The Ministry of Commerce's Interim Provisions on Equity Contribution Involving Foreign-Invested Enterprises ("the Provisions") came into effect on October 22, 2012. These Provisions provide operational guidelines for equity contribution by foreign-invested enterprises.

I. Forms of Equity Investment by Foreign-Invested Enterprises

The Provisions clarify that domestic and foreign investors ("equity contributors") may use the equity they hold in enterprises within the People's Republic of China ("equity enterprises") as capital contribution to establish and modify foreign-invested enterprises ("investee enterprises"). The specific forms of contribution are as shown in the following figure:

The forms of equity investment by foreign-invested enterprises regulated by the Provisions include: 1. Establishing a foreign-invested enterprise in the form of a newly incorporated company; 2. Increasing capital to convert a non-foreign-invested enterprise into a foreign-invested enterprise; 3. Increasing capital to cause changes in the equity of a foreign-invested enterprise.

II. Equity of Real Estate Enterprises, etc. Shall Not Be Used for Contribution

The Provisions impose restrictions on the equity used for contribution, specifying that equity of an equity enterprise whose registered capital has not been fully paid, equity that has been pledged or frozen, equity that is not transferable as stipulated in the articles of association, or equity of a foreign-invested enterprise that has not participated in or failed the annual joint inspection of foreign-invested enterprises for the previous year shall not be used for contribution. Additionally, the Provisions specifically stipulate that "the equity of real estate enterprises, foreign-invested investment companies, and foreign-invested venture capital (equity) investment enterprises" shall not be used for contribution.

To prevent foreign investors from evading foreign investment management through equity contribution, the Provisions require that after the equity contribution, the investee enterprise, the equity enterprise, and their directly or indirectly held enterprises shall comply with the national Catalog for the Guidance of Foreign Investment Industries and relevant regulations.

III. The Contributed Equity Shall Be Evaluated and Shall Not Exceed 70% of the Investee Enterprise's Registered Capital

In accordance with the Provisions, the equity used for contribution shall be evaluated by a legally established domestic evaluation institution, and the price of the equity shall be determined through consultation on this basis. The amount of equity contribution shall not be higher than the evaluated value of the equity. Furthermore, the sum of the amount of equity contribution and the amount of capital contribution made by作价 of other non-monetary properties shall not exceed 70% of the registered capital of the investee enterprise.

IV. Issues to Be Further Clarified After the Implementation of the Provisions

The promulgation of the Provisions has made equity contribution by foreign-invested enterprises possible, but the following issues need to be urgently clarified:

1. Whether the equity contributor needs the consent of other shareholders when contributing with the equity of the equity enterprise
In practice, most companies take the form of limited liability companies, which are both capital-based and person-based. Pursuant to the Company Law, when a shareholder of a limited liability company transfers equity to an external party, other shareholders are required to waive their preemptive right. However, according to the Provisions, an equity contributor may transfer the equity of the equity enterprise to the investee enterprise without the consent of other shareholders of the equity enterprise.

Assuming that the investee enterprise is 100% controlled by the equity contributor, the equity investor may inject the equity of the equity enterprise into the investee enterprise and then transfer the equity of the investee enterprise to achieve the effect of actually transferring the equity of the equity enterprise, thereby evading the restrictive legal provisions that require other shareholders to waive their preemptive right when transferring the equity of the equity enterprise externally.

2. Whether income tax is payable on the premium arising from the pricing of equity contribution.

The Provisions do not specify which tax administration regulations shall apply to equity contribution. If the amount at which the equity contributor prices the shares used for contribution or the amount of equity contribution is higher than the original price, the Provisions do not clarify whether income tax is payable on the premium portion. It is believed that with the development of practical operations, relevant implementation rules will be further clarified, and it is expected that the Provisions will bring more convenience to the development of foreign investment in China.