Hong Kong: The 6th Revision Of The Foreign Direct Investment Industries Guidance Catalogue

On 13 March 2015, the PRC Ministry of Commerce ("MOFCOM") and National Development and Reform Committee ("NDRC") released the 6th revision of the Foreign Direct Investment Industries Guidance Catalogue ("2015 Catalogue") 1. It is welcomed by most of the foreign investors as the 2015 Catalogue echoes the market expectations for greater openness and liberalization through lifting many restrictions on foreign investment in various industry sectors.

In this tax flash, we highlight some of the notable changes in the 2015 Catalogue as well as the development of a new Foreign Investment Law.

OVERVIEW OF THE 2015 CATALOGUE

Foreign Direct Investment Industries Guidance Catalogue ("Investment Catalogue") was first published in 1995. It divides foreign investment into four categories: "Encouraged"2; "Restricted"3 and "Prohibited"4 (industry sectors not listed in the Investment Catalogue are deemed to be "Permitted"). It also stipulates the rules on foreign ownership restrictions and the allowable corporate forms that foreign investment can be invested. During the past 20 years, several revisions have been made to reflect the change of the Central government's economic and industry development policies.

Compared to the 5th revision, the number of "Encouraged" sectors in the 2015 Catalogue has been slightly increased to 349, whilst the "Restricted" sectors sharply reduced from 79 to 38 and the "Prohibited" sectors slightly reduced from 38 to 36.

Below are some of the major changes in each categories:

"ENCOURAGED" CATEGORY

Automobile Manufacturing

  • The requirement of PRC majority shareholding on "Production and R&D of Automobile's Embedded Electronic Integrated System" has been lifted. Foreign investors are now permitted to establish wholly foreign owned enterprises to produce and research on the related products.

Production and Supply of Power, Gas and Water

  • "Construction and Operation of Power Grids" has been moved from the "Restricted" category to the "Encouraged" category. However, such projects still require majority ownership by Chinese partners.

Scientific Research, Technical Services and Geological Prospecting

  • Development and application of "Internet Technologies" is added to the "Encouraged" category. This is in line with the supportive State policy in the new and high technology field.

Communication and Transportation, Storage, Post and Telecommunication Services

  • The requirement of PRC majority shareholding on "Construction and Operation of Urban Subway, Light Railway and other Track Transport" has been lifted. Foreign investors can set up wholly foreign owned enterprises to construct and operate the aforesaid projects.

Leasing and Commercial Service Industry

  • The restriction of joint venture or partnership on "Accounting and Auditing" has been lifted. Foreign investors can set up wholly-owned accounting firms in the PRC5 to provide accounting and auditing related services.

Education

  • "Occupational Training" is added into the "Encouraged" category, reflecting the supportive State policy in this field.

Public Health, Social Security and Social Welfare

  • Further to the Announcement [2014]No.81 "Matters Relating to Foreign Investors' Establishment of For-profit Elderly Care Institutions" issued by the Ministry of Commerce and the Ministry of Civil Affairs on 24 November 2014, "Elderly Care Institutions" is now added into the "Encouraged" category.

Art, Sports and Entertainment Industries

  • The requirement of PRC majority ownership on "Operation of Performance Venues" has been lifted.

"RESTRICTED" CATEGORY

Most of the liberalized industries lie in the manufacturing sector (See "Permitted" Category below). Comparing with the 5th revision, the number of sectors requiring Sino-foreign joint venture structure in the 2015 Catalogue was reduced from 43 to 15, and the number of sectors requiring PRC majority ownership decreased from 44 to 35.

Automobile Manufacturing

  • Manufacturing of whole units of automobile, special automobiles (except agricultural vehicles) and motorcycles are classified as "Restricted", reflecting government's support for PRC domestic car manufacturers. PRC ownership in the joint venture enterprises should not be less than 50%. Except for merger of other domestic automobile manufacturing enterprises with PRC joint ventures, the same foreign investor is not allowed to invest in more than two joint venture enterprises manufacturing the same type of motor vehicles.

Transportation, Storage and Postal Services

  • "Value-added and basic telecommunications TMT businesses" is still categorized as "Restricted" and subject to 50 percent or more PRC ownership requirement;

Financial Industries

  • Banks, insurance companies, securities companies, insurance brokers and futures companies are still categorized as "Restricted" and subject to restrictions.

Education

  • "Pre-school Education" and "Tertiary Education" has been added to the "Restricted" category and limited to co-operative joint ventures led by a PRC party.
  • "Upper years of Comprehensive Secondary School Education" is still categorized as "Restricted" and limited to co-operative joint ventures led by a PRC party.

Public Health, Social Security and Social Welfare

  • Although wholly foreign-owned medical institutions are allowed to be set up in the Shanghai Free Trade Zone and seven pilot cities and provinces (Beijing, Tianjin, Shanghai, Jiangsu, Fujian, Guangdong and Hainan), in the 2015 Catalogue, "Medical Institutions" is moved to the "Restricted" category and limited to joint ventures.

Art, Sports and Entertainment Industries

  • The requirement of PRC majority ownership on "Operation of Performance Venues" has been lifted.

"PROHIBITED" CATEGORY

New prohibited industries have been added to the list, including the following:

Processing Industry of Petroleum, Coking and Nuclear Fuel

  • "Production of Nuclear Fuel" is added

Wholesale and Retail Trade Industries

  • "Wholesale and Retail of Tobacco" has been moved from "Restricted" category to "Prohibited" category.

Leasing and Commercial Service Industry

  • "Provision of PRC Legal Advice"6 has been moved from "Restricted" category to "Prohibited" category.

Research and Technical Services Industries

  • "Production of world administrative map, national administrative map, administrative map of the provincial level and below, national teaching map, compilation of local teaching map and three-dimensional map; compilation of navigation electronic map; surveys relating to regional geological mapping, mineral geology, physical geography, geochemistry, hydrogeololgy, environmental geology, geological disaster and remote sensing geology" is added.

Education

  • "Compulsory Education" (i.e. primary school and lower years of secondary school) is still categorized as "Prohibited".

Art, Sports and Entertainment Industries

  • "Internet Publishing Services" is added, which is in line with the government's prevailing policies.
  • "Auction Houses and Antique Shops engaging in Antique Auction" is added.
  • Construction of "Golf courses and villas" is still categorized as "Prohibited".

"PERMITTED" CATEGORY

Manufacturing Industries

  • Manufacturing industries such as beverages, chemical raw materials and chemical products, pharmaceutical manufacturing, chemical fibres, general and special equipment (except for "Arms and Ammunition" which is still "Prohibited"), transportation equipment, communications equipment, computers and other electronic equipment are removed from the "Restricted" category Information Technology
  • "E-commerce for Technology, Media and Telecommunications Business" is removed from the "Restricted" category.

Financial Industries

  • "Non-bank Financial Institutions, Trust Companies, and Currency Brokerage Companies" is removed from the "Restricted" category.

Real Estate industries

  • "Real Property Projects" is removed from the "Restricted" category. No more restrictions on foreign investment in land development and construction and operation of high-class hotels, high-class office buildings and international convention and exhibition centres, investment in real estate secondary market and real estate brokerage.

Art, Sports and Entertainment Industries

  • "Operation of Golf Courses" and "Operation of Entertainment Venues" have been removed from the "Prohibited" category.

THE OUTLOOK

The 2015 Catalogue reflects the PRC Central government's economic restructuring plans and industrial policies. It offers more liberalization, lifts restrictions and encourages foreign investments in sectors such as advanced manufacturing, modern services, and scientific/technological research and development. The 2015 Catalogue is a welcome change to the PRC existing foreign investment regime.

Currently, the PRC government is also working on a new Foreign Investment Law to replace the existing laws regulating foreign investments in the PRC (i.e. the Sino-Foreign Equity Joint Ventures Law, the Sino-Foreign Cooperative Joint Ventures Law and the Wholly Foreign-Owned Enterprises Law). The new law aims to set forth a more transparent legal framework of guidance for foreign investments in the PRC. A consultation draft ("Consultation Draft") covering topics like market entry, national security review system, contemporaneous and post-registration supervision and administration, foreign investment protection and coordination etc. was issued by the MOFCOM on 19 January 2015.

Some of the key proposed changes under the Consultation Draft include:

  • The granting of "national treatment" to foreign investors: foreign investors can make investments on the same terms as PRC investors;
  • For foreign investment enterprises and projects, a shift from the current "case-by-case pre-approval mechanism" to the "negative list" post-supervision mechanism (i.e. the "special administrative measure list" approach currently adopted by the Shanghai Free Trade Zone).

In the future, unless the foreign investment falls within the "negative list" (which is expected to be issued separately by the State Council) or the investment exceeds certain amount7, foreign investors will be subject to a record filing system (just like the domestic counterparts) instead of the current "case-by-case pre-approval" system. This will largely alleviate the foreign investors' administrative burdens.

  • Introduce the concept of "effective control" for determining whether a project should be classified as foreign investment: the Consultation Draft adopts the "substance over form" approach. In a case where a domestic enterprise established in the PRC is "controlled" by a foreign investor, the domestic enterprise will deem to be a foreign invested enterprise according to the Consultation Draft even if the domestic enterprise is directly owned by Chinese shareholders. "Control" is defined as:
  • the ownership of not less than 50% of the voting rights
  • the right to appoint (or the ability to secure) a majority of the board of directors
  • the ability to otherwise materially influence the decisions of the board or shareholders meeting of a company, or
  • the ability to exercise decisive influence over a company by way of contractual or trust arrangements

If the Consultation Draft is finalized and takes effect without further changes, foreign investors would no longer be able to use Variable Interest Entity ("VIE") structure to bypass the foreign investment restrictions stipulated under the Foreign Direct Investment Industries Guidance Catalogue. Offshore structure set up by PRC citizens which are duly registered with the local State Administration of Foreign Exchange may still use the VIE structure to "control" operating enterprises in China engaged in the "Restricted" or "Prohibited" sector as the ultimate beneficial owners are not "foreign investors". Existing VIE structure used by overseas listed companies or the VIE structures controlled by foreign investors (non-Chinese ultimate beneficial owners) would also be affected. Hopefully, the national treatment principle could apply in the way that "the negative list" would only cover industries/sectors that are prohibited to both foreign and PRC domestic investors.

  • Foreign investment matters that may endanger national security will be subject to national security review. The State Council will organize an inter-departmental commission (sponsored jointly by the NDRC and MOFCOM) to conduct national security reviews of proposed foreign investment projects.
  • Sets forth a standardized information reporting system for foreign investments: According to Article 30 of the Consultation Draft, foreign investors will be required to report basic information to MOFCOM, including: (1) foreign investor identification information; (2) investment project information; (3) foreign-invested enterprise information; and (4) any change in ultimate beneficiary owner.

We will closely monitor the changes of the foreign investment system and the development of the new PRC Foreign Investment Law and keep you posted further development.

Footnotes

1 Chinese version of the 2015 Catalogue: http://www.mofcom.gov.cn/article/b/f/201503/20150300911747.shtml

2 "Encouraged": Foreign investments are welcomed by the PRC government if the sector is under the "Encouraged" category. Investors may enjoy certain benefits such as tax incentive, cheaper land cost, simplified approval procedures etc.

3 "Restricted": Restrictions such as foreign shareholding ratio's, limits on the business scope and special approvals etc. are imposed if the sector is under the "Restricted" category.

4 "Prohibited": No foreign investment is allowed if the sector is under the" Prohibited" category.

5 The chief partner must be a PRC national.

6 Except for providing information about the impact of PRC legal environment

7 if the underlying business falls within the "negative list" or the investment exceeds certain amount, market entry clearance by MOFCOM or its local counterparts would be required.

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.

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