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Q: What are the options for foreign enterprises to establish a permanent presence in China?

There are three main forms business establishments can take for foreign companies operating in China:

1) Representative Offices

2) Joint Ventures and

3) Wholly Foreign Owned Enterprises.

The form chosen by a foreign investor is dependent on many factors:

1. How active one wants to be in China
2. The industry one is investing in
3. Whether or not a Chinese partner is necessary, either because it is required by law or to benefit from the partner's experience within and access to the Chinese market.

One of the popular forms of foreign company establishment is a Representative Office. The downside to this establishment type is that Representative Offices are very limited in the activities they can carry out. They can not carry out direct business activities and are limited to activities such as market research and liaison. In practice, some Representative Offices exceed their business scope and thus leave themselves open to negative legal ramifications.

If a foreign company wants to legitimately carry out profit making business activities in China then they must set up a Joint Venture with a Chinese partner or a Wholly Foreign Owned Enterprise (WFOE). Many investors prefer Wholly Foreign Owned Enterprises to Joint Ventures as it gives them full control over their business. However, there are certain industries in which a Wholly Foreign Owned Enterprise cannot be established, although this list is getting progressively shorter. Some investors do still choose to cooperate with a Chinese partner and form a Joint Venture for strategic reasons. In general, though, WFOEs are gaining popularity, mainly because they are easier to establish now than in the past.

Related FAQs From the topic Foreign Invested Enterprises

1.Representative offices may not carry out direct business activities. What does this mean and are representative offices subject to taxation?2272

Representative offices may promote but must not sell. That is, under Chinese law, Representative Offices may not engage in direct business activities and therefore should not directly generate profits. Permitted activities include establishing and arranging contacts, rendering advice, preparation of market studies, and general collection of information and liaising with authorities and business partners. Representative Offices may not bill clients or sign contracts.

It should be noted, however, that it is advisable to seek professional advice before opening a representative office in order to ensure that its activities fall within the permitted scope and that all tax benefits are applied.
2.I set up a representative office for my international company in China, but things have not worked out. How do I go about closing the office down and discontinuing my business?2271

Closing down a representative office in China can be a lengthy process if it is not handled in the correct way, particularly if the office was not originally established entirely in accordance with the law, but rather through “back-door” connections. China’s legal system is becoming more and more transparent and administrative bodies are increasingly enforcing the law, so it pays to do things the right way. Simply walking out of the country is not the way to go!

There are several steps required to close down an office.

Firstly, tax payment certificates and receipts from the national and local tax bureaus must be given to the authority responsible for closing the office, along with a brief statement about the settlement of debts and credits. The Tax Bureau will require the closure audit report to be approved by a Certified Public Accounting firm.

Secondly, various documents need to be prepared and given to the relevant authorities. Cancellation forms need to be submitted to the Industrial and Commercial Bureau, along with a detailed explanation as to why the office is closing. Both Chief Representative and the authorised person of the parent company must sign the forms. A separate application also needs to be made by the holding company’s letterhead, and must be stamped with the holding company’s seal. There must also be a board resolution that agrees to the closure of the office or a statement expressing the company’s wish to close the office, signed by the chairman of the parent company. The Certificate of Incorporation must be returned to the Industrial and Commercial Bureau.

Furthermore, the bank must provide a notice that confirms the cancellation of the office’s bank account. The official seal and financial seal should be returned to Public Security Bureau. If all the necessary documents are provided and taxes have been paid, the closure procedure should take roughly 9 to 18 months.
3.What is an Equity Joint Venture?2270

An Equity Joint Venture is the older and less flexible type of JV. Equity Joint Ventures must operate in the form of a Limited Liability Company, which means that the personal wealth and property of the actual individuals who are responsible for the company are shielded from corporate loss.

The most significant difference between Equity Joint Ventures and Cooperative Joint Ventures is the allocation of profits. In Equity Joint Ventures, profits must be allocated according to the ratio of the capital contributions made by the partners. In other words, if one party puts in 40% of the capital investment, they will reap 40% of the total profits.

Equity Joint Ventures are the preferred investment vehicle for most manufacturing Joint Ventures. However, potential investors must be clear about their purpose before deciding which form of Joint Venture they will use.
4.What is a Cooperative Joint Venture?2269

Cooperative joint ventures allow for more flexible agreements between the joint venture parties. In cooperative joint ventures companies have the choice to organise themselves as a limited liability company or as a non-legal person in which the partners are subject to unlimited liability. This means that the partners are entirely liable for losses the joint venture may incur. In practice, the majority of cooperative joint ventures are set up as limited liability companies.

The other major difference between a cooperative joint venture and an equity joint venture is that, in a cooperative joint venture, profits can be allocated according to the partners’ discretion and do not have to be proportional to the investments made by the partners. The parties may also agree that one party recovers its investment through an accelerated repayment structure, whereas the other party will become the owner of the joint venture’s assets after termination of the joint venture.
5.Some foreign companies invest in China using an offshore company. What are the advantages of structuring an investment in this way?2268

There are various reasons why foreign investors use offshore companies to structure their investment in China. Offshore companies add an additional layer of limited liability, removing risk from its valuable parent company. The corporate law of offshore jurisdictions is often very flexible. The sale of the investment in China can be made by transferring the offshore entity, rather than the stake in the Chinese entity. This saves bureaucratic hassles in China.

Most importantly, offshore corporations can be used for tax planning purposes. By correctly arranging financial affairs, significant tax savings can be achieved. However, it should be noted that some schemes may constitute illegal tax evasion, rather than legal tax planning, so great care should be taken before setting up in one of these jurisdictions. Offshore jurisdictions are typically small islands in exotic locations. Examples are the Cayman Islands, British Virgin Islands, Samoa and Mauritius. Hong Kong is also a popular jurisdiction, due to its special status and proximity to the mainland.

It should be noted, that placing the administration side of a company far from China causes practical difficulties, for instance when opening a bank account or when verifying documents.

All in all, offshore companies offer many advantages to investors, but there are many traps one could fall into. Therefore, sound legal advice should be sought before setting up an offshore company as an investment vehicle for China.
6.When forming a joint venture in China, what are some of the IP issues that I should be concerned about?2267

Intellectual Property is becoming more and more important in today’s information-based economy. This means that one must protect oneself when entering into new business relationships. The following are some areas that deserve extra attention when setting up a JV:

Improved and New Intellectual Property

In the growth and development of a Joint Venture, new IPRs will come about, and these will be regarded as belonging to the Joint Venture. Therefore, it is also up to the Joint Venture to assign it or to apply for protection. If the foreign investor only holds a minority stake in the Joint Venture, then she/he may find themselves in a weak position regarding control over new IPRs. It is recommended that you deal with these matters in the joint venture agreement before they become problems.

Investment Capital Contribution

The transfer of technology or the IPRs of a foreign investor into a joint venture can serve as a contribution of capital. Depending on the investment sector of the Joint Venture, the transfer can make up a certain percentage of the Joint Venture.

License/Royalty Fees

Licensing or Royalty fees from the transfer of IPRs in a joint venture deserves close attention.

Control

Probably the most important question to take into account is control of the IPRs after being transferred or licensed to a joint venture. If the IPR holder is a minority shareholder, it is even more of a concern.

Although IPRs can be controlled through a detailed joint venture agreement, control also depends on the investment sector, the type of IPR and the size of the investment among other things. However, in China, it is very important to select a partner that you can trust to not misuse or misappropriate your IPRs.
7.When obtaining a company through mergers and acquisitions, what sort of IPR-related issues should I think about?2266

As the investment market in China is becoming more and more deregulated, the practice of acquiring a company is becoming popular. One of the most important things to determine in an acquisition is the structure of the transaction. This may be dictated by investment regulations. However, whether an asset or share purchase transaction structure is used will greatly affect how the IPR involved will be affected.

It is very important to carry out a due diligence check before following through on a merger or acquisition. The majority of enterprises have some form of IPRs and how integral those IPRs are to the business under acquisition is very important to know. An IPR-specific due diligence can be very useful.

Registered IPRs, such as trademarks and patents, can be simply checked with the relevant office. Not yet registered IPRs can prove difficult. In some cases they may mean that an in depth investigation of the business history, including employment contracts, confidentiality agreements and other documents that can determine the security of an IPR must be conducted. When acquiring a company that has licensed its IPRs from another company, it cannot be stressed enough that one must first review these license agreements to guarantee that the licensing contracts are in fact transferable.
8.What is the structure of the Chinese Investment Fund Market?2265

An investment fund serves as an institutional investor, which collects funds by issuing securities, and primarily invests in the securities market.

At this time foreign investment firms are not allowed to participate in the investment fund market other than through giving advice to fund management companies in China. However, after the WTO accession, fund management companies will be allowed up to 33% foreign ownership in a joint venture. By now, the foreign equity interest has been increased to 49%. Needless to say there is great potential in the China Investment Fund market. The investment funds in China are categorised under so-called close-ended and open-ended funds, where all existing funds today are close-ended. Close-ended funds have a pre-determined total issuing amount and a fixed total number of fund units. These funds are listed and can only be transacted through stock exchanges.
9.What are the different types of FIE acquisition?2264

Many investors choose acquisition before establishing an enterprise since it means that the investor can take over an already established and ongoing business operation with all relevant licenses and permits.

An acquisition can be made directly or indirectly. In a direct acquisition the investor becomes a direct party to the FIE. If the acquisition is indirect the investor acquires shares in the foreign party to the FIE and holds an interest in the company in that way. For a direct acquisition, normally there must be a unanimous board resolution, waivers of preemptive rights, consent of the parties, and an approval of the original approval authority.

Instead of acquiring an interest in an FIE, an alternative is to acquire the assets of the company. Such a purchase does not have an effect on the existence of the parties to the transfer. Also, in asset purchasing it is important that legal due diligence is performed, especially concerning the good title of the assets.
10.Which issues should be considered when effecting an equity acquisition in an FIE?2263

In order to gain approval for the acquisition, important issues to bear in mind are:

1. If it is an acquisition that is in the shape of a Joint Venture, the foreign ownership must be at least 25%.

2. Debt/equity ratios should be complied.

3. If the acquisition creates a WFOE, the business scope may not be in an area prohibited to foreign undertakings.

4. If PRC law demands that a majority stake is reserved for the Chinese party, a foreign party cannot not gain control.

5. The MOFTEC Foreign Investment Guidelines must be complied with, as well as the Several Provisions on Changes in Equity Interests of Investors in Foreign Invested Enterprises.

Furthermore, legal due diligence is highly advisable. Firstly, the investigation should include the background and history of the project and a preliminary project approval. Secondly, the joint venture contract and/or articles of association are important documents to consider since they contain regulations concerning the rights of the parties as well as rules concerning mutual rights and obligations of the parties to the FIE. The investor should also ensure that the FIE has been duly approved. Other important points to consider are:

a) The formulation of the business license,

b) The need for any special permits or licenses,

c) The capital verification report and investment certificates in order to see the amounts of capital injection of the parties,

d) If any conditions are imposed on the parties equity interests,

e) Land use documentation,

f) Construction permits,

g) Technology and intellectual property rights,

h) Environmental requirements and assessments.