After a foreign investor set up a foreign invested enterprise(“FIE”) in China, the FIE might have problem with its working capital. Then the foreign investor need to consider injecting more money into the FIE.
However, China put many off-limits on a foreign investor injecting money into China. Based on our experience in FDI sector, we would like to lay out the following options for the foreign investor’s consideration to ease FIE’S capital shortage:
I Foreign Debt
Under PRC legal scheme, a FIE may borrow money from overseas entity or individual and inject the loan into China. The loan between the FIE and overseas entity or individual will be deemed to be a foreign debt and therefore the FIE should meet the conditions of foreign debt as required by PRC laws. Those conditions include but not limited to:
1) the percentage of contribution by the foreign investor to the registered capital of FIE should exceed 25%;
2) the loan should be subject to difference between the FIE’s total investment amount and registered capital and the sum of othe aforesaid loan and FIE’s existing foreign debt(i.e. long term foreign debt, the remaining amount of short term foreign debt and overseas guarantee) should not exceed the aforesaid difference;
3) the initial payment to the registered capital of the FIE has been made in full; and
4) the foreign investor did not violate any time limit in respect of capital contribution.
After the FIE registered foreign debt with local foreign exchange control authority, they can open an account with local bank and use it to receive the loan.
II Capital Increase
PRC authority also allows a FIE to increase capital to fix working capital problem. In order to increase capital, the FIE needs to satisfy the conditions regarding capital contribution, namely, the registered capital of the FIE has been paid in full.
Capital increase approach would work in case that the FIE is a wholly foreign owned enterprise; however, if the FIE is a joint venture, capital increase will give rise to the issue of voting rights of board of directors and dividend distribution. When setting up a joint venture, the foreign investor should reach agreement with partners on voting rights and dividend distribution, which will be stated in articles of association and investment contract. With the capital increase approach, the foreign investor normally requests to change the voting rights of board of directors and dividend distribution percentage accordingly, which would not be accepted by other shareholders of joint venture. Then the foreign investor needs to pay a lot of efforts to negotiate a deal with other shareholder on the above said issues.
III Consulting Agreement
In practice, some companies may use consulting agreement to inject overseas money into China. In details, the FIE enter into consulting agreement with its foreign shareholder/investor in which the FIE provide consult service to the foreign investor and the foreign investor pay the service fee to FIE, which will allow the FIE’s foreign investor to inject overseas money into China. However, under such approach, tax inefficiency will become an issue, and, if the FIE uses consulting agreement to inject money, the services stipulated in the service agreement should be in line with the business scope of the FIE.
IV Sales Agreement
The FIE may also use sales agreement to inject overseas money into China, namely, the FIE enter into sales agreement with its foreign shareholder in which the FIE sell the goods to its foreign investor and the foreign investor pay the purchase price to the FIE.
However, under such approach, the goods should be actually shipped out of China, and the goods should be items of the inventory of the FIE. Also, for accounting purpose, all paper work such as bills of stock-in and stock-out should be well prepared. Further, an exportation should be declared at the customs and an exportation should be reported at the state tax authority.
By Adam Li