In our June 2022 Issue of Newsletter, we will discuss some of the important updates in PRC Tax in the first half of 2022.

1.  Limitation on Use of Capital for Wholly Foreign Owned Enterprise (“WFOE”) in Mainland China

The use of WFOE’s Registered Capital for Non-Self-use Property and Listed Stock Investment is strictly forbidden in Mainland China

In May 2022, the State Administration of Foreign Exchange issued a FAQ to clarify its latest view on the use of proceeds from foreign exchange capital accounts (e.g., Registered share capital). In principle, such proceeds cannot be used to make any Securities Investment or high-risk Wealth Management Products.

In the past, only investments in Principal-Guaranteed wealth management products were allowed. However, in 2018, there was a change in the regulations of wealth management products. The products are classified from R1 to R5 depending on the risk level (with R1 being a low-risk product, while R5 as a high-risk product). The words “Principal-Guaranteed” are not allowed for promotion of Wealth Management Products. As such, there is a need to update the interpretation on Foreign Exchange Control Regulations on the permitted class of investment for proceeds from foreign exchange capital accounts.

The FAQ in May 2022 has clarified that the proceeds from foreign exchange capital accounts can be used to invest in products under the ranking of R1 and R2. Investments of R3 or above are strictly not allowed.

POINTS TO NOTE
We expect the State Administration of Foreign Exchange shall exercise stricter control on foreign exchange. We have seen an increasing number of penalty cases for prohibited use of proceeds from Capital Account. With advanced technology, it is not difficult for the State Administration of Foreign Exchange to detect such non-compliance.

As a general reminder, besides the above restrictions, Multi-National Corporations should be fully aware of the below restrictions on the use of proceeds from Capital Account (especially the Registered Share Capital): -

It shall not be used for expenditures outside the business scope of the WFOE or prohibited by laws and regulations;
Unless otherwise expressly provided, it shall not be used for securities investment or other investment and wealth management products other than those risk level at the ranking of R1 or R2;
It shall not be used to issue loans to non-affiliated enterprises, unless the business scope is expressly permitted;
It shall not be used for the construction or purchase of non-self-use real estate (except for real estate enterprises).
Based on the above, acquisition of real estate which are occupied by tenants and payment made on behalf of unrelated parties with close business relationship are strictly not allowed for the use of the proceeds from Capital Accounts. However, these are the common mistakes we have seen in court cases.

When making China Inbound Investment, Multi-National Corporations are encouraged to consult with advisors before they utilise their proceeds from Capital Accounts, while there are much less restrictions on subsequent proceeds from Current Accounts (e.g., business profits).

Reference: https://www.safe.gov.cn/safe/2022/0509/20943.html