To ensure compliance with legislation and prevent potential risks, FIEs in China need to carefully review their existing financial procedures in accordance with the requirements of the Clarification.

Key Highlights:

• Detailed Explanation of Reserve Types

Statutory Surplus Reserve – mandatory, intended for covering losses and increasing capital. Discretionary Surplus Reserve – formed at the discretion of shareholders and can be used more flexibly, for example, to fund research, development, or dividend payments. Capital Reserve – formed from non-operating activities, has strict limitations on its use.

• Clear Rules, Restrictions, and Order of Reserve Utilization Established

The Statutory Surplus Reserve should be used first, followed by the Discretionary Surplus Reserve (if available). The use of the Capital Reserve is permitted only under certain conditions and is strictly regulated by law. The Clarification particularly emphasizes detailed planning and justification for the loss coverage process, requiring approval by the board of directors and shareholders, and notification to creditors.

• Tightened Requirements for the Valuation of Non-Monetary Assets for Capital Contributions, with Emphasis on Fair Market Value

The Clarification requires an independent valuation of non-monetary assets when contributing to registered capital to determine their fair market value in accordance with current laws and regulations. This measure aims to prevent overvaluation of assets and protect the interests of investors.

The new rules outlined in the Clarification require changes to the financial reporting and internal procedures of FIEs in China. It is essential to carefully study the new requirements for the use of reserves and non-monetary asset contributions, and to promptly reallocate funds in accordance with the Clarification. Non-compliance with the Clarification may result in fines and other sanctions.

We would be happy to answer your questions and conduct a detailed analysis of the applicability of the rules regarding the formation and use of reserves to your company in China.