Deacons
  January 6, 2006 - Hong Kong

China: Revised Rules on Forex Controls in M&A Transactions

The State Administration of Foreign Exchange (“SAFE”) issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Round Trip Investment through Special Purpose Companies by Residents Inside China on 21 October 2005. The Notice, which became effective on 1 November 2005, repeals the earlier notices regarding the use of overseas holding companies for round trip investment that were issued earlier this year: the Notice of the State Administration of Foreign Exchange on Relevant Issues in Perfecting Foreign Exchange Control in Mergers and Acquisitions by Foreign Investors and the Notice on Relevant Issues in the Registration of the Offshore Investments of Individual Domestic Residents and Foreign Exchange Registration of Mergers and Acquisitions by Foreign Investors (as discussed in the 2005.2 issue of China Legal Update). These earlier Notices required residents in China who, directly or indirectly, invested in the establishment or assumed control of an enterprise outside China for the purpose of making investment in China to carry out approval and registration formalities with the foreign exchange authorities. Definitions For the purpose of the Notice, the term “special purpose company” is an enterprise outside China established directly or controlled indirectly by a legal person resident inside China or a natural person resident inside China through equity financing (including convertible bond financing) by means of the assets or equity of an enterprise inside China held by such person. The term “round trip investment” as used in the Notice refers to direct investment activities carried out inside China by residents inside China through a special purpose company. Round trip investment includes but is not restricted to the following activities: • to acquire or swap the interest of the Chinese party in an enterprise inside China; • to establish a foreign investment enterprise (“FIE”) inside China and acquire or agree to control assets inside China through that FIE; • to agree to acquire assets inside China and use such assets to invest in the establishment of an FIE inside China; or • to contribute to the capital increase of an enterprise inside China. The term “legal person resident inside China” is defined in the Notice as an enterprise or institute legal person or other economic organisation. The term “natural person resident inside China” is defined in the Notice as a natural person who holds legal identification documentation such as an identity card or passport of the People’s Republic of China or who, although he holds no legal status inside China, resides habitually inside China for economic reasons. In the remainder of the summary, legal person residents inside China and natural person residents inside China are collectively referred to as Chinese residents. For the purpose of the Notice, the term “control” means that a Chinese resident has obtained operating rights, profit rights, or decision-making power over, a special purpose company by way of non-exclusivity acquisition, trust or voting rights. Foreign exchange registration Before a Chinese resident may establish or control a special purpose company outside China, it is required to register the overseas investment with its local foreign exchange authority. The Notice details the application documents which need to be submitted for this purpose. Once a Chinese resident has injected assets or equity of an enterprise inside China into the special purpose company or engages in overseas equity financing after the injection of such assets or equity, the Chinese resident shall amend the registration to reflect the changes. Repatriation and use of funds Upon completion of the overseas equity financing by the special purpose company, the Chinese resident may repatriate the funds which were earmarked for use inside China in accordance with the planned use of the funds stated in its registration materials. The use of funds in China by the special purpose company is subject to the standard formalities. After the Chinese resident has completed the foreign exchange registration or change of registration procedures, the special purpose company may receive profits, dividends and liquidation funds from the invested enterprise in China. If a special purpose company undergoes any major capital change, then the Chinese resident shall report the change to the relevant foreign exchange authority within 30 days after the change has occurred. Other provisions The Notice requires a Chinese resident who has established or has gained control over a special purpose company and has completed the round trip investment prior to the date on which the Notice is implemented but failed to carry out the relevant foreign exchange registration procedures to retroactively attend to the relevant formalities before 31 March 2006. The repatriation of funds received by the Chinese resident from the special purpose company is required within 180 days. The Notice provides that a venture capital enterprise inside China can establish a special purpose company outside China to engage in venture capital investment activities with reference to the provisions of the Notice.