Authors
Johnny Zhao

Johnny Zhao

Partner

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Stella Yang

Counsel

Read More
Authors
Johnny Zhao

Johnny Zhao

Partner

Read More

Stella Yang

Counsel

Read More

15 February 2022

Looking at the capitalisation of a Chinese Foreign Invested Holding Company in the era of the Foreign Investment Law

  • Briefing

The Foreign Invested China Holding Company (CHC) was introduced as a special legal entity by the Provisions of the Ministry of Commerce (MOFCOM) on the Establishment of CHCs by Foreign Investors (CHC Regulation) in 1995. But in recent years it's lost some of its charm due to its high capitalisation and qualification requirements and the availability of other investment vehicles for foreign investors.

After the revival of the Chinese markets post-COVID-19 and the Chinese government's efforts to promote investment vehicles like CHCs (indicated by several local governments authorizing the relaxation of CHC investor qualification requirements) , we've seen a number of foreign investors (the US's Huntsman and Japan's Rohto Group to name a few) setting up CHCs as part of their strategy to restructure their Chinese operations. 

But issues can arise when applying CHC Regulation in the context of the Foreign Investment Law (FIL). The practice of local authorities seems inconsistent causing foreign investors confusion. In this article, we explore the issues around CHCs, providing our own analysis on how best to navigate them.

 

The history behind CHCs

When the CHC Regulation was released by the Ministry of Foreign Trade and Economic Cooperation in 1995, there was a requirement of minimum registered capital (RC) of no less than USD30 million for CHCs (Article 3).

Article 3 was removed by the MOFCOM in 2015 when it aligned various MOFCOM regulations with the central government's reform on capitalisation requirement due to the 2014 Amendment to the PRC Company Law. However, another provision (Article 8) referring to a requirement for CHCs to invest a minimum amount of USD30 million out of their registered capital in new projects remains intact, giving rise to the inconsistent requirement around RC of CHCs by the new authorities.

“CHC shall have RC no less than 30 million USD to be used for the following purposes: (i) RC of a newly established FIE, or (ii) the amount of RC of FIEs (including increased part of RC) invested and established by the parent company or affiliated company has not been paid for, or (iii) investment to be used for setting up the R&D center, (iv) share purchase price to be used for acquisition of a domestic company inside the territory of China.” (Article 8 of the CHC Regulation)

Our observations

Taken literally, Article 8 may be understood to impose a requirement on the minimum RC of the CHC. Some local authorities (mainly local AMR) apply Article 8 further by requiring a RC of USD30 million to be committed by a CHC upon its establishment.

But does this practice really reflect the original intention behind the removal of Article 3 in 2015 and comply with the Foreign Investment Law? Particularly given that for Chinese domestic investment companies or holding companies, there have never been comparable RC requirements and the effective foreign investment negative list doesn't provide any special restriction in this regard.

In practice, it creates more questions or issues, like how and when the authorities will supervise and enforce a CHC’s performance of Article 8, and if there's any penalty if Article 8 is breached. So far, the MOFCOM has made no attempt to address the above questions or issues, leaving local authorities to exercise their discretion. Interestingly, so far there's no public case where the MOFCOM or the State Administration for Market Regulation (SAMR) has penalised any CHC in breach of Article 8.

Our research indicates that so far the majority of local authorities tend to take a more flexible position that a CHC may set its RC at its own will and need at the time of establishment, while Article 8 shall be fulfilled by the CHC without specific timeframe. This means the CHC may increase RC later and gradually in order to fulfill Article 8. Some local authorities have even indicated that they'll examine the fulfillment of Article 8 by the CHCs only at the time of liquidation of the CHC.

This approach of the local authorities is confirmed by our own experience in Shanghai and Hunan. In addition, based on public information in 2018 two Japanese companies, Tosoh and Rohto, set up their respective CHCs in Shanghai with RC of only USD10 million.

Final thoughts

CHC Regulation and other MOFCOM regulation governing foreign invested enterprises (FIEs) will need to be further fine-tuned to cope with the general framework set up by the FIL, although most of those provisions in conflict with the FIL have been repealed/superseded. As SAMR will become the major regulator responsible for the registration of FIEs, it's anticipated that any future amendment to CHC Regulation will be a joint effort between the SAMR and MOFCOM.

How best to capitalise a CHC is essentially driven by business demand. Local governments may offer substantial subsidies and other supports to CHCs in their region to attract headquarter businesses. The amount of subsidies are often linked with the amount of RC, meaning CHCs with higher RC will be granted more subsidies.

This becomes one of the major commercial factors for foreign investors in deciding the RC of their CHCs. For any foreign client contemplating a CHC for its China business, we'd advise discussing how to address the capitalisation requirements and related benefits under their investment agreement with the local government.

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