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While domestic companies have a wide range of alternatives in establishing business operations in China, foreign companies are more restricted, with the most common business vehicles for foreign investors being:
– Representative Offices
– Wholly Foreign Owned Enterprises
– Joint Ventures (Cooperative and Contractual)
1.0 Representative Offices
General
The fastest and easiest method for a foreign company to establish a presence or ‘footprint’ in China is through registration of a Representative Office of a foreign company. While this is true, there are certain factors that must be considered when deciding whether an RO is the appropriate structure:
i) ROs cannot conduct direct profit-making activities (cannot earn income) and may only serve a liaison function between head office and suppliers/distributors/customers in China;
ii) ROs do not have separate legal personality and may only contract or conduct business on behalf of head office;
iii) practically, ROs are limited with regards to business relations with Chinese companies who may prefer to deal with Mainland registered company;
iv) taxes must still be paid (though there are no profits);
v) ROs, while simple to establish, are relatively more complex when closing.
An RO is permitted to:
– Conduct data collection and research on local market
– Liaise with local contacts on behalf of parent company
– Coordinate parent companies activities in China such as contract negotiations
– Coordination of warranty and after-sales service
– Conduct services for parent company such as coordination of import, export, and distribution of products
An RO is not permitted to:
– Directly engage in business for profit
– Sign contracts on its own behalf
– Represent entities other than the parent company
– Collect money or issue invoices for products or services
Representative offices are governed by the Procedures for the Registration and Administration of Resident Representative Offices of Foreign Enterprises in China and the Detailed Rules of the Ministry of Foreign Trade and Economic Cooperation for the Implementation of the Provisional Regulations Governing the Examination, Approval and Administration of Representative Offices of Foreign Enterprises.
Registration
Unlike many other countries, Representative Offices in China are subject to registration requirements. A filing must be made with the local Administration for Industry and Commerce, which, if successful, will issue an Approval Certificate for the Representative Office. Thereafter, a number of filings with other authorities such as the Foreign Exchange Bureau must be made, and a ‘Business License’ issued by the local Administration for Industry and Commerce.
Registration is generally valid for only three years and application must be made prior to expiration for renewal of the term.
It is important to note that in order to establish an RO in China, it is necessary to establish a physical office space (in cities such as Shanghai, only certain commercial buildings may be used to register ROs).
2.0 Wholly Foreign Owned Enterprises
General
Wholly Foreign Owned Enterprises (WFOEs) or limited liability companies whose investors are purely foreign are quickly becoming the most popular method of foreign investment in China. While foreign companies once thought (and were often compelled by laws) that a local partner was necessary to operate business in China, this is increasingly no longer the case in a wide range of industries.
Characteristics of WFOEs:
– Between one to fifty shareholders
– Restricts the right to transfer shares
– Prohibits public offering of shares
– Equity is divided based on contribution to registered capital and not allocation of shares
– Liability is limited to the amount of registered capital contributed
WFOEs are governed by the Law of the PRC on Enterprises Operated Exclusively with Foreign Capital, and relevant implementing regulations.
Advantages of WFOEs:
– Management control
– Simpler establishment procedures
– Easier to terminate
– Easier to increase investment
– Protection of intellectual property
Disadvantages of WFOEs:
– Lack of experience and local connections
– May not be listed on stock exchange
Establishment
There are a number of steps required to establish a WFOE:
– Filing of articles of company introduction letter, articles of association, feasibility study, and other corporate documents with the local foreign commerce bureau for approval and issuance of Foreign Investment Approval Certificate.
– Collateral filings with other government authorities such as:
o Local and national tax bureaus
o Foreign exchange bureau
o Customs bureau
o Statistics bureau
o Public security bureau
– Within 30 days of obtaining Foreign Investment Approval Certificate, obtain temporary Business License from the Administration for Industry and Commerce
– Make Registered Capital Contributions and Audit by Domestic Accounting Firm
– Submit investment report to Administration for Industry and Commerce to obtain Permanent Business License
Important considerations
Name
A company name must be in both English and Chinese, though, for practical purposes, only the Chinese name is important. It cannot be identical or similar to a previously registered company name. The name can be pre-reserved for a period of up to six months, which will expire if not used for establishment purposes during this time.
Business scope
Unlike companies in many western nations where they are permitted to do any range of business activities unless otherwise stated in laws and regulations, foreign investors in China are required to define their company’s business scope at the outset of operations and must conduct business within this scope, subject to modification through re-application.
Registered capital
As per the business scope defined, a foreign investor will be required to invest a certain minimum amount of capital which must be registered or recorded with the appropriate authorities as having been made to the WFOE. Generally, this amount will range from RMB 30,000 to several million RMB for larger projects. Capital must simply be invested into the company and recorded as having been made with the local administration for industry and commerce.
Shareholders
Shareholders must all be foreign and there must be between one to fifty who hold an interest in the WFOE.
Directors
The WFOE must designate a board of directors (or single director) who shall act for the initial term of office (as set out in the articles of association).
Legal Representative
Only one individual may bind the WFOE through simple signature (without use of company chop), and they must be designated as the Legal Representative in the formation documents.
Senior Managers
At a minimum, the WFOE must designate its first general manager.
From a purely legal perspective, the directors, senior managers, supervisor and other senior personnel do not have to be a resident in China, though it may be more practical to do so.
Supervisor(s)
At least one individual who is not a Director or Senior Manager must act as the WFOE’s supervisor.
Physical address
Each company must have a unique physical address at which the company is registered. Unlike other nations in which virtual offices are permitted, China requires that a company have a physical office space.
Annual filing
Within three months of the end of each calendar year, the WFOE must undergo an annual inspection. Prior to the annual inspection, the firm must hire a domestic accounting firm to conduct an audit of the books.
3.0 Joint Ventures
Joint Ventures, in this specific context, refer to a registered legal entity cooperation between at least one foreign investor and Chinese investor. Previously, this structure was more common, though it has been steadily decreasing due to the disadvantages set out below.
Joint Ventures can be classified into two different types:
– Equity Joint Ventures
– Cooperative Joint Ventures
The main distinction between the two is that the latter provides for more flexibility in distribution of revenues. Whereas Equity Joint Ventures require that the joint venture partners share in distribution of profits based on their proportionate contribution to registered capital, Cooperative Joint Ventures allow for distribution and sharing in losses based on the contractual terms of cooperation rather than on monetary/asset contributions.
Equity Joint Ventures are governed by the Law of the PRC on Equity Joint Ventures, and relevant implementing regulations.
Cooperative Joint Ventures are governed by the Law of the PRC on Cooperative Joint Ventures, and relevant implementing regulations.
Some advantages of Joint Ventures include:
– Only option, as industry is Restricted
– Guanxi (connections)
– Quick establishment/contribution of existing facilities
– Local expertise
Some disadvantages include:
– Inflexibility
– Difficulties in expanding investment (partners have pre-emptive right to purchase newly issued capital and transferred shares to third parties)
– Differing business plans
– Differing management styles
– Exposure and theft of intellectual property
Establishment
Establishment of a Joint Venture is very much similar to that of a WFOE, with the addition of one key document, the Joint Venture Contract. The Joint Venture Contract has many of the same features as a WFOE’s articles of association, however, it contains more terms akin to a Shareholders’ Agreement.
This type of documentation and negotiations with the Chinese party can get quite complex and will usually require the assistance of a lawyer.
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Source by Gregory Sy
