In China, companies, banks, and individuals must comply with a “closed” capital account policy. This means that money cannot be freely moved into or out of the country unless it abides by strict foreign exchange rules.
China made promises to liberalize its foreign exchange market when acceding to the World Trade Organization (WTO), but changes are being introduced gradually. Currently, the government is using China (Shanghai) pilot free trade zone to test full currency convertibility and further liberalizations for foreign investors. If successful, regulators will likely expand liberalizations nationally.
China’s foreign exchange system
The main bodies responsible for overseeing the flow of foreign exchange is the State Administration of Foreign Exchange (SAFE) and the People’s Bank of China (PBOC), the central bank. SAFE is the administrative agency responsible for managing foreign exchange activities in China, setting relevant regulations, and administering China’s foreign exchange reserves. SAFE’s approval or record-filing is required for a range of transactions involving inbound and outbound forex payments.
In the Chinese foreign exchange system, there are two main accounts: the current account and the capital account. The current account applies to ordinary recurring business transactions, including trading receipts and payments, payment of interest on foreign debt, and repatriation of after-tax profits and dividends, amongst other transactions.
The capital account, on the other hand, deals with capital import and export, direct investments, and loan and securities, including principal repayment on foreign debts, overseas investments, investment in FIEs, and more.
Compliance requirements
According to SAFE rules, incorporated foreign-invested enterprises (FIEs) are subject to the general debt to equity ratio requirement. This means that out of the total investment of an FIE, a certain percentage must be comprised of capital contributed by the investors.
Previously, SAFE required all FIEs to submit a statement of foreign investors’ equity in order to clarify and demonstrate the proposed outflow and inflow of foreign currency. Additionally, an authorized domestic CPA firm had to issue a foreign exchange annual inspection report. However, with the issuance of the notice on further simplifying and improving the foreign exchange management policies for direct investment on June 1, 2015, the foreign exchange annual inspection for foreign investors was cancelled. Instead, investors must submit an “existing right registration” before September 30 of each year.
If the FIE fails to comply with SAFE requirements, the foreign exchange bureaus can take over the capital account information, and banks will refuse to process any foreign exchange business under the FIE’s capital account. Furthermore, if the FIE does not meet SAFE’s conditions, then banks will not allow the FIE to distribute profits to foreign shareholders.
Common challenges for foreign businesses
Given China’s restrictions on foreign currency exchange, companies have to be strategic about their funding plans early in the pre-investment stage.
- Running out of funds
A common pitfall for foreign businesses is underestimating their costs, and overestimating their profits, leading to a shortfall of capital.
In one case, Company A optimistically established itself in China with a lower amount of registered capital on the assumption that it would be able to generate revenue quickly. The assumption was based on an agreement with a large client whereby the client would place a sizeable order and settle payment within 90 days. However, the payment was delayed, and the company was unable to meet its cash flow target. Company A incurred substantial startup costs, including warehouse rent, raw materials expenses, and salary commitments.
To meet costs, the overseas parent company initiated steps to inject more registered capital, but it would be weeks before the entire process could be completed. In the meantime, Company A was unable to pay its employees and missed mandated social insurance contributions. Therefore, besides its initial costs, the company faced additional penalties including a fine and potential labour disputes.
- Restrictions on overseas transfers
FIEs may find that repatriating capital or profits out of China now includes increased layers of inspection and security from the government. Due to record levels of outbound direct investment (ODI) in recent years, the Chinese government introduced new capital controls through a number of announcements by government agencies at the end of 2016. The announcements indicated that certain outbound transactions would not be approved unless given specific approval. The transactions in question that can affect FIEs include:
- Outbound investments made by limited partnerships;
- FDI involving an acquisition of 10 percent or less of the shares of an overseas listed company;
- Overseas investments made by newly-established entities without substantial operations;
- Outbound transactions inside the core business of the company involving US$1 billion or more;
- Transactions involving domestic capital participation in the delisting of overseas listed Chinese
Government scrutiny of ODI varies based on the amount of money being sent, the industry of the target, the receiving country, and the investor. Starting July 2017, banks and financial institutions in China have to report all domestic and overseas cash transactions of RMB 50,000 (US$7,600) or more; the previous threshold was RMB 200,000 (US$30,350). Any overseas transfers by individuals of US$10,000 or more will also be reported.
Additionally, those seeking to transfer money will need to explain how they plan to use the foreign currency and fill out an online form pledging not to use foreign exchange to purchase overseas property, securities, life insurance, or similar products.
New rules to ease cross-border transactions
On October 23, 2019 China’s State Administration of Foreign Exchange (SAFE) issued a notice which covers 12 facilitation measures to ease the controls over cross-border trade and investment financing requirements.
Cross-border trade financing
- Facilitate foreign exchange receipts and payment for trade
- Simplify the receipt and payment of the cross-border e-commerce trade for small-to-micro enterprises
- Optimize the foreign exchange reporting method of trading businesses
- Ease the opening of to-be-verified accounts for export earnings
- Facilitate the registration of enterprise branches
- Allow contracted engineering enterprises to open overseas account for capital centralized management
Cross-border investment financing
- Remove the restrictions on domestic equity investment of capital fund of foreign investment enterprises not engaging in investment activities
- Expand the pilot scheme to facilitate foreign exchange of capital
- Ease the restrictions on the use of foreign exchange settlement of capital account
- Reform the registration of foreign loan
- Remove limits to the number of foreign exchange accounts opened for capital
- Expand the pilot plan of domestic credit assets transfer to foreign countries
Disclaimer:
The Canadian Trade Commissioner Service in China recommends that readers seek professional advice regarding their particular circ*mstances. This publication should not be relied on as a substitute for such professional advice. The Government of Canada does not guarantee the accuracy of any of the information contained on this page. Readers should independently verify the accuracy and reliability of the information.
Content on this page is provided in part by Dezan Shira & Associates a pan-Asia, multi-disciplinary professional services firm, providing legal, tax, and operational advisory to international corporate investors.
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