Removal of Restrictions on the Use or Conversion of Registered Capital Denominated in Foreign Exchange of Foreign-Invested Enterprises in China for Purposes of Domestic Equity Investment

Originally in the PRC, foreign-invested enterprises (“General FIEs”), which are not foreign-invested holding companies, foreign-invested venture capital enterprises or foreign-invested equity investment enterprises, were not allowed to use or convert their registered capital denominated in foreign exchange (“Foreign Exchange Capital”) for making domestic equity investment in the PRC (“Equity Investment”). They could only use their profits or their cash flow to invest in or acquire subsidiaries.

Such restrictions on General FIEs to use or convert Foreign Exchange Capital for purposes of Equity Investment have been gradually relaxed, especially by the respective circulars published by the State Administration of Foreign Exchange (“SAFE”) in 2015 and 2016, i.e. the Circular of the State Administration of Foreign Exchange on Reforming the Management Approach regarding the Settlement of Foreign Exchange Capital of Foreign-invested Enterprises (Hui Fa [2015] No.19) and the Circular of the State Administration of Foreign Exchange on Reforming and Regulating Policies on the Control over Foreign Exchange Settlement of Capital Accounts (Hui Fa [2016] No.16) (collectively, the “Circulars”).

According to the Circulars, General FIES are permitted to use or convert Foreign Exchange Capital to make Equity Investment.

However, in practice and in our experience, local PRC foreign exchange authorities/banks would normally check whether the business scope of General FIEs contained such wording as “investment” or “equity investment”, if General FIEs were not registered in specific pilot free trade zones (“Pilot Zones”) in the PRC. In other words, subject to a few approval exceptions on a case-by-case basis, notwithstanding that restrictions on General FIEs to use or convert Foreign Exchange Capital for purposes of Equity Investment have been relaxed according to the Circulars, in practice though, if General FIEs were not registered in the Pilot Zones, local PRC foreign exchange authorities/banks normally would not grant approvals should the business scope of General FIEs not contain such wording as “investment” or “equity investment”.

On 23 October 2019, the SAFE published the Circular of the State Administration of Foreign Exchange on Further Promoting the Facilitation of Cross-border Trade and Investment (Hui Fa [2019] No. 28) (“Circular No. 28”). It took effect on the same day.

On 23 October 2019, the SAFE also published the Circular of the State Administration of Foreign Exchange on Streamlining Foreign Exchange Accounts (Hui Fa [2019] No. 29) (“Circular No. 29”), which will take effect on 1 February 2020.

Below is an overview on the key items of both Circular No. 28 and Circular No. 29.

1. Removal of Restrictions on General FIEs for purposes of Equity Investment

According to Article 2 of Circular No. 28, restrictions on General FIEs to use or convert Foreign Exchange Capital for purposes of Equity Investment are removed.

From our phone consultations with the SAFE, for use or conversion of Foreign Exchange Capital by General FIEs for Equity Investment, there are two material improvements under Circular No. 28 compared to the Circulars, General FIEs in any place in the PRC (regardless whether they are registered in the Pilot Zones) and General FIEs of any business type (regardless whether the business scope contains such wording as “investment” or “equity investment”) are now free to use or convert their Foreign Exchange Capital in order to make Equity Investment. In other words, local PRC foreign exchange authorities/banks in practice will no longer request General FIEs to include such wording as “investment” or “equity investment” in the business scope before granting the approvals to use their Foreign Exchange Capital for Equity Investment.

a) According to Circular No. 28, there are below major requirements for General FIEs to use or convert Foreign Exchange Capital for Equity Investment.

(1) General FIEs shall meet the legal requirements as provided for in the applicable Special Administrative Measures for Access of Foreign Investment (Negative List), which may be amended from time to time; and

(2)The projects to be invested by General FIEs should be true, authentic and compliant with the relevant PRC law.

b) For General FIEs to use or convert Foreign Exchange Capital for Equity Investment, there are basically two payment procedures.

(1) Use of Foreign Exchange Capital in original Currency

If General FIEs transfer Foreign Exchange Capital in original currency for making payments (“Funds”) to a PRC company (“Target”) for Equity Investment, the Target should first handle registration procedures for domestic re-investment at the local banks where its legal address is registered. Then the Target should open a capital account in order to receive the Funds to be paid by General FIEs.

(2)Settlement of Foreign Exchange Capital into Renminbi

If General FIEs settle Foreign Exchange Capital into Renminbi for paying Funds to the Target for the Equity Investment, the Target should first handle registration procedures in relation to domestic re-investment at the local banks where its legal address is registered. Then the Target should open a “Capital Account - Account Pending for Foreign Exchange Settlement Payment” in order to receive the Funds to be paid by General FIEs.

2.Restrictions on the Scope of Use of Foreign Exchange Capital

According to Circular No. 28, restrictions on General FIEs to use or convert Foreign Exchange Capital for purposes of Equity Investment are removed. According to Circular No. 29, however, restrictions on the scope of the use of Foreign Exchange Capital as provided for in the Circulars still remain unchanged.

a) As to the foreign exchange income under the capital account and the Renminbi funds settled therefrom of General FIEs, they may be used for purposes of:

(1)Expenditures under its current account within its business scope; or

(2)Expenditures under its capital account to the extent permitted by the PRC law.

b)Further, use of foreign exchange income under the capital account and the Renminbi funds settled therefrom of General FIEs shall also be subject to the following requirements:

(1)It shall not, directly or indirectly, be used for expenditures beyond the General FIEs’ business scope or expenditures prohibited by the PRC law;

(2)Unless otherwise provided for under PRC law, it shall not, directly or indirectly, be used for investments in securities or other investments and financial products (excluding banks' principal-secured products);

(3)It shall not be used for the granting of loans to General FIEs’ non-affiliated enterprises, except where this is expressly permitted in the business scope; and

(4)It shall not be used for the construction or purchase of real estates for purposes other than self-use (except for real estate enterprises).

Therefore, according to Circular No. 28 and Circular No. 29, regarding the use or conversion of Foreign Exchange Capital of General FIEs, only the restrictions in respect of Equity Investment are removed. Other restrictions on the scope of use of Foreign Exchange Capital remain the same.

3. Conclusion

In the past, use of Foreign Exchange Capital by General FIEs was still subject to restrictions, since local PRC foreign exchange authorities/banks in practice required to add the term “investment” or “equity investment” into the business scopes of General FIEs. Circular No. 28 now expressly removes such restrictions. Thus, in the future, it will become easier for General FIEs to use their Foreign Exchange Capital to establish or acquire subsidiaries.