Last month China overtook Japan as the second biggest economy in the world. With the Chinese economy worth an estimated $5.8 trillion, China is a tantalising proposition for foreign investment.
Foreign companies looking to invest in China may no longer be faced with a lack of legal and regulatory transparency, but investment into China remains challenging for foreign businesses. Careful consideration should be given to the best corporate vehicle to adopt.
The main direct investment structures available to foreign companies are:
- Representative offices (RO);
- Wholly foreign owned enterprises (WOFE); and
- Joint ventures (JV).
Tax structures will play a part in the type of corporate vehicle adopted by a foreign investor and is a subject we will examine more closely in future alerts in this series. Setting up a corporate vehicle is not, of course, the only option available to foreign investors. Alternatives include distribution, agency and franchising along with mergers and acquisitions. Even so, establishing a local presence is the most effective way to take advantage of the myriad of business opportunities available in China.
Given the alien nature of local laws and the business environment in China, foreign companies need to be fully aware of the options available to them when setting up a presence in China.
Who is permitted to invest in China?
When considering an investment in China, companies should start by checking whether their industry sector is permitted, encouraged, restricted or prohibited under the Foreign Investment Industrial Guidance Catalogue (the Catalogue).
The Catalogue, set out by the Chinese Ministry of Commerce, is applicable throughout China. However, some provinces or regions may have their own investment catalogues which provide more detailed classification of industries.
The classification of an industry as encouraged, restricted, or prohibited will impact on the level of investment permitted. Those industries not included in the Catalogue are automatically permitted.
A summary of the current position for industries covered by the Catalogue is as follows:
Click here to view table
The establishment of a RO is relatively straightforward, making it an attractive option for western businesses looking to test the water in China. Equally, exit procedures for a RO are also uncomplicated. The main requirement is that a foreign owned company should have been incorporated for two years or more.
A foreign company seeking to establish a RO is required to obtain formal registration and complete all the relevant registration procedures. These include submitting the following documents to the local Administration of Industry and Commerce (AIC):
- Certificate of incorporation of the parent company;
- Credibility letter issued by the bank in which the parent company has a bank account;
- Office lease of the premises that will be used as a RO; and
- A nomination letter for the chief representative of the RO.
The timescales for setting up a RO is relatively quick and takes no longer than a month to establish.
Wholly foreign owned enterprises
A WOFE is a Chinese legal limited liability entity established by a foreign investor. Under Chinese law it is a requirement that the establishment of a WOFE provides benefits to the national economy. As such a WOFE will not be approved by Chinese authorities if it:
- Threatens national security;
- Breaches Chinese laws or regulations;
- Has a detrimental impact on public interest;
- Does not align with the Government's five year plan; or
- Is likely to cause environmental pollution.
Specific industries where WOFEs are prohibited include media and telecommunications. As discussed above, a WOFE can only be established if the industry falls within either a permitted or encouraged category of the Catalogue.
The process of establishing a WOFE involves applying for approval from the Ministry of Commerce (MOFCOM) or the local foreign investment bureau and registration with the AIC. In some industries, such as road haulage, an additional licence is required.
In order for a foreign business to establish a WOFE a minimum amount of registered capital is required. Unfortunately, WOFE laws and regulations do not specify the minimum registered capital needed. The required level is treated on a case by case basis depending on the application made by the foreign entity.
A joint venture (JV) with a Chinese partner is another commonly used vehicle for foreign direct investment in China. Any investment made between two or more foreign entities will be treated as a WOFE rather than a JV. There are two forms of JVs open to foreign investors:
- Equity Joint Venture (EJV)
An EJV takes the form of a limited liability company created by one or more Chinese parties and one or more foreign parties. It is a cross between a corporation and a partnership. It can own assets and responsibility for its liability lies with the company itself. Each party's liability will be capped at its total capital contribution. Equally, profits must be awarded in proportion to their respective contributions to the registered capital rather than financial support.
- Contractual/Cooperative joint venture (CJV)
A CJV is a contractual relationship setting out the partnership between one or more Chinese parties and one or more foreign parties. Investments are not necessarily calculated in financial terms. For example, the Chinese partner may contribute local "know-how" and take responsibility for administrative arrangements.
Profits will be shared in accordance with the terms of the JV agreement and earnings may not be distributed in cash, but by way of products or shares. The options for sharing risk, obligations and management will be determined by the parties as set out in the JV agreement.
The CJV is seen as a more flexible structure than an EJV and can be tailored to suit the party's requirements. Unlike an EJV, the foreign party can enjoy priority in recovering its investment.
Approval of JVs is similar to that of a WOFE. It requires an approval process with MOFCOM or the local foreign investment bureau and adherence to the registration procedure with AIC. As with WOFE, some industries require an additional licence. The main difference between incorporating a WOFE and a JV is that undertaking due diligence, along with negotiating and signing the JV agreement with a Chinese partner, can take considerable time.
The registered capital required for a JV will also be treated on a case by case basis, and determined on application.
The key aspects of a RO, WOFE and JV are set out below:
Click here for table
Before a foreign company sets up in China it is important for it to review its current investments and future business plans to determine the optimal corporate vehicle to adopt. Not only does a company need to select the right corporate vehicle, it should also consider its intellectual property, day-to-day contracts and employment law.