China Real Estate Laws, Part I

Posted by Dan on May 1, 2007 at 03:28 AM Discussion: Comments (8) : TrackBacks (0) : Linking Blogs : Add to del.icio.us By Steve Dickinson On March 16, 2007, China adopted a new Property Law, set to become effective on October 1, 2007. This post will be the first in a fairly long series of posts explaining China's real estate laws. This first post is meant to serve as a general overview of China's real property laws. Ownership of real property in China is based on the Constitution as revised in 2004, on the new Property Law and on three key laws: The Land Management Law (Adopted 1986, amended 2004), The Urban Real Estate Management Law (adopted 1994), and The Rural Land Contract Law (adopted 2002). The new Property Law did not repeal these laws, but it does make them subject to the new Property Law and the new Property Law will control where there are differences. Regulations supplement these statutes. China's Constitution clearly distinguishes between land and buildings/fixtures located on land. Only the state can own land. Ownership of buildings was an unclear concept until the new Property Law provided that buildings and fixtures on land are owned separately from the land on which they sit. Urban land in China is owned by the state. The State Council has the authority to represent the ownership interests of the state in land. Rural land in China is owned by rural cooperatives and it is reserved exclusively for agricultural purposes. The only permitted use of rural land is for farming and residences for farmers, together with essential buildings such as schools, hospitals and agricultural support facilities. All land that will be used for commercial purposes or for non-farmer residences must first be transferred to the national government. All commercial and residential development must be conducted on state land. However, land cannot be sold. Instead, the state has the power to transfer the use right in land for a fee. Use rights are transferred for a specific period of time: residential property for 70 years; industrial/commercial property for 50 years; and recreational property for 40 years. Once acquired, land use rights can be transferred to third parties. However, such transfers are subject to restrictions on use provided in the original contract of transfer and are subject to the original time limit of the basic grant. At the end of the time period, in principal the land use right terminates. For residential land, the new Property Law provides that the land use right is automatically extended at the end of its term. This is a major change in the law. However, the new Property Law does not state whether the extension is for another 70 years or for some other term nor whether payment of a land use right renewal fee will be required. For industrial, commercial and recreational land, the basic rule is that the holder of the land use right can petition for extension of the right. If no such request for renewal is made, the land use right terminates and the ownership of any buildings or fixtures located on the land reverts back to the state. There are no specific provisions on the term for any such renewal nor any on whether a new land use fee must be paid on renewal. Any natural or legal Chinese person has the right to own buildings located on urban land. This ownership is clearly separate from the ownership of the underlying land. Ownership of urban buildings is recorded in the local real estate register. However, ownership of buildings is subject to the underlying land use right of the land on which it sits, both in terms of limitations on use and on the time limit of the underlying land use right. Buildings can be freely purchased and sold, subject to the underlying land use right.

The land use right automatically transfers when the ownership of a building is transferred. As a result of this, purchasers of buildings in China acquire what we could call a defensible ownership interest. The ownership right in the building/fixture is absolute, but it is subject to the time and use limitations imposed by the underlying land use right. This system results in a great deal of uncertainty about real estate ownership in China. What happens when the time limit for the land use right comes to an end? Will the state act reasonably in granting extensions and in limiting the imposition of new fees, or will the state see this as an opportunity to earn a windfall profit from new fees? Will the state seize productive commercial property with no compensation? Will the state seek to engage in social engineering by restructuring ownership interests to accommodate new conditions? The uncertainty concerning the land use right time limit was partially resolved in the new Property Law by the provision that such a right in residential property renews automatically. However, the failure to address the period of the renewal and the rules concerning new fees still leaves significant uncertainty. Nothing has been done to clarify the issue regarding commercial, industrial or recreational real estate. On the other hand, the basis of the new Property Law is that persons have an absolute ownership right to buildings and fixtures on land. This right has all the features of classic ownership, including the right of disposal (sale), inheritance and gift. The new Property Law makes the critical decision that land use rights and ownership rights of buildings/fixtures are property rights and not contract rights. This is a major revolution in Chinese law that likely will have far reaching consequences. The fundamental point is that contract rights are personal to the parties and cannot be freely purchased and sold. Such rights are therefore not suitable for a market economy. Property rights have the opposite characteristics. Until the adoption of the new Property Law, many of the rights to property were treated as contract obligations, preventing the development of a true market system. The new Property Law also makes clear that in dealings in land use rights and building property rights, the state and private persons are on an equal footing, with the same rights and liabilities. This too is a monumental change in Chinese law. The fundamental reason is also based on the need to create a market economy in China. Since the state is so heavily involved as the owner of land, the state must be treated as an equal to allow the market economy to function. The new Property Law is based on civil law models, in particular the German, Swiss and Japanese civil codes. These "Law of Things" codes descend from Roman law. This all makes China's approach to real property very different from the U.S. and British common law systems. The new Property Law is made even more difficult because the German civil code concepts have been supplemented by a unique set of concepts applicable only to China. The most obvious example is the tripartite division of ownership between the state, collectives and persons. I will give two examples that are common in my discussions with U.S. real estate professionals. Under the Chinese system, there is no deed for property. Ownership of land, disposition of the land use right, and ownership of buildings and fixtures are all settled by entries in the relevant land registry. One innovation of the new Property Law is to establish a unified real property registry where all information can be recorded in one place. Proof of ownership is evidenced by various certificates issued by the state land offices. Private deeds and contracts are of no meaning under this system. Indeed, no transfer of any right to real property is effective unless and until it is entered into the land use registry. Leases are treated as contracts under the civil law system. This differs from the U.S. common law system, which treats leaseholds as a form of real property law. It is therefore dangerous to analogize any form of Chinese real property as equivalent to a lease and it is also dangerous to interpret Chinese leases in accordance with civil law real property principles.

The new Property Law also burdens all real property with numerous obligations requiring accommodation to the rights of neighboring properties. This burden is automatic and does not require an easement agreement or the filing of any particular registration. Since these rights include the right of sunlight, view and ventilation, as well as the right not to be inconvenienced by excessive noise or pollution, these new obligations could form the basis for much litigation regarding real property in China. Though China's real property system is complex and quite foreign to U.S. real estate concepts, it can form the basis for rational real estate investing. In future posts, I will both go into greater depth on some of the issues covered here and I will also cover new China real estate legal issues. See other posts in: Legal News

China Restricts Foreign Real Estate Investment

Posted by Dan on July 25, 2006 at 06:32 AM Discussion: Comments (0) : TrackBacks (0) : Linking Blogs : Add to del.icio.us It's finally official: China today announced new laws restricting foreign real estate investment. The Wall Street Journal, in its article, "China Restricts Foreign Spending on Real Estate," says the new rules will "reduce the amount big foreign property buyers can borrow by requiring them to provide at least 50% of the capital up front for property investments of $10 million or more, up from 35% of the total now. The rules also limit who can purchase an apartment to overseas nationals who actually live in China." It is questionable how much effect these relatively small measures will have on China real estate investment: The rules, unveiled yesterday, target property speculation and could help reduce investment from overseas. But their effect on the overall market is likely to be primarily psychological because foreign money accounts for a relatively small share of total spending on property in China, analysts said. Foreign real estate purchases in China are believed to make up less than 2% of the total and it is unclear how much these new rules will impact that: China's property market is driven mostly by domestic spending. Foreign purchases of property totaled about $3.4 billion in 2005, according to Chinese government data. While precisely comparable figures weren't available, government data show that investment in residential property alone totaled about $165 billion last year. Foreign spending on real estate has been growing and these rules will no doubt serve at least to slow that down a bit. "And foreign investment is spreading beyond well-known cities like Shanghai and Beijing. Last month, a real-estate unit of ING Groep NV said it would invest $22.4 million in a joint venture with a Chinese partner to develop residential and other projects in the central city of Changsha." Like all laws in China, it remains to be seen how rigorously these new ones will be enforced, particularly if the real estate market starts cooling down. You can read more on this topic in the China Daily as well as at the China Economic Review, the Sinofile Weblog and Forbes online (hat tip to China Digital Times). For an interesting, on the ground, contrarian view of Chinese real estate, check out the Shenzhen Ren Blog. See other posts in: Legal News

Foreign Ownership Of Real Estate In China/China's New Forex Rules

Posted by Dan on February 21, 2007 at 01:20 AM Discussion: Comments (51) : TrackBacks (3) : Linking Blogs : Add to del.icio.us By: Steve Dickinson 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 real estate in China ignore the requirements of Chinese individuals 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: a. Individuals can freely convert foreign exchange to RMB up to an annual limit of $50,000 US. b. 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. c. 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 Steve and I will be speaking in San Francisco on those days at a seminar on China real estate investments. Steve will be speaking on China's new real estate regulations and I will be moderating a session on China's second tier cities. More information on this seminar will be forthcoming shortly. See other posts in: Legal News

Comments
"There are somewhat less restrictive rules for residents of Hong Kong and Taiwan. These foreign individuals are limited to one residence. " Well, not really for Taiwanese. We are only Chinese politically but "foreigners" commercially and economically. Posted by: David Li | February 21, 2007 12:31 AM Mr. Li --

After seeing the two sentences you quoted, I flipped them around in the article, for clarity. I will need to check with Steve to see what's different for Taiwanese, but something is. Posted by: China Law Blog | February 21, 2007 12:40 AM Excellent post. Thank you for this -- it clarifies a lot of questions. How does one prove a specific and legitimate use for the $50,000 USD rule in order to get permission? Posted by: Shaun Rein | February 21, 2007 2:01 AM Hi Steve/ Dan, I agree with Shaun in the quality of the post. How are you larger clients reacting though? In my view, it is really the little guys that were building 2-3 unit portfolios that were hurt, but for those at the 10+ stage, it was a great opportunity to go an pool funds for larger buys. With many of the big guys structuring offshore anyway, what laws could come out to slow down offshore share transfers? Posted by: All Roads Lead To China | February 21, 2007 8:52 AM Hi Dan, Appreciate if you could post the difference here. Thanks. Posted by: David Li | February 21, 2007 8:59 AM While the opinion expressed herein may reflect the intent of the government, how many of you have actually completed a transaction on residential properties in China in the last 12 months? How many have completed multiple transactions, which would provide a much better understanding of the actual effect of the new regulations? I believe that you are mistaken in thinking that the Chinese government will enact tax policy that creates the impression of unfairness, scares away foreign capital or has the effect of penalizing investors who purchased multiple properties prior to this regulation being drafted. The risk many foreign observers fear is nothing more than an inexperienced view of the marketplace as viewed through western eyes. Don't talk to a tax official and get one opinion. Go talk to officials in BJ, SH, GZ and other cities and get multiple opinions. I personally know a number of investors who continue to convert and transfer out capital and capital gains on real estate deals with no problems. They sell the property, pay the tax and Bank of China transfers the funds. It happens every day and continues to this day. Finally, it is not realistic to pontificate about what happens 'all over China'. Everyone who lives there and does business there knows that these policies have great latitude and are interpreted differently in each city, based on the local conditions.

In the market I live and work in, the effect has been nothing like what is described or predicted here. RD Posted by: Richard Donnington | February 21, 2007 9:23 AM "Don't talk to a tax official and get one opinion. Go talk to officials in BJ, SH, GZ and other cities and get multiple opinions." Again we see vast and powerful contradictions between local gov't interests and Beijing's macroeconomic viewpoints. But don't think the party will go on forever. I'm sure zhongnanhai knows that the rules are being circumvented and if they decide to act decisively, many foreign investors will be caught with their hands in the meat grinder. This policy is due in part to a widespread belief that it is primarily foriegn speculators (including "nice" people like Stanford U.) driving up real estate prices far, far beyond what locals can afford. Just ask a taxi driver. And yes, the policy makers are indeed ignoring local real estate barons who arbitrarily set real estate prices based on whims and competition with each other. Posted by: nanheyangrouchuan | February 22, 2007 12:07 AM Shaun -The Detailed Rules provide clear and explicit instructions on the documentation required for virtually any type of transaction. In general, what is required is some written evidence such as a contract, invoice or receipt. For example, for lease payments, a registered copy of the lease and a formal receipt are required. This identifies the problem: for many leasing arrangements in China, the lease is not registered and there is no formal receipt provided by the landlord. The reason is that the landlord is evading tax on his rental income. In such cases, the bank will refuse to allow the currency conversion. It is the same for other types of transactions. If the transaction is "under the table" and lacking in formal documentation, the currency conversion will be denied. This is exactly what Beijing intended. Posted by: China Law Blog | February 22, 2007 9:48 PM All Roads Lead to China -The people who were really hurt by the new rule were the real estate developers who were focusing on luxury condominiums and luxury second homes. This group was almost exclusively focused on foreign buyers who purchased almost on impulse. The requirement that such buyers must now form a WFOE before they buy pretty much precludes the impulse buy. To me it is odd that these developers seem not to have figured out that all they need to do is set up a program so that their buyers create a WFOE as part of the process. Instead, they have reacted with panic and many projects are in serious trouble. On the buy side, no one has really been hurt because it is a relatively straightforward process to purchase real estate in China through a WFOE. The issue seems to be ignorance of the required procedure. It is true that for larger scale purchases, the big players have the advantage since they are able to form a WFOE that can pool funds and then purchase over time from the pool. The smaller players do not seem too comfortable with that approach. China is considering a number of rules that would restrict the sale of stock in WFOEs held overseas. However, none of these rules are directed at sales of offshore companies that act as the shareholder of a WFOE. The structure you describe is a good way to gain many of the benefits of a REIT for holding Chinese real estate. The main problem at this time is that WFOEs are NOT pass through entities, so the tax benefits of holding real estate do not pass through to the offshore shareholder.

Posted by: China Law Blog | February 22, 2007 9:52 PM Mr. Donnington -It appears you have misunderstood our post. 1. In terms of real estate transactions since the new rules were imposed, we and our clients have been involved in hundreds. 2. As the post states, the new forex rules do nothing whatsoever to change or vary the 2006 rule on foreign ownership. I therefore completely agree that the Chinese government has no intention of blindsiding foreigners with new and arbitrary rules. However, many existing tax rules in China have been loosely enforced in the past. China now has a clear policy to force local tax authorities to follow the law as it already exists. Many foreign businesses are finding that the tax authorities are showing up with bills for many years of unpaid taxes. This process is expected to increase over the next several years. The goal of the Chinese government is to reduce and eliminate local variation in the enforcement of tax and other regulations, particularly as they apply to foreign companies and individuals operating in China. I can tell you from the urgent e-mails and calls we are receiving that this is happening. 3. In terms of taxation, the issue is this: many individual investors who have already purchased income producing property in China believe the only tax they owe is 1) the stamp tax on their monthly rental income and 2) the capital gains tax on the sale. This is NOT true. Rental income is ordinary income subject to the China's individual income tax. Owners who have not paid that tax, or any other applicable tax (there are many possibilities), will NOT be permitted to sell their property. This will be a brutal surprise. It will be an even more brutal surprise when they see the size of the bill for back taxes, inflated by interest and penalties. I have seen this too with my own eyes. 4. Many foreign individuals in China have chosen to ignore the 2006 rules and continue to purchase multiple properties in China in open violation of the new rules. They are relying on the fact that China does not have a good system of tracking real estate ownership on a national level. Our concern is that, later, when the owner decides to sell the property, China will have improved the system to the point where such tracking is possible. If this happens, the sale will be prohibited and various penalties will be imposed. Since creating a WFOE to own such properties is a relatively simple process, these individuals usually are taking unnecessary risks. 5. In terms of speaking with tax officials from other regions outside of Shanghai, 1) these rules are national rules, there is no room for local interpretation, and 2) we have done these transactions in Beijing, Tianjin, Dalian, Qingdao, Wuxi, Suzhou, Shanghai, Hangzhou, Xiamen, Chengdu, Guangzhou and Shenzhen. Seeing as how this covers the bulk of the cities in which foreigners buy property, I am confident this is a wide enough sample. 6. On the question of no one really being concerned, I am speaking from experience. I know from personal experience that many persons were extremely concerned about the impact of the new forex rules and I know from personal experience that many persons have misinterpreted the 2006 rules on foreign ownership and I know from personal experience concerning the failure to pay tax and the purchase of multiple properties in open violation of the rules. Either we are living in two separate worlds or you are guilty of wild extrapolation. Posted by: China Law Blog | February 22, 2007 10:01 PM Mr. Li --

Taiwanese and HK citizens need not live in China for a year before they can buy a (single) place in China in which to live. Posted by: China Law Blog | February 22, 2007 10:25 PM crap. i have one flat and in the process of buying another (my 2 unit portfolio). i was forced to use "alternative currency exchange dealers" to change my HKD into RMB because the banks refused to more than USD10k per month for a RMB180K property. But none of our real estate people (Changhui & china merchant) informed us of this law. Transaction went quite smoothly. If i decide to rent out a unit, how would the tax authorities know about it? even if i decide to use a real estate agent to do so. Lots of "village" flats have no land deeds, some of which are in the process of being converted into spanking new apartment estates with swimming pools, bells & whistles and a 70yr ownership period deeds. I think some "foreigners" could end up accidently owning a whole shed load of residential property. WFOE? Whatisthis/Howdoigetit? I am not a ML/HK/TWer. Posted by: Bigflush | February 22, 2007 10:49 PM Dan, Appreciate the thoughts. At this time, the people we work with could care less about any future rules about changing shares of WFOEs on the mainland. they will do all of that offshore. I am sure your clients will have the same reaction as well. With regard to the impact on developers, I was sitting with one of the largest SW developers who had recently finished a master plan for a villa development. At first glance, it was worst case as they just changed the rules and he had just spent a fortune on the planning. He wasn't worried.. I expect many of the new regulations will only be enforced in the major markets where there has been a dramatic rise, and even then there are workarounds. Foreigners buying multiple apartments or even holding multiple apartments will only have problems if they are raising funds onshore. If they want to pay cash, or have raised their money offshore... mei wenti. Especially if it is in a city that is in need of the cash.. Posted by: All Roads Lead To China | February 22, 2007 11:10 PM Big Flush (great name) -Thanks for checking in. This is the problem, but I will say you are smart enough to recognize it. We have some people who insist there is no problem because "they allowed me to pay the money." Steve and I are

always talking about how everyone is out there encouraging the illegal deal and how easy it is to get into it, but how difficult it can be to get out cleanly. That is a very good question about how the tax authorities would know about your renting out your flat. The answer is they might and they might not. The problem is they will no doubt ask for proof that you lived in that flat and if you don't have proof, I am sure they will be pretty skeptical if you tell them it just sat vacant for five years. A WFOE is a wholly foreign owned entity. You can find out more about them here: http://www.chinalawblog.com/chinalawblog/2006/03/this_post_focus.html and here: http://www.chinalawblog.com/chinalawblog/2006/03/yesterday_in_a_.html Posted by: China Law Blog | February 22, 2007 11:43 PM All Roads -I definitely agree things will be looser in the hinterland, but I also expect things will toughen up in places like that eventually as well. There will always be ways to get money out of China illegally and I have no doubt that you know some of them, but to do that right takes money and it has its own separate risks. Setting up a WFOE is so relatively painless, why not just do it? Posted by: China Law Blog | February 22, 2007 11:49 PM Are you saying I am shady? the buyers of 1-2 flats do not see the gain of a WFOE at this point, and I am not sure that I would advise them to go through that process. The reason is simple. the transaction timing and costs are too much at that level. However, everyone I know buying floors/ buildings are already doing this. But they are not doing it because the forced them into it... they do it for tax purposes. As for the hinterland losing. The national leaders will not let that happen. this policy was a case of city level policy taken too far. It was only the markets of Shanghai, Nanjing, Beijing, and a few other cities that needed to be cooled off... and this measure will not be enforced in cities like Changsha, Xi'an, etc where they are trying to attract foreign and local talent to build their industries. Just not going to happen. Posted by: All Roads Lead To China | February 23, 2007 12:35 AM Thanks for the WFOE link. All_roads_lead_to_china raises a question i have been wondering about: Can "Foreigners" borrow money from Chinese banks? On the purchase of the second property, our intentions are to raise funds via a bank loan onshore in PRC. however our local (Shenfa) bank manager insist, according to his reading of the law, it can only be borrowed in the name of a PRC citizen even if the property deeds are in my (UK citizen's) name. (inconvenient to say the least.) I can only assume that all the real estate agents (in partnership with the same banks like Shenfa) offering loans to foreign buyers are using the above loophole?

Posted by: Bigflush | February 23, 2007 1:48 AM All Roads -Knowing how to shoplift does not make one a shoplifter. Knowing how to kill someone does not make one a murderer. So no, I am NOT saying you are shady. I have no idea how you conduct your business. None at all. All I was saying was that since you have been in China a long time, you pretty much have to be aware of various ways to get money out illegally. I am certainly aware of those ways. In fact, I am aware of the existence of money changers who are so high end, you can give them RMB in China and within hours have dollars in your bank account in the U.S. If you are advising your clients to engage in illegal activities, whether the risk warrants or not, you are setting yourself up for a potential lawsuit from any of those clients who end up getting hit with problems down the road. Maybe it will happen to 1 out of 3 or one out of 20 . . . . who knows? Do you? They might not enforce the real estate laws in Xi'an and Changsha today but can you tell me exactly when they will start enforcing it so people can be sure to sell their properties the day before? Are you so sure that they will let your money out, even though that does not benefit China? Posted by: China Law Blog | February 23, 2007 7:04 AM Bigflush -Why are you calling this a loophole? I don't get it. Don't you think the bank and the real estate agent want to be able to borrow the money, but simply feel it would be illegal to do so? Posted by: China Law Blog | February 23, 2007 7:07 AM Regarding your point #3 and the comment that "how then do you explain the difference between what tax authorities are charging you and your clients in all those cities what the SH district authorities are charging my clients and me? In any case, if anyone wants to convert currency or send out of China some USD, almost any bank in SH will transfer $5,000 - $10,000 with no questions asked and with no safe approval requirement. It doesn't matter what the regulations say. Go into a Chinese bank and see what the teller does. As silly as this may seem, it's true. People always talk about what Beijing is thinking. More practical adivce should also include the facts on the ground, right? RD Posted by: Richard Donnington | February 23, 2007 9:29 AM I agree practical advise should include both the law as it is written AND as it tends to be enforced. Indeed, I cannot imagine anyone would disagree with that. The real question in each instance is how much weight to provide to each. This will depend on many things, including the amount at stake. We have clients who illegally lease property and then, in turn, illegally sublease that same property. These are mostly small properties, with little upkeep necessary. They figure they can make enough under the radar. But, it would be crazy for someone to invest $3 million in renovations without first making sure all of the legalities are in place. It all comes down to risk and rewards. Shanghai IS different from Chengdu. A well known building

is different from an obscure one. Your tenants might affect the calculation. And, of course, the dollars involved and the time frame. Our overriding point is that it is not that difficult to get legal and no reasonable person can dispute that there is less risk in doing things legally than in doing them illegally. Yesterday I overstayed in my parking space for 20 minutes and did not get a ticket. I got lucky. Will I the next time? It is the same sort of thing. I am not sure what relevance your ability to transfer out $5,000 to $10,000 USD has to do with this post. Please explain. Posted by: China Law Blog | February 23, 2007 9:49 AM Dan. That was some good tap dancing. Actually. at the 1-2 level I would not advise my clients to use a WFOE, and that is not an illegal practice. Actually, if my clients were using cash, they could by 8 properties LEGALLY before needing a WFOE for the same price as a WOFE. Want to know how? Simple. set up a HK shell company to hold each property. Technically, the "foreign" entity is not holding more than one property.. it is still cheaper on tax.. and it is much easier on the exit side. Of course, I have only heard of this from a few "friends".. and I would never "advise" this.. but the law of one one property per "foreign entity" does leave room for those who are willing to think not on the intention of what a law is.. but on the actual application thereof. again. I never advise clients to break any law. I like you do believe that the past catches up with everyone here, and as such I believe that the straight and narrow is the way to go. however, in many cases (real estate being one of them), there are various applications of a single law.. All of them legal. Posted by: All Roads Lead To China | February 23, 2007 12:30 PM All Roads Lead to China -Though you indicate you would never advise a client to act contrary to Chinese law, the advice you are providing appears to do exactly that. Any purchase of real property in China not for personal use MUST be done through a WFOE. The law is clear on this point. There is no ambiguity. None. Of course there is some expense in forming a WFOE and doing so does tend to slow the process down. That is the intent of the new rules and sometimes following the law is, at least in the short term, difficult. Working through a Hong Kong company does NOT change the situation and I do not even understand how you can be claiming otherwise. The new rules are directed specifically at Hong Kong companies since individuals and companies from Hong Kong are the major players in China's real property markets. Purchase through a Hong Kong corporation requires formation of a WFOE; a Hong Kong company cannot buy property in China directly. That WFOE can, of course, purchase multiple properties, but only if the

scope of business of the WFOE provides for that and only if provision is made in the capitalization that allows for such multiple purchases. In addition, regardless of when real property was purchased, the purchaser owes tax on the rental income for the real property. Further, regardless of when the real property was purchased, the purchaser must form a WFOE if the purchaser is renting the property to third parties and earning income from such rental. That has always been the law in China and the new rules did not change that. In fact, all the new rules did is clarify what was already a requirement under Chinese law. I do not know whether you have not read the applicable laws, read them and misunderstood them, or simply do not care, but in any event, I find it disconcerting that you are telling people to violate the law. For yourself, you may decide to take the risk of not complying with Chinese law but I find something very wrong in your telling others to ignore the law either because you do not understand it or because you personally believe the law will not be enforced. What will you do a few years from now when one of your clients tells you he cannot sell the real property you told him to buy with a Hong Kong company or is not able to get his money out of China from such a sale. I just do not understand how you can be telling people to take that kind of risk. Are you at least telling them what the law actually says and letting them know of the risks involved, or are you telling them this stuff as though it is the law itself? Posted by: China Law Blog | February 24, 2007 1:32 PM When I emailed you asking you not to post my reply it was because I needed to clarify a few things. So, first (to address the above) as I explained in the above that there are three scenarios. (1) a person is buying 1-2 properties; (2) 3-10 properties; (3) 10+/ floor/ building investments. For the first, and even for the second, the on the ground reality (as Donnington points out above) is that people are trading without restriction. Maybe this will change. Maybe it won't. However, the advice that I give to those investors is to speak to a lawyer and accountant to get the most up to date information in each market. The reason why I think those buying Second, as I explaining above. Anyone with 10+ properties should definitely WFOE, and everything you say above is correct. Depending on the size of the investment and structure of the portfolio, I may even suggest they look at 2 separate entities (one to hold properties and the other to manage) as the exit strategies may be easier, and it can reduce the tax exposure of the capital holding . Again. They would need to meet with a lawyer and accountant to understand what structure is best for them, but paying 27% tax on top of all the other taxes would basically be a hurdle too high for anyone. And as we are seeing in the news, there are more investors coming to market than hurdles. Now. With regard to the HK shell game that I described. I should not have claimed it to be legal as again, I am not a lawyer, nor have I read the law in its entirety. It was one of the things I would have edited, however I have recently seen large firms use this structure, and their advisors included the top law and accounting firms. I was not in anyway involved in the physical structuring of the deals, but the deals as they were explained to me involved that very model.

I am posting based on what I have seen in the market, and as Richard Donnington said above, what is going on here is not 100% with what you have written above. That is not to say that your interpretation of the law is incorrect, it just means that the local markets are applying the laws in different ways. Posted by: All Roads Lead To China | February 25, 2007 5:27 AM All Roads -Sorry, I check my e-mails on a different schedule than the checking and approval of comments, which is done not just by me. You say people are "trading without restriction." We know there are plenty of people BUYING properties illegally, but are you aware of people succeeding in recently selling these illegally bought properties and getting the money out without problems? I will admit our view is skewed because, as lawyers, we mostly see the sellers when they are having problems. At the same time, however, we are always saying that it is easy to get people to take money on an illegal deal, it is when it comes time to get the money out that problems usually arise. Just because others have done something does not mean it will work now or that it is the best way to do things. Just about everyone used to go into China as part of a JV because that was what was allowed. My firm still gets calls from companies that believe going in as a JV is the best way for them (even though it clearly is not), simply because that is how their competitors went in. One of the most dangerous things companies can do is to copy other companies as though the law never changes. The law does change and this is probably truer in China than anywhere else in the world. One must act based on today's laws, not yesterday's. There is also something to be said for acting based on the law and not on the likelihood of getting caught. The other day, I overstayed by twenty minutes at a metered spot and I did not get a ticket. I recognize I got lucky and I am sure not going to base what I do in the future on this, particularly if I the government announced it would be stepping up its enforcement. Which leads me to another, related, subject. Many ex-pats seem to think Beijing is not serious about its plans to step up tax enforcement against foreigners. I find that incredible for a number of reasons. First off, it ignores the reality that this is already happening. Talk to the lawyers and accountants who represent foreigners in China if you want confirmation. I have had this conversation with many such people and to a person they all agree. Secondly, it flies in the face of logic. Beijing very much wants to maintain its power and its legitimacy. Governments rarely joke about stepping up enforcement of particular laws and then fail to do so as that would only highlight their lack of resolve and their lack of control. Thirdly, it flies in the face of increasing sentiment in China against went the Chinese perceive to be favoritism towards foreigners. Beijing wants to appear to be cracking down on foreigners and it has said it will do so simply by enforcing its existing laws. We know exactly why those buying less than ten properties resist forming a WFOE. They do not want to do things legally in China for fear it will cost more and what this really means is not that they are so concerned about paying the relatively insignificant cost of forming a WFOE, it is that they do not want to pay Chinese taxes. There are obviously some foreigners in China who choose not to pay their required Chinese taxes, but again, you would be hard pressed to find a real accountant in China who would tell you anything other than that China is starting to really increase its tax collection efforts (its greatly improving tax collection numbers bear this out), particularly against foreigners. I do not see the benefit of setting up two separate entities (one to manage and one to hold the properties) as I do not understand how that would reduce taxes or do anythng other than increase costs and complications. I

can definitely see where such a structure might make sense in some very limited instances, but not usually. Please explain. The other day we had someone in our office with 25+ different companies in four different countries. We asked why so many companies and he said tax and liability reasons. We asked if he thought it had helped and he said no. We asked if having so many companies was expensive and an administrative nightmare and he said yes. We eventually determined only three of the companies deserved continuous existence and we are acting accordingly. I mention this because it is somewhat typical (though larger) of what we often see: companies going way overboard to avoid one thing (oftentimes taxes) without fully plotting out the ramifications and implications. So often, their machinations create new and bigger problems. There are definitely instances where it makes sense to form an HK company to invest in China (be it in real estate or otherwise), but at least among the companies with which my firm works, those instances are rare. Again, an HK company will not solve the WFOE requirement on China real estate. Of course what you are seeing in the market "is not 100% with what" we are writing on what the law is. I can write that marijuana is illegal in the California and be right about that, but I have no doubt that many people could also tell me that at their college or university in California, "it might as well be legal." So what? Our post was meant to tell people how they can obey China's real estate laws and by doing so, greatly reduce their risk of having very expensive legal problems down the road. Again, we have no doubt there are hundreds of illegal ways someone can buy and sell real estate in China, but seeing as how we are lawyers and this is the China LAW Blog, it really does not make sense for us to advocate people do those things. People usually go to lawyers to determine what the law is and how they can successfully act within the law or they go to lawyers after they have violated the law to figure out what they should do next. People do not usually go to lawyers to ask for assistance in violating the law. We want people to know what the law is so that they can analyze their own risks. Too many real estate investors in China are listening to non-lawyers and never getting the real story on what the law is. Without knowing the law, it is impossible for them to know their own risks. You can talk about the market you see, but what we see are the people who come to us AFTER years after having taken advice from someone with no real clue on Chinese law. Of those who come to us with big legal problems now on deals they did years ago, not a single one used a good China law firm to assist them on their deals. NOT ONE. All of them either did their deals without a law firm, or they did them using a strictly domestic U.S., European or Korean law firm, or they did it with the assistance of a non-lawyer consultant. You want to increase the risk of losing your China property, getting hit with huge tax penalties, and maybe going to jail, then violate the law; you may get lucky. Otherwise, follow the law. This advice holds true everywhere in the world. Posted by: China Law Blog | February 25, 2007 9:44 AM Dan, First I know of people who have sold, and like Richard Donnington above, and there has yet to be a problem. That is not to say that will not change (as you say). Intereting analogy to your client, and that sounds like a fun project to unwind. I am not suggesting the creation of an SOE to manage this. Multiple WFOEs would be something the average person would not need, it is for an investor putting in significant $$ in a particular market or several markets who wants to introduce some flexiblity into their exit and tax strategies. I would explain more, but this thread is already too long, and I couldn't possibly condense.

Non-lawyers like me can only speak to what is going on here on a day to day basis, and make sure our clients see a good lawyer (and good accountant). Posted by: All Roads Lead To China | February 25, 2007 7:10 PM All Roads -Sounds good. Posted by: China Law Blog | February 25, 2007 11:13 PM Well, various comments here about the law and about "getting lucky" in China. It's ill considered imo. "Getting Lucky" in China usually means a corner cutting exercise intended to circumnavigate various regulations. Do that, secure the deal and you're lucky? I don't think so. China has a seven year statute of limitations as well as enforcable laws, and if you get found out - they will enforce them. It's as simple as that. Hopefully people like Mr. Donnington will remain in China a very long time because I make a lot of money in legal fees in having to advise on sorting out the legal mess that "cutting corners", "getting lucky" or believing that the situation in Chengdu will remain indefinately more "flexible" than Shanghai inevitably brings in terms of transactions and investments that ultimately failed because people sought to get around the law. Selling property Mr. Donnington as an investment is a two stage process. You would be well advised to remember that your clients have to be able to sell on at a profit, and then repatriate their margins legally in future years -- a point that seems to have conveniently fallen by the wayside in your professional desire to make your deal work at the front end and for you to get your commission. If the client gets into trouble later down the line because you advised them that "Chengdu is different than Shanghai" - are you going to make up the failed transaction cost? Sounds like an added risk assessment is needed to me if that's your angle on selling properties. There is a law. Abide by it -- or factor in the higher risk. And for properties -- can you sell it on at a profit and what are the tax and repatriation implications if you do? "Chengdu different than Shanghai...." yeah right. Today yes, but wait five years. Will you be around to explain to your clients the problems they may face then? Posted by: Chris Devonshire-Ellis | February 28, 2007 4:05 AM Chris D-E -I could not have said it better. BRAVO! Posted by: China Law Blog | February 28, 2007 4:09 AM What is the policy regarding foreigner buying a new apartment. It seems there are many conflicting information. Thanks Mike Posted by: Mike Kim | March 8, 2007 1:19 AM Mr. Kim --

Thanks for checking in. The answer to your question can be found in paragraphs 2 and 4 of this post. You can buy ONE apartment to live in if you "have been legally resident in China for at least one year while employed or as a student." Posted by: China Law Blog | March 8, 2007 6:18 AM Only if Steve Dickinson's writing were as smooth to read as that of Times, or Wall Street Journal. Of course I am asking too much! Halfway through, I gave up! Eric Lien, San Francisco Posted by: Eric Lien | March 16, 2007 10:38 PM Mr. Lien -Thanks for checking in. 1. There is an old expression: the law is a seamless web. We wanted to get everything out there on these important topics and they are difficult to simplify and make easy. 2. Hey, we are just a couple of lawyers. We never claimed to be world class writers. 3. Check out today's post on forming a WFOE in China. It is pretty much written by a non-lawyer and that is definitely one of its strengths. Posted by: China Law Blog | March 16, 2007 11:05 PM Totally confused! My wife has three condos in China; 2 are completely done with furniture and one in unfinished. I have one unfinished. We are in the process of a divorce in the US and I'm not sure what happens next. I have a deed to my condo and she has three deeds to her's. I'm not sure about remodeling or selling. I'm a resident of the US and so is She. Of course she's Chinese. :) The most she every paid was 1700 per meter and several were less than that. My wife is a clever real estate investor; but it's no fun getting tangled up in Chinese rules and regulation. I really don't have a clue about Chinese real estate, except I like not paying annual real estate taxes! So if I end up with a condo in China then what? It's a 4 bedroom flat 158 m2 unfinished, in a pretty nice development. Great place to live if you like China (Tunxi). Not much polution there! Hank Posted by: hankua | April 1, 2007 3:13 PM Hank --

I am not going to give you specific legal advice on this blog, but I will tell you that you are definitely facing a whole host of legal issues if you are going to come into ownership of Chinese real estate and I would strongly suggest you secure good legal counsel right away IN China to assist. Posted by: China Law Blog | April 1, 2007 4:55 PM Could a said China real estate investor not open a company in a foreign country that in turn owns the shares in a real estate investment WFOE and still partake of the tax regime of the foreign country i.e. depreciation schedule, mortgage interest rebate and legally reduce their personal income tax liability in that foreign country by off-setting the costs of the China investment against the taxable income? And couldn't a said investor simply sell the shares in his overseas incorporated company (that directly owns shares in the WFOE, which in turn directly owns the Chinese real estate) to any other willing investor anywhere in the world? Would the sale of shares in the foreign incorporated company need to be notified to the Chinese authorities? I can't imagine that being necessary. So is this said way not a said means for easily and relatively painless buying and selling of 10s or hundreds or thousands of Chinese properties? A question: Do you think if my grandmother lived in China for 12 months in 1983, that she would automatically qualify to own a Chinese property according to the new law? Assume that she has never returned to China since. the green monkey Posted by: simon | April 15, 2007 12:58 AM A very informative post. Thanks for that. I have a couple of comments too: 1. Are there not minimum capital requirements for setting up of WFOEs for investment in real estate? With average units going at about 5,000RMB / sqm and below in 2nd tier cities that would be only US$70,000 for a 100sqm unit. Can WFOEs in this field be set up at such low capitalizations? 2. You point out some tax issues above. To point out a few more, there is the 17% tax imposed on rental transactions (5% business tax, 12% property tax). The WFOE will also be liable for 33% tax on profits. In the residential market most people rent from other Chinese individuals who own multiple "touzifang" (investment properties). Renting from such individuals means no tax whatsoever is paid - they are essentially cash transactions, "under the radar" as Dan puts it above. Under these circumstances, foreign investors looking to lease property they own through a WFOE are massively disadvantaged, effectively priced out of the market unless they are renting to other foreigners or possess some rather unique property. I am concerned that some foreign investors may jump in without realizing this. 3. I believe a WFOE can only raise up to 30% of total investment as debt until the total investment reaches US$3,000,000. That equals quite a lot of real estate in China! Additionally, foreign banks are not yet sophisticated enough to lend small amounts backed by liens over residential units - they have not developed such structures for small loans yet (at least not here in Dalian). In a business typically heavily reliant on loans this is another major disadvantage for the smaller foreign investors. 4. There is not only a setup cost but also an operating cost involved with WFOEs (monthly tax filings, annual audits etc.). Small investors should factor this into their calculations to determine whether they can get a reasonable yield from their investment. Of course these negatives are offset by the strengthening RMB and the enticing capital gains on offer. I just want to point out that the playing field in the residential rental market may not be as level as it seems. Posted by: adam livermore | May 8, 2007 8:13 PM

Simon -In response to your first question, the answer would depend entirely on the country in which the WFOE owning company is based. As for your second question, I do not know as we always refer Chinese domestic law issues out to Chinse law firms. Posted by: China Law Blog | May 10, 2007 1:15 PM adam livermore -1. It depends. In Shanghai or Beijing, almost certainly not. Elsewhere, probably yes. 2. Very good point. 3. Right again. 4. Again, I concur. Posted by: China Law Blog | May 10, 2007 1:20 PM TThe article includes the following comment: "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." This seems inconsistent with the WFOE requirements as set out in "Forming a Wholly Foreign Owned Entity (WFOE) in China": "...the Chinese regulators will still seek to trace the ownership of the foreign investor back to a viable, operating business enterprise." Many private individuals won't have such an enterprise & thus seem to be barred from using WFOE's to invest in Chinese real estate. Or am I missing something? Posted by: onebir | May 23, 2007 6:44 AM Would it be possible for a law firm to set up a single WFOE to allow real estate investment by an (unrelated) group of foreign investors - giving them independent rights over each property, but cutting down admin costs & delays? Posted by: onebir | May 23, 2007 9:19 AM onebir (i)-You are actually very astute. The reality is that it is possible even to form a WFOE that is owned by an individual. I do not recall my firm ever having done this, but once, and the client ended up having us abort the process very early on when it became clear it would be much easier to just form a US LLC than to go through all the procedural and documentary hoops necessary to have it owned by an individual. I think the perceived inconsistency comes from what constitutes a "viable, operating business enterprise." About all one needs to meet that definition is an active LLC that has enough in its home country bank account to get its bank to issue a letter vouching for it. Posted by: China Law Blog | May 24, 2007 12:17 PM

onebir (ii) -It would be possible, but I think in most cases it would create more administrative costs than it would save. The thought of accounting for the taxes, etc. just about boggles my mind. Posted by: China Law Blog | May 24, 2007 12:22 PM I am a foreigner in China, having been here for two and one half years.I have worked for some of this, but only for a short while- four months with a legitimate "Z" Visa. Further, to obtain permission to buy in my name I would have to return to my country to obtain the "character clearance". The problem is with the time involved and the expense. I have paid a deposit- 100k to buy a property in my girlfriend's name, but now I have run into the problem of bringing sufficient funds into China. Would this constitute a legitimate purpose for bringing more than the standard permitted ANNUALamount50,000 USD into China, BEARING IN MIND THAT IT WILL BE A PURCHASE IN MY GIRLFRIEND'S NAME. Posted by: Noel | May 28, 2007 3:18 AM Re Adam Livermore's comment - "The WFOE will also be liable for 33% tax on profits" - maybe holding the WFOE via an HK company could be a way round this. HK companies are only liable to tax on profits "arising in or derived from Hong Kong". So a management charge levied on a mainland WFOE to reduce its profitability to zero would be non-taxable in HK. Since HK doesn't levy withholding tax, the company could then redistribute this charge back to the WFOE owner. But this is all based on about 5 mins of internet searches, so there maybe I've missed something... If I haven't, what about the costs of setting up/administrating an HK company (whose sole activity is 2 transactions a quarter?) And would HK banks lend to it, based on it's ownership of the WFOE's underlying assets? Posted by: onebir | May 28, 2007 8:23 AM Noel -I have no idea if you can bring those funds into China for the reason you have given and I also know nothing of your relationship with your girlfriend. I will, however, tell you that my firm has been asked probably around 100 times to help men get back the money they paid to purchase an apartment in their girlfriends' name in various countries where they did so to get around the inability or difficulty of making the purchase in their own name. We have seen cases like this in China, Russia, Vietnam, and Korea (and probably other places I am forgetting). In every single case, there is nothing in writing indicating the property belongs to the guy and in every single case the by now ex-girlfriend claims it was a gift. In every single case, the local counsel we have brought on to examine the pros and cons of litigating such cases has told us it will be difficult to win and expensive. I know this is not what you want to hear and I am sure that there have been arrangements like this that have worked out just fine; of course those people have no reason to contact a law firm. Posted by: China Law Blog | May 28, 2007 4:38 PM onebir --

I am not a tax lawyer so I really cannot say. What I can say though is that China is getting increasingly tough on transfer payments and I do not see how this arrangement would prevent taxation on the sale of the property in any event. What I can also say is that before you even think of doing something like this you should secure good professional advice from the right people in China. Posted by: China Law Blog | May 28, 2007 4:43 PM "What I can also say is that before you even think of doing something like this you should secure good professional advice from the right people in China." Point well taken! Who are the right people though? Posted by: onebir | May 28, 2007 8:39 PM onebir -I have had this blog for more than a year now and I have studiously avoided making a pitch for my own law firm because I have always felt that would compromise the blog. But, in light of the fact that I just received an e-mail from a China consultant thanking us for Steve's great work on a real estate deal in China to which this consultant referred one of his clients, and in light of the fact that Steve really is someone people should be using for real estate deals in China, I just cannot resist: Steve Dickinson of Harris & Moure. Sorry, everyone. Posted by: China Law Blog | May 29, 2007 5:45 PM i am from sri lanka I want to know how can buy a land in china thanks... Posted by: ags kumara | June 4, 2007 9:30 AM could you kindly include the links to the full text of these two legislation? Thanks! Posted by: fred | June 13, 2007 2:39 AM