businessmen quickly learned to set up their own oﬀshore company (in oﬀshore jurisdictions like BVI, Bermuda and Cayman Island) that will come back to China as foreign investors so as to enjoy those favorable treatments available.
This trick has been widely adopted and China governments are no fools and started to scrutinize and regulate such fake foreign investments, mainly by virtue of foreign exchange control.
To appreciate the matter, one shall know that China has not allowed its citizens (for purpose of this article, Chinese citizens refer to those citizens who are also tax residents within China, excluding overseas Chinese citizens who have obtained permanent residences in foreign countries) to engaged in foreign direct investment in other countries. In other words, it is illegal for Chinese citizens to invest outside China, a prohibition aimed at preventing capital ﬂight out of the country. I know you have known many Chinese citizens investing all over the world, but if they have not taken their domestic funds out of China or vice versa, then it is not a real concern of China governments.
On the other hand, even if Chinese citizens have already managed to set up their business entities in foreign countries and use such foreign entities to invest in China, they may have trouble when caught by China State Administration of Foreign Exchange (SAFE). They are often caught when the companies they invest in China pay big amount of dividend to the foreign parent holding company. There have been quite a few cases published by China SAFE in this regard. Typically, such cases involve Chinese citizens using their oﬀshore entities to invest in mainland China without disclosing the controlling persons of such oﬀshore entities, and there has even been a case in which a Chinese couple was penalized for not updating their oﬀshore entity information after they migrated to Singapore and became real foreigners.
(1) Circular NO. 37 Issued by SAFE
A major piece of regulation of round-trip investments by Chinese citizens is the so called
“Circular No. 37” issued by China SAFE on July 4, 2014. There are other related regulations I will brieﬂy touch on later.
A few takeaways of Circular NO. 37.
(i) Deﬁnition of Special Purpose Vehicle
Circular No. 37 deﬁned the term “Special Purpose Vehicle” (SPV) which is a foreign entity directly or indirectly established or controlled by Chinese residents (domestic resident entities and domestic resident individuals) for purpose of investments or ﬁnancings, contributing their assets and interests legally owned onshore or oﬀshore.
While it is always diﬃcult for any Chinese individuals to use their domestic assets (those located in China) to make oﬀshore investments (except as permitted in limited circumstances such as oﬀshore IPO or employee stock plan in foreign companies), the regulation does for the ﬁrst time acknowledge SPV set up by Chinese individuals using their oﬀshore assets so long as such assets are legal (as a result of your work, borrowing etc.).
(ii) Foreign Exchange Registration for Outbound Investments
China SAFE’s primary concern is China’s ﬁnancial security that is often aﬀected by enormous inﬂow or outﬂow of money across border. Thus, SAFE monitors closely the activities of foreign exchange capital accounts, in particular, cross-border investments by asking banks to record any and all such activities.
According to Section 3 of the Circular, before Chinese residents (bear in mind, including Chinese entities and individuals) contribute capital to the SPV, they shall eﬀect the foreign exchange registration for outbound investments with relevant banks. Without forex registration, funds cannot be sent out for capital contribution and future proﬁts obtained outside the country cannot be taken into China.
(iii) Forms of Round-trip Investments