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LEGAL: Regulation on Equity Contribution in Relation to FIEs
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altI. Introduction 
On 21 September 2012, the Ministry of Commerce (MOC) issued the Interim Regulations regarding Equity Contribution of Foreign Investment Enterprise (Interim Regulations) which became effective on 22 October, 2012. The Interim Regulations clarify many detailed issues from the practical perspective of making capital contribution into a foreign invested enterprise (FIE) with equity interest in another Chinese company. 
Under PRC Company Law, the capital contribution to a company can be performed with cash or other non-cash assets which can be evaluated and legally transferred unless it is otherwise provided by the law. Therefore, in 2009, the State Administration for Industry and Commerce (AIC) promulgated the Administrative Measures for the Registration of Capital Contributions Made with Equities (Administrative Measures) which regulate the AIC registration of equity contribution. As the establishment and capital increase of an FIE shall be approved by the local branches of MOC before it can be registered with the AIC, the issuance of the Interim Regulations provide the legal framework to apply and approve the capital contribution to FIEs with equity.
II. Content of the Interim Regulations
The most significant points as mentioned in the Interim Regulations include the following:
1. Scope of Application
The Interim Regulations is applicable in the following circumstances:
a. Equity contribution during the establishment of a new FIE;
b. Equity contribution during the capital increase of a domestic-invested company, which transforms it into an FIE;
c. Equity contribution during the capital increase of a FIE;
It is notable that the equity used for the contribution shall always be of a company established in PRC.
2. Unqualified Equity Interests
The Administrative Measures provides that for all companies, in the following circumstances the equity interests are not allowed to be contributed to another company:
a. The registered capital of the company whose equity is to be used for contribution (Equity Company) has not be fully paid-in;
b. The equity has been pledged or frozen;
c. The equity can not be transferred according to the AOA of the Equity Company;
d. The necessary approval as required by the laws and administrative regulations for transfer of the equity has not been granted;
e. Other circumstances as prohibited by the laws and administrative regulations.
Now the Interim Regulations further provide the following circumstances under which the equity contribution to an FIE is prohibited:
a. The Equity Company has not passed the annual inspection of last year.
b. The Equity Company is a real estate company, foreign invested investment company or foreign invested startup investment enterprise.
3. Compliance with Foreign Investment Policies
After the equity contribution, the target company (Target FIE) as an FIE, the Equity Company as a Domestic Enterprise Invested by FIE, and their (other) subsidiaries shall comply with the Provisions on Guiding the Orientation of Foreign Investment and the Catalogue of Industries for Guiding Foreign Investment. Otherwise, before applying for approval of equity contribution, they shall withdraw from or transfer such business that would be inconsistence with the provisions of the above regulations.
4. Evaluation
According to the Interim Regulations, the equity to be contributed to the Target FIE shall be evaluated by an appraising entity established within PRC. The contributing party and the other shareholder(s) of the Target FIE can agree on a deemed value of the equity based on the evaluated price. The parties can also agree on the portion of the deemed value to be contributed to the registered capital of the company. However, the portion to be contributed to the registered capital can not be higher than the evaluated price of the equity.
5. Procedure of Contribution
The equity contribution shall be examined and approved by the local branch of the MOC (Approving MOC) of the Target FIE at provincial level. When the Equity Company is also an FIE but is governed by a different Approving MOC, the Approving MOC of the Target FIE shall ask for opinion on the envisaged equity contribution from the Approving MOC of the Equity Company at provincial level before approving the equity contribution.
It is notable that the application documents submitted to the Approving MOC for the equity contribution shall include a Chinese lawyer’s written opinion about the compliance of the Equity Company with the conditions as mentioned above in section 2 and section 3.
Once the equity contribution is approved, the Approving MOC of the Target FIE will issue a new Certificate of Approval to the Target FIE indicating ‘equity contribution not paid-in’. Then the equity shall be transferred to the Target FIE in the following circumstances:
a. If the Equity Company is not an FIE, it will become a Domestic Enterprise Invested by FIE owned by the Target FIE;
b. If the Equity Company is an FIE and after the equity contribution it still has one or more foreign shareholders, the Equity Company will become a joint venture owned by the Target FIE and the other shareholder(s);
c. If the Equity Company is an FIE and after the equity contribution it will not have any foreign shareholders, the Equity Company will also become a Domestic Enterprise Invested by FIE owned by the Target FIE.
After the equity is transferred to the Target FIE, and the new business license of the Equity Company is obtained, the Equity Company shall perform the other registration modifications with the tax authority, foreign exchange authority and customs, etc.
Following the above registration modifications of the Equity Company, the Target FIE can apply to its Approving MOC for issuance of the new Certificate of Approval indicating equity contribution paid-in.
Please note that according to the Administrative Measures, in the case of establishing a new company, the equity shall be contributed within one year after the establishment of the new company. Whilst in the case of capital increase with equity contribution, the equity shall be transferred before the application for registration of the new registered capital.
6. Foreign Debt Limitation 
The Interim Regulations also provide that the limit of the foreign debts that can be raised by the Target FIE shall be decided by the total investment corresponding to the registered capital of the Target FIE, which does not include the part contributed with equity. However, this provision is quite general, thus further clarification might still be necessary from the MOC in order to implement it in practice.
III. Conclusion
With the implementation of the Interim Regulations, there is no doubt that equity contribution will be a useful instrument available to the foreign investors to make their investments in PRC. This option is especially advantageous as it could save the cash flow required to make the capital contributions.
Of course, the restrictions imposed by the Interim Regulations shall also be taken into account by the investors before choosing this alternative, which include, among others:
a. The registered capital of the Equity Company shall be fully paid-in;
b. The Approving MOC for equity contribution is of relatively high level (provincial);
c. The equity must be evaluated;
d. The foreign debt quota of the Target FIE is limited.
 

By  Garrigues
 
 
 
 
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