The Ministry of Commerce (MOFCOM) recently issued regulations on how to contribute equity in one Chinese company to the registered capital of another Chinese company in order to establish a foreign-invested enterprise (FIE) or change an FIE’s equity.
These regulations are based on the draft for comment issued on 4 May 2011, so their contents are not new. But their formal issuance creates greater certainty for foreign investors wanting to use equity in one Chinese company to invest in another.
They may also enable certain types of tax-free reorganisations involving share swaps under China’s enterprise income tax rules, although the scope for such reorganisations is still relatively narrow.
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What the regulations say
MOFCOM’s Provisional Regulations on Capital Contributions with Equity Involving Foreign-Invested Enterprises, effective 22 October 2012, provide that contributing one company’s equity to another company’s registered capital can be used to: establish a new FIE; convert a domestic entity into an FIE; or change an existing FIE’s equity.
The contributed equity must be:
- held with a clear title (unencumbered);
- “full equity rights” (not equity in companies with capital that is only partly contributed, or which did not undergo or pass the annual inspection);
- transferable (it may not be frozen or have restrictions on its transfer in the company’s articles, or require for its contribution approval not yet obtained);
- not from a real estate enterprise, foreign-invested investment-type company or venture capital investment company;
- (for equity in an FIE) in an FIE properly approved and complying with foreign investment regulations, including foreign investment industry policy.
A qualified China appraisal firm must evaluate the equity before the contribution, in addition to the usual capital verification after contribution. The parties can negotiate the equity’s value based on the appraisal, but the value cannot be higher than the appraised value. The invested enterprise’s registered capital must be at least 30% cash (as the Company Law requires), with equity and other non-cash contributions no more than 70%.
FIEs established (or changed) with equity contributions are approved at the provincial level, unless existing regulations require central-level approval.
Other regulations (e.g. for tax, state-owned assets, national security review, mergers and acquisitions, and investment-type companies) generally still apply, but contributed equity does not count towards an FIE’s total investment for purposes of the customs exemption for imported equipment.
The invested company’s initial approval certificate is marked “equity capital contribution not yet contributed”. The “equity enterprise” – the enterprise whose equity is contributed – then updates the contributed equity’s registered owner and other registrations. Finally, the invested enterprise applies for its permanent business licence, marked “equity capital contribution contributed”.
Where the invested company is a China-listed company, including where foreign investors participate in a private placement or transfer of equity by agreement, securities regulations also apply.
MOFCOM issues a “letter of approval in principle” for the transaction, which the equity enterprise then uses to register the change in its equity ownership. After the transaction, the listed company obtains an FIE business licence from MOFCOM and changes its registration with the administration for industry and commerce.
Actions to consider
Foreign investors can now consider using equity in existing China FIEs and their subsidiaries to establish or invest in other China companies, based on the greater regulatory certainty these regulations provide. There will, however, continue to be a degree of practical uncertainty, and possibly inconsistencies, between various local authorities as the authorities work out how to apply these new regulations.
Possible tax-free reorganisations may be of particular interest to some investors.
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Business Law Digest is compiled with the assistance of Baker & McKenzie. Readers should not act on this information without seeking professional legal advice. You can contact Baker & McKenzie by e-mail at: Zhang Danian (Shanghai) danian.zhang@bakermckenzie.com
