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. Yesterday’s 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 more than USD$50,000 out of China 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 able to help this person get more than $50,000 out of China. There are sometimes 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.
My phone calls with the real estate and home building company lawyers last a few minutes longer. I tell these 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 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 these emails 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 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 how a Chinese investor can 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 host of other things) factor into 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 you will end up being mistaken. Even worse, someone in China could end up in jail over this.
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 a 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, benefit to China, and deal structure as the three key elements.
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 likely 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 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 that 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. 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 will assume you have a side deal with your Chinese buyer to funnel some portion of the $3 million extra to a bank account held by the owner of your Chinese buyer in your home country. When our China lawyers have been given evidence to the contrary (perhaps all sorts of bells and whistles were added to the $5 million machine, for example), the odds are good on the money eventually being able to leave China. But if you are planning to push over the $3 million or so extra to your Chinese friend, the money will likely never leave China.
2. The foreign company is selling the $5 million piece of industrial equipment to an advertising agency in China.
3. The foreign company selling the $5 million piece of industrial equipment has never previously sold anything to China and the Chinese company buying the $5 million piece of industrial equipment has never bought anything similar from overseas. 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 way 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 the Chinese government more closely scrutinize deals that involve an ethnic Chinese person on the foreign side. 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 China recently changed its rules regarding outgoing funds, but that is not correct. China’s regulations on sending money out of China have not changed. But Chinese banks — acting on instructions from Beijing — are becoming stricter with remittances. This new strictness is 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 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 must 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 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.
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, or after.
With the recent problems in getting money out of China, when doing a deal with a Chinese company or individual, you should require a nontrivial amount be paid to you upfront, and you should confirm payment before you 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, a Chinese entity that wants to send US currency to a foreign entity must have approval from the transmitting Chinese bank to do so. This generally requires you have an executed contract for goods or services you submit a formal invoice in a form acceptable to the Chinese 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 is 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.
A. Documentation
When a Chinese company seeks to send money to 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 designed to protect China’s foreign exchange reserves but are now used to prevent capital from illegally leaving China. Payment of falsified invoices is one of the primary ways capital illegally leaves China, so careful review of all transactions is 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 needs to be 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 is in Chinese or 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 is in Chinese or 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 the 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.
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. 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 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.
Your Chinese counter-party is going to be better positioned than you to secure China bank/government approval and it is therefore essential that your deal and your contract with your Chinese counter-party put the onus on the Chinese company and incentivize it to get the job done.
B. Taxation
It comes as a shock to many foreign service providers that the amount paid 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 taxes are paid. No wire transfer can be made until this happens.
We have seen tax amounts imposed ranging from 10% to 40% of the invoice amount and even top China accountants do not have a 100% success rate in predicting the amount.
Resolving 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 the foreign party with which it is doing business and it pays the required taxes on behalf of the foreign party.
The amount of tax can be high and the time required for processing can be long. It is therefore important you understand the issues and enter into an agreement with the Chinese party on how to proceed. Under international commercial practice, it is 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 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 be incentivized 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 risk of the Chinese tax system on the foreign party. The foreign party should consider whether to abandon the transaction or move forward without certainty on the amount of payment it 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 China, there is risk of delay and that no payment will ever be approved by the Chinese bank. It is therefore important you early on confirm the ability of the Chinese side to make payment. The contracts the China lawyers at my law firm draft usually require the Chinese make an initial payment before any substantial work is done or before anything of value is sent to China. We do this to determine how quickly the payment will be processed and to gain information on the amount of the tax that will be imposed on payment.
We also often get called by service companies upon learning 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. It iw important you get your contract terms right from the get-go because once you don’t, your odds of the money ever leaving China have permanently decreased.
B. Draft your contract assuming the money you need will never leave China.
Your contract should have a provision making clear exactly what will happen if the funds owed you never arrive. For instance, if you are seeking equity funding for your company, you must not grant the putative Chinese funder any equity in your company before you receive the money required. 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 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.
5. Your Chinese Counter-Party Should Figure Out How to Get Its 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. We usually 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 to facilitate that. If your Chinese counter-party is unwilling to hire and pay for its own lawyer to help it get money it owes you out of China, you should assume it does not want to pay you.
