Document 39 and New Opportunities for Foreign Investment

China has been working to improve market access for foreign investors, and an announcement in August was a major step in this direction. On August 8, the State Council unveiled its Notice on Measures for the Promotion of Foreign Investment” (State Council, No.39, 2017). This policy announcement, widely known as Document 39, extended greater market access and offered more financial support to foreign investors. The same document built on a foundation put in place earlier in the year with the Notice on Measures for the Promotion of Opening Up with Active Utility of Foreign Investment”(State Council, No.5, 2017). Document 39 and Document 5 put forward 22 detailed suggestions on reducing restrictions on foreign capital, formulating tax and support policies, facilitating immigration formalities for foreign employees and improving the overall investment environment of national level development zones. Document 39 gives clear guidance on the relaxation of foreign capital access in response to market developments and demand from foreign investors already in China. Some of the policies will no doubt require further elaboration.

A Lower Threshold for Foreign Capital Access
Document 39 clearly states that it is necessary to expand market access, and proposes 12 specific areas that will be further opened to the outside world. These include new energy vehicles, special-use vehicles, ship design, regional and general aircraft maintenance, international maritime transport, railway passenger transport, gas stations, premises for Internet access businesses, call centers, agents for entertainers, banking, securities and insurance.

Document 39 may require another revision of the Foreign Investment Industry Guidance Catalog (often referred to as the 2017 Catalog), which was jointly issued by the National Development and Reform Commission and the Ministry of Commerce in June 2017. During the 2004—2015 period, the Catalog of Foreign Investment Industries had been revised four times. The 2017 Catalog updated a document released two years previously. If the existing Catalog is updated again this year, that would be unprecedented.

Additionally, the so-called negative list for foreign investment, which permits investment in any area not specifically placed off limits, should be promoted on a national scale as soon as possible. This negative list concept was originally employed on a trial basis in free trade areas. These free trade areas (FTAs) enjoy a higher degree of market opening than other parts of the country. The Special Management Measures in Foreign Capital Access in Free Trade Pilot Areas (Negative List) (2017 Edition) was released in June 2017 as an updated version of existing rules. Compared to the previous version, the 2017 edition eliminated 10 articles and 27 measures related to aviation manufacturing, pharmaceutical manufacturing, Internet and related services, banking services and insurance. It is likely that these business areas will be gradually liberalized on a national scale. China may also move to open up the automotive, telecommunications, financial and other key sectors in the future.

Let us first look at the auto sector. Foreign investors have long sought to remove the restrictions which require joint ventures and limit foreign shareholdings in auto production. Although Document 39 makes it clear that China should relax foreign capital limits on the production of special-use and new energy vehicles, it does not address the key concern of foreign investors - conventional auto production. The 2017 version of the Catalog and the Free Trade Area Negative List continue the restrictions on foreign investment in automobile production. They maintain the limit of 50% equity in any venture as well as the “2+2” structure, which restricts foreign automakers to two joint ventures for passenger cars and two joint ventures for commercial vehicles. It is noteworthy that in 2016, officials of the Ministry of Industry and Information Technology and the National Development and Reform Commission publicly stated that the government was considering canceling the 50% equity ceiling and that would be accomplished in three to eight years. In April this year, the Ministry of Industry and Information Technology, the National Development and Reform Commission and the Ministry of Science and Technology issued their Long-term Development Plan for the Automobile Industry and made it clear that authorities should relax the share ratio restrictions on joint ventures in a orderly fashion.

Turning to telecommunications and Internet services, the 2017 version of the Catalog provided almost no changes from the past. Barriers to foreign capital in the telecommunications industry remain in place. Document 39 has listed Internet service corporate premises and call centers as areas for more market access, but it did not touch cloud computing, Internet access services or other value-added services where there is considerable interest from foreign concerns. It is noteworthy that, as early as in 2014, the Shanghai Free Trade Area tried to open up equity ratio restrictions on value-added telecom services for foreign investors. The ratio for information service corporations, storage and forwarding, call centers, domestic multi-party communication services and Internet access services in the Shanghai Free Trade Area can exceed 50%. The share ratio restrictions of online data processing and transactions (including e-commerce operations) were removed in 2015, and that has since been promoted on a national scale. In May 2005, Some Suggestions from the Communist Party Central Authorities and the State Council on the Construction of an Open Economy also proposed a gradual reduction of restrictions on foreign investment in telecommunications and other infrastructure areas as long as national security requirements are met. At present, some aspects of value-added telecom services that have been opened up in the Shanghai Free Trade Area may gradually be applied nationally in the future.

Lastly, we should examine the financial sector where we can see a cautious liberalization.  The 2017 Catalog has not eliminated the key restrictions on the financial sector. Document 39 clearly states that banking, securities and insurance are included in the 12 areas that will be liberalized, but there is no indication of which restrictions on ownership and business areas will be removed. In June 2017, Zhou Xiaochuan, the governor of the central bank, told the Lujiazui Forum, a major business conference, that financial services would be gradually liberalized. The State Council's Document No. 5 also said it was necessary to relax curbs on foreign capital in banking and finance, securities, securities investment fund management, futures trading, insurance, and insurance intermediaries. Both are positive signals on the future opening up of the financial service sector.

Formulating Tax and Fiscal Support Policies
In order to encourage foreign investment, Document 39 states that foreign investors using profits from enterprises in China to invest in encouraged business areas may be entitled to deferred tax treatment, allowing them to avoid the payment of withholding tax.

Prior to 2008, dividends distributed to foreign investors from their investments in China's domestic enterprises were generally exempt from withholding tax. But as of January 1, 2008, the corporate income tax law ended this treatment. Since then, unless it can enjoy the corresponding tax treaty treatment, dividend income of foreign investors in China generally requires a 10% withholding tax. Even if after-tax profits were used for reinvestment in China, foreign investors were still subject to withholding tax.

In order to avoid the 10% withholding tax, many foreign investors chose to set up an investment company in China as a platform for the collection and reinvestment of profits. However, there are some requirements for establishing an investment company, and these can be difficult to meet. These include having total assets of not less than US$400 million and registered capital of at least $30 million for the the investment company alone. This has discouraged many smaller multinational companies. S