JLJ - Making Your Way on the Mainland

This article is contributed by The JLJ Group was published by New Zealand Trade & Enterprise ( September 2007 )

Creating an in-market presence in the vast Chinese market seems a daunting task – but knowledge is power. Here, we lay out the fundamentals of establishing a legal entity for business purposes.

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.

China is notorious for its bureaucracy and the business registration process is no exception to the country’s penchant for regulation. Using an authorized agent can smoothen and speedup the process, though there are no longer any statutory requirements to do so. Even when using an agent for registration, however, understanding the fundamentals is essential for any foreign company with an interest in conducting business in China.

When a foreign investor decides to launch business venture in China they will need to decide whether to launch the business in the form of an actual capital investment or whether it is better to start out more carefully by scanning the market and building networks. 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.

Foreign investors 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.

Calculated approach

Along with the level of financial risk and control a company prefers for its China operations, government restrictions on specific industries affect the investment type made. Media, automotive and telecom 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-authorized 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 local employees of its own accord. However, WFOEs do have a minimum investment requirement that is dependent upon the locality and nature of the business.

WFOEs are becoming more and more common: In the 1990s only 20 percent of FIEs were in the form of a WFOE. Presently the figure is about 80 percent.

Equity Joint Ventures (EJVs) - These companies have capital 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 14percent 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.

Cooperative Joint Ventures (CJVs) - CJVs are also partnerships with a local company; however, the amount of risk and profit shared by each accordingly. 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 and other necessities.

Sector-specific rules are often included in the basic investment forms, with a variety of different additional regulations. Laws and regulations can vary substantially between industries and procedures vary accordingly.

Typical process for setting up FIE sand representative offices

Notes:

1. Official company stamps are required for many business and banking transactions in China.

2. Equivalent to a personal identification number for the licensed company.

3. This process can be completed at any stage following foreign exchange approval and registration with the tax bureau.

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.

Steps to registration

The chart above right shows the typical processor 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 company’s 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 company’s expenses. This may include rents, salaries and product purchases. It is considered a felony to state a specific amount of funds and then not contribute. It is also a felony 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 US$3,700 (approx. 30,000 RMB). In practice, however, as this kind of a capital injection would rarely cover the startup expenses of a company, in order to be approved the required amount is usually substantially more.

Overall it can be stated that 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.

Nature of the business

Foes, EJVs and CJVs must declare the nature of their business during the licensing phase of the registration process. The intended scope of operations in China and the capital investment the company is willing to make determine the category of business that a foreign company declares.

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 implies, 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, might be more complicated than for other business categories, as manufacturing plants may require additional certifications.

3. International Trading WFOE

To set up a trading WFOE, the company has to register in a Free Trade Zone (FTZ). As a trading FOE, 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.

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.

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

As foreign companies entering the market begin to navigate the bureaucratic landscape, having a clear understanding of the investment and business options available will be crucial to successfully establishing a business and operating in China.

With China’s gradual compliance with its WTO membership obligations, the business registration process should also continue to improve while more industries open to foreign investment.

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