Out-Law Guide | 06 May 2022 | 1:24 pm | 12 min. read
Such immense change does not happen by chance – policy and new laws have paved the way. As a result, China's legal framework is a work in progress. There are gaps and ambiguities in the law, policy can sometimes change quite quickly and without warning and the changes are not always ones that everyone would prefer. Therefore, although economic opportunities are real and the legal framework backing up those opportunities quite solid, the legal environment remains challenging.
This guide provides basic information on the legal framework for foreign investment and operations in China, in three parts:
The legal system of the Peoples Republic of China (the PRC) is based on the PRC Constitution, which was last amended in 2004. It consists of a hierarchy of written laws, regulations and administrative directives.
The Constitution formally stipulates that political power is exercised by the people, from the bottom up, through the hierarchy of representative People’s Congresses from the local up to the provincial and national levels. The traditional Leninist concept for this institutional ideal is known as “democratic centralism”. In practice, policymaking and administration can at times be highly centralised and uniform in nature, and at others highly decentralised and fragmented.
At the central level, the National People’s Congress (NPC) and the Standing Committee of the NPC are empowered by China's Constitution to exercise the legislative power of the state. The NPC has the power to amend the Constitution and to enact and amend basic laws governing state departments and public, civil and criminal matters. The Standing Committee of the NPC has the power to interpret, enact and amend laws other than those required to be enacted by the NPC.
Although it is not granted any formal legal status or powers in the Constitution and is technically separate from the government, the Chinese Communist Party (the Party) parallels, overlaps with, and controls the government at all levels – its power is truly pervasive. Companies that employ more than three Party members are required to establish a Primary Party organisation, while those that employ more than three but less than 50 Party members should establish a Party Branch.
This system helps the Party to ensure a high degree of national uniformity and cohesion, but it also sets the Party above the government, which can make it difficult in practice to subject the Party itself and its individual members to the rule of law.
The State Council of the PRC (State Council) is the highest organ of state executive administration, and has the power to enact administrative rules and regulations consistent with law. Ministries and commissions under the State Council are also vested with the power to issue orders, directives and regulations and to undertake enforcement action within their respective areas of competence. The State Council also submits legislative proposals to the NPC or the Standing Committee of the NPC for enactment into law.
The Ministry of Commerce (MOFCOM) is the main administration responsible for approving foreign investment. The State Administration for Market Regulation (SAMR) and local AMR also play an important role. They are responsible for business registration along with a number of business oversight functions.
The judicial power to apply the law in civil and criminal matters is vested in the people’s courts at various levels: the central Supreme People’s Court (SPC), provincial High People’s Court, municipal Intermediate People’s Courts and local Basic People’s Courts. People’s courts at different levels are not independent, but carry out the judicial function in fairly close coordination with the courts, government and Party at the same and higher levels.
In the PRC’s civil law system, court decisions do not constitute binding precedents for the judiciary. However, numerous court opinions are published annually, and may provide useful guidance for outcomes in similar cases. SPC decisions provide non-binding judicial guidance for lower courts, and the SPC’s detailed Interpretations on the application of national laws are considered to have the force of law.
The Party-controlled legislative/executive/judicial structure at the central level is repeated at lower levels. The people’s congresses of provinces and their municipalities may enact local rules and regulations. Administrative organs at those sub-national levels – bureaux of the central state ministries and administrations – enforce local and central enactments, and may make administrative rules and directives applicable to their respective administrative areas. People’s courts at lower levels look to courts at higher levels and to government and Party at the same and higher levels for guidance.
Laws and regulations made at lower levels must not conflict with those made at higher levels, and generally only serve to implement central-level enactments. Regulations, rules or directives are, however, occasionally enacted or issued at the provincial level in the first instance on a trial basis and later enacted on a national basis after sufficient experience has been gained.
In spite of the uniformity resulting from centralisation, there can be a great deal of variation in local practice and interpretation where central policy is silent or unclear. Legal analysis should therefore always take into consideration the conditions in the relevant parts of the country.
Since it began opening to the world in the modern era, China’s eagerness to gain the benefits of foreign know-how and capital have been tempered by a concern to minimise the perceived competitive and other negative effects of foreign investment. There has been a steady trend toward greater opening to foreign investment since China's accession to the World Trade Organisation (WTO) in 2001; however, foreign direct investment is still not uniformly permitted in all business sectors.
The first step in analysing the legal feasibility of an investment in China is to ascertain whether, and under what conditions, the contemplated activity is open to foreign investment. Those conditions may also include more favourable policy treatment for activities in which the government is eager to encourage foreign investment.
Companies registered in Hong Kong, Taiwan and Macao are treated as “foreign” for the purposes of most PRC regulations governing foreign investment.
Under China’s prescriptive approach to regulating business activities, all companies, including foreign invested enterprises (FIEs), receive a business license permitting operations only within a specifically enumerated and relatively narrow scope of business, rather than for "any lawful purpose". Permissible business lines are limited to those spelled out in the National Economic Industry Category Definitions.
It is typically not possible to combine fundamentally unrelated activities/industries in the same business license (e.g., film production and manufacturing).
Historically, China maintained a 'foreign investment guidance catalogue' under which all business activities were classified as one of "encouraged", "restricted", "prohibited" or "permitted" to foreign investment.
A more liberal 'negative list' approach, first used in China's free trade zones (FTZs), has now been extended nationwide and is set out in the PRC Foreign Investment Law (FIL), which came into effect on 1 January 2020.
The negative list, or "Special Administrative Measures for Foreign Investment Access", is a document jointly issued by the NDRC and MOFCOM and is updated periodically. Activities on the list may be prohibited to foreign investment outright (e.g. TV or film production), or may be restricted. Where an activity is restricted, approval is at the discretion of the authorities and a joint venture (JV) with a Chinese party will be required. Any activity that is not included on the negative list is supposed to be "permitted" and, under the principle of "national treatment", should be subject to the same criteria and requirements as domestic investment in the same area.
The most recent version of the negative list should always be consulted as a first step when planning any investment. However, local approval authorities have significant discretion in interpreting the list and implementing related policy. Even though an activity is not included on the negative list and is technically 'permitted', it still may not be approved in fact by the approval authorities. The permissibility of the planned FIE scope of business should always be confirmed in advance on a case-by-case basis through consultation with the competent local authorities.
There is also a negative list specific to free trade zones (FTZs), which operates alongside the national negative list. This provides somewhat improved terms of access for certain activities in the FTZs, although as the national negative list is itself already a distillation of the areas that China considers most sensitive for foreign investment it does not significantly increase access. The FTZs continue to offer preferential access policies for certain trading functions, like customs clearance and foreign exchange cash pooling. They may also continue to enable foreign investment in certain areas first liberalised there but not generally open elsewhere – for example, training schools, hospitals and internet data centre businesses in the Shanghai FTZ.
Following the introduction of the negative list, MOFCOM and the NDRC now maintain a separate list of projects in which foreign investment is encouraged. This is called the Catalogue of Industries Encouraged for Foreign Investment (encouraged catalogue).
The negative list is supplemented by the Catalogue of Priority Industries for Foreign Investment in the Central-Western Region (central-western catalogue). This lists activities and sectors in which foreign investment is encouraged in China's less-developed central and western regions, as well as in the north east region and on Hainan Island. Activities included in the encouraged catalogue are also eligible for preferential treatment under a range of policies when undertaken in these regions. The central-western catalogue is revised on a regular basis.
The PRC and Hong Kong entered the first phase of the Closer Economic Partnership Arrangement (CEPA) in June 2003. Macao also has a similar arrangement in place. Among other things, CEPA provides eligible Hong Kong resident companies with more liberal investment access to the mainland than is available to companies from other jurisdictions. This means that eligible Hong Kong companies can enter into certain activities before companies from elsewhere.
Any location search should also consider the possibility of gaining benefits offered by a variety of different development and trade zones
The CEPA eligibility requirements for Hong Kong Service Supplier (HKSS) status are designed to ensure that companies with an active presence in Hong Kong are the main beneficiaries. However, there are exceptions to the HKSS requirements, and newly-established Hong Kong entities may be able to benefit from CEPA in these cases.
Because of this complexity, and because the details of the liberalised sectors are open to interpretation in certain respects, the availability of CEPA preferences for any particular investment must be confirmed in detail through consultation with the relevant PRC approval authorities.
The standard foreign investment regime for commercial entities does not apply to foreign NGOs. A more restrictive regime, the Law on the Management of Foreign Non-governmental Organisation Activities in China (the foreign NGO law) applies to the activities of foreign NGOs in China.
The choice of location is a fundamental step in establishment planning. Since different geographic areas are developing at different rates, some of the most fundamental geographic distinctions are economic. Probably the most basic division in the country is that between the eastern coastal regions and the less developed western and central regions, but there are similar distinctions between heavy industry in the north and the newer, more dynamic light industrial, services and tech-focused economies of the south.
Apart from these broad geographical variables, any location search should also consider the possibility of gaining benefits offered by a variety of different development and trade zones. The range of zones includes:
Most foreign manufacturing businesses are located within a zone of some type because of the range of benefits offered by these areas.
For simple economic and industrial development zones, the principal benefits can include access to land and infrastructure, proximity to suppliers, customers and talent and certain tax and fiscal incentives. For intensely managed export processing zones, the benefits also include duty-free import and re-export of processing components and products.
However, the zones' ability to offer tax and financial incentives to new investors is gradually being curtailed. Before planning to locate to any area, the permissibility and sustainability of any specific preferential terms or conditions should be confirmed in detail.
Following the establishment of the Shanghai pilot FTZ in 2013, the central government began experimenting with wide-ranging, but limited, liberalisation and rationalisation in the foreign investment regulation, company registration and foreign exchange control regimes on a limited geographical basis. The experiment has now been extended to 21 new pilot FTZs in China as of 2020, including in Tianjing, Guangdong, Fujian and Hainan.
The intention is that the reforms trialled in the pilot FTZs will eventually be extended to the country. But the FTZ reforms represent incremental rather than fundamental change, and firms operating in the pilot FTZs face broadly similar challenges to those operating elsewhere.
Although the pilot FTZs are not a panacea, foreigners should consider them as a location for any new establishment. Indeed, for activities opened to foreign investment only in the Pilot FTZs, foreign investors may have no choice but to locate there. However, bear in mind that it may not be feasible to establish in an FTZ and operate broadly elsewhere. Other target localities outside of the pilot FTZs may not necessarily be ready to approve branches of pilot FTZ foreign companies to undertake activities that are still off limits to foreign companies in the target locality. For such activities, the feasibility of establishing a company in an FTZ and establishing operating branches in other target locations should be confirmed in advance in the target locations.
The Shanghai FTZ launched on 29 September 2013. It consolidated four existing free trade zones in Shanghai, with an area of 120.72 square kilometres.
The Shanghai FTZ was billed as a crucial step towards China's next wave of reform and opening up. But not all the reforms are primarily intended to benefit foreign companies – many are directed at domestic companies. Some of the main reforms include:
The Tianjin FTZ is located in the central area of the Bohai Economic Rim, giving it a regional advantage as a transportation hub for North China.
There are three parts of the Tianjin FTZ: the Tianjin Port district, the Tianjin Airport district and the Binhai New Area Central Business District. The total area is about 119.9 square kilometres.
Elements of the Tianjin FTZ include:
The Guangdong FTZ covers an area of 116.2 square kilometres and consists of three zones: the Guangzhou Nansha New Area, the Shenzhen Qianhai Development Zone and the Zhuhai Hengqin New Area.
Measures which distinguish the Guangdong FTZ from other FTZs are:
The Fujian FTZ covers 118.04 square kilometres made up of three independent areas: Pingtan Area, Xiamen Area and Fuzhou Area. The Fujian FTZ sets out specific functions for each of the three areas.
The Hainan FTZ was announced in October 2018. Unlike the other zones, the Hainan FTZ covers the full Hainan province - a relatively massive area of some 35,000 square kilometres. The focus of the zone will be technology, tourism and ecology, and the opening of a gateway to SE Asia.
The NDRC issued the Hainan Free Trade Port Encouraged Catalogue in the second half of 2020. There are two catalogues of encouraged industries in the list: the encouraged industries in the current national industrial catalogue and the newly added encouraged industries in the Hainan Free Trade Port (Hainan FTP). There are 128 items in the latter category, particular to the Hainan FTP, including construction, education, healthcare, tourism, wholesale and retail, information technology and transportation among others. The Hainan FTP includes plans to establish China’s biggest free trade port by 2035.
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