Has spring arrived? Regulatory developments in China’s finance lease industry

apple-blossom-80334There have been a number of recent regulatory developments concerning finance lease companies in China. Dr Joachim Glatter and Sophie Yun Wei of Taylor Wessing provide details on what they are, and say that although there is still some fine tuning to be done the finance lease industry in China is changing for the better.

China’s finance lease industry contains two major groups of finance lease companies[1]: foreign-owned finance lease companies (FFLCs), supervised by the Ministry of Commerce (MOFCOM); and finance lease companies (CBRC-FLCs) supervised by the China Banking Regulatory Commission (CBRC). Subject to the approval of the CBRC, the business scope of CBRC-FLCs may be broader than that of FFLCs and may include, for example, interbank borrowing, therefore the threshold for setting up a CBRC-FLC is higher than that for establishing a FFLC.[2] As a general phenomenon, foreign investors have mostly entered into China’s finance lease market by setting up FFLCs. Both groups have achieved rapid growth in recent years.[3]

Along with its significant development, the Chinese Government seems to have realised that the industry as a whole could be an important complement to bank credit and securities financing to businesses. From 2013-2014, China’s finance lease regulatory environment changed remarkably in a number of aspects.

butterfly-225819Regulatory developments

Tax rules

In 2012, China launched a tax reform under which value-added tax (VAT) took the place of business tax. As a result, all finance lease companies in China were subject to VAT since August 2013. They soon discovered that their tax burdens were likely to increase under the reform, especially with regard to their sale-and-lease-back deals (which previously enjoyed tax exemption regarding the sale of the respective asset by the lessee to the lessor). In view of this, on 12th December, 2013, the State Administration of Taxation (SAT) and the Ministry of Finance (MOF) jointly issued Circular Caishui [2013] No. 106 to clarify that such tax exemption would still be available to sale-and-lease-backs, effectively removing tax concerns for sale-and-lease-back deals.

Furthermore, on 3rd March, 2014, the SAT and the MOF jointly issued Circular Caishui [2014] No. 18 to exempt stamp duties on aircraft purchase contracts signed by finance lease companies for the purpose of leasing aircraft.

Foreign exchange rules

On 10th January, 2014, the State Administration of Foreign Exchange (SAFE) issued Circular Huifa [2014] No. 2. This simplifies foreign exchange registration requirements for cross-border leases: a finance lease company is no longer required to obtain an approval from SAFE for a cross-border lease. Instead it only needs to register with SAFE within 15 working days of obtaining its creditor’s rights (against overseas parties). Outbound credit amounts under cross-border leases are no longer subject to quotas.

Interpretation of the Supreme People’s Court

On 24th February, 2014, the Supreme People’s Court of China promulgated the Interpretation on Application of Laws in the Trial of Disputes over Finance Lease Contracts (SPC Interpretation). The SPC Interpretation, long awaited by the public since its first version was drafted in 2010, clarifies a number of legal issues critical for finance lease contracts and related disputes. For example, the question of whether a contract constitutes a finance lease contract or another type of contract (e.g. a loan contract) shall now be comprehensively analysed by courts based on relevant legal provisions, the nature and value of the leased property, the structure of rental payments and the contractual rights and obligations of the parties.

Furthermore, the SPC Interpretation lists a number of circumstances in which a third party cannot claim to have purchased a leased property from a lessee on a bona fide basis. These circumstances include cases in which: (i) the lessor has placed a mark at a prominent position on the leased property so that the third party, when dealing with the lessee, knows, or ought to know, that such property is a leased property; and (ii) the third party, when dealing with the lessee, has failed to conduct a search for finance lease transactions with the corresponding organisations according to law, administrative regulations or the requirements of industry regulators or regional authorities.

New CBRC Rules

The CBRC released its newly amended Administrative Rules for Finance Lease Companies[4] (New CBRC Rules) on 13th March, 2014. The New CBRC Rules, like their previous versions, only govern CBRC-FLCs, not FFLCs. Compared to previous versions, the New CBRC Rules lower the entry barriers for setting up a CBRC-FLC and further extend their business scope. For example, previously a CBRC-FLC was only allowed to borrow overseas loans in foreign currency. Now these loans can be denominated in renminbi (from abroad). Furthermore, if the CBRC-FLC is well operated and satisfies conditions set by the CBRC, it may conduct additional businesses, including issuing bonds, establishing project companies in domestic bonded zones for finance lease business, assets securitisation and providing security for the subsidiaries and project companies it controls.

China (Shanghai) Pilot Free Trade Zone Policies

The finance lease industry is specifically supported by quite a few local governments (e.g. Tianjin and Shanghai) and free trade zones. On 18th September, 2013, a set of preferential policies for finance lease businesses in the China (Shanghai) Pilot Free Trade Zone (CSPFTZ or Zone) was published under Circular Guofa [2013] No. 358. One of these policies allows finance lease companies registered in the CSPFTZ to engage in commercial factoring business. Export tax refunds would be available for cross-border leases conducted by finance lease companies or subsidiaries of CBRC-FLCs registered in the Zone.

pink-84575Our observations: has spring arrived?

The regulatory environment for the finance lease industry in China is changing for the better. A combination of tax, finance and judicial policies to support finance lease companies has emerged. However, some obstacles still remain that need to be removed. For instance, Chinese law does not contain a general regulation on registration of moveable properties, which means that the abovementioned SPC Interpretation still might not be sufficient to protect lessors from claims by bona fide acquirers of leased properties. In general, finance lease companies still lack sufficient legal means to re-possess leased properties. A patchwork of rules or regulations issued by local governments or different State Council departments might not be the best way to solve these problems. Rather, it appears advisable to pass a Finance Lease Law comprehensively regulating all major aspects of finance lease transactions.

Taylor Wessing is a full service law firm with approximately 900 lawyers in Europe, the Middle East and Asia, with offices in Shanghai and Beijing. For more information please visit www.taylorwessing.com. Dr Joachim Glatter is a partner of Taylor Wessing based in Shanghai advising international enterprises on the legal aspects of their business transactions in China, in particular on the formation of companies, corporate restructuring and commercial contracts as well as arbitration proceedings. Sophie Yun Wei is a counsel in Shanghai particularly knowledgeable in China’s commercial law, income tax, indirect tax, free trade zones and international tax treaties.

[1] In addition to FFLCs and CBRC-FLCs, there are also a few domestically invested lease companies selected and approved by MOFCOM to conduct finance lease business. They are also called “Finance Lease Pilot Enterprises (融资租赁试点企业)”. Unless otherwise indicated, “finance lease companies” referred to under this article include FFLCs, CBRC-FLCs and Finance Lease Pilot Enterprises.

[2] For example, a FFLC shall have a registered capital of no less than USD 10 million (i.e., RMB 63 million); while a CBRC-FLC’s registered capital must be no less than RMB 100 million which must be paid-up in cash in a lump sum. Further, investors to CBRC-FLCs must fulfill higher qualification requirements than investors intending to establish a FFLC.

[3] As of the end of 2012, the number of FFLCs was 509, increasing by 264 compared with 2011; the growth rate was more than 108% and total assets of such 509 FFLCs amounted to over RMB 353 billion. The number of CBRC-FLCs increased by 3 to 20 in 2012. As of the end of 2012, these CBRC-FLCs’ total assets value reached RMB 800 billion, approximately, with a yearly growth rate of 52%. (http://www.clba.org.cn/_d270193987.htm)

[4] Order of China Banking Regulatory Commission [2014] No. 3