Foreign Direct Investment in China – What Are the New Laws?

Foreign investors who are looking to invest in the Chinese market will need to be aware of the new laws for FDI in China that will become effective on January 1, 2020. A new regulation system will be implemented with the hope of streamlining foreign investments and simplifying the process so that foreign companies can invest in the Chinese market.

While China previously tried to pass these rules, many speculate that the government is trying to implement the new rules now because it is facing international criticism regarding its openness to foreign businesses.

The new Foreign Direct Investment in China is attempting to address common complaints received from foreign businesses and governments.

It is important to understand how new foreign investment laws may affect you.

New FDI in China – How It Will Affect Foreign Investors

The new set of regulations serves as a unified law that will replace three existing FDI laws that were passed in 2015, which are:

  • The Law of the People’s Republic on WFOE – Wholly Foreign Owned Enterprises
  • The Law of the People’s Republic of China on Sino-Foreign Equity Joint Ventures
  • The Law of the People’s Republic of China on Sino-Foreign Cooperative Joint Ventures

The new Foreign Direct Investment in China consists of 42 articles, a drastic reduction in the 170 articles that these three laws comprised. The new law is called the “Foreign Investment Law.”

Companies that were incorporated under the previous laws will have five years from the implementation of the new regulations to adapt to the new rules. 

Individuals and entities that must comply with the Foreign Investment Law include:

  • Foreign-invested enterprises
  • Wholly foreign-owned enterprises
  • Sino-foreign joint ventures
  • Investors in Hong Kong, Taiwan, and Macau
  • Individual foreign investors

The purpose of the new FDI in China is to build an environment of stability, predictability, transparency and fair competition for foreign investors and to encourage foreign investment throughout the world.

With the new law, the Chinese government hopes to attract foreign investment and provide greater protection through the legislature. A number of provisions in the new law seek to allow foreign investors to be on a level playing field with domestic companies.

Rules that can impact foreign investors are discussed below.

Read: What Industries in China Encourage Foreign Investment 

Omission of Variable Interest Entity Restriction

China has laws that restrict foreign investment into certain industries. However, some investors still invest in these industries through a Variable Interest Entity (VIE).

This process works by funding domestic companies in exchange for control and profits in those companies. The government realized this loophole. This process was restricted under the laws of 2015 by defining foreign investment to include domestic companies that are controlled by a foreign entity.  

The new Foreign Direct Investment in China that will be implemented do not contain this same restriction, so the VIE process may be used by foreign companies again, pending any further regulations. 

Reduction of Industries on the Negative List 

China has specific economic areas that it considers too sensitive for foreign firms to handle. The negative list in China is a comprehensive list of restrictions on foreign investment that the State Council determined is necessary to protect the country.

While many countries have these types of bans on foreign companies, the negative list in China is rather extensive. The new regulations require the government to make this list public and to reduce the industries that are on the negative list. This change could have a direct impact on the type of business that can be set up in China. 

For companies to set up wholly foreign-owned enterprises, the type of business must not be included on the negative list.

With the expected changes, there will be far fewer restrictions regarding many industries, resulting in fewer businesses on this negative list. This change may open up the option to invest in a business type that was previously barred to foreign investors.

However, the company may have to acquire a separate license to legally operate the business, depending on whether the company imports or exports goods, manufactures or conducts certain other activities.

Even though the company might not be on the negative list, foreigners must check if an additional license is necessary to legally operate their business. 

Eased Foreign Setup Process

Previously, setting up a foreign business has been a difficult process that required foreign investors to comply with complex regulations and deal with multiple regulatory schemes.

The new FDI in China is seeking to equalize the setup process for domestic and foreign businesses. A significant change is that the pre-approval for foreign companies before being able to set up will no longer be necessary.

Despite the change, it is still a complex process to set up a foreign business in China. This is why many foreign companies choose a domestic service provider like New Horizons to ensure that they take all of the necessary steps to establish their business in China.

Forming this important relationship helps businesses ensure that their company structure complies with all relevant regulations and that the company’s scope of activity is clearly identified. 

Foreign Exchange Assurance

International companies experience unique challenges with money, including having to frequently move money across borders.

The Foreign Investment Law allows foreign companies to transfer money acquired from capital gains, profits, technology transfer royalties and other funds to and from the host country and China, as long as appropriate legal procedures are followed. 

Government Procurement

Traditionally, the China government has preferred to conduct business with domestic businesses, leaving many foreign companies without the same privilege and profitability.

The new regulations will require the Chinese government to consider both domestic and foreign companies when considering which to use for government business activities.

Streamlined Process Across Jurisdictions

The Chinese government structure is complex and consists of local, intermediate and national level governmental entities. Different rules have often been at play in different regions of China, which further complicates foreign investment.

The new FDI rules in China will prohibit local governments from infringing on the rights of, imposing additional requirements, setting harsher market entry or exit conditions or interfering with the operations of foreign companies, unless the central government approves special conditions. 

If the public or national interest is involved that justifies special circumstances that make it more difficult to establish or run the business, companies are entitled to compensation for the losses that they have suffered. 

Loosened Regulations on Corporate Governance and Decision-Making

China has historically extensively regulated corporate governance and the decision-making authority of foreign companies. However, the new law will loosen these regulations so that foreign companies operate more autonomously and at the same level as companies based in China. 

One example of this loosened regulation is the shareholders’ authority.

Based on previous laws, the board of directors had to tightly control foreign companies. Under the new law, shareholders will have the highest authority like they typically do with most companies today, including domestic Chinese companies. The Articles of Association will establish the board of directors and will give shareholders greater voting power. 

Another important change that the new Foreign Direct Investment in China is bringing about is the ability for investing parties to appoint certain individuals to leadership and legal roles in the business by following the company’s Articles of Association. 

Additionally, foreign companies will be able to make decisions more easily than they were able to before the implementation of the new regulations since a unanimous vote is no longer necessary for every major decision.

These major decisions include such topics as:

  • Amending a shareholder’s agreement or Articles of Association
  • Increasing or reducing registered capital
  • Merger
  • Division of a company
  • Liquidation
  • Termination

When a unanimous vote was required, minority shareholders had the power to block important decisions. This made it particularly necessary to carefully vet all shareholders since they could negatively and substantially impact the business.

Shareholders with more bargaining power can now better dictate the decisions of the business. 

Another significant change that will be brought upon because of the new regulations is the ability to share profits as the company deems fit.

Before the new rules were implemented, the profits had to be split proportionally to shareholder equity. The same rule applied to proceeds from the liquidation of the business.

If all shareholders unanimously agree to a different split, the profits or liquidation proceeds can be divided as they prefer.

Reciprocity Rule

One rule that may not be good for foreign investors is a newly incorporated reciprocity rule.

According to this rule, if a country adopts negative measures against Chinese investments in that country, the Chinese government reserves the right to take corresponding measures against that country by taking action against its businesses in China. 

Limitation on Expropriation and Fair Value Rules

Some foreign companies have expressed disdain over the expropriation of their property by the Chinese government.

The current rules state that the government is not to expropriate property made through the investment of a foreign investor.

The Chinese Constitution does allow the government to take certain property, though, when it is in the public’s interests. However, to take the property, the government must comply with statutory provisions and is required to provide fair and reasonable compensation to the business.

These additional measures can protect foreign investments from arbitrary expropriation. 

National Security Review

Some foreign investments can be subject to national security reviews under the new FDI in China. National security decisions are final and are not able to be appealed.

Strengthening of Intellectual Property Rights

One of the barriers for many foreign businesses was the lack of intellectual property rights in China. Many foreign companies have experienced issues with counterfeit Chinese goods after having only a portion of a product manufactured in the country.

Some foreign companies have accused local officials of inspecting their factories, stealing their trade secrets and giving them to domestic companies.

The new regulations are seeking to protect the rights of foreign investors and are requiring local authorities to protect the intellectual property rights of foreign companies.

The regulations state that Chinese joint venture partners cannot steal intellectual property and trade secrets from their foreign partners. Additionally, government officials are barred from utilizing administrative measures to cause forced technology transfers.

These provisions include criminal consequences for violations.

Foreign Directive Investment in China – Get Help with Your Foreign Investment 

The new regulations signal the Chinese government’s willingness to encourage foreign investment and to allow more diverse foreign businesses to establish a presence in the country.

The legislative measures discussed above are likely to inspire a surge of foreign businesses into the Chinese market.

If you need assistance in establishing a foreign business in China or wish to diversify your investment portfolio, the experts at New Horizons Global Partners can help you.

Our innovative China PEO solution and China company registration assistance can help you establish your business faster and with less capital overlay. Contact us today to learn how we can help you with your expansion objectives.

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