For the last few months, I alone have been averaging a call or email a day from someone inquiring about getting money out of China. I had three phone calls and one email on this topic yesterday (and woke up to two more such emails this morning), and they run the gamut.
Two of yesterdays calls were typical. One was from a realtor wanting to know how the Chinese buyer of a two million dollar house could get her money out of China to pay for it. The other was from the General Counsel of a large housing construction company with essentially the same question, but more general.
I try to make the single house purchase calls as short as possible and I do that by spewing out the following as quickly as I can:
China law forbids anyone from sending out of China more than USD$50,000 in any given year without government approval and it is virtually impossible to get this approval to buy a house overseas. So the odds are overwhelming that we will not be successfully in helping this person get more than $50,000 out of China and we are not going to help in getting the money out illegally. There are sometimes some legal workarounds, but for us to know if there are any in this case, we would need to be retained and we would need to know a lot more facts. And doesn’t it make more sense for your buyer to retain her own Chinese attorney in her hometown since she is Chinese and this is an issue of Chinese law?
Our China lawyers have been hired on single purchase house deals, but only by sellers who want to use our services to justify getting out of the deal with their Chinese buyers because they now have a higher offer on the table and they are tired of waiting. This makes sense.
My phone calls with the real estate company and the home building company lawyers last a few minutes longer. I tell those callers the same thing about the law, but I also tell them that in light of this, they should consider requiring larger initial nonrefundable deposits from overseas buyers.
Then there are the near daily emails from people who think that they have come up with THE solution for getting money out of China. These emails propose things like bitcoin, loans, company to company transfers and various other things, far too often with a tone that they have discovered the one method that can trump Chinese government restrictions and would I just confirm this for them. It was one of those that spurred me to write this post:
What’s the best way for a Chinese investor to send RMB out of China to the U.S.? We are setting up this transaction as a services deal from corporation to corporation.
That’s it. No explanation of the parties involved in the deal. No explanation of the deal itself. No explanation of the money involved. Not even really a question; just a statement as to how they are going to do the deal, and essentially a request that we bless it. Here is my standard response to these kinds of emails:
There is no way I can answer your question on the best way for a Chinese investor to get RMB out of China without knowing, at the bare minimum, the following:
1. The nature of the transaction.
2. The nature of the parties (a lot more than just their structures).
3. The histories of the parties.
4. The location of the parties.
5. The nationalities and even the ethnicities of the parties (especially the receiving party).
In our experience all these things (and a whole host of other things) are factors in whether the Chinese government will allow money to leave. If you think just doing it corporation to corporation will get the money out, the odds are overwhelming that you will end up being sorely mistaken
The more legally interesting calls — and the ones on which our China lawyers can often help — come from Western companies facing the following sorts of situations:
- Western company selling some really expensive item (usually a piece of industrial equipment) to a Chinese company and the money isn’t leaving China.
- Western company waiting for funds to arrive on an IP licensing deal.
- Western company waiting for funds to arrive from a Chinese company which is supposed to be investing into the Western company.
- Western company waiting for funds in payment of services provided.
1. Chinese Government Factors for Allowing Money to Leave China
Based on the many deals on which our China attorneys have worked, and the reports we get from our clients and their bankers and financiers, and from China consultants and bankers and financiers with whom we regularly share information, we see legitimacy and benefit to China and deal structure as the three key elements. In this post, I will address “legitimacy.” In subsequent posts, I will address the other factors.
By legitimacy we mean exactly that. If a China company needs a $5 million dollar piece of industrial equipment for its factory and it pays $5 million for that industrial equipment, the deal will almost certainly go through. My law firm has a number of U.S. and European clients who sell this sort of equipment and for whom we have drafted contracts that work and none of these clients have reached out to us with any problems. Nor has any other company selling such equipment legitimately.
Just to repeat. Chinese company needs $5 million in industrial equipment to make its factory run better, the Chinese government will almost certainly allow the money to go through. Why then do we get so many calls and emails from U.S. and European (usually for us, German or Italian or Spanish) companies who are not getting paid for their industrial equipment sales? Two reasons. Bad contract and an appearance or a reality of illegitimacy.
Here are the situations where we have seen problems on what should be a routine equipment purchase:
1. The foreign company is selling the $5 million piece of equipment for $8 million. Come on. If you have sold your $5 million piece of equipment to China five times in the last year for $5 million and now all of a sudden you are selling it for $8 million, the Chinese government is going to assume that you have some sort of side deal with your Chinese buyer to funnel some large portion of the $3 million extra to a bank account held by the owner of your Chinese buyer in your home country. When we have been armed with evidence to the contrary (perhaps you have added all sorts of bells and whistles to the $5 million machine, for example), the odds are good on your eventually getting the money out. But if you are in fact planning to push over the $3 million or so extra to your Chinese friend, the odds are not so good that the money will ever leave China.
2. The foreign company is selling the $5 million piece of industrial equipment to an advertising agency in China. Come on.
3. The foreign company selling the $5 million piece of industrial equipment has never sold anything to China previously and the Chinese company buying the $5 million piece of industrial equipment has never previously bought anything similar from overseas before. If your deal is truly legitimate, you ought to be able to prove it and you ought to be able to get paid. If your deal is really just a scam, your odds of succeeding are even less.
4. The foreign company selling the $5 million piece of industrial equipment is wholly owned or largely owned or even partially owned by an ethnic Chinese. Call it discrimination or call it whatever else you want, but we often see deals involving ethnic Chinese on the foreign side held up to much greater scrutiny by the Chinese government. I first wrote about this Chinese government criteria back in January of this year, in Getting Money Out of China: What The Heck is Happening?
2. China Laws on Getting Money out of China
It is widely believed that China recently changed its rules regarding outgoing funds, but that is not really correct. China’s regulations on sending money out of China have not changed. There is no limit on the amount a compliant Chinese company can send abroad. But Chinese banks — acting on instructions from Beijing — are becoming much stricter with remittances. This new strictness has come about in an effort to limit capital outflows and to make sure taxes are paid in China before money leaves the country.
Chinese law generally requires a Chinese company to obtain a “tax certificate” from its local tax bureau before more than USD$50,000 worth of RMB can be converted into a foreign currency and remitted abroad. As the name might suggest, the certificate confirms that the Chinese company has made all necessary tax payments on the money or has some kind of exemption for the money. To obtain the certificate the Chinese company needs to submit copies of the relevant contracts (and oftentimes invoices) and provide particulars of the transaction. The tax certificate must be presented to the foreign exchange bank before the payment transaction occurs.
The regulations provide for a blanket $50,000 exemption from approval. No proof or justification is usually required for up to the $50,000 limit. However, we are getting many reports of Chinese banks denying requests for RMB conversion of amounts below the $50,000 limit.
Sometimes, the real problem, especially with larger remittances, is simply that the Chinese company can’t get a tax certificate, or doesn’t want to get a tax certificate, because that would require it to pay taxes it wasn’t planning on paying. To be fair, problems sometimes arise when the Chinese company genuinely wants to make a remittance and is prepared to pay the applicable taxes. These problems vary depending on the type of payment. They mostly affect payments for services, royalty payments and Foreign FDI or M&A payments. Payments for the purchase of goods are generally not as complicated, so long as the foreign side has its own paperwork in order as well.
3. How to Structure Your Deal and Draft your Contract to Get Paid
The one thing you as the foreign company can control is whether you provide your Chinese counter-party with your product, your company shares, your assets, or your services before you receive payment for those things, or after.
With all of the recent problems in getting money out of China, it makes sense that when doing a deal with a Chinese company or individual, that you demand a nontrivial amount upfront, and confirm payment before you even lift a finger. Do this to prove that the Chinese side can in fact make a payment on the contract. The renminbi is still a nonconvertible currency, and aside from a $50,000 annual exception, any time a Chinese entity wants to send US currency to a foreign entity, it needs to get approval from the transmitting Chinese bank. This generally means that the parties have executed a contract for goods or services that are acceptable for foreign entities to provide, and that you have submitted a formal invoice in a form acceptable to the bank – because the bank in turn usually needs to get approval from government authorities. Sometimes this approval never comes, and the Chinese counter-party is unable to make any payments at all. It’s a lot better for you to find this out at the beginning.
To get paid from China, there have always been and for the near future will always be two critical points you must consider: documentation and tax.
When a Chinese company seeks to send you as a foreign company money, it is not a simple matter. The Chinese company must go to its foreign exchange bank. At the bank, RMB must be converted to U.S. dollars or some other convertible currency. This conversion is subject to strict rules issued by the State Administration of Foreign Exchange (SAFE). The foreign exchange bank acts as the agent for SAFE in enforcing the rules. These rules were originally designed to protect China’s foreign exchange reserves but now they are used to prevent capital from illegally leaving China. Payment of falsified invoices is one of the primary ways capital illicitly leaves China, so careful review of all transactions is therefore required to prevent fraud.
To comply with these rules, the Chinese company is not permitted to simply make a wire transfer request; it is required to provide documentation proving there is a legitimate underlying transaction for which payment is being made. The following is the basic documentation usually required for money to flow:
- A formal written contract, executed, dated by both parties and sealed by the Chinese party. Though not officially required, it is best if this contract includes a Chinese translation.
- A Formal, written invoice, signed and dated by the foreign service provider. There must be a separate, signed invoice for every required payment. Again, though not required, it is best if this invoice includes a Chinese translation.
These first two requirements are mandatory and will always be required. Depending on the specific situation, the foreign exchange bank may also impose the following additional requirements:
If the invoice amount is high, or if the bank otherwise suspects fraud, the bank may request proof of existence of the foreign company. The proof required varies from bank to bank. For some banks, a copy of a business license is sufficient. Other banks will require a formal certificate of good standing from the secretary of state or a related document. China just keeps getting tougher on this front.
If the bank determines the payment is a royalty for a technology license or similar licensing agreement, it will require the contract be registered in accordance with the requirements of Chinese law. Depending on the locality, this registration can take from three days (Shanghai) to six months or more (Shandong Province). Our China intellectual property lawyers register China licensing agreements as a matter of course, and you should too.
Banks can impose other requirements, depending on their mood and their concern about the legitimacy of the transaction. The bank controls the situation and you have no real standing to discuss the matter. No payment can be made until the bank is satisfied and the bank has no incentive to approve the transaction. Delay in processing payment for services is therefore the norm rather than the exception.
Your Chinese counter-party is going to be better positioned than you to secure China bank/government approval and it is therefore essential then that your deal and your contract with your Chinese counter-party both put the onus on the Chinese company and incentivize it to get the job done.
It comes as a shock to many foreign service providers that the amount paid to them may be subject to Chinese tax. The Chinese tax authorities deem all service work provided to Chinese clients as Chinese source income. Licensing fees are also usually subject to tax. As with the SAFE rules, the foreign exchange bank serves as an agent for the local tax office to ensure that the correct amount of tax is imposed and paid. No wire transfer can be made until this happens.
We have seen tax amounts imposed ranging from 10% all the way to 40% of the invoice amount. Even the same tax office will take an inconsistent position on the amount of tax to impose. One payment will be taxed at 10% and the next payment for exactly the same services will be taxed at a substantially higher rate.
The resolution of the tax issue is critical because the invoice cannot be paid until the tax amount is calculated and paid. Your Chinese counter-party acts as the agent for the foreign service provider and pays the required amount on behalf of the foreign party. Since the total amount paid by the Chinese company does not change, it has virtually no incentive to work with the tax office to lower the tax amount unless your contract with. Since you, the foreign company want to get paid as soon as possible, the incentive for the Chinese company is to agree with whatever the tax office decides and to make the tax payment as soon as possible without complaint about the amount imposed.
The amount of tax can be high and the time required for processing can be very long. It is therefore important that you understand the issues and enter into an agreement with the Chinese party on how to proceed. Under international commercial practice, it is most common to simply provide that 1) the Chinese side is liable for all taxes imposed by the Chinese government and 2) the amounts payable by the Chinese side are net of taxes. That is, the amount invoiced by the foreign party must be paid in full without regard to any taxes imposed in China. This provides certainty to the foreign party and places the burden of dealing with the complex, uncertain and constantly changing Chinese tax system where it belongs: on the Chinese party. Since the Chinese party is responsible, the Chinese party will then have the appropriate incentive to advocate for the lowest tax possible. Certainly the Chinese party is better positioned to do this than you are.
It is common for the Chinese party to resist this standard approach and to seek to place all of the risk of the Chinese tax system on you, the foreign party. This means you must consider whether to abandon the transaction or move forward without certainty on the amount of payment you actually will receive. There are various complex ways to mitigate the risk of tax payment, but these measures must be negotiated carefully in advance.
Any time you enter into a contract with a Chinese company that requires it pay you outside of China, there is risk of delay and there is risk that no payment will ever be approved by the Chinese bank. It is therefore important that you confirm the ability of the Chinese side to make payment very early. Usually we provide in the contracts we draft that the Chinese side will make an initial payment before any substantial work is done or anything of much value is sent.
We do this to determine how quickly the payment will be processed and the tax that will be imposed on payment. Often, the Chinese side itself has no idea what will be the result.
We also often get called by service companies upon learning that their payment is going to be delayed and taxed heavily. By that point, there is little we can do.
4. Contract Drafting to Get Money out of China
The below are some of the many things you can do with your Chinese contracts to improve the odds of money leaving China.
A. Draft your contract with the Bank of China and the Chinese Government in mind.
Two similar technology licensing deals. One has no Chinese version and talks about software that can be used to maximize retail sales. The other has a Chinese version and talks about how the software can maximize production line efficiencies. The second one has a much better chance of clearing Chinese government approval than the first one. It’s important that you get this right from the get-go because once you don’t, your odds of the money ever leaving have permanently decreased.
B. Draft your contract assuming the money you need will never leave China.
In other words, your contract should have a provision(s) making clear exactly what will happen if the funds never arrive.
For instance, if you are seeking equity funding for your company, you must not grant the putative Chinese funder equity in your company before you receive the money required. I know this sounds obvious, but trust me when I say that is not always the case. If you allow a Chinese company to get equity in your company before you receive the money, you will likely be facing the untenable situation of needing to sue (perhaps even in China) and argue for stripping the Chinese company of all equity for non-payment. Structure your deal so equity comes only upon payment!
Where we also often see problems is in licensing deals where the American or European company will provide some or all of its technology before receiving payment. For why it always makes sense to get paid upfront when licensing your technology to a Chinese company, check out Three Myths of China Technology Transfers
5. Your Chinese Counter-Party Should Figure out how to get the Money out of China, not you.
Our China lawyers are nearly always contacted by the American or the European side for help on getting their Chinese counter-party’s money out of China. This does not make much sense and our response is usually to tell them that my law firm’s role should be to represent the foreign party in overseeing what the Chinese party does to try to free up its own money and if the Chinese party is serious about wanting to get its money out of China, it should hire its own Chinese lawyer in China. If your Chinese counter-party is unwilling to hire and pay for its own lawyer to help it get the money it owes you out of China it must not want to pay you nearly as much as it claims.