China Strengthens Regulations on Private Enterprises’ Foreign Exchange

Following China’s liberalization of her economy, private enterprises are developing at an amazing speed. A large number of businessmen in mainland China have consequently accumulated substantial wealth. Among these emerging millionaires, many of them realize that they can easily make use of the mechanism of offering preferential treatments to foreign investors which was introduced in the early 80’s when China started her economic reform by posing as overseas investors and make handsome profits. Some people call these “quasi-foreign enterprises”.

The most common practice of such “quasi-foreign enterprises” is to use asset in China as consideration for the acquisition of the shares of an oversea company (such as in Hong Kong). Then the mainland Chinese investors can, in a new capacity, either take over or set up an enterprise in the mainland. Such an arrangement is virtually shifting out profits from the country en masse, thus seriously affects the international balance of payments. In view of the problem, the State Administration for Foreign Exchange of China issued the “Notice on Improving the Management of Foreign Exchange Problems Arising from Acquisitions by Foreign Capital” in January 2005. It is pinpointing at the foreign exchange problems brought about by the practice of private enterprises investing in domestic business through companies registered overseas.

The Notice stipulated that the SAFE will supervise and monitor closely outward remittance of profits, re-investment of profits and transfer of shares by private enterprises, and will take immediate enforcement action whenever any problem is spotted. In one of the provisions, it stated that pursuant to the Provisional Regulations on Acquisition of Domestic Enterprises by Foreign Investors, mainland Chinese citizens are required to seek approval from the foreign exchange administration authority before they can dispose of any asset and shares they own in the country with a view to acquiring shares of any overseas company or any other proprietary rights off shore. Without approval, mainland Chinese citizens are strictly prohibited to acquire shareholdings or any other proprietary rights outside China by using domestic asset or shareholdings in China as considerations. In this connection, the Hong Kong SAR is regarded as outside China.

Another important provision is that the foreign exchange authorities are to closely scrutinize registrations of foreign enterprises set up through acquisitions by foreign investors, so as to find out whether such foreign investors are in fact established or controlled by any mainland Chinese citizens, or are having the same management as the subject of the acquisitions.

From now on, as far as those affluent private enterprises owners are concerned, the use of off shore companies as bridges of shifting out capital is no longer available.

Prepared on 15 April 2005.