As every foreign invested enterprise in China, Chinese foreign
invested holding companies ("HoldCos") are allowed to use
their legitimate income earned in China (including profits
distributed by / received from its Chinese subsidiaries) to
reinvest in China, i.e. to establish new companies in China or to
increase the registered capital of their existing Chinese
1. New requirement from the State Administration of Foreign
On 29 March 2011, the PRC State Administration of Foreign
Exchange ("SAFE") issued a Circular titled Notice
regarding Issues related to the Capital Verification Confirmation
for Reinvestment Made by HoldCos, i.e. Circular Huizihan
 No.7. The Circular took effect on 29 March 2011.
Under this Circular, before a HoldCo can reinvest its legitimate
income earned in China (including profits from invested
subsidiaries), the HoldCo must first increase its own registered
capital by the same amount. That is to say, capital increase of the
HoldCo itself is now a pre-condition for reinvestment of a
HoldCo's legitimate income earned in China.
From a tax point of view, this means that foreign investor(s) of
a HoldCo may have to pay 10% withholding tax in China because
converting earnings into registered capital is regarded as a
dividend distribution made by the HoldCo followed by a reinvestment
of such dividends from its foreign shareholder(s).
2. Reaction from the Authorities of Commerce
The SAFE claims that the new Circular is based on Decree 
No. 3 of the Ministry of Commerce ("MoC"). However,
Decree  No. 3 only covers the situation where the foreign
investor(s) of a HoldCo uses their legitimate income earned in
China as capital contribution to the HoldCo. Decree  No. 3
has no relevance for capital contribution made by a HoldCo to its
subsidiaries. The SAFE may have misunderstood the earlier MoC
Like other capital increases of foreign invested enterprises,
using earnings to increase the capital of a HoldCo is also subject
to the approval from the competent Authority of Commerce. According
to information we received from the Shanghai Authority of Commerce,
currently, faced with the new regulation from the SAFE, they have
been instructed by the Ministry of Commerce to temporarily suspend
issuing such approvals until further notice from the latter.
For the time being, the SAFE and the MoC seem to have different
opinions on this issue. They are reported to be in the process of
coordinating with each other and working out a joint guidance.
3. Practical implications
Due to the fact that the Authorities of Commerce have suspended
approving HoldCos to increase their registered capital by use of
earnings, for the time being, HoldCos that intend to do so may have
to wait until the MoC has coordinated this issue with the SAFE.
Alternatively, if time is essential, HoldCos may consider
financing their new projects by other funds, such as its registered
capital or a shareholder loan.
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