Revising the Foreign-invested Holding Company Regulations

Qualifications and Application 

The minimum US$30 million registered capital requirement for the establishment of a holding company remains in place under the November 17 Revision.² In earlier regulations, including the February 13 Revision, a foreign company also needed to have either: (1) minimum total assets of US$400 million in the year preceding the application, at least one existing foreign-invested enterprise (FIE) in China with minimum registered capital of US$10 million, and at least three proposed investment projects; or (2) at least ten FIEs in China with aggregate minimum registered capital of US$30 million, but the November 17 Revision abolished the minimum proposed investment project requirement under (1).³  This added flexibility permits foreign companies with sufficient capital but without major immediate investment plans in China to establish a holding company before making specific investment commitments.  This enables them to demonstrate their commitment to the China market while allowing them time to explore the investment environment at the outset.  However, holding companies must have utilized at least US$30 million in actual new (post-establishment) investments, whether to new or existing FIEs, in order to engage in activities permissible only to fully invested holding companies.  Holding companies that are not yet fully invested may only engage in a narrower scope of business activities, whereas holding companies that qualify as regional headquarters (see the discussion on regional headquarters below) may engage in an even broader scope of business activities.  The table on page 49 sets forth the various categories of business activities open to holding companies that qualify as regional headquarters, fully invested holding companies, and all holding companies in general. 

Other changes relate to document submission requirements.  Most holding companies are held by a single foreign investor, but can also be established as Chinese-foreign joint ventures.  An application to establish a joint venture holding company need no longer include a feasibility study report, but instead requires only an application report, and the requirement to submit project proposals has been eliminated for both joint venture and wholly foreign-owned holding companies.⁴

Clarification of Distribution Rights

The February 13 Revision provided additional privileges for holding companies that qualify as regional hubs or headquarters, most notably the right to import products from the parent company for distribution in the domestic market.⁵  However, it was not made clear at the time whether a holding company would acquire distribution rights simply by qualifying as a regional headquarters, or if the holding company would require additional approvals to engage in distribution activities pursuant to relevant regulations.  The November 17 Revision provides some clarification by stipulating that holding companies that engage in commission agency, wholesale, retail and franchising activities must comply with the relevant provisions of the Administration of Foreign Investment in the Commercial Sector Procedures (the Commercial Sector Procedures)⁶ and amend their scope of business accordingly.⁷  This is emphasized in each reference to import rights of holding companies in the November 17 Revision, which specifically state that such rights do not include the right to conduct retail activities.⁸  To engage in distribution activities, a holding company can either apply to establish a new foreign-invested distribution enterprise,⁹ invest in an existing domestic distribution enterprise with the requisite distribution permit, or expand its business scope to include specific distribution activities.¹⁰  However, the text does not make clear whether this right to engage in domestic distribution of the parent company¡¦s products that is granted to qualified holding companies or the longstanding right of holding companies (subject to unanimous approval by the board of directors of the relevant investee) to sell products manufactured by its investee enterprises onshore or offshore¹¹ are automatically extended to a holding company once it fulfils the requisite requirements, or whether a holding company must apply for approval under the Commercial Sector Procedures.  Based on confidential inquiries with MOFCOM officials, we understand that MOFCOM is electing to interpret the Holding Company Regulations in the strictest sense even after the November 17 Revision.  That is to say, MOFCOM intends to require new or existing holding companies whose scope of business does not presently permit them to conduct commission agency, wholesale, retail and franchising activities to apply for approval with respect to such commercial activities in accordance with the Commercial Sector Procedures.  However, this liberalization of distribution rights for holding companies as well as FIEs remains moot until MOFCOM promulgates overdue implementing regulations.

Expansion of Permitted Activities 

The November 17 Revision permits holding companies to provide after-sale services not only for products manufactured by their parent company but for all imported products, and to import (but not sell through retail channels) products from their parent company into the domestic market.¹²  The November 17 Revision also stipulates that holding companies that engage in the import or export of goods or technologies must comply with MOFCOM¡¦s Registration for the Record of Foreign Trade Operators.¹³ If the import activities described in this paragraph exceed the original scope of business of the holding company, it will have to file a registration for the record (a ministerial process less demanding than an application for approval) with the relevant registration authority.¹⁴ 

Regional Headquarters

The February 13 Revision, which first addressed the issue of granting additional privileges to holding companies that qualified as multinational company regional headquarters, set forth requirements to qualify as such headquarters under the Holding Company Regulations.  A holding company had to: (a) fulfil all requirements with respect to utilization of registered capital applicable to holding companies; (b) establish at least two R&D organizations (one of which must be a legal person) in accordance with relevant regulations; and (c) have (i) minimum paid-in registered capital of US$100 million or (ii) minimum paid-in registered capital of US$50 million, investments in companies with a total asset value of not less than Rmb3 billion, and have earned total profits of not less than Rmb100 million (based on consolidated financial statements) as of the year prior to the application date.  The requirement with respect to the establishment of R&D organizations has now been relaxed.  The November 17 Revision provides that only one R&D organization is required, and it need not be a legal person.¹⁵ 

The November 17 Revision also expands the privileges enjoyed by holding companies that qualify as regional headquarters.  They can now import and sell in the domestic market products not only of their respective foreign parents, but also products of affiliates in which the foreign parent has a controlling interest.  Regional headquarters are now also permitted to entrust other onshore enterprises to manufacture/process their products or products of their parent company for sale in domestic and foreign markets.¹⁶

The February 13 Revision first introduced the concept of encouraging holding companies that met specific requirements to apply for recognition as regional headquarters by permitting such hybrid entities to expand their scope of business to include additional import, service and finance functions.  These provisions remain unchanged in the November 17 Revision.  Not long after the February 13 Revision was promulgated, we were given to understand from discussions with MOFCOM officials that holding companies that also qualified as regional headquarters under less stringent local rules could also be eligible for the privileges provided to such hybrid entities under these regulations.  As of this date, there are no plans to require such holding companies to fulfil the stipulated requirements retroactively in order to retain their status as regional headquarters, so it is likely that they will be grandfathered.  Although we were given to understand that the existing local rules governing establishment of regional headquarters would be revised to conform to the national-level requirements as first provided in the February 13 Revision, in mid-February 2005, we received verbal confirmation from the Shanghai Commission on Foreign Economic Relations and Trade (Shanghai COFERT) that the Shanghai Municipality, Encouraging Foreign Multinational Companies to Establish Regional Headquarters Tentative Provisions and their Implementing Rules (promulgated respectively on July 20 2002 and March 1 2003, collectively, the Shanghai Rules) were still in effect, and Shanghai COFERT was still accepting applications to convert to regional headquarters under the Shanghai Rules.¹⁷  It appears that many companies have elected to take advantage of this transitional gap in the regulations to qualify as regional headquarters under the less rigorous Shanghai Rules.  Some 30 new regional headquarters were approved in Shanghai in 2004, bringing the total number of regional headquarters in Shanghai to 86 by the end of the year.

On the other hand, based on discussions with Beijing Commerce Bureau officials, we understand that holding companies in Beijing seeking to qualify as regional headquarters can no longer look to the earlier local requirements, but must now comply with the more rigorous national-level requirements first set forth in the February 13 Revision and which were left intact in the November 17 Revision.  However, notwithstanding the more stringent requirements, Beijing approved seven new regional headquarters in 2004.

Conclusion

The holding company structure has proven to be an effective vehicle for multinational companies to hold their China investments under a single umbrella entity to permit consolidation with respect to corporate governance, strategic planning and administrative functions.  The recent regulatory reforms analyzed above further streamline the application procedure and provide greater flexibility with respect to establishment and broaden the scope of permitted activities for holding companies. 

Unfortunately, the requirement for unanimous approval by the boards of directors of joint venture FIEs in order for the holding company to provide them with sales, logistics and warehousing services¹⁸ remains, and the structure does not provide the much-needed right to file consolidated tax returns that is commonplace in other jurisdictions.  However, a holding company is a pass-through entity with respect to the taxation of dividends, and dividends payable to foreign investors are tax-exempt.  Moreover, enterprise income injected back into existing FIEs to increase registered capital or paid out as dividends that are reinvested to establish new FIEs for a minimum of five years would be eligible for tax rebates.¹⁹     

A holding company provides several advantages.  It is permitted to conduct a broader scope of activities than a manufacturing or service FIE – although this gap is narrowing as China grants broad trading rights to all entities and opens distribution to foreign investors.  A holding company is also an excellent vehicle for conducting government relations.  Furthermore, there are potential efficiencies from centralizing the provision of administrative resources and other functions (e.g., R&D, sourcing and marketing) to investees, thus allowing investees to focus on operations.  

With China¡¦s WTO entry, it is now regarded as an important target market and source of revenues as opposed to a mere export manufacturing base.  Aside from the official incentives in the form of additional benefits to holding companies that qualify as regional headquarters, it may make sense from a corporate strategy perspective to place a company¡¦s regional senior management where its key market in that region is located, as opposed to a more distant location.  The February 13 and November 17 Revisions demonstrate the Chinese government¡¦s desire to encourage multinational companies to elect China as their home base in Asia, rather than more traditional locations like Hong Kong or Singapore.  Recognizing China¡¦s rapid growth as a major economic power and its enormous market potential, many multinational companies have decided to move their regional headquarters to China.  This trend is expected to continue as China plays an increasingly important role in the global economy. 

Endnotes

1    Establishment of Companies of an Investment Nature by Foreign Investors Tentative Provisions (issued by the former Ministry of Foreign Trade and Economic Cooperation on April 4 1995, the Original Regulations).

2    The November 17 Revision, Article 3(3).

3    Ibid, Article 3(1).

4    Ibid, Article 7.

5    Ibid, Article 22 (originally Article 21 of the February 13 Revision). 

6    Issued by MOFCOM on April 16 2004 with effect from July 1 2004.

7    The November 17 Revision, Article 11. 

8    Ibid, Articles 15 and 22. 

9    The Commercial Sector Procedures, Article 12. 

10  Ibid, Articles 23 and 24. 

11  The November 17 Revision, Article 10.

12  Ibid, Article 15.

13  Ibid, Article 11.

14  MOFCOM, Registration for the Record of Foreign Trade Operators (issued June 25 2004 and effective July 1 2004), Article 14.

15 The November 17 Revision, Article 22(1). 

16 Ibid, Article 22(2).

17  Under the Shanghai Rules, the requirements to become a regional headquarters are: independent legal person status, total assets (of the parent company) of not less than US$400 million, China investments (of the parent company) of not less than US$30 million, and at least three subordinate entities (onshore or offshore) under its supervision. For a holding company to qualify as a regional headquarters in Shanghai, the following must be submitted to Shanghai COFERT: (i) an application form signed by the holding company¡¦s legal representative; (ii) a  document signed by the legal representative of the holding company¡¦s parent company authorizing the holding company to perform all the basic functions of a regional headquarters; (iii) an approval certificate, business licence and capital verification report of the holding company (photocopies); and (iv) approval certificates and business licenses of all PRC entities invested in by the holding company or its parent company (photocopies).

      Shanghai COFERT is to complete its review and make its decision within 30 working days after receipt of complete application materials, and then issue the qualification certificate and make a report to MOFCOM for the record. 

18  The November 17 Revision, Article 15(1).

19  The specific percentages vary depending on the nature of the entity receiving such investment, 100% tax rebates are available for investments in qualified product export or advanced hi-tech FIEs and 40% for investments in other FIEs.