Establishing an Enterprise in China

Following 3 decades of intensive economic growth, growing private consumption, convenient infrastructure and competitive work force, China today is the focus for international investors and companies from a wide range of sectors. Choosing the right legal vehicle for you business in China is important milestone for entering the market and reflects on varies issues that have to do with funds transfer, marketing, sales and other tax related issues. Here you can find a summery on the different forms of conducting your business in China.

The below information is courtesy of Deloitte Touche Tohmatsu.
Updated: January 2008

Principal forms of doing business
Establishing a branch
Setting up a company

Principal forms of doing business
Foreign investors may invest in China through legal entities or non-legal entities. Legal entities that can be set up by foreign investors generally include wholly foreign-owned enterprises (WFOEs), equity joint ventures (EJVs), co-operative joint ventures (CJVs) and joint stock companies. Non-legal entities include representative offices (ROs) and branches, as well as certain CJVs. Another more recently developed investment vehicle is the partnership enterprise.
WFOEs continue to outpace EJVs as the favoured investment vehicle. Although the number of WFOEs has risen significantly, some foreign investors may still favour a non-legal entity (eg an RO), depending on the specific facts and circumstances. An investor’s particular commercial considerations, any applicable regulatory limitations and home country tax considerations may play a role in determining the most appropriate form in which to conduct business.

Foreign investment enterprise
FIEs generally refer to Chinese entities with at least 25% foreign investment. FIEs are permitted to conduct business activities in accordance with the scope of their business as approved by the government authorities. FIEs are mainly organised as limited liability companies, and the investor’s ownership in an FIE is represented by the amount of registered capital it injects into the entity. FIEs do not issue common or preferred shares.
The main forms of corporate entity for FIEs in China are the WFOE, the EJV and the CJV.
Wholly foreign-owned enterprise. A WFOE organised as a limited liability company is generally a desirable investment vehicle for foreign investors provided the investment regulations do not require the participation of a Chinese partner. The limited liability company offers foreign investors sole control of the business operation and avoids lengthy negotiations with the Chinese partner, as in the case of an EJV or CJV.
There is no legal minimum or maximum capital contribution requirement for a foreign company to establish a WFOE. Capital may be contributed as hard currency or tangible assets or (with approval) renminbi. Valuation must be consistent with international principles. Under the Company Law, in theory industrial property and technology may not exceed 70% of the registered capital of the enterprise. When capital is contributed in instalments, the first instalment must be not less than 20% of the total contributed capital and must be delivered within 90 days from the date the business licence is issued. The deadline for completing the contribution is two years from the date the business licence is issued.
There is no mandatory management structure for a WFOE, but the articles of association must set out a structure in detail (including the duties and limits of authority of the legal representative, chief accountant, general manager and chief engineer). The articles of association must specify procedures for termination and liquidation and for amending the articles.
Equity joint venture. An EJV, organised as a limited liability company, is a separate legal entity established by one or more foreign and one or more Chinese investors. Ownership and the share of profits and losses are determined based on the respective contributions to the registered capital of the EJV.
Generally, the minimum level of foreign participation in an EJV is 25%. There is no upper limit on foreign participation. Capital can be contributed in the form of cash, with foreign currency converted into renminbi at the exchange rate announced by the SAFE on the day the funds are submitted. In certain cases, capital may be contributed in the form of tangible assets (eg equipment, buildings and other material) or intangible assets (eg industrial property rights and know-how). When participants in an EJV contribute tangible or intangible assets, their value is determined jointly by the participants or by a third party designated by the participants, generally a China-registered accountant.
There is no official upper percentage limit per se on the amount of intangible assets that can be provided by a foreign partner. However, as the new corporation requires a minimum cash contribution of not less than 30% of the JV’s total registered capital, it is unlikely that any contribution of intangible assets could exceed 70% of the registered capital.
Partners must pay their contribution within a timetable fixed in the contract. Failure to make capital contributions on time may lead to cancellation and compulsory surrender or revocation of the business licence.
The governance of an EJV is different from that of corporations in the West. Investors hold equity interest, but no stock. Voting authority is vested in the board of directors rather than the shareholders. The directors are appointed by the investors and, in general, reflect the ratio of the capital contributions of the partners. EJVs generally have a limited duration, typically 30 years.
Contractual or co-operative joint venture. A CJV differs from the EJV in two fundamental ways. A CJV does not have to be a separate legal entity, and even if a CJV is not incorporated as a limited liability company in its own right, it may elect to be taxed at the entity level. In most cases, a CJV elects to be treated as a taxable entity rather than a flow-through primarily in order to have more clarity of tax treatment. A CJV that is incorporated as a limited liability company is subject to tax at the entity level. The ownership and profits/losses are not necessarily shared based on equity contributions (as in the case of an EJV) but on the basis of a contractual agreement. The CJV thus may provide more flexibility with respect to profit-sharing and risk-taking among the partners. For example, the shareholder(s) may be guaranteed a certain amount of fixed annual return without regard to the actual performance of the CJV.
Capital is contributed in a ratio agreed by the parties to the CJV contract. Contributed capital may take the form of cash, land-use rights, technology (patented or unpatented), materials and equipment, trademarks and other property rights—essentially the same as for an EJV. As with EJVs, foreign partners’ contributions in the form of intangible assets generally may not exceed 50% of the total foreign capital contribution or 20% of the CJV’s total registered capital. Unlike an EJV, parties to a CJV may share profit in a ratio that differs from the ratio of capital contributions.
A CJV must have a board of directors or a joint-management committee. “Hybrid” CJVs tend to adopt management systems resembling those of the EJV; “true” CJVs tend to take the more flexible form of a joint-management office. Under the latter structure, no general manager exists as such, although the parties usually appoint a legal representative. Generally, “true” CJVs, which do not have independent legal status in China, use the Chinese partner to enter into such contracts, under a grant of power of attorney by the foreign party.

Foreign investment joint stock company
China is opening up its stockmarket to FIEs and foreign investors. FIEs are increasingly likely to be listed on Chinese stockmarkets (both A- and B-shares) and overseas stockmarkets. Only foreign investment joint stock companies (JSCs) qualify for public listing; any FIEs that are planning to be listed on a Chinese stockmarket must be converted into a JSC, which generally means that the registered capital must be converted into stock of the company.
The minimum registered capital of a JSC limited company is Rmb5m. However, JSCs wishing to list shares on a stock exchange must have total share capital of at least Rmb30m. A JSC with foreign investment must have total registered capital of at least Rmb30m. In most cases, the foreign share capital should not be less than 25% of the registered capital. As with WFOEs and JVs, capital may be contributed in the form of cash, tangible assets, proprietary technology or land-use rights needed by the company for production and business purposes.
JSCs may be established through a sponsorship or share offer. Shanghai regulations require companies with foreign investment to be established through a sponsorship (that is where all the shares to be issued by the company are subscribed to by the sponsors themselves). Sponsors of a company limited by shares must be legal persons or departments that have been authorised by the state to make investments. Where the sponsor of a company limited by shares is a Chinese-foreign EJV or CJV, the parties to the venture should reach an agreement on their respective rights and obligations following establishment of the company. In Shanghai, before establishing a company limited by shares, the sponsors should reach an agreement and jointly select a sponsor registered in the Shanghai municipality to apply for establishment of the company.
A company limited by shares is governed by its articles of association, which must be approved by the local examination and investment-approval authorities. The articles outline the system of management and control that is to govern the company. They detail the rights and obligations of the shareholders; the official powers and rules of procedure of the shareholders’ general meeting; the establishment, official powers and rules of procedure of the board of directors, supervisory board and manager; and the procedure for amending the articles of association.
The board of directors, which should have 5–19 members, is the permanent executive organ of the shareholders’ general meeting. Shareholders and non-shareholders may serve as directors. The board of directors generally has one chairman (who is the legal representative of the company) and, when necessary, one or two vice-chairmen. The chairman and vice-chairman are typically appointed by different parties to the JV. The manager of the company is appointed and dismissed by the board of directors and is the person in charge of the company under the board of directors. Generally, the chairman of the board of directors may not concurrently hold the position of manager. A supervisory board composed of no fewer than three members (one-third of whom must be staff and workers of the company) supervises the activities of the board of directors and management personnel.
All the capital must be divided into equal shares represented by share certificates. They may be ordinary or preferred shares (the latter generally have no voting rights). Companies must receive approval from the local branch of the central bank and other authorities to issue both A-shares (denominated in renminbi and available to Chinese citizens and to qualified foreign institutional investors) and B-shares (denominated in US dollars). A-shares are further divided into shares owned by individuals, legal persons and the state. In the past, while A-shares owned by individuals may be traded freely through a securities trading house under relevant laws and regulations, A-shares owned by a legal person or by the state may not be traded freely (although there are plans to makes such shares freely tradeable).

Partnership
There is no legal minimum or maximum for capital contributed by the partners to a partnership enterprise. As with WFOEs and JVs, capital may be contributed in the form of currency, in kind or in the form of land-use rights, intellectual property rights or other property rights. Contributions other than currency must be appraised at a specific value. Partners may increase their capital contributions to the partnership enterprise, as stipulated in the partnership agreement or as decided by all of the partners. Such additional contributions should be used to expand the scale of business or to make up losses.
There are no specific limits on the number of partners to a partnership enterprise. Under the law, each partner has equal rights in the conduct of routine affairs. The admission of new partners is subject to the approval of the partners and the conclusion of a written partnership agreement according to law. New partners have the same rights and responsibilities as the original partners.
The partners may jointly run the routine affairs of the partnership enterprise, as stipulated in the partnership agreement unless they decide otherwise. One or more partners may be entrusted with running the routine affairs of the partnership enterprise. However, the non-managing partners have the right to supervise managing partners and inspect operations. The partnership agreement must outline the methods for distributing profits and sharing losses; how routine affairs are conducted; admission to and retirement from the partnership; dissolution and liquidation; and legal liability.

Chinese holding company
Foreign investment can also be accomplished through a Chinese holding company. A Chinese holding company is a company engaged generally in investment and management activities in China. To qualify to set up a holding company, approvals are required and the registered capital of the company should not be less than US$30m.

Taxes and fees on incorporation
All forms. Fees payable are calculated on the following basis: Rmb10m or less, 0.1% of registered capital (with a minimum of Rmb50); portion in excess of Rmb10m, 0.05%; portion in excess of Rmb100m, no fee. With any increase in registered capital, the same fees are payable again on the entire new amount. Fees of Rmb100 each apply to advance registration of a venture’s name and to recording ordinary changes in registered items. Companies must also pay an annual registration-inspection fee of Rmb50.
Partnership. No taxes or fees on incorporation are required.

Establishing a branch
Branches. Any company may set up a branch of a foreign company, although it may be necessary to obtain approval. A branch remains part of its head office company and thus is not entitled to the rights and protection accorded to Chinese legal entities. A branch must appoint a Chinese legal representative and it is liable under civil law for its business activities. A branch may be closed only after a formal liquidation.
Representative offices. Foreign companies, particularly those in the services industries, continue to rely on representative offices (ROs) to conduct business. Although ROs allow foreign investors to enter the Chinese market with little initial investment, they are prohibited from direct profit-making activities.
In general, an RO of a foreign company may only engage in non-operational business activities in China, including the following:
n Liaison with clients of the head office;
n Introducing the products of the head office;
n Market research; and
n Collection of information.
Thus an RO of a foreign company may not sign and conclude contracts with Chinese customers directly and is prohibited from engaging in any “direct business operations” (with certain exceptions, such as the representative office of a law firm).
Foreign companies must apply to the ministry at the local or national level, depending on the business, to set up an RO.
Foreign financial institutions must follow separate rules to establish ROs. Special rules also apply for ROs in the Shenzhen SEZ, Guangdong province and the Shanghai municipality. Despite differences in the details of these provisions and those of the national registration regulations, the basic registration procedure remains the same: (1) formal approval to establish the office must be obtained; and (2) formalities must be completed with the SAIC to obtain a registration certificate.
The central bank is responsible for granting registration certificates to ROs established by foreign banks and insurers.

Setting up a company
WFOEs are spreading from small-scale, export-directed manufacturing projects to domestic transport, high-tech and integrated manufacturing/investment conglomerates. WFOEs have been allowed to operate in the wholesale, retail and trade sectors since 2004. Some municipalities, such as Qingdao in north-eastern Shandong province, are encouraging WFOEs as a way to buttress foreign-investment interest and reduce potential disputes.
For foreigners, WFOEs offer a simpler approval procedure and complete management control. Foreign companies also often use the WFOE form to protect technology. WFOE status permits greater use of renminbi to pay for business expenses and local sales.
To establish a JV, it is critical to select an appropriate Chinese partner. The following are some factors that should be considered: a potential partner’s access to domestic financing; its ability to provide a domestic market for its products; the skills level of its labour force; and its integrity and strength of management.
The holding company format can offer certain economies of scale in operations and management through its collection of investments under one corporate identity. These include centralised purchasing of production materials, collective training of subsidiary-project personnel, co-ordination of project management and the establishment of a single entity to market all subsidiary products.
By contrast, JSCs—or companies limited by shares—offer different advantages. An FIE opting for this corporate form can invite the participation of shareholders in the company, both to expand capital and to secure links with other legal entities in China. A JSC also offers greater liquidity in transferring interests. Both EJVs and CJVs normally require the prior consent of the other partners, as well as the original examination and approval authority to transfer interests. Companies limited by shares need no prior consent from others to dispose of interests, although the promoters must wait one year from the company’s first registration before assigning their shares.
Some drawbacks of the shareholding corporate forms are the complex approval process and more restrictions on an FIE in terms of capital increases, statutory reserves and the level of public disclosure. Other disadvantages include the following:
n Stricter definitions on the internal workings of the company, including the functions and powers of shareholders’ meetings, and the composition and duties of boards of directors.
n Stricter definitions of who may serve as a company officer. Certain individuals may not act as a director, supervisor or manager of a company.
n Greater worker participation in management. Compared with WFOEs and JVs, companies must obtain the opinion and suggestions of the trade union and employees before deciding on major production and operational issues.