New Rules Clarify Reinvestment by Foreign-Invested Holding Companies in China

New Rules Clarify Reinvestment by Foreign-Invested Holding Companies in China

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China's Ministry of Commerce ("MOFCOM") and State Administration of Foreign Exchange ("SAFE") jointly promulgated a notice on December 8, 2011 which clarifies the situation created by an earlier, initially unpublished SAFE notice with respect to reinvestment of income by foreign-invested holding companies in China.

The Earlier Notice

The earlier SAFE notice (huizihan [2011] No. 7, entitled Notice of SAFE's Capital Projects Management Section Concerning the Dissemination of Operational Guidance on Relevant Issues Involving the Checking of Funds and Inspection of Certificates for Reinvestment by Foreign-Invested Holding Companies, "Document No. 7"), issued March 29, required that all dividends, interest, liquidation proceeds and other income received by the holding company be treated as an increase to its registered capital before it can be reinvested in projects in China. For our analysis of that notice, please see our August 2, 2011 Alert entitled, "Foreign-Invested Holding Companies in China Newly Subject to Unpublished SAFE Notice."

The requirement to reinvest income as registered capital was seemingly inconsistent with central government policy to encourage the establishment of foreign-invested holding companies and hampered their efforts to invest in China. The requirement to increase registered capital above the existing level (US$30 million statutory minimum) before holding companies could reinvest proceeds in China was inconsistent with the Company Law and central government regulations governing the establishment and operation of foreign-invested holding companies. It also substantially hindered foreign investors' ability to repatriate profits earned by holding companies as foreign investors are restricted from reducing registered capital and because reserve funds are required to be allocated based on registered capital before profits can be repatriated.

Document No. 7 raised uncertainty and serious concern as to whether foreign-invested holding companies would be forced to make capital-inefficient reinvestments of their income, delaying or reducing their ability to declare and repatriate dividends to their shareholder(s). A number of foreign-invested holding companies put investment plans on ice after the issuance of Document No. 7.

The New Notice

The new notice, entitled the Notice on Further Perfecting Relevant Administrative Measures on Foreign-Invested Holding Companies (shangzihan [2011] No. 1078) ("Document No. 1078"), appears to resolve the issue and provide clear guidance.

Document No. 1078 provides that foreign-invested holding companies, subject to commerce authority approval and local SAFE bureau verification, may (a) directly reinvest dividends, recovered investments, liquidation proceeds, proceeds from share transfers, income derived from a reduction in investment and other legitimate RMB proceeds earned in China, or (b) use the same to increase the registered capital of holding companies before reinvestment. With respect to the flow of funds, the document clarifies that after receiving SAFE verification, the RMB proceeds may be wired directly to the entities to be invested or first wired to the holding companies and then wired to the entities to be invested.

Under this new document, holding companies are no longer required to first increase their registered capital before they can reinvest legitimate RMB proceeds earned in China. Rather, they can choose to reinvest such RMB proceeds in China directly after obtaining commerce authority approval and SAFE bureau verification.

Although Document No. 1078 does not expressly state that it replaces Document No. 7, we understand that this is nevertheless the case. Unlike Document No. 7, which was issued by SAFE alone, Document No. 1078 was jointly promulgated by MOFCOM and SAFE, which indicates that the two agencies have coordinated with each other on their respective responsibilities.

Document No. 1078 also specifies that the Foreign Investment Division of MOFCOM and the Capital Transactions Department of SAFE are the two departments directly responsible for any questions that may arise during the implementation of this document.

In addition to clarification on reinvestment, the document also provides that foreign-invested holding companies may not use the proceeds of domestic loans for reinvestment in China, which is consistent with existing policies on debt/equity ratios of such companies.

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