On 20 May, the State Administration of Foreign Exchange (SAFE) issued the Foreign Exchange Control on Domestic Residents Who Carry out Financing and Round-trip Investment Through Offshore Special Purpose Companies Operational Procedures (Hui Fa [2011] No. 19) which became effective as of 1 July.
Evolution of the controls
- In 2005, the State Administration of Foreign Exchange published the Issues Regarding Foreign Exchange Control on Domestic Residents Who Carry out Financing and Round-trip Investment Through Offshore Special Purpose Companies Notice (Hui Fa [2005] No. 75);
- in 2007, the General Affairs Department of the State Administration of Foreign Exchange published the internal document Distribution of the “Issues Regarding Foreign Exchange Control on Domestic Residents Who Carry out Financing and Round-trip Investment Through Offshore Special Purpose Companies Notice” Operational Procedures Notice (Hui Zong Fa [2007] No. 106); and
- in 2009, the General Affairs Department of State Administration of Foreign Exchange published the Foreign Exchange Control on Capital Accounts Business Operational Procedures (2009) Edition (Hui Zong Fa [2009] No. 77).
Documents 106, 77 and 19 are all operational procedures for document 75. Document 106 was superseded by document 77 and repealed from the date of publication of document 77, while document 77 remains in force even after the promulgation of document 19. In the event of any inconsistencies between document 19 and document 77, document 19 will prevail.
Forex registration requirements
Document 19 calls for the foreign exchange registration of three major categories of company, namely overseas special purpose vehicles (SPVs) owned by individual PRC residents, and foreign investment and offshore direct investment by PRC institutions. The following describes the major changes in the types of documents that must be submitted for review, the principles of the review and the scope of authority under the first category referred to in document 19 as compared with document 77.
Individual PRC residents
Pursuant to document 19, an individual resident of the PRC who applies for the establishment of or acquires control of an offshore SPV refers to any individual who holds an identity card, passport or other legal personal identification document of a resident of the PRC, and also to the following three categories of individuals who have no lawful status in China but habitually reside in China for economic reasons (whether or not such people hold lawful PRC personal identification documents):
- Natural persons who habitually reside in China but have left temporarily due to overseas travel, education, medical treatment, work, overseas residency requirements or other reasons, and will return to their permanent residence after the above reasons no longer apply;
- Natural persons who hold the Chinese-invested equity interests in domestic enterprises; and
- Natural persons who hold Chinese-invested equity interests in domestic enterprises and remain the ultimate owners even though such equity interests are changed to foreign-invested equity interests.
Initial foreign exchange registration
Additional documents must now be submitted for review, including documents proving the identity of new shareholders (or de facto controllers), resolutions of a domestic enterprise approving offshore financing (in case the domestic enterprise is not yet established, a written explanation should be provided by an owner of the Chinese-invested equity interests approving such offshore financing) and documents substantiating that any individual PRC resident holds, directly or indirectly, the assets of or equity interests in a domestic enterprise that proposes to carry out overseas financing.
The following review principles are stipulated:
- Document 19 clarifies that the documents mentioned above will be reviewed by a local foreign exchange bureau in the place where the assets or equity interests of a domestic enterprise are located, rather than a local foreign exchange bureau in the place where the domestic individual resident is situated or where an enterprise which is to be established to carry out round-trip investment is located; and
- If an entity other than an SPV has invested directly into the PRC and this is identified as “round-trip investment by an entity other than an SPV”, PRC residents are allowed to change the non-SPV entity to an SPV.
The initial registration of an SPV is to be approved by a bureau or an administrative department. Delegating approval authority to a lower level is prohibited.
Changes to foreign exchange registration
With respect to the materials for review, a new requirement is introduced requiring the giving of notice after financing funds are credited into an account. Moreover, a registration form giving details of SPV financing must be completed in relation to any change of registration due to financing.
The following review principles are stipulated:
- If there is a change in the financing arrangements made by an SPV, the SPV should complete the formalities for change of registration within 30 working days of first crediting the financing funds into an account. If such formalities are not completed for offshore financing funds, these funds are not allowed to be repatriated to China for use;
- If an SPV directly sets up or indirectly controls a company abroad, it should complete a change of registration within 30 working days of the date of establishing or controlling the company. Unregistered overseas companies are not allowed to act as a legal entity to carry out follow-up financing or round-trip investment;
- Except for the three scenarios of (1) offshore financing, (2) direct establishment or indirect control of offshore companies by SPVs and (3) receipt of income by individual PRC residents from capital changes, that require the separate re-registration of foreign exchange, any other changes in foreign exchange may be processed together during the annual inspection of foreign-invested enterprises.
Any change in the registration for an SPV is to be approved by a bureau or an administrative department. Delegating approval authority to a lower level is prohibited.
New domestic enterprises and M&A
The following new documents are required for review: a competent commercial authority’s approval documents and approval certificate for the formation (or establishment through merger or acquisition) of a foreign-invested enterprise. (If both parties to the M&A project are connected parties or the foreign investor acquires the domestic company with foreign equity, it should present the approval documents or approval certificate issued by the Ministry of Commerce.) In the case of establishment of a new foreign-invested real estate company or establishment of such a company by means of merger or acquisition, it is also necessary to submit proof documents and the undertakings already filed with the Ministry of Commerce.
The review principles reaffirm that if an SPV has completed registration, the foreign exchange bureau in the place where its round-trip investment enterprise is located may handle foreign exchange registration procedures for the enterprise and identify it as “round-trip investment by SPV”; if round-trip investment is carried out by means of a merger or acquisition, the approval documents from the Ministry of Commerce should be examined. Moreover:
- If a foreign investor increases the registered capital during the merger or acquisition of a domestic enterprise, it is not required to provide the business licence of the company after the change;
- If a merged or acquired domestic enterprise obtains an endorsed approval certificate and business licence, and during registration is unable to provide a registration form for offshore investment in foreign exchange by a resident domestic individual, it may not be required to do so. However, the wording “valid for 14 months from the date of issuance” should be endorsed on the system; and
- If a foreign investor merges or acquires a domestic company with foreign equity, the foreign exchange bureau should endorse on the system the wording “valid for eight months from the date of issuance”. Before this endorsed wording is removed, the domestic company is not permitted to distribute profits to shareholders, provide guarantees for associates or pay for capital account items for any foreign parties. Within six months from date of issuance of an endorsed business licence by the department of commerce and industry, if any overseas or domestic company fails to complete its formalities for a change in equity interest, the foreign exchange registration of a foreign–invested enterprise will expire automatically.
Approval authority can be delegated to a branch under the jurisdiction of a bureau (a foreign exchange administrative department).
Replacement registration
Document 19 has initiated a replacement registration regime for SPVs belonging to individual PRC residents, which primarily covers the following:
- SPVs: the replacement registration under document 19 applies to SPVs which, before the date of application, have been directly or indirectly controlled by domestic individual residents and have undergone substantial changes in capital or shareholding (such as offshore financing, changes in shareholding, and round-trip investment).
- “Penalty first followed by replacement registration”: SAFE focuses on investigating irregularities such as: (1) whether there has been a substantial change in the capital or shareholding of an offshore SPV prior to registration; (2) whether a round-trip investment enterprise has made false undertakings during foreign exchange registration; and (3) after 1 November 2005, whether domestic enterprises controlled directly or indirectly by SPVs have made payments to foreign parties in relation to profits, liquidation, share transfer, capital reduction, advance recovery of investment, principal and interest on shareholder loans and other payments. If, following investigation, they are found to have committed irregularities, they will first be transferred to the foreign exchange inspection department for penalty, and then go through replacement registration for SPVs.
- Non-SPVs: if a domestic individual resident has made a direct investment in China through an offshore company which is not an SPV as referred to in document 75, that offshore company will be deemed a non-SPV. The individual PRC resident is not required to handle registration as an SPV for that offshore company.
Replacement registration for an SPV is to be approved by a bureau or an administrative department at the approval level. Delegating approval authority to a lower level is prohibited.
Other major provisions
In addition to the above, document 19 sets out detailed operational procedures for the following matters:
- Other foreign exchange registration matters concerning SPVs belonging to individual PRC residents (including approval of the crediting of income derived by individual PRC residents from change in the capital of SPVs, and foreign exchange deregistration of SPVs belonging to individual PRC residents);
- Foreign exchange registration of foreign-invested enterprises (including foreign exchange registration of newly formed foreign-invested enterprises, foreign exchange registration of foreign-invested enterprises by foreign investors after such foreign investors acquire domestic enterprises and change or cancellation of foreign exchange registration of foreign-invested enterprises). It should be noted that if a foreign investor is directly or indirectly owned or controlled by a domestic resident, it is not to be regarded as an SPV. The foreign exchange bureau will, during foreign exchange registration, conduct a compliance review of the following: (1) if the foreign investor is directly or indirectly controlled by a domestic institution, the foreign exchange bureau should verify whether the domestic institution has completed foreign exchange registration formalities for overseas investment in accordance with regulations; (2) if the foreign investor is directly or indirectly controlled by a domestic individual resident, the foreign exchange bureau should examine whether irregularities in violation of the foreign exchange regulations are involved, such as evasion of state control of foreign exchange, illegal purchase of foreign exchange and unauthorized change in the use of foreign exchange, while these overseas equity interests are being created; and
- Foreign exchange registration of domestic institutions that carry out direct offshore investment (including initial foreign exchange registration, change of registration, foreign exchange filing and deregistration as well as approval of capital reduction, share transfer or crediting of liquidation funds in respect of the overseas-invested enterprises of domestic institutions).
Business Law Digest is compiled with the assistance of Haiwen & Partners. The authors can be emailed at baochen@haiwen-law.com. Readers should not act on this information without seeking professional legal advice.
