Since the outbreak of the global financial crisis in 2008, an increasing number of foreign investment enterprises (FIEs) in China are downsizing their Chinese operations to deal with declining sales. In the U.S., downsizing generally means cutting unnecessary expenses, staff lay offs, reduced capital expenditures and wage freezes. These same measures implemented in China can pose real problems for FIEs.

Capital Reduction. Unlike domestic Chinese enterprises, FIEs must be capitalized consistently at the discretion of the local government approval authorities. As a result, foreign investors often must "trap" capital in China and FIEs must follow intricate rules for dividending or returning capital to investors. Due to the financial crisis, many foreign shareholders of FIEs are also finding it difficult to raise funds to meet capital contribution requirements. In both scenarios, foreign investors must apply for a capital reduction from the local Bureau of Commerce (BoC). Additionally, in case of a return of capital, the BoC requires FIEs to publish a notice in a newspaper declaring the company's intention of reducing capital and notify their creditors. Any FIE seeking to reduce or return capital currently invested in China should be aware of the administrative difficulties of this endeavor.

Lay-Offs. When the world economy began to decline in September 2008, numerous factories throughout China declared bankruptcy and began laying off workers. Currently, the Chinese government is struggling to preserve employee rights while keeping businesses alive to stimulate the economy. In some regions of China (i.e., Guangdong and Beijing), the local authorities have recognized the need to bolster FIE interests even though the 2008 Contract Labor Law strengthened employees rights on terminations and provided for mandatory severance pay for laid off workers. As a result, new labor regulations in those areas of China simplified required layoff procedures and relaxed government controls to make layoffs easier.

Notwithstanding these localized policy changes, layoffs remain a very sensitive social issue to the Chinese government and may not be easily approved. Any FIE interested in implementing layoff plans should be prepared to negotiate in advance with the local Chinese government officials to avoid any potential adverse impact.

Transfer Pricing Issues. The Chinese government has stringent foreign exchange control rules that are strictly enforced. Beginning in late 2008, the State Administration for Foreign Exchange (SAFE) and its local agencies began watching FIEs even more closely than before. Typical agreements (i.e., service, licensing, management or technical service agreements, etc.) put in place between a foreign parent company and its affiliated Chinese company are being scrutinized to ensure they comply with transfer pricing rules under Chinese tax law. An "unchecked" agreement risks rejection from the local SAFE or tax bureau that may result in freezing movement of funds from the FIEs foreign accounts to its Chinese currency accounts. To increase the chance of approval, FIEs and their foreign shareholders should consult with competent counsel to establish contractual fees that meet transfer pricing standards. Advanced planning can prevent interruption of crucial cash flow to and from China.