China’s SAFE Issues Circular 37 to Replace Circular 75

January 1, 0001


On July 14, 2014, the State Administration of Foreign Exchange (“SAFE”) of the People’s Republic of China (“PRC”) issued the SAFE Circular Relating to Foreign Exchange Administration of Offshore Investment, Financing and Return Investment by Domestic Residents Utilizing Special Purpose Vehicles (“Circular 37”). Circular 37 repeals and replaces the well-known “Circular 75”, which had been the governing rule for nearly a decade. Circular 37 significantly expands the scope of foreign exchange registrations that PRC domestic residents can make for their offshore investments and financings, liberalizes cross-border capital outflow by domestic residents, and relaxes certain requirements for foreign exchange registrations by domestic residents.

Amendments to Key Definitions

Circular 37 amends several key definitions used under Circular 75:

  • "Special Purpose Vehicle" (“SPV”) is now defined as an offshore company directly formed or indirectly controlled by domestic residents (including domestic institutions and domestic resident individuals) for the purpose of investing or obtaining financing, utilizing assets or interests (onshore or offshore) legally held by such domestic residents. Compared to Circular 75, where the purpose of the SPV was limited to obtaining offshore financing, Circular 37 expands the purpose to include offshore investment as well. Domestic residents may use their offshore assets or interests (in addition to their onshore assets or interests) for offshore investment or financing activities. As a result of these changes, domestic resident individuals may now make foreign exchange registration for their offshore investments even where such foreign investments do not involve any PRC domestic assets or interests. This is a significant development for the PRC foreign exchange regulation regime for individuals.

  • "Return Investment" is now defined as onshore direct investments made directly or indirectly by domestic residents through SPVs, namely by forming foreign-invested enterprises or projects (“FIEs”) in China through greenfield investment, acquisition or other means and gaining the ownership, control, operation and management power, or other interests in such FIEs. Under Circular 75, contractual control was explicitly listed as a method of return investment. Circular 37 instead uses a general description to define return investment without mentioning contractual control. A few years prior to the issuance of Circular 37, SAFE stopped accepting foreign exchange registration applications that mentioned contractual control arrangements. It is uncertain whether SAFE will take a similar approach after Circular 37.

  • "Domestic Residents" include domestic institutions and domestic resident individuals. “Domestic Resident Individuals” is now defined as PRC citizens who hold PRC ID cards, service IDs or armed police IDs, and offshore individuals who do not have legal PRC ID papers but habitually reside in the PRC for reason of economic interests. . Pursuant to Circular 37 and its implementing instructions, an individual who legally holds both a PRC and foreign ID (including Hong Kong, Taiwan and Macau) will be treated as a foreign individual and does not need to complete foreign exchange registration unless he or she habitually resides in China for reasons of economic interests and uses onshore assets or interests for offshore investment or financing. Circular 37 also clarifies that, in contrast from practice followed by certain local SAFE offices prior to Circular 37, evidence of offshore permanent residence (such as a green card) cannot be used to establish foreign identity for SAFE registration purposes. This means that PRC citizens who have permanent residence in another country (but not holding a formal foreign ID) are still required to complete foreign exchange registration for their offshore investments or financing.

Expansion of the Scope of Foreign Exchange Registration

Under Circular 75, in order to complete foreign exchange registration, the related domestic residents must meet each of the following three requirements: (i) have existing onshore assets or interests, (ii) utilize such onshore assets or interests to seek offshore financing, and (iii) make return investment after completion of offshore financing. Under Circular 37, domestic residents may also use their offshore assets or interests (in addition to onshore assets or interests) to make offshore investments (in addition to offshore financings with a plan for return investment). This means that, in addition to foreign exchange registrations involving return investments conducted through either contractual control arrangements or acquisition of domestic entities which have been covered since Circular 75, Circular 37 now also provides for the foreign exchange registration of: (i) pure play offshore investments by domestic residents using offshore SPVs, and (ii) greenfield type return investments made by domestic residents using offshore SPVs that they form or control. While Circular 37 and its implementing instructions do not expressly repeal the implementing rules previously issued by SAFE under Circular 75 (such as Circular 59), they also do not provide guidance relating to foreign exchange designation for “Return Investment by Non-SPV”[1] mentioned under Circular 59. With the expanded scope of foreign exchange registration under Circular 37, it is reasonable to assume that SAFE may no longer require foreign exchange designation for “Return Investment by Non-SPV”. However, how SAFE will implement this rule remains uncertain.

Separate Procedures Apply for SPVs Formed or Controlled by Domestic Institutions

Circular 37 clarifies that, while it regulates SPVs formed or controlled by both domestic institutions and domestic resident individuals, nonetheless a separate foreign exchange registration procedure stipulated under the PRC outbound investment regime (i.e. the Foreign Exchange Administration for Offshore Direct Investment by Domestic Institutions issued by SAFE on July 13, 2009) still applies to SPVs formed or controlled by domestic institutions.

Registration of Incentive Shares Issued by Private Companies Now Possible

Under Circular 37, if a private SPV offers its own equity or options as incentive to the directors, supervisors, senior officers or employees of the domestic entity under its direct or indirect control, the relevant individuals may apply for foreign exchange registration before exercising their options. Prior to Circular 37, foreign exchange registration could only be made for exercising equity incentives granted by public companies in accordance with SAFE Circular 7, which is a separate set of foreign exchange rules . Circular 37 requires evidence of a legal employment or labor relationship in order to carry out foreign exchange registration with respect to option exercise. It is unclear whether advisors or consultants of domestic entities will be able to file applications for foreign exchange registration for their shares or options received under an equity incentive scheme of a private SPV.

Outbound Funds Flow Now Expressly Allowed

Under Circular 37, domestic residents may, based on actual and reasonable needs, purchase and remit foreign exchange out of China to establish an SPV, repurchase or delist shares of an SPV. In addition, domestic entities[2] under direct or indirect control of a domestic resident may, based on actual and reasonable needs, finance their registered SPVs. Although the implementing rules for these outbound fund flows have yet to be issued, these are very significant and positive developments as they indicate that the PRC government is becoming increasingly flexible in allowing outbound fund flows by domestic institutions and resident individuals.

New Timeline for Foreign Exchange Registrations

Circular 37 sets forth a new timeline for foreign exchange registrations:

Initial SAFE Registration

Prior to Circular 37, domestic residents could form an SPV first and then apply for initial SAFE registration provided that there was no offshore financing, shareholding changes at the SPV level or return investment prior to completion of the foreign exchange registration. Circular 37 provides that domestic residents can form a SPV first but shall not make any capital contribution before completing the initial foreign exchange registration, with the exception of paying registration fees for the SPV formation. Under Circular 37, domestic residents are no longer required to submit business plans for their initial SAFE registration.

Furthermore, pursuant to Circular 37, a domestic resident only needs to register the first level of SPV owned or controlled by it, instead of registering all SPVs it owns or controls (as required in the past under Circular 75 and its implementing rules). In a typical red-chip structure used by domestic residents in offshore investing or financing, there are multiple levels of offshore SPVs, including BVI , Cayman Islands and Hong Kong companies; exit transactions can occur at any level. While this simplification is very encouraging and will minimize foreign exchange registration requirements for domestic residents, it remains uncertain as to how SAFE will implement this in practice.[3]

Amended SAFE Registration

Circular 75 had imposed a 30-day deadline to apply for amended SAFE registration when required for making significant changes at the SPV level (including long-term equity or debt investment by the SPV and provision of guarantee by the SPV). Circular 37 only requires that the domestic resident file for amended SAFE registration in a timely manner following a significant change, such as change of domestic resident (including name change), change of operation term of the SPV, share swap, merger and acquisition or spin-off of the SPV, or ownership increase or decrease or share transfer by the related domestic residents. SAFE has not imposed a hard deadline for such amendments, but stipulates that they must be completed in a timely manner prior to the SPV’s next cross-border capital transaction, which includes cross-border remittance of dividends and other distributions. Circular 37 no longer require amended SAFE registration for long-term equity or debt investment by SPVs or provision of guarantee by SPVs.

No Mandatory Requirement for Repatriation of Profits Onshore

Circular 75 had required the repatriation into China of all profits, dividends and proceeds arising from disposal of interest in the SPV within 180 days of the receipt of such profits, dividends or proceeds. Circular 37 does not have this mandatory repatriation requirement.

Specified Penalties for Violations

Differing from Circular 75, Circular 37 sets out specific penalties for various violations. For example:

  • If any domestic resident or any domestic entity under its direct or indirect control remits capital to a SPV through fictitious or fabricated transactions, SAFE may order such domestic resident or domestic entity to return the capital to China within a specified time and may impose a fine of up to an amount equal to the amount remitted to the SPV. Criminal liability may be imposed if the related violation is severe.

  • If any domestic resident fails to complete foreign exchange registration, misrepresents the de facto controller of the return investment enterprise, or makes a false statements, such domestic resident will be subject to a fine of up to RMB300,000 (for domestic institutions) or RMB50,000 (for domestic individuals). In addition, to the extent that any capital inflow or outflow resulted from such irregularities, SAFE may order rectification of such misconduct (including the return of such amount to China if there is a capital outflow) or impose a fine up to an amount equal to the amount of capital inflow or outflow. In the event of a capital outflow, criminal liability may be imposed if the related violation is severe.

[1] “Return Investment by Non-SPV” means return investments made by offshore special purpose vehicles formed or controlled by domestic residents that do not meet the definition of SPV under Circular 75, which include the greenfield type of return investments mentioned above.

[2] Circular 37 does not offer an explicit definition for “domestic entity”. It is unclear whether such “domestic entity” only refers to the wholly-owned foreign entity of the related SPV, or if it also includes affiliated domestic entities such as variable interest entities controlled by the SPV through contractual arrangement.

[3] If the special purposes vehicles below the first-level SPV are not registered with SAFE, the PRC government would have less means to track and monitor them for tax collection and other purposes. It would seem unlikely that the PRC government would give up its jurisdiction for the special purposes vehicles below the first-level SPV.

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