On May 29, 2007, the General Affairs Department of the State Administration of Foreign Exchange (SAFE) published an operating procedure for the Circular on Foreign Exchange Issues Related to Equity Finance and Return Investments by Domestic Residents through Offshore Special Purpose Vehicles (“Hui Zong Fa  No. 106”) which effectively stopped the implementation of Schedules 6 and 7 of Hui Zong Fa  No. 124 and clarified the relevant issues in the implementation and application of Circular No. 75. This update will briefly summarize the background, contents, implementation, and impact of Hui Zong Fa  No. 106.
Prior to the issuance of Hui Zong Fa  No. 106, SAFE and General Affairs Department of SAFE issued Circular 111, Circular 292, Circular 753, and Hui Zong Fa  No. 1244 in an effort to regulate equity financing and return investment activities. Though Circular 75 technically allowed domestic residents to establish offshore financing platforms, however, it did not address the issues that arise in the operation and management of such platforms. Hui Zong Fa  No. 106 clarifies these issues and provides a standard operating procedures for Circular 75.
Based on Circular 75 and Hui Zong Fa  124, Hui Zong Fa  106 includes seven schedules that track registration requirements for offshore fundraising and return investment activities. The main requirements are as follows:
1. Registration of offshore investment by contribution of assets or interests through special purpose vehicles.
Circular 75 states that a domestic resident must provide a business plan5 for the foreign exchange registration of offshore investment in order to complete the foreign exchange registration process for offshore investment. Hui Zong Fa  106 further explains what the business plan comprises: financial statements of the previous three years, introductions to the chief executive and the management team, certification that the domestic resident’s assets were transferred to the special purpose vehicle and the special purpose vehicle’s methods of controlling those assets, a description and legal analysis of future finance activities, an explanation on the investment relationship between the domestic resident and the domestic enterprise controlled by the resident and between the domestic resident and the special purpose vehicle, employee share ownership plans and stock options for the management team, description of planned financing activities, an introduction to the financial situation, offshore finance activation, and so on.
Second, Hui Zong Fa  106 further clarifies the definition of a special purpose vehicle provided in Circular 75. According to Hui Zong Fa  106, a special purpose vehicle is “one or more overseas enterprises directly or indirectly controlled by a domestic resident” through which he/she may use the assets or interests he/she holds in China to engage in offshore financing activities (such as initial public offering, private placement, and borrowing of bridge loan offshore) or capital contribution offshore (such as stock-swap transactions). This has effectively expanded the scope of Circular 75’s application on the special purpose vehicle to include all of the aforementioned offshore activities.
Third, Hui Zong Fa  106 clarifies the meaning of “natural persons who have no legal identity in China but habitually resides there for economic reasons”6. According to Hui Zong Fa  106, there are three types of persons: persons who permanently reside in China but temporarily leave in order to visit, study, work or receive medical treatment overseas; persons who own Chinese assets or interests in a domestic enterprise; and persons who beneficially own foreign assets or interests which were previously assets in a domestic enterprise but were converted into foreign assets or interest.
Lastly, the schedules clarify the prerequisites for the registration of a special purpose vehicle and the qualification of the registering person.
2. Registration of offshore investment by contribution of offshore interests and return investments.
Hui Zong Fa  106 lists various materials that a domestic resident must submit in order for his/her foreign exchange registration to be filed. These materials include written confirmation that “the source of all his/her assets and interests invested overseas shall be in accordance with the laws and regulations of China; he/she has not engaged in any illegal or criminal activities such as money laundering and he/she has fulfilled the tax obligation as a Chinese resident. If there is any false statement, he/she will assume the relevant legal responsibility.” At the same time, SAFE schedules provide that, in case where the company cannot prove the legitimacy of its overseas assets and interests or cannot supply audited financial statement or tax returns for the previous two years (or one year if the enterprise involves in science and technology research and development), his/her offshore company or return investments registration will not be filed. From the above provisions, it is clear that the purpose of SAFE is to prevent the use of special purpose vehicles as a means to launder money, commit foreign exchange fraud, or evade foreign exchange settlement.
3. Registration of the transformation of an offshore investment enterprise into a special purpose vehicle conducting return investments by a domestic resident legal person.
Though Circular 75 does not distinguish between a domestic resident legal person and a domestic resident natural person in terms of foreign exchange registration, Hui Zong Fa  106 has provided treatment on such resident legal person with distinction. For the domestic resident legal person, the schedules provides for detailed filing requirements. At the same time, the schedules set forth two additional requirements on offshore enterprises that make return investments in domestic enterprises: (1) the approved offshore investment projects continue to operate effectively without deviation from the business lines of the former operator who originally obtained approval from the relevant authorities; and (2) offshore enterprises continue to operate for three years from their original registration date.
The schedules also provide that domestic enterprises cannot pay profits; transfer stocks; reduce their registered capital; draw back contributions in advance; or settle the income tax, principal, and interest of shareholders’ loans to the enterprises that have not fully completed the registration or amended any change on overseas investments. Any violation of these provisions will be dealt with as an act of evasion of reporting of foreign exchange earning.
4. Registration with respect to the establishment of a special purpose vehicle or its merger with or acquisition of a domestic enterprise.
Hui Zong Fa  106 has replaced Schedule 7 of Hui Zong Fa  124 with a new stimulation that “enterprise shall fully complete the foreign exchange registration within 30 days after it [receives] the business license” and “only after full completion of the foreign exchange registration or filing of change may the special purpose vehicle fully complete the foreign exchange registration for its established or acquired domestic enterprise,” and so on. This stimulation also imposes legal liability on the domestic controlling person of a special purpose vehicle on returned offshore financing proceeds, dividends, or income of transfer by false or misleading statement to the competent authority.
5. Foreign exchange registration or filing of change with respect to material changes in capital structure of a special purpose vehicle.
The schedules explain in detail the materials and procedures involved in foreign exchange filing, examination, and registration. The schedules also specify the standards for domestic assets that can be transferred to overseas special purpose vehicles and the standards for domestic residents who can transfer their assets, interests, or equities into these special purpose vehicles.
6. Supplementary registration with respect to an existing special purpose vehicle established by a domestic resident natural person.
Though Circular 75 describes a situation in which a domestic resident establishes or controls an offshore special purpose vehicle and makes return investments without meeting the legal requirements for foreign exchange registration, it does not provide regulations to deal with this situation. Hui Zong Fa  106 supplies these regulations: if a domestic resident uses an already established special purpose vehicle to make return investments (in this case, the domestic enterprise receiving the investments has already completed the foreign exchange registration process) but does not register his offshore investments, then he must go through the formalities of supplementary registration; if a domestic resident controls an already established special purpose vehicle that is not registered but has not made any return investments (in this case, the domestic enterprise to receive the investments has not completed the foreign exchange registration process), then he must go through the formalities of foreign exchange registration for newly established special purpose vehicles.
7. Account opening and remitting funds to China from a special purpose vehicle established by a domestic resident.
In terms of account opening and the remittance of funds, Circular 75 emphasizes that, after the special purpose vehicle accomplishes overseas financing, the domestic resident shall remit funds back to China within 180 days after the funds are received, pursuant to the plan for the use of such funds as stated in the business plan or in the prospectus. The SAFE schedules further clarify the detailed rules that:
- Returns of funds due to capital change of the special purpose vehicle shall enter into the special foreign exchange account of the capital account approved by the local bureau of foreign exchange, and profits, dividends, and other income shall enter into the foreign exchange account of the current account, subject to approval.
- Return of funds received by domestic resident natural person from capital change of the special purpose vehicle shall enter into the personal capital account under the special foreign exchange account in accordance with the Personal Foreign Exchange Management Method and Its Implementation published by the local bureau of foreign exchange where the return investment enterprise is located, subject to approval from the bureau of foreign exchange, and profits, dividends, and other income gained from the special purpose vehicle shall be remitted to the personal foreign exchange savings account.
The schedules provide that the competent authority, when examining the special accounts under the capital account, shall determine whether or not the domestic resident has fully completed the overseas investment registration change of the special purpose vehicle.