Inside the Foreign-Subsidiary Loophole That Shook the US-China Chip War

How the Loophole Emerged: The May 2025 Rescission

The Biden administration issued the AI Diffusion Rule on January 15, 2025, with compliance requirements set to take effect on May 15, 2025 . The rule aimed to restrict global access to advanced AI chips and prevent diversion to prohibited end users, particularly Chinese military and intelligence actors.

In May 2025, the Trump administration rescinded that rule before it could take full effect, and Commerce Under Secretary Jeffery Kessler instructed BIS enforcement officials not to enforce the rule while a replacement was being developed . The replacement rule never materialized during the subsequent year.

This created a roughly one-year enforcement vacuum. Because the rescinded rule had never clearly closed the "foreign subsidiary" channel, Chinese firms were able to order advanced chips through offshore entities without facing export license requirements . The Foundation for Defense of Democracies characterized the move as the Commerce Department "partially suspending controls on the sale of high-end chips to Chinese firms" .

Scale of the Damage: Hundreds of Thousands of Chips

Reuters, citing chip-industry sources, reported that an estimated hundreds of thousands of advanced chips may have been exported to Chinese entities through this loophole during the year-long regulatory vacuum . The specific chips include Nvidia's Blackwell and Rubin processors and AMD's MI350x accelerators .

The exact number remains uncertain and likely unknowable. The BIS guidance explicitly notes that firms could "continue to operate already-purchased components" , meaning chips that already reached Chinese-linked entities remain in their hands. Existing licensed sales of lower-tier chips also continue under earlier terms .

China's Response: Accusations of Abuse and Supply Chain Disruption

On June 4, 2026, China's Ministry of Commerce responded through spokesperson He Yongqian, who said the United States' "abuse of export controls has seriously undermined the stability of global semiconductor industrial and supply chains" . China expressed "high concerns" over the US actions and urged Washington to "correct its practices" .

The statement fits a consistent pattern of Chinese official responses to US semiconductor export controls dating back to October 2022, when Beijing first accused Washington of "weaponizing" export controls and using them as tools of "technological hegemony" .

The Parallel Subsidy Dispute: China Rejects OECD Report

In a separate statement the same day, China's Ministry of Commerce rejected a recent OECD report that found Chinese manufacturing firms receive three to eight times more state subsidies than their OECD counterparts . The OECD MAGIC database—which tracks subsidies received by 525 of the world's largest manufacturing groups across sectors including semiconductors—documented $108 billion in industrial subsidies across 15 key sectors in 2024 .

China's commerce ministry said the OECD report "lacks rigorous conceptual definitions, suffers from biased sample selection, and draws one-sided and arbitrary conclusions" . The ministry argued that the report's definition of "subsidies" lacked uniform measurement standards and deviated from multilateral frameworks such as the World Trade Organization . China further contended that its firms' global market share gains stem from "economies of scale, production efficiency, and technological iteration" rather than state support .

Broader Implications for the US-China Technology Rivalry

The episode illustrates a structural challenge in US export control policy: rules designed by one administration can be dismantled by the next, creating windows of opportunity for adversaries. The AI Diffusion Rule rescission was part of a broader Trump administration pattern—the 50 percent Affiliates Rule, which required BIS to investigate companies with significant ownership ties to blacklisted Chinese entities, was also suspended for a full year immediately after being announced .

The May 31 guidance represents an effort to assert control without provoking an immediate crisis. It is "enforcement clarification, not a sweeping ban" . Already-shipped products remain in customer hands, and existing licensed sales of lower-tier chips continue . The approach allows the Commerce Department to demonstrate toughness without disrupting ongoing trade negotiations.

Whether the guidance effectively blocks future circumvention remains an open question. Chinese firms pursued deliberate strategies to route purchases through third-country subsidiaries during the enforcement gap , and legal ambiguities persist around how nationality-based licensing interacts with complex multinational corporate structures.