China: Significant Regulatory Changes For Foreign Invested Companies In China

Asia Update

 A common concern of foreign investors when considering forming a company in China is the requirement of paid-in capital. The newly effected laws and regulations, amongst other changes, make the concept of paid-in capital history.

This alert outlines recent significant regulatory changes for foreign invested enterprises ("FIEs") in China, which include Wholly Foreign-owned Enterprises ("WFOEs"), Equity Joint Ventures ("EJVs"), and Cooperative Joint Ventures ("EJVs").

Effective as of March 1, 2014, China's law making body and the State Council amended the People's Republic of China Company Law (the "Company Law"), the Implementing Rules for the Laws of the People's Republic of China on Wholly Foreign-owned Enterprises (the "Implementing Rules on WFOEs"), the Implementing Rules for the Laws of the People's Republic of China on Cooperative Sino-foreign Joint Ventures (the "Implementing Rules on CJVs") and the Implementing Rules for the Laws of the People's Republic of China on Equity Sino-foreign Joint Ventures (the "Implementing Rules on EJVs")  (collectively, the "Amendments").Following is a summary of the regulatory changes for FIE's resulting from the Amendments.

1. From "Paid-in Registered Capital" to "Subscribed Registered Capital"
   
   The change from"paid-in registered capital" to "subscribed registered capital" is one of the most significant changes in the Amendments. Before the Amendments, FIEs were required to pay-in a fixed amount of registered capital within two years, 15% of which was required to be paid-in within 90 days after the issuance of the business license. Failure to do so could make the FIE subject to a fine, or revocation of business license under several circumstances. Once the registered capital was paid-in, although it could be used for business operations, including paying employees and rents, it could not be remitted back to the shareholders unless the FIE went through a dissolution process. Even though a reduction in the amount of registered capital of an FIE was permitted under the former law, this was often unachievable in practice.  As a result, for some FIEs with large registered capital requirements, these funds basically just sat in Chinese bank accounts and were not utilized for business.
   
   The Amendmentsabolish thepaid-in registered capital requirement andallowshareholder(s) of an FIE to determine the amount of registered capital and the timing of the capital contributions, which may be necessary to carry out the company's business plan. It is important to note thatthe foregoing change does not apply to 27 kinds of companies, including companies limited by shares established by public offer, foreign-invested banks, financial asset management companies, financial leasing companies, labor dispatch enterprises, etc. (Please refer to Appendix 1 for the complete list.)
    
2. Removing the Minimum Registered Capital Requirements
   
   Before the Amendments, the Company Law, which mainly governs domestic companies, specified the minimum amount of registered capital of a company. Although there was no specified minimum amount of registered capital in the laws and regulations,and the Implementing Rules on WFOEs only stated that the registered capital of a WFOE should match the scale of its business operation, in practice the Chinese authorities used internal guidance to determinethe minimum amount of the registered capital for a particular type of FIE. For example, a simple consulting WFOE in Shanghai was required to have a registered capital no less than RMB100,000 (approximately US$16,000).
   
   The Amendments abolish the minimum registered capital requirement for domestic companies, and delete the requirement that "the registered capital of a WFOE matches the scale of its business operation." However, it is not clear if the internal guidance regarding the minimum amount of aforementioned registered capital is still applicable, and responses by government authorities have not been consistent. We understand that the Ministry of Commerce will issue a directive in this regard sometime in April 2014. We will keep a close eye on the developments in this area, which will be the subject of a follow-up notice.   
   
   It should be noted thatif other laws, administrative regulations, and decisions issuedbytheState Council require minimum registered capital, then such provisions shall still apply.(Please refer to Appendix II.)
    
3. Removing the Ratio Requirement between Cash Contribution and In-kind Contribution
   
   Before the Amendments, the Company Law required that shareholders' cash contributions for a company shall not be less than 30% of the registered capital, and the Implementing Rules on WFOEs provided that the capitalized value of industrial property rights or proprietary technology invested by foreign investors shall not exceed 20% of a WFOE's registered capital. With the effectiveness of the Amendments, these provisions were abolished, meaning that the ratio requirement on cash and in-kind contribution is no longer required, and foreign investors may have industrial technology, equipment, or other types of in-kind capital constitute their entire capital contribution to the FIE. That said, there are still some restrictions regarding in-kind contributions, which are: 1) investors are required to prove the value of in-kind contributions to an FIE by providing a verified valuation report issued by a public accountant registered in China; 2) any machines, equipment, or other materials to be contributed to an FIE shall be necessary to the production of the FIE; and 3) relevant ownership certificates of in-kind contributions shall be provided.
    
4. Simplifying the Annual Inspection Procedure
   
   Before the Amendments, the annual inspection that FIEs were required to go through each year was complicated and time consuming as the procedure involved many Chinese authorities (such as Commerce Bureaus, tax bureaus, statistic bureau, and quality supervision bureau), and required an individual representative from the company to go to the AIC where the company is registered in order to submit various required documents in person.  
   
   An online reporting system was established with the Amendments to replace the annual inspection procedure. Between January 1to June 30 of each year, all companies and other entities, including FIEs, are required to file their annual reports for the preceding year, which should include contributions of shareholders, equity transfer information, business operation information, and change of management officers (the specific contents of which to be specified by the State Council), to the AIC where the company is registered through an online "Enterprise Credit Information System."
   
   In addition, from March 1, 2014, a new version of business license is available to new companies or existing companies applying for changes in their registration.  Companies with old versions of business licenses have the discretion to apply for the new version.  However, the old version of business license can not be in use after February 28, 2015.
    
5. Unchanged Matters
   
   Although there are significant regulatory changes in the Amendments, certain related matters that require foreign investors' attention have not been changed:

• A public accountant registered in China is still required to issue an FIE's capital verification report: (1) when a division or merger of a WFOE, or significant transfer of capital of a WFOE,  occurs; and (2) after the investment or terms of cooperation have been contributed by the parties to a CJV or EJV.
• The increase or reduction of the registered capital of FIEs is still subject to the approval of Commerce Bureaus and registration with the AIC.
• The requirement on the statutory gap between the total amount of investment and registered capital remains same. FIEs are only allowed to borrow an amount of overseas loans within the statutory gap.

BLANK ROME COMMENT

The Amendments grant foreign investors more flexibility and greater efficiency when investing and operating in China. However, as the Amendments were only recently issued, the implementation of the Amendments requires the coordination among various Chinese government authorities, which may lead to inconsistencies. Before further clarification is issued, it is advisable for FIEs to consult with legal counsel and local authorities prior to engaging in any activities for any company related to the Amendments. 

APPENDIX I       27 INDUSTRIES REMAIN SUBJECT TO PAID-IN REGISTERED CAPITAL

APPENDIX II         Examples of FIEs Remaining Subject to Minimum Registered Capital
 (Not Exhaustive)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.