Attention! Major changes to the “three funds” contribution rules of Chinese FIEs!
In June 2025 the Ministry of Finance issued the Notice on Financial Treatment Issues after the Implementation of the Company Law and the Foreign Investment Law, fundamentally revamping the reserve-fund regime for foreign-invested enterprises (FIEs). The core change is the abolition of the long-standing three-fund contribution system, aligning the profit-distribution rules of FIEs with those of domestic companies.
Effective 1 January 2025, FIEs will no longer set aside a reserve fund, an enterprise-development fund or an employee bonus and welfare fund. Existing balances in the reserve fund will be reclassified as statutory surplus reserve, while balances in the enterprise-development fund will become discretionary surplus reserve.
-
Background to the change
The adjustment is needed to ensure a smooth transition after two key statutes took effect.
-
The amended Company Law (revised December 2023) entered into force on 1 July 2024.
-
The Foreign Investment Law has been in effect since 1 January 2020 and provided a five-year grace period allowing FIEs to retain their original organizational forms and related rules until 1 January 2025.
Once the grace period ends, FIEs must fully apply the Company Law. The Ministry of Finance’s new notice clarifies how the legacy “three funds” will be handled.
-
How the three funds are treated
The notice introduces three headline changes:
a) Stop contributing: From 1 January 2025 no FIE may accrue the three funds. Any contributions made after that date must be reversed.
b) Convert balances: Reserve-fund balances become statutory surplus reserve; enterprise-development-fund balances become discretionary surplus reserve. Non-corporate FIEs must follow the same approach.
c) Employee welfare fund: Existing employee bonus and welfare funds may still be used for their original purposes under the original conditions and procedures. Upon liquidation, any portion that should be treated as a liability will be handled in accordance with the rules on liquidation-period financial management for FIEs. -
New rules on discretionary surplus reserve
Under the new framework, extraction and use of discretionary surplus reserve must observe the following:
-
Order of application: When covering losses, discretionary and statutory surplus reserves must be used first; only if these are insufficient may eligible capital surplus be used.
-
Permitted capital-surplus items: Only two categories of capital surplus may be used to offset losses—(i) premiums on capital contributions in cash or in kind, and (ii) capital injections received through debt assumption, debt forgiveness or donations.
-
Specific restrictions: Capital surplus earmarked for specific shareholders or restricted purposes cannot be used to offset losses without the explicit consent of the entitled party. Conditional capital surplus can only be used after the amount is fixed.
-
Practical steps for FIEs
To transition smoothly, FIEs should:
-
Convert accounts immediately: Cease accruing the three funds and, in the 2025 interim or annual financial statements, reclassify reserve-fund balances as statutory surplus reserve and enterprise-development-fund balances as discretionary surplus reserve.
-
Conduct a compliance check: Verify whether any three-fund accruals were made after 1 January 2025 and reverse them if necessary.
-
Strengthen governance: Establish formal procedures for the extraction and use of reserves. Any plan to offset losses with capital surplus must be prepared by management, reviewed by the board and approved by the shareholders’ meeting.
-
Enhance disclosure: FIEs using capital surplus to cover losses must disclose the amount separately under “undistributed profits” in the notes to the financial statements and, within 30 days after the shareholders’ resolution, notify creditors or make a public announcement.
-
Impact and risk mitigation
The change offers opportunities but also carries risks:
-
Capital release: Eliminating the mandatory three-fund contributions will ease FIEs’ cash burdens. Experts at Central University of Finance and Economics estimate the freed-up funds can be channeled to R&D, dividends or debt repayment, improving liquidity and operational vitality.
-
Compliance risk: Failure to convert balances or continued accrual after 1 January 2025 will constitute non-compliance. The 1 January 2025 cut-off must be strictly observed.
-
Governance challenges: Non-compliance with decision-making procedures (shareholder approval, creditor notification) when using reserves to offset losses may invalidate resolutions and lead to litigation.
-
Employee interests: After contributions to the employee bonus and welfare fund cease, alternative mechanisms must be created to safeguard employee benefits and avoid labour disputes.
-
Recommended response strategy
FIEs should adopt the following measures:
-
Redesign the system: Replace the legacy three-fund mechanism with a profit-distribution framework aligned with the Company Law, incorporating statutory and discretionary surplus reserves. Draft a “Profit Distribution Management Policy” specifying extraction ratios, usage conditions and approval authority.
-
Re-engineer processes: Establish an internal workflow for loss coverage using reserves, covering four key steps: (1) finance department prepares the plan, (2) auditor reviews, (3) board deliberates, (4) shareholders vote. When capital surplus is used, add creditor-notification steps.
-
Seek professional support: For complex capital transactions, engage qualified advisers to verify asset values and ownership, preventing future disputes.
-
Communicate with stakeholders: Proactively explain the changes to shareholders, creditors and employees—especially adjustments to employee benefits—to ensure a smooth transition.