On December 2, 2009, China’s State Council issued the Administrative Measures on the Establishment of Partnership Enterprises in China by Foreign Enterprises or Individuals (the “FIP Measures”). With effect from March 1, 2010 foreign companies and individuals will be permitted amongst themselves or in partnership with domestic individuals or entities to directly establish foreign invested partnerships (“FIPs”) in China. The FIP Measures are a significant development in China’s foreign investment regime in that they offer an alternative and important legal structure that previously was only available to domestic individuals and entities.

However an important caveat to this development in China’s foreign investment regime and one that is not uncommon in the legislative process in China, is the fact that the FIP Measures in their current form represent only a framework set of rules for foreign investment in partnerships. In fact as is evident from the discussion that follows, the current FIP Measure heavily reference, and need to be applied in conjunction with, other existing laws and regulations.

Requirements and Approvals

The FIP Measures do not impose any specific qualification requirements on the foreign partner, other than having to satisfy the general conditions stipulated in the Partnership Enterprise Law of China (“Partnership Law’), which apply to both foreign and domestic partners. In addition, the FIP Measures subject FIPs to the same industry restrictions as other types of foreign-invested enterprises (“FIEs”). For example, if a certain industry is categorized under the Foreign Investment Catalogue as “prohibited” for foreign investment, foreign investors cannot circumvent such prohibition by investing through an FIP.

Traditionally, all forms of foreign investment in China are subject to review and approval by the Ministry of Commerce and its local counterparts (“MOFCOM”), and only upon approval by MOFCOM will an FIE be established and registered with the State Administration of Industry and Commerce and its local branches (“SAIC”) for the issuance of a business license. A surprising and significant departure from this approval process under the FIP Measures is that the establishment of an FIP does not require MOFCOM approval. Rather, the applicant can simply register the establishment of the FIP directly with SAIC, which shall following registration simply notify MOFCOM at the same level of such registration of the FIP. However, should the FIP’s business scope involve business activities that require approval by specific government authorities, then the FIP must still first obtain the relevant approval before it can register with SAIC.

Capital Contribution

The FIP Measures generally require the foreign investor to make partner contributions in freely convertible foreign currencies or Renminbi that are lawfully obtained. It is not clear from the language of the FIP Measures whether non-cash contribution— i.e., goods, land-use rights, intellectual property rights or other property rights permissible for domestic partnership under the Partnership Law are also recognized as valid capital contributions for FIPs.

Interestingly, the FIP Measures do not specify minimum requirements for contribution of partnership capital or any contribution timeline, as is the case under the corresponding rules for other FIEs. In the absence of express further requirements, presumably the Partnership Law would apply whereby the partners may agree on capital contribution related matters in the partnership agreement.

Tax Treatment

Although the FIP Measures are silent on the taxation of a FIPs, they do state that taxation, as well as other operational matters pertaining to a FIPs, such as foreign exchange and customs, will be subject to other “relevant laws and regulations.” In the absence of specific tax rules that apply to FIPs, one would assume that the tax authorities would apply the domestic partnership tax rules to FIPs, including, for example, applying flow-through tax treatment, meaning that income tax would only be calculated at the partner level.

However the expectation is that the tax authorities will shortly issue separate circulars in order to specifically address the tax treatment of FIPs.

Implications on Foreign Private Equity Investment

The FIP Measures are of particular interest to foreign PE and VC funds which usually have a preference to be organized in the form of a limited partnership. In the past, as the Partnership Law has not permitted foreign investors to establish partnership enterprises in China, the lack of an appropriate structure for investing onshore funds in China (the so-called “RMB funds”) has been a significant hurdle for foreign PE/VC funds looking to tap the potential of the domestic market.

The FIP Measures do generally allow a foreign investor to act as a general partner or limited partner of a limited partnership in China. However, the FIP Measures provide that for foreign-invested partnership enterprises that list investment as their principal business, there must also be compliance with relevant national regulations pertaining to foreign-invested partnership enterprises. This would suggest compliance with the Administrative Measures on Foreign-Invested Venture Capital Enterprises dated March 1, 2003 ( “FIVCE Measures”). What remains to be seen is the extent to which the FIVCE Measures, which as a general rule are onerous and less attractive to foreign fund managers, would override the FIP Measures. For example, as mentioned above, there is no minimum capital requirement under the FIP Measures, whereas the FIVCE Measures require a minimum of US$10 million in registered capital. More importantly, the FIP Measures only require registration with the SAIC, whereas the establishment of FIPs will have to go through the arduous MOFCOM approval if the FIVCE Measures were to apply.

Conclusion

There is little doubt that the release of the FIP Measures represents an important legislative development in China’s foreign investment regime. However, the FIP Measures, comprising only 16 brief articles, do not contain sufficient practical guidance on the formation and operation of FIPs, nor do they adequately address other key areas, including tax, foreign exchange, accounting and customs. It therefore currently remains somewhat unclear as to how the FIP Measures will be interpreted and implemented by the government authorities at various levels and departments.