For Chinese individuals making outbound investment, overcoming the obstacles from the aspects of regulatory and foreign exchange control becomes a priority.
As China is now the second largest economy in the world and produces millionaires and billionaires faster than any other country every year, going abroad and investing overseas has become increasingly attractive for Chinese individuals.
While many Chinese high net worth individuals are emigrating from China to other countries such as the US, Canada, the UK, Australia, and Singapore every year, and while the Chinese tourists are now the biggest customer group of luxury goods in Europe, investing overseas by Chinese individuals is still a mission impossible. For example, a Chinese individual cannot remit out cash of more than USD 50,000 a year even for buying a home. In addition to the difficulty in moving money offshore, investing overseas by Chinese individuals requires strict government approval, for which amazingly no clear rules have been issued so far.
Regulatory Approval Requirement
From a legal perspective, investment overseas by Chinese individuals mainly involves two big issues – the regulatory approval requirement and the foreign exchange control restriction.
In 2004, the National Development and Reform Commission (the “NDRC”) issued the “Interim Measures for the Administration of Verification and Approval of Overseas Investment Projects” (the “Measures”). The Measures primarily apply to Chinese enterprises. However, Article 26 of the Measures states that “with regard to the verification and approval of a project carried out by an individual or other organization, these Measures shall apply as the reference”. With that, it seems that the examination and approval procedures for overseas investments by individuals shall be the same as that applicable to Chinese enterprises. However, in practice, this has not been tested so far and we are not aware of any case where a Chinese individual has successfully gone through such approval procedures.
Furthermore, after getting the NDRC approval, an investor needs to get one more round of approval from the Ministry of Commerce (the “MOC”). However, the “Measures for the Administration of Overseas Investment” issued in 2009 by the MOC only set out the specific approval procedures for Chinese enterprises, without any specific references to offshore investments by Chinese individuals. Following the common legal practice in China, no rules usually means not allowed. As a result, the MOC will simply not accept an application for approval for overseas investments by Chinese individuals.
Foreign Exchange Control
The foreign currency used for overseas investments by Chinese individuals is deemed as for capital use, which is currently under strict control. Although the existing foreign exchange control rules seem to allow that overall, there are no operating rules setting out whether and how individuals can apply to the relevant authorities for remitting out cash of more than USD 50,000 every year. In practice, the foreign exchange authorities will simply use this as a reason for turning down such a request. The annual quota of USD 50,000 is stipulated in the “Administrative Measures for Personal Foreign Exchange”. As such, Chinese individuals often find it impossible to obtain the foreign exchange approval for overseas investments.
How to Get around Those Obstacles
Among many creative ways for getting around the legal obstacles mentioned above, the more straightforward way is for a Chinese individual to use a Chinese company as the investment vehicle. This is allowed although various government approval and registration procedures have to be followed. This structure may have a tradeoff from a Chinese tax perspective though, because it adds one more layer of Chinese tax. For example, if an individual directly invests in a HK company and sells the HK company later on, the capital gains will be subject to a 20% Chinese individual income tax. If the individual invests in HK company through a Chinese company, the same capital gains will be first taxed at 25% at the Chinese company level and further taxed at 20% at the individual shareholder level (i.e. at an effective tax rate of 40%).
Another way is for a Chinese individual to form an offshore company in one of the traditional offshore financial centers such as the BVI, the Cayman Island and HK and use transfer pricing techniques to move cash from China to that offshore company. For example, the individual may arrange for a Chinese company he or she owns to export products to a HK related company at a relatively low price, which will then sell such products to a third party at a high price. This obviously creates a tax issue as transfer pricing between two related parties is always subject to scrutiny. However, many Chinese individuals tend to ignore such a risk.
A third way is to use a bank product that is called “security onshore and lending offshore” to get a loan overseas. A simple description of that product is that a Chinese individual will arrange for a Chinese company that he or she owns to place a security with a bank in China, which will then instruct an overseas branch to grant a loan to an overseas related party of the Chinese company. Technically speaking, the Chinese company must own the overseas company. In practice, this requirement is not always followed by banks.
Other than those ways of moving cash offshore, which are technically legal, there are other alternatives. But most of those alternatives are within the grey area and some even directly violate the Chinese foreign exchange rules. One example is to move cash offshore by using an underground fund remittance agency.