MinterEllison. By Thomas Keenan Member of the Minter Ellison China Interests Group

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1 By Thmas Keenan Member f the Minter Ellisn China Interests Grup Thmas.keenan@minterellisn.cm An Overview f Freign Direct Investment Law and Prcess in China China has taken great steps since 1979 t mdernize its ecnmy and raise the standard f living f many f its citizens. The refrm and prmulgatin f freign direct investment (FDI) laws, the prmtin f the rule f law and accessin t the WTO are sme f the greater steps taken by the Chinese gvernment t these ends. China s first laws gverning freign direct investment in China were created in 1979 with The Law f the Peple s Republic f China n Jint Ventures using Chinese and Freign Investment, a law that established the gvernment s firm hand in the evlutin frm a centrally planned ecnmy t a scialist ecnmy with Chinese characteristics with incrprates market elements. T further these gals, in 1978, the gvernment established the first f several special ecnmic znes which wuld experiment with capitalism thrugh direct freign investment. These znes were specifically develped t encurage the creatin f jint ventures using freign capital and t access freign technlgy and knw hw. In 1986, mre favrable regulatins and prvisins were develped t encurage freign direct investment inflw, especially exprt riented jint ventures and jint ventures using advanced technlgies. Whlly wned Freign Enterprises (WOFE) were als allwed fr the first time. The Chinese State Cuncil prmulgated the Prvisins f the State Cuncil f the Peple s Republic f China fr the Encuragement f Freign Investment. These s called 22 Article Prvisins prvided freign jint ventures with preferential tax treatment, the freedm t imprt inputs such as materials and equipment, the right t retain and swap freign exchange with each ther, and simpler licensing prcedures. Additinal tax benefits were ffered t exprt riented jint ventures and thse emplying advanced technlgy. The gvernment als attempted t guarantee further the autnmy f jint ventures frm external bureaucratic interference, t eliminate many unfair lcal csts, and t prvide alternative ways fr jint ventures t balance freign exchange. Privileged access was prvided t supplies f water, electricity and transprtatin (paying the same price as statewned enterprises) and t interest free RMB lans. Cmpeting Tensins Within the Law China s freign direct investment laws tday are shaped largely by tw ppsing sets f tensins. On ne hand, China s 2002 accessin t the Wrld Trade Organizatin (WTO) and its membership required that it reduce r dismantle prhibitive tariffs n freign prducts and give freign access t Chinese markets. Secndly, the Chinese gvernment set a gal t capture 1/3 f all freign direct invested capital in the develping wrld. T d this, the gvernment needed t establish a legal framewrk and a rule f law legal culture that wuld cunter t the internally and externally perceived ntin that law in China was ambiguus.

2 On the ther hand, the Chinese Cmmunist Party (CCP), as the highest authrity within the gvernment, feels the need t cntrl, limit r eliminate a freign presence in industries that are essential r natinal interests. Chinese freign direct investment laws, in their current incarnatin, embdy these tensins and leave a fair amunt f ambiguity s that an investr shuld prceed with cautin. The Impact f FDI n China s Ecnmy and its Rle in Maintaining Scial Order Because f its lwer labur csts, emerging middle class and a stable freign direct investment schema, China is the biggest recipient f freign direct investment capital amngst develping natins in the wrld. FDI investments in China have grwn frm $40 billin USD in 1999 t a recrd $92.4 billin USD in The CCP understands the imprtance f FDI n the develpment f China s GDP and by extensin, the rle f FDI n helping t build prsperity in the lives f rdinary Chinese thrugh the prsperity the rise in incme brings. As a result the Chinese gvernment is intensely fcused n maintaining a steady and increasing inflw f freign capital thugh n its wn terms t maintain scial stability. Mre than 50% f FDI int Chinese industry cmes frm Taiwan and Hng Kng. Althugh plitically they are cnsidered t be part f China, frm a legal perspective they are seen t be freign territries. The Hng Kng limited cmpany is a cmmn freign entity used fr investments in China. The Chinese gvernment, thrugh early FDI law, sught freign capital fr a wide variety f prjects regardless f envirnmental impact, waste r energy use. Tday, given China s energy crises and pllutin prblems, the future shaping f the Chinese FDI industry catalgue will take int accunt a balancing between the need t attract ever mre scarce freign capital with the need t shift investments twards the high tech, envirnmentally friendly, energy efficient end f the spectrum. The FDI Apprval Schema Apprval fr an investment in China is made alng tw axes. The first axis is the amunt f the investment itself. Depending n the size f the investment t be made, apprvals can be delegated authrities at the prvincial, vice prvincial r even municipal level. Typically investments f less than $10,000,000 USD are apprved at the municipal level while investments up $100,000,000 USD are apprved at the prvincial level while thse that exceed this size need t be apprved by the Ministry f Cmmerce (MOFCOM) itself. The investments are valued by the input f capital, equipment and intellectual prperty. The secnd axis is the review amngst fur distinct categries f investment as set ut by the MOFCOM with their wn limits. These categries include Encuraged, Restricted, Prhibited and Permitted industries. The Ministry updates and publishes the list f industries 2 every few years in respnse t the Central Gvernment s blueprint fr develping the ecnmy. Here is a brief verview f these categries. 1 Surce Ministry f Cmmerce Peple s Republic f China February

3 Encuraged Industries Industries in this class typically include investments in high technlgy where there is high degree f knwledge transfer frm a freign party t the Chinese side. Investments in this categry rarely require a Chinese partner, have any wnership restrictins and n ther cnsideratin is required by the MOFCOM. Industries in this categry include the textiles and pharmaceuticals. Restricted Industries Industries in this categry typically require d nt require specific prject by prject apprval by the MOFCOM, but are subject t ther cnstraints including the need fr a Chinese partner and limits in freign equity, nrmally nt t exceed 49% f the enterprise. Industries in this categry include the autmbile industry, real estate develpment and certain service sectrs. Prhibited Industries As can be determined frm the name, industries in the categry are ff limits t freign investment fr reasns f natinal security. These industries include weapns develpment and sme natural resurces explitatin amngst thers. Permitted Industries All target investment industries that d nt fall int the first three categries fall int this default categry. The MOFCOM states that freign investrs cntemplating an investment in this area shuld apprach the MOFCOM fr specific apprval fr each prject fr a determinatin f any stipulatins that any putative investment may be subject t. The prcess itself can take between six and twelve mnths, and in sme cases, even lnger. While there are n clear guidelines as t hw the MOFCOM apprves specific applicatins, it is likely that the Ministry will impse sme frm f restrictins n an investment when ne f the fur fllwing criteria are met: a party has a turnver exceeding $200,000,000 USD the freign investr bught mre than 10 cmpanies in ne year a party cntrls (including a dmestic partner) mre than 20% f the dmestic market the parties tgether will reach 25% f the market The ambiguity f the permitted industry is a significant disincentive t any party lking t make an investment in China, as the csts, effectiveness and cnstraints f the investment will nt be fully knwn until apprval is given. Factrs t Cnsider When Deciding t Enter China There are many reasns t invest in the Chinese market, including the need t access lw cst prductin, the need t wn and cntrl ne s wn assets fr the sake f maintaining prprietary infrmatin r the desire t side step tariffs t grw dmestic sales. 3

4 Ptential investrs in China shuld cnsider amngst ther things, the need fr, and the ability t find a suitable lcal partner. A lcal partner may be required when there are restrictins t either prductin r dmestic sales licenses. Cmmn pitfalls that freign cmpanies encunter when investing in China include a misunderstanding f Chinese land law, inadequate intellectual prperty prtectin, experiences with energy shrtages and labur issues. Parties lking t invest in China shuld seek lcal expertise in these areas befre making any cmmitment t invest in China. Dispute reslutin prcesses need t be carefully cnsidered when taking n a lcal partner. Depending n the ptins available, a party may wish t acquire a lcal Chinese cmpany, t create a Whlly wned Freign Enterprise (WOFE) r establish an Equity r Cntractual Jint Venture with a Chinese partner. The Gvernment's Rle in the Acquisitin f a Chinese cmpany Gvernment agencies, particularly the MOFCOM, play an imprtant rle in Chinese M&A transactins. There is a higher level f gvernment participatin in M&A transactins in China than is typical in ther jurisdictins. Despite the recent relaxatin f freign investment restrictins, pervasive apprval requirements remain a distinctive feature f M&A transactins in China. In these transactins, PRC gvernment agencies d nt merely act as anti trust r cmpetitin regulatrs. Their cncern is nt limited t the ecnmic cnsequences f a transactin. They play a much brader rle in reviewing and apprving deal specific arrangements. In many M&A transactins, gvernment agencies act as bth regulatr and vendr, and will have scial and plitical cncerns that extend well beynd the cmmercial aspects f the transactin. The discretinary apprvals required fr an M&A transactins are nt mere frmalities, and may take cnsiderable effrt t btain. Understanding the applicable regulatry framewrk, the gvernment's rle in the acquisitin prcess and the individual decisin makers are imprtant t successfully cncluding transactins in China. The Prcess fr Establishing a Equity Jint Venture (EJV) r an Cntractual Jint Venture (CJV) Cmpany in China Share hldings in a jint venture are usually nn negtiable and cannt be transferred withut apprval frm the Chinese gvernment. Investrs are restricted frm withdrawing registered capital during the life f the jint venture cntract. Regulatins surrunding the transfer f shares with nly the apprval f the bard f directrs and withut apprval frm gvernment authrities will prbably evlve ver time as the size and number f internatinal jint ventures grw. There are specific requirements fr the management structure f a jint venture but either party can hld the psitin as chairman f the bard f directrs. The freign partner(s) must cntribute a minimum f 25% f the capital. There is n minimum investment fr the Chinese partner(s). 4

5 Befre applying fr the establishment f an EJV r CJV, the fllwing dcuments must t be btained: The necessary wrk and resident permits fr the legal representatives The apprval and crrespnding certificate frm varius authrities like the Planning Bureau, the Public Security Department, the Freign Ecnmic and Trade Bureau, etc. The apprval frm the Industrial and Cmmercial Registratin Office t use a certain cmpany name A reprt f crprate capital verificatin issued by a Chinese public accuntant Once all the dcuments that are needed fr the applicatin have been btained, the applicatin prcedure can take effect. The prpsal fr the establishment f an EJV r CJV has t be submitted t the relevant examinatin and ratificatin authrities. Once the prpsal has been apprved wrk can start n researching the prject feasibility. As sn as the research n the prject feasibility has been cmpleted, the reprts theren have t be submitted. Once they are apprved, the parties invlved can start negtiatins n the signing f the legal dcuments, such as the cntract r the articles f crpratin f the cmpany. As sn as the negtiatins are cmpleted successfully, the cntract and the articles f crpratin f the cmpany t be established have t be submitted t the relevant departments f the MOFCOM. Once they have apprved the dcuments, they will issue the Apprval Certificate fr Enterprises with Freign Investment. A decisin is nrmally rendered within 30 days f submissin f all dcuments. With the issued Apprval Certificate, the investrs will have t g t the State Administratin fr Industry & Cmmerce (SAIC) t cmplete the registratin prcedure fr the cmpany. Under PRC law, the agreement t transfer shares in a sale f equity agreement des nt becme binding until it is apprved by the Apprval Ministry. Current Trends and Outlk fr 2009 and Beynd The current glbal ecnmic crisis and seen a dwnturn in direct freign investment in China and ther develping markets and there are indicatins frm the Central Gvernment and the MOFCOM that China will return t qualified exprt grwth mdel. The return t this mdel will see a return t supprt fr lw tech, high emplyment manufacturing investments t ffset jb lsses that have ccurred in the last six mnths f 2008 until the present. The qualificatin t the return f the exprt mdel will be the strnger prhibitin f high pllutin, high waste, energy inefficient prjects just t btain investment. There are nt expected t be any adverse changes in the incme tax cde in the near future t prtect lcal cmpanies; the level playing field tax plicy will cntinue. Further tax incentives may be created t encurage develpment in central and western regins f 5

6 China. While crprate incme tax rates remain stable, ther taxes such as VAT and ther lcal taxes change ften. In respnse t the grwing number f unemplyed migrant wrkers frm central China, the Central Gvernment is planning an verhaul f the VAT tax system that will benefit investrs fcused n exprt riented and lw tech manufacturing in an effrt t sak up these wrkers. The current catalgue f investment industries is expected t remain the same fr the freseeable future and there n plicy changes are expected that might discurage M&A activity. Cnclusin The FDI climate in China is changing as a result f the current glbal ecnmic dwnturn. China has been especially hard hit and the gvernment recgnizes the rle f FDI in maintaining scial stability. China s respnse t the dwnturn has brught abut a qualified return t lw tech, exprt riented, high emplyment industries in rder maintain the current GDP grwth rates and t stave ff scial instability. The freign investr needs t cnsider and weigh a number f factrs befre deciding whether r nt t acquire a cmpany, establish a jint venture r a WOFE. VAT and incme tax plicies, aimed a prtecting certain industries r encuraging investments in a certain sectr, change regularly and can have a significant impact n the peratins f any investment either actual r in the future. Finally, the rle f the Chinese gvernment in M&A transactins shuld nt be underestimated. Given the nature f the Chinese plitical system and the tendency t prtect indigenus cmpanies, smetimes seemingly straightfrward investments may cme under intense scrutiny and require significant effrt t realize. With the further refrm f FDI laws, the prmulgatin f better cmmercial laws t versee dispute reslutin and the further establishment f the rule f law, China is set t increase its share f freign capital available fr generatins t cme. Abut Minter Ellisn: Minter Ellisn is ne f the largest full service law firms in the Asia Pacific regin. With mre than 280 partners and 1,000 legal staff lcated in Australia, Hng Kng, The Peple's Republic f China, Indnesia, New Zealand and the United Kingdm, Minter Ellisn supprts leading industry and gvernment clients. Fr mre infrmatin, please visit: 6

Canadian Embassy and Canada Spain Chamber of Commerce Encounter. Economic Agreement between the EU and Canada

Canadian Embassy and Canada Spain Chamber f Cmmerce Encunter INTRODUCTION Ecnmic Agreement between the EU and Canada 11 March 2009 I shuld like t thank the Chamber f Cmmerce and the Embassy fr the invitatin