SAFE Circular 28, issued and effective from 25 October 2019, introduces twelve new measures to facilitate China cross-border trade and investment. This includes the removal of restrictions on foreign invested enterprises (FIEs) from using their registered capital for domestic equity investments. Restrictions previously applied where these were not ‘FIE investment enterprises’ (i.e. FIEs with equity investment as a listed activity in their registered scope of business).  The change, which builds on earlier pilot schemes, should facilitate the expansion of foreign business and investment in China.

Since 2008, policies governing FIE use of registered capital for domestic equity investment have evolved:

• SAFE Circular 142 (2008) stipulated that the RMB capital obtained by an FIE from foreign exchange settlement had to be used within its approved business scope. Such RMB capital should not be used in domestic equity investment, unless specifically provided (e.g. the regimes for FIE investment enterprises). In addition, FIE investment enterprises, such as foreign invested venture capital investment enterprises (FIVCIEs) or qualified foreign limited partnerships (QFLPs), could only transfer RMB capital for equity investment after obtaining SAFE approval.  Subsequent SAFE Circulars 59 (2012), 21 (2013), 13 and 19 (both 2015) simplified the forex administration processes, but they did remove the limitation on FIE non-investment enterprises. 
• In July 2019, Shanghai and Shenzhen SAFE branches issued Shanghai Pilot FTZ Policy and Notice 19.
  These provided that FIE non-investment enterprises in the Shanghai FTZ and Qianhai/Shekou area could use their forex capital account and RMB capital obtained from foreign exchange settlement to undertake domestic equity investment.  This is subject to the investment being ‘genuine’ and reasonable, and complying with the Foreign Investment Negative List. Under the latter certain sectors are prohibited or restricted for foreign investment; in the latter case they may need to meet special conditions and get special approvals.

SAFE Circular 28 now takes the latter treatment for FIE non-investment enterprises nationwide. 

Key impacts of Circular 28 for foreign investors include:

• Previously, FIE non-investment enterprises could only invest in China equity by using their accumulated business profits. Going forward, foreign investors have more flexibility to use foreign capital to establish enterprises in China (e.g. establish onshore holding companies and underlying China operating companies), conduct mergers and acquisition, and undertake restructurings. There is no need to change the business scope to include ‘equity investment’ to do so.
• In view of this, FIE non-investment enterprises could become an alternative structure for making domestic equity investments, alongside QFLP, FIVCIEs, and other variants of FIE investment enterprises.  Indeed, the tax rules are clearer for FIEs than for other investment platforms such as QFLP.  FIEs can also benefit from the incentive in Circular 102 (2018) which defers the application of withholding tax (WHT) on dividends where profits are reinvested in China. 
• Red chip structures (i.e. Chinese companies with a Hong Kong or Cayman top company as listing entity) can also benefit. These can inject the foreign capital raised overseas into their onshore controlled entities, which can then make onward domestic equity investments.

A number of additional points are worth noting:

• Circular 28 provides that the domestic investments made with registered capital should be “genuine” and reasonable. It is not entirely clear what this means - it could be that capital cannot be invested in companies without a substantive business. Further guidance is needed in this regard.
• Circular 28 states that FIE non-investment enterprises can use registered capital in domestic equity investments. The Shanghai FTZ pilot policy goes broader, allowing foreign debt, and other capital, to be used as well. It remains to be seen whether Circular 28 scope will be similarly expanded.
• There are differences in the cash flow and registration procedures for FIE non-investment enterprises and FIE investment enterprises. The latter can directly remit capital into the RMB settlement accounts of subsidiaries or equity transferors without restrictions. The subsidiaries or equity transferors themselves do not need to complete an information registration on receiving the payments. FIE non-investment enterprises are subject to more cumbersome rules.

With an overall deepening of reform and opening-up, China is exerting even more efforts to optimize the business environment. KPMG will continue to pay close attention to relevant policies and assist investors with investing and expanding their businesses in China. We can provide the following services:

• M&A tax advisory;
• Tax due diligence;
• FIE set-up advisory;
• China tax advisory and compliance.