2020 will see China's new law governing Foreign Investment become effective. We highlight the changes, benefits and potential pitfalls of the new legislation.
The China National People's Congress introduced a new law on 15 March 2019 governing Foreign Investment (FI) into China, which will become effective starting 1 January 2020. This will sweep away the current three laws governing Foreign Direct Investment (FDI) and integrate all of the regulations into a single consolidated law that introduces much more openness and greater opportunities for foreign investors. The new law aims to further promote China as a desirable place to invest and to provide additional protections to the current legislation. With only nine months to go, current and prospective investors need to prepare early if they are to gain maximum advantage from the further opening up of the Chinese market and avoid falling foul of the changes that may affect current investments.
Investments under the new law
The new law covers both direct and indirect foreign investment through:
- establishing a new foreign funded enterprise, either solely or with any other investor;
- acquiring shares or equities of a Chinese enterprise;
- investment into a project within China, either solely or with any other investor;
- investment through any other method allowed under the law.
This latter point potentially leaves it open for the authorities to introduce some future regulation and clarity around treatment of Variable Interest Entities (VIEs), although there is nothing clearly targeted at VIEs in the current legislation.
Changes in boards
There is a significant change to the control of an enterprise, now placing the Board of Shareholders as the ultimate authority of the company rather than the Board of Directors. There is a five-year transition period, starting 1 January 2020, but companies will need to consider how they need to implement this change that will likely affect many aspects of organisational management, as will become clearer as the details are announced in future regulations.
Profit distribution, transfers and capital contributions
Under the new law, Company Law will apply in terms of distribution of profits, which will allow companies to distribute profits on a basis different from the proportionate contribution to a company's capital, which is a change. Distribution of other assets on liquidation has also changed, with them now to be distributed in proportion to shareholding.
Currently all shareholders must approve the transfer of shares from a shareholder to another person, but under the new law this will now only require a majority of over 50% to give approval, and any shareholder that neither gives consent nor offers to purchase the shares itself, shall now be deemed to have given consent.
In another change, capital contributions may be made in equities of either a Chinese or a foreign entity, removing current restrictions. Although the detail of how this will be implemented is yet to be clarified by the relevant authorities.
It should also be noted that a foreign investment information reporting system will be established that will require companies to report investment information through the enterprise registration system, which will then be available to the public.
China Negative list
The China Negative list defines those business sectors that are prohibited from receiving foreign investment and also lists sectors where prior approval must be gained from the appropriate authority. This is not new but it is as yet unclear whether approvals granted under the current law will remain valid under the new law or whether companies will need to reapply for approval. This does not affect the rules surrounding the additional negative lists for special economic free trade zones.
A further control is being introduced in the form of a security review system, that will consider foreign investment into projects in China. It will rule as to whether they constitute a risk to national security, in which case the investment will not be permitted.
Equality of treatment and intellectual property protection
Provided an activity is not prohibited or restricted, a foreign investment will be treated equally to a domestic investment under the new law. This includes enjoyment of the same enterprise development policies, participation in government procurement exercises, fundraising in capital markets via issuance of shares, corporate bonds and other securities or other means of funding allowed under the law, creating a level playing field for obtaining funds.
Protection of Intellectual Property (IP) has long been an issue for foreign companies. This is strengthened under the new law. Any IP held by a foreign entity or a foreign invested entity will be protected and any reported infringements investigated and valid claims upheld. Royalties can be transferred freely out of the country and any government body that becomes aware of the IP held by a foreign entity in the normal course of their business, will uphold the confidentiality of the IP.
The new law is quite wide ranging but there are still nine months to go until it becomes effective. Companies and investors must continue to operate under the current three laws until they are abolished at the end of 2019. In the meantime, companies and investors need to familiarise themselves with the changes and prepare ahead of time. In particular, it may be necessary to reapply for permits that were granted under the current laws, and any change in board responsibilities is likely to require significant organisational change.
Talk to us
TMF China can help you to keep pace as regulations transition towards the new law coming into effect. There are many clarifications and rule changes that will need to be implemented that could affect your business and investment decisions. We aim to help you keep abreast of these changes. To learn more about TMF Group and our services, Talk to us.
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.