Why does every businessman accuse the GST system

Foreign Law & Investments Newsletter Q2 2019

From the Luther world

Lectures / events

Luther China Talk

Successful start to the “Luther CHINA Talk 2019” series of events.

China is and will remain one of Germany's most important trading partners. At the same time, Germany is one of the most popular investment destinations for Chinese investors. In our new “Luther CHINA Talk” series of events, experienced speakers from our China practice, together with company representatives and other China experts, report on current developments in and with China.

The start was on March 13, 2019 with the breakfast event "Digital Economy in China - No Admission for Foreigners?" In Cologne. With applications such as artificial intelligence, robotics, the Internet of Things and cloud computing, the digital transformation is in full swing, especially in China. Almost everywhere people pay with the smartphone, online offers and new digital concepts are developing rapidly in China, but foreign providers are struggling with old and new challenges in the “digital economy”. After a brief welcome and an introduction to the topic by Thomas Weidlich (Luther Cologne), Philip Lazare (Luther Shanghai) and Dr. Yuan Shen (Luther Cologne) talked about the regulatory network of the new Chinese network security world and drew attention to obstacles such as cross-border data transfer and VPN use. Oliver Gäbisch (head of the IT department at Luther) gave insights from IT practice and reported on technical and linguistic difficulties in working with Chinese IT experts and lawyers. Our guest speaker Oliver Nauditt from Alibaba Cloud Frankfurt explained how Alibaba - China's largest online marketplace and the third largest cloud provider in the world - supports international companies in developing and operating their IT in China.

In our webinar "China Tax Update" on March 21, 2019, the participants from Germany and China were able to find out about the latest developments in Chinese tax law from Philip Lazare and Qu Jing (both from Luther Shanghai). Because since January 1, 2019, a fundamentally changed income tax law has been in effect in China. In addition, the Chinese tax return is to be simplified by the introduction of a tax app and will be made electronically in future. A number of tax breaks are also planned for companies with the aim of relieving the Chinese economy. After a comprehensive overview of central aspects and innovations of the Chinese tax system, the speakers also answered questions from the participants.

Another hot topic was discussed on April 26th in Shanghai and on May 14th, 2019 in Cologne at the "FDI Update: New Investment Environment for Foreign Companies in China". Foreign companies have been complaining about the restrictions on market access in China for many years. On March 15, 2019, the 13th National People's Congress passed the Foreign Investment Act (AIG). This should eliminate the existing special rules for foreign-invested companies, which are to have the same market access as Chinese companies in the future. Ni Ningjin (Luther Shanghai), Thomas Weidlich (Luther Cologne) and Philipp Baron von Drachenfels (Luther Shanghai) explained the background to around 30 participants and pointed out what foreign companies in China will have to be prepared for in the future. A lot will change, especially for joint ventures, even if there are transitional regulations. Experienced China experts reported on current developments from the company's point of view and contributed exciting practical tips: Dr. Anne Daentzer, head of the legal department at Schott AG with more than 20 years of experience as a lawyer in China, pointed out the special challenges for joint ventures in China and Wolfgang Haselberger, owner of arsa consulting GmbH, reported on his many years of experience in compliance investigations in China. Felicitas Kaupp, Regional Manager Greater China at the German Asia-Pacific Business Association, gave a macro outlook on the current mood in China and also discussed the trade dispute with the USA.

Together with TÜV Rheinland, a workshop on "Internet of Things, Data Protection and 5G Security - Opportunities and Risks for Chinese Companies in Germany" took place on May 28, 2019 at the headquarters of the international testing service provider in Cologne. Adrian Hoppe and Dr. Yuan Shen (both from Luther Cologne) informed the 30 or so participants about the EU's data protection regulations and analyzed the legal consequences of violations based on current court decisions in Germany and other EU countries. The compliance risks that internationally operating companies are confronted with when exchanging data across borders and using common Chinese means of communication such as WeChat became clear. Stefan Eigler (Global Leader Data Protection and Privacy, TÜV Rheinland) emphasized the need for data protection and network security and gave pragmatic advice for IT compliance management in medium-sized companies. Steffen Häberer (Luther Leipzig) then gave a lecture on the framework conditions of German procurement law and explained the challenges faced by foreign companies when participating in public tenders in Germany. Against the background of the current debate in connection with the expansion of the German 5G network and the possible involvement of the Chinese telecommunications supplier Huawei, this led to a lively exchange between participants and speakers following the workshop presentations.

Chinaforum Bayern: “Establishing a company in China” on March 11, 2019 in Ingolstadt

The Chinaforum Bayern e.V. organized a full-day workshop for medium-sized companies intending to set up a company in China in the Ingolstadt business start-up center in cooperation with the China Center Bavaria. Philip Lazare (Luther Shanghai), together with other China experts, explained all the essential steps that need to be taken into account when setting up a company in China. Valuable tips for the location analysis as well as legal recommendations for the establishment of a company were given. Other topics included personnel and labor law issues such as the posting of employees, the drafting of employment contracts and regulations regarding income tax and social security contributions. Following the workshop, the participants were able to exchange ideas with the speakers at a dinner and deepen the aspects addressed.

Lecture on dispute resolution at the AHK Shanghai on April 23, 2019

On April 23, 2019, Zhang Zheng (Luther Shanghai) gave a lecture on dispute resolution at a "Legal & Tax" workshop of the German Chamber of Commerce in Shanghai. Using various case studies, she explained to more than 20 Chinese company representatives how to establish effective dispute settlement clauses in a contract and how to avoid other legal risks in practice. In a subsequent Q&A session, Ms. Zhang answered the participants' most important questions. The workshop met with a very positive response from the participants, most of whom came from Shanghai and the region.

Business Day China of the IHK Bonn on May 29, 2019

On the occasion of the tenth anniversary of the city partnership between Bonn and the southwest Chinese city of Chengdu, the IHK Bonn / Rhein-Sieg organized a full-day workshop in which China experts and practitioners spoke about new business opportunities and suitable business models for German companies in China. Thomas Weidlich (Luther Cologne) gave in his lecture on the subject of “New investment environment for foreign companies in China - between the old economy and the digital economy” an overview of important legal framework conditions, for example in e-commerce or cross-border data exchange. He also drew attention to the changes that will result from the recently enacted new Foreign Investment Act (AIG) for German companies in China, and in particular for joint ventures. More than 50 German and Chinese representatives from politics and business took part in the event.

Event information - "Save the Date"

Luther CHINA Talk

Our “Luther CHINA Talk” series of events will be continued after the summer break with current developments in the areas of compliance, personnel and e-commerce. The events mainly take place as a "breakfast seminar" or in the form of a webinar. All dates at a glance Compliance Overtaking the West: Between Sense and Overregulation in China Essen | October 8, 2019 Compliance in Germany: what makes a “good” Chinese company? Cologne | September 4, 2019 Labor Law Human Resources Issues in China: Overview and Current Developments Webinar | July 2 and 9, 2019 Personnel management and dealing with employee representatives as a success factor at Post Merger Integration Düsseldorf | September 25, 2019 China and Germany in the competition for joint ventures, cooperations and license agreements with Chinese partners Cologne | September 19, 2019 Shanghai | September 26, 2019 China's National Strategies and the West's Response - A Debate Cologne | November 7, 2019 E-Commerce in China Alibaba, Taobao and Co. - How to get started in China's online trade Düsseldorf | November 21, 2019 The current event schedule can be found herehttps: //indd.adobe.com/view/3e22862d-ea78-4778-b0ac-e3a25cbc9295.

India Day 2019

This year's India Day is a very special one: We look back on a 10-year tradition and have put together a very exciting and varied program. Against the background of the elections and other current developments in India, entrepreneurs and experts will discuss practical challenges and opportunities on the Indian market - from market entry and cooperation with Indian partners to sales and production to personnel issues and outsourcing.

The 10th India Day will take place on Tuesday, June 25, 2019 in the festive Flora in Cologne. The entrepreneur forum offers both India newcomers and India experts updates, informative discussions, exclusive practical lectures and a unique exchange platform on the Indian market. A compulsory course for every entrepreneur working in an international environment.

Further information about the event with the complete program and information on registration can be found at: https://www.indiaday.de/

China Investment Summer Festival on July 11, 2019 in Cologne

Investment Platform China / Germany, network corporate finance and Luther invite you to the China Investment Summer Festival on the Luther roof terrace with a view over the Rhine. In a relaxed, informal atmosphere, we would like to offer our clients and business friends interested in China a platform to get to know each other, to exchange professional ideas and to make new contacts. Prof. Dr. Herbert Schuster, successful entrepreneur and founder as well as one of the most renowned digitization experts in Germany, will hold the key note on the subject of “AI: Completely New Opportunities - and Competitors. An overview of the status quo and a look into the future. "

The event starts on July 11th at 6 p.m., places are limited. Here is the registration link. http://goingpublic-events.de/china-investment-sommerfest

One-day seminar on setting up a sales subsidiary in China on October 17, 2019 in Ludwigshafen

The IHK Pfalz will hold a full-day event on October 17, 2019 on the subject of "Customer proximity in the distance - instructions for setting up a sales subsidiary in China". The seminar provides practical information on how to successfully set up a sales subsidiary in China. Philip Lazare (Luther Shanghai) and other China experts use extensive materials and examples to explain the process of founding a company in China, explain the tasks that have to be carried out in China or in the German parent company and which special features have to be taken into account when setting up a company in China should.

Program and registration at the IHK Pfalz via this link: https://www.pfalz.ihk24.de/System/vst/1308808?id=323852&terminId=527616

Publications

BREXIT study

After the resignation of British Prime Minister Teresa May, it is more unclear than ever how things will go on with Brexit. At the EU special summit on April 10, 2019, the EU27 heads of state agreed with Great Britain on a flexible extension of the deadline to a maximum of October 31, 2019. However, it is uncertain whether an agreement in the House of Commons and between the United Kingdom will be reached by the end of the deadline and the European Union. Should no agreement be reached, a “no-deal” Brexit will automatically occur, which will have profound effects on trade between the European Union and the United Kingdom. A “no deal” means that the United Kingdom will not only leave the European internal market and the European customs union, but also that freedom of movement and freedom of establishment will cease to exist without replacement. Britain would become a third country.

Our Luther team of experts dealt with the consequences of a “no deal” Brexit at an early stage and comprehensively and compiled the effects on companies in a Brexit brochure, which you can download from this link: https: //indd.adobe. com / view / 9f849eb5-d48c-4ed1-af4d-8f4d6068759d

Thomas Weidlich, LL.M. (Hull)
partner
Luther Rechtsanwaltsgesellschaft mbH
Cologne
Phone +49 221 9937 16280
[email protected]


International

National Industrial Policy and Investment Control - New Walls in the West?

Germany, too, does not seem immune to the protectionism virus, which is rampant around the world. At the end of last year, the federal cabinet decided to further tighten the investment review for company investments by foreign investors. Due to the 12th amendment to the Foreign Trade Ordinance, an investment review by the Federal Ministry of Economics (BMWi) is now partially possible when foreign investors take over 10% of the voting rights. In addition, the group of notifiable takeovers has been expanded. At the European level, too, stricter regulations are currently being drawn up and considerations are being pushed forward for a European industrial strategy aimed primarily at China. At the beginning of February, Federal Minister of Economics Peter Altmaier presented his “National Industrial Strategy 2030”. The minister openly admits that he has taken the “Made in China 2025” industrial strategy of the People's Republic of China as an example.

"National Industrial Strategy 2030"

Industrial policy is currently experiencing a renaissance in many parts of the world, not just under President Trump in the USA. France and Germany are jointly campaigning for a European industrial strategy that should be confidently represented especially towards China. The declared aim of the “National Industrial Strategy 2030” is to strengthen Germany as a business location and make it fit for the future. Innovative technologies should be promoted more strongly and strategically important areas should be protected. Funding is available in particular for artificial intelligence, which will play a central role in the development of autonomous driving and medical diagnostics, for example, and electromobility, which the German government is currently making available one billion euros for setting up a domestic battery cell production facility. In addition, a sovereign wealth fund is to be created that can temporarily participate “in very important cases” (KUKA sends its regards) to ward off hostile takeovers. Altmaier is also concerned that hardly any new large corporations are emerging in Germany and would like to relax EU competition law in order to create national and European champions. Here, too, the minister has his sights set on the Chinese state-owned corporations, which German competitors would have to face "on an equal footing".

There was some support from the German economy, but mostly there was clear criticism of the plans of the federal government. The promotion of new technologies is widely welcomed, but new measures to prevent company takeovers are rejected. The VDMA (Verband Deutscher Maschinen- und Anlagenbau), which represents the interests of German mechanical engineers, is “extremely skeptical” and sees government interventions as “more of a curse than a blessing”. The first reactions of numerous other business associations were similar, where the German SME sector with its export orientation is promoting open markets. Many entrepreneurs ask themselves what the state claims to be able to assess future business areas better than the market when politics in the "old economy" already has so many unsolved problems. Energiewende, Deutsche Bahn and Berlin Airport cite a long list of examples that suggested that the state is not the better entrepreneur. There is a lot of catching up to do in Germany, especially in the area of ​​IT infrastructure.Minister Altmaier reacted to the unusually violent attacks from the economy and invited business associations and unions to a “crisis summit” at the beginning of May. There were no concrete results there, the minister intends to present his final strategy in the autumn.

In the short term, however, the uncertainty triggered by the debate means that private investors will wait and see. This is already noticeable with Chinese investments: After the record year 2016 with EUR 37.2 billion and still EUR 29.1 billion in 2017, EU direct investments from China fell back to EUR 17.3 billion in 2018, almost to the level of the previous year 2014 (EUR 14.7 billion). Germany is still one of the main target countries in Europe, but here, too, Chinese investors have recently held back, which is due to the changed conditions in China as well as the new framework conditions and signals from Germany.

Investment control in Germany

The review of company holdings by foreign investors has long been a marginal issue in Germany outside of merger control. With the increase in Chinese takeovers and some very high-profile transactions (KUKA, Aixtron, etc.), this has changed and the number of test procedures has increased significantly since 2016. Until now, the Foreign Trade Act (AWG) and the Foreign Trade Ordinance (AWV) stipulated that every acquisition of shares in a company based in Germany with voting rights of at least 25% can be checked. As a basis for the assessment, the decisive factor is whether the acquisition of the relevant shares jeopardizes public order or security or essential security interests of the Federal Republic of Germany.

Due to the 12th amendment to the AWV, an investment review by the BMWi is now possible in some cases even when foreign investors take over 10% of the direct or indirect voting rights (Section 60a (1) AWV). In addition, the group of notifiable takeovers has been expanded. When the changes came into force, since December 19, 2018, stricter regulations have been in effect for the acquisition of particularly security-relevant civil companies by EU / EFTA foreigners as part of the cross-sector audit (§§ 55 ff. AWV). The same applies to the acquisition of key military technologies or IT systems for the encryption of sensitive government information as part of the sector-specific test (§§ 60 ff. AWV). The particularly security-relevant civil companies include above all critical infrastructures in the fields of electricity, gas and drinking water supply as well as telecommunications, which are listed as "key industries" in Section 55 (1) sentence 2 AWV and which, in the opinion of the Federal Government, are particularly security-relevant and therefore special Need protection in connection with foreign investors. The amendment now also includes “companies in the media industry” that “contribute to the formation of public opinion by means of radio, telemedia or print products” and are characterized by “particularly topicality and broad impact”. This is intended to ensure the independence of the media and prevent attempts at foreign influence and disinformation. According to the old law, companies in the media industry already had a right of the BMWi to examine the acquisition of a company in accordance with Section 55 (1) sentence 1 AWV. Due to the change, however, media companies are now also required to report.

For the civil companies mentioned in section 55 (1) sentence 2 AWV, which are particularly security-relevant in the context of the cross-sector audit, as well as for the companies covered by the sector-specific audit (§§ 60 ff. AWV), the audit entry threshold has now been increased from 25% to 10 %, which means that the reporting requirement is also expanded accordingly. This enables the Federal Government to examine even smaller investments by foreign investors in particularly security-relevant areas at an earlier stage and to initiate appropriate measures. It is likely that the share increases of a foreign investor will also be checked again in the future. For other companies, the test entry threshold remains at 25%.

Background to the stricter regulation

The trigger for lowering the test entry threshold was not least the acquisition of 50Hertz by the Chinese investor SGCC (State Grid Corporation of China) last year. The investment control did not come into play in this transaction because only 20% of the company shares in the German transmission system operator 50Hertz were to be acquired. Ultimately, the federal government was only able to prevent the takeover by asserting the right of first refusal by an old investor and temporarily acquiring the shares by the Kreditanstalt für Wiederaufbau (KfW). The surprising entry of the Chinese car maker Geely at Daimler also sparked discussions. The German financial regulator BaFin examined a possible violation of the securities reporting requirements, but finally came to the conclusion that the Chinese shareholder had announced its participation in good time and did not impose a fine on Geely. Another example shows that the political pressure in Germany has increased overall and investment controls are more strictly regulated: At the beginning of 2018, the Chinese Yantai Taihai Group was able to take over Duisburg Tubes Production AG - a German supplier to the nuclear industry - without any problems. In August of the same year, however, the attempted takeover of the German mechanical engineering company Leifeld Metal Spinning, whose metal parts can also be used in the nuclear industry, failed. The Chinese Yantai Taihai Group terminated the transaction prematurely after a ban by the federal government became apparent.

Effects on Transaction Practice

Even after the changes to the AWV in December 2018, Germany is and will remain a very investment-friendly country. The facts are clear: between 2016 and 2018, around 200 transactions were examined by the Federal Ministry of Economics, of which almost a third were acquisitions with Chinese participation. Only in a very few cases, such as the planned takeover of the mechanical engineering company Leifeld by the Chinese Yantai Tahai Group, was there a threat of prohibition; the BMWi has not actually stated this in a single case to date. However, the test deadlines are being extended, especially in particularly sensitive areas such as energy or telecommunications, and we are generally seeing increased testing effort. The lowering of the audit entry threshold will lead to a higher number of audit-relevant acquisition cases - both for the cross-sector audit according to § 55 Paragraph 1 Clause 2 AWV and for the sector-specific audit according to § 60 AWV - because even smaller and thus potentially even more transactions are recorded.

The BMWi has already had a wide margin of discretion in its examination and the introduction of further indefinite legal terms such as "media business" increases the legal uncertainty as to whether the respective acquisition process falls within the material scope of the AWV. In contrast to merger control, the investment review under the AWG does not provide for a prohibition of execution, but acquisitions by foreign investors are subject to the subsequent condition that the BMWi does not prohibit the transaction (Section 15 (2) AWG). In case of doubt, the parties involved must therefore submit an application to the BMWi for the issue of the clearance certificate according to § 58 AWV or the release according to § 61 AWV in order to obtain legal certainty with regard to the (imminent) acquisition process as quickly as possible. Even in unproblematic cases - and this is likely to continue to be the vast majority of cases - the requirement of submitting an application and making a decision about it is a fact that should be planned in terms of time by those involved and considered in legal terms when drafting the contract. Thorough preparation and timely registration of the transaction are more important than ever.

Recent developments show that Chinese investments in Germany and Europe in particular are being scrutinized more closely. We will present the situation at European level in detail in the next edition of this newsletter.

Thomas Weidlich, LL.M. (Hull)
partner
Luther Rechtsanwaltsgesellschaft mbH
Cologne
Phone +49 221 9937 16280
[email protected]


Australia

New Modern Slavery Reporting Requirements for Australian Businesses

On January 1, 2019, the Modern Slavery Act 2018 (Cth) came into force in Australia. This makes Australia one of the few countries that regulates modern slavery in global supply chains. In particular, the obligation was introduced for certain companies (reporting entities) to publish a so-called modern slavery statement every year. This is intended to reveal the risks of modern slavery within the company and its global supply chains. Furthermore, it must be explained how the company counteracts these risks. This reporting requirement serves to ensure transparency for consumers and investors. The company's reputation is at stake if the company fails to meet its reporting obligations or does not adequately address disclosed risks of modern slavery.

Modern slavery

The term “modern slavery” describes a variety of practices, such as forced labor, the creation and exploitation of relationships of dependency, child labor and human trafficking. According to the International Labor Organization (ILO), there are currently more than 40 million victims of modern slavery worldwide, 56% of whom live in global production locations in the Asia-Pacific region. The problem of modern slavery was addressed in the UN Guiding Principles on Business and Human Rights 2011 and should be combated internationally.

In Germany, too, a corresponding draft law is currently being worked on. Within the EU, only Great Britain and France have passed corresponding laws so far.

Which companies are affected?

According to the Modern Slavery Act 2018 (Cth), foreign companies operating in Australia or Australian companies with a consolidated annual turnover of more than AUD 100 million must prepare a Modern Slavery Statement every year and submit it to the Australian Department of Home Affairs. The Modern Slavery Statement is then placed in a publicly accessible register. A lower sales threshold of AUD 50 million will soon apply to companies operating in New South Wales, as this state has enacted its own Modern Slavery Act 2018 (NSW), which is expected on July 1, 2019 will come into force. The two laws at the federal and state level partially overlap in their areas of application. However, it is sufficient if a company that falls under the scope of both laws complies with its reporting obligation at the federal level.

When does the Modern Slavery Statement have to be submitted for the first time?

The first reporting year according to the Modern Slavery Act 2018 (Cth) begins on July 1, 2019. When a company that exceeds the sales threshold (so-called reporting entities) has to submit a Modern Slavery Statement for the first time depends on the applicable financial year. Companies with a fiscal year ending June 30th in Australia must prepare their first report by June 30th, 2020 and file by December 31st, 2020, whereas companies with a fiscal year ending on December 31st must prepare their first report by December 31st, 2020 and must submit by June 30, 2021.

What must the Modern Slavery Statement contain?

The Modern Slavery Statement must contain the following information: "

  • the structure, business operations and global supply chains of the company must be presented; "
  • any risks of modern slavery within the group and its suppliers must be described; "
  • Measures to combat modern slavery must be presented (this includes, for example, due diligence checks and specific control measures with regard to identified risks); "
  • Opinion on the effectiveness of the measures taken; and "
  • additional information that the company believes is relevant.

The Australian Ministry of the Interior published draft guidelines for creating the Modern Slavery Statement on March 29, 2019 and invited companies and stakeholders to comment. Any comments must be submitted by May 19, 2019. The guideline specifies specific requirements for the above-mentioned content. The guide also gives the following tips: "

  • the company management (e.g. representatives of the legal department, the purchasing department as well as the risk and compliance management) should deal with the preparation of the modern slavery statement; "
  • the company should avoid copying “snippets” from other companies or using generic statements; "
  • the company should work to improve the disclosure and fight against modern slavery year by year; "
  • the company should employ third parties experienced in modern slavery to develop effective modern slavery disclosure and control measures.

What happens if you don't submit a Modern Slavery Statement?

The Modern Slavery Act 2018 (Cth) does not include any authority to impose fines. However, the Minister of the Interior can take the following measures in the event of a breach of the reporting obligations: "

  • publicly announce that the company has failed to comply with its reporting requirements; "
  • request the company to comply with its reporting requirements; "
  • - asking the company to explain why it has not complied with its reporting requirements.

Although no fines can be imposed, there is a risk of a loss of reputation.

The Modern Slavery Act 2018 (NSW), however, provides for sensitive fines of up to AUD 1,100,000 if the company: "

  • a Modern Slavery Statement is not drawn up on time; "
  • fails to publish the Modern Slavery Statement; or "
  • the Modern Slavery Statement contains information that the Company knows to be false or misleading.

What should I do?

Any company with consolidated annual sales in excess of AUD 100 million that operates in Australia (or AUD 50 million if it operates in NSW) should review whether it complies with the Modern Slavery Act 2018 (Cth) or Modern Slavery Act 2018 (NSW) is subject. As far as the company is subject to these regulations, it should deal with the creation of a Modern Slavery Statement as soon as possible and then check its own production facilities and global supply chains to determine whether there are any risks of modern slavery. In this respect, the company should ask itself the following questions: "

  • Are supplier prices “too cheap”? "
  • Are there suppliers or your own manufacturing facilities in the risk countries of the Asia-Pacific region? "
  • Are workers from temporary employment agencies involved in the manufacturing process?

Insofar as risks are disclosed, they must be addressed and appropriately combated. If a company is required to prepare a Modern Slavery Statement in several countries (e.g. UK and Australia), it should ensure that the content of the report complies with the requirements of the relevant laws in the relevant countries, so that only one report is prepared for the group of companies got to.

China

The New Foreign Investment Law - Equal Rights for Foreign-Invested Companies?

In March, the 13th National People's Congress passed the Foreign Investment Act ("AIG"). It comes into force on January 1, 2020 and creates new framework conditions for foreign investors in China. Despite the overwhelming restriction on general principles, it brings about concrete changes for foreign-invested companies. At the recently concluded EU-China summit in Brussels, Chinese Prime Minister Li Keqiang emphasized that European companies will be given equal market access conditions in the future. Beijing is celebrating the new law as a milestone in further market opening for the approximately one million foreign companies in China, while there is only muted applause for the AIG in the foreign community due to the many ambiguities and some “back doors”.

background

The first draft of the AIG was published in 2015 and, with a total of 170 articles, contained much more detailed regulations than the now passed law. After the draft had not been further developed for three years, the Standing Committee of the National People's Congress published a new draft at the end of 2018, which was then adopted in March 2019. The exceptionally fast legislative process could be one of the reasons why the law with 42 articles is comparatively short and general.The assessment of various regulations will only be possible after specific implementing provisions have been issued.

The new law replaces the existing laws for foreign-invested companies (Law on Sino-Foreign Equity Joint Ventures, Law on Sino-Foreign Cooperative Joint Ventures, Law on Wholly Foreign-owned Enterprises). It summarizes some provisions from these laws, but does not contain any new regulations for the organization of foreign-invested companies, but refers to the Company Act and the Partnership Company Act. In this respect, it leads to a standardization of the regulations for foreign-invested and Chinese companies. For existing foreign-invested companies, a transition period of up to five years applies, during which they can retain their organizational form in accordance with the old regulations. The AIG is already mandatory for start-ups from January 1, 2020.

Market access for foreign investors

In Article 4 of the new law, the principle of national treatment of foreign investors is determined for the first time, with the exception of the negative list. This expressly includes equal treatment prior to the establishment of a company and thus goes beyond the scope of the investment protection agreement signed between Germany and China in 2003, in which only the equal treatment of investments that have already been made was agreed.

Despite equal treatment, the AIG names the following potential market access barriers: "

  • Negative list, "
  • Establishment of a security check system, "
  • Review based on antitrust requirements, "
  • Requirement of special licenses, "
  • Retaliation Against Other States.

The negative list emerged in 2018 from the earlier control catalog for foreign investments and currently includes 48 industrial sectors in which foreign investments are either only possible to a limited extent (20 sectors) or completely prohibited (28 sectors). The number of restricted or prohibited sectors has been steadily reduced in recent years. In 2017, for example, 63 industrial sectors were still listed as restricted or prohibited in the steering catalog.

The new law provides for the establishment of a security check system for foreign investments that impair or may impair state security (Art. 35).

While the draft in 2015 contained a separate chapter with 26 articles on the procedure, duration, documents to be submitted and factors to be taken into account during the examination, the AIG lacks detailed regulations. The law only states that the decision made as part of the security review is final. It remains to be seen to what extent a detailed design of the security check will take place within the framework of the following implementation provisions. The basic regulation in this context is the National Security Act, which came into force in 2015, which also provides for the possibility of a security check for foreign investments. The concept of national security is defined here relatively broadly and includes state authority as well as state sovereignty and unity as well as sustainable economic and social development.

For takeovers of domestic companies by foreign investors and their participation in the concentration of companies in other ways, Article 33 refers to the provisions of Chinese antitrust law. In this respect, foreign and Chinese investors are fundamentally subject to the same examination procedures and restrictions in the context of merger control.

Likewise, depending on their business activity, foreign-invested companies may require special licenses, for example for the production of food or pharmaceuticals. In this respect, Art. 30 makes it clear that the examination of applications from foreign investors is generally carried out according to the same conditions and procedures as for domestic investors.

Finally, Article 40 regulates that the People's Republic of China can take appropriate measures against this state in the event of discriminatory, prohibitive, restrictive or comparable measures by other states in investment matters. As a result, the possibilities of imposing retaliatory measures known from trade policy are transferred to the market access of foreign investors. It remains unclear in which cases measures by another state are considered discriminatory and which retaliatory measures could be taken against this state or any investors from this state.

Investment protection and investment promotion

In addition to market access, the law contains numerous regulations on investment promotion and the protection of foreign investments. The latter seem to be at least partially symbolic. According to Art. 22, administrative bodies or functionaries may not force the transfer of technology through administrative measures. However, it is often not administrative measures, but legal and factual entry barriers that force foreign companies to cooperate with Chinese contract partners and to transfer the corresponding technology.

Administrative bodies and officials have to treat the business secrets of foreign invested companies, of which they have come to know in the course of their duties, confidentially and are not allowed to disclose or illegally pass them on to others (Art. 23). Similar obligations can already be found in numerous other regulations (e.g. Art. 10 Regulation of the SAIC on Prohibiting Infringement upon Trade Secrets). With regard to the consequences of violations, reference is also made to the general statutory provisions (Art. 39).

In addition, the establishment of a complaint mechanism for foreign-invested companies is planned (Art. 26). In the event of a violation of their rights in administrative practice, the latter can request coordination and settlement by the complaints office to be set up. Furthermore, they can apply for a further administrative examination and the administrative legal process. The latter means, however, already exist and are rarely used by companies. Often it is less time-consuming and costly to obey the orders of the authorities or to negotiate a compromise with them.

In the context of investment promotion, the law also contains principles which, although they can be classified as positive, the actual effects of which will primarily depend on the implementation. This applies both to the participation of foreign-invested companies in setting standards (Art. 15) and to equal treatment in public procurement (Art. 16). In addition, the establishment of a reporting system for foreign investments is planned (Art. 34). The 2015 draft also contained a separate chapter with detailed reporting requirements, which were reduced to a single article in the new law. The wording of the law now prescribes the principle of necessity for the content and scope of the reports, which should be emphasized positively. It remains to be seen whether there will be a desirable standardization of various official registrations in this context.

Effects on Foreign Invested Companies

The repeal of the special laws for foreign invested companies and the applicability of the general company law leads to concrete changes. This primarily affects joint venture companies whose organizational structure adapts to the structure specified in the Company Act; the highest body of an equity joint venture is no longer the board of directors, but the shareholders' meeting. The Board of Directors, on the other hand, is only a management body and reports to the shareholders' meeting. Decisions of central importance are to be made by the shareholders' meeting rather than the board of directors. For resolutions on amendments to the articles of association or capital increases that require a qualified majority, a 2/3 majority of the votes in the shareholders' meeting is sufficient. According to current law, a unanimous resolution in the Board of Directors is (still) required for this. Depending on the shareholding, the minority shareholder could therefore lose the right of veto for important decisions.

In addition to the change in the organizational structure, the change in the law gives joint ventures more flexible design options. There is no mandatory link to capital shares when appointing directors or distributing profits, so that deviating regulations are possible. Not only the chairman of the board of directors, but also a managing director or general manager can be appointed as legal representative. According to the wording of the law, Chinese natural persons will probably also be permitted to be shareholders in a joint venture in the future. The existing regulations basically stipulate that the Chinese shareholder must be a company, a company or another economic organization.

Before the transition period expires at the end of 2024, existing joint venture companies will therefore have to make adjustments to the articles of association and the joint venture agreement, which could lead to new negotiations between the joint venture parties. However, the AIG does not contain any regulations on how an adjustment is to be made, nor on the consequences if no adjustment is made by the end of the transition period. It merely refers to implementing provisions to be issued.

Not only the shareholders of existing joint ventures, but also the shareholders of future joint ventures should keep an eye on the change in the law. If the company is founded before January 1, 2020, the existing regulations still apply (at least in theory). In this respect, the change in the organizational structure should already be taken into account in order to avoid renewed negotiations with the JV partner immediately after the establishment of the JV.

Conclusion and practical note

The AIG is a step towards market opening and equal treatment for foreign investors in China. In particular, the repeal of the existing special laws for foreign-invested companies should be viewed positively. How big or small this step will be depends largely on the implementation provisions and the implementation of the announced measures in detail. The outstanding regulations on security checks and the reporting system are to be highlighted here. It is also unclear whether the announced national treatment will also lead to a lowering of the requirements for foreign-invested holding companies or a lifting of existing capital restrictions.

There is a need for action, especially for joint venture companies. Affected shareholders should prepare in good time for the change in the organizational structure and keep an eye on the more flexible design options.

Great Firewall: Action against illegal VPN use in China

If you search for certain terms or websites in China, you usually end up with a blank page or receive an error message. Some foreign search engines such as Google and most western social networks, video portals and short message services such as Facebook, YouTube and WhatsApp are completely blocked. Anyone who travels in China for business or pleasure usually uses a VPN account to overcome the “Great Firewall” and to be able to access blocked Internet sites and services. A VPN account establishes an encrypted connection to a VPN server abroad so that the data is transmitted securely through so-called VPN tunnels. So far, this has been a common practice for foreign business people and tourists as well as domestic users of foreign websites. The use of VPN has been more strictly controlled since the beginning of the year and the first penalties against private users have already been imposed.

Tighter controls by the authorities

In December 2018, the Guangdong Provincial Public Security Bureau imposed the first fine on a Chinese private individual for illegally using VPN. The person concerned had accessed around 500 illegal Internet connections within a week via a VPN app. In January 2019, another private individual in Chongqing was also summoned to a political investigation by the local public security agency for setting up or using illegal channels for international network connections. The authority has not disclosed the specific facts. Among the bloggers, it was suspected that the accused had reached a blocked website via a VPN connection and published critical statements against the party there. These two cases have caused some unrest among overseas VPN users in China. Because until now the official measures were only directed at VPN software developers or commercial dealers and took place against the background of a campaign by the Ministry of Industry and Information Technology (MIIT). As part of the “Cleaning Up and Regulating the Internet Access Service Market” decree, fines of up to RMB 500,000 and prison sentences of up to 5.5 years were imposed between January 2017 and March 2018. Apparently, the three state telecommunications providers (China Telecom, China Mobile and China Unicom) were also instructed to restrict or make more difficult the use of VPN services.

background

This tendency to change the direction of action against illegal VPN use is not due to changes in the law, but rather to stricter enforcement of the existing regulations. The essential legal bases for regulating the use of VPN in China have existed since 1996: "

  • Interim Regulations on Administration of Computer Information Network International Connectivity (“Interim Regulations”), enacted by the State Council and in force since February 1, 1996, “
  • Implementation Rules of the Interim Regulations, enacted by the State Council and in force since February 13, 1998, and "
  • Administrative Measures on International Communication Gateways, enacted by the Ministry of Industry and Information Technology (MIIT) and in force since October 10, 2002.

According to the authorities, the legal basis for the two cases of private VPN use was Clauses 6 and 14 of the Interim Regulations. According to Clause 6, any direct international connection of a computer information network must be made through the international Internet exchange channel established by the State Public Telecommunications Network of the Ministry of Post and Telecommunications (now MIIT). So far, however, only the three state telecommunications providers have received the relevant license from MIIT. No other channels may be set up or used for the international network connection. Strictly speaking, this also includes Internet access via an in-house VPN. In the event of a violation of Section 6, the Public Safety Authority may suspend the network connection in accordance with Section 14, issue a warning and impose a fine of up to RMB 15,000. However, setting up and using an in-house VPN for internal data exchange is not illegal per se. However, in accordance with section 22 sentence 2 of the Administrative Measures on International Communication Gateways, the MIIT must be informed about this.

Data exchange via VPN

The Chinese subsidiaries of German companies usually use a cross-border Internet channel from one of the three Chinese state-owned telecommunications providers, either via a service contract from the German parent company or via a direct contract with one of the Chinese telecommunications providers. A VPN for internal company data exchange is also set up via these providers and is legal, provided it remains a closed network. On the other hand, it is problematic if the employees in China also have access to the public Internet network abroad through the company's internal VPN. This would then no longer meet the requirements of Section 6 of the Interim Regulations.

 

 

outlook

So far, there is no known case in which the Chinese authorities have taken action against international Internet use using an in-house VPN. Due to the widespread practice, this will probably continue to be tolerated, provided that the VPN is used to the normal extent and extent. In view of the current trend towards more stringent enforcement of the existing regulations, it is nevertheless advisable for foreign companies to take preventive measures. In connection with a VPN facility, for example, the introduction of a blacklist with critical websites and terms or restricted access to exclusively business-relevant websites for employees in China would be conceivable. Rules for Internet use with the company computer or mobile phone should also be laid down in the employee handbook. Employees should also be made aware of the topic through regular training.

In summary, it can be said that cross-border data exchange is becoming increasingly difficult for foreign companies and that access to information and websites abroad via a VPN account is being further restricted. German companies in China should therefore deal with the topic at an early stage and take appropriate precautionary measures.

Dr. SHEN Yuan, LL.M. (Cologne)
Luther Rechtsanwaltsgesellschaft mbH
Cologne
Phone +49 221 9937 25075
[email protected]

ZHANG Yuhua / 张玉华
Luther Rechtsanwaltsgesellschaft mbH
Shanghai
Phone +86 21 5010 7526
[email protected]

China's new tax policy - many changes in 2018

2018 was a year of major changes in China, including in the area of ​​tax law. On the 40th anniversary of the reform and opening up of China, the unrestrained growth of the Chinese economy for many years turned into qualitative growth. Despite a challenging environment, the Chinese economy was able to develop so stably. In the midst of the many changes in the national and international investment environment, the trade disputes between China and the USA, government reforms and the rapidly advancing digitalization, China's tax system was significantly restructured in the past year. The requirements for obtaining residence and work permits for foreign employees were already made simpler at the beginning of 2018 (see the article in our Foreign Law & Investment Newsletter 4th quarter 2017) and since January 1, 2019, a fundamental change has been in effect in China Income tax law. The tax rates have not changed, but the shift in tax brackets, which is overdue after almost 20 years, and the newly introduced additional special deductions are relieving the income earners. In addition to reforms in tax collection and administration, the Chinese government has taken a number of economic opening measures to attract foreign investors. Further tax cuts were announced at the 13th National People's Congress.

In this article, we provide an overview of key changes to the tax reform that are of particular interest to foreigners living in China and foreign investors. The first part of this article deals with the changes in procedural and income tax law, including the taxation of foreign employees. We will present the effects for foreign-invested companies in a second part of the next edition of this newsletter.

Reform of the tax collection and administration system

2018 was also the year of China's tax administration reform. The merger of the national and local tax authorities ended the 24-year tax sharing system. The reform promises to simplify tax processes for taxpayers and reduce tax costs, as well as improve the efficiency of tax collection and administration. Since the introduction of the so-called Golden Tax Phase III (national electronic tax collection and control system) in 2016, Chinese taxpayers have been able to pay their taxes more quickly online. The automation of the process has led to a nationwide concentration of data that is helping tax authorities to better monitor non-compliance with tax obligations. For example, the determination of due tax claims, unusual income / costs / margins etc. by the tax authorities is now easier. Taxpayers should keep abreast of changes in tax policy, particularly with a view to tightening scrutiny of widespread evasion techniques. Companies should strengthen their compliance management and adjust investment and business plans in good time.

Reform of the income tax law

The sensational reform of the Income Tax Act was approved by the Standing Committee of the National People's Congress on August 31, 2018 and officially entered into force on January 1, 2019. The seventh revision of China's personal income tax law marks a historic reform of personal income tax in China that exceeds the scope and impact of previous changes. At the end of 2018, the implementing ordinances of the Income Tax Act along with some application ordinances were published, which can be summarized in the following key points:

New distinction in terms of tax liability
In principle, the resident status of the natural person and the source of income determine the tax liability for personal income tax. In this context, the concept of “residents” has now been explicitly introduced and the internationally recognized standard of “183 days” for people without permanent residence in China has been adopted.

To determine the taxable income and, if applicable, the applicable tax rate, a distinction must be made between whether the person is domiciled in China or whether the person is staying in China for more than 183 days in a tax year (= calendar year). As is customary internationally, a person resides in China if either a household is registered there or the family or economic center of life is in China. Determination can be difficult in individual cases.

"Five Year Rule" is replaced with "Six Year Rule" for non-residents of China
People who are not resident in China are considered to be "residents" in the sense of tax law if they stay in China for a longer period of time (as described here, the "183 days" rule). China sourced income ”) and tax liability, also with regard to foreign income, does not exist until after several years of residence in China. Instead of the so-called “five-year rule” previously used, a “six-year rule” now applies. People who are not resident in China and who stay in China for more than 183 days in a calendar year and a total of less than six (previously five) years are only subject to income tax on their income generated in China, i.e. they do not have to pay tax on their global income in China. The world income principle applicable in Germany does not apply in China, however, people with residence or habitual abode in Germany may still be subject to unlimited taxation in Germany. In addition, special provisions apply to managing directors and senior employees who work in the context of a project in China that is classified as a permanent establishment for tax purposes. According to this, such employees are fully taxable in China, regardless of their days of presence, and the regulations in the applicable double taxation agreements are to be used to avoid double taxation.

In addition, the new implementing ordinances stipulate that the calculation of the now “six years” begins again if the taxpayer leaves for a period of more than 30 days within a calendar year. So far it was enough if the 30-day departure took place within five years in a row and thus also over the turn of the year during the Christmas holidays; this no longer leads to the period starting anew.

Changes in income brackets, tax rate and tax deductions
There are also changes to the income classes, the tax rate, the salary group and the deduction options. "

  • Income bracket
    According to the old Income Tax Act, taxable income was divided into different classes, each of which is taxed separately. As a result of the tax reform, some of the taxable classes will be grouped under current income tax, i.e. four of the labor incomes (income from wages and salaries, income from remuneration for personal services, income from payment as an author, income from license fees) will become "consolidated income “Summarized and taxed accordingly. Operating income and other income such as interest, dividends, dividend income, property leasing income, property transfer income and occasional income will continue to be taxed separately. "
  • Change in tax rate
    The income tax rates that have been in effect since January 1, 2019 are no longer calculated on a monthly basis, but on an annual basis. A 7-step progressive tax rate of 3% to 45% remains, which is now applied to total income. At the same time, the gaps between the thresholds have been widened in favor of the lower and middle income classes (i.e. 3%, 10% and 20%).
  • Increase in the lump-sum allowance
    The flat-rate allowance for wages and salaries increases from RMB 3,500 per month to RMB 5,000 per month (i.e. to RMB 60,000 per year) and is based on total earnings. The monthly deduction of RMB 1,300 for non-resident residents of China has been abolished with the reform. The flat-rate deduction applies to both foreign and Chinese people alike. "
  • New special deductions for tax residents
    The special deductions in the previous Income Tax Act were limited and mainly related to statutory social security expenses. In order to take into account the increased cost of living, the tax reform introduces additional special deductions so that certain cost of living can be deducted before calculating personal income tax and thus reduce the tax base. The additional special deductions include expenses for raising children, expenses for further education, interest expenses for housing loans, rent for apartments, maintenance of the elderly and medical expenses for serious illnesses.
  • First introduction of avoidance clauses
    For the first time, the tax reform introduced avoidance clauses in the income tax law, according to which the Chinese tax authorities can, under certain conditions, make tax adjustments, collect unpaid taxes retrospectively and levy interest. However, there are still no specific implementing provisions, which is why the new rules have triggered great uncertainty, especially among private individuals with assets outside of China.

Transitional provisions
In addition to the passing of the new Income Tax Act and the implementing ordinances, the state tax administration has issued a document (Cai Shui 2018 No. 164) on the continued application of some tax incentives, which already attracted a great deal of attention before the new law came into force. Particularly noteworthy are the transitional provisions for one-off bonus payments at the end of the year and tax-free grants for foreigners: "

  • Tax break method for the year-end bonus
    Under the old tax law, the year-end bonus could trigger a significantly lower personal tax burden, as the bonus was taxed separately from the monthly taxed wages and salaries and the applicable tax rate for the year-end bonus was simply divided by 12. In the course of the tax reform, which now calculates the tax on the consolidated income of a resident on an annual basis (and not, as before, monthly), it was generally assumed that the tax break method for the year-end bonus will be abolished. The tax administration has now clarified this, but there is a transition period of three years so that the tax break method for the year-end bonus will continue to apply until December 31, 2021. From January 1, 2022, a resident's year-end bonus will be included in the consolidated income for the year and calculated and paid together. Taxpayers can also decide to include the year-end bonus for calculating the tax in the consolidated income for the year and to calculate it together. For those on a low income, this approach can be beneficial. "
  • Tax-free grants for foreigners
    So far, the grants that a foreigner receives for his accommodation, food, clothing, family visits, language training and schooling of his child without cash or as a reimbursement of expenses (so-called “tax-free grants”) were exempt from individual income tax. Under the new provisions, foreigners can decide in the period from January 1, 2019 to December 31, 2021 whether they want to continue to enjoy the tax-free treatment of the above-mentioned grants or to take advantage of the additional special deductions. From January 1, 2022, the tax exemption for the above-mentioned grants will no longer apply to foreigners, but the general special deductions can be applied.

The article will be continued in the next issue of this newsletter with an overview of the effects of the tax reform on foreign-invested companies.

Philip Lazare
Luther Law Offices
Shanghai
Phone +86 21 5010 6585
[email protected]

India

India after the elections - a legal & compliance update

After the overwhelming victory of Narendra Modi's Hindu nationalist party BJP in the Indian House of Commons elections in May, hopes are high both at home and abroad. In business circles, one looks in particular at whether the Prime Minister in his second term of office can now successfully further develop the many initiatives launched during his first term of office. In India, however, it is mainly expected that Modi 2.0 will get the ever-increasing high unemployment under control, as he promised in the 2014 elections.

Foreign investors particularly focus on the new industrial policy, incentives to promote production in important employment-rich sectors, the acceleration of slow-moving large infrastructure projects, the simplification of labor and tax law, the expansion of the Smart Cities mission and the advancement of digitization. In the last few months before the elections, however, there were some setbacks in the area of ​​tension between deregulation and protectionism. Modi will only achieve its ambitious growth targets if it gets the foreign capital inflow going again. To achieve this, consistent economic reforms and further deregulation of the market are inevitable.

India is and will remain a huge growth market with a lot of potential. However, the country continues to pose major challenges for foreign companies and investments in India must be well planned and intensively monitored. We summarize some of the new legal and compliance requirements below.

New compliance requirements

Active Company Status Reporting
In its efforts to improve corporate governance and compliance of companies in India, the relevant ministry has introduced the ACTIVE (Active Company Tagging Identities and Verification) e-form. The government hopes that this will curb tax evasion, especially in connection with the high number of letterbox companies.

Companies that were founded before December 31, 2017 are required to submit the ACTIVE e-form by June 15, 2019. The form must be accompanied by photos of the outside and inside of the company headquarters and of a manager or a director.

Any company that fails to submit the form may not change the authorized and / or paid-up share capital, merge or divide, appoint new directors or change its registered office. Submission after the deadline is still possible, but a late fee of approx. 130 EUR must then be paid.

Disclosure of late payments to MSME suppliers
In order to support the growth of small and medium-sized enterprises (micro, small and medium enterprises, "MSME"), the Ministry of Corporate Affairs (MCA) published the Specified Companies (Furnishing of information about payment to MSME suppliers) order in January 2019 .

A company that receives delivery from an MSME and has delayed a payment to it by more than 45 days must now use the "MSME Form I" to explain why there was a delay and what amount is still outstanding. For the period from October 2018 to March 2019, the form must be submitted by April 30, 2019. For the period from April to September 2019, the deadline for submission is October 31, 2019.

Start of business activity
Companies that were incorporated after November 2, 2018 are now required to submit a statement within 180 days of their incorporation confirming that the founders have paid up their contributions and that within 30 days of incorporation Confirmation of the registered business address at the Registrar of Companies (ROC) has been made.

Failure to comply with this provision can lead to the deletion of the company's name from the commercial register.

Shareholders' meetings
There are also facilities for holding shareholders' meetings. An unlisted company can now hold its Annual General Meeting (“AGM”) anywhere in India and is no longer limited to the company's registered office.

In addition, Indian subsidiaries (“WOS”) wholly owned by foreign companies are now allowed to hold their Extraordinary General Meetings outside of India.

Fiscal year
In India, the fiscal year generally runs from April 1 to March 31. It was previously possible to set a different fiscal year, but an application for approval had to be submitted to the National Company Law Tribunal, where processing took a very long time.

Companies can now submit an application to the responsible ministry to determine a different financial year. As a result, a shorter processing time can be expected.

Foreign trade and investment

Since the beginning of January 2019, companies that import and sell electronic and IT-related products in India have been required to register with the Bureau of Indian Standards (BIS) in advance. Import shipments without valid registration must be re-exported by the importer, otherwise the goods must be destroyed by customs.

The requirement for registration is the indication of the Indian address of a liaison or branch office. Manufacturers without a domestic address require a domestic representation.

Taxes
On April 5, 2019, the Central Board of Direct Taxes (CBTD) announced the new forms for the income tax return (ITR) for the financial year 2018/19. The deadline for submission is July 31, 2019.

The new ITR forms aim to improve tax collection and reduce tax evasion, but also to reduce the time it takes to process income tax returns.

According to the amended ITR forms, expats and other taxpayers who take advantage of tax breaks based on a double taxation agreement (DTAA) must provide detailed information on income from other sources and taxes paid on them, the tax identification number of their home country, foreign assets and a certificate of residence.

Rumyana Prodanova
Luther Corporate Services Pvt. Ltd.
Gurugram
Phone +91 9599 0508 71
[email protected]

Pramod Kumar Chaubey
Luther Corporate Services Pvt. Ltd.
Gurugram
Phone + 91 9599 0508 70
[email protected]

Changes to the requirements for foreign currency loans facilitate group financing in India

In practice, it is not uncommon for a German parent company to want to provide its Indian subsidiary with an intra-group loan in order to overcome a financial bottleneck at the Indian subsidiary. In India, there is also the fact that taking out a loan from an Indian bank through the Indian subsidiary usually entails high interest rates. Up until now, foreign currency loans from the foreign parent company in India were regulated quite restrictively, among other things, they were not allowed to be used to finance working capital. Against the background of the parliamentary elections and domestic political developments in the Indian banking sector, some of the restrictions have been removed, so that shareholder loans to Indian subsidiaries can now be extended more easily and flexibly.

Previous legal situation for foreign currency loans

The taking out of a loan from a foreign person by an Indian company has long been strictly regulated and severely restricted in India. In India, loans from foreign persons - including a loan from the German parent company to its Indian subsidiary - are subject to the guidelines (“ECB guidelines”) of the Reserve Bank of India (“RBI”). These ECB guidelines stipulate the conditions under which loans from foreign persons can be granted, be it as a so-called "foreign currency loan" or as a "rupee loan". In addition to the granting of loans in the form of funds, the ECB guidelines also cover loans in the form of bonds or debentures (with the exception of fully and legally convertible instruments), trade loans over three years, or finance leases. Foreign currency loans in the form of funds are particularly relevant for intragroup financing, to which we therefore limit ourselves in this article.

In the case of foreign currency loans of up to USD 500 million, no approval from RBI was previously required, provided that certain requirements, including the purpose, minimum term and maximum interest rate, were complied with (so-called automatic route). In all other cases, prior approval from RBI had to be obtained before a foreign currency loan was granted (so-called approval route). If the following requirements were complied with, no approval from the RBI was required: "

  • Foreign currency loans were not allowed to be used to finance the current assets of the Indian company (as so-called working capital), but only, for example, to finance capital goods such as equipment in the production facility. "
  • If the loan from the foreign shareholder exceeded an amount of USD 5 million, a debt-equity ratio of 4: 1 had to be observed. The foreign currency loan of the foreign shareholder could thus amount to a maximum of four times the amount of the equity capital of the Indian company that the foreign shareholder contributed to the Indian company. "
  • Minimum contract term: For loans under USD 20 million, the term of the loan had to be at least three years, for loans with an amount between USD 20 million and USD 500 million even at least five years. It was therefore not possible for the German parent company to grant a bridging loan to overcome a short-term financial bottleneck at the Indian subsidiary. "
  • Interest: The maximum limit for the payment of interest was the 6-month LIBOR (London Inter Bank Offered Rate). It was a maximum of plus 250 basis points for a term of the loan of more than five years and a maximum of plus 150 basis points for a term of the loan of three to five years. The interest accrued after six months.

Due to these regulations, it was advisable in the past to ensure that foreign currency loans to be granted by the German parent company to the Indian subsidiary remained below the limit of USD 5 million, otherwise if the debt-equity ratio of 4: 1 was exceeded the approval of the RBI had to be obtained. The ban on using the loan as working capital also brought certain restrictions.

Restructuring of foreign currency loan regulations

On January 16, 2019, the ECB guidelines and thus also the legal framework for granting foreign currency loans were restructured. Indian companies can now take out foreign currency loans more easily.

Borrower and Lender
So far, depending on the minimum term of the loan and depending on the branch of the Indian company, only certain groups of borrowers have been allowed to receive foreign currency loans, for example from the areas of software development, infrastructure, research & development and manufacturers of certain products. As part of the new regulations for foreign currency loans, the list of eligible borrowers has been expanded and now includes, among other things, all companies that are allowed to receive foreign direct investments. This means that all companies are entitled to foreign currency financing that are allowed to receive foreign investments according to the currently valid version of the Consolidated Foreign Direct Investment Policy, 2017 under the Automatic Route or the Approval Route. India has opened the market at least partially and in some sectors 100% to foreign investors in recent years. Bans only exist in a few areas, such as investments in the real estate industry, production of tobacco products, nuclear energy, railway operations (with exceptions) or lotteries. The term “Indian Entity” was also redefined by the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018, so that LLPs can now also receive foreign loans. The expansion of eligible borrowers brings considerable relief to the financing of the business in India, in particular for the financing of service and trading companies that were previously dependent on their own equity or on loans from Indian lenders.

The concept of lender has also been expanded. The prerequisite is now that the lender is domiciled in a FATF or IOSCO-compliant country. This means that multilateral and regional financial institutions, individuals or foreign branches or subsidiaries of Indian banks can also be lenders.

Usage
So far it has not been possible to use foreign currency loans granted to the Indian company as working capital, but this was often the background of the Indian subsidiary being financed by the foreign parent company. This has been changed with the restructuring of the ECB guidelines. Foreign currency loans can now also be used as working capital, for general corporate purposes or to repay rupee loans. The use of the loan for the acquisition of real estate, for investments in the capital market or for an equity stake of the Indian company in other companies is still excluded from the intended use. Indian companies are also prohibited from using the foreign currency loan granted to them to grant a loan. The use of the foreign currency loan to repay a loan received locally from the Indian company is only possible under strict conditions.

Minimum term
In principle, the minimum term for foreign currency loans is three years, but the following two exceptions apply:

  • The minimum term for foreign currency loans up to USD 50 million for companies in the manufacturing sector is one year; "