New SAFE Regulations on Foreign Direct Investment

In addition to the freely convertible foreign exchange, tangible assets, intangible property, and profits in renminbi that are already recognized as eligible as capital contributions, the Circular expands the forms of capital contributions. The Circular allows assets acquired by a foreign investor through advanced withdrawal of investment, liquidation, share transfer and reduction of capital of the FIEs invested, and for the purposes of increasing investment in an existing FIE, its share in the development funds, reserve funds or equivalent funds in that FIE, undistributed profits, payable dividends and the accrued interest, and the duly registered foreign loans borrowed by the FIE from the foreign investor.

The Circular sets forth the procedures for foreign exchange registration in connection with acquisition of shares by foreign investors in domestic enterprises, which will help SAFE to assure the authenticity and legality of foreign capital.

With regard to enterprises with foreign shareholding below 25%, the Circular, in response to a newly promulgated rule that identifies such enterprises as FIEs, specifies the foreign exchange administration rules for such enterprises, and therefore closes the loophole in this respect.

Verification of Capital and Foreign Exchange Registration of FIEs

The Circular unifies the criteria for SAFE to conduct verification of capital and foreign exchange registration for FIEs. The rationale behind these criteria is to verify the actual investment of the foreign investors.

Among others, the Circular provides the following guidelines: (i) where the foreign exchange capital funds paid by the foreign investors exceed the approved ceiling of the capital fund accounts of FIEs, SAFE may give confirmation for capital verification and make foreign exchange registration pursuant to the actual paid-in capital, provided that the exceeding amount shall not exceed 1% of the above ceiling and the amount of such excess shall not exceed US$10,000; (ii) for the purposes of confirmation for capital verification inquiry and foreign exchange registration, the value of the tangible assets shall be based on the value identified by the commercial inspection authorities, irrespective of the value as recorded in the bill of entry at customs; (iii) where the actual paid-in capital of an FIE exceeds the registered capital as a result of premium investment, the value of the tangible assets identified by the commercial inspection authorities exceeding the declared value at customs, or fluctuation of the exchange rate etc., both the registered capital and the actual paid-in capital shall be registered; and (iv) where the name of a foreign investor of an FIE is inconsistent with the name of the person who remits the investment funds from abroad, SAFE may give confirmation for capital verification inquiry and handle foreign exchange registration, but shall indicate the inconsistency in the confirmation letter.

Integrated Administration by SAFE and MOFTEC

In an attempt to further attract foreign capital, the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) issued the Investment Within China by Foreign Investment Enterprises Tentative Provisions and the Acquisition of Domestic Enterprises by Foreign Investors Tentative Provisions (see page 27) in September 2000 and March 2003, respectively. SAFE issued the Circular with an aim to strengthen and improve foreign exchange administration in tandem with macroeconomic policy that encourages FDI and the new changes in regulating FDI.

Vested with different powers, SAFE and MOFTEC (or the new Ministry of Commerce) still need to harmonize their respective roles in administration of FIEs. In the aforementioned 2000 Provisions, the nature of the reinvested enterprises is not explicitly stated; it is only provided that the reinvested enterprises under certain circumstances can be treated as FIEs. The Circular, however, avoids such ambiguity and provides that all such reinvested enterprises, for the purposes of borrowing foreign debts, shall be treated as FIEs. It is yet to be seen whether such a provision of the Circular matches MOFTEC's intentions.

We also note that the Circular requires that SAFE shall not approve any transfer of foreign exchange between the FIEs and the reinvested enterprises, or any transfer among the different reinvested enterprises, unless approved by SAFE as a special case. Such requirement could help SAFE to supervise foreign exchange and identify the foreign capital that has actually been absorbed.

By Charles Qin and Ice Xu,

Llinks Law Office

Shanghai