In July 2006, the Chinese government issued rules prohibiting foreign individuals and companies from directly owning commercial real estate in China. Just this month, China’s State Administration of Foreign Exchange (“SAFE”) issued new foreign exchange rules. In my experience dealing with real estate investors here in Shanghai and elsewhere in China, both of these rules are misunderstood.
The Opinion on Regularizing and Managing the Entry of Foreign Capital into the Real Estate Market (“Opinion”) requires foreign participation in commercial real estate investment be through a Chinese commercial entity. This means foreign companies and individuals can own real estate in China only through a Foreign Invested Enterprise (FIE), such as a Wholly Foreign Owned Entity (WFOE) or through an Equity or Contractual Joint Venture (JV). Residential property not for personal use is considered commercial real estate and its ownership is similarly restricted. This is true even if the residential property is not rented to third parties.
This rule applies to all of China. The ramifications of this new rule are clear: foreign individuals and foreign companies can buy commercial real estate in China only if they do so in the name of a Chinese corporation (such as a WFOE or JV) established for this purpose. This is a clear and inflexible rule. It also is not actually a change in Chinese law, just a reaffirmation by opinion of what has always been the case.
The opinion has one limited exception to its no foreign ownership rule and that is for residential real estate as a personal residence. This exception is limited to Representative Offices or to foreign individuals who have been legally resident in China for at least one year while employed or as a student. These foreign individuals are limited to one residence. There are somewhat less restrictive rules for residents of Hong Kong and Taiwan.
Following on the Opinion, the relevant authorities issued detailed rules on foreign exchange issues related to the foreign individual purchase and sale of real estate. These rules were issued on September 1, 2006 as the Notice on Various Issues Relating to the Management of Foreign Exchange in Connections with the Regularization of the Real Estate Market (“Forex Notice”). The Forex Notice recognizes that most individual purchasers of real estate in China will be using foreign exchange form their home country for the purchase. These rules require proof of the real estate purchase in China, proof of identity, and proof of residence for at least one year. The exchange of funds must be made at the real estate buyer’s bank, with the fund directly transferred to the seller’s bank. No cash can be withdrawn.
The Forex Notice also provides rules for converting Renminbi (RMB) proceeds from a real estate sale by foreign individuals. The Forex Notice provides that RMB proceeds can be converted to foreign exchange if the foreign individual provides an application, a copy of the sales agreement, and proof of payment of all taxes related to the property and the sale.
The local tax offices with which I have discussed this tell me “all taxes” means any capital gains tax resulting from the sale and all taxes accrued during the foreign individual’s ownership of the property, including the stamp taxes due on rental payments and individual income tax on any income earned from the property. Without proof of payment of taxes, conversion of foreign exchange will not be permitted. One of the tax officers with whom I discussed this told me that taxes are not a major issue in foreign exchange conversion since the sale itself would not be approved absent proof of payment of taxes.
I am aware of many foreign residents in China who are going to be facing a very unpleasant reality when they try to sell their China properties. Many foreign owners of China real estate ignore the requirements of China’s individual income tax law and fail to file the appropriate tax return. Since taxes are owed on income earned from real property, the Chinese government will not approve the property’s sale until the tax issue is resolved. This is another example of China starting to take a very serious approach to tax compliance.
I am also aware of a number of foreign residents who are violating Chinese law by buying more than one property. They tell me they feel safe in doing so because the Chinese government does not effectively track foreign real estate ownership. These people are taking large and unnecessary risks. The risk is unnecessary because all they need do to buy multiple properties legally is to form a WFOE and make the purchases through it. I view the risks as huge because I fully expect China to have effective tracking mechanisms in place before most of these people are able to sell.
This month, SAFE also issued new rules concerning the conversion of foreign exchange to RMB, called the Method for Management of Foreign Exchange by Individuals (“Forex Method”) and the Detailed Rules on the Method for Management of Foreign Exchange by Individuals (“Detailed Rules”). The new system works as follows:
- Individuals can freely convert foreign exchange to RMB up to an annual limit of $50,000 US.
- When individuals exceed the $50,000 US annual limit, they must obtain permission for the exchange, which permission is automatic, provided the individual provides proof the exchange is for a specific and legitimate purpose.
- The Forex Method provides that a foreign individual’s sale and purchase of real estate is a legitimate purpose and should be processed according to existing rules. Section 21 of the Detailed Rules provides that such transactions should be processed according to the Forex Notice discussed above.
Accordingly, the new Forex system established this month has no impact on the purchase and sale of real estate in China by foreign individuals. Despite this, many people who contact me incorrectly believe the new rules imposed an absolute limit on foreign exchange conversion or prohibit foreign exchange conversions for buying real estate. The new rules are actually a liberalization of the old rules, not an attempt to impose new restrictions.
For those wishing to learn more on China real estate, mark May 3 and 4 on your calendar as both my co-blogger Dan Harris and I will be speaking in San Francisco on those days at a seminar on China real estate investments and doing business in China overall. I will be speaking on China’s new real estate regulations and Dan will be moderating a session on China’s second tier cities. Needless to say, you can expect many of us at that seminar to be talking about foreign ownership of real estate in China.