By Carol Xu

Recently, MOFCOM issued the regulation permitting the use equity interest as capital contribution in FIEs (“the Provisions”).

According to PRC’s Company Law (amended in 2005), investors are only allowed to make capital contributions in cash, in kind or in such intangible property rights as intellectual property rights, land use rights or other transferable non-cash property with appraisable value. A pilot scheme permitting equity interest as capital contribution was launched in 2009 by the State Administration of Industry and Commerce (“SAIC”)[1], which stipulated that equity interest contributed as capital shall be registered with SAIC or its local counterparts. However, such measures fell short on giving a clear guidance on how equity interest can be contributed as capital in FIEs. Therefore, the issuance of the Provisions filled the gap and provided clearer guidance in this area.

As per the Provisions, domestic or foreign investors (“investors”) are allowed to contribute their equity interests in PRC domestic enterprises in connection with: (1) establishment of new FIEs; (2) conversion of domestic companies into FIEs through capital increase; and (3) change the equity of an FIE through capital increase. The Provisions also set forth several requirements on the equity to be used as capital contributions. The equity interest shall be free and clear from encumbrance, fully paid in, and transferrable. No equity interests in real property enterprises, foreign-invested holding companies or foreign-invested venture capital enterprises can be contributed as capital. Furthermore, both investor and investee continue to be subject to the requirements of foreign investment catalogue and other relevant rules and regulations on foreign investment.

The equity interests to be contributed shall be appraised by a PRC domestic appraisal institution, and the booked value of the equity interest shall be no higher than the appraised value. In addition, the Provisions limit non-cash capital contribution to a maximum of 70% of registered capital of an investee, which is in line with the current PRC Company Law.

Additionally, an investor making capital contribution in an investee using its equity interests may benefit from a deferred corporate income tax if certain criteria are met in accordance with Circular 59.

Capital contributions using equity interests are subject to approval by MOFCOM or provincial level counterparts where the investee is registered. However, the Provisions do not stipulate a time frame for approval. Furthermore, the time needed for appraisal also adds to the degree of uncertainties.

Despite the uncertainties, the Provisions open up new ways for foreign investors to structure their investments in China. The move to a more flexible foreign investment regulatory regime reflects a positive signal on the PRC government’s welcoming attitude on foreign investment.

[1] Order No.39 of the State Administration for Industry and Commerce, “Measures for Registration Administration of Capital Contribution with Equity Interests”. Issued on 14 January 2009, effective on 1 March 2009.