Seeking clarity

The State Council has promulgated revised implementing regulations for China's Wholly Foreign-Owned Enterprise (WFOE) Law. These amend or remove 17 articles of the original 1990 regulations, mostly to bring them in line with China's commitments to the World Trade Organisation (WTO) and current law and practice. Some revisions are outlined below.

Article 3 no longer requires either advanced technology, new products or import substitution, or annual exports of at least 50 percent by value to establish a WFOE, but instead only encourages advanced technology and exports. This change is significant, though less so than it might appear since these requirements have been interpreted broadly and enforced loosely in recent years.

In Articles 9 and 14, the requirement to include a WFOE's export ratio (proportion of production to be exported) when establishing a WFOE has been deleted. But the practical importance of this change is limited, since enforcement, of export ratios has long been loose and less demanding export ratios have been approved in recent years.

Article 21 now permits, with the consent of the approval authority, a WFOE to reduce its registered capital ?if really necessary.?

Under Articles 26 and 27, investment of capital equipment is no longer restricted to items not available in China, and invested intellectual property or technology need no longer make products urgently needed in China or suitable for export. These former requirements had long been neglected in practice. A WFOE may still have only 20 percent of its registered capital in the form of intellectual property rights or technology.

Articles 43 and 44, on a WFOE's right to sell products it makes, now explicitly permit (unqualified) domestic sales, and no longer require exports in accordance with an approved export ratio or approval of domestic sales beyond that ratio. WFOEs are still ?encouraged' to export, but after China joins the WTO, giving this any practical effect would contravene WTO requirements.

Language in Article 46, making domestic sales subject to Chinese price control regulations and requiring that domestic sales prices be reported to price control and tax authorities, has been deleted, reflecting current practice. Language requiring that import and export prices be no worse than international market prices has been retained, but will likely continue to be of little practical significance.

Articles 50 and 51 now provide for tax exemptions, reductions or rebates… in accordance with relevant PRC tax laws and regulations' (instead of a blanket exemption) for capital equipment and imported raw materials. This is in line with long-established tax regulations and practice. A WFOE must generally still pay taxes for the stated equipment and imported raw materials if they are sold in China.

Old Article 56 on foreign-exchange balancing requirements has been deleted, again reflecting current law and practice.

Old Article 87, that gave Moftec the responsibility for interpreting the regulations, has been deleted, and the regulations are now silent on this point. This may be in part because the State Council (instead of Moftec) promulgated the revised regulations, and in part because it is uncertain which government body will have responsibility for approving foreign investment in the future.

The revised regulations retain many provisions that are different from practice in developed jurisdictions, potentially incompatible with WTO requirements or behind current Chinese realities. These include:

-a list of situations in which WFOEs may not be approved, some very broad and potentially incompatible with WTO requirements, such as injury to China's sovereignty and incompatibility with the requirements of China's economic development

-approval of basic matters such as the establishment of WFOEs, increases or decreases in its registered capital, the value of invested equipment or intellectual property, and termination and liquidation

-annual import and export plans (no longer required in practice), and semi-annual licences (which authorities have pledged to replace with notification systems)

-State Administration for Foreign Exchange approval for foreign exchange bank accounts inside and outside of China.

The existence of such discrepancies, however, does not eliminate the fact that significant improvements were made. The changes, generally, accomplish the goal of bringing the regulations more closely in line with domestic law and practice. More importantly, perhaps, they remove some of the uncertainty surrounding the WFOE process and give greater assurance that this process will be conducted on the basis of business, rather than bureaucratic reasons.

For further information on this topic, please contact James Dunlap at Freshfields Bruckhaus Deringer by telephone (+852 2846 3421) fax (+852 2810 6192) or email (fames. dun lap @ freshfields.com).