In the wake of a notable decrease of foreign direct investment (FDI) in the first half of 2017 (down 5.43% year-on-year), the Chinese government is making tremendous efforts to encourage more foreign investment in China in the interest of sustainable long-term economic growth. On June 28, the country’s National Development and Reform Commission (the “NDRC”) and Ministry of Commerce (the “MOFCOM”) issued the 2017 Foreign Investment Industrial Guidance Catalogue (the “2017 Catalogue”); the 2017 Catalogue, which took effect on July 28, relaxes restrictions on foreign investment. As well, on July 30 the MOFCOM introduced changes that ease corporate filing requirements for foreign investment enterprises. Furthermore, the State Council (the cabinet) announced on July 28 that a number of incentives will be rolled out to attract more foreign capital.

The 2017 Catalogue

The “Negative List” Approach

The Negative List for the Market Entry of Foreign Investment was issued in conjuction with the 2017 Catalogue. The negative list is an administrative measure that restricts market entry of foreign investment in certain industries. The negative list was first introduced in the Shanghai free trade zone in 2013, and extended to several new free trade zones in 2015. The 2017 Catalogue includes the first national negative list for FDI.

Generally, foreign investment is permitted in all industries outside the negative list. But even within the negative list, some industries are classified merely as “restricted,” and foreign investment is permitted if certain shareholding or senior executive requirements are met and approval procedures completed. Foreign investors are not permitted to invest in the prohibited industries.

New Structure of the 2017 Catalogue

The 2017 Catalogue – the eighth version – has adopted a new structure to guide market entry for foreign investment. In the previous version (2015), there were three parts: encouraged, restricted and prohibited industries. The 2017 Catalogue has only two parts:

• Encouraged industries; and
• The negative list, which contains:
  • Prohibited industries;
  • Restricted industries; and
  • Encouraged industries that are subject to certain restrictions.

It is important to note that industries that are prohibited for both domestic and foreign investment are not included in the negative list. Foreign investment in these industry sectors is subject to the same treatment as domestic investment in these sectors. These sectors include, for example, business related to the development of large theme parks, golf courses and villas; the construction of certain coal-fired power generation plants; the processing of certain traditional Chinese medicines ; and ivory carving, processing of tiger bones, etc.

More Sectors Opened Up

The 2017 Catalogue has reduced the number of restricted and prohibited items from 93 (in the 2015 Catalogue) to 63. The changes are mainly focused on the mining, manufacturing and service industries.

• Mining industry: Restrictions on several mining sectors are eliminated, including non-conventional oil and gas (fracking), precious metals, lithium ore and rare metals.
• Manufacturing industry: Restrictions on several sectors are removed – for example, manufacturing of railway transportation equipment, electric bus network equipment, batteries for new-energy vehicles, motorcycles, marine engineering equipment, diesel engines for vessels, satellites, edible oils, and fuel ethanol. In addition, the limitation on the number of joint venture (JV) enterprises that can be established by a foreign enterprise for the manufacture of electric cars has been eliminated (previously, a foreign enterprise could establish no more than two such JV enterprises).
• Service industry: Restrictions on certain service sectors are removed, including highway transportation of passengers, cargo handling, creditworthiness investigation and rating, accounting and auditing, construction and operation of agricultural wholesale markets, construction and operation of water control hubs.

New Restrictions on Cultural Sectors

Newly added restrictions in the 2017 Catalogue are mainly in the cultural sector, such as the editing and publication of books, newspapers, magazines, audiovisual products and electronic publications; provision of radio and TV video on-demand services; installation services for satellite TV broadcast receiving facilities and broadcasting to China of radio and television programs; internet-based news and information services and internet information publication services.

Amended Filing Measures for Foreign-Invested Enterprises

For foreign-invested enterprises (FIEs) that fall outside the negative list, things have relaxed as well. In October 2016, China replaced its existing approval regime for the establishment and alteration of these FIEs with a simplified record-filing process. This process is outlined in MOFCOM’s Interim Measures for the Record-filing of the Incorporation and Changes of FIEs. On July 30, 2017, MOFCOM issued an amended version of the filing measures (the “2017 Measures”), further facilitating certain types of foreign investment.

Facilitate Foreign Investors’ M&A Transactions and Strategic Investment in Listed Companies

Before the roll-out of the 2017 Measures, foreign investors’ mergers and acquisitions of domestic enterprises and strategic investments in publicly listed enterprises were subject to approval by MOFCOM. Under the 2017 Measures, MOFCOM approvals are no longer required if the business scope of the involved domestic enterprises is outside the negative list. Instead, the transaction will go through the record-filing process with the MOFCOM or its local counterparts, which will be less time-consuming than obtaining an approval.

On the administration side, the 2017 Measures stipulate two new requirements:

• Disclosure of the ultimate controlling party: When setting up an FIE or changing the ultimate controlling party the shareholding structure showing the ultimate controlling party of the FIE is required.
• New prerequisite to receive offshore shares as consideration: When foreign investors use shares of a qualified foreign enterprise as payment consideration, the domestic recipient should provide its Outbound Investment Certificate for record-filing purposes. Please note that the term “qualified foreign enterprise” needs further clarification from MOFCOM. As of now, we suggest only publicly listed foreign enterprises can be considered qualified foreign enterprises.

Looking Forward

In its July 28, 2017, executive meeting, the State Council announced five measures will be rolled out to attract more foreign investment.

1. Expand the negative list approach nationwide and relax the administrative measures. Improve the legal system by making it more complete and clearer in relation to attracting foreign investment.
2. Give preferential withholding tax deferral treatment when foreign investors use profits repatriated by the resident enterprises to directly invest in projects that are encouraged by the government. Expand the preferential corporate income tax treatment for advanced technology enterprises nationwide.
3. Discuss taking measures to cut or lift the shareholding restrictions for foreign enterprises in some manufacturing sectors and service industries, and encourage local governments to attract multinational companies to set up regional headquarters. Permit foreign investors to set up FIEs in China through M&A transactions. Strengthen intellectual property protection for foreign investors.
4. Empower designated national development zones with greater authority in terms of investment management. Prioritize foreign-invested projects’ need for construction land that is compliant with planning. To attract foreign investment, offer more government financial support to  the science and technology, environmental protection and public service sectors of the national development zones in the western region and northeast industrial bases.
5. To attract and retain foreign talent, streamline work permit applications, expand visa issuance and extend visa expiration dates.

According to the statement, the State Council expects all the above measures to be implemented by the end of September 2017.

Alvarez & Marsal Taxand Says:

In practice, the negative list is not the only market entry standard for foreign investment in China. We suggest that before making any decisions, foreign investors need to consider other legal requirements as well, including regulatory, policy and industry standards or requirements. The local business environment and local preferential policies should also be carefully considered.

While restrictions on many sectors have been eased significantly, it is worth noting that China is more rigorous than ever on market entry for cultural sectors. The Chinese government is also more sensitive about certain service sectors (finance, education, medical treatment) and infrastructure sectors (transportation and telecommunications). Therefore, foreign investors will have to be more patient about such sectors opening up to foreign investment.

In 2015, MOFCOM issued a draft Foreign Investment Law for public comment. Although it is still under discussion, there is recent news that the legislation process will be expedited. Once finalized, the new law will have significant ramifications for the foreign investment regime in China. Foreign investors should keep an eye on developments.

The series of measures discussed in this article are part of the Chinese government’s strategy to encourage more foreign investment, optimize the industrial structure and support the development of the local economy. The changes in the 2017 market entry catalogue make it clear that the Chinese government is encouraging foreign investment in high-end manufacturing, high technology, energy conservation and environmental protection, new energy, and modern services. The State Council executive meeting further indicated that policymakers are determined to improve China’s business environment for foreign investment. From a more complete and better clarified foreign investment legal system to practical support from the local government, this is definitely good news for foreign investors who are willing to invest and succeed in China, the second-largest economy and one of the biggest markets in the world. 

Disclaimer

The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisers. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisers before determining if any information contained herein remains applicable to their facts and circumstances.

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