SAFE relaxes grip on forex controls

January 16, 2013 | BY

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Circulars from the State Administration of Foreign Exchange have reduced the approval burden on the capital account, a move that has boosted investor confidence by showing a renewed commitment to liberalising foreign exchange controls

Over the past few years, the State Administration of Foreign Exchange (SAFE) has been tightening administration on capital account transactions. In particular, the inflow of foreign exchange into China and exchange of registered capital of foreign invested enterprises (FIEs) from foreign exchange to renminbi. SAFE issued the famous Circular 142, or the Circular on Operational Issues Relevant to Improving the Control of the Payment and Conversion of Foreign Exchange in Connection with the Foreign Exchange Capital of Foreign-invested Enterprises (关于完善外商投资企业外汇资本金支付结汇管理有关业务操作问题的通知) in 2008. The most significant principle under Circular 142 is that foreign-invested enterprises are allowed to exchange their registered capital to renminbi only for business included in their business scope. SAFE issued further regulations in 2011 to elaborate detailed applications of this principle. On November 19 2012, SAFE issued another two new regulations both of which came into force on December 17 2012:

Circular 58 provides that the administration of the capital of foreign-invested partnership enterprises (FIPEs) will be similar to the administration of registered capital of FIEs. This means that an FIPE can exchange the capital contributed by its foreign partners only for business included in its business scope. This indicates that a private equity fund established in the form of an FIPE can exchange the capital contributed by foreign partners to renminbi for making equity investments in China, if equity investments are included in its business scope.

Circular 59 relaxes some restrictions and abolishes many governmental approval requirements, but it does not touch upon the foregoing principle under Circular 142. The relaxations under Circular 59, although substantial, are mostly related to procedural matters. Compared with previous regulations, under Circular 59, SAFE delegates its power to banks to administer exchange matters. The changes will shorten the time needed for foreign exchange funds to flow into China and facilitates multinational companies and financial investors investing in China.

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Circular 58

This is the first national-level foreign exchange regulation on FIPEs. Investors have been waiting almost two and half years for it, since the State Council promulgated the regulations on FIPEs, which came into effect on March 1 2010.

The foregoing principle applicable to FIEs under Circular 58 is also applicable to FIPEs. If its foreign partners contribute to an FIPE in foreign exchange, the FIPE should also open a special bank account which will be administered in the same way as the foreign exchange capital account of an FIE. FIPE's will now be subject to the same strict requirements for exchanging its foreign exchange capital to renminbi, as provided in a series of SAFE regulations, including Circular 142, and Circulars 88 and 45 from 2011. See figure 1 for a list of the primary restrictions on the exchange.

Figure 1: Restrictions on exchanging registered capital to renminbi:

  • An FIE/FIPE can exchange its registered capital to renminbi only for use in business included in its business scope;
  • An FIE/FIPE shall not exchange its registered capital to renminbi for use in equity investment, unless its business scope includes equity investment;
  • An FIE/FIPE shall not exchange its registered capital to renminbi for extending any entrusted loan, repayment of any loan owed to another enterprise, or repayment of any bank loan that is extended to a third party;
  • An FIE/FIPE shall not exchange its registered capital to renminbi for purchasing a real estate property that is not for its own use;
  • An FIE/FIPE shall not exchange its registered capital to renminbi for paying any kind of guarantee;
  • If an FIE/FIPE exchanges its registered capital to renminbi for paying the land use right grant fee of a piece of land, it shall provide its land use right grant contract and relevant non-tax invoice to its bank;
  • When exchanging its registered capital to renminbi, an FIE/FIPE shall provide the tax receipt showing the expenditure of the renminbi fund from the previous exchange of registered capital, as well as the document generated from the tax authority's online system confirming the authenticity of the tax receipt or a confirmation document issued by the tax authority, which shall be affixed with the FIE/FIPE's corporate seal or financial affairs seal;
  • If 95% of the foreign exchange registered capital of an FIE/FIPE has been exchanged or spent, including for use as petty cash, no further exchange or spending will be allowed until its bank has completed an authenticity review of all its tax receipts for the previous exchanges; and
  • An FIE/FIPE can exchange no more than $50,000 of its registered capital for use as petty cash in a single exchange, or no more than $100,000 accumulatively in a month.

The restrictions in figure 1 mean that an FIPE's foreign exchange registered capital can be used for its daily business operations, but not in equity investment (unless included in its business scope), provision of debt financing or acquisition of real estate properties that are not for its self-use. But if an FIPE's business scope does include equity investment, based on Circular 58, it should be allowed to exchange its registered capital to renminbi and use the exchanged funds to make equity investment. This is a great step nationwide and will facilitate financial investors investing in China.

Repatriation of dividends

This is a big issue that every foreign partner cares about. Notably, one of the documents that an FIPE shall submit is a resolution made by all the partners in a format as required under the PRC Partnership Enterprise Law (中华人民共和国合伙企业法) and in accordance with stipulations in the partnership agreement regarding the distribution of dividends to partners. Compared with an FIE, which is generally subject to the requirement that its dividend shall be distributed to shareholders in proportion to their shareholding, under the Partnership Enterprise Law, partners of an FIPE have the right to determine how to distribute dividends based upon their own agreement. This right is not mentioned in the previous FIPE regulations issued by the State Council and the State Administration for Industry and Commerce (SAIC), but finally confirmed in Circular 58.

Further investment by a foreign partner

If a foreign partner intends to make investment by using the dividend or funds generated from the liquidation of its FIPE or sale of its partnership interest, it has to make another registration with the SAFE local office of the FIPE's place of registration. SAFE's review of such investment by a foreign investor of an FIE has been abolished under Article 2 of Circular 59 and accounting firms can directly verify the capital contribution through SAFE's online system. Hopefully, foreign partners of FIPEs will be allowed to enjoy the same treatment in the future, which will save them the time waiting for SAFE's review.

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Circular 59

Circular 59 abolished governmental approval requirements for a number of matters. This will simplify the investment procedures related to foreign exchange, shorten the time needed for opening bank accounts and transfer of funds, under certain transactions. However, the principle of how foreign exchange capital can be exchanged into renminbi under Circular 142 remains untouched. In essence, the relaxations under Circular 59 remove certain repetitive procedural requirements and delegate power to verify documents and information to banks. This will not weaken SAFE's administration over the exchange of foreign exchange into renminbi. SAFE still carefully and firmly implements its policy to try to keep less foreign exchange from flowing into the total money supply in China.

Simplifying procedures

Certain provisions under Circular 59 abolish repetitive administration, but the substantive administration on exchange to renminbi remains unchanged. For example, SAFE unified various types of bank accounts of foreign investors into only one type, the pre-opening account and SAFE's approval is no longer required for opening such an account. Although in general it was not difficult for foreign investors to open bank accounts, this change will save foreign investors' time. Approvals by SAFE are still required for exchanging the foreign exchange funds in such an account into renminbi and for remitting the remaining foreign exchange back to the foreign investor. Without SAFE's approval, the foreign exchange funds in the pre-opening bank accounts can only be spent in the form of foreign exchange for direct investment in China, but cannot be exchanged to renminbi and spent for other purposes.

Another example is no approval by SAFE is required for a number of matters related to investment by a foreign invested holding company, including foreign exchange registration of the invested enterprise (unless a foreign investor also invests in such enterprise), transfer of foreign exchange funds into the invested enterprise, capital contribution by the holding company, and receiving dividends from the invested enterprises. This will really simplify the procedures and shorten time needed for holding companies' investment. However, it does not mean that the invested enterprises can use the foreign exchange capital contributed by a holding company without any restriction. The invested enterprise shall open a special bank account for receiving the foreign exchange capital contributed by its holding company shareholder and spend such capital subject to the same restrictions applicable to an FIE/FIPE's registered capital, pursuant to Circular 142 and other relevant regulations.

On asset realisation accounts of Chinese sellers in M&A transactions, no approval by SAFE is required for recording the funds into such accounts. However, pursuant to Circular 45 from 2011, Chinese sellers cannot exchange the foreign exchange funds in such account into renminbi until they have duly paid their taxes. It will be permissible for FIEs to open foreign exchange capital accounts and Chinese sellers to open asset realisation accounts in a place other than the place of registration of the FIE. This may save the FIE or Chinese sellers some time in transferring funds within China, but the exchange of capital to renminbi is still subject to the principle under Circular 142.

Other relaxations

No approval by SAFE is required for a foreign investor to increase its FIE's registered capital by using legitimate proceeds, such as the capital reserve, reserve surplus of the FIE, or to make further investment in China by using the dividend distributed by its FIE, transfer of equity of its FIE or decrease of registered capital of its FIE. This will save investors time.

No approval by SAFE is required for the exchange of renminbi to foreign exchange in order to make the following outbound payments: payment by FIEs to their foreign investors of funds from a decrease of the FIE's registered capital, liquidation of the FIE, or early recoupment of investment or; payment by Chinese parties to foreign parties for acquiring companies invested by such foreign parties. Before Circular 59, it was not difficult to obtain the approval from SAFE for these two matters, as long as the applicant could submit all the documents required by SAFE, but this will save investors time.

FIEs will be allowed to extend financing to their foreign investors, provided that the value of the financing shall not exceed the sum of the distributed but not yet remitted dividend and the undistributed dividend that the foreign investor is entitled to. This is a new change, and will surely be beneficial to multinational companies whose Chinese subsidiaries are operating well and can provide some funds to their foreign parent companies.

Compared with previous regulations, under Circular 59, SAFE delegates more power to banks to administer exchange matters. SAFE has been delegating power to banks over the past few years. With the establishment of a number of online systems linking SAFE, banks, enterprises and accounting firms, SAFE now feels comfortable delegating more power to the banks. SAFE will no longer directly administer millions of enterprises across China on foreign exchange matters listed under Circular 59, but will achieve the administration by supervising and monitoring banks. Therefore, how a specific foreign exchange matter covered under Circular 59 will be handled, may largely depend upon banks and their staff. It also comes down to their efficiency and understanding of SAFE's regulations and carefulness in reviewing documents. Although regulations promulgated by SAFE are generally implemented nationwide, now investors will more frequently deal with different branches of different banks, and it is likely that different banks or staff may have various interpretations on the same matter.

Lu Ning, Covington & Burling, Beijing

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