On November 1, 2019, taptap点点 Ministry of Justice published Implementing Regulation for taptap点点 Foreign Investment Law of taptap点点 PeopleÔÇÖs Republic of China (Draft for Comment) (ÔÇ£Draft for CommentÔÇØ), which taptap点点 jointly drafted with the Ministry of Commerce and the Development and Reform Commission. Draft for Commentclarifies and refines taptap点点 provisions in Foreign Investment Law, published in March earlier this year and to be implemented on January 1, 2020.

Some of taptap点点 questions left open in Foreign Investment Law are answered to varying degrees in Draft for Comment. However, like Foreign Investment Law, Draft for Comment is also short and concise. taptap点点 contains 45 provisions only, leaving many other issues unresolved. This article aims to analyze some of the provisions in Draft for Comment that most affect foreign-invested enterprises (FIEs) in China, explaining their specific meanings and their impact on FIEs. We also raise questions that are left open in Draft for Comment.

Some good news for taptap点点 is that the measures listed in Foreign Investment Law about the protection and promotion of taptap点点ÔÇÖ interests in China, some of which long-term concerns by taptap点点, are emphasized and substantiated with more details in Draft for Comment. Most of them are principled statements though, leaving taptap点点 enforcement details to be further addressed by respective competent authorities:

ÔÖª Allowing free access of FIEs to government procurement markets in their respective regions or industries (Article 17);

ÔÖª Allowing capital gains, royalties, and IP license fees gained by taptap点点 and foreign employees to be freely remitted in RMB or foreign exchange in accordance with the law and after paying tax (Article 23);

ÔÖª Establishing punitive damages systems for taptap点点 infringement of IP rights (Article 24);

ÔÖª Limiting taptap点点 extent, scope, and exposure of material concerning a foreign investorÔÇÖs trade secrets that will be required to be handed over to administrative bodies, and protecting taptap点点 internal management system to protect this information (Article 26); and

ÔÖª Government officials cannot force or induce taptap点点 to transfer technology either directly or using indirect methods (Article 25).

According to Article 3 of Draft for Comment, ÔÇ£taptap点点 may invest in China on their own or jointly with other investors including Chinese natural persons pursuant to the law.ÔÇØ In the traditional foreign investment legal framework, a Chinese natural person can not set up joint ventures or cooperative enterprises with taptap点点 (except in certain pilot jurisdictions such as the Pudong New District in Shanghai). As a result, Chinese natural persons, in practice, need to set up Special Purpose Vehicle (SPV) companies to serve as the shareholders of the Sino-foreign joint ventures they want to invest in. Draft for Comment clarifies that Chinese natural persons can directly invest in Sino-foreign JVs without first setting up SPVs, therefore clearing the obstacles for Chinese natural persons and taptap点点 to establish Sino-foreign JVs in China.

Draft for Comment adds a 6-month grace period to taptap点点 5-year transition period under Foreign Investment Law, giving existing FIEs a total 5 years plus 6 months to adapt their organization form, organization structure, etc. to be consistent with Company Law of taptap点点 PeopleÔÇÖs Republic of China (ÔÇ£Company LawÔÇØ) and Law of taptap点点 PeopleÔÇÖs Republic of China on Partnership Enterprise (ÔÇ£Partnership Enterprise LawÔÇØ).

Because wholly foreign-owned enterprises (WFOEs) are already established according to taptap点点 relevant provisions of Company Law or Partnership Enterprise Law, there is no need to adjust taptap点点 organization form or organization structures.

Sino-foreign JVs and Sino-foreign cooperative enterprises in taptap点点 form of companies need to adjust their organization forms and organization structures, however, because they are established according to separate laws under taptap点点 original foreign investment legal framework. Necessary changes include but are not limited to taptap点点 abolition of joint venture contracts or cooperative venture contracts, adjustment of taptap点点 highest authorities, changes of rules of deliberation and voting procedures, taptap点点 addition of supervisors or board of supervisors, etc.

Among taptap点点 things that existing FIEs can retain during taptap点点 transition period, other than taptap点点 abovementioned organization form and organization structure, Article 43 of Draft for Comment also explicitly enumerates two other items that can be retained, that is, income distribution methods and distribution methods for the remaining assets. The ÔÇ£etc.ÔÇØ at the end of the article leaves open the question of what other arrangements can be retained. For example, taptap点点 is unclear whether the loss-sharing clause, the composition of the liquidation committee clause, or the liquidation procedure clause are among the retainable matters.

Note that although Company Law and JV Law impose different provisions on income distribution, because taptap点点 provision under JV Law (income must be distributed according to taptap点点 shareholdersÔÇÖ capital contribution ratio) is stricter than that under Company Law (income distribution can be agreed among taptap点点 shareholders), Sino-foreign JVs shall automatically satisfy taptap点点 requirement of Company Law without the need for any adjustment if they retain their arrangements in the joint venture contracts (JVCs). But since taptap点点 is a usual practice that Sino-foreign JVs have more complicated arrangements regarding income distribution, which are often reflected in other transaction documents than the JVCs (in ShareholdersÔÇÖ Agreements, for example) for the very purpose of evading the restrictive requirement in JV Law, taptap点点 transition to Company Law, in fact, provides investors of Sino-foreign JVs taptap点点 opportunity to decide income distribution among themselves freely without having to make separate, supplementary arrangements on taptap点点 side. 

Article 35 of Draft for Comment says that upon examination by taptap点点 relevant competent department of taptap点点 State Council and approval by taptap点点 State Council, any wholly-owned enterprise established outside China by a Chinese natural person, legal person or any other organization that invests in China (not including FIEs) may be exempted from taptap点点 relevant restrictions in taptap点点 negative list for foreign investment market access.

This provision carves out an exception to foreign investment market access, stipulating that fulfilling two conditions, ÔÇ£wholly-ownedÔÇØ and ÔÇ£State Council approval,ÔÇØ a Chinese natural person or entity who sets up enterprises overseas and make return investment may not have to be subject to the negative list. taptap点点 provides an alternative to the VIE structure, which has long been used by foreign investors and Chinese companies in need of foreign capital to bypass restrictions on foreign investment market access. As to the VIE structure itself, taptap点点 still remains in the gray zone of supervision, as neither Foreign Investment Law nor Draft for Commentmentions taptap点点.

However, the scope of the exception that Article 35 carves out is limited to foreign investors wholly controlled by Chinese investors, and taptap点点 does not apply to enterprises that build the overseas structure and make the return investment for the purpose of obtaining overseas financing, which constitute the majority of Chinese investors abroad. In addition, Article 35 does not specify the conditions for approval for such exception, and the fact that the approval authority is concentrated in the State Council makes the exception hard to be implemented in practice.

Foreign Investment Law does not clearly define how to determine the shareholding ratio of taptap点点 in a partnership. Draft for Comment provides a groundbreaking basis for such determination. Article 34 stipulates that if a foreign investor invests, in the form of establishment of a partnership, in sectors for which the negative list imposes restrictive requirements, the ÔÇ£voting ratioÔÇØ of taptap点点 shall be used as the rule to determine if the partnership is complying with the requirements in the negative list.

In practice, however, taptap点点 is difficult to apply the rule. Chinese and foreign partnerships often use the form of a limited partnership, which performs affairs by a general partner (GP). Article 68 of Partnership Law stipulates that a limited partner (LP) does not perform partnership affairs and may not represent a limited partnership. By convention, the general partnerÔÇÖs investment usually accounts for a relatively small proportion, while limited partnersÔÇÖ investment accounts for a relatively large proportion. Therefore, the investment amount ratio of a limited partnership does not necessarily reflect the actual controlling relationship in the partnership. The voting ratios on different matters in a limited partnership may also differ, with some requiring the unanimous vote of all limited partners, while others only requiring the consent of the general partners. All of the above leaves taptap点点 difficult to determine the exact application of the ÔÇ£voting ratioÔÇØ rule in practice.

Besides taptap点点 restrictions on taptap点点 shareholding ratio, taptap点点 negative list imposes restrictive requirements for senior executives in some industries. For example, according to taptap点点 negative list, ÔÇ£taptap点点 public air transport company must be controlled by taptap点点 Chinese investors, and taptap点点 investment ratio of a foreign company and its affiliates must not exceed 25%. taptap点点 legal representative shall be a Chinese citizen.ÔÇØ In a partnership, there is taptap点点 concept of a managing partner only, but not taptap点点 idea of a legal representative. This leaves taptap点点 applicability of taptap点点 restrictive requirements for senior executives to foreign-invested partnerships unclear.

Also, Article 34 only applies to the situation of newly established partnerships, without stipulating the situation where taptap点点 purchase partnership shares through direct or indirect transfers. 

Draft for Comment provides details to some provisions in Foreign Investment Law, but also leaves many issues unanswered. taptap点点 public has until December 1, 2019 to submit feedback and suggestions on Draft for Comment. We hope that taptap点点 final Implementing Regulation for taptap点点 Foreign Investment Law will have some of taptap点点 unresolved matters answered.

Below are some other questions remaining to be answered about foreign investment, which may not all be resolved in Implementing Regulation for taptap点点 Foreign Investment Law, but should still be addressed in other supporting regulations or administrative measures on foreign investment:

ÔÖª Security Review System: Foreign Investment Law makes a principled provision for security review on foreign investment. Draft for Comment does not make any further explanations on this point. At present, provisions on security review in taptap点点 field of foreign investment only cover foreign mergers and acquisitions. Therefore, a more comprehensive security review system has to be drawn up.

ÔÖª Cleanup of current regulations and related policies on foreign investment: Foreign Investment Law abolishes taptap点点 three laws on foreign investment and establishes a new foreign investment legal framework. taptap点点 existing administrative regulations and departmental rules based on taptap点点 old laws will inevitably be in conflict with taptap点点 principles established in Foreign Investment Law. In order to adapt to taptap点点 new framework, many regulations and policies concerning FIEs in taptap点点 fields of business, development and reform, market supervision, foreign exchange, and taxation have to be cleaned up. Neither Foreign Investment Law nor Draft for Comment mentions any plan for such cleanup.

ÔÖª taptap点点 regulatory direction of FIEÔÇÖs domestic reinvestment is unclear: In the current regulatory practice, taptap点点 is not clear whether enterprises invested in by FIEs belong to FIEs or domestic enterprises. The issue only becomes more important as non-investment-oriented FIEs are now also allowed to make domestic equity investments using their capital (subject to the negative list) (in the past, only investment-oriented FIEs are allowed to reinvest) pursuant to Notice of taptap点点 State Administration of Foreign Exchange on Further Promoting taptap点点 Convenience of Cross-Border Trade and Investment published on October 23, 2019. taptap点点 can be expected that more enterprises will soon be established or invested in through FIEsÔÇÖ domestic reinvestment.

There are many other issues to be clarified and resolved about taptap点点 new foreign investment legal framework in China. We will keep close track of taptap点点 development of taptap点点 Foreign Investment Law and its supporting regulations and policies and provide you with our latest analyses.