Hong Kong: PRC Projects Or Companies In Which Foreign Investors Contribute Or Hold Less Than 25% Of The Equity Given Official Recognition By MOFTEC

Summary

A Circular issued by the Ministry Of Foreign Trade And Economic Co-operation ("MOFTEC"), the State Administration of Taxation, the State Administration for Industry and Commerce ("SAIC") and the State Administration of Foreign Exchange ("SAFE") jointly on 30 December 2002 (the "Circular"), requires all PRC companies, in which foreign investors hold or have contributed less than 25% of the registered capital, to be examined, approved and registered in accordance with the relevant laws and regulations governing foreign-invested enterprises ("FIEs"). As from 1 January 2003 (which is the effective date of the Circular), the shareholders' agreement or joint venture contract and articles of association of every such PRC company will have to be submitted to the local branch of MOFTEC for approval. If approved, a certificate of approval will be issued stating that the company has foreign investment of less than 25%. The company should, based on MOFTEC's approval certificate, carry out registration with the local branch of SAIC and will be issued with a business licence stating that it is an enterprise which has less than 25% foreign investment.

A PRC company which has been approved and registered with less than 25% foreign investment will not, however, enjoy the tax concessions and preferential treatments of a FIE, and will not be granted exemptions from or reductions in customs duty when importing equipment, materials and commodities into China.

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1. Scope of Application

The Circular applies to all foreign investment projects, regardless of whether the investment of foreign investors is greater or less than, or equal to, 25% of the registered capital of a project. Prior to the issuance of the Circular, Chinese entities in which foreign investors hold less than 25% of the equity interest were not recognised as foreign investment projects, and MOFTEC had refused to acknowledge any foreign investment or participation in such entities. MOFTEC's previous official attitude was that foreign investors' investment in any PRC project or company, which does not reach 25%, was not made in compliance with the laws and regulations governing foreign investment (comprising principally of the PRC Law on Equity Joint Ventures and PRC Law on Co-operative Joint Ventures, and their Implementation Regulations). Hence, foreign investors run the risk that any investment of less than 25% in a Chinese entity would not be protected by PRC law, and there were also problems with remitting dividends paid on such investment, and proceeds derived from the sale of such investment, in foreign exchange out of China.

2. Registration with SAFE

A PRC company in which foreign investment does not reach 25% is now entitled to carry out foreign exchange registration with SAFE, against presentation to the local branch of SAFE of its certificate of approval and business licence showing that it has foreign investment (although below 25%).

The Circular further requires the government authority that grants approval for the acquisition by foreign investors of equity interest or shares in a PRC company, to send a copy of such approval to the local branch of SAFE in the place where the PRC company is located. SAFE will then monitor the remittance by foreign investors of the purchase price for the acquisition.

Hence, the Circular enables a PRC company which has received foreign investment, but which does not qualify as a FIE, to carry out foreign exchange registration with SAFE, and SAFE will have a record of foreign capital invested in that company. Foreign investors should now be able to receive dividends in foreign exchange, and should also be able to repatriate funds received upon liquidation of such company, or from the sale of its interest in such company, in foreign exchange out of China.

3. Time Limit for Payment of Purchase Price or Contribution of Registered Capital

If a foreign investor's investment in a PRC company is less than 25% of that company's registered capital, then the capital contribution must be made by the foreign investor within 3 months after the amended business licence of the PRC company is issued. If capital is to be contributed by the foreign investor in the form of non-cash assets or industrial property rights, then the contribution may be made within 6 months from the issuance of the amended business licence.

In the case of an acquisition by foreign investors of the equity interest or shares of a PRC enterprise (which will be converted to a FIE following such acquisition), the purchase price should be paid within 3 months from the date of issuance of the FIE's business licence. In special situations and subject to approval from the relevant government authorities, the time period for payment of the purchase price may be extended, with 60% of the purchase price payable within 6 months, and 40% payable within one year, after the issuance of the FIE's business licence. The Circular further provides that prior to the full payment of the purchase price, the foreign investor cannot obtain the management and decision making right of the FIE and is not entitled to consolidate the FIE's assets and liabilities in its own financial statements.

The branch of SAFE in the place where the transferor of equity interest or shares in the PRC company is located, will be in charge of monitoring the payment of the purchase price by the foreign investor, and will issue the foreign exchange registration certificate, which document will serve as evidence of payment of the purchase price by the foreign investor.

4. Natural Persons may become Investors in a Sino-Foreign Joint Venture

Under the PRC Equity Joint Venture Law, the PRC Co-operative Joint Venture Law and their Implementation Regulations, only PRC entities with legal person status may enter into a joint venture contract with foreign investors to establish a Chinese-foreign equity or co-operative joint venture company. The Circular provides one exception to this rule in the situation where a joint venture is formed as a result of foreign investors acquiring equity interest or shares in an existing Chinese enterprise. Paragraph 5 of the Circular states that where the shareholders of a Chinese enterprise are natural persons and they have been shareholders of such enterprise for more than one year, then these natural persons may, subject to obtaining the approval of the relevant government authorities, continue to be the Chinese investors of the FIE established as a result of the purchase of equity interest or shares by the foreign investors in such enterprise. The Circular reiterated the prohibition for natural persons to form joint ventures with foreign companies, economic organisations or individuals except in the above-mentioned situation.

5. Deadline for Examination, Approval and Registration of Chinese Enterprises with Foreign Investment

The Circular emphasizes the legal requirement for all PRC companies with foreign investment to undergo examination and approval by MOFTEC, and registration with SAIC, SAFE and other relevant government authorities, in accordance with the procedures laid down by the Circular. With regard to those Chinese enterprises which have already received foreign investment of less than 25% of their registered capital prior to the issuance of the Circular, the Circular sets a deadline of 6 months (i.e. 30 June 2003) for completing all procedures for examination, approval and registration. SAIC is empowered to punish any such Chinese enterprise which fails to complete the examination, approval and registration procedures before expiry of the deadline, by imposing a fine of between RMB10,000 and RMB100,000 on such enterprise in accordance with Article 63 of the Regulations of the People's Republic of China on Company Registration.

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