China
is notorious for its bureaucracy and the business registration process
is no exception to the country’s penchant for regulation. Unlike many
other countries, registering a business in China may require the
assistance of an agency authorized by the government to assist with the
process. Prior to October 2004 companies were not allowed to register
themselves but were required by law to use an authorized agent. With
China’s constantly changing regulations, inconsistencies with
interpretation and enforcement, and general lack of transparency, the
process of properly establishing an entity to ensure against
encountering problems in the future is far more complicated than in
more developed markets. Engaging the services of a qualified consultant
can substantially improve on chances of avoiding problems with
compliance and decrease the time to get established.
Even
when using a consultant for registration, understanding the
fundamentals of the process and how the investment and business
categories affect the operations of a company, is essential for any
foreign company with an interest in conducting business in China
1.1:
Nature of the Investment
1.2:
Registration Steps
1.3:
Registered Capital
1.4:
Nature of the Business
1.1: Nature of the Investment
When
a foreign investor decides to launch a business venture in China they
will need to decide either to launch their business in the form of an
actual capital investment or to start out more cautiously by scanning
the market, building networks and using local representatives.
Foreign
investors without a comprehensive understanding of the China market may
wish to test the market first to see if it is worth establishing a
legal entity in China and investing 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 should
consider establishing a legal entity. In the case that a legal entity
is preferred, 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, as well as if a Chinese partner is desirable or even
mandatory for the business, along with other general commercial and
strategic considerations. 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.
Representative Office
(Rep. Office)
A Representative
Office (Rep. Office) represents
the interests of the foreign investor by acting as a liaison office for
the parent company. Rep. Offices may conduct market research, develop
partnerships and business channels; however, all business transactions,
including issuance of invoices, are managed by the parent company.
Furthermore, Rep. Offices may not directly hire local employees but
must rely on a government-authorized employment agency. Since Rep.
Offices do not have a minimum investment requirement, they are not
considered a Foreign Invested Enterprise. Rep. Offices are the least
complicated way for a foreign firm to have a legal presence in China
and are often the choice for foreign companies with little or no
previous experience in the country. However, given the restrictions on
direct employment of local employees, transactions and taxation on
expenses, Wholly Foreign Owned Enterprises may be a better option for
entrants seeking to develop their business domestically.
Wholly
Foreign Owned Enterprise (WFOE)
Wholly Foreign Owned
Enterprise (WFOE), the
most popular Foreign Invested Enterprise (FIE), is a limited liability
company fully invested by one or more foreign investors. Along with the
rights afforded to a Rep. Office, a WFOE may also legally conduct
business transactions within China and hire local employees on its own
accord. However they do have a minimum investment requirement that is
dependent upon the locality and nature of the business. WFOEs are
becoming more and more common and have begun to outpace Joint Ventures
as the most popular vehicle for a China presence
Equity
Joint Venture (EJV)
Equity Joint Venture (EJV) companies
have capital investments from both local and foreign firms. The
percentage of the capital investment determines the amount of profit
and risk that both the foreign and local company assumes. Foreign firms
entering industries where WFOEs cannot operate, often use JVs although
this is becoming less prevalent as more and more industries begin to
gradually open up to WFOE’s.
The
risk associated with entering into partnerships with other companies
applies in China and is often exacerbated by disparities in culture and
business practices between the foreign and local partners. Foreign
Companies should enter into JV’s only when both parties have reached a
clear understanding of the business objectives and appropriate exit
strategies have been developed.
Cooperative Joint Venture (CJV)
Cooperative Joint
Ventures (CJV)
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. CJVs were
used more in the 1990’s when the Chinese economy was not as developed.
International companies often injected funds while the local Chinese
companies provided equipment and other necessities. Laws and
regulations can vary substantially between industries and procedures
vary accordingly.
Mergers & Acquisitions (M&As)
Recent
years have shown a trend towards investing in China through mergers
& acquisitions (M&As). 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 establishment
of FIEs also apply to M&As.
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1.2: Registration Steps
Below
is the typical process for setting up both foreign invested enterprises
and Rep. Offices. The government offices involved in this process
include the Ministry of Commerce, the Administrative Bureau for
Industry and Commerce, State Administration of Foreign Currency,
Taxation Bureau, the Customs Office, and the Statistics Bureau.
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1.3: Registered Capital
FIEs-
WFOE’s and JV’s- require the foreign investor to establish a minimum
amount of funds from abroad within China; called Registered Capital.
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 between foreign contributed capital and debt.
The registered capital should cover all the initial investment expenses
that the foreign entity will have and may be used immediately for the
newly formed company’s expenses. This may include paying rents,
salaries and purchasing products etc. 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.
One purpose of the registered capital is to provide confirmation to
creditors of the company’s financial adequacy.
In
theory most small to medium sized companies entering the market are
required to invest a minimum of US$ 3,700 (30,000 RMB) for a multiple
investor WFOE. In practice, however, this kind of a capital injection
would rarely cover the start up expenses of any company. Furthermore,
in order to receive government approval 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 sales,
company size, location of setup and judged on a case by case basis.
Chinese authorities will consider what would be a reasonable capital
injection for each specific project in question.
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1.4: Nature of the Business
For
Foreign Invested Enterprises- WFOE's, EJV’s and CJV’s- 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, determines the category of
business that a foreign company declares. The following categories are
by far not exhaustive but represent the most common forms of foreign
invested enterprises operating in China today. Other categories of
business include Purchasing Centers, Research and Development Centers,
Investment (Holding) Companies and Regional Headquarters.
Service Company
As
the name implies, the foreign firm provides services to either
companies or consumers. In most cases, the Company may not manufacture
or trade goods. Examples of service companies include consulting,
training, restaurants and management service companies.
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 other business categories as manufacturing plants may
require additional certifications.
Foreign Invested
Commercial Enterprise – (FICE)
A
FICE allows foreign companies greater flexibility in terms of business
activities. These activities include retail, wholesale and franchising
operations. Once established, a FICE is granted both import and export
rights. FICE’s may also buy and sell products freely in China without
an intermediary. It is also possible for manufacturing FIE’s to apply
to extend their business scope to include FICE capabilities and vice
versa.
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
establish 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.
When
choosing a business registration agency, foreign companies should
consider the agency’s knowledge of recent policy changes, transparency
on the registration process and its track record of successful
registrations. Selecting an appropriate service provider that can
effectively guide foreign investors through the complicated process
will go a long way in insuring a smooth entry into the market.
A detailed summary of entity types can be found in the downloadable
pdf version of this handbook.
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