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China’s State Council formally issued the long-awaited Administrative Measures for Foreign Enterprises and Individuals to Establish Partnerships in China (Decree No. 567 of the State Council, hereinafter “Measures”) on 2 December 2009. The promulgation of the Measures is the most significant development in this area since the Partnership Law was introduced in 2006 ("Partnership Law"). The Measures, which become effective 1 March 2010, basically allow foreign investors more alternatives for structuring investments in China. Until now, foreign investors generally have had to set up investments in the form of wholly foreign-owned enterprises, equity joint ventures or cooperative joint ventures.
Salient Points
· The Measures allow a partnership to be established by (i) two or more foreign enterprises or individuals; or (ii) a foreign enterprise(s) or individual(s) and a Chinese individual(s), enterprise(s) or other organization(s) (hereinafter "foreign partnership"). The Measures also allow foreign enterprises and individuals to become partners in a partnership formed by Chinese individuals, enterprises or other organizations.
· The establishment of a foreign partnership only requires registration with the local branch of the State Administration of Industry and Commerce.
· There are no minimum capital requirements for a foreign partnership.
· Foreign partnerships that make investments in special projects or industries that do require special approval should be pre-approved by the relevant authorities.
· The setting up of a foreign partnership whose main business is to make investments may be subject to other rules and regulations.
Observations
Partnership capital
It is interesting that the Measures specifically require that cash capital contributions to a foreign partnership by a foreign enterprise or individual should either be in freely convertible currency or legitimately obtained Renminbi (“RMB”). The Measures do not specifically mention in-kind contributions by foreign partners as capital to a foreign partnership, where as the Partnership Law specifically mention that partners in a domestic partnership may make in-kind contributions as capital to the partnership.
General partner and limited partner
The Measures do not address whether the foreign investor can be a general partner or a limited partner in a foreign partnership. Article 3 of the Measures states that the Measures should generally follow the Partnership Law, which allows different types of partners (general vs. limited) and partnerships (limited partnership or special general partnership).
Using a foreign partnership to make investment
In light of the recent flurry of activities and press reports around major global venture capital and private equity fund players launching RMB-denominated investment funds in China or expressing an interest in doing so, many firms are exploring ways to set up such investment funds in the form of a partnership and are hoping the Measures will resolve the uncertainties relating to direct participation in investment funds set up in the form of a partnership. At this stage, it may be premature to conclude that the Measures provide clear guidance on this issue because, according to article 14 of the Measures, the setting up of a foreign partnership whose main business activity is to make investment should follow the other rules and regulations applicable to investment. The wording of article 14 is ambiguous and may lead to different interpretations. One possible interpretation is that investors may need to await further guidance specifically addressing the use of foreign partnerships for investment purposes and, until that guidance is issued, foreign partner direct participation in such foreign partnerships is not allowed. This interpretation would seem to be in line with the official Q&A press release on the Measures published on the government's website ( http://www.gov.cn/zwhd/2009-12/02/content_1478320.htm ),which appears to grant discretion to the government to introduce further guidance in respect of using a foreign partnership as a vehicle to set up an investment fund. Alternatively, one could interpret article 14 to mean that, in the absence of any rules specifically stating otherwise, a foreign partnership may make direct investments. The latter interpretation may be more in the nature of wishful thinking than a viable alternative interpretation since this is generally not a widely accepted method used by the administrative or judicial authorities in interpreting Chinese laws.
Partnership taxation
The Measures provide that foreign partnership-related tax matters should follow the prevailing applicable tax rules and regulations. Even though China does not currently have comprehensive partnership taxation rules (or foreign partnership tax rules), article 6 of the Partnership Law sets out the fundamental taxing principle, which simply states that each partner should separately pay income tax on its share of income derived from a partnership.
The Ministry of Finance and the State Administration of Taxation jointly issued a circular in December 2008 (Caishui [2008] No.159 ("Circular 159"), Notice on Issues Concerning the Income Tax Levied on Partners of a Partnership) that reconfirms the taxing principle outlined in the Partnership Law that individual and enterprise partners are subject to individual income tax and enterprise income tax, respectively, on income allocable from the partnership in which they are partners.
While clearly allowing flow-through tax treatment is a significant benefit and a reason to set up a foreign partnership, there are a number of important tax-related uncertainties and issues in the Measures that could create hurdles and will need to be resolved. For example, when a foreign partnership is allowed to make investments, will permanent establishment issues arise for the foreign partners as a result of investment in foreign partnership investment funds, the tax treatment of carried interests earned by a foreign general partner, etc. In addition, it is not entirely clear how the foreign partners should pay tax on income received from the partnership. Circular 159 states that where the partner is an enterprise, it will be subject to enterprise income tax. However, there is no guidance on how a foreign enterprise that is a partner would compute the tax and whether the after-tax profits would be subject to tax when the funds exit China. It is also unclear when a foreign partner sells its partnership interest, whether the undistributed after-tax profits would be added to the basis of the partnership interest when computing any gain or loss on the sale. Likely, the Chinese tax authorities may have to issue new rules governing the taxation on foreign partners to provide more clarification. And from a practical perspective, foreign investors will need to consider issues such as the foreign currency conversion of capital injected by foreign investors into a foreign partnership investment fund.
Summary
Overall, the Measures are welcomed, as they offer a new alternative investment vehicle for foreign investors in China, and with the new rules becoming effective on 1 March 2010, the foreign partnership structure should be considered. Hopefully, the authorities will issue additional guidance that clarifies and resolves the outstanding issues. | 
