The State Administration of Foreign Exchange (SAFE) released circular No.75 on October 21, this year's third relating to foreign exchange (forex) management in foreign acquisitions of or buy-ins into Chinese companies.

These are the main points of the ruling, which came into effect on November 1, 2005:

1) Outbound investments need only be registered with the forex watchdog. Approval was previously required;

2) "Domestic resident" is defined as anyone with Chinese citizenship (not necessarily including naturalized citizens) or anyone (including foreigners) who has been given the right to reside and do business in China;

3) Asset evaluation procedures apply only to state assets. International accounting standards will be applied to asset evaluation and account statistics;

4) The ruling sets out the regulations pertaining to domestic residents' investment in China through special purpose vehicles (SPVs);

5) SPVs that have already completed investments in China but haven't reported these investments to the forex watchdog have until next March to register their investments. 

The circular repeals previous circulars No.11 and No.29. For the first time, No.75 allows domestic residents to set up SPVs and use them as financial platforms to conduct their financial and financing business in international markets. Such activities would include reversed acquisitions, and share swaps.

In January and April respectively, SAFE released circulars No.11 and No.29 to regulate capital outflow and to curb tax evasion. The two circulars set many registration and approval procedures for outbound investments and foreign acquisitions of Chinese companies. They effectively blocked the financial channels of many private enterprises.

A sluggish capitals market and tight controls on bank loans were two of the reasons why companies, private companies in particular, resorted to indirect overseas listing to raise capital. In a typical situation, a company would set up an offshore venture overseas, usually in one of the tax havens, acquire domestic (China) assets in the name of the offshore venture, and go for foreign listing.

This is how more than 270 private Chinese companies have obtained foreign listings, Ma Shaobo, an interceder with China Chamber of International Commerce (CCOIC), was quoted by Economic Information Daily as saying.

These include companies such as Baidu.com, R&F Properties (HKEX: 2777), China Longgong, Yurun Food (HKEX: 1068), Neptunus Interlong and Xinyu Hengdeli (HKEX: 3389). Companies that obtained foreign listing last year include Gome Appliances, Mengniu Dairy, Shanda, HC International, Jinxi Steel, Ace-High International, Comba Telecom Systems, 51job.com, Tiens International and Yinqiao Dairy.

It has been reported that several other firms are considering following suit. These include Sunco, Huiyuan Juice, Nanjing Joymain Sci&Tech Group, R&F Group, Aux Electronics, Lijun Pharmaceutical, Tangshan Ganglu Steel and Hanwang Technology.

Sun Qiang, chair of China Venture Capital Association (CVCA), said that the No.75 circular opens a new investment channel for overseas venture capital into China, and renews the channel for Chinese firms to go public overseas.

The most important thing, Sun stressed, is that the government can still supervise overseas investments by domestic companies. 

However, worries of possible asset and tax losses still remain.

"Many private enterprises set up shell companies in tax havens, and use foreign exchange to acquire domestic assets in the name of foreign investors, thereby causing an outflow of capital and assets," Ma warned.

Strictly speaking, this amounts to tax evasion. Preferential tax rates given to foreign-funded enterprises are also one of the reasons why private enterprises register their businesses overseas. Currently, the average tax rate for domestic companies is 33 percent while that for foreign firms is 15 percent.

Dr. Mei Xinyu, a senior researcher with the Chinese Academy of International Trade and Economic Cooperation, said that this mode of business could result in huge losses of national wealth, and it increases the likelihood of state assets being sold cheaply.

Although Circular No.75 purports to standardize forex registration procedures, it doesn't specifically deal with the taxation issue. What is needed is coordination with the State Administration of Taxation and the Ministry of Commerce (MOFCOM). Industry watchers hope that policies will be aligned by the first quarter of next year.

Background information

January 24, 2005 SAFE issues circular No.11:

Notice of State Administration of Foreign Exchange on Improving Forex Management of Foreign Acquisition into Chinese Companies. The circular set strict approval procedures for setting up companies overseas (especially in offshore tax havens) and related asset exchange and acquisition activities.

April 21, 2005 SAFE issues circular No.29:

Notice of State Administration of Foreign Exchange on Forex Registration in Domestic Residents' Outbound Investment and Foreign Acquisition in China. The circular strengthens supervision on forex use in outbound investments and foreign acquisition of Chinese firms.

(China.org.cn by Tang Fuchun, November 8, 2005)