Direct distribution

Ownership structures

May a foreign supplier establish its own entity to import and distribute its products in your jurisdiction?

Under the current regulatory environment, a foreign supplier may establish its own entity (wholly owned) to import and distribute its products in China, subject to some exceptions such as certain audi0visual work, agricultural products and gasoline where joint venture arrangements remain as the requisite structure to attain approval. There are some product categories that are still not open to foreign investors such as genetic testing equipment and military products, and local importers and distributors have to be engaged for importing these products.

May a foreign supplier be a partial owner with a local company of the importer of its products?

As mentioned, a foreign supplier may enter into a joint ownership arrangement with a local company or importer for the importation of its products, except products that are still not open to local trading by foreign investors. There are two major joint ownership structures: joint ventures in China and limited liability companies invested by the parties in China. For a joint venture in China, there is a choice of two types: equity joint ventures and contractual joint ventures. For an equity joint venture, each party must make a cash or permitted contribution and share the profits in proportion to its subscribed percentage of the venture’s registered capital. For a contractual joint venture, the parties may agree in the joint venture contract that profits will not be distributed in proportion to the subscribed percentage of the venture’s registered capital. Parties can invest in limited liability companies with a direct shareholding structure to set up holding companies outside China (using locations such as Hong Kong owing to certain tax considerations) and then the Chinese entity can be placed under such offshore holding structure.

What types of business entities are best suited for an importer owned by a foreign supplier? How are they formed? What laws govern them?

Unless it is required by law that a joint venture be established, from a corporate management perspective, a wholly foreign-owned enterprise (WFOE) is generally the preferred type of business vehicle for a foreign supplier to import and distribute its own products. A WFOE will be incorporated as a limited liability company in which the foreign supplier is the only shareholder. The establishment, operation and termination of the WFOE is governed by the Company Law of the People’s Republic of China (PRC) and the Law of the PRC on Foreign-invested Enterprises. There are different local approval procedures for certain businesses.

Restrictions

Does your jurisdiction restrict foreign businesses from operating in the jurisdiction, or limit foreign investment in or ownership of domestic business entities?

The Chinese regulatory environment is more focused on the regulation of business than on the ownership of business entities, and the scope of business of a business entity is specifically defined in the corporate formation documents. In essence, conducting any business beyond the approved scope of business is illegal. Foreign investors are required to follow the Catalogue of Industries for Guiding Foreign Investment (Catalogue) to verify whether the proposed business is restricted under national and local regulations. In the Catalogue all industries are divided into three groups:

  • encouraged industries;
  • restricted industries; and
  • prohibited industries.

Foreign investors are not allowed to conduct business, or invest, in prohibited industries and are subject to several restrictions for investing in restricted industries. The Catalogue may be subject to changes by the government from time to time.

Equity interests

May the foreign supplier own an equity interest in the local entity that distributes its products?

See question 3.

Tax considerations

What are the tax considerations for foreign suppliers and for the formation of an importer owned by a foreign supplier? What taxes are applicable to foreign businesses and individuals that operate in your jurisdiction or own interests in local businesses?

The major relevant taxes are corporate income tax, value added tax and customs duties. China also follows the Organisation for Economic Co-operation and Development model on the issue of transfer pricing. The tax authority in China has been using the industrial average profit margin generated from its database to determine whether the assessable income should be adjusted due to certain transfer pricing arrangements between related companies.