Real Estate 2021

Last Updated April 13, 2021

China

Law and Practice

Authors



JunHe LLP was founded in Beijing in 1989 and was one of the first private partnership law firms in China. Since its establishment, JunHe has become one of the largest and most widely recognised Chinese law firms. It has 13 offices around the world and a team comprised of more than 800 professionals, including over 240 partners and legal counsel, as well as over 560 associates and legal translators. JunHe is committed to providing top-tier legal services in commercial transactions and litigation, and is well known for being a pioneer, innovator and leader in the re-establishment and development of the modern legal profession in China. The firm has a great deal of experience advising international clients on China's constantly changing legal environment and its effect on their investments and operations in China. In addition, the lawyers often concurrently hold high posts in international organisations, government agencies, trade associations and arbitration tribunals.

The main sources of real estate law in the People’s Republic of China (PRC) include the laws, administrative regulations, ministerial rules, local regulations, and other normative documents promulgated by the national and local governments. Among these, the laws promulgated at the national level include the Civil Code, the Land Administration Law of the PRC, the Urban and Rural Planning Law of the PRC, the Construction Law of the PRC, and the Urban Real Estate Administration Law of the PRC, etc.

During the last 12 months, the top 10 real estate transactions in the PRC in terms of transaction volume (Source: Colliers International Group Inc, Review of 2020 and Expectation of 2021: Annual Analysis for Real Estate Transactions in China, 19 January 2021) involve real estate assets located in four cosmopolitan cities, including five in Shanghai, three in Beijing, one in Shenzhen and one in Chengdu, spanning a spectrum of office, retail and integrated complex commercial assets. Apparently, office space is still the most sought-after asset class. The list is topped by GIC’s acquisition of a commercial complex in Beijing from LG with a transaction volume of CNY8 billion. The acquisition by ByteDance, an IT company in Beijing and the owner of the famous app Toutiao, of an office asset in Beijing with a transaction volume of CNY5 billion, ranking number four on the list, echoes the ongoing emergence, strong financial power and influence of IT companies in Beijing. 

As a result of the COVID-19 pandemic, major cities in China saw a significant decline in the volume of bulk real estate transactions in 2020. For instance, Beijing and Shanghai saw a 30% and 45% decrease respectively in the transaction volume. Meanwhile, due to international travel restrictions as a result of the pandemic, there was a significant decline in foreign investment in 2020. In major cities, around 80% of the transaction value was contributed by domestic purchasers. Bulk real estate transactions in Guangzhou, Shenzhen and Chengdu were all completed by domestic purchasers. In addition, the volume of residential property sales saw a sharp drop in the first quarter of 2020 but rebounded later in April as the pandemic was brought under control.

No significant changes have been seen.

One of the most significant recent reforms in the real estate sector was the promulgation of the Civil Code (adopted by the Third Meeting of the Thirteenth National People's Congress on 28 May 2020 and effective on 1 January 2021).

There are two main categories of property rights under PRC laws.

  • Ownership right is the right to possess, use, receive proceeds from and dispose of the properties of the owner. A typical example is ownership of the title to buildings and structures. Under PRC law, land may only be owned by the state or collectively owned by farmers.
  • Usufructuary right is the right to possess, use and receive proceeds from the properties owned by other persons, such as land-use right, contracting right for farmland, farmer’s right to homestead land, right of habitation and easement right.

National laws and regulations governing the transfer of title to real estate mainly include the Civil Code, Urban Real Estate Administration Law, the Interim Regulations of the PRC Concerning the Assignment and Transfer of the Right to the Use of State-Owned Land in Urban Areas, the Interim Regulation on Real Estate Registration, etc.

The effectiveness of the transfer of real estate is subject to registration with competent real estate authorities, and no transfer is valid unless the same is duly registered or otherwise provided by law. For example, a court judgment, arbitration award or, in the event of government taking or expropriation, an administrative decision of government, may serve to effect a title transfer if the same is effectively issued.

Title insurance is not common in the PRC.

A buyer typically performs due diligence investigations on a variety of aspects, such as legal, tax, financial, environmental and technical.

Asset Deal

In terms of legal due diligence, the scope for an asset deal focuses more on the property, such as title, existing encumbrances, zoning and licence requirements, environmental compliance, leasing, operation and management status, but also covers verification of key aspects of the seller which may prevent or materially affect the sale of the property, such as the corporate governance structure and legal capacity of the seller, restrictions under financing obligations, and ongoing or pending material litigation, arbitration and administrative penalties involving the property.

Equity Deal

The scope for an equity deal is generally a comprehensive investigation, subject to the client’s specific instruction, of both the target company and the target property. The investigation of the target company generally covers the corporate history, corporate governance structure, business operation, material contracts (including financing contracts), environmental compliance, material litigation, arbitration and administrative penalty, intellectual property, labour and employment, taxes, subsidiaries and investment into other entities. The investigation of the target property is similar to that of an asset deal if not already covered in the part on the target company in the due diligence report.

Impact of the COVID-19 Pandemic

Due diligence investigations have been affected by the COVID-19 pandemic. Onsite due diligence investigations and verifications have been made more difficult, if not completely impossible, and conference calls, database verification and virtual interviews have been used much more often in due diligence practices.

A buyer generally requests the seller to make representations and warranties on itself and on the target (ie, the target property in an asset deal, and the target property, the target company and the target equity/shares in the target company in the event of an equity deal). Typical representations and warranties on the seller include capacity, power, authority, solvency of the seller, all authorisations, consents and approvals obtained, the binding effect of the contract and the sale of the target without contravention or claim by third parties or other contracts.

Target Property

Typical representation and warranties on the target property in an asset deal include clean title to the target property (free from encumbrances or, as the case might be, with disclosed existing encumbrances), the state of the target property, leasing status, no pending fees and no knowledge of taking, seizure or expropriation.

Target Equity/Shares

In an equity deal, sellers are often requested to make additional representations and warranties upon the clean title to the target equity/shares (free from encumbrances or, as the case might be, with disclosed existing encumbrances), legal capacity and status, financial condition, tax matters, compliance with laws, environmental matters, indebtedness and loans, leases and other material contracts, employees, intellectual property and no pending litigation in respect of the target company.

Coverage of Representation and Warranties

The coverage of representation and warranties is subject to business negotiations between the parties to a transaction. In general, parties to cross-border transactions are more comfortable with standard broad representation and warranties provisions, while domestic players tend to welcome a shorter version of an asset or equity transfer agreement, in other words, a more condensed coverage of representation and warranties.

Breach of Representations and Warranties

If the seller is in breach of the relevant representations and warranties, the buyer is generally entitled, in accordance with the contract or relevant PRC laws, to claim for damages, refuse to proceed with the closing or even terminate the contract.

A sophisticated seller may insist that the buyer may only refuse to proceed with the closing or terminate the contract when the seller is in breach of fundamental representations and warranties, and may otherwise only claim for damages in the event of breach of general representations and warranties.

Breach of certain representations and warranties is articulately regulated by the relevant PRC laws to protect the interests of buyers when purchasing property from real estate developers. For instance, the failure of a seller, being a developer, to have a pre-sale permit for a building under construction might lead to the invalidity of a strata title property sales contract.

See 1.1 Main Sources of Law, 2.2 Laws Applicable to Transfer of Title, 2.11 Legal Restrictions on Foreign Investors and 5.4 Applicable Governance Requirements.

The Environmental Protection Law of the PRC and Soil Pollution Prevention and Control Law of the PRC provide that the person causing the soil pollution (the “causing person”) is responsible for managing the soil pollution risks and the remediation of the soil pollution it caused. However, if the causing person cannot be identified, the land-use right owner (eventually the buyer, unfortunately) is responsible for managing the soil pollution risks and the remediation of the same, even if the land-use right owner did not cause the pollution or contamination.

A buyer can ascertain the permitted use of a parcel of real estate by viewing the construction land planning permit (建设用地规划许可证 in Chinese), land grant contract (土地出让合同 in Chinese), the construction works planning permit (建设工程规划许可证 in Chinese), other relevant zoning documents, and the title certificate. In addition, a buyer may also make further verification by accessing, with the authorisation of the seller, the relevant files of the real estate at the competent planning and land resources authorities (PLRA) or the competent local urban construction archives.

The state may, in the public interest:

  • expropriate real estate, including land collectively owned by farmers and buildings or other real estate owned by any entities or individuals, with appropriate compensation; or
  • temporarily requisition the real estate of any entities and individuals which will be returned to the said entities and individuals after such use.

The power of expropriation and temporary requisition must be exercised with due authority and legitimate process. For instance, the expropriation of land collectively owned by farmers shall be approved by the competent authorities, announced by the local government and enforced by taking into consideration the farmers’ and other affected persons’ opinions.

Compensation

The compensation must be fair and reasonable in case of expropriation and temporary requisition. Where the land to be expropriated is collectively owned by farmers, they shall be compensated according to the principle that their living standard is not negatively affected; while the land user, in respect of land under a land grant contract to be taken back by the government for public interest, shall be compensated, taking into account the actual elapsed term of the land use and the status and condition of the developments made on the land. In the case of requisition, compensation shall be made for any damage to or destruction of the requisitioned real estate.

In respect of the purchase and sale of real estate, taxes payable may differ depending on the different transaction structures.

Asset Deal

In an asset deal, taxes payable include:

  • enterprise income tax/individual income tax;
  • value added tax and surcharges; and
  • land appreciation tax, stamp duty and deed tax.

Of these:

  • the seller is obliged to pay enterprise income tax/individual income tax, value added tax and surcharges, land appreciation tax, and stamp duty; and
  • the buyer is obliged to pay deed tax and stamp duty.

Equity Deal

In an equity deal (regardless of whether to purchase all or a portion of the equity/shares), taxes payable include:

  • enterprise income tax/individual income tax, which the seller is obliged to pay; and
  • stamp duty, which the seller and the buyer are obliged to pay.

In addition, see 7.2 Assigning Responsibility for the Design and Construction of a Project for the potential exposure to land appreciation tax in an equity deal.

Tax Rates

Enterprise income tax

The rate ranges from 10% to 25%. The individual income tax rate is generally 20%, but an individual who transfers their sole residential housing after holding it for more than five years is exempt from individual income tax payment.

VAT

The rate ranges from 5% to 9%. Surcharges imposed on the VAT payable include tax for maintenance and construction of cities at an applicable rate ranging from 1% to 7%; education surtax at an applicable rate of 3%; and local education surtax, the rate of which varies in different localities. See 7.1 Common Structures Used to Price Construction Projects for more detailed analysis.

Land appreciation tax

The rate for this is progressive, ranging from 30% to 60%, but an individual who transfers their residential housing is exempt from paying this tax.

Deed tax

This generally ranges from 3% to 5%, but an individual who purchases a sole residence for their family (including their spouse and underage children) with a gross floor area of more than 90 square metres is eligible for a reduced rate of 1.5% and with a gross floor area of less than 90 square metres, of 1%.

Stamp duty

The rate is generally 0.05% for each of the seller and the buyer. Currently, an individual who purchases or transfers residential housing is exempt from paying this tax.

A major restriction on foreign investors acquiring real estate in the PRC is the “commercial presence” requirement, ie, offshore entities or individuals are not allowed to acquire real estate in the PRC for non-personal use unless a foreign-invested enterprise is established or has been established in the PRC to own and operate the real property. The following restrictions also apply to foreign investors:

  • a foreign individual is only allowed to purchase one housing unit (in practice, one title certificate represents one unit of housing) for their own use, subject to the requirement of residing or studying in China for more than one year; and
  • a branch or representative office of an offshore entity in China is allowed to purchase non-residential real estate for its office use in the city where such branch or representative office is registered.

In addition, no real estate companies are currently allowed to acquire offshore loans except for foreign-invested real estate companies that were incorporated prior to 1 June 2007.

Acquisition by an Onshore Entity

If commercial real estate is acquired by an onshore entity (including a foreign-invested enterprise), generally the onshore entity may seek financing from banks within the PRC, subject to certain restrictive conditions required by the China Banking Regulatory Commission. For instance, the facility amount shall not exceed 60% of the total acquisition price, and the term of the loan shall not exceed seven years. If the onshore entity intends to arrange loans from offshore bank(s) or offshore entities, including shareholder(s), to acquire a commercial real estate, it must also meet the requirements and restraints in relation to foreign debt under the PRC laws. Currently, no real estate companies are allowed to arrange loans from offshore, except for foreign-invested real estate companies that were incorporated prior to 1 June 2007. In the event of an equity acquisition by the said onshore entity, considering the target company is a real estate company, the onshore entity might still be practically prevented from arranging loans from offshore banks or entities.

Offshore Acquisition and Onshore Fixed-Asset Loans

Where a foreign investor acquires commercial real estate through an equity deal (by acquiring equity interest in the onshore company holding the real estate), the most common financing structure is an offshore acquisition loan accompanied by an onshore fixed-asset loan in renminbi. The offshore acquisition loan is extended by an offshore bank to the offshore buyer to pay for the equity/share purchase price in the same currency as that of the equity/share purchase price, secured by a pledge over the equity interest in the onshore target company acquired by the buyer. The onshore fixed-asset loan is generally extended to the onshore target company by an onshore subsidiary of the offshore bank, secured by a mortgage over the real estate owned by the onshore target company. Nowadays, we are seeing more onshore domestic banks directly extending foreign-currency acquisition loans to offshore buyers to finance the purchase price payment.

Where a commercial real estate investor that intends to acquire or develop real estate, acquires a loan from a lender, generally it will be required to provide the following forms of security:

  • the mortgage over the real estate;
  • the pledge of the equity interest of the target or project company by such investor;
  • the guarantee made by the investor;
  • the pledge of the account receivables, which are usually the rental proceeds generated from the real estate; and
  • the agreement for the transfer of interests in material contracts, which generally include material lease contracts, the property management contract, asset management contract and insurance policies in relation to the real estate.   

Although the PRC laws do not prohibit an offshore lender from being the mortgagee of real estate collateral, in practice, certain local real estate registration centres, which serve as the competent authority in charge of real estate mortgage registration, such as in Xiamen and Wuhan, refuse to register an offshore entity (including offshore banks) as the mortgagee. Therefore, in terms of practicality, it may not be possible to register a mortgage in favour of offshore lenders in certain localities, resulting in a failure to create an effective mortgage. 

A borrower is generally able to make repayments to its offshore lender without further restrictions, after it has gone through the relevant foreign exchange regulatory formalities for the cross-border loan (including, but not limited to, the registration of such cross-border loan) in accordance with the PRC laws. 

If a mortgage is created over real estate, both the mortgagor and the mortgagee are obliged to pay stamp duty for the mortgage contract at a tax rate of 0.05% each of the secured debt. A minimal registration fee for a real estate mortgage (CNY80 for residential property and CNY550 for non-residential property, per registration) is charged by the registration authority and often borne by the mortgagee.

Furthermore, if the mortgagor and mortgagee agree in the mortgage contract to an enforcement notarisation, a fee for enforcement notarisation may be incurred, which is usually borne by the mortgagor. Such fee is charged by the notary public office at a rate equal to a certain agreed percentage of the amount of the secured debt, which may vary at different localities. In Beijing, the maximum fee for an enforcement notarisation is 0.2% of the secured debt.

Under PRC laws, certain real estate may not be used as collateral to secure a debt, such as:

  • land ownership (other than land-use right which can be a valid collateral), land-use right to certain collectively-owned land such as farmers’ homestead land (other than collectively-owned construction land), educational, medical and other public welfare facilities owned by non-profit schools, nurseries and/or medical institutions, real estate subject to title dispute or without clear title, real estate under attachment, detainment or custody orders; and
  • as mentioned in 3.3 Restrictions on Granting Security over Real Estate to Foreign Lenders, although the PRC laws do not prohibit an offshore lender from being the mortgagee of real estate collateral, in practice, certain local real estate registration centres, which serve as the competent authority in charge of real estate mortgage registration, such as in Xiamen and Wuhan, refuse to register an offshore entity (including offshore banks) as the mortgagee.

When a lender enforces its security over real estate against a defaulting borrower, if the lender and the mortgagor have explicitly agreed in the mortgage contract to apply the enforcement notarisation approach, the lender may directly apply to the competent court for enforcement by presenting the duly notarised mortgage contract and the enforcement certificate issued by the notary public's office. If the lender and the mortgagor have not explicitly agreed in the mortgage contract to apply the enforcement notarisation approach, the lender may, by agreement with the mortgagor, dispose of the collateral by negotiating a purchase price, by auction or sale of the collateral, and the lender may claim its senior debt against the proceeds from such a negotiated purchase price for auction or sale of the collateral. Failing an agreement between the mortgagor and the mortgagee on the means of disposal of the collateral, the lender may apply to the local court to auction or sell the collateral. In either case, the sale or negotiated purchase price of the collateral shall be based upon market price.

An existing mortgage debt may become subordinated to a newly created mortgage debt, the mortgage interest of which has been duly registered, only if the mortgage over such existing debt has not been duly registered. But if the mortgage over the newly created debt has also not been duly registered, the existing debt will rank pari passu with the newly created debt.

Given the principle that whoever causes the pollution shall be responsible for remediation, the party causing the pollution shall be held liable. Therefore, the lender, being the mortgagee of the real estate, will not generally be held liable. However, if the lender becomes the land-use right owner in respect of such real estate as a result of foreclosure (or enforcement) of the mortgage, the lender may be held liable for such non-compliance if the party that caused the pollution cannot be identified.   

The security interests created by a borrower in favour of a lender will not be made void if the borrower becomes insolvent, and the lender may continue to claim its senior debt against the collateral, although this will be subordinated to the contractor’s lien. In the event of restructuring during the bankruptcy proceeding, the lender will have to temporarily suspend its enforcement of mortgage (unless damage to the collateral or a situation likely to result in an apparent diminishment in the value of the collateral might endanger the mortgagee’s interests). If the borrower enters into reconciliation or a liquidation procedure, the lender may continue to enforce the mortgage.

To deal with the anticipated expiry of the LIBOR by the end of 2021, the lender and borrower often agree, mostly in a cross-border facility agreement, that an alternative interest rate (such as the interest rate published by the relevant reference banks) shall apply where there is no applicable LIBOR.   

The PRC laws applicable to strategic planning and zoning at the state level mainly include the Land Administration Law, the Urban and Rural Planning Law, etc.

Local governments shall, in accordance with these laws, prepare the urban planning and zoning, and reasonably determine the development scale, steps and construction standards of the urban locality.

In addition to the relevant laws and regulations, such as the Construction Law of the PRC and Regulation on the Quality Management of Construction Projects, the design, appearance and method of construction are also governed by the national standards promulgated by the relevant authorities of the state council, such as the:

  • Unified Standard of Civil Building Design;
  • Unified Standard for Energy-Saving Design of Industrial Buildings;
  • Code for Fire-Protection Design of Buildings;
  • Standard for Quality Acceptance of Building Decoration and Refurbishment; and
  • Unified Standard for Constructional Quality Acceptance of Building Engineering.

Generally, these regulations and rules apply to both the construction of a new building and the refurbishment of an existing building. Local governments may also promulgate detailed implementing rules according to the relevant national regulations and policies.

The development and designated use of real estate are generally governed by the competent authorities of the state and local governments, such as:

  • the competent development and reform commission (DRC) in respect of the approval or filing of the project initiation;
  • the PLRA in respect of planning and zoning approval, grant of land-use right and issuance of land-use right certificate; and
  • the housing and urban-rural development authority (HUDA) in respect of preliminary design approval, issuance of the construction works construction permit (建筑工程施工许可证 in Chinese) and filing for completion acceptance.

The approval process for development of a new building and/or infrastructure project can be divided into the following four phases:

  • phase 1 for project initiation and land-planning permission, which includes approval or filing of the project, and issuance of the construction land planning permit (建设用地规划许可证 in Chinese);
  • phase 2 for engineering and project permission, which includes a project design examination, and issuance of the construction works planning permit (建设工程规划许可证 in Chinese);
  • phase 3 for construction permission, which includes design confirmation of fire-protection and civil air defence, and issuance of the construction works construction permit (建筑工程施工许可证 in Chinese); and
  • phase 4 for completion acceptance, which includes completion acceptance of zoning, land, fire protection, civil air defence and other relevant matters, and the completion acceptance filing.

Refurbishment and expansion of an existing building also require the relevant approval and permits, which generally include the construction works planning permit (建设工程规划许可证 in Chinese), the construction works construction permit (建筑工程施工许可证 in Chinese), and the completion acceptance filing. Local authorities may also issue detailed implementation orders. For instance, a developer or project owner for an interior refurbishment works in Beijing is allowed to apply directly for the construction works construction permit (建筑设工程施工许可证 in Chinese), without the need to obtain any prior government approvals or permits.

In addition, in the event of any modification to urban and rural zoning, the relevant authorities that prepared such urban and rural zoning shall solicit public opinion by holding hearings or using other methods. In the event of any modification to the approved detailed construction plan or master plan of a project design, the relevant zoning authorities shall solicit the interested parties’ opinions by holding hearings or using other methods. Also, any entity or individual is entitled to report any zoning non-compliance to the competent zoning or other relevant authorities.

If a real estate developer objects to the approval decision of the competent authority, generally such developer may submit applications for administrative review to the local government or the administrative department at the higher level. If such developer further objects to the administrative review decision, it may file an administrative lawsuit to the court, unless such administrative review decision is, as provided by law, a final decision.

A developer or investor may enter into an investment or joint development agreement with the competent subdivision of the local government, specifying, among other things, local regulatory requirements upon construction, progress and the investment intensity, and the fiscal preferential treatment offered by the local government. The specific contents of such agreement vary from project to project and are subject to local policies and negotiations.

The regulatory authorities may enforce restrictions on the development and designated use of a piece of land in various ways.

  • If any entity occupies land without due approval or with approval obtained by deception, such entity shall be ordered to return the land, and any building and other structures newly constructed on the land may be ordered to be confiscated or dismantled. In addition, a fine may be imposed concurrently, and the relevant persons responsible for the illegitimate occupation may also be subject to criminal liability.
  • In the event of any illegitimate land transfer, the income gained by the transferor from such transfer shall be confiscated, and the newly constructed buildings on the land may be ordered to be confiscated or dismantled.
  • If construction work is carried out without a permit or the approval of the competent authorities (including failure to obtain permission or failure to carry out construction in compliance with the construction works planning permit), the project owner or developer may be ordered to correct the violation and dismantle the building or structures, they may be liable to pay a fine and the illegitimate properties may also be confiscated.

Investors generally set up companies to hold real estate assets, unless an individual prefers to own a real estate asset directly. Under the Company Law, the types of companies include limited liability companies (有限责任公司 in Chinese) and limited companies by shares (股份有限公司 in Chinese). The liability of each shareholder of either a limited liability company or a limited company by shares is limited to its respective subscribed capital contribution to the company. Limited liability companies are most commonly used to acquire real estate assets, for both domestic and offshore investors.

Both limited liability companies and limited companies by shares are formed and governed by their articles of association (章程 in Chinese), which also govern their shareholders, directors, supervisors and officers, in addition to the companies themselves. These provide for, among other things, capital contributions, shareholding percentage, governance rights, distribution rights, dissolution and liquidation matters.

The minimum capital for companies engaging in real estate development may not be less than CNY1 million.

A Limited Liability Company

Pursuant to the Company Law, a limited liability company shall have:

  • less than 50 shareholders and have a shareholders’ assembly consisting of all the shareholders (or one sole shareholder) which is the highest authority of the company;
  • a board of directors consisting of three to 13 directors (or one executive director in lieu of a board of directors if there is a limited number of shareholders or the company is small in size), which is responsible to the shareholders’ assembly (or shareholder); and
  • a board of supervisors of no less than three supervisors (or one or two supervisor(s) in lieu of a board of supervisors if there is a limited number of shareholders or the company is small in size).

Board directors are appointed by the shareholders’ assembly (or shareholder). A limited liability company may have a general manager, responsible to the board, to be appointed or dismissed by decision of the board.

A Limited Company by Shares

A limited company by shares is incorporated by two to 200 sponsors, with at least half of them having residence in the PRC, and has:

  • a general assembly of shareholders consisting of all shareholders, which is the highest authority of the company;
  • a board of directors consisting of five to 19 directors, which is responsible to the general assembly of shareholders;
  • a board of supervisors of no less than three supervisors; and
  • a general manager.

As in the limited liability company, board directors are appointed by the general assembly of shareholders, and the general manager is appointed or dismissed by decision of the board of directors.

Upon incorporation, a company must submit the annual report for the preceding year to the administration for market regulation through the corporate credit information disclosure system between 1 January and 30 June each year. No fees are required for the submission of such report.

Companies are also required to prepare financial accounting reports at the end of each fiscal year, which must be audited by an accounting firm. In addition to such accounting expenses, additional fees may be incurred for other financial matters as agreed in a company’s articles of association. Such fees vary depending on the location of the accounting firm and the company's assets and financial condition.

Leasing is the most commonly used method to obtain the right to occupy and use any or all of a building for a limited period of time. In addition, the habitation right, if duly registered, is another method to occupy and use another person’s dwellings, generally free of charge unless otherwise agreed. The habitation right is a newly created right under the Civil Code.

Methods to obtain the use right to a piece of land vary depending on the type of land. According to the Land Administration Law, land is classified into farmland, construction land and unused land:

  • farmland means land that is directly used for agricultural production, including cultivated land, forest land, grassland, etc;
  • construction land mainly includes land zoned for the construction of buildings and other structures; and
  • unused land refers to land other than farmland and construction land.

The use right to farmland may be obtained through a contracting arrangement, whereby contractors may enter into an agreement with a landowner or other entities with delegated authority to engage in agricultural production such as planting, forestry, animal husbandry, and fishery on the land, and benefit from such production.

The use right to construction land may be obtained by entering into a land grant contract (with land premiums to be paid) or a land allocation contract (no land premiums required to be paid) with the competent local land authorities if it is stated-owned or with the relevant collective if it is collectively-owned.

In addition, real estate owners are entitled, under the PRC laws, to use the land or buildings adjacent to their own real estate for the purpose of obtaining and draining water, passage, ventilation and lighting, etc that are necessary for their life or production. Such neighbouring right is mandatory and no agreement between the parties is required. Parties may also create easement through execution of agreements to obtain the right to use another party’s real estate. For example, easement may be created to obtain a right to pass through another’s land or to build and maintain a penstock on another’s land, for a party’s own convenience.

In practice, commercial leases may be divided into the following categories depending on the different rent payment methods:

  • lease with a fixed rent, often seen in office leases, under which the rent is a fixed amount as agreed by the parties;
  • lease with a turnover rent, under which the rent is calculated at an agreed percentage of the tenant's gross turnover generated from the leased property; or
  • lease under which the rent is the higher of a fixed base rent or a turnover rent. For example, if during a given month the turnover rent is higher than the fixed base rent, the tenant should pay the rent calculated as the agreed percentage of the tenant's gross turnover generated from the leased property, or vice versa.

PRC laws stipulate the term in a lease agreement cannot exceed 20 years. If the term exceeds 20 years, the period in excess will be invalid. When the lease term expires, the parties may renew the lease agreement for up to 20 years from the date of renewal of the lease agreement. Lease agreements with a term longer than the remaining term of the land-use right to the land located beneath the property may be at risk because it is uncertain whether the landlord will still have the right to use the land after the land-use term expires.

The rent for a commercial lease is generally negotiable and subject to agreement between tenant and landlord. However, rent for affordable housing such as public rental housing (公共租赁住房 in Chinese) and low-rent housing (廉租房 in Chinese) may not exceed the guiding rental rate promulgated by the local government.

Allowances Made for COVID-19

In the wake of the COVID-19 pandemic, the Supreme People's Court issued a special guiding opinion on 15 May 2020 and later, ministries and local governments issued various administrative orders to address leases affected by the pandemic. Termination of lease and claims for damages made by a landlord on the basis of a tenant's failure to pay the rent of a commercial lease, where the tenant's business proceeds have significantly declined, or the tenant has encountered working capital difficulties as a result of the pandemic or its control measures, will not be supported by the court. Macro and small businesses which are tenants of state-owned landlords are entitled to a rent reduction or exemption for a period up to three months in most cases. Other tenants of commercial leases may apply to the court to adjust the terms of the lease if the continued performance of the lease becomes inequitable or unfair under the circumstances of the pandemic.

Generally, the length of a lease term is subject to the agreement between the landlord and the tenant, but shall not exceed 20 years (see 6.3 Regulation of Rents or Lease Terms). The landlord and tenant may also agree in the lease whether the term may be renewed and if so, how the lease may be renewed.

PRC law provides that the landlord shall be responsible for the maintenance and repair of the leased premises, unless otherwise agreed by the parties. The tenant has the right to require the landlord to maintain and repair the leased premises within a reasonable time limit when necessary. Where maintenance and repair affect the use of the leased premises, the rent may be reduced or the lease term extended accordingly.

The frequency of rent payment is, subject to the agreement between the landlord and the tenant, generally on a monthly, quarterly or yearly basis.

The tenant shall pay rent in the amount and manner as agreed in the lease agreement. If agreed in the lease, the rental rate may be adjusted based on the agreed adjustment mechanism. For example, the rental may be adjusted annually based upon the increase or decrease in the consumer price index in the preceding year. Parties are not allowed to unilaterally change rent payments, unless otherwise agreed by the parties or provided for by PRC laws, such as due to the occurrence of a force majeure, or an unforeseeable material change (other than commercial risks and force majeure) of circumstance.

When deciding the price adjustment mechanism, a fixed yearly increase rate, the consumer price index or fair market prices are often taken into consideration.

The landlord is responsible for the payment of VAT on the rent income generated from leasing real estate.

Generally, in addition to rent, a refundable security deposit, equal to rent plus a management fee of three to six months in most cases for commercial leases (or one to three months for residential leases), is required to be paid to the landlord at the start of a lease. In the event that the tenant wishes to improve or fit out the property, the tenant may be required to pay a security deposit for the fitting-out or improvements, which is refundable after the completion of the work. Improvements or fitting-out work undertaken by the tenant is in most cases borne by the tenant, unless otherwise agreed.

Under the PRC laws, unless otherwise agreed by the parties, the landlord is responsible for the maintenance and repair of the leased premises. In practice, small maintenance and repairs of common areas and shared equipment, machinery and facilities is generally conducted by the property manager engaged by the landlord, and covered by the management fees, which are payable to the property manager by either the landlord or the tenant, subject to the lease agreement.

In practice, the tenant pays their own utilities and telecommunications fees incurred in respect of, or consumed at, the leased premises. Utilities and telecommunications fees incurred in respect of common areas, and public equipment, machinery and facilities are often shared and charged to the end-user (ie, the tenant in most cases, or the landlord if otherwise agreed in the lease, or if the premises are vacant) in proportion to the floor area of the leased premises.

The landlord will usually take out and maintain, at their own cost, property all-risks insurance for the leased premises, which covers physical loss of or damage to the insured property arising from any natural hazards or accident. Damages caused or expenses incurred by intentional acts or gross negligence, confiscation, requisition, destruction or damage by any action or order of any government or public authority, war, coup d'état, or strike are generally excluded. On the other hand, the tenant is usually requested by the landlord to take out and maintain through the lease term construction/installation works all-risks insurance for the tenant's fitting-out or improvement works, and public liability insurance for the tenant's business operations in the leased premises.

In practice, the landlord commonly imposes various restrictions in the lease agreement on how a tenant shall use the leased property, including but not limited to restrictions on the permitted use, subleasing, assignment, and fitting-out of the leased premises. Applicable PRC laws also require that use of the leased premises shall be in accordance with the zoned usage, and the tenant shall not change the load-bearing structure or demolish indoor facilities without the landlord's approval.

Generally speaking, the tenant must obtain the landlord’s prior consent if the tenant intends to improve or fit out the leased premises. A fitting-out plan is typically required in order to obtain the landlord’s written consent. To ensure the safety of the leased premises, the landlord usually requires that the tenant takes out insurance for such improvement or fitting-out works and engages qualified contractors. As discussed in 6.12 Restrictions on the Use of Real Estate, the tenant may not change the load-bearing structure or other main structure of the leased premises without approval. Furthermore, it is common practice for the landlord to require the tenant to complete all the approval, filing and recording procedures required by the competent authorities (including but not limited to the planning, construction and fire-protection approvals and completion acceptance) for such improvement or fitting-out at the tenant's own cost.

Leasing of various types of real estate are mainly governed by the:

  • Civil Code of the PRC;
  • Administrative Measures for Commodity Real Estate Leasing; and
  • Interpretation of the Supreme People’s Court on Certain Issues Concerning Specific Application of Law in the Trial of Contractual Disputes over the Leasing of Urban Housing 2009 (as amended in 2020).

It is common practice to specify in the lease that the landlord is entitled to terminate the lease should the tenant become insolvent. Failing explicit agreement, the Enterprise Bankruptcy Law of the PRC shall govern. If the court accepts the tenant’s application for bankruptcy, the tenant’s bankruptcy administrator has the right to decide whether to rescind or continue to perform the lease agreement. Failure by the bankruptcy administrator to notify the landlord of its decision within two months from the date when the bankruptcy application was accepted, or to reply to the landlord within 30 days after receiving the landlord’s exhortation, will result in the rescindment of the lease agreement, however.

Rescindment of the Lease Agreement

Where the lease agreement is so rescinded, the tenant shall reinstate and return the leased premises, and the landlord is entitled to declare its claims to the court, in accordance with the bankruptcy proceedings, for the damages incurred thereunder. Where the administrator decides to continue the performance of the lease agreement, the landlord must comply. However, the landlord has the right to request the administrator to provide security. The lease agreement will then be deemed rescinded if the administrator fails to provide security.

It is common practice to specify in the lease that the tenant shall pay a refundable security deposit to secure the performance of its obligations under the lease agreement, and the security deposit may be utilised by the landlord, in whole or in part, to rectify the tenant's default. The security deposit is in most cases equal to rent plus a management fee of three to six months for commercial leases, or one to three months for residential leases.

After the expiry or termination of a lease, the tenant generally has no right to continue occupying the leased premises. However, if the tenant continues to use the premises after the expiry of the lease without any objection from the landlord, the original lease shall be deemed as remaining in force but without a fixed term. Under such circumstances, either party can terminate the lease at any time, provided that the landlord gives the tenant reasonable prior notice of such termination. In addition, if the landlord intends to lease the premises after the expiry of the lease, the tenant shall have a right of first refusal under the same terms and conditions.

According to the PRC laws, the tenant may sublease part or all of the leased premises to a third party with the prior consent of the landlord. The sublease term should not be longer than the residual lease term of the original lease agreement, however. In addition, the tenant is liable for any damages caused by such third parties to the leased premises.

Tenant's Right

The following circumstances are often seen in a lease as causes for termination by the tenant:

  • damage to the leased premises preventing the tenant from using the leased premises;
  • insolvency of the landlord; and/or
  • frequent interrupted supply of water, electricity, air conditioning or elevators.

The PRC laws also give the tenant the right to terminate the lease in the event of:

  • the leased premises endangering the safety or health of the tenant; 
  • the occurrence of any of the following circumstances for reasons not attributable to the tenant, thus rendering the tenant unable to use the leased premises:
    1. the leased premises being attached by judicial or administrative organs;
    2. title claim to the leased premises; or
    3. violation of the mandatory provisions of laws and administrative regulations in respect of the requirements on the use of the leased premises.

Landlord's Right

The following circumstances are often seen in a lease as causes for termination by the landlord:

  • failure by the tenant to pay the rent, management fee, deposit or other amounts due, and the outstanding amounts remain unpaid for a reasonable period after receipt of notice from the landlord;
  • insolvency of the tenant;
  • unauthorised suspension or close of business operations; and/or
  • damage to the main structure or unauthorised fitting-out or improvement of the leased premises by the tenant.

The PRC laws also give the landlord the right to terminate the lease should the tenant sublease the leased premises without the landlord’s consent.

The PRC laws provide that a lease agreement shall, within 30 days of its execution, be filed with the competent real estate authority of the city where the real estate is located, otherwise the parties to the lease will be ordered to comply. Should the parties fail to comply within the prescribed time period, the parties shall be subject to a fine of CNY1,000 (in the case of an individual) or CNY1,000 to CNY10,000 (in the case of a legal entity).

The lease of real estate is not usually reflected in the Land Record.

If the lease is terminated as a result of the tenant’s default, the tenant must reinstate and return the leased premises in a timely manner. Should the tenant fail to do so, after the lease has been duly terminated, the landlord may cut off the water or electricity supply to force the eviction of the tenant.

The landlord may file a lawsuit to the court with competent jurisdiction for its confirmation that the lease is duly terminated. If the tenant still occupies the leased premises after the court has found that the lease has been terminated, the landlord may apply for an enforced eviction based on a valid judgment. In practice, the time period required for a court to make a judgment and complete the enforcement procedure varies in different localities, but is usually longer than a year.

A third party who is not a party to the lease cannot generally terminate the lease because it is not a party to the lease. However, under certain circumstances, third parties may make it impossible for the lease to be performed or fulfilled, resulting in early termination of the lease.

The most common pricing structures for construction include:

  • fixed quota pricing (工程定额计价 in Chinese);
  • bill of quantities pricing (工程量清单计价 in Chinese);
  • fixed lump-sum price (固定总价 in Chinese);
  • fixed unit price (固定单价 in Chinese);
  • cost plus fee (成本加酬金 in Chinese); and
  • adjustable price (可调价 in Chinese).

These are not mutually exclusive and sometimes, multiple pricing structures might be included in the same contract.

Fixed Quota Pricing

Fixed quota pricing means that the construction price, in accordance with the bidding documents, is a total of:

  • the direct construction cost, which is calculated based on the unit labour price, material price, equipment price and other information formulated by the relevant administrative authorities and the market price for the same during the same period;
  • the indirect construction cost (including management salaries, office expenses, employees’ insurance, etc);
  • profit; and
  • taxes.

Bill of Quantities Pricing

Bill of quantities pricing means that the aggregate of the price for each component of the construction work, which is calculated based on the integrated unit price and quantity of such component, is determined based on the construction drawing and construction management and engineering skills.

Fixed Lump-Sum Price

With a fixed lump-sum price, the total construction price is a fixed amount which is not adjustable within the agreed work scope and conditions.

Fixed Unit Price

This means that the unit price is a fixed amount, which is not adjustable in response to any change in conditions or quantities, and the total construction price is the product of the weighted summation of the fixed unit price multiplied by the quantity required.

Cost Plus Fee

Cost plus fee means that the contractor is paid a fee in the amount agreed between the parties, in addition to reimbursement of the actual construction cost.

Adjustable Price

With an adjustable price, the contract price is adjustable subject to agreed conditions, such as an increase in labour or material costs due to inflation or market change, a change in the order, a change of quantities or other geotechnical conditions.

An owner may either enter into an EPC Contract with a general contractor, or separately enter into a design contract and a construction contract with a local design institute and construction contractor, respectively.

EPC Contracts include the following according to market practices:

  • an Engineering-Procurement-Construction (EPC) arrangement, under which the contractor is responsible for the engineering, procurement and construction of the project, and fully answers for the project (including but not limited to the quality, safety, schedule and price); 
  • a Design-Build (DB) arrangement, under which the contractor is responsible for the engineering and construction of the project, and fully answers for the project (including but not limited to the quality, safety, schedule and price);
  • an Engineering-Procurement (EP) arrangement, under which the contractor is only responsible for the engineering and procurement of the project, and not the construction thereof;
  • a Procurement-Construction (PC) arrangement, under which the contractor is only responsible for the procurement and construction of the project, and not the engineering thereof; and
  • a Lump-Sum Turn-Key (LSTK) arrangement, under which the contractor is responsible for the engineering, procurement, construction and installation, commissioning service, and delivery of the project qualified for use. 

Construction risks may be allocated between the parties to a contract, taking into consideration factors such as bargaining power, fairness and justice. For instance, the owner may transfer the risk of price increase to the contractor by adopting the fixed lump-sum price contract, or the contractor may agree to indemnify the owner only to the extent of the total contract price. Generally, risk allocation arrangements are valid and recognised by the courts, provided they are not in violation of the mandatory provisions of PRC laws and administrative regulations.

Furthermore, a project owner may require a contractor to take out and maintain project-related insurance (such as contractor’s all-risks and third-party liability insurance) in favour of the owner.

The owner and contractor generally specify a duration for work, including milestone and completion dates in the contract, and manage the work progress through the following contractual arrangements:

  • the contractor is required to make and update the work schedule, report in a timely manner any risks of extension of work duration, take all actions necessary to stick to the agreed schedule and pay the delay damages;
  • the owner has the right to terminate the contract in case of severe delay of the schedule; and
  • the circumstances under which the owner must agree to extend the duration of the contract must be specified.

Monetary compensation may be claimed by an owner in accordance with the contract or by law, if certain milestone and completion dates are not achieved. 

In practice, the following forms of security are generally requested by the owner:

  • a performance bond, in the form of a bank guarantee or third-party guarantee, which is issued to the owner by the guarantor for the purpose of securing the performance of the contract by the contractor; 
  • a payment guarantee in the form of a bank guarantee or third-party guarantee, which is issued to the subcontractors, suppliers or construction workers by the guarantor, for the purpose of securing the payment obligations of the contractor under the relevant contract(s); and
  • retention money is an amount retained from each progress payment which is generally released to the contractor after the contractor has fully performed its contract obligations, usually after the expiry of the defect liability period.

The contractor for construction work has the right of contractor’s lien over the construction in the event of non-payment by the owner, which is senior to a mortgage or other debts. Such contractor’s lien is valid for up to 18 months, commencing from the date the construction payment becomes due. The contractor’s lien may be removed if the overdue payments are made in full by the owner by voluntary payment, or by being offset against the negotiated sale price (between owner and contractor) of the construction, or the proceeds from the auction of the construction, ordered by a competent court. 

Completion Acceptance

The PRC laws explicitly stipulate that no construction shall be delivered for use unless it passes completion acceptance. The owner must organise for the geological survey contractor (勘察 in Chinese), designer, contractor and jianli (监理 in Chinese) (professional supervision engineer mainly for the supervision and management of construction quality and schedule) to attend the completion acceptance inspection; and, after the completion acceptance is passed, the owner must go through specific completion acceptance filing formalities at the relevant government authorities, and obtain the Completion Verification and Acceptance Filing Certificate for the Construction Project (建设工程竣工验收备案证书 in Chinese), which may be replaced by an electronic notice from HUDA declaring that the completion acceptance has been passed, for certain small-scale non-residential construction works in some localities.

Residential Housing Requirements

In addition, in the case of a residential housing project, the PRC laws also require the Residential Housing Quality Warranty and Residential Housing Use Manual to be provided by the real estate developer when delivering such housing, and certain localities, such as Shanghai, Shandong province and Tianjin, further require a certificate of delivery and occupancy issued by the local HUDA, to be obtained by the real estate developer before inhabitation of the newly-built residential housing.

PRC companies are subject to payment of VAT for the sale of real estate, and the seller is the obliged taxpayer. The taxes payable are equal to the sale price multiplied by the applicable tax rate. Two methods are applied to calculate the sale price: 

  • under the simplified method, the sale price includes all the costs received by the seller plus the out-of-price expenses; and
  • under the general method, the sale price equals the balance of the total amount of the costs received by the seller and the out-of-price expenses after deduction of the expenses incurred during the sale of the real estate.

For a general taxpayer, if the seller acquires the real estate before 30 April 2016, it may choose to use either the simplified method (at an applicable rate of 5%) or the general method (at an applicable rate of 9%). If the real estate is acquired after 1 May 2016, only the general method may be applied (at an applicable rate of 9%).

For a small-scale taxpayer (ie, whose VAT-taxable sales are no more than CNY5 million per year), the simplified method at an applicable rate of 5% will be applied. In the event that the VAT-taxable sales are no more than CNY100,000 per month, such taxpayer is exempt from the payment of VAT.

An equity deal is often chosen by companies over an asset deal as a way to mitigate tax liabilities. However, the State Administration of Taxation has issued certain official replies on a case-by-case basis to collect land appreciation tax from the seller in certain equity transfer transactions where the main asset of the target company acquired was the real estate. As a result, there might be potential exposure to land appreciation tax liability in similar equity deals.

Property tax and urban land-use tax are the main municipal taxes paid on the occupation and usage of real estate:

  • for property tax, the applicable rate is 1.2% if it is calculated based on the residual value of the real estate (ie, the original price of the real estate reduced by 10% to 30%), and it is 12% if the tax is calculated based on the rental income from the real estate; and
  • the applicable rate of urban land-use tax varies from CNY0.6 per square metre to CNY30 per square metre, depending on the city where the real estate is located.

Exemptions

Preferential policies on property tax and urban land-use tax in respect of commercial real estate are available to taxpayers in a less favourable financial situation or in certain specific industries. For example, property tax and urban land-use tax may be reduced or even exempted subject to the approval of local government or the tax bureau, should the taxpayer have difficulty in paying such taxes. If real estate owned by a profit-driven medical institution is used for its business operations and the revenues generated by such institution are directly used to improve medical and hygiene conditions, the institution shall be exempted from paying property tax and urban land-use tax for three years after the issuance of its business licence.

In the case of an offshore entity holding an onshore project company, which in turn holds real estate in the PRC, such offshore entity is subject to:

  • withholding income tax at an applicable rate of 10% for any dividends received from the onshore project company; and
  • withholding income tax at an applicable rate of 10% for the net income generated from the transfer of equity in such onshore project company,

if under each circumstance such offshore entity has no establishment in the PRC or such income has no actual connection with such establishment if any, unless otherwise provided in a more preferential bilateral tax treaty.

In the case of an offshore entity directly holding real estate in the PRC, which existed before July 2006, such foreign investor, if it has no establishment in the PRC or the income generated in the PRC has no actual connection with such establishment, is subject to:

  • withholding income tax upon the net income generated from the transfer of the real estate at a rate of 10%; and
  • withholding income tax at a rate of 10% for the rental proceeds generated by the real estate.

According to the PRC Enterprise Income Tax Law, real estate held by a company is typically treated as fixed assets, which may be depreciated and the relevant depreciation amounts are allowed to be deducted from taxable income. The land-use right held by companies is usually treated as a non-tangible asset, which may be amortised and the relevant amortised amount may be deducted from taxable income.

JunHe LLP

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8 Jianguomenbei Avenue
Beijing 100005
PRC

+86 10 8519 1300

+86 10 8519 1350

zhanglp@junhe.com www.junhe.com
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Law and Practice

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JunHe LLP was founded in Beijing in 1989 and was one of the first private partnership law firms in China. Since its establishment, JunHe has become one of the largest and most widely recognised Chinese law firms. It has 13 offices around the world and a team comprised of more than 800 professionals, including over 240 partners and legal counsel, as well as over 560 associates and legal translators. JunHe is committed to providing top-tier legal services in commercial transactions and litigation, and is well known for being a pioneer, innovator and leader in the re-establishment and development of the modern legal profession in China. The firm has a great deal of experience advising international clients on China's constantly changing legal environment and its effect on their investments and operations in China. In addition, the lawyers often concurrently hold high posts in international organisations, government agencies, trade associations and arbitration tribunals.

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