On October 22, 2012, the Interim Provisions of the Ministry of Commerce on Equity Contributions Involving Foreign-Invested Enterprises (Interim Provisions) came into force. The provisions were promulgated to clarify the regulations on equity contributions involving foreign-invested enterprises as provided in the Administrative Measures for the Registration of Capital Contributions Made with Equity(1). The Interim Provisions are aimed at facilitating and promoting foreign investment in China. This article offers further comments based on the author's understanding of some key provisions of the provisions.
I. Scope of Application
The Interim Provisions apply to equity contributions made by domestic and foreign investors ("equity investors") when incorporating or transforming a non-foreign-invested enterprise into a foreign-invested enterprise ("invested enterprise") by making capital contributions using the equity of enterprises located within the territory of China ("equity enterprises", including limited liability companies and joint stock limited companies). Equity contributions include the following circumstances:
l Setting up a new foreign-invested enterprise, including a wholly foreign-owned enterprise, Sino-foreign joint venture and Sino-foreign cooperative enterprise;
l Transforming a non-foreign-invested enterprise into a foreign-invested enterprise through capital increase; and
l Modifying the equity structure of a foreign-invested enterprise through capital increase, including alteration the equity structure and altering the percentage of shares without changing the equity structure.
II. Approval Authority
The "approval authorit[ies]", i.e. the agencies with authority to approve equity contributions under the Interim Provisions, are the Ministry of Commerce ("MOFCOM") and its provincial counterparts ("Provincial MOFCOM") where the invested enterprises are located.
III. Limitations on Equity Used for Capital Contribution
The Interim Provisions stipulate that the equity used for capital contribution shall be free from encumbrances, complete in rights and transferable under the law. If an equity enterprise is a foreign-invested enterprise, it shall be legally formed with necessary approvals and comply with the industry policies for foreign investment. However, equity under any of the following circumstances shall not be used for capital contribution:
- The registered capital of the equity enterprise has not been paid in full;
- The equity has been pledged;
- The equity has been frozen pursuant to law;
- The equity is not transferrable as agreed on in the bylaws (contract) of equity enterprise;
- The equity is that of a foreign-invested enterprise which fails to participate in, according to relevant provisions, or has failed to pass the joint annual inspection of foreign-invested enterprises in the previous year;
- The equity is that of a real estate enterprise, a foreign-invested investment company, or a foreign-invested venture capital (equity) investment enterprise;
- The equity transfer is subject to approval in accordance with laws, administrative regulations or decisions of the State Council but has not been approved;
- The equity is otherwise not transferrable as provided for by laws, administrative regulations or decisions of the State Council.
The Interim Provisions also stipulate that after an equity contribution, the invested enterprise, the equity enterprise, and the enterprises in which they directly or indirectly hold shares shall comply with relevant foreign investment industrial policies and provisions.If any of the above enterprises do not conform to relevant regulations, relevant assets or businesses shall be stripped off or an equity transfer shall be conducted before applying for the equity contribution. Investors shall not attempt to circumvent foreign investment administration requirements via equity contribution.
IV. Equity Appraisal
The Interim Provisions stipulate clearly that the equity used for capital contribution shall be subject to appraisal by a domestic appraisal institution established pursuant to law.Based on the equity appraisal, an equity investor may, together with the shareholders or other investors of the invested enterprise, determine the equity price and the amount of equity contribution through negotiation.The amount of equity contribution shall not exceed the appraised value of the equity.
In addition, the Interim Provisions further stipulate that the total amount of capital contribution made with equity and other non-monetary property by all shareholders of an invested enterprise shall not exceed 70% of the registered capital of the enterprise.
V. Approval/Filing Process
- Requirements for filing an application with the approval authority:
- Applicant: investor or the invested enterprise;
- Approval authority: Central or provincial MOFCOM where the invested enterprises are located.
- Application documents: aside from submitting an application for equity contribution, applicants must submit an agreement on equity contribution, a certificate of the equity contributor's legal holding of the equity, proof of the Business License of the equity enterprise or Certificate of Approval of a Foreign-invested Enterprise and certificates of passing the joint annual inspection (if it is a foreign-invested enterprises), an equity appraisal report issued by an appraisal institution, a legal opinion issued by a law firm on the Certificate of Approval, and an annual inspection and appraisal report.
- Decision-making by the approval authority
If the application for equity contribution is approved, the approval authority shall issue or reissue a Certificate of Approval (indicating "equity contribution not paid" in the remarks column). If the equity enterprise is a foreign-invested enterprise and is subject to approval by an approval authority different from that of the invested enterprise, the approval authority for the invested enterprise shall solicit opinions from the provincial approval authority of the place where the equity enterprise is located; the provincial approval authority of the place where the equity enterprise is located shall issue a reply within 20 working days after receiving a letter asking for opinions(if no reply is issued, it will be deemed to have consented).
- Modification of equity enterprises after approval
If the equity enterprise is not a foreign-invested enterprise, the equity enterprise shall, in accordance with the Interim Provisions on Investment in China by Foreign-Invested Enterprises(2) and other relevant provisions, undergo registration or approval formalities for modifying the equity holders.
If the equity enterprise is a foreign-invested enterprise, it must undergo relevant modification procedures as provided in Article 13 of the Interim Provisions(3) depending on whether there are still any foreign investors after the capital contribution is made into the invested enterprise.
In addition, the equity enterprise shall file modification registration formalities with local industry and commerce, tax, customs, foreign exchange administration and other relevant departments in accordance with relevant provisions of the state.
- Change of the invested enterprise after approval
After an equity enterprise completes the modification, the invested enterprise shall apply to the approval authority for reissuance of a Certificate of Approval (indicating "equity contribution paid" in the remarks column) on the basis of relevant modification documents.
The Interim Provisions stipulate that when foreign debt registration and import duty-free quotas are handled for an invested enterprise, assessment shall be conducted on the basis of the amount of total investment determined according to the registered capital of the invested enterprise by subtracting the amount of equity contribution. If the equity contribution and transfer involves state-owned property rights in enterprises or state-owned equity in listed companies, foreign-invested investment companies and security examination on mergers and acquisition shall adhere to relevant regulations on the administration of state-owned assets.
We note the following points in particular:
- The wide scope of equity investors: equity contributors can be either domestic enterprises or foreign investors who hold equity in domestic enterprises which can be used for capital contribution;
- Standards for equity used for capital contribution: Equity that does not have clear or defective property ownership, or equity that cannot be transferred cannot be used for capital contribution.
- Limitation on amount of capital contribution: The total amount of capital contribution shall not exceed the equity appraisal amount, and the total amount of non-monetary property of an invested enterprise shall not exceed 70% of the registered capital of the enterprise;
- Approval procedures involve two different approval authorities: If the equity enterprise is a foreign-invested enterprise and is subject to approval by an approval authority different from that for the invested enterprise, the approval authority for the invested enterprise shall refer to the opinions of the provincial approval authority where the equity enterprise is located before making a decision;
- The regulations stipulate for the first time that a lawyer shall issue a legal opinion on equity contribution: The participation of lawyers is legally required to guarantee the legitimate status and compliance of industrial policies in the equity contribution.
It is particularly significant that the Interim Provisions clearly stipulate the means for equity contribution. Firstly, equity contribution is an important contribution channel, in ways more flexible than the direct transfer of equity and dividends. It benefits the equity investors by allowing for additional investment choices, and it even allows for reinvestment through equity contribution to promote asset restructurings and mergers. Secondly, equity contribution can speed up the circulation of equity, lower the cost of transfer and promote investment in new areas and industrial sectors. Such contribution mechanisms can save time and lower costs for equity contributors.
It should be noted, however, that some provisions of the Interim Provisions still need to be clarified. For example, an equity contribution is not allowed under the Interim Provisions if the equity transfer is subject to approval as provided by the laws and regulations, administrative regulations or decisions of the State Council but has not been approved by relevant authorities. However, it is unclear what the above equity transfer refers to. In addition, the promulgation of these Interim Provisions might affect enterprises in other areas, such as the different taxation policies between equity contribution and other contribution channels. More importantly, since the Interim Provisions are newly promulgated, different local governments may follow different rules in practice based on their own understanding of the equity contribution involving foreign-invested enterprises. This is likely to generate inconsistency or disputes while enforcing the Interim Provisions. It is recommended that parties involved in equity contribution appoint legal counsel or external lawyers to consult with relevant approval authorities to get more detailed guidance to try to ensure successful contribution.