Now! China - Restructuring Foreign-invested Enterprises in China

Foreign business generally adopt one of the three forms of legal organisation when investing in China: Sino-foreign joint venture, Sino-foreign cooperative enterprises, and wholly foreign-owned enterprises. It is common for enterprises to restructure the assets or equity of foreign-invested enterprises already established in China to meet the needs of business strategies, production management, and capital financing. 

Equity Restructuring and Assets Restructuring 

Asset restructuring involves the sale of all assets by the foreign-invested enterprise to another foreign-invested or domestic-invested enterprise, resulting in the dissolution of the original entity.

In contrast, equity restructuring offers several advantages, such as streamlined procedures, shorter restructuring time, and reduced tax burdens. Therefore, in practice, the majority of foreign-invested enterprise restructuring is carried out through equity restructuring. However, it's essential to acknowledge the drawbacks associated with equity restructuring, notably the challenge of managing debt risks. Issues like external guarantees, contract defaults, and outstanding accounts payable pose significant risks to enterprises opting for this route. These risks often necessitate professional third-party institutions to conduct due diligence to minimise risks as much as possible.

Legal forms of restructuring for Foreign-invested Enterprises

There are various legal forms of restructuring for foreign-invested enterprises, such as: 

1. Equity restructuring of foreign-invested enterprises
2. Merger and division of foreign-invested enterprises
3. Restructuring of foreign-invested enterprise into joint-stock enterprises
4. Liquidation of foreign- invested enterprises. 

This article focuses on the first and second forms.

Equity Restructuring of Foreign-invested Enterprises

Equity restructuring of foreign-invested enterprises occurs in three scenarios: (1) the foreign party acquires the equity of the Chinese party to make it as a wholly foreign-owned enterprise; (2) the Chinese party acquires the equity of the foreign party to make it as a domestic enterprise; (3) new shareholders are introduced to increase the equity proportion of Chinese or foreign parties. Here we will look into scenarios (1) and (2).

(1) The foreign party acquires the equity of the Chinese party to make it as a wholly foreign-owned enterprise

When this occurs, two primary issues need to be considered:

• The protection of state-owned assets in China
  
  The initial local partners for introducing foreign-invested enterprises in China were predominantly state-owned enterprises. However, after decades of development, the Chinese and foreign parties often diverged in their positioning and development direction for joint ventures, leading to restructuring. When dealing with the disposal of state-owned shares, the requirements of state-owned asset supervision necessitates evaluating the target first and obtaining confirmation from the state-owned asset management department before determining pricing to prevent the loss of state-owned assets. In the restructuring process, foreign parties typically opt to engage internationally renowned accounting firms with branches in China to intervene as third-party service institutions.
  
  
• The restructuring is regulated by industrial policies
  
  Once the enterprise undergoes acquisition or restructuring and remains categorised as foreign investment, it must adhere to the "Special Administrative Measures for Foreign Investment Access (Edition 2021)" issued by the National Development and Reform Commission and the Ministry of Commerce of China, commonly referred to as the “Negative List”.

According to the Negative List, there are 10 industries that must be controlled by the Chinese party, 21 industries that prohibit the establishment of wholly foreign-owned enterprises, and additionally, some industries have special requirements for the proportion of foreign investment. Therefore, when a foreign party acquires the equity of a Chinese party, it must adhere to these regulations.

(2) The Chinese party acquires the equity of the foreign party to make it as a domestic enterprise.

When this occurs, as a foreign shareholder, two primary issues need to be considered：

• The fairness of equity transfer income
  
  The declared equity transfer income by the transferring party should be reasonable and supported by valid justifications:
  1. If the declared income is significantly low or lacks proper justification, the tax authorities have the right to make adjustments to ensure the fairness and reasonableness of the declaration;
  2. If the Chinese party’s subscription price for foreign equity or the registered capital corresponding to the purchase of equity exceeds 150%, several risk factors arise, including the reasonableness of equity transfer pricing, confirmation of the identity of foreign shareholders, whether the transaction involves related party transactions, and whether it is related to sensitive areas or sanction lists. In addressing these risks, special attention should be paid to ensuring that the pricing complies with market fairness principles, authenticating the reliability of foreign shareholder identities, and avoiding potential related party transactions and risks of violating sanctions regulations;
  3. If the target company being transferred holds assets with significant appreciation potential, such as real estate or intangible assets, an asset appraisal report is usually required to confirm the fairness of the equity transfer income. The asset appraisal report can provide professional evaluation opinions, thereby helping to determine a reasonable price for the equity transfer.
•  Tax issues
  
  Whether as a company or an individual acting as the transferor, there is an obligation to pay corporate income tax or personal income tax, and consideration should be given to related taxes and fees such as stamp duty. Additionally, since the transferor is a foreign shareholder, the impact of international taxation also needs to be comprehensively considered. This includes adhering to double taxation agreements or other international tax treaties to ensure compliance with the transaction and minimise tax risks to the greatest extent possible.

Merger and Division of Foreign-invested Enterprises

Merger and division are also significant forms of restructuring of foreign-invested enterprises. To regulate behaviors related to these processes, the Ministry of Commerce has issued the “Provisions on Merger and Division of Foreign-invested Enterprises,” in accordance with the laws and administrative regulations concerning foreign-invested enterprises outlined in the “Company Law of the People's Republic of China.”

(1) The organisational form of the enterprise after merger

Following a merger, the resulting enterprise may take on one of two organisational forms: "newly established mergers" or "absorption mergers."

1. Limited Liability Company + Limited Liability Company = Limited Liability Company;
2. Company Limited by Shares + Company Limited by Shares = Company Limited by Shares; 
3. A Public Company Limited by Shares + Limited Liability Company = Company Limited by Shares;
4. An Unlisted Company Limited by Shares + Limited Liability Company = Company Limited by Shares/Limited Liability Company.

(2) Issues of claims and debts after merger or division

A company merger refers to the process in which two or more companies combine into one company in accordance with procedures and conditions prescribed by law, with the debts and claims of the merging parties fully assumed by the merged company. The merging parties should sign a merger agreement, prepare a balance sheet, and a list of assets and liabilities. The company should notify creditors within 10 days from the date of the merger resolution and announce it in the newspaper within 30 days. Creditors, within 30 days of receiving the notice or within 45 days from the date of announcement if they did not receive the notice, may demand the company to repay debts or provide corresponding guarantees. 

A company division refers to the act of a single company splitting into two or more companies in accordance with legal procedures and conditions, after settling external debts or making arrangement for the debts that are recognised by the creditors. In the division of a company, the disposition of its assets, as well as debts and claims, should be correspondingly divided. The company should also prepare a balance sheet and a list of assets and liabilities for the division. The company should notify creditors within ten days from the date of the division resolution and announce it in the newspaper within thirty days. 

(3) Approval jurisdiction

The "Provisions on the Merger and Division of Foreign-Invested Enterprises" establish the principle of "original approval authority as the main reviewer" concerning approval jurisdiction. This means that the original approval authority is responsible for the primary review of mergers and divisions of companies within the same area. For mergers involving companies located in different areas, the approval authority where the merged company is situated primarily conducts the review. If the scale of the company post-merger exceeds the jurisdiction of the local approval authority, it should be submitted to the higher-level approval authority for primary review. 

(4) Control over monopolies and unfair competition involved in mergers

The Bureau of Commerce serves as the approval authority for company mergers. If the Bureau of Commerce determines that a company’s merger exhibits signs of industry monopoly or may establish a dominant market position for a particular product or service, impeding fair competition, it has the authority to convene relevant departments and institutions to hold a hearing on the proposed merger of the company and conduct an investigation into the company and its associated market. Consequently, the review period for the merger application may be extended to 180 days.

China Updates

Accounting and Taxation

• Cai Shui [2024] No. 8: Notice on the Pilot Program of Preferential Policies of Stamp Duty on Offshore Trade in China (Shanghai) Pilot Free Trade Zone and Lingang New Area
  • Trade contracts concluded by enterprises registered in the China (Shanghai) Pilot Free Trade Zone and the Lingang Special Area for the purpose of offshore trade are exempted from stamp duty.
  • For the purpose of this Notice, "offshore trade" shall mean the purchase of goods by a resident enterprise from a non-resident enterprise and subsequent resale of the goods to another non- resident enterprise, where the goods have never actually entered or exited the Customs territory of China.
  • This Notice shall come into effect 1 April 2024 and remain in effect until 31 March 2025.
• To promote the construction of affordable housing, the ‘Announcement on the tax and fee policy of affordable housing’ was jointly issued by the Ministry of Finance, the State Administration of Taxation, and the Ministry of Housing and Urban-Rural Development on 28 September 2023. The key points of the announcement are described as follows:
   
  • Exemption of the following taxes related to land use for affordable housing projects:
    1. Urban land use tax for project construction land
    2. Stamp duty for affordable housing management units, relevant housing, and purchasers
  • Exemption of Land Value Added Tax (VAT) for the transfer of old houses to affordable housing, provided that the appreciation ratio is lower than 20%.
  • Exemption of deed tax for management units to buy-back affordable housing.
  • Individuals purchasing affordable housing are subjected to a preferential deed tax of 1%.
  • Exemption of the following administrative fees and government funds for affordable housing projects:
    1. Air defense basement change site construction fees
    2. Urban infrastructure equipment fees
    3. Education fee surcharge and local education surcharge, etc.
  
  The above policies became effective on 1 October 2023.

Human Resources

• On 8 February 2024, the Office of the National Healthcare Security Administration, the General Office of the Ministry of Education, the General Office of the National Health Commission, the Office of the Women and Children's Working Commission of The State Council, and the General Office of the All-China Women's Federation issued a notice on the special action for children to participate in basic medical insurance. This notice clearly proposes effectively increasing the participation rate of children, with the goal of insuring more than 80% of newborns by the end of 2024.
  
  Regarding the optimisation of the newborn insurance process, the notice requires all localities to promote the implementation of integrated management of "birth one thing" and ensure timely inclusion in newborn insurance. In principle, newborns should participate in insurance payment within 90 days after birth, with medical expenses incurred from the date of birth included in the scope of medical insurance reimbursement. Individual pooling areas that do not comply with these provisions are urged to make adjustments promptly. 
  
  Local governments are encouraged to explore the use of birth medical certificates for newborn insurance. They can apply for medical insurance codes through family accounts or handling agencies and use these medical insurance codes to directly settle medical bills in designated medical institutions within 180 days after birth.

Corporate Governance

• On 19 March 2024, the Chinese government released the Circular of the State Council on Issuing the Action Plan on Solidly Promoting High-level Opening-up and Intensifying Efforts to Introduce and Utilise Foreign Investment. This initiative calls for the implementation of policy support measures aimed at enhancing the country’s attractiveness to foreign investment. The Action Plan outlines 24 measures across five aspects, including:

1. • Abolishing all market access restrictions on foreign investment in manufacturing.
   • Continuing to expand opening-up in telecommunications and healthcare.
   • Allowing certain foreign-invested enterprises in the pilot free trade zones in Beijing, Shanghai, and Guangdong to conduct development and application of gene diagnosis and treatment technologies on a pilot basis.
   • Expanding access for foreign financial institutions to the banking and insurance industries.
   • Supporting qualified foreign financial institutions in participating in domestic bond underwriting.
   • Expanding the scope of pilot investment programmes for qualified foreign limited partners in China.
   • Supporting data flow between foreign-invested enterprises and their headquarters.
   • Better aligning domestic rules with high-standard international economic and trade rules.