4 March 2013
China’s foreign exchange regulator, the State Administration of Foreign Exchange (“SAFE”), recently issued the Circular on Further Improving and Adjusting Foreign Exchange Administration Policies on Direct Investment (国家外汇管理局关于进一步改 进和调整直接投资外汇管理政策的通知, Hui Fa [2012] No. 59, “Circular 59“). Circular 59, which became effective on 17 December 2012, relaxes controls on cross-border foreign exchange flows in connection with foreign direct investments into China (“FDI“), as well as facilitating Chinese outbound investment.
To put this development into context, Circular 59 can be seen as a major overhaul of China’s foreign exchange regime, which was established in the 1990s when China was hungry for foreign capital and had very low foreign exchange reserves. Fast forward through 20 years of rapid economic development, and China has now become the holder of the largest foreign exchange reserves in the world. China is also making determined efforts to ‘internationalize’ its currency, the Renminbi (See our client note ‘New Channel Opened for Flowing-back of Overseas Renminbi’.). It was perhaps felt time for China, having handed our power to a new generation of leaders, to move away from the strict controls that were more suited to an earlier era and to focus more on facilitating inbound and outbound commerce and investment in a difficult international economic environment.
Traditionally, China has divided cross-border payments into two categories, one for ‘current account’ items which refer to trade and other recurring transactions, and the other for ‘capital account’ items which basically cover equity investments and loans/debts. Under the existing regime, China imposes strict restrictions on capital account transactions, which are subject to SAFE approval both for the opening of the account, as well as for fund movements within such an account. Current account items are liberalised and hence SAFE’s pre-approval is generally not required; payment can normally be processed directly by a designated foreign exchange bank (Most of the large Chinese and international commercial banks in China are designated as foreign exchange banks.) subject to performing checks to confirm that there is a genuine and lawful underlying transaction.
Circular 59 reflects SAFE’s intention to gradually relax restrictions on capital account transactions, and more broadly the trend towards the type of lighter touch regulation applicable to current account transactions. For instance, Circular 59 abolishes the original requirement for SAFE approval under certain circumstances, streamlines the processes by reducing documentary requirements and shortening timelines, and eases restrictions on the use of capital for direct investment purposes. As will become clear from the analysis below, SAFE will primarily require the relevant transaction information to be registered with it rather than approval of the transaction, and commercial banks will play an increasingly important role in the process. It will be the banks, not SAFE that will review specific documents to ensure that the proposed flow of foreign exchange is necessary and justified. In addition, they will file details on the cases they handle in the uniform database system (the “SAFE System”), so that SAFE can oversee and use such information for statistical purposes. All in all, Circular 59 marks yet another important step on the road towards the long-term goal of liberalisation of conversion out of, or into, the RMB on the capital account, including for FDI and outbound investment transactions.
This article discusses certain changes brought about to China’s foreign exchange control regime by Circular 59, and analyses in detail how they may facilitate both inbound investment to China and outbound investment from China.
I. Summary of Key Changes
Foreign Exchange Administration Matter |
Before Circular 59 | After Circular 59 |
Opening of Pre-investment Expense Account, Foreign Capital Account, Asset Realization Account, and Security Account |
SAFE approval required, which may take up to 20 working days |
No approval required; can open account directly at bank |
Payment into Asset Realization Account and Outbound Lending Special Account |
SAFE approval required, which may take up to 20 working days |
No approval required; bank can deposit funds directly based on information in SAFE system |
Opening of Foreign Exchange Capital Account and Asset Realization Account outside the residence of the FIE in question |
Restricted | Restriction removed |
Number of Foreign Exchange Capital Accounts for each FIE |
Restricted | Restriction removed |
Purchase and remittance of foreign exchange as a result of capital reduction, liquidation or early repatriation of investment in an FIE |
SAFE approval required, which may take up to 20 working days |
No approval required; bank can directly process based on information in SAFE system |
Purchase and remittance of foreign exchange as a result of transfer of equity in FIE to a Chinese domestic entity or individual |
SAFE approval required, which may take up to 20 working days |
No approval required; bank can directly process based on information in SAFE system |
Purchase and remittance of upfront expenses for Chinese outbound investment |
SAFE approval required | No approval required; bank can directly process based on information in SAFE system |
Remittance of funds from Outbound Lending Special Account |
SAFE approval required | No approval required; bank can directly process based on information in SAFE system |
Remittance of funds from Outbound Lending Special Account |
SAFE approval required | No approval required; bank can directly process based on information in SAFE system |
Conversion of registered foreign debt into equity; re-investment of capital reserve fund, undistributed dividend, etc. |
SAFE approval required | No approval required; bank can directly process based on information in SAFE system |
Re-investment of lawful incomes derived in China, such as profit, proceeds of equity transfer, capital reduction, liquidation and early repatriation of investment |
SAFE approval required | No approval required; bank can directly process based on information in SAFE system |
Payment of capital contribution by a foreign Investment Company (as defined below) in China; payment of dividend to such Investment Company |
SAFE approval required | No approval required; bank can directly process based on information in SAFE system |
SAFE registration of investee company of a foreign Investment Company (as defined below) in China |
SAFE registration required | Not required unless there is another offshore investor in the investee company |
Extension of loan from FIE to its offshore shareholders |
Not permitted | Permitted with restriction on amount |
II. Asset Realization Accounts (资产变现账户 “ARAs“)
Circular 59 provides for two types of ARAs: one for realization of onshore assets (境内资产变现账户 “Onshore Asset ARAs“) and the other for realization of offshore assets (境外资产变现账户”Offshore Asset ARAs”). The opening of, changes to,cancellation of, or the remittance of foreign exchange funds into, an ARA no longer requires SAFE’s pre-approval. Previously each of these items was subject to such pre-approval. For domestic sellers (whether a company or an individual) selling onshore or offshore assets to foreign investors, this means that a bank designated by SAFE to handle foreign exchange matters (a “Bank“) can, based on the relevant information or form recorded in the SAFE System (Namely, Equity Transfer Information Registration Form in the case of an Onshore Asset ARA, or the foreign exchange registration form of a PRC resident company or the Foreign Exchange Registration Form relating to Overseas Investments by a PRC Individual Resident (境内居民个人境外投资外汇登记表) in the case of an Offshore Asset ARA.) , directly open, change or cancel an ARA, and accept remittances of foreign exchange funds into such account (subject to the inflow quota recorded in the SAFE System in the case of an Offshore Asset ARA).
For any given transaction for the transfer of onshore equity interests, a domestic seller can only open one ARA. SAFE no longer requires this ARA to be opened in the seller’s locality. When the foreign investor remits the consideration from an offshore account into such ARA, the seller’s Bank should, on the strength of the Equity Transfer Information Registration Form recorded in the SAFE System, accept the remittance and report the arrival of the remittance to the
The funds held in an ARA can be used to make payments under current account transactions (subject to the Bank checking to confirm that the underlying transaction is lawful and genuine) as well as capital account transactions approved by, or registered with,
In addition, Circular 59 also allows transfer of the funds in an ARA to the following types of accounts (without conversion into RMB) based on actual needs and premised on a genuine and lawful underlying transaction: special guarantee accounts for receiving remittances within China (境内划入保证金专用账户), domestic reinvestment special purpose accounts (境内再投资专 用账户), entrusted loan accounts (委托贷款账户), cash pooling accounts (资金集中管理专户), outbound lending special purpose accounts (境外放款专用账户), and principal-protected money management special accounts (保本型银行理财专户).
Compared with the previous rules regarding
Circular 59 also makes it easier for individual Chinese sellers to convert foreign exchange funds in an ARA. Prior to the promulgation of the SAFE Circular on Issues relevant to Further Clarification and Standardization of the Administration of Certain Foreign Exchange Matters regarding Capital Accounts (国家外汇管理局关于进一步明确和规范部分资本项目外汇业务管 理有关问题的通知, Hui Fa [2011] No. 45, “Circular 45“) on 9 November 2011, conversion of foreign exchange (whether owned by a domestic individual or a domestic capital company) was subject to the same rules as are applicable to conversion of foreign exchange in capital accounts of FIEs. The previous rules did not differentiate between company account owners and individual account owners, which made the conversion of funds in an ARA (ARSFEA refers to Asset Realization Special Foreign Exchange Account (资产变现专用外汇账户), which was used under previous rules. This is basically the same as ARA.) owned by an individual equally difficult.
Following Circular 142 of 2008, an individual seller would also be required to submit documentary proof confirming use of proceeds (e.g., a purchase contract) and justify each disbursement by official tax receipts issued by the goods or services vendor (Fapiao) in connection with its application to convert foreign exchange into RMB. As a result, if an individual seller did not have a specific plan on how to spend the converted RMB, he would not be allowed to convert his sales proceeds into RMB. Under Circular 45 and as confirmed by Circular 59, as long as the individual owner of an ARA has obtained the required foreign exchange registration form and a tax clearance certificate for the equity transfer, he or she may apply to the Bank for conversion of foreign exchange received in the ARA without having a specific plan on how to spend the RMB funds derived from the conversion. Under Circular 59, upon the Capital Contribution Confirmation and obtaining of the tax clearance certificate by the individual owner of an ARA, such owner may apply to the Bank for conversion of foreign exchange in the ARA without submitting any Fapiao. In other words, Circular 59 and related rules make it easier for individual sellers to convert sales proceeds and keep RMB as long as they have paid the requisite taxes.
III. Foreign Exchange Accounts for Upfront Expenses (“Expense Accounts”)
Foreign investors are allowed to open an Expense Account (前期费用外汇账户) in China to cover upfront costs before they set up an FIE. According to Circular 59, an Expense Account is used to deposit a foreign investor’s money to fund all types of upfront expenses in relation to direct investment activities in China. Under Circular 59, as long as a foreign investor files a Foreign Direct Investment Foreign Exchange Registration Form (外商直接投资外汇登记业务申请表) with
Compared with the previous rules, Circular 59 also relaxes
Furthermore, for any FDI project, Circular 59 has generally increased the inflow quota of upfront expenses from USD 100,000 (or 5% of the contemplated total investment amount) to USD 300,000, and allows local SAFE to further increase the quota on a case-by-case basis. In line with prior practice, upfront expense funds which have been remitted in and spent can be capitalized when the FIE is established. However, foreign investors were always concerned about the requirement for SAFE’s pre-approval each time conversion or transfer of funds in upfront expenses accounts was needed. Many foreign investors wanted to capitalise their upfront expenses, but abandoned the idea due to the time-consuming SAFE approval procedures. Now, Circular 59 grants more authority to Banks to carry out conversion and transfer of funds into Expense Accounts more efficiently on the one hand, and substantially streamlines the SAFE procedures on the other hand. It can be anticipated that foreign investors will now find it much easier to capitalize upfront expenses than before.
IV. Re-investment in China
Overall, regulation on re-investment of proceeds from existing FDI projects is significantly relaxed under Circular 59.
1. Re-investment by Foreign Investor
(i) Registration of re-investment with
The FIE registers the relevant information about the proposed re-investment by the foreign investor (which has been approved by the Ministry of Commerce or its local authorised organ with
(ii) Opening of Domestic Re-Investment Special Account
The FIE proceeds to open a Domestic Re-Investment Special Account (境内再投资专用账户) with the Bank, and the Bank opens such account (only one such account can be opened) based on the information previously registered with
(iii) Transfer of re-investment amount
The Bank transfers (划转) the re-investment amount (which has been pre-registered with
(iv) Verification of re-investment
The accounting firm in China engaged by the foreign investor verifies the above re-investment by the foreign investor after checking with
This new procedure under Circular 59 is much more straightforward as compared to the original
First, registration is a procedural rather than a substantive process. For the registration,
Second, the registration typically only involves submission of an application form. This contrasts to the relatively burdensome documentation requirements for approval. If approval were to be required, the FIE would have had to have submitted a considerable amount of documentation, such as an application letter, a board resolution of the FIE, the foreign investor’s written confirmation of its intention to re-invest, the FIE’s most recent annual audit report and capital verification report, and the tax clearance for the foreign investor for the purposes of making the re-investment.
More importantly, timing wise, registration generally only takes up to five business days for
2. Re-investment by FIE Investment-type Companies
Another highlight of Circular 59 is the change in the rules for foreign invested holding companies (外商投资性公司), foreign invested venture capital investment enterprises (外商投资创业投资企业), foreign-invested equity investment enterprises (外商投 资股权投资企业), and other foreign invested companie whose main business is investment (together referred to as “Investment Companies” below). Circular 59 significantly facilitates capital flows between an Investment Company and its portfolio companies by abandoning the requirement for
For example, a portfolio company wholly owned by an Investment Company no longer needs to register with
In addition, certain capital flows between the Investment Company and the portfolio company no longer require
Moreover, the accounting firm engaged by the Investment Company does not need to make enquiries with
The de-regulation with respect to Investment Companies is welcome because it will make re-investment by Investment Companies in China less burdensome than before. It also means these types of companies will become more attractive as investment vehicles to foreign investors. resumably the rationale behind such relaxation is that the capital inflows to an Investment Company have already been monitored in the first place when the foreign currency capital was originally remitted in from overseas to the Investment Company, so the Investment Company’s subsequent use of money to invest into portfolio companies and receipt of returns from portfolio companies should not be subject to repeated scrutiny.
V. Outbound Investment
1. Upfront Expenses for Outbound Investment
Circular 59 also simplifies the procedures for outbound investments by Chinese companies. Under Circular 59,
First of all, registration with
Furthermore, the documentation burden is substantially reduced. More specifically, in order to receive
Furthermore, the lead time for payment has been significantly reduced. The
2. Loans Extended by Domestic Entities to Their Affiliated Offshore Borrowers (“Outbound Loans”)
Circular 59 eases
Circular 59 also repeals the requirement for
In terms of the qualification for granting Outbound Loans, Circular 59 adopts the basic principles set forth in the Circular on Issues regarding the Administration of Foreign Exchange in Cross-Border Loans Granted by Domestic Enterprises (关于境内企 业境外放款外汇管理有关问题的通知, Hui Fa [2009] No. 24, “Circular 24”) issued by
In terms of the quota on Outbound Loans extended by an onshore lender to its offshore subsidiary, Circular 59 also follows Circular 24. Namely, the quota should not exceed (i) 30% of the equity interests held by the lender in the borrower or (ii) the registered outbound investment amount that the lender commits to contribute to the borrower. Circular 59 allows local
Compared with Circular 24, Circular 59 substantially streamlines the
VI. Round-Tripping Investments
Circular 59 and the
(i) Circular 59 no longer requires a separate “approval for the crediting of revenue generated through equity changes earned by a PRC individual resident from a special purpose vehicle (“SPV“)” (境内居民个人从特殊目的公司获得的 资本变动收入入账核准) set forth in Circular 19. Rather, the PRC individual resident only needs to complete the foreign exchange amendment registration relating to the SPV established by him/her before the revenue can be remitted back to China. Once the foreign exchange amendment registration is done, the SAFE System will record the quota on revenue which can be remitted back to China, and the said individual can then apply to the Bank for opening an Offshore Asset ARA and crediting of such revenue within the approved quota;
(ii) Circular 59 differentiates between “round-tripping investments made by a non-SPV of an institution” (机构非特殊目 的公司返程投资) and “round-tripping investments made by a non-SPV of an individual” (个人非特殊目的公司返程 投资), while Circular 19 generally uses “round-tripping investments by a non-SPV” without distinction (非特殊目的 公司返程投资);
(iii) Circular 59 no longer requires separate foreign exchange registration relating to the establishment of PRC enterprises or mergers and acquisitions involving PRC enterprises by SPVs. Rather, this type of registration is now partially absorbed by the foreign exchange registration system for newly-established FIEs and partially absorbed by the foreign exchange registration of FIEs through mergers and acquisitions of domestic enterprises by foreign investors. Such separate registration was required for SPVs under the Acquistions of Domestic Enterprises by Foreign Investors Provisions (关于外国投资者并购境内企业的规定), as amended on 22 June 2013 (“M&A Rules“) and the Notice on Relevant Issues concerning Foreign Exchange. Administration of Corporate Financing Through Offshore SPVs and Round-tripping Investments of Chinese Residents (关于境内居民通过境外 特殊目的公司融资及返程投资外汇管理有关问题的通知), issued by SAFE on 21 October 2005 (“Circular 75“); and
(iv) Circular 59 reiterates the requirement for
Like Circular 19, Circular 59 and the
Circular 59 marks another important milestone on the long road towards relaxing capital flows into and from China. It abolishes quite a few