Circular 59 and Circular 21 adopt welcome moves, further streamlining foreign exchange controls over foreign investment in China. They will no doubt much facilitate foreign investment activities in China, especially in light of the detailed guidance as specified in the Forms attached thereto.

 

Mr. Alex Liu is a Beijing-based partner with Global Law Office who specializes in takeover and restructuring of listed companies, cross-border M&A, onshore and offshore IPOs, debts financing, PE/VC investment, FDI and overseas investment, antitrust and transaction tax. (E-mail: alliu@glo.com.cn)