Foreign-invested partnerships: challenges and opportunities

By Kevin Xu, Martin Hu & Partners
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Article 108 of the PRC Partnership Law laid the legal foundation for the creation of a new form of foreign-invested enterprise, the foreign-invested partnership. The State Council Establishment of Partnership Enterprises in China by Foreign Enterprises and Individuals Administrative Measures (Measures) and the State Council Administration of the Registration of Foreign-Invested Partnerships Regulations (Regulations), both of which entered into effect on 1 March 2010, have opened the way for the establishment of foreign-invested partnerships.

New features, new opportunities

The Measures and Regulations contain new provisions that differ from those of existing foreign investment laws and that are particular to partnerships.

许江晖-Kevin-Xu-胡光律师事务所合伙人-Martin-Hu-_-Partners
Kevin Xu
Partner
Martin Hu & Partners

Chinese natural persons can enter into partnerships with foreign businesses. Under current foreign investment laws, Chinese natural persons are forbidden from investing in Sino-foreign equity and cooperative joint ventures. In contrast, the Measures and the Regulations permit Chinese natural persons to establish partnerships jointly with foreign enterprises or individuals.

Approval of the Ministry of Commerce (MOFCOM) is not required. The Measures and the Regulations permit partners to apply directly to the relevant Administration for Industry and Commerce (AIC) for the registration of their partnership, following which the AIC will report this to the competent branch of MOFCOM at the same level. The prior approval of the competent MOFCOM authority is not required.

Capital contributions can be made in the form of services. The Partnership Law permits Chinese partners to make their capital contributions in the form of services. The Regulations, further, expressly provide that foreign general partners may also make their capital contributions in the form of services. The foreign partner must provide a valid employment permit, and the value of the capital contribution made in the form of services must be determined by the partners through consultation.

Problems and challenges

Various challenges and problems are likely to be encountered in the course of the implementation of the Measures and the Regulations.

Civil capacity and investment qualifications of foreign natural persons.The Partnership Law requires partners who are natural persons to have full civil capacity. However, Articles 48 and 50 of the law specify that Chinese natural persons with no or limited civil capacity can become limited partners in limited partnerships. The Measures and the Regulations permit the establishment of foreign-invested limited partnerships, which would seem to indicate that foreign natural persons with no or limited civil capacity could also become limited partners in foreign-invested limited partnerships.

Enforcement against foreign investors with unlimited joint and several liability. Where all of the assets of a foreign partner are located abroad, this may make effective enforcement action against such an investor difficult. If a situation requiring a foreign investor to bear unlimited joint and several liability arose, a party in China could face the awkward predicament of being unable to actually effect enforcement.

Seeking comments in writing from the relevant authorities. If an investment project requires advance government approval, a foreign-invested partnership is required to submit the relevant approval document at the time of registration. Furthermore, the Regulations require the AIC to seek the comments of the relevant authority for a project in the restricted category that does not require advance approval or another project falling within the purview of the relevant authority. This provision is relatively broad and vague, which will result in a great deal of uncertainty.

Restrictions on the industries in which foreign investment may be made. The Regulations specify that “foreign-invested partnerships may not be established for projects in the prohibited category of the Guidance Catalogue for Foreign Investment in Industry, those marked as ‘limited to equity joint ventures’, ‘limited to cooperative joint ventures’, ‘limited to equity and cooperative joint ventures’, ‘the Chinese party shall hold a controlling interest’ or ‘the Chinese party shall hold a dominant position’ and those for which there are requirements in respect of the foreign investment ratio.” This somewhat restricts the fields in which foreign-invested partnerships can invest. According to a direct reading of the provisions, the above restrictions should not have a substantive impact on the reinvestment operations in China of investment-type foreign-invested partnerships. However, if an investment-type foreign-invested partnership were to reinvest in an industry in which the establishment of foreign-invested partnerships is prohibited, could this be construed as the establishment in a disguised manner of a foreign-invested partnership and thus be determined to be a violation of regulations? How the regulatory authorities will interpret and enforce the aforementioned industry restrictions in reality waits to be seen.

Investment-type foreign-invested partnerships. The Regulations require foreign-invested partnerships that have investment as their core business to register with the provincial level or sub-provincial level AIC, and also do not require advance approval by the competent commerce authority. However, this appears not to have eliminated the confusion caused by Article 14 of the Measures. This provision states that “If the state provides otherwise in respect of the establishment in China by foreign enterprises or individuals of partnerships that have investment as their core business, matters shall be handled in accordance with such provisions.” It is reported that the equity investment partnership enterprise jointly established by Carlyle and Fosun obtained its business licence without examination and approval by MOFCOM. (For a detailed discussion of this issue, please refer to Do new foreign partnership rules point to a future without MOFCOM?, China Business Law Journal February 2010.)

Tax. Both the Measures and the Regulations provide, in a vague manner, that foreign-invested partnerships are required to pay taxes in accordance with relevant tax regulations. Pursuant to current tax regulations, the principle of “distribute first, then pay tax” applies to the production and business income and other income of partnerships, with no enterprise income tax imposed; instead, only individual income tax is imposed on the business income of the investors. How these relevant tax regulations will be applied in reality to partners in foreign-invested partnerships (particularly foreign investors) will be worthy of continued attention.

Kevin Xu is a partner at Martin Hu & Partners.

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许江晖 Kevin Xu

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