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Revolutionizing Foreign Investment in China

Since the early 1990s, welcoming foreign investment has been one of the cornerstones for China's economic development, while at the same time foreign investors have continued to be subjected to stricter rules and procedures than their domestic counterparts. This is about to change with the new PRC Foreign Investment Law, which will simplify procedures for foreign investors to establish in China, and lift some of the remaining restrictions to foreign investment in specific industries. The draft PRC Investment Law was published on 19 January 2015 for public comment, and is expected to be issued this year for implementation in early 2016. The current draft will likely be subject to some further revisions, but some of the key principals are expected to remain:

  1. The new PRC Foreign Investment Law replaces the existing legal framework for foreign-invested enterprises, consisting of separate laws for wholly foreign-owned enterprises (WFOEs), equity joint ventures (EJVs) and cooperative joint ventures (CJVs) with foreign investment, as well as their implementing rules. Existing WFOE's and JV's will have three years to comply with the new rules.
  2. The approval procedures that currently apply to the establishment of foreign-invested enterprises will be replaced by a direct registration with the local Administration for Industry and Commerce (AIC), which will not only save time but also limit scrutiny on key documents such as the articles of association and joint venture contract (where applicable). Foreign investors will thus have more flexibility to make arrangements on a commercial basis, as long as they comply with the PRC Company Law.
  3. Currently, the Catalogue for Guidance of Foreign Investment Industries determines whether foreign investment in a certain sector is encouraged, restricted or prohibited; foreign investment is permitted in all sectors not listed. This Catalogue will be replaced by a "Negative List" containing prohibited and restricted sectors, which is expected to be shorter. Only foreign investment in restricted sectors, or investments above a certain monetary threshold, will remain subject to approvals or, in some cases, a national security review, while no foreign investment will be allowed in the prohibited sectors. 
  4. Foreign investment is no longer defined with regard to ownership but rather, should reflect on control. As a consequence, round-trip investments by Chinese investors will no longer be subject to foreign investment restrictions. On the other hand, Variable Interest Entities (VIE) whereby a foreign company controls a domestically-owned business through a contractual arrangement will be regarded as foreign investment, as may other forms of foreign control such as long-term foreign financing and the acquisition of concessions to explore natural resources. The widespread use of VIEs to circumvent restrictions on foreign investment in prohibited or restricted sectors (e.g. media, internet) seems therefore no longer allowed when the new law comes into force. It is yet uncertain if and how existing VIEs (e.g. Alibaba, Baidu) in such sectors may continue to operate.
  5. To counter the removal of prior approvals, including for routine changes such as of address, registered capital or even ownership, the PRC Foreign Investment Law introduces new reporting requirements, compelling foreign-invested companies to submit initial reports, subsequent reports and periodical reports on operational and financial performance, the actual controller of the investment etc. Considering that the law also introduces the principle of national treatment, it remains to be seen how this burden will work in practice. 

Interestingly enough, many of the provisions including the removal of approval procedures and the introduction of a Negative List, have already been successfully tested in the Shanghai Free Trade Zone. Many questions remain, including what will happen to tax and customs duty benefits that some foreign-invested companies have been enjoying. Nonetheless, the immediate conclusion remains that this law is the natural next step in the gradual process of lowering barriers to foreign investment, and providing foreign-invested businesses with more freedom to engage in activities on commercial terms and in full and fair competition with domestic-invested counterparts.

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