China's State Administration of Foreign Exchange
("SAFE") promulgated a notice on March 29 that may
complicate the financial planning for foreign-invested holding
companies1 in China.
Document No. 7 (huizihan [2011] No. 7, entitled Notice of
SAFE's Capital Projects Management Section Concerning the
Dissemination of Operational Guidance on Relevant Issues Involving
the Checking of Funds and Inspection of Certificates for
Reinvestment by Foreign-Invested Holding Companies)2
requires that all dividends, interest, liquidation proceeds and
other income received by the holding company be treated as an
increase to its registered capital before it can be reinvested in
projects in China.
The requirement to reinvest income as registered capital is
seemingly inconsistent with central government policy to encourage
the establishment of holding companies. Document No. 7 also raises
serious transparency concerns.
Foreign-invested holding companies are holding companies
established in China which are at least 25%, and usually 100%,
owned by foreign investors to manage their investments and provide
services to their subsidiaries in China. Holding companies are
barred from engaging in manufacturing or other types of production
but may engage in trading (import and export), distribution and
R&D. Because holding companies are subject to a $30 million
minimum registered capital investment requirement, and must already
have at least one subsidiary in China, only larger multinationals
with ambitious expansion plans in China tend to be interested in
establishing holding companies.
The Chinese Government has issued several regulations in recent
years to incentivize foreign investors to establish holding
companies. Such foreign investors are generally larger
and have the wherewithal to make substantial investments.
Among the biggest incentives is increased leverage. Depending on
the amount of registered capital, holding companies can borrow four
to six times the amount of their registered capital. By
contrast, even the largest foreign-invested companies generally
have their borrowing capacity capped at twice the amount of their
registered capital.
The requirement to reinvest income as registered capital is
unnecessary as well as inconsistent with central government
regulations that accord holding companies enlarged borrowing
capacity. Indeed, requiring a company to increase its registered
capital above minimum requirements is inconsistent with the Company
Law, which eliminated mandatory registered capital requirements
when it was amended in 2005. Moreover, a wholly foreign-owned
holding company is subject to the requirement to allocate 10% of
its annual after-tax profits to its company reserve fund before it
can declare dividends to its shareholders, provided that the
holding company is no longer required to make such allocation when
the reserve fund reaches 50% of the amount of registered capital.
The requirement to treat the amount to be reinvested as an increase
to registered capital will result in a proportionate increase to
the reserve fund, which will diminish a company's ability to
declare dividends to its shareholder(s). This is inconsistent with
the rules governing distribution of profits from all other types of
companies under the Company Law and other regulations. While there
may be some rationale for barring a holding company from declaring
and remitting dividends until subscribed for registered capital has
been fully contributed, there is no apparent rationale for
maintaining the restriction after registered capital has been fully
contributed. Moreover, registered capital of a holding company may
not be withdrawn by its shareholders before the liquidation or
dissolution of the company. As such, the requirement to reinvest
through increases to registered capital makes such restriction more
onerous.
Document No. 7 also suffers from a lack of transparency, despite
China's transparency obligations under the World Trade
Organization and bilateral commitments. It was issued to implement
a 2006 Ministry of Commerce revision of its regulations on holding
companies.3 No explanation appears to have been
published for the multi-year delay. Issued on March 29, it has yet
to be published and does not include an effective date, although
SAFE officials will provide copies during in-person meetings, at
which time they will explain that the effective date is April 1,
three days after issuance.
Unless Document No. 7 is withdrawn or substantially revised, many
foreign-invested holding companies will be forced to make
capital-inefficient reinvestments of their income, delaying or
reducing their ability to declare and repatriate dividends to their
shareholder(s). They will find the holding company structure to be
more costly and cumbersome than they had anticipated, which will
reduce its attraction to other investors.
Footnotes
1. 外商投资公司。
2. 汇资函[2011]第7号， 国家外汇管理局资本项目管理司关于外商投资性公司再投资所涉验资询证有关问题操作指引的通知。
3. Supplemental Regulations Concerning Investment Companies Established by Foreign Investors [关于外商投资举办投资性公司的补充规定].
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
