Legal Analysis on Foreign Investment in Chinese Real Estate Industry

Legal framework of a land use system

Separation of a land use right and land ownership

Private ownership of land has been abolished in China. Under article 10 of the 1982 Constitution, urban land belongs to the state, with rural land owned by the collectives. Since the rural collectives are administratively subject to the leadership of the central and local governments, it can be generally construed that all land ownership is commanded by the state. 

Although private ownership of land is not available in China, article 2 of the Constitution's Amendment Act 1988 provides that a land use right is allowed to be transferred. Under this context, a land use right becomes divisible from land ownership, thus making it likely for the former to be privatized. Transfer of a land use right has accounted for most of the business activity in the primary real estate market. It is actually a kind of administrative practice by the land administration authority which, on behalf of the government, takes charge of granting permission to prospective land users who have already paid the required land transfer fees.

However, it was not until the amendment of the Constitution in 1988 that a land use system had been able to be established on a leasehold basis, which means for a fixed term. Most Chinese organizations in the past were administratively assigned free properties for the purpose of their business use. Because of this historical reason, a dual land use system is still operational at present. In the instance of a wholly foreign invested enterprises, foreign investors have to pay for the use of the required site. When it comes to the joint venture enterprises, many local Chinese entities are in possession of the right to use and control the land obtained free from the state, and may transfer such right to other parties or contribute them as an investment substitute in equity or co-operative joint ventures. Although in theory the land owner, that is, the state, is entitled to claim back part of the profits from the local entities in question, a lack of legal provisions in the existing legislation has exempted them from being asked to do so. That is why some foreign investors, when talking about real estate business, often grumble at the current uneven footing in competition with local counterparts. 

Unification of the dual land use system can hardly be fulfilled in a short time. Alteration of the on-going system is as a matter of fact closely connected with the performance of the country's corporation-based enterprise reform, which first of all has to deal with the basic issue of a state business entities' property right. This requires that state-owned organisations be conferred the right to own and use state assets as independent business entities, with no further administrative influence being applied to them. However, this can only be brought about by implementing a full leasehold system of all land use rights. 

Regulatory structure

The main rules regulating real estate business conducted by foreign investors are composed of two parts. First, the central government has provided several guiding principles, most notably the Interim Rules 1990 on Sale and Transfer of State Land's Use Rights in Cities and Towns (the 1990 Interim Rules), and the Regulations 1990 on Development and Management of Tracts of Land by Foreign Investors (the 1990 Regulations). Secondly, local authorities have also promulgated some regional policies, oriented towards providing more incentives to foreign investors and are only applied in particular local jurisdictions.

The State Land Administration Bureau as the government-designated agency is the regulatory authority responsible for overall administration of the State's land. All the land has to be registered and recorded by it. And the Bureau in turn issues a land registration certificate for entitlement of any specific use. No right can be acquired from the primary market or further traded on the secondary market unless the site concerned has been granted such a certificate. To obtain the right, foreign investors need to apply to the Bureau for approval. The Bureau in this sense plays the most momentous role in regulating foreign investment activity on both the primary and secondary market.

[Related Laws & Regulations]
Interim Regulations of the People's Republic of China Concerning the Assignment and Transfer of the Right to the Use of the State-owned Land in the Urban Areas (Promulgated by Decree No. 55 of the State Council of the People's Republic of China on 19th May, 1990 and effective as of the date of promulgation)
Land Administrative Law of the People's Republic of China (Promulgated by the Standing Committee of National People Committee, effective as of 1st Jan. 1999)
Implementing Regulation for Land Administrative Law of the People's Republic of China (Promulgated by the State Council, effective as of 1st Jan. 1999) 
Circular on Administration of Strengthening Transfer Plan of the Right to the Use of the State-owned Land (Promulgated by Ministry of Construction, effective as of 26th Dec. 2002) 
Provisions on Transfer of the Right to the Use of the State-owned Land by Inviting Public Bidding (Promulgated by Ministry of State Land Resources, effective as of 9th May. 2002)
Provisions on Transfer of the Right to the Use of the State-owned Land by Agreement (Promulgated by Ministry of State Land Resources, effective as of 1st Aug. 2003)
Circular Concerning Strengthening Administration of Land Supply and Promote the Speed and Healthy Development of Real Estate Market (Promulgated by Ministry of State Land Resources, effective as of 24th Sep. 2003)

Legal Framework of Real Estate Development 

The real estate development and management referred to in these Regulations means acts of infrastructure construction and housing construction carried out by real estate development enterprises on state-owned land within urban planning zones, and those of transfer of real estate development projects or sale and rental of commercial resident.

Regulatory Structure

The competent department of construction administration under the State Council shall be responsible for the work of supervision and administration of real estate development and management activities nationwide. 

The competent departments of real estate development of local people's governments at and above the county level shall be responsible for the work of supervision and administration of real estate development and management activities within their respective areas. 

The departments in charge of land administration of people's governments at and above the county level shall, in pursuance of the provisions of the relevant laws and administrative regulations, be responsible for the land administration related to real estate development and management.

The Establishment of Real Estate Development Enterprises

To establish a domestic real estate development enterprise in accordance with the relevant PRC laws and regulations should meet the following requirements:
(1) has a registered capital of over RMB 1 million Yuan; and
(2)has more than 4 full-time technical personnel with certificates of qualifications of real estate specialty and construction engineering specialty and more than 2 full-time accountants with certificates of qualifications. 

Establishment of a real estate development enterprise shall, in addition to compliance with the conditions for enterprise establishment prescribed by relevant laws and administrative regulations, fulfill the forgoing conditions:

People's governments of the provinces, autonomous regions and municipalities directly under the Central Government may, in the light of the actual conditions prevailing in their respective localities, work out provisions for the conditions of registered capital and specialized technical personnel for the establishment of a real estate development enterprise higher than those in the preceding paragraph.

Establishment of a real estate development enterprise by foreign investors shall, in addition to compliance with the above mentioned provisions of these Regulations, apply for approval in pursuance of the provisions of laws and administrative regulations on foreign business invested enterprises.

Transfer of Real Estate 

Where the land-use right is obtained by way of granting, transfer of the real estate shall meet the following conditions: 
1. to have paid all the fees for the granting of the land-use right as agreed upon in the granting contract and obtained the certificate of the land-use right; and
2. to have invested for development as agreed upon in the granting contract and have fulfilled twenty-five percent or more of the total investment for development in the case of housing projects, or have constituted conditions of land-use for industrial purposes or other construction projects in the case of developing tracts of land.

Where real estate is transferred with the construction of houses completed, the certificate of the house ownership shall be acquired.
Where the land-use right is obtained by way of allocation, the transfer of the real estate shall, according to the provisions of the State Council, be reported for examination and approval to the people's government that has the authority for approval. Upon approval of the transfer by the people's government with the authority for approval, the transferee shall go through the formalities for the granting of the land-use right and pay the fees therefor according to the relevant provisions of the State.

Where the land-use right is obtained by way of allocation and the transfer of the real estate is reported for approval, and where the people's government that has the authority for approval decides in accordance with the provisions of the State Council that the formalities for granting the land-use right need not be gone through, the transferor shall, pursuant to the provisions of the State Council, turn over to the State the proceeds obtained from land in the transfer of the real estate or dispose of such proceeds otherwise.

Pre-sale

Pre-Sale commercial resident by a real estate development enterprise should meet the following conditions: 
(1)total amount of land use right transfer money has been paid and certificate of land use right obtained; 
(2)it holds a permit of construction project planning and a construction permit; 
(3)input of capital for development and construction reaches over 25% of the total investment in project construction on the basis of calculation of the sale in advance of commercial residentprovided, and construction progress and dates of completion of construction and delivery have been determined; and
(4)registration for pre-sale has been completed with the obtainment of permit for sale in advance of commercial resident.
A real estate development enterprise that applies for the registration for the pre-sale of commercial residentcommercial residentshould present the following documents: 
(1)certification materials about: : (a)total amount of land use right transfer money has been paid and certificate of land use right obtained;
(b) it holds a permit of construction project planning and a construction permit; 
(3)input of capital for development and construction reaches over 25% of the total investment in project construction on the basis of calculation of the sale in advance of commercial residentprovided, and construction progress and dates of completion of construction and delivery have been determined;
(2)business license and certificate of human quality grade; 
(3)the project construction contract; 
(4)floor chart of commercial residentcommercial resident for sale in advance; and
(5)proposal for pre-sale of the commercial resident.
The competent department of real estate development should, within 10 days starting from the date of receipt of an application for the sale in advance of commercial resident, make a reply agreeing to the sale in advance or not agreeing to the sale in advance. Where approval for the sale in advance has been granted, a license for the sale in advance of commercial resident should be issued; reasons should be explained for non-approval of the sale in advance.

[Related Laws & Regulations]
Interim Measures for the Administration of the Foreign-Invested Development and Management of Tracts of Land (Promulgated by Decree No. 56 of the State Council of 
the People's Republic of China on 19th May, 1990 and effective as of the date of 
promulgation)
Law of the People's Republic of China on Administration of the Urban Real Estate (Adopted at the Eighth Meeting of the Standing Committee of the Eighth National People's Congress on July 5, 1994, promulgated by Order No.29 of the President of the People's Republic of China on July 5, 1994, and effective as of January 1, 1995)
Detailed Rules of Ministry of Construction Concerning Examination and Approval of Sino-Foreign Joint Venture Enterprises (Ministry of Construction, effective as of 28th June, 1996) 
Construction Law of the People's Republic of China (National People Committee, effective as of 1st Mar. 1998)
Regulations on Urban Real Estate Development and Management Control (Promulgated by Decree No. 248 of the State Council of the People's Republic of China on July 20, 1998)
Provisions on the Establishment of Foreign-Funded Construction Enterprises (Promulgated by the Ministry of Construction and the Ministry of Foreign Trade and Economic Cooperation on September 18, 1995)

Market Access and Foreign Participation 

Prior to China's accession to the WTO, real estate was categorized in the then-current version of the Foreign Investment Industrial Guidance Catalogue (Catalogue) as a "restricted" industry and foreign investors were prohibited from establishing wholly foreign-owned enterprises (WFOEs) in the real estate sector. 

As a result of revisions to the Catalogue in 2002 that reflect China's commitments set forth in its Protocol of Accession to the WTO (Protocol), development and construction projects of ordinary residential housing are now "encouraged" and foreign investors may freely participate in such projects in the form of WFOEs or joint ventures (JVs). However, the new Catalogue does not provide any guidance on the distinction between ordinary residential housing projects and other residential housing projects. 

Although China reserved its right in the Protocol to prohibit foreign companies from establishing WFOEs to engage in high-level real estate projects (except for luxury hotels), i.e., those with unit construction costs exceeding double the average for the same city, the new Catalogue merely categorizes construction and operation projects of deluxe hotels, villas, office buildings and international conference centres as "restricted". In practice, officials of the Ministry of Commerce have stated that notwithstanding China's reservation of rights in the Protocol, such high-level real estate projects may be carried out by foreign companies in the form of WFOEs. Nevertheless, it should be noted that China would not contravene its WTO commitments if it later prohibits foreign companies from establishing WFOEs to carry out such projects.

China did not make any commitment in the Protocol in respect of tract land development. Under the new Catalogue, tract land development is categorized as "restricted" and foreign investors are only permitted to participate in such projects in the form of equity or cooperative JVs. Although there is no PRC law or regulation that explicitly limits foreign equity participation in tract land development JVs, in practice, officials of the Ministry of Commerce have stated that they generally discourage foreign investors from holding equity interests of more than 75% in tract land development JVs. 

In respect of companies engaging in real estate services on a fee or contract basis (such as real estate brokerage services), the Protocol provides that foreign companies are permitted to participate in this sector only in the form of equity JVs, with foreign companies allowed to hold majority shareholding percentage in such enterprises. Nevertheless, there is no such restriction under the new Catalogue and it is well known in the industry that there are a number of real estate agencies or brokers already operating in China in the form of WFOEs. 

Notwithstanding China's reservation of rights in the Protocol to restrict foreign investment in certain real estate sectors, current PRC laws and practice give more leniencies to foreign investors than China's Protocol commitments require. China reportedly already has more than 5,000 foreign-invested real estate enterprises, which constitute an astonishing 20% of all real estate development enterprises in the country. While China's WTO accession has created greater opportunities for foreign investors in the market, who in general find themselves on a more equal footing with domestic players, the country is certainly not immune to the cyclical nature of the global real estate market and China's government is not yet beyond attempts to micro-manage sub-sectors of the industry.

[Related Laws & Regulations]
Catalogue for the Guidance of Foreign Investment Industries (Promulgated by The State Development Planning Commission, the State Economy and Trade Commission, the Ministry of Foreign Trade and Economic Cooperation, effective as of 11th Mar. 2002)
Catalogue of Encouraged Foreign Investment Industries
VIII. Real Estate Industry 1. Development and construction of ordinary residential houses
Catalogue of Restricted Foreign Investment Industries
VIII. Real Estate Industry 1.Development of pieces of land (equity joint ventures or contractual joint ventures only) 2. Construction and operation of high-ranking hotels, villas, high-class office buildings and international exhibition centers

Taxation
The Category of Tax for a Real Estate Development Enterprise Involved Foreign Investment
Tax Objects Tax Items Tax Rate
Income Income Tax on enterprise with foreign investment and Foreign Enterprises 33%
Construction & Transfer of Real Estate Properties Business Tax 3% for Construction
5% for Transfer of Real Estate Properties
Properties Ownership Urban Real Estate Tax 1.2% (by the Residual Value)
12% (by the Rent Fee)
Land Appreciation in Transfer of Real Estate Properties Land Appreciation Tax Land Appreciation Tax shall adopt four level progressive rates as follows: For that part of the appreciation amount not exceeding 50% of the sum of deductible items, the tax rate shall be 30%.
For that part of the appreciation amount exceeding 50%, but not
exceeding 100%, of the sum of deductible items, the tax rate shall be 40%.
For that part of the appreciation amount exceeding 100%, but not
exceeding 200%, of the sum of deductible items, the tax rate shall be 50%.
For that part of the appreciation amount exceeding 200% of the sum of deductible items, the tax rate shall be 60%.
Transfer of Land Use Rights & Sales and Purchases of Real Estate Deed Tax 1.5-5%

[Related Laws & Regulations]

The Law of the People's Republic of China on Income Tax on enterprise with foreign investment and Foreign Enterprises (adopted by the National People's Congress on April 9, 1991 and published on the same day)
Provisional Regulations of the People's Republic of China on Business Tax (the State Council, effective as of 13th December 1993)
Interim Regulations Concerning Urban Real Estate Tax (Promulgated by the Central People's Government Administration Council on August8, 1951)
Provisional Regulations of the People's Republic of China on Land Appreciation Tax (Adopted at the 12th Executive Meeting of the State Council on November 26, 1993, promulgated in Decree No.138 by the State Council of the People's Republic of China on December 13, 1993 and effective as of January 1, 1994)
Provisional Regulations of the People's Republic of China on Indenture (the State Council, effective as of 1st Oct. 1997)
Circular Concerning Income Tax Administration of Foreign Invested Real Estate Development and Operation Enterprises (Promulgated by State Administration of Taxation, effective as of 20th Dec. 2001)
Circular Concerning Tax Settlement on Foreign Invested Enterprises Involved in Real Estate Business (Promulgated by State Administration of Taxation, effective as of 1st Jan. 2000)

Tax on Sino-foreign Cooperative Construction of Houses

After the Chinese side performs the procedures for the transfer of the land-use right in its cooperation with the foreign party on the land it obtains, the method of whether distributing the area of the completed commercial resident, or distributing the income from the sales of the commercial residentdoes not conform with the stipulations of the current policy that "business tax is exempt from the behavior of investing and buying shares with invisible assets, participating in and accepting the investor's profit distribution and jointly undertaking the investment risk"; therefore, business tax shall be levied in accordance with the tax category of "transferring invisible assets"; its business volume should be all the income actually gained, including charges not included in the calculated prices; the tax payment schedule should be the very day when the income is gained.

At the same time, tax shall also be levied on the sales of commercial resident. If the method of distributing houses (including the distribution of area) which are then sold respectively by each party is adopted, then business tax shall be levied on the incomes from the sales of commodity houses by both Chinese and foreign parties in accordance with the stipulation of "selling immovable property"; if the method of unified sales of houses and redistribution of sales income is adopted, then business tax is levied on the income from unified sales of commodity houses in accordance with the stipulation of "selling immovable property"; if the method of paying fixed profits to the Chinese party is adopted, then business tax is levied on all the incomes gained by the foreign party from the sales of commodity houses in accordance with the stipulation of "selling immovable property".

[Related Laws & Regulations]
Official Reply on the Question Concerning the Levy of Business Tax on Sino-Foreign Cooperative Development of Real Estate (State Administration of Taxation, 6th December 1994)

Foreign Exchange Administration 

Provisional Deposit Account 
A foreign investor who wants to pay land deposit to related administrative agencies of land before the establishment of Foreign Invested Enterprises could apply to State Administration of Foreign Exchange ('SAFE') for opening a "Provisional Land Deposit Account". This provisional account could be used to keep remitted foreign exchange for paying land deposit, and foreign investors should pay land deposit to related administrative agencies of land through this account.

[Related laws & regulations]
Official Reply to Certain Issues on Foreign Exchange Registration of Foreign Investors Purchasing Land Use Rights (issued by SAFE, effective as of 4th July, 2002)