FIE Status and the 25% Rule

According to the 25% rule, MOFTEC will not grant a FIE approval certificate to an enterprise in which the foreign investment accounts for less than 25% of the registered capital. Without the approval certificate, regardless of whether the enterprise has foreign investment, it will not have the status of a FIE under the FIE Laws. According to the SAIC, only if MOFTEC approves an enterprise in which the capital contributions made by foreign investor(s) are less than 25% of the registered capital may it be registered by the SAIC as a domestic-invested enterprise. Theoretically, MOFTEC, as the department governing foreign investment, has the authority to require all foreign investors to obey the 25% rule. Therefore, it remains uncertain whether an enterprise with foreign investment but without the approval certificate can be registered with the SAIC.

Taxation Policies

If a foreign investment enterprise does not satisfy the 25% requirement and thus isn't eligible for FIE status, it cannot enjoy the special tax holidays and incentives to which FIEs are entitled. The 25% rule also applies to FIEs investments within China. But according to the State Administration of Taxation, taxation treatment for domestic-invested and foreign investment enterprises will be unified at some point after China's entry into the WTO. It seems that FIE status will not be so important when a unified tax policy is adopted.

Foreign Exchange Control

According to the State Administration of Foreign Exchange (SAFE), even after China's accession to the WTO the current foreign exchange control policy will remain in force to protect China from a severe economic contraction like the Asian financial crisis of a few years ago. As such, it appears that no fundamental change will be made to the laws and regulations controlling remittance of foreign exchange profits to FIEs' foreign investors outside China. According to the relevant laws and regulations on foreign exchange control, without the approval certificate and the corresponding FIE status, an enterprise will have difficulty opening a foreign exchange account to remit profits overseas. However, in practice, many entities remit profits abroad to foreign investors as, for example, "service fees" under a "service agreement", or "payments" under a "sales contract", thus circumventing the above restrictions.

FICLS & IPO

On January 10 1995, MOFTEC promulgated Certain Questions on the Establishment of Foreign-funded Companies Limited by Shares Tentative Provisions (Tentative Provisions), pursuant to which a FIE may be restructured into a foreign-invested company limited by shares (FICLS). The FICLS has been an alternative for foreign investment and has afforded more flexibility when compared with FIEs. According to the Tentative Provisions, the 25% minimum foreign investment rule also applies to FICLS. Only a company limited by shares, in which the foreign investor(s) hold(s) not less than 25% of the shareholdings, can gain the FICLS status and is qualified for the preferential treatment that has been granted to the FIEs.

In accordance with the Questions Relevant to Foreign-funded Companies Limited by Shares Circular, promulgated by the General Office of MOFTEC on May 17 2001, a FICLS may apply for IPO and have its shares listed, provided that the percentage of the non-listed shares held by foreign shareholders after the listing still account for not less than 25% of the total shares of the FICLS. In light of this requirement and the unavoidable dilution of the shareholding of the original foreign shareholders due to the new allotments in a listing, the percentage of total share capital held by foreign shareholders has to be designed to exceed 25% during the restructuring process for the purposes of later listing. Perhaps because MOFTEC admits that the IPO of a FIE is an issue governed not only by foreign investment authorities but also by securities authorities, MOFTEC has changed the requirements. The Foreign Investment Issues Relating to Listed Companies Several Opinions (the Opinions), jointly issued by MOFTEC and the China Securities Regulatory Commission (CSRC) in November 2001, require that the percentage of the non-listed shares held by foreign shareholders in a FICLS after listing make up not less than 10% of total share capital though this isn't clearly stated. But to enjoy the preferential treatment for a listed FICLS, the foreign capital proportion of total share capital must still be at least 25% or the FIE approval certificate will be revoked.

Conclusion

For a FIE or a FICLS, the 25% rule only means there is still the opportunity to enjoy preferential treatment, but it does not mean that foreign investor(s) absolutely cannot hold less than a 25% stake in any circumstances. Perhaps this rule will lose its importance when China further liberalizes foreign investment down the road after WTO accession.

By Christophe Han and Sidney Qin

Llinks Law Office, Shanghai