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Access to Mainland China

By Richard Kimber Published 10/26/2007 | Business and Finance , Legal


Creating an on the ground presence in the vast Chinese market seems a daunting task but fore-warned is fore-armed. Here, we lay out the fundamentals of establishing a legal entity for business purposes.

There are several ways to establish a presence in China; how to do so will depend on your level of commitment, the size of your planned investment and the particular industry in which your company operates.

The business registration process is prone to bureaucracy and over regulation. Using an authorised agent or legal representative can assist with the process. Even when using an agent for registration, you should bear in mind that certain locations in China and special economic zones are geared to attract different types of industries and offer tax incentives or financial inducements.

When a foreign investor decides to launch a business venture in China they will need to decide whether to launch the business in the form of an actual capital investment or whether to look for local distributors or suppliers. The latter approach does not require sizable investment but you should ensure that your contractual arrangements are binding and enforceable.

Foreign investors without a comprehensive understanding of the China market may wish to test the market strength first to see whether it is worthwhile to establish a full operation in China and invest a large sum of capital.

Those with more experience and understanding of the China market who intend to conduct a full range of business activities need to establish a legal entity. In that case, the form of the entity chosen is quite crucial. Aspects that have to be considered are the sector of business and amount of money invested; if a Chinese partner is desirable or even mandatory for the business; and other general commercial and strategic considerations. Foreign investment is classified into encouraged, restricted or prohibited categories, so it is important to determine which category your industry falls within.

Measured Approval

Government restrictions on specific industries may affect the investment type made. Media, automotive and telecommunication industries are examples of industries that require foreign-invested enterprises to have local partners.

There are several ways to establish a presence legally in China; the choice will depend on your desired level of commitment, and the size of your planned investment.

Representative offices A representative office represents the interests of the foreign investor by acting as a liaison office for the parent company. Representative offices may conduct market research, and develop partnerships and business channels. However, all business transactions, including issuance of invoices, are managed by the parent company. Furthermore, representative offices may not directly hire local employees but must rely on a government-authorised employment agency.

Since representative offices do not have a minimum investment requirement, they are not considered a Foreign Invested Enterprise (FIE), and as such are the least complicated way for a foreign firm to have a legal presence in China. This is often the choice for foreign companies with little or no previous experience in the country.

Wholly Foreign Owned Enterprises
The most popular FIE, the Wholly Foreign Owned Enterprise (WFOE) is fully invested by foreign entities. Along with the rights afforded to a representative office, a WFOE may also legally conduct business transactions within China and hire its own local employees. However, WFOEs do have a minimum investment requirement that is dependent upon the locality and their type of business scope.

Equity Joint Ventures (EJVs)
These companies have capital or asset investments from both local and foreign firms. One advantage EJV companies enjoy is that they retain the special benefits of their local partner. Also, foreign firms entering industries where WFOEs cannot operate often use EJVs, although this is becoming less prevalent as more and more industries open up to WFOEs. EJVs account for about 14 percent of all FIEs.

As elsewhere, there are risks associated with entering into partnerships, and in China these are often exacerbated by disparities in culture and business practices between the foreign and local partners. Foreign companies should enter into EJVs only when both parties have reached a clear understanding of their joint business objectives. It is also equally important to conduct legal and financial due diligence of a potential local partner.

Cooperative Joint Ventures (CJVs)
CJVs are also partnerships with a local company; however, the amount of risk and profit shared by each party is not determined by capital investment but rather agreed upon at the beginning of the partnership. JVCs were used more in the 1990s when the Chinese economy was less developed. International companies often injected funds while the local Chinese companies provided equipment or were able to provide licenses or permits for the conduct of the particular business.

Sector-specific rules are often included in the basic investment forms, with a variety of different additional regulations. Laws and regulations for setting up an entity can vary substantially between industries and procedures also vary from province to province.

Mergers and acquisitions (M&As)
Recent years have shown a trend toward investing in China through mergers and acquisitions. There are many options for M&As in China, including equity and asset acquisitions as well as mergers. As a form of foreign direct investment, the general rules on the establishment of FIEs also apply to M&As.

Registration Procedures

The chart below shows the typical process for setting up FIEs and representative offices. The government offices involved in this process include the Ministry of Commerce, the Administrative Bureau for Industry and Commerce, the State Administration of Foreign Currency, the Taxation Bureau, the Customs Office and the Statistics Bureau.

Registered Capital Requirement

FIEs WFOEs and EJVs require the foreign investor to establish a minimum amount of funds abroad within China, termed Registered Capital. The purpose of the registered capital is to provide confirmation to creditors of
the companys financial adequacy.

The amount of registered capital must be declared during the licensing phase of the registration process. The total investment figure is represented by a ratio of foreign contributed capital to foreign debt.

The registered capital should cover all the initial investment expenses of a foreign entity, and should be used immediately in the companys expenses. This may include rents, salaries and product purchases. It is considered a crime to state a specific amount of funds and then not contribute. It is also a crime to inject the funds as stated and then withdraw the injection.

In theory most small to medium sized companies entering the market are required to invest a minimum of US3,700 (approx. 30,000 RMB). In practice, however, approval authorities will require more substantial registered capital and will also examine the investors projected business turnover and business scope to determine if the registered capital is sufficient.

In summary, the investment required is dependent upon the scope of business, volume of sale and company size, and is judged on a case-by-case basis. Chinese authorities will consider what would be a reasonable capital injection for each specific project in question, and where the intended investment is in the field of manufacturing will look closely at whether there are environmental impacts or waste disposal requirements.

Nature of the Business

WFOEs, EJVs and CJVs must state the nature of their business (business scope) during the licensing phase of the registration process. The following categories are not by any means exhaustive but represent the four most common forms of FIEs operating in China today.

1. Service Company
As the name indicates, the foreign firm provides services to companies within China. The company may not manufacture or trade goods. Examples of service companies include consulting and management service companies.

2. Manufacturing Company
The nature of this business allows the foreign company to produce goods for sale on premises as well as sell finished goods domestically and internationally. Manufacturing companies do not require an intermediary to sell goods locally or internationally and may import raw materials for production. The registration process, however, is often more lengthy than for other business categories, as manufacturing plants may require additional certifications, in respect of environment and waste treatment or disposal.

3. International Trading WFOE
To set up a trading WFOE, the investor has to register in a Free Trade Zone (FTZ). As a trading WFOE, the company is allowed to import and export products with no customs tax as long as trading is conducted within the FTZ. Products sold in China but outside of the FTZ require the services of an import/export agency and are subject to applicable tariffs. However, as of July of 2005, FTZ companies have been able to apply for trading rights that will allow them to trade within China without the use of an agent. Investors often choose an FTZ if they are sourcing components from suppliers in or near the FTZ or to take advantage of bonded processing precedures.

4. Foreign Invested Commercial Enterprise (FICE)
Commercial Enterprises are an FIE setup that allows foreign companies greater flexibility in terms of business activities. These activities include retail, wholesale and franchising operations. Once established, an FICE is granted both import and export rights. FICEs may also buy and sell products freely in China without an intermediary. It is also possible for manufacturing WFOEs to apply to extend their business scope to include FICE capabilities. A FICE is also the entity used for establishing retail outlets in China.

Other categories of business include Research and Development Centers, Investment (Holding) Companies and Regional Headquarters.

A clear understanding of the investment and business options available will be crucial to successfully establishing a business and operating in China. With Chinas gradual compliance with its WTO membership obligations, the business registration process should also continue to become more streamlined and transparent.

Richard Kimber has practised as a lawyer in Greater China for the past 15 years and as principal of RHK Legal has assisted over 100 companies to establish an operating presence in China. For more information, visit www.rhklegal.cn or contact Richard Kimber at [email protected]