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Blog This new Chinese law will affect all foreign-invested companies

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This new Chinese law will affect all foreign-invested companies

by Angel Ho | 29 January 2020

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On March 15th, 2019, China's legislature approved the new Foreign Investment Law (FIL), it would replace the Three Laws on Foreign Investment as the new basic law in the field of foreign investment in China.

The keywords of foreign investment management will be changed from "government approval (政府审批)" to "equality inside and outside China (内外平等)" and "national treatment (国民待遇)".

With the new FIL coming into effect on January 1st, 2020, the following is our analysis of the main impacts on existing foreign-invested companies:

1. Company management system

As mentioned above, the Foreign Investment Law (FIL) replaced the original Three Laws on Foreign Investment from January 1st, 2020. 

At that time, the organizational form, corporate structure and operating rules of the newly established foreign-invested enterprise will be implemented in accordance with the Company Law and the Partnership Enterprise Law.

For existing foreign-invested enterprises, they can maintain the existing corporate structure within five years from the effective date of the Foreign Investment Law (ie, January 1st, 2020). 

After the five-year transition period, all those foreign-invested enterprises should comply with the Company Law or the Partnership Enterprise Law.

The Partnership organizational form is rarely used in practice, so most foreign-invested enterprises can apply the Company Law.

Since 2006, WFOE has been implemented in accordance with the Company Law in terms of organizational form and corporate structure. Thus, we believe that the Foreign Investment Law (FIL) has a very limited impact on the WFOE.

Compared with the WFOE, the Foreign Investment Law (FIL) will have a more significant impact on existing Chinese-foreign equity joint ventures and Chinese-foreign contractual enterprises. 

The main reason is that there is a fundamental difference between the company's organizational form and corporate structure stipulated in the two joint venture laws and the Company Law.

For example, the corporate governance rules of traditional joint ventures and cooperative enterprises will give more protection for minority shareholders and restrict freedom of contract. And in the absence of agreement, it will often lead to a company deadlock and unable to move forward.

With the formal entry into force of the Foreign Investment Law (FIL), existing Chinese-foreign equity joint ventures and Chinese-foreign contractual enterprises will have the opportunity to restructure and adjustment so that major shareholders can enjoy a certain degree of final decision right.

It is also important to note that under the principle of equal treatment of foreign and domestic enterprises, foreign-funded enterprises can participate in government procurement bids and allow the establishment of chambers of commerce and associations. This was previously not allowed and restricted, which is a great improvement.

 

2. Dividend mechanism

According to the Joint Venture Law, the profit distribution between the shareholders of a Chinese-foreign joint venture must be proportional to its registered capital, and there is no room for agreement between the shareholders.

The dividend distribution mechanism stipulated by the Company Law is similar to the Joint Venture Law, but it provides room for shareholders to choose other options. This flexibility will provide investors (especially financial investors) with some new dividends tools.

The Cooperative Enterprise Law actually provides quite a flexible profit distribution mechanism, it allows investors to share profits according to the provisions of the joint venture contract.

In this sense, contractual Chinese-foreign cooperative enterprises may be less affected by the Company Law in terms of dividends. However, compared with the number of Chinese-foreign equity joint ventures, Chinese-foreign contractual enterprises account for only a small proportion in China.

 

3. Relaxation of foreign exchange freedom

At present, cross-border capital remittance and repatriation are still restricted, but it is worth noting that the Chinese government has not prevented the legal remittance of dividends to overseas.

In recent years, government departments have tightened relevant policies from time to time, but this situation may greatly improve after the Foreign Investment Law (FIL) comes into effect.

According to Article 21 of the Foreign Investment Law (FIL),

Foreign investors can freely repatriate profits outside China according to law after the taxation of profits, capital gains, asset disposal income, intellectual property use fees, and salary income.

We anticipate that foreign investors will still not be able to make "full freedom" in cross-border remittances, but we believe that foreign investors will enjoy more convenience policies when repatriating profits outside China.

 

4. Minimum shareholding ratio

According to the two joint venture laws and related regulations, the proportion of foreign investors in Chinese-foreign equity joint ventures should generally not be less than 25%. If it is less than 25%, foreign investors cannot enjoy preferential tax treatment.

Since 2008, foreign-invested enterprises should bear the same corporate income tax as domestic-funded companies, the preferential tax treatment for foreign-funded enterprises has been significantly reduced.

But in practice, some regions still require that the threshold for foreign investors' shareholding in Chinese-foreign equity joint ventures 25%.

With the entry into force of the Foreign Investment Law (FIL), these 25% minimum shareholding requirements will no longer exist, which will provide more flexible options for foreign investors with only a minority stake.

The important point is that foreign-invested enterprises can be listed in China, and they can also open securities accounts to purchase publicly issued shares and funds.
5.Intellectual property protection

The new Foreign Investment Law (FIL) emphasized the equal protection of intellectual property rights for foreign investors and foreign-invested enterprises, increased punishment for intellectual property infringements, and strengthened enforcement of intellectual property rights.


In response to the issue of compulsory technology transfer that is of widespread concern to foreign investors, Article 24 of the Implementation Regulations clearly stipulates that administrative agencies and their staff shall not use methods such as the implementation of administrative licenses, administrative inspections, administrative penalties or administrative coercion to force foreign investors and foreign-invested enterprises to transfer technology in disguise.

After the Foreign Investment Law (FIL) was published, the State Council has made amendments to the Regulations on the Administration of Technology Import and Export. Improve the ownership of technology, technology and procurement sources, product sales channels, etc., and expand the space for free negotiation of technology import contracts.
The above laws and regulations will work together to ensure that technology transfer conforms to the principle of voluntary equality, enhance China's level of intellectual property protection, and reduce concerns for foreign investors.

 

Conclusion: 

The Foreign Investment Law (FIL) is not just China's response to the trade war and "mitigation of globalization" (that is, the decline of global integration). The Foreign Investment Law (FIL) is a welcome message from the Chinese government that the Chinese market is always open for overseas Business.

At the time when China's reform and opening-up was more than 40 years old, although it was incredible, the birth of this law marked that China was actually a winner in the process of trade and investment liberalization.

There is no doubt that the Foreign Investment Law (FIL) will reshape China's foreign investment legal system and will outline a new pattern of China's foreign investment in the long run.

For those who just wait in the distance or are considering whether to enter the Chinese market, they cannot feel the strongest and most direct impact of the Foreign Investment Law (FIL).

However, for all foreign-invested companies in China (especially 300,000 existing Chinese-foreign equity joint ventures), their shareholders will have the opportunity to reshape their corporate organizational structure and governance rules in a flexible manner.

Topics: Chinese Law, doing business in China, Law Reform

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