In 2019, the Chinese government passed the Foreign Investment Law (FIL) marking a new era for U.S. investors with current or future interests in China.
Taking effect on January 1st, 2020, The FIL updates and unifies three previous laws that established rules and regulations on how foreign investors form and incorporate businesses, known as foreign-invested entities (FIEs) in China.
In this article, we explain what changes came into effect and how these changes affect the way foreign entities do business in China.
A brief history of Chinese regulations that governed foreign investment
Prior to the new FIL legislation, China had established three corporate laws that allowed foreign companies and individuals to do business in the country. They are:
- Sino-Foreign Equity Joint Ventures Law. Passed in 1979, this law permitted foreign companies, enterprises, other economic entities, or foreign individuals to incorporate into equity joint ventures with Chinese companies, enterprises, or other local economic entities on the principle of equality and mutual benefit – subject to authorization by the Chinese government. At this time, foreign involvement in an enterprise in China could only be done via equity joint ventures.
- Wholly Foreign-Owned Enterprises Law. In 1986, this law created the WFOE entity which eliminated the previous requirement under the Sino-Foreign Equity Joint Ventures law for the involvement of a mainland Chinese investor in the creation of a Chinese entity. This law permitted foreign investors to own 100% of a business enterprise in the country.
- Sino-Foreign Cooperative Joint Ventures Law. This law was passed in 1988 and allowed investors to make capital contributions in forms other than those permitted for an equity joint venture.
Foreign enterprises were limited to utilizing only these business vehicles. FIEs followed a different set of rules than their domestic counterparts, conferred more restrictions, and limited investor contributions to only cash and specified IP and property rights.
Key aspects of the new Foreign Investment Law
To open its domestic market and attract more international investment, the new law provides a unified scope for foreign investors and enterprises to do business in China and grants the same provisions as domestic companies. Below are some of the most important aspects of the FIL:
A unified process for doing business in China
The FIL was designed to improve market opportunities and rights for foreign investors by streamlining the process of entity formation. FIEs can now follow the Company Law and the Partnership Enterprise Law in the same way that domestic companies do.
Specifically, the law removes the requirement for case-by-case review and approvals for foreign investors and standardizes regulations for foreign investment reporting, security reviews, etc.
Furthermore, the law extends the same business development support that domestic companies enjoy. This support includes eligibility for investment incentives, the right for legislative comment, and the ability to bid on government contracts.
Free transfer of funds and assets
The FIL allows for the free transfer of funds and assets into and out of China, whether they be profits, contributions, income from the disposal of assets, intellectual property (IP) royalties, or other sources of funds such as income from liquidation within the territory. This change provides protection for the investors should they repatriate from China (although tax and other obligations required when remitting funds outside the country must be adhered to).
Protections
The FIL also introduces changes to the country’s IP regulations, prohibiting administrative authorities from requiring foreign technology transfers while encouraging collaboration based on free will and good business practice. China has traditionally had weak protection of IP rights, and the inclusion of this provision in the law suggests it is taking a new direction.
Negative list
The FIL also institutes changes to the country’s “Negative List.” The term refers to restrictions on access to sensitive industries and fields by foreign investors. Previously, all foreign enterprises were required to submit a special filing with the Ministry of Commerce (MOFCOM) before and after registering their foreign-invested entity with the Administration for Market Regulation (AMR).
The FIL removes that requirement, allowing foreign entities with business activities that fall outside of the Negative List to register directly with the AMR without the need for approval or a filing record from MOFCOM.
Why is the FIL important for companies doing business in China?
The new foreign investment law provides some positive news for foreign investors and businesses, offering a more level playing field, a streamlined approach to the supervision of foreign investment, and enhanced investor protections. Below are some of the main benefits to businesses:
Corporate governance
By repealing past foreign investment laws, the FIL has unified corporate governance in the country. FIE regulations now fall under the Company Law and the Partnership Enterprise Law of China and are subject to the same corporate rules as domestically invested companies. Existing FIEs (established under the previous three laws) now have a five-year transition period (deadline of December 31, 2024) in which to modify their current corporate structures and governance to meet Company Law requirements.
In addition, the law provides investors with new flexibility in the way an entity is structured and operates. For example, per the previous Sino-Foreign Equity Joint Venture Law, the highest decision-making body was the board of directors. The new law replaces this requirement with a shareholder meeting. To comply with this and other changes, FIEs must amend their shareholders’ agreement, joint venture contracts, articles of association, and other governance documents to reflect these requirements.
The FIL also impacts Wholly Foreign Owned Entities (WFOE). Under the new law, WFOEs are not limited to forming a limited liability company (LLC), they can also establish a joint-stock company. The law also requires that WFOEs allocate at least 10% (capped at 50%) of after-tax profits to a reserve fund. They may also make discretionary contributions to employee bonuses and welfare funds.
Flexibility in funding
The previous laws permitted only certain types of capital contributions made by foreign entities. The new FIL permits companies to be capitalized using equity rights, allowing – among other things – for M&A transactions to be undertaken via share swaps, etc.
The law also opens various financing methods that were only reserved for domestic companies such as the public issue of stocks, bonds, and other securities, and facilitates the use of debt and equity markets in China to fundraise.
Incentivizing a business-friendly environment
A key part of the legislation is that it emphasizes a foreign investor’s eligibility for investment incentives, the right to comment on legislation, the right to participate in standard-setting, and the right to participate in the government procurement market. The law also prohibits regulation of foreign investment via unpublished policies. All are important measures that help increase the transparency of doing business in the country which has been notoriously protective of its domestic market.
Conclusion
The implementation of the FIL brings in an air of change to the country’s corporate and investment environment with more benefits to foreign enterprises and incentives to enter this market. While the repeal of the previous foreign investment laws provides more opportunities, companies must now review contracts, corporate governance documents, articles of associations, and organization structure and make any necessary changes to ensure they are compliant with the relevant regulations.
China remains a complex country to do business in, so ensuring you understand the rules and regulations that apply to corporate entities and investment structures is key to maintaining compliance and ultimately safeguarding your business’ operations in the country.
To learn more about doing business in China and how our Global Transactional Services can help manage your compliance needs, contact a CT Corporation specialist today.