China’s legal system (excluding that of Hong Kong, Macau and Taiwan for the purpose of this article) is commonly accepted to be a civil law system.

China’s legislative framework is premised on its Constitution, which designates the National People’s Congress and its Standing Committee as the supreme source of legislation. Regulations are promulgated at the central level, as well as the local provincial or municipal levels, with national-level laws taking priority over provincial and municipal-level laws. Under China’s Constitution, the National People’s Congress and its Standing Committee may annul or override any laws promulgated by other administrative bodies.

The judicial system in China comprises the Supreme People’s Court (the final appellate court), local people’s courts (at provincial, municipal, district or lower-level) and special people’s courts (courts designated for military, intellectual property or financial matters). Notwithstanding that the Chinese legal system is commonly accepted to be more aligned with civil law frameworks with no principle of binding judicial precedent like in common law jurisdictions, the Supreme People’s Court has issued guidelines requiring lower courts to conform their judgments to the judicial interpretations of the Supreme People’s Court and the Supreme People’s Procuratorate. Such prior decisions are referenced in civil proceedings. The introduction of the Chinese Case Guidance System, to promote consistency in judicial decisions at various levels, may in the future increase the persuasive value of judicial precedent in Chinese legal proceedings.

FDI Review and Approval

During the past three decades, foreign investments have been subject to a case-by-case approval system. Consistent with the recent trend towards market liberalisation, the Foreign Investment Law of 2020 marked the evolution of China’s case-by-case approval system for foreign-invested companies to a system that does not distinguish between foreign-invested companies and local companies for the purposes of establishment and registration, except in a limited number of sectors regarded as highly sensitive. Going forward, both foreign and local-invested companies can submit application for their incorporation and establishment applications to the State Administration for Market Regulation of China or their local counterparts (AMR) without prior approval, except for very few sectors which are prohibited or subject to licensing requirements.

Negative List

Foreign investors have the same access as locally owned enterprises to the PRC market, except for sectors identified in the Special Administrative Measures for Market Access of Foreign Investment (Negative List), the latest version of which took effect on 1 January 2022, which has cut down the number of prohibited and restricted sectors in the 2020 version by approximately 10%. Foreign investment restrictions fall into the following two categories:

• prohibited sectors – in which foreign investment is fully prohibited (eg, postal services, tobacco wholesale, compulsory education and online publication services); and
• restricted sectors – in which foreign ownership is limited (eg, healthcare institutions, civil airport construction and operation, and certain telecommunication-related sectors).

Sectors Subject to Additional Rules and Scrutiny

Sectors subject to additional review and approval requirements and scrutiny include the education sector, telecommunications, media, publishing and healthcare.

Investing in Public Companies in Mainland China

Investments in Chinese public companies (ie, companies listed in Shanghai, Shenzhen and Beijing stock exchanges) will also be subject to requirements under the securities laws and regulations. Please refer to our answers in the following sections for details about investing in public companies.

Investing in Public Companies in Overseas Stock Exchanges

The latest Negative List provides that if a company engaging in business prohibited to foreign investment is listed abroad, the foreign shareholding percentage shall comply with the ownership limit imposed by QFII’s investment in domestic public companies. Historically, most of such companies have adopted the so-called VIE structure and some people believe that this may be the first time that the central government “endorses” the VIE structure. Chinese companies seeking to be listed abroad are likely to be subject to more scrutiny from the authorities in the future, such as cybersecurity review.

Other Approvals

In addition to the approvals mentioned in this section, foreign investors should note that certain investments may be subject to prior merger control clearances required under the Anti-Monopoly Law or national security review, as further explained in 6. Antitrust/Competition and 7. Foreign Investment/National Security.

Based on data published by China’s central government, FDI in China for the first nine months of 2022 grew by 18.9%. China’s GDP growth for the first nine months of 2022 was 3.0%, which was lower than expected.

2021 was the 20th anniversary of China joining the WTO. The Chinese government has emphasised on several occasions its ongoing commitment to integrate with the global economy and to further liberalise the China market. This commitment has been supported through several initiatives in 2020 and 2021, including the promulgation of Foreign Investment Law and the opening up of the financial sector to allow full foreign ownership of certain financial services companies.

Also, there has been an increase in the volatility of China’s foreign and trade relations with the USA, Australia and India, which has led to several retaliatory and protectionist measures being promulgated by such jurisdictions. The heightened concern expressed by various countries about data privacy and espionage risks associated with Chinese manufactured telecommunications equipment – and the steps taken by certain countries to limit Chinese access to advanced technology – may continue to push China to focus on developing these technologies independently, and to take retaliatory or self-protective measures such as the recent promulgation of export control laws and data protection laws. Attracted by the low labour and operation costs, some foreign invested companies have moved their manufacturing plants in China to South-East Asian countries.

On 1 January 2022, the Regional Comprehensive Economic Partnership (RCEP) – a trade and investment treaty between ASEAN Countries and six major economies, including China – took effect. RCEP represents 30% of the world’s economy. On 16 September 2021, China submitted an application to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), a treaty between 11 Asia-Pacific economies representing 14% of the global economy.

Acquisitions in China can be structured as asset or share acquisitions, and such transactions are substantially similar to M&A deals conducted in other jurisdictions. Except for the prior review clearances and approvals mentioned under 3.2 Regulation of Domestic M&A Transactions, and the foreign ownership limits in certain industries, foreign acquisitions of Chinese business would not be subject to any other significant restrictions.

Acquisitions of Chinese public companies are subject to further regulation, as is customary in other jurisdictions, for change-in-control transactions. These trigger tender offer requirements.

For companies engaged in businesses in which foreign ownership is restricted or otherwise prohibited, certain deal structures – ie, the variable interest entity arrangements (the VIE structure) – have evolved to facilitate foreign investment in these businesses. These VIE structures typically involve investment by a foreign investor in an offshore entity that controls the onshore entity by way of contractual arrangements. These VIE arrangements are also typically used in companies listed outside China.

Investors should also be aware of the procedural issues involved in acquiring business held by Chinese parties, exiting from investments in China and remitting proceeds across the border. In most cases, disposal and offshore remittance involve the remittance bank’s examining of it to ensure it satisfies procedural requirements. These procedures would require equity transfer to be registered with the company registry before the payment can be made. Accordingly, the closing execution for investments in China and divestments of Chinese investments may differ from the standard closing procedures in other jurisdictions. Such procedural requirements also make it difficult to put in place a price adjustment mechanism in a cross-border transaction.

Investing in Public Companies

Investing in public companies is subject to approvals, as elaborated under 5.2 Securities Regulation, and may trigger disclosure or general tender offer requirements pursuant to the securities laws and listing rules.

Merger Control Review

Depending on the turnovers of the concentrating parties, an M&A transaction may require clearance from the competition authority. Please refer to 6. Antitrust/Competition.

National Security Review

Depending on the nature of the transaction, a national security review may be triggered. Please refer to 7. Foreign Investment/National Security.

Review and Approval by Sector Regulators

Prior approval from regulators may be required if the sector in which investment is made is regulated, as is the case with financial institutions.

State-Owned Asset Rules

If the target asset or company is deemed a state-owned asset, the transaction may fall within the purview of the State-owned Assets Supervision and Administration Commission (SASAC) or its local counterparts or delegates. It may then need to comply with certain requirements, such as asset valuations and appraisals, prior approvals or filings with SASAC or competitive bid requirements.

Under the PRC Company Law, companies may form as either a limited liability company (LLC) or a company limited by shares. Private companies may choose either of the two forms, but they typically form as LLCs, whereas public companies must form as companies limited by shares. LLCs are limited to a maximum of 50 shareholders, while the number of initial incorporators of a company limited by shares is limited to 200 shareholders.

Foreign investors typically prefer to form LLCs in China because LLCs have greater flexibility in allocating corporate governance and shareholder rights as compared to a company limited by shares.

Before the Foreign Investment Law, foreign-invested enterprises (FIEs) could be incorporated in various forms. These included Sino-foreign equity joint ventures, Sino-foreign contractual joint ventures and wholly owned foreign enterprises. The corporate governance of these forms (especially joint ventures) was different from the corporate governance of domestic PRC companies.

From 1 January 2020, foreign-invested and domestic PRC companies have been subject to the same corporate governance requirements under the PRC Company Law. There is no longer any corporate governance distinction between FIEs and domestic PRC companies. FIEs established using the historical forms before 1 January 2020 have a five-year grandfather period to convert into either an LLC or a company limited by shares.

The Company Law is in the process of a major overhaul. A draft revision was released for public comments in December 2021 which adds and amends about 70 articles to the current Company Law.

Shareholders of Chinese companies are protected under Chinese company law and, in the case of public companies, securities laws and the listing rules and regulations of the Chinese stock exchange on which the company is listed. Statutory shareholder protections under the PRC Company Law include:

• the right of shareholders holding 10% or more of the voting rights to request the court to revoke company resolutions on the grounds of defective procedures;
• the right to initiate a derivative lawsuit by shareholders holding 1% or more of the voting rights for more than 180 days in a company limited by shares and by any shareholder in an LLC;
• the right to request repurchase of equity interests or shares if the shareholder votes against certain resolutions; and
• the right of shareholders holding 10% or more of the voting rights of the company to apply for voluntary liquidation.

Both domestic and foreign-invested companies are required to submit filings to the AMR when there are any changes to the company’s corporate information. This includes changes to shareholders and shareholding structure, changes to registered capital, operation operating term, business scope, registered address, directors, supervisors, legal representatives and general managers. The information will, in the case of foreign-invested companies, be forwarded by the AMR to the Ministry of Commerce (MOFCOM). Therefore, the foreign-invested company does not need to submit separate MOFCOM filings for these corporate change matters. In addition, FIEs are required to submit additional information (ie, changes) to the ultimate beneficial owners.

The two primary stock exchanges in Mainland China are those of Shanghai and Shenzhen. Historically, only companies incorporated in Mainland China can be traded in these stock exchanges. Red-chip companies, which refer to foreign-established companies, with an overseas shareholding structure, that have significant assets and businesses primarily in China, may also be listed on the Shanghai Science and Technology Innovation Board STAR Market, which commenced trading on 22 July 2019. On 15 November 2021, the third primary stock exchange in Mainland China, Beijing Stock Exchange, commenced trading.

PRC companies have historically been listed on a variety of overseas securities exchanges, notably NASDAQ or NYSE and HKSE, in addition to the Chinese stock exchanges. Recently, with the promulgation of the Holding Foreign Companies Accountable Act by the SEC of the USA, which is said to be targeted at Chinese companies listed in the USA, it is expected that more companies will choose HKSE over NASDAQ and NYSE as the forum for listing.

Based on the latest data published by the People’s Bank of China, the principal source of funding for Chinese enterprises is still considered to be bank loan financing. However, capital market funding has grown as an alternative source of capital since changes in capital markets regulations, allowing for registration-based securities offerings as opposed to a merit-based approval approach.

Companies listed on the securities exchanges of the PRC are subject to the Chinese Securities Law, in addition to the listing rules and regulations of their home securities exchange. The CSRC has oversight over the PRC securities markets and listed issuers.

In general, foreign investors are not subject to PRC securities laws unless the foreign investor intends to invest in a listed PRC company. If a foreign investor is a strategic investor, the investor must meet qualification requirements for strategic foreign investors. These include thresholds on total assets and sound financial management capability. The strategic foreign investor is also required to hold no less than 10% shares in the company and subject to a lock-up period of three years. In practice, stock exchanges would still require foreign strategic investors to obtain a confirmation from MOFCOM confirming that such investment is no longer required to be approved by MOFCOM.

A new draft of regulations for foreign strategic investors in public companies was released for comment on 18 June 2020. The draft contains lower investment thresholds, eliminates MOFCOM’s prior approval requirement and relaxes the minimum shareholding percentage requirements. The draft regulations have not yet been passed.

Non-strategic foreign investors may also invest via QFII (Qualified Foreign Institutional Investor) status; the thresholds for QFII qualifications were lowered in November 2020 to encourage further foreign investment in the PRC.

Foreign investment funds investing in PRC-listed public companies are generally required to invest as a QFII and are accordingly subject to compliance with the QFII-related requirements to invest. The QFII requirements also include post-investment obligations, such as the obligation to make certain information reports to the CSRC.

Foreign investment funds investing in non-listed PRC companies are not subject to the QFII requirements. However, if the fund establishes a domestic fund in the PRC or if a domestic fund has overseas investors, it will be designated a “Qualified Foreign Limited Partner” (QFLP) and the establishment of the fund will have to be approved by the finance office of the local government in the fund’s domicile. The rules governing QFLPs vary between cities and are not centrally regulated.

China has a “pre-notification” merger control regime. Under the PRC Anti-monopoly Law (AML), a “concentration of undertakings” that meets certain turnover thresholds must be notified to the State Administration for Market Regulation (SAMR) for merger control clearance and may not be implemented without SAMR’s approval. On 1 August 2022, the amendments to the AML came into effect (the “Revised AML”) following almost two years of public consultation. The Revised AML provides several key changes to the merger control regime in China, including:

• strengthening control of “killer acquisitions” and reiterating the power to review below-threshold transactions;
• introducing a “stop-the-clock” mechanism to the review timeframe and increasing the penalties for failures to notify; and
• the power to delegate the review of simple case filings to local authorities.

Concentration of Undertakings

The following types of FDI transactions may constitute a concentration of undertakings for the purpose of merger control notification:

• merger;
• acquiring control over another undertaking by virtue of acquiring its equity or assets;
• formation of a joint venture (JV) where at least two parties can exercise control over the JV; and
• acquisition of control over another undertaking or the ability to exercise decisive influence over the other undertaking by virtue of a contract or any other means (such as a VIE structure).

Definition of “Control”

There is no explicit definition of “control” under the Revised AML. SAMR has broad discretion in determining control by considering a wide range of factors. The Revised AML sets out certain types of governance rights that would confer control over another business, including: (i) the right to appoint or remove senior management personnel; (ii) the right to approve financial budget; and (iii) the right to approve business plan (Listed Strategic Rights). As there is no de minimis shareholding for the definition of control, the ability to veto any of the Listed Strategic Rights will likely be sufficient to confer control even with a minority shareholding.

Other relevant factors in evaluating “control” include the purpose of the transaction, the target’s shareholding structure, shareholders’ reserved matters, board composition and the voting mechanism at board and shareholders’ meetings.

In practice, “control” could refer to:

• holding 50% or more shares or voting rights; or
• having approval or veto power over the target’s material business and management matters, such as the Listed Strategic Rights.

Turnover Thresholds

Where an FDI transaction constitutes a “concentration of undertakings”, the transaction is notifiable if the undertakings to the concentration also meet the following turnover thresholds:

• the aggregate global turnover of all the undertakings to the concentration exceed CNY10 billion, or the aggregate Chinese turnover of such entities exceed CNY2 billion in the preceding financial year; and
• each of at least two of the undertakings to the concentration had a turnover in China exceeding CNY400 million in the preceding financial year.

Special rules apply to the calculation of the turnover of undertakings in the financial sector.

On 27 June 2022, SAMR proposed revision to the notification thresholds：

• raising the aggregate global turnover of all the undertakings to the concentration from CNY10 billion to CNY12 billion;
• raising the aggregate Chinese turnover of all the undertakings to the concentration from CNY2 billion to CNY4 billion; and
• raising the turnover in China of each of at least two of the undertakings to the concentration from CNY400 million to CNY800 million.

The proposal also sought to strengthen regulatory review over “killer acquisitions”, namely transactions where an established large player acquires an innovative target to stunt the target’s development and pre-empt future competition. A new set of thresholds has been proposed in this regard and transactions meeting these thresholds must also be notified:

• the Chinese turnover of one business operator involved in the concentration exceeded CNY100 billion in the preceding financial year; and
• the market value or valuation of another relevant party is no less than CNY800 million, and the Chinese turnover of such party exceeds one third of its global turnover in the preceding financial year.

The second limb of the above threshold captures transactions in which the target, despite not having a turnover exceeding CNY800 million, has a relatively high market value and a significant portion of business in China.

It should, however, be noted that the proposal has not yet been finalised and the effective date of the proposal remains uncertain.

The Revised AML reiterates SAMR’s right to review transactions that do not meet the turnover thresholds, provided that there is evidence that the transaction may have the effect of eliminating or restricting competition.

No Possibility of Exemptions for Foreign Investors or Investments

Where the merger requirements are met, no exemption is available for foreign investors or investments.

Process and Timeline

The merger review procedures in China include the simplified procedure (ie, expedited merger review procedure for certain types of transactions unlikely to raise concerns in China) and the normal procedure (ie, standard procedure for the remaining types of notifiable transactions).

Upon notification, all transactions enter a pre-acceptance phase where SAMR may request further information about the transaction and the notification. There is no statutory time limit for the pre-acceptance phase; the actual duration depends on the questions and time needed to collect the requested information. In our experience, the pre-acceptance phase generally lasts four weeks on average under the simplified procedure, and four to eight weeks under the normal procedure. A notification will only be accepted once SAMR considers the information it receives to be complete and satisfactory.

Once the case is accepted, it will enter into a three-phase review period. Most cases undergoing the simplified procedure are cleared within Phase I (ie, 30 days upon case acceptance).

For cases undergoing the normal procedure, if the transaction does not raise competition concerns it is usually cleared within the review period for Phase II (ie, 90 days).

For transactions with competition concerns, the review extends to Phase III (ie, 60 days). In practice, SAMR’s review of cases with significant competition concerns may exceed the maximum statutory period of 180 days for the three phases. In these cases, the parties will need to discuss with SAMR the withdrawal and refiling of the notification, which restarts the review – this is known as “pull and refile”. According to SAMR’s public record, some conditionally cleared cases have been pulled and refiled more than once.

The Revised AML introduced a “stop-the-clock” mechanism whereby the statutory merger control review period can be suspended under three scenarios, namely:

• if the filing parties fail to submit supporting information in a timely manner, which prevents the progress of the review;
• when new circumstances or facts that materially impact the review arise and need to be verified; or
• when remedy conditions need to be further evaluated (provided that the filing parties consent).

Clearance and Transaction Closing

Merger clearance must be obtained before the closing of the proposed FDI transaction which, in the case of a greenfield JV, refers to the incorporation of the JV and, in the case of an equity or asset transfer, the registration of the equity or asset to be acquired.

Delegation to Local Authorities

SAMR announced a pilot programme to delegate the review of certain simple case filings to five local authorities in Beijing, Shanghai, Guangdong, Chongqing and Shan’xi Provinces during a three-year pilot period commencing on 1 August 2022. Based on SAMR’s guidance, a transaction can be delegated to one of the five Local AMRs where it has one of the following nexus to the relevant city or province:

• at least one of the notifying parties is based in that city/province;
• the target is based in that city/province;
• in the case of the establishment of a new joint venture, the joint venture is based in that city/province;
• the relevant geographic market of a transaction is assessed to be regional, and such regional market entirely and mainly falls within that city/province; or
• where SAMR deems appropriate to delegate.

Substantive Review of the Transaction

The Chinese merger control regime involves a substantive overlap and competitive assessment of the investment. The substantive test involves:

• identifying the relevant markets based on the transaction parties’ horizontal overlap (ie, competing businesses), vertical links (ie, upstream/downstream relationship) or neighbouring relationship (ie, complementary products);
• assessing the market share and market power of the transaction parties and the effect of the transaction on the level of concentration in the relevant markets;
• assessing the transaction’s impact on market entry, technological development, suppliers and customers; and
• assessing the transaction’s impact on market entry, technological development, suppliers, national economic development, industry policy and public interest.

Remedies

SAMR may conditionally clear a concentration on remedies, including structural, behavioural or hybrid remedies, based on a case-by-case assessment.

Structural remedies

Similar to the EU and US competition authorities, SAMR may require merging parties to commit to divest a business, assets or minority interests within a specified time frame post-closing. An example of such a remedy imposed by SAMR was Danfoss/Eaton on 24 June 2021.

Behavioural remedies

Compared to the EU and US competition authorities, SAMR is more receptive to behavioural remedies, despite them being more difficult to implement and monitor than structural remedies. Behavioural remedies can include “hold separate” remedies that require the transaction parties to operate independently for a period of time until the remedy is lifted, FRAND commitments and commitments restricting tying and bundling.

In 2022, SAMR imposed behavioural remedies on two global transactions and one domestic transaction:

• On 21 January, SAMR conditionally cleared AMD/Xilinx – the parties produced complementary semiconductor products. SAMR imposed behavioural remedies including obligations (i) not to tie/bundle the relevant products, (ii) to continue supplying the relevant products on FRAND terms, and (iii) to ensure interoperability. The conditions are valid for six years and can only be lifted subject to SAMR’s approval based on application.
• On 28 June, SAMR conditionally cleared II-VI/Coherent, a vertical merger, imposing behavioural remedies including obligations (i) to honour existing contractual obligations, (ii) to continue supplying the relevant products on FRAND terms, and (iii) not to engage in exclusive purchasing behaviour for certain relevant upstream products. The remedies are valid for five years and expire automatically.
• On 14 September 2022, SAMR imposed behavioural remedies on the proposed establishment of a cargo terminal services joint venture between Shanghai Airport and China Eastern Air Logistics. The remedies, which aimed at addressing potential co-ordination between the parents, included commitments that the parent companies must not exchange commercially sensitive information in order to continue competing with each other properly. The parties can apply to SAMR to lift the conditions after eight years.

Hybrid remedies

Often, SAMR imposes hybrid remedies, which are a combination of structural and behavioural remedies. On 20 January 2022, SAMR imposed hybrid remedies in the GlobalWafers/Siltronic case. SAMR believed the transaction raised competition concerns in overlapping horizontal markets as both parties engaged in the production of wafers and thus imposed structural remedies (divestment of GlobalWafers’ float-zone wafer business) and behavioural remedies (an obligation to continue the supply of wafer products to customers within China on FRAND terms) – the behavioural condition is valid for five years and can only be lifted upon SAMR’s approval based on application.

The Authority’s Ability to Block or Otherwise Challenge FDI

As described in 6.3 Remedies and Commitments, SAMR has the ability to challenge an FDI transaction (eg, impose remedies) before the investment is made, to the extent that the transaction substantially affects competition in China.

If conditions are not sufficient to address competition concerns, SAMR has the ability to block the transaction. Since the AML took effect in 2008, only three transactions have been prohibited by SAMR:

• Coca-Cola’s proposed acquisition of Chinese fruit juice producer Huiyuan in March 2009;
• the proposed Maersk/MSC/CMA CGM P3 Network shipping alliance in June 2014; and
• the proposed merger between game-streaming platforms Douyu and Huya in July 2021.

Possibility to Appeal and Timeline

Under the AML, a transaction party may appeal to SAMR for administrative review within 60 days of receiving the decision. The timeframe for administrative reconsideration is 60 days.

If a notifying party is not satisfied with an SAMR administrative review decision, it can bring an administrative action within 15 days of receipt of SAMR’s decision.

If still unsatisfied with the result of the administrative action, the party can seek judicial review within six months of the final administrative decision. However, to date, no court challenges have been brought against SAMR merger control decisions.

While appeal is legally possible, the writers are unaware of any case where a company appealed SAMR’s conditional approval decision so far.

Higher Penalty for Submitting False or Misleading Information

The Revised AML imposes higher penalties on the notifying parties for providing false disclosure or omissions in filings. For the notifying party, the fines have been increased from CNY200,000 to a maximum of 1% of the party’s turnover in the preceding financial year. Responsible individuals are also subject to a fine of up to CNY500,000 (increased from CNY100,000).

Sanctions for Closing Before Clearance

The AML prohibits parties from implementing a notifiable transaction before filing a merger control notification (“failure to notify”) and obtaining a merger control clearance (“gun-jumping”).

Following the AML amendments, SAMR published further guidance on what would constitute “gun-jumping”. Such actions include but are not limited to the following:

• effecting changes in register of shareholders;
• appointing senior management personnel;
• participating in business decision-making and management;
• exchanging sensitive information with other operators; and
• carrying out business integration.

The Revised AML increased the maximum fine for failure to notify and gun-jumping from CNY500,000 to CNY5 million where the transaction has no anti-competitive effect. Where the transaction has or may have anti-competitive effect, the maximum fine is 10% of the party’s turnover in the preceding year.

In addition to imposing fines, SAMR can order the transaction parties to undertake the following steps to restore the situation to the pre-transaction state:

• suspend the transaction;
• dispose of shares or assets within a specified time limit;
• transfer the business within a specified time limit; and
• implement other measures as required.

In July 2021, SAMR issued a penalty decision against Tencent for its failure to notify an acquisition of a 61.64% stake in China Music Corporation. SAMR imposed the maximum fine of CNY500,000 (the maximum fine at the time) and imposed remedies to restore competition in online music broadcasting platforms through measures such as abandoning exclusive music copyright licensing arrangements. Tencent was also required to notify SAMR of future transactions, including those that fall below notification thresholds – a requirement that generally goes beyond the scope of remedies contemplated under the AML.

While the Revised AML notes that criminal liabilities may be imposed for breaches (including gun-jumping), the precise application of criminal liabilities on undertakings and individuals is expected to be clarified in amendments to China’s Criminal Law.

National Security Review (NSR) Overview

In China, FDI that has an impact or a potential impact on national security is subject to national security review, as stipulated in both the National Security Law and the FIL. The review regime is established in 2011 and updated in the Measures for Security Review of Foreign Investment (the “NSR Measures”) jointly published by the National Development and Reform Commission (NDRC) and MOFCOM on 19 December 2020 and effective from 18 January 2021.

NSR Industry Scope

China’s NSR regime targets foreign investments in two categories related to defence and national security in China.

• Category A – defence-related sectors, which are notifiable regardless of whether the foreign investor will have control over the target:
1. investment in sectors related to national security, such as the military and arms industry, or other ancillary industries; and
2. investment in areas adjacent to military or arms facilities.
• Category B – other sectors concerning national security, notifiable only if the foreign investor will acquire control:
1. important agricultural products;
2. important energy and resource;
3. significant equipment manufacturing;
4. critical infrastructure;
5. critical transportation services;
6. important cultural products and services;
7. important information technology and internet product and services;
8. important financial services;
9. critical technology; and
10. other industries with national security importance (ie, assessed on a case-by-case basis, with factors including whether the Chinese government has separately flagged or designated certain sectors or certain products or services as “strategic”).

FDI Types

The national NSR regime applies to direct or indirect investments by foreign investors (including those in the regions of Hong Kong, Macau and Taiwan) in Chinese domestic enterprises, primarily in the form of (i) investment in a greenfield project or establishment of a foreign-invested enterprise in China, independently or jointly with other investors, and (ii) M&A (ie, asset or equity acquisitions). The NSR regime can be extended to other transactions such as contractual control, trusts, multi-layer investments, overseas transactions, leases or convertible bonds, created to achieve the same purpose as a direct share or asset acquisition. In particular, foreign investors investing in offshore entities who (directly or indirectly) own equity in Chinese companies or assets located in China (also called “foreign-to-foreign” deals) is also a covered investment transaction.

For an FDI transaction originally not subject to NSR, NSR approval will need to be sought before the parties can make any changes to, for example, the business structure, business scope or identity of foreign controllers, that result in the FDI falling within the scope of the NSR. Likewise, if an FDI transaction has already received NSR approval but the parties contemplate making changes to the transaction, the parties must seek new NSR approval before they make the changes.

Control Determination

With regard to “Category B” investment, a foreign investor is regarded as a controller if:

• the foreign investor and its affiliates acquire 50% interest or more in an enterprise;
• the foreign investor with another foreign investor acquires 50% interest or more in an enterprise; or
• the foreign investor acquires less than 50% interest in an enterprise but has sufficient voting rights to materially influence shareholder meeting or board of director meetings; and
• there are other factors allowing the foreign investors to exert significant influence over the enterprise’s operational decisions, human resources matters, financial matters and technology.

Monetary Thresholds

There are no monetary thresholds for a transaction to be qualified for NSR review.

Changes to Existing Transactions

As well as new transactions, changes to existing transactions that may affect national security (eg, changes to the foreign investor’s contractual rights, the business scope of the foreign-invested entity, or the foreign investor’s identity) may trigger NSR notification obligations afresh.

Reviewing Authority

An interagency function called the “NSR Working Mechanism” is empowered under the NSR Measures to organise, co-ordinate and supervise the NSR review. This function, which is consensus-driven, is jointly led by NDRC and MOFCOM and, depending on the investment areas concerned, other ministries of the central government, such as the Ministry of National Defence (MOD), the Cyberspace Administration of China (CAC), the Ministry of Industry and Information Technology (MIIT), the Ministry of Transport (MOT), may also be involved to give their opinions.

The Office of the NSR Working Mechanism (the “NSR office”), which comes under NDRC, carries out the day-to-day NSR functions, including accepting the notifications and handling all communications with parties to the NSR process.

Process and Timeline

The review process involves three phases, as follows.

• Notification and pre-acceptance phase (15 working days) – the transaction parties notify the NSR office by submitting the following materials: (i) notification form; (ii) investment plan; (iii) explanation as to whether the foreign investment will affect Chinese national security; and (iv) other materials required by the NSR office. The NSR office shall determine within 15 working days from its satisfaction regarding receipt of complete notification materials as to whether NSR review is required.
• General review phase (30 working days) – if the NSR office determines that NSR review is required, it shall conduct a general review and determine in 30 working days whether to approve the FDI or extend to the special review phase.

• Special review phase (60 working days or longer if necessary under special circumstances) – if the NSR office considers that the notified transaction may have national security concerns during the general review phase, it will launch a special review of 60 working days. The special review period may be extended if special circumstances apply. However, the NSR Measures do not specify the circumstances to trigger such extension or the time limit for the extended review period.

During the review process, the NSR office may request additional information and the review period shall be suspended (ie, “stop the clock”) while awaiting materials from the transaction parties.

NSR review will consider the FDI’s impact on national defence and security, including the production of national defence products and relevant equipment, national economic stability, basic social stability, the research and development of key technologies related to national security, national cultural safety and public ethics and national network security. However, no specific criteria have been published for the substantive assessment.

The NSR is a highly discretionary process and is subject to the opinion of the NSR office, in particular the specific industrial and regulatory authorities for the invested sectors.

Foreign investors can amend the investment structure or commit to restrictive conditions to address NSR concerns. However, there are no specific rules or guidance on the types of concerns the NSR office may have and the restrictive conditions that may be required to address its concerns. The NSR is a highly discretionary process subject to the NSR office’s opinions in case-by-case assessments.

In the case of approval with conditions, the parties have a continuing obligation to perform and implement the conditions imposed under the approval decision.

NSR – Possibility to Block FDI

Where the FDI has impacted or will likely significantly impact national security and the effect could not be remedied by conditions, the NSR office may reject the investment. If the investment has already been implemented, the NSR office may unwind the relevant transaction.

Only a handful of investments have been blocked, according to public information.

Consequences for Investing Without Prior Notification to the Relevant Authority

The following consequences are possible.

• Unwinding of the transaction – the NSR office may order the transaction parties to make an NSR notification if a transaction has been implemented without the requested NSR notification. Failing to follow such order may result in the transaction being unwound, even if it does not raise national security concerns. And if the NSR office identifies a national security concern which cannot be mitigated by the parties’ proposed remedy measures, then it will also have the power to unwind the transaction.
• Adverse record in China’s credit information system – failures to notify relevant transactions will be recorded in China’s credit information system and subject to associated penalties. This will also likely result in reputational risks and an impaired relationship with the Chinese government.

Under the NSR Measures, there is no monetary penalty imposed on foreign investors for the failure-to-notify violation.

Foreign Exchange Control Regime

China has foreign exchange control regulations administered by the State Administration of Foreign Exchange (SAFE). Cross-border transactions are classified into two categories: capital items and trade items. Capital items – capital contributions, loans and dividend distributions – are subject to stricter scrutiny than trade items. SAFE has delegated most transaction review and oversight powers to PRC banks.

Outbound Direct Investment Regime

PRC enterprises, no matter whether foreign or domestically owned, must obtain approvals before investing overseas (ODI approvals). These approvals include those from NDRC, MOFCOM and SAFE. The procedures to obtain these approvals may take weeks or sometimes months.

Investment in Manufacturing

Domestic and foreign investment in manufacturing projects require additional governmental approvals, including from NDRC, which has oversight over manufacturing activities and production capacity nationwide. The project may also need to obtain EHS-related permits, zoning permits and construction permits.

Investment via Red-Chip Structure

A red-chip structure is a common holding structure used by Chinese companies to access overseas financing or to achieve a listing on offshore stock exchanges. It was used especially in the past when China’s domestic listing rules were more restrictive. In a typical red-chip structure, the holding company is incorporated in Hong Kong or Cayman and holds shares in the PRC subsidiaries.

If the target company engages in business restricted from or prohibited to foreign investment, a VIE structure is typically adopted. A VIE structure is a set of contracts that allow the foreign holding company to control target companies via contractual arrangements instead of holding shares in the target. PRC law has not recognised the VIE structure as a legitimate investment structure.

Investment in a red-chip structure sometimes allows foreign investors more flexibility in information reporting, share transfers, corporate governance and so on. This flexibility results from the investment in the overseas holding company not being considered as FDI. Thus, the filing and registration requirements for foreign investment in a PRC company are not triggered.

Sanction Regime

In June 2021, China passed the Law Against Foreign Sanctions answering to the sanctions imposed by foreign countries against Chinese companies. Persons that are associated with sanctioned persons declared by the Chinese government may be subject to penalties such as seizure of their assets in China.

Enterprise Income Tax

Enterprise income tax (EIT) is one of the major taxes applicable to companies doing business in China.

Tax payers are classified into PRC resident enterprises and non-resident enterprises, as described below.

PRC resident enterprises are enterprises incorporated in China or having de facto management bodies in China. PRC resident enterprises are subject to 25% EIT on their income. Reduced EIT rates apply to:

• qualified high-tech enterprises;
• small micro-profit enterprises; and
• enterprises in western China that engage in industries encouraged by the Chinese government.

FIEs are subject to the same EIT rate as domestic companies.

Non-resident enterprises are enterprises that are not incorporated in the PRC, do not have de facto management bodies in the PRC, but either have an establishment in the PRC or have income sourced from the PRC. If the non-resident enterprise does not have an establishment in the PRC but has PRC-sourced income, or if the non-resident enterprise has an establishment in the PRC but has no PRC-sourced income connected to the establishment, the non-resident enterprise is subject to a reduced EIT rate of 10%.

Value Added Tax

Value added tax (VAT) applies to the sale or import of goods, provision of labour for the processing and repair of products, provision of services and the sale of intangible properties and immovable properties. The VAT rate depends on the type of business activity. Input VAT can be credited against output VAT under certain circumstances.

Other Taxes

In addition to EIT and VAT, companies are subject to other taxes such as stamp duty, consumption tax, land appreciation tax and real estate tax.

Dividends and interest paid to a foreign investor, assuming the foreign investor is a non-resident, are subject to withholding tax at 10%. The withholding taxes may be subject to tax treaty arrangements that prevent double taxation or other applicable exemptions under tax treaties.

Restructuring transactions may be eligible for tax deferral treatment if they meet the prescribed requirements and are approved by the tax authorities.

Taxes are shared by the central government and local governments. To encourage investments, local governments sometimes provide subsidies based on the amount of estimated future tax payments by the foreign investor or the FIE. Therefore, foreign investors can negotiate investment agreements with local governments before investing to ensure the most favourable tax treatment possible.

Under the Law on Enterprise Income Tax, capital gains are deemed as taxable income and therefore subject to EIT.

Even if a transaction takes place overseas, as long as the target company holds equity interest or shares in a PRC subsidiary, the seller is also subject to EIT for the capital gains attributable to the equity interests or shares in the PRC subsidiary.

PRC tax law provides that all business transactions between related parties must be made on an arm’s-length basis; otherwise, the tax authority may apply special tax adjustments to the transactions. The tax authorities may also investigate the related party transactions and review transfer pricing documents.

In China, the employment relationship between an employer and an employee is mainly governed by:

• national laws including the PRC Labour Law, PRC Employment Contract Law, PRC Social Insurance Law, PRC Law on Mediation and Arbitration of Labour Disputes, and certain provisions on the implementation of these national laws;
• interpretation by the PRC Supreme Court on the Application of Law in the Trial of Labour Dispute Cases (I);
• national regulations and policies issued by relevant governmental authorities, particularly the Ministry of Human Resources and Social Security; and
• local regulations and policies issued by local governmental authorities.

Under the PRC Trade Union Law, a basic-level trade union committee should be established in any enterprise with 25 or more members but, in practice, not all enterprises establish these trade union committees. According to the 2021 China Statistical Yearbook, around 2.47 million basic-level trade union committees had been established in China by 2020.

However, even in enterprises with trade union committees, collective bargaining is not common in practice in China.

Foreign investors should also pay attention to the immigration regulations in China, including work visa, work permit and residence permit requirements at national and local levels. Foreign investors who wish to initially establish representative offices instead of companies should note that PRC laws restrict representative offices of foreign enterprises from directly hiring local employees and require them to hire local employees through labour dispatch service providers.

Typically, employees in China are entitled to salary payments, statutory social insurance and housing fund contributions. Statutory social insurance contributions comprise basic pension, basic medical insurance, work-related injury insurance, unemployment insurance and maternity insurance.

Other benefits include statutory annual leave and certain benefits applicable to certain classes of workers. In addition, in tech and other start-up companies, equity-incentive compensation has also become rather common through employee stock options and restricted share awards.

Under PRC law, a change in the controlling investor or shareholder of an employer does not affect the validity or effectiveness of the employer’s employment contracts. Neither does it entitle employees to additional compensation as a matter of law unless employment is terminated, in which case severance based on law and mutual consultation may apply.

Generally speaking, unless there are changes to the employment relationship or arrangements following an acquisition, change-of-control or other investment transaction, employees will not be entitled to additional rights or severance payments. However, if the employer wishes to terminate an employee, the employee will be entitled at minimum to the statutorily prescribed severance based on the duration of employment and, in most cases, 30 days’ prior written notice. The employee’s salary and benefits terminate as of the termination date unless both parties agree otherwise.

The transfer of employment from one employing entity to a new entity requires mutual agreement between the employer and employee. In an asset or business sale, the employer and purchaser often offer employees the opportunity to transfer employment to the purchaser. If the employee agrees to the transfer, either the employer (ie, the seller) will pay the transferred employee’s severance based on the employee’s service years, with the employee then being deemed a new hire of the purchaser, or the purchaser will recognise the employee’s previously accumulated service years in the new employment contract.

Employers deciding matters directly affecting the immediate interests of employees are required to comply with consultation and notification procedures prescribed in the labour laws. These consultation and notification procedures include seeking comments from the employee representatives’ congress or all employees, discussing the comments with the trade union or the representatives nominated by the employees, and notifying all employees of the final decision.

With the aggravation of international competition on science and technology, intellectual property plays a more and more important role concerning foreign direct investment. It is welcomed that any intellectual properties, especially high-end technologies, are invested into China. The aforesaid technology, including any kind of technology, such as patents, patent applications, technical secrets and relevant licences, may be transferred in trade or investment, and economic or technological collaboration between Chinese and foreign businesses.

In regard to technology exports, a stricter control can be expected. Technologies are categorised into three classes: prohibited, restricted and non-restricted ones. Technologies falling within the prohibited category cannot be exported, and restricted technologies can only be exported upon prior approval of government.

MOFCOM and the Ministry of Science and Technology (MOST) maintain a Catalogue of Technologies Prohibited or Restricted from Export, which provides specific technical parameters for export control. Due to pressure from the competitive environment, the range of restricted items is still in the process of expanding.

In 2021, China continued the rapid development of knowledge innovation it has maintained in recent years. Compared with 2020, granted invention patents in China had increased by 31.3% in 2021, while those of foreign applicants had a year-on-year increase of 23.0%. Trade mark registrations had a year-on-year increase of 34.3%, while approved foreign geographical indication registrations had increased by 2.4%. The number of layout-designs of integrated circuits announced and certified in 2021 had increased by 11.6%. The amount of intellectual property pledge financing in 2021 was CNY309.8 billion, showing a year-on-year increase of 42.1%.

Correspondingly, China provides a stronger means of protection for intellectual property. The main intellectual property laws have been amended successively in recent years. In order to keep pace with the development of the times, the Copyright Law has broadened the scope of works, substituting cinematographic works with audiovisual works. The revised Trade Mark Law strengthens the trade mark protection against malicious trade mark registration. The new Patent Law improves the priority system, extends the term of patent protection, and establishes the pharmaceutical patent linkage system. The Anti-unfair Competition Law is now under amendment again, although it was amended in 2018 and 2019.

All the amendments to the intellectual property laws increase the amount of statutory damages to CNY5 million yuan and provide for punitive damages of up to five times the actual amount of damages. For the newly added rules of punitive damages, the Supreme Court released a relevant judicial interpretation and exemplar cases awarding punitive damages, conveying a strong signal of strengthening protection of IP rights in China. A judgment rendered by the IP Tribunal of the Supreme Court awarded the damages of CNY159 million yuan in a trade secret infringement case. On the other hand, the application of preliminary injunctions also paves the way for IP owners to quickly go back to their normal businesses.

Currently, China’s legal regime for data protection comprises three main legislations, namely the Personal Information Protection Law (PIPL), the Data Security Law (DSL) and the Cyber Security Law (CSL). The DSL and the PIPL came into force, respectively, on 1 September 2021 and 1 November 2021. Both the PIPL and the DSL propose clear extra-territoriality application to data processing activities that take place outside China.

The DSL regulates the security and protection of data processing activities, and the data in the DSL is defined broadly to include all categories of data including but not limited to personal data and non-personal data.

Many provisions of the PIPL seem to be inspired by the EU General Data Protection Regulation. These include hefty fines of up to 5% of a company’s revenue during the preceding year or CNY50million, and the legal ramifications also apply to an individual who processes personal data in breach of the PIPL. The regulators also have the power to suspend or terminate any mobile app or online service that illegally processes personal data. Those who are responsible for causing the violation may be disqualified from being directors, supervisors, general managers or personal data protection officers. There are, however, key differences, notably that the PIPL has a strong focus on consent by individuals as to how their personal data is processed. The concept of “legitimate interest” for processing personal data, which is widely used in the EU, is not recognised in the PIPL.

During 2022, China’s primary data protection regulator, the Cyberspace Administration of China (CAC) issued various draft and finalised rules regulating cross-border data transfer, in particular the following.

• The CAC released the Measures on the Security Assessment of Cross-Border Data Transfer (the “Measures”) on 7 July 2022, which came into force on 1 September 2022. The Measures are intended to implement the rules of security assessment for cross-border data transfer under the CSL, the DSL and the PIPL. According to the Measures, a data handler should submit for security assessment and seek the CAC’s approval under any of the following circumstances: (i) where a data handler transfers “important data” outside China; (ii) where an operator of critical information infrastructure (CIIO) or a personal data handler who processes personal data of more than one million individuals transfers personal data outside China; (iii) where a data handler who has transferred personal data of more than 100,000 individuals or sensitive personal data of more than 10,000 individuals cumulatively as of January 1 of the previous year transfers personal data outside China.

• The CAC released the Draft Provisions on the Standard Contract on Cross-Border Data Transfer (the “Draft Standard Contract Provisions”) as well as the draft of the CAC-prescribed Template for Cross-Border Data Transfer Contract (the “Standard Contract”) for public comments on 30 June 2022. Aside from the Standard Contract per se, the Draft Standard Contract Provisions also proposed the scenarios where the Standard Contract can be used – ie, where a personal data handler can comply with all of the following requirements, the entity can use the Standard Contract as the legal mechanism for cross-border transfer of personal data: (i) it is not a CIIO; (ii) the volume of personal data processed does not reach one million individuals; (iii) the cumulative provision of personal data outside China since January 1 of the previous year has not reached the volume of 100,000 individuals; and (iv) the cumulative provision of sensitive personal data outside China since January 1 of the previous year has not reached the volume of 10,000 individuals. Further, it is also required that the concluded Standard Contract should be filed at local CAC at provincial level within 10 working days since the effective date of the Standard Contract together with the data protection impact assessment report in the context of cross-border transfer of personal data.

• The CAC together with the State Administration for Market Regulation released the Rules for Implementation of Personal Information Protection Certification (the “Certification Rules”) on 4 November 2022, which provide implementation rules for cross-border transfer of personal data based on certification by a licensed agency (the “Protection Certification”) as a legal mechanism recognised by the PIPL. The Certification Rules provide the relevant information on the certification model, the implementation process, the standards on certificates and marks, etc, and also require that the licensed agencies can only provide certification services after being approved. So far, the CAC has not officially approved any agencies to conduct Protection Certification, and therefore companies that plan to apply for the Protection Certification are suggested to keep this in view.

Multiple Chinese regulators have been actively enforcing the data protection laws and their implementation measures. Areas of focus in these law enforcement actions include transparency and personal data protection, children’s privacy and consumer protection, implementation of security measures, protection of critical information infrastructure and illegal cross-border data transfer. In July 2022, the CAC fined the ride-hailing platform DiDi Global Inc CNY8.026 billion (approx. USD1.2 billion) according to the PIPL, the DSL, the CSL, etc for its illegal processing of personal data.

Privacy litigation has been on the rise in China, which may continue to be the case – particularly with PIPL lowering the bar for data subjects to bring claims against companies.

There are no significant issues not covered elsewhere in this chapter.