On March 1, 2010 a new Chinese partnership law will come into effect, opening an alternative mode for foreign investment. The Administrative Measures for the Establishment of Partnership Enterprises in China by Foreign Enterprises or Individuals (“FEIP Measures”) permits the establishment of Limited Liability Partnerships between two or more foreign enterprises or individuals, or between foreign entities and Chinese individuals or enterprises3. The regulations also apply to partnerships established by Hong Kong, Taiwan, and Macau entities operating in China.
Partnership structures were first permitted in 1997 under China’s Partnership Enterprise Law4; however, foreign investment via partnerships has remained restricted. The opening of the partnership structure as an investment structure is significant in that it will allow easier entry into certain Chinese markets by eliminating the need for prior approval by the Ministry of Commerce (“MOFCOM”) and local agencies. In addition, the use of this partnership structure may, in certain situations, provide beneficial tax results when compared to wholly-owned foreign enterprises and equity or contractual joint ventures.
Under the Partnership Enterprise Law there are two varieties of partnerships open to foreign entities, General Partnerships and Limited Partnerships. Similar to common law jurisdictions, general partners are jointly and severally liable for the debts of the partnership whereas limited partners are liable only to the extent of their capital contributions. Under the Partnership Enterprise Law, limited partnerships must include at least one general partner. Both general and limited partners may be persons or enterprises except when such enterprise is a state-funded or owned company, a listed company, public welfare-oriented public institution, or social organization. These entities are limited from becoming the general partner of a limited partnership.
The registration procedures under the FEIP Measures are straight-forward. They require interested entities to file the following materials with the relevant local level State Administration for Industry and Commerce (“SAIC”):
- An application form for establishment registration as signed by all the partners;
- Identity certificates of all the partners;
- Power of attorney issued to the representative designated or the agent for all partners;
- The partnership agreement;
- Confirmation letters issued by all the partners for each partner’s financial subscription or actual payment;
- The certificate of the principal place of business; and
- An industrial policy compliance statement.
Pursuant to the Partnership Enterprise Law, the partnership agreement should detail each partner’s methods of contribution to the partnership, contribution amounts, and the schedule and amounts of distributions. There are no set maximum or minimum amounts for initial capital contributions.
One important feature of these new foreign partnership enterprises is a relaxation of regulatory requirements for entry into certain industries. Whereas joint ventures and wholly-owned foreign enterprises must seek approval by MOFCOM prior to engaging in investment activity, foreign partnership enterprises need only register with provincial or local branches of the SAIC. Investments in “Restricted Industries,” as defined in the Foreign Investment Industrial Guidance Catalogue (the “Investment Catalogue”), will still require MOFCOM and/or other agency approval prior to registration. To ensure adherence to these rules, the FEIP Measures require partnerships to submit an industrial policy compliance statement along with their applications to the SAIC.
Another notable feature of the partnership structure is the way in which a partnership is taxed. Both general and limited liability partners are taxed individually, the partnership itself is not liable for enterprise level taxes. Foreign individual partners are taxed according to the applicable marginal personal income tax rate and foreign enterprise partners at the Enterprise Income Tax (EIT) rate of 25 percent. The “EIT” applied to partnerships is the same as that applied to other Chinese corporate forms; the tax benefit lies instead in the absence of a tax on dividends. Unless a favorable tax treaty exists, distributions from joint ventures and wholly-owned foreign enterprises to shareholders are typically subject to a 10 percent tax rate. In a partnership, revenue passes directly to partners and therefore avoids this level of taxation.
Foreign investors may be hesitant to deviate from tried-and-true business structures and attempt a partnership for investment in China. However, the partnership form may provide many advantages to small and medium business, as well as venture capital startups. Additionally, the State Counsel has expressed its desire to use the FEIP Measures to “encourage foreign enterprises or individuals with advanced technologies and management experience to establish partnerships in China to boost the development of the modern service industry.” Paired with the recent announcement that the Investment Catalogue will be revised to encourage investment in the service industry, it is clear that China has set a course for substantial growth in this sector with partnership vehicles playing a central role as a flexible alternative to existing corporate entities.