When setting up an FIE, the financing structure shall be carefully planned ahead. In general, two options of financing – equity financing and debt financing need to be structured, as defined and elaborated below.
The registered capital is the total amount of equity subscribed by investors.
Under PRC FIE legal regime, debt financing shall be subject to an upper limit which is allowed to borrow under the PRC laws.
Equity financing is still the most used method of financing a FIE.
– What kind of contribution can be made?
Unless in holding companies, contributions can be made:
- Cash, since 2013 there is no mandatory minimum amount for cash contributions to the registered capital required by the law;
- “Non-cash properties” which can be valued in currency and transferrable, including physical assets such as equipment, machines, buildings, intellectual property rights and/or technology licenses, land use rights, usufruct, non-patent technology and equity interest.
Under the PRC laws, certain local SAMR also accept debts as non-cash contributions. However, it is expressly prohibited to make capital contributions in the form of labor services, credit, name of a natural person, goodwill, franchise rights or properties on which security interests are created.
Moreover, non-cash contributions are required by the Company Law to be evaluated in the PRC. It can be evaluated among and agreed by the shareholders if there is no dispute on the value. However, a qualified asset appraisal firm shall be appointed for the evaluation of the shareholders cannot agree on the value.
– Are FIEs restricted on borrowing money?
Due to foreign exchange control, there are restrictions on the amount that FIEs may borrow from foreign entities (i.e. foreign banks, foreign shareholder, etc.).
Technically, FIEs cannot borrow more than the amount exceeding an upper limit, which is also known as the quota of foreign debt (“Foreign Debt Quota”). There are two models to determine the Foreign Debt Quota:
- Model of “Borrowing Gap”
Based on the amount of the registered capital, the FIE shall be allowed with a maximum “total investment amount”. The “registered capital-to-total investment ratio” varies from 33% to 70%. The difference between the total investment amount and the registered capital (“Borrowing Gap”) represents the capacity of the FIE to borrow foreign loan and/or benefit from foreign securities.
Foreign Debt Quota = (Total Investment Amount – Registered Capital) * (capital actually paid by the foreign shareholder / registered capital subscribed by the foreign shareholder) – existing debt owed to any foreign entity (if any).
- Model of “Full-coverage”
Under this model, the Foreign Debt Quota will be calculated as follows:
Foreign Debt Quota = Capital or Net Assets * Leverage Ratio * Macro-prudential Adjustment Parameter
(Leverage Ratio for enterprises: 2; Macro-prudential Adjustment Parameter: 1.25)
As the Foreign Debt Quota to be calculated under this model is based on the financial reports, in practice, the local SAFE or its authorized bank may raise queries and lower the actual amount of the Foreign Debt Quota if the figure in the financial reports looks not reliable.
An FIE will be required to choose either the above model when it borrows money from abroad (such as shareholder’s loan) for the first time. Regardless of which model the FIE chooses, the FIE will be required to register with the local SAFE for a shareholder’s loan.
Nevertheless, like PRC domestic companies, FIEs are not restricted from borrowing money from entities (i.e. banks, other corporate entities, etc.) in China.
Financing for reinvestment
Under the new FIL, FIEs in general may use their registered capital to make domestic equity investments, subject to the restrictions provided by the Negative List and on the premise that the domestic investments are true and legal.
Foreign exchange control
– Which authority is in charge of foreign exchange control in China?
The State Administration of Foreign Exchange (SAFE) strictly controls foreign exchange in China. Due to recent legal reform, SAFE has authorized banks to conduct certain formalities in terms of foreign exchange. For exemple, foreign exchange registration for newly incorporated FIE, capital increase, and others. However, some foreign exchange involved matters are still under control by SAFE. For exemple, borrowing of foreign loan, benefiting from foreign securities, etc.
– Is it mandatory to file foreign exchange registration?
An FIE shall complete foreign exchange registration with the bank before opening foreign currency capital account to receive registered capital from the foreign shareholder.
– Does SAFE also supervise “foreign debt”?
Offshore loans and securities are qualified as “foreign debt” and are subject to the SAFE supervision. Before incurring foreign debt within the legitimate capacity, FIEs shall file a registration with the SAFE.
-> This article may also be of interest to you : Determine the Foreign Debt Quota – Financing the structure
To know more, download our legal handbook related to setting up a business structure in China …
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