One of the features of China’s new Foreign Invested Enterprise (FIE) online filing registration for is the requirement that the foreign investor state who will be the “actually controlling person” of the foreign invested entity. Under the new rules, the management of all FIEs must complete an online registration form. This form defines “actually controlling person” is either a) the person or persons who collectively have 50% ownership in the foreign investor that will establish the FIE OR b) the persons who actually control the foreign investor through means other than ownership, such as contractual control over the foreign investor’s decision making body. For background information on China’s new foreign company registration laws, check out China’s New Foreign Investment Law — Less Than Meets the Eye.
For anyone who works with modern corporation ownership and management, it is obvious that this simply posed question of “who is in control” will in many instances actually be quite difficult to answer. Anyone who works in the field can give examples of complex structures for non-public companies that are intentionally structured to ensure that no single individual has actual control.
We represent many private company clients with multiple owners, none of whom as individuals have actual control. In some cases, the ownership structure is complex, involving individuals, family trusts, angel funds and employee ESOPS. For these clients, my first response to the form was to reply “none” when asked who is the actually controlling person, since that is the only sensible answer. However, the new form does not allow for this simple response. The new form only allows two answers: either the controlling person is an individual or group of individuals OR the controlling person is a public corporation. No “in between” answer is allowed. We all know this simple scenario does not reflect the reality of modern corporate finance and governance. But the new PRC regulations do not allow for any alternative response.
How does all this work? In the section on “actually controlling person”, the new form gives the following options that must be chosen through a checkbox (translation supplied by me):
从以下类型中勾选 Select from the following categories：
□境外上市公司 Foreign Listed Company
□境外自然人 Foreign Natural Person
□外国政府机构（含政府基金）Foreign Government Agency
□国际组织 International Organization
□境内上市公司 Domestic Listed Company
□境内自然人 Domestic Natural Person
Note that NO private business entity of any kind is listed here even though that is one of the most common types of business entity my firm sees; the system allows only for a public company or natural person. That means that for every investor that is NOT a public company, we will need to identify the natural person or persons who control the private entity. In many private companies, no individual owns a controlling share. In this situation, it will not work to say that each owner has a 10% share, so no one is in control. It appears instead that the required response will be that the group of individual shareholders are natural persons who are collectively in control, so we will have to list every one of them. And, if one of the owners is an entity, we will need to drill down and report the ownership of that entity until we finally reach the point of reporting the name of a natural person or the name of a public company.
China’s intent with this new system is clear. The PRC government will no longer allow the use of special purpose vehicles and related entity structures to hide the actual ownership of the investors in PRC foreign invested enterprises. And any attempt by a foreign investor to invoke foreign law that allows secrecy with respect to ownership will almost surely be ignored. MOFCOM has plans to carefully audit all FIEs and that audit will include careful reviewing their ownership structures. More important, however, is that a response that does not list out owners will simply not be accepted by the automated system. A response is therefore forced. A false response is a violation of law that can result in penalties and other legal/administrative action by the PRC government and its agencies.
The way the online form is written does not provide any way around this. We often have clients whose situation is such that listing out their ownership structure as required by the new online company registration system would reveal that Chinese individuals are owners of the U.S. investor, and for that reason the whole investment constitutes a round trip investment. This new company registration system is designed to root out just such round trip investments. Note that Chinese individuals are generally not allowed to have ownership in foreign companies without prior Chinese government approval.
For U.S. investors who are not in this category, this requirement will still be a problem because the actual ownership of the investor is often complex and not public. Think private equity, VC funds, angel funds, family trusts, and limited partnerships. It also is not normal in the United States for private entities to publicly reveal their shareholders. In fact, there are private entities that do not even know who their ultimate individual shareholders are.
The new rules go beyond requiring identifying the controlling persons; they require identifying of each source of investment in the FIE. The online form requires the investor state a) the amount of the investment, b) the type of investment (cash, equipment, land, buildings, intellectual property, etc.) and c) the specific source of each of those types of investment. Under this approach, it is not possible to bury round trip investments from China under other investments that come from outside China. Even if a small part of the total investment is sourced from China, this source must be clearly identified.
As I noted in my earlier post, this new online registration system will not reduce the amount of information that must be provided to MOFCOM. It is just the opposite. To properly complete the online form, substantially more information will need to be gathered and provided to MOFCOM. In addition, local governments will still require their own documentation, and that documentation will still require authentication and other similar procedures. So in the end, China’s new foreign company registration system will end up being even more complex and cumbersome than its current system.
To make it worse, since the MOFCOM report is filed online, there will be no government official available in a local office from whom we can obtain clarification on what is required. This means the form will be submitted without a prior “pre-approval” from the local agency. This will have two negative results. First, it could result in numerous submissions to the online system as an attempt is made to do it right while operating in the dark. Second, due to the vagueness of the requirements, there is substantial risk that MOFCOM officials will find a mistake or defect on subsequent audits.
Registering a China WFOE just got tougher.This article was written by Steve Dickinson and published on China Law Blog. Original Post: http://www.chinalawblog.com/2016/10/chinas-new-foreign-investment-law-the-actually-controlling-person-requirement-is-going-to-be-tough.html