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China's New Foreign Investment Industrial Guidance Catalogue

Update
02.23.2012

The Foreign Investment Industrial Guidance Catalogue (2011 Revision) (the "2011 Catalogue") issued by the China National Development and Reform Commission ("NDRC") and the Ministry of Commerce ("MOFCOM") went into effect in China on January 30, 2012.  The 2011 Catalogue marks significant changes to the Chinese government's policy in guiding foreign investment to certain industry sectors in China.

Background Information

The 2011 Catalogue is an update to the Foreign Investment Industrial Guidance Catalogue (the "Guidance Catalogue"), a long-standing tool used by the Chinese government to guide foreign investment in China.  The Guidance Catalogue divides industry sectors into three categories -- Encouraged, Restricted and Prohibited -- each of which enumerates the industry sectors and industrial projects classified in such categories. 

For industrial projects in the "Encouraged" category, foreign investors are generally allowed to establish wholly owned subsidiaries (commonly referred to as wholly foreign-owned enterprises or "WFOEs") in China to operate those industrial projects unless the Guidance Catalogue specifically requires a foreign investor to enter into a joint venture with a Chinese partner and, on occasion, for the Chinese partner to hold a majority of the equity interests of such joint venture. 

Foreign investment for industrial projects in the "Restricted" category is typically made through a joint venture with a Chinese partner, and the foreign investor's equity interest in such a joint venture may be subject to limitations.  As for industrial projects in the "Prohibited" category, foreign investment is not allowed.  Industrial projects not listed in the Guidance Catalogue are generally regarded as "Permitted" and open to foreign investment.

The first Guidance Catalogue was issued in 1995 and has been revised several times.  The last Guidance Catalogue, prior to the 2011 Catalogue, was issued in 2007.  The 2011 Catalogue reflects changes in China's macro-economic and industrial policy outlined in the 12th Five-Year Plan adopted by the National People's Congress in March 2011.  Specifically, the 2011 Catalogue reflects the Chinese government's emphasis on developing certain key industry sectors, such as information technology, clean technology, value-added manufacturing and services.

Major Changes in the 2011 Catalogue

This Update highlights the following major changes in the 2011 Catalogue.

1.  More Encouraged and Fewer Restricted or Prohibited Industrial Projects. 

The 2011 Catalogue reflects a direction of the Chinese government to further open up and liberalize foreign investment by increasing the types of industrial projects classified in the "Encouraged" category and removing numerous industrial projects classified in the "Restricted" and "Prohibited" categories.  Furthermore, the 2011 Catalogue removes the requirement that a Chinese partner hold a majority of the equity interests of many joint ventures in the "Encouraged" category and loosens restrictions on the percentage of the equity interests that may be held by foreign investors in certain other industrial projects.  For example, production of natural additives for food and food ingredients is no longer limited to joint ventures, which means foreign investors may form WFOEs to operate these types of industrial projects.

2.  Additional Guidance regarding what Constitutes New Technologies

The Chinese government desires to transform China's manufacturing industry and provide incentives for the industry to adopt new technologies, processes, materials and equipment.  The 2011 Catalogue reflects that recognition and specifies the scope of "Encouraged" industrial projects through the use of specific definitions and descriptions regarding what constitutes these new technologies, processes, materials and equipment.  Various new products and technologies in the textile, chemical, non-metal mineral products, mechanical manufacturing and other manufacturing industry sectors have been added to the "Encouraged" category.  For example, specific descriptions of pollution control equipment and solid waste treatment and disposal equipment have been listed in the 2011 Catalogue for several industrial projects in the "Special Equipment Manufacturing Sector" classified under the "Encouraged" category.

3.  Development of Strategic New Industries. 

Foreign investment is encouraged in development of strategic new industries, such as energy conservation, next generation information technology, biotechnology, high-end equipment manufacturing, alternative energy, new materials and alternative fuel vehicles.  The 2011 Catalogue encourages utilizing energy efficient, environmentally friendly technologies and using renewable resources.

Although automotive manufacturing no longer falls in the "Encouraged" category, the manufacture of key components of alternative fuel vehicles has been added to the "Encouraged" category and foreign investors may hold up to 50% of the equity interests in these types of industrial projects.  Additions to the "Encouraged" category include production of bio fiber through the use of renewable resources and environmentally friendly techniques, construction of waste recycling plants, manufacture of high-tech batteries, manufacture of conductive glass for the solar power sector and manufacture of pollution control equipment, non-conventional water treatment equipment, reuse equipment and water quality monitoring equipment.  The 2011 Catalogue also includes in this category the development and manufacture of next-generation Internet system equipment based on Internet Protocol version 6, including software and microchips.

4.  Development of Service Industries

The 2011 Catalogue broadly expands the "Encouraged" category in various service industries in line with China's policy of encouraging foreign investment to develop a modern service industry in China.  Nine industrial projects have been added to this category, including rural distribution chains, electric vehicle charging stations, venture capital businesses, intellectual property services, household services and vocational skills training.  In addition, foreign-invested medical institutions, sales of pharmaceutical products and automobiles, commercial product auctions, commercial franchises, agencies, business management and financial leasing are removed from the "Restricted" category.  Distribution of audio-visual products (excluding movies) remains in the "Restricted" category and businesses with foreign investment in these types of industrial projects still need to be conducted through a joint venture with a Chinese partner; however, the Chinese partner no longer has to hold a controlling interest in the joint venture.

5.  New Restricted or Prohibited Industrial Projects. 

To curb overcapacity and discourage energy-inefficient manufacturing that uses outdated technology, certain industrial projects have been added to the "Restricted" or "Prohibited" categories.  Notably, construction of villas is added to the "Prohibited" category and manufacture of inorganic salt that uses methods that cause undue resource consumption and pollution is added to the "Restricted" category.  Domestic courier service is another newly added "Prohibited" industrial project.

Effect of 2011 Catalogue

The 2011 Catalogue does not apply retroactively.  Therefore, a WFOE that was formed for an industrial project originally in the "Encouraged" category under the 2007 Catalogue does not have to be turned into a joint venture even if that industrial project now falls in the "Restricted" category under the 2011 Catalogue.  However, the 2011 Catalogue may be applied prospectively to the WFOE if the WFOE undergoes significant corporate changes, such as a capital increase, an equity transfer or an initial public offering outside of China.

Many foreign investment related regulations will need to be modified in accordance with the 2011 Catalogue, so it is not clear how the 2011 Catalogue will apply in practice in each specific industry sector.  Foreign Investors should carefully monitor subsequent regulatory changes following the release of the 2011 Catalogue.

A Chinese version of the 2011 Catalogue can be found at http://www.gov.cn/flfg/2011-12/29/content_2033089.htm.

© 2012 Perkins Coie LLP