Recently, several actions have been taken by various central governmental agencies, including the Ministry of Commerce (MOFCOM), the State Administration of Foreign Exchange (SAFE) and the State Administration of Taxation (SAT), to ensure control over the investment or use of foreign capital in China’s real estate sector. The aim of these changes is to prevent an overheated real estate boom as a result of the increasing inflow of foreign capital from international speculators.

I. New Rules to Further Regulate Foreign Direct Investment in China’s Real Estate Sector

On May 23, 2007, MOFCOM and SAFE issued the Circular on Further Strengthening and Regulating the Examination, Approval and Supervision of Foreign Direct Investment in China’s Real Estate Sector (?????????????????????????????????? ?????, ???[2007]50 ?, “Circular No. 50”), intended to ensure control over the direct investment of foreign capital in China’s real estate sector.

Circular No. 50 requires that all local competent departments of commerce should strictly implement the Opinions on Regulating Market Access and Management of Foreign Investment in China’s Real Estate Market (???????????????????, ???[2006]171 ?, the “Rule No. 171”); the Opinions and the Notice of the General Office of the Ministry of Commerce on the Related Issues of Fulfilling the Opinions on Regulating Market Access and Management of Foreign Investment in China’s Real Estate Market (????????????«???????? ???????????»???????, ???[2006]192 ?, “Circular No. 192”); strengthen the examination, approval and supervision of Foreign Invested Real Estate Enterprises (“FIREE”); and strictly control the foreign investments in luxury real estate projects.1

Circular No. 50 reiterates the principle of “Commercial Presence” as set forth in Rule No. 171, requiring that foreign investors need to establish a FIREE before investing in real estate projects,2 and foreign investors investing in real estate who fail to obtain the Foreign-Invested Enterprise Approval Certificate and the Business License should not engage in real estate development or operations in China.3 At the same time, however, Circular No. 50 introduces the principle of “Obtaining Projects [Approval] Prior to Establishing a FIREE”. Prior to establishing a FIREE, investors are therefore required to obtain land use rights or the ownership of the real estate project, or the investor should have at least entered into an indicative land grant contract or indicative property purchase agreement with the land administrative department, developer of the land or the owner of the property.4 Obviously, the principle of “Obtaining Projects [Approval] Prior to Establishing a FIREE” is in contradiction with the principle of “Commercial Presence”. The contradiction might bring confusion for the foreign investors, who would be left with no clear guidance on whether they need to establish a FIREE before investing in real estate projects, or whether they can invest in real estate projects (obtain projects) before establishing a FIREE. Until now, no guidance on how to interpret and implement the two principles in contradiction has been issued by MOFCOM or SAFE and further official interpretations are highly expected. Without further clarifications from MOFCOM, we believe that entrance of commercial agreements by foreign investors with the right to develop or own real estate property should satisfy the minimum threshold for the establishment of FIREE.

Circular No. 50 also reiterates that

  •  Neither the Chinese nor the foreign investors of a FIREE may enter into any arrangement guaranteeing fixed return or disguised fixed return to any party by any means.5 
  • Foreign investors should also obtain approval from the local competent department of commerce if they wish to expand their business scope in order to be able to invest in new real estate projects.6 
  • Foreign investors would not be allowed to bypass the above regulations by investing in domestic real estate enterprises via acquisitions or changing the actual controller of domestic enterprises. A FIREE set up through willful evasions or misstatements should be subjected to legal liabilities of failing to report foreign exchange for its remittance of capital and proceeds thereof imposed by the foreign exchange administrative departments.7 
  • Upon approving any FIREE, local competent departments of commerce should promptly effect the filing of any such FIREE with MOFCOM. 8 For any FIREE failing to effect the filing with MOFCOM or failing to pass the comprehensive annual inspection for FIEs, the foreign exchange administrative departments and designated foreign exchange banks shall not handle the procedures for settlement and sale of foreign exchange under the capital account of such FIREE.9 MOFCOM would investigate approvals by local competent departments of commerce and deal with irregularities, and the foreign exchange administrative departments should not handle the foreign exchange registration of the said FIREE.10

II. New Rules to Cancel Certain Preferential Treatments of Land Use Tax

On June 11, 2007, SAT issued the Notice on Canceling Certain Administrative Examination and Approval Items for Local Taxes (??????????????????, ???[2007]629 ?, “Circular No. 629”), which came into force as of the date of its issuance.

Circular No. 629 cancels certain preferential treatments of land use tax as set forth in Article 4 and Article 6 of the Notice of the State Administration of Taxation on Printing and Distributing the Supplemental Provisions on Several Specific Issues Concerning Land Use Tax (???????? ??«??????????????????»???, ????[1989]140 ?, “Circular No. 140”).11 According to Article 4 of Circular No. 140, for certain infrastructure construction projects, in particular the large-scale infrastructure construction projects supported by relevant national industry policies, which need large areas of land and long-term construction but without operational revenues during the construction period, the exemption or reduction of land use tax may be granted by the taxation bureau at the provincial level based on the specific situations. According to Article 6 of Circular No. 140, for the real estate development enterprises that have difficulty in paying the land use tax prior to the sale of commercial real estates, the exemption or reduction of land use tax may be granted by the taxation bureau at the provincial level based on the specific situations.

On December 31, 2006, the State Council issued the Decision on the Revision of the Interim Regulations Governing Urban Land Use Tax (???????«??????????????? ???»???, ????483 ?, “Circular No. 483”), under which the land use tax would be three times the amount of that of the same tax before which is came into effect as of January 1, 2007, and foreign invested enterprises would also be required to pay land use tax. The cancellation of the above preferential treatments of land use tax is a further step to strictly implement the standards of the collection of land use tax, which would further impact the real estate sector. To a certain extent, the new rules would increase the cost of the use of land, and further regulate investments in China’s excessively speculative or overheated real estate market and promote the reasonable development and use of land.

Other administrative examination and approval items for local taxes cancelled by Circular No. 629 include the exemption or reduction of land use tax as a benefit for using land for port construction, electric power industry and coal industry.

III. Special Actions to Initiate Examination for Short-Term Foreign Debts

On June 26, 2007, SAFE announced that 19 domestic banks and 10 foreign-invested banks were penalized for three kinds of irregular activities.12

SAFE has strengthened the examination of abnormal and irregular foreign capital inflow and foreign exchange settlements since last year, intending to control the inflow of short-term hot money. According to Ms. Hu Xiaolian, Director General of SAFE, the examination revealed that there are several irregular activities deserving special attention, including the inflow of foreign hot money into real estate market through disguised trade or investment channels due to the failure of the banks in performing their duty to examine and verify the authenticity of foreign exchange business.

According to Ms. Hu Xiaolian, one of the major tasks of foreign exchange administration in the near future is to strengthen the supervision and administration of the inflow of short-term hot money, and the flow of cross-border capital, especially short-term capital. To fulfill the task, SAFE will initiate a special nationwide examination on the implementation of the control of the scale of short-term foreign debts and relevant foreign exchange regulations