Foreign Investment In China Foreign Exchange

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                                                                                      Spring 2006


   I. Administration of Foreign Exchange         enterprise, the share/equity structure of the
   for Domestic Residents Engaging in            overseas SPC, and the overseas financing
   Financing and Inbound Investment Via          arrangements. Where a domestic resident
   Overseas Special Purpose Companies            contributes assets or share/equity rights of
                                                 a domestic enterprise in an SPC, or
   The State Administration of Foreign           engages in financing abroad after
   Exchange promulgated its “Notice on           contributing assets or share/equity rights in
   Relevant Issues Concerning Foreign            an SPC, the resident must complete the
   Exchange Administration for Domestic          procedures for modification of the foreign
   Residents to Engage in Financing and          exchange registration of overseas
   Inbound Investment via Overseas Special       investments.
   Purpose Companies” on October 21, 2005,
   which became effective from November 1,       After an SPC secures overseas financing,
   2005.                                         the domestic resident should transfer the
                                                 funds into China in accordance with the
   Pursuant to the Notice, the term "Return      letter of commercial plans or the
   Investment" refers to all direct investment   prospectus. Where a SPC uses the funds
   activities carried out within China by a      raised overseas for return investment or
   domestic resident via an overseas special     provides a domestic enterprise with a
   purpose company (an "SPC"). More              shareholder’s loans or other debt funds,
   specifically, Return Investment is defined    the relevant domestic enterprise must
   as an overseas enterprise directly            complete the applicable foreign exchange
   established or indirectly controlled by a     administration procedures in accordance
   domestic resident legal person or domestic    with the presently applicable laws and
   resident natural person for the purpose of    regulations for administration of foreign
   engaging in financing abroad with the         debts and foreign exchange.
   enterprise assets or interests held inside
   China. A domestic resident must submit a      Provided that the necessary foreign
   number of documents to the local foreign      exchange procedures for the domestic
   exchange office to apply for foreign          resident and the domestic
   exchange registration of overseas             enterprise have been completed, the
   investments. The documents include a          profits, dividends, liquidation expenses,
   written application stating in detail the     stock right assignment expenses, capital
   basic information of the domestic             decrease expenses etc of the domestic

   enterprise can be remitted to the SPC.          investment. The re-investment shall not
   Where a SPC affects a major capital             enjoy the preferential tax treatment on
   modification event such as a capital            return of the tax provided by Article 80 of
   increase or decrease, stock right               Rules for the Implementation of the
   assignment or exchange, merger or               Income Tax Law of the People’s Republic
   division, investment with long-term stock       of China for Enterprises with Foreign
   rights or credits, provision of guaranty to a   Investment.
   foreign party, etc., and is not involved in
   return investment, the domestic resident        However, the Notice does provides for an
   shall, within 30 days of the major event,       exception to this rule. If a foreign investor
   apply to the foreign exchange office to         consigns the shares from (i) a foreign
   complete the procedure for modification or      investment which is directly or indirectly
   archival filing of the foreign exchange         owned by him or the whole share is owned
   registration of the overseas investments.       by one person; or (ii) if the consignment is
   Where, before the Notice came into force,       made at a cost price of the shares, then if
   a domestic resident had established             the foreign investor re-invests with the
   or controlled an overseas SPC and has           profit allotted before the consignment of
   already implemented a return investment         shares, he may enjoy the preferential
   project, but has not yet completed the          return of tax treatment as provided by
   foreign exchange registration of overseas       relevant provisions.
   investments, it must complete the
   registration with the local foreign
   exchange office by March 31, 2006.              III. Letter of Credit Disputes – Recent
                                                   Regulations of the Supreme People’s
   II. Notice of the Ministry of                   Court of China.
   Administration of Tax on Relevant
   Issues of the Return of Enterprise              On November 14, 2005, the Supreme
   Income Tax.                                     People’s Court of China (“SPC”)
                                                   promulgated the “Regulations of the
   The Ministry of Administration of Tax           Supreme People’s Court on Relevant
   promulgated “Notice of the Ministry of          Issues on Trying Cases of Letter of Credit
   Administration of Tax on Relevant Issues        Disputes”, (“LC Regulations”) which
   of the Return of Enterprise Income Tax”         came into force on January 1, 2006.
   on November 17, 2005, which became              According to this new ruling, the SPC will
   effectively immediately.                        now try cases involving letters of credit
                                                   disputes in accordance with Uniform
   This Notice has no retroactive effect on        Customs and Practice for Documentary
   cases where the taxpayer enjoyed earlier        Credits (“UCPDC”).
   preferential tax treatment. The Notice
   states specifically that in the event a         This new regulation significantly amends
   foreign investor acquires shares of an          the authority entrusted to banks by
   enterprise by means of consignment, then        allowing them to examine letters of credit
   subsequent to said consignment of shares,       independently, and consequently decide on
   the foreign investors shall re-invest in        whether to accept discrepancies under the
   China all profits gained from any such          LC, regardless of whether the LC has been

   accepted or rejected. The LC Regulations       2005, which came into effect on March 1,
   also deal specifically with the issue of       2006.
   fraud in letter of credit transactions. It
   enumerates four separate types of fraud in     A venture capital investment enterprise
   LC transactions, and specifies that, in        may take the form of a limited liability
   these types of cases, all entities which       company, a company limited by shares or
   have an interest in the letter of credit,      other form of legal enterprise. The venture
   including the issuing bank, will now have      capital investment enterprise may also
   the right to apply to the courts for           specify its term of existence, which shall
   injunctions on payment instructions.           not be shorter than seven years. The
   Additionally, such entities, so long as they   venture capital investment enterprise shall
   meet certain enumerated conditions, may        report to the relevant supervisory
   apply for injunctions prior to the             authorities at all important events during
   commencement of any such action.               the investment operation, such as the
                                                  amendment of the articles of association
   The SPC now has the authority to               and other important legal documents,
   terminate or suspend payment based upon        increasing or decreasing its capital,
   the applications in most circumstances         division and merger, the change of senior
   when the issuing banks, the confirming         officials or investment management
   banks and the negotiating banks have all       agency, and its liquidation and
   made bona fide payment. According to the       termination.
   new ruling, the SPC shall make a decision
   within 48 hours after the receipt of the       A venture capital investment enterprise
   application, and any suspension order shall    established in the form of a company may
   take immediate effect.                         appoint another venture capital investment
                                                  enterprise or venture capital management
   The LC Regulations also deal with              consulting enterprise to manage its
   liabilities of the guarantors. Specifically,   investment business. The amount invested
   the guarantors shall not be exempt from        by a venture capital investment enterprise
   their liabilities solely by reason that the    into a single enterprise shall not exceed 20
   issuing bank has accepted the discrepancy      percent of the total assets of the venture
   without prior approval. However, if the        capital investment enterprise. Furthermore,
   issuing banks amend the letter of credit       it may only invest in unlisted enterprises.
   without the approval of the guarantors, the
   guarantors shall only be liable within the     However, if an unlisted enterprise
   scope of the previous guarantee.               subsequently lists on a stock exchange, the
                                                  venture capital investment enterprise need
                                                  not immediately dispose of its interest in
   IV. Venture Capital Investment                 that enterprise. A venture capital
   Enterprises                                    investment enterprise must not engage in
                                                  banking operations (the making of loans)
   The National Development and Reform            or in real estate transactions except for its
   Commission passed the Interim Measures         own use. The Provisions Concerning the
   for the Administration of Venture Capital      Administration of Foreign-funded Venture
   Investment Enterprises on November 15,         Capital Investment Enterprises also

   applies to foreign-funded venture capital      The bank may contract some electronic
   investment enterprises. A legally              payment businesses out to lawful
   established foreign-funded venture capital     professional service suppliers, however,
                                                  the obligations of the bank to its customer
   investment enterprise is entitled to the       and the corresponding duties shall not be
   benefit of the preferential policies under     transferred as a result of the outsourcing.
   the Measures if its investment operations      The disposal of information on RMB
   are in line with the relevant Measures.        electronic payment businesses and the
                                                  settlement of funds incurred within the
                                                  territory of China must be completed
   V. Electronic Payment                          within the territory of China.

   The People's Bank of China promulgated
   its Guidelines for Electronic Payment on
   October 26, 2005, which apply to the           The Maalouf Law Firm represents U.S.
   electronic payment business of domestic        companies engaging in business in China,
   banking financial institutions. Electronic     as well as Chinese entities doing business
   payments are classified into on-line           in the U.S.
   payments, telephone payments, mobile
   payments, sales terminal transactions,         We counsel clients on a variety of matters
   ATM transactions and other electronic          including corporate entity structure, tax
   payments.                                      treaties, joint venture and partnership
                                                  agreements, and government regulatory
   When conducting an electronic payment          matters.
   transaction, the client needs to open a bank
   account in the relevant bank. The opening      If you have any questions or would like
   and use of the account should comply with      assistance regarding the matters
   the Measures on Administration of              discussed in this memorandum, please
   Renminbi Bank Balance Accounts and the         contact the following:
   Regulation on Administration of Domestic
   Foreign Exchange Accounts.
                                                   John J. Maalouf, Esq. or
   For an individual client, the amount per        Cindy Liu, Esq.
   transaction shall not exceed RMB 1,000          MAALOUF LAW FIRM, LLC
   and the daily aggregate amount shall not        500 FIFTH AVENUE – 14TH FL.
   exceed RMB 5,000. The limit can be              NEW YORK, NEW YORK 10110
   exempted through a digital certificate,         Tel: 212.789.8717
   electronic signature and other security         Fax: 212.789.8718
   certification methods. The bank must  
   insure the security of the processing
   system of electronic payments and keep
   the authentication data like passwords and
   secret keys secure.