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Foreign investment law

What are the projects foreign investors are prohibited to invest in China?
What are the projects foreign investors restricted to invest in the P.R. China?
What are the projects China encourages foreign investors to invest in?
What types of foreign investment are allowed in China?
How to establish a foreign- funded enterprise in China?
How to establish a wholly foreign owned enterprise in China?
How to set up a resident representative office in Beijing, P.R. China?
Documents Required and Necessary Procedures
How to establish an equity joint venture in China?
How to set up a cooperative joint venture in China?
What are the options for foreign enterprises to establish a permanent presence in China?
Representative offices may not carry out direct business activities. What does this mean and are representative offices subject to taxation?
What is an equity joint venture?
What is a cooperative joint venture?
The Wholly Foreign Owned Enterprise Regulations were recently amended. What are the most significant changes?
Specifically, what type of businesses will the changes to the Wholly Foreign Owned Enterprise regulations affect?
In anticipation of China's WTO accession, the Joint Venture Law was amended. How will these amendments affect Joint Ventures in China?
Some foreign companies invest in China using an offshore company. What are the advantages of structuring an investment in this way?
Recently, there has been a lot of discussion regarding the current trend of foreign joint venture partners buying out their Chinese counterparts. What are the major obstacles in these restructurings?
When forming a joint venture in China, what are some IP issues that I should be concerned about?
When obtaining a company through mergers and acquisitions, what sort of IPR-related issues should I think about?
What are the different types of FIE acquisition?
Which issues should be considered when effecting an equity acquisition in an FIE?
Are there any limitations on the duration of operating a joint venture?
Are there any limitations on foreign exchange accounts in China?
Are there any limitations on the transfer of shares in a joint venture?
How is the management of an equity joint venture structured?
What is the difference between the terms registered capital and "total investment"?
What are the new requirements of Foreign-Invested Enterprises?
What are the Liabilities of Foreign Invested Companies?
Can Foreign-Invested Companies be capitalized?
Will Foreign Investment increase in china’s foreign market?
What are the regulations regarding the registration of an FIE in China?
What are the capital requirements for investment in China?
What are the management measures and procedures concerning the usage and upkeep of assets?



What are the projects foreign investors are prohibited to invest in China?

In accordance with the "Provisions on Guiding Foreign Investment Direction", any of the following projects is prohibited to be invested in:
(1) those that harm the national security and social public interests;
(2) those that cause environmental pollution, or do great damage to natural resources and wealth or people's health;
(3) those that occupy a great deal of farm land, do not do favor to the protection and development of land resources;
(4) those that harm the security of military infrastructures and its efficiency of application;
(5) those that make use of the unique technique or technology that the P. R. China possesses in purpose of production of products;
(6) The other cases stated in the laws and relevant administrative regulations.

What are the projects foreign investors restricted to invest in the P.R. China?
In accordance with the "Provisions on Guiding Foreign Investment Direction", any of the following projects is restricted:
(1) those that lag behind in technology;
(2) those that does not do favor to the frugality of power and improvement of ecological environment;
(3) those that are concerned with special exploration and mining protected by the state and in accordance with the state provision;
(4) those industries that are opened by the state gradually;
(5) other cases stated in the laws and relevant administrative regulations

             

What are the projects China encourages foreign investors to invest in?
In accordance with the provision of the "Guiding Directions for Foreign Investor to Invest", the projects China encourages foreign investors to invest in are listed as follows principally:
1. those that are categorized as advanced new technology for agriculture, agriculture integrated development, power, traffic transportation, and important raw materials;
2. those that are categorized as advanced new technology and appropriate technology which could improve performance of products and enterprise's economic and technological performance, or produce new equipment and new materials that domestic production capacity can not meet;
3. those that can improve and update the product's quality level and explore new market, or enhance the competence of the product in the international market, pursuant to the requirement of marketing;
4. those that are categorized as advanced new technology and new equipment which can save power and raw material, make comprehensive use of resource and renewable resource, prevent from and bring environmental pollution under control;
5. those that can give full play to the advantages of human resources and natural resources of the China western region, and accord with the state's industrial policies;
6. those that are prescribed by other laws, administrative regulations, and measures.

             

What types of foreign investment are allowed in China?

Branch Offices
A branch office in China is one that is used for business purposes for which the main company office holds responsibility. It is not a legal entity and it can only carries out liaison and coordination work. Such a situation would involve the existence of an offshore "parent", the People's Republic of China would be denied control of the entity - a situation which it seeks to avoid. In this way, China does not officially recognise branch offices, nor does it officially allow them to operate. Therefore, the difficulties posed by such restrictions and lack of legal standing mean that the branch office cannot be recommended as a vehicle for investment.
Sino- Foreign Equity Joint Ventures
These are enterprises established in China with joint investment from foreign companies, enterprises or other economic bodies and Chinese economic bodies. As the name suggests, such enterprises involve joint investment, operation and share of risk in proportion to the amount of investment inputted by the respective parties. Each party is accordingly jointly responsible for the profits and losses of the enterprise. Investment can come in the form of (amongst other things) currency, buildings, industrial property or equipment. In general, the level of investment offered by the foreign company should not be less than 25%.
The corporate form of such joint ventures is the limited liability company, with a Board of Directors as its supreme body of power. Some joint ventures in China have now adopted this corporate form.
Sino-Foreign Co-operative Joint Ventures

Sino-foreign co-operative joint ventures also refer to Chinese- foreign contractual joint ventures. They are enterprises established in China with investment or conditions for co- operation jointly offered by foreign companies, enterprises or other economic bodies as well as by Chinese economic bodies.
The main difference from the equity joint venture we have just discussed is that the investment of the parties involved will not necessarily be converted into ratios of investment.
The rights and obligations of the parties involved with regards to such issues as distribution, investment, operation and sharing of risks and profits is determined by the contracts signed by the parties from the outset of the venture. These ventures tend to involve the foreign partner providing most or all of the funds whilst the Chinese partner contribute land, facilities and a perhaps a limited amount of funding. The usual approach is to stipulate in the contract that the Chinese party will own all the assets of the venture once the date of expiry of the venture is reached, with the foreign party recouping its investment within the duration of the venture.
Such forms of co-operative joint venture are universally attractive, for they allow the Chinese partner to have a source of investment whilst permitting the foreign company to recoup its investment.
Wholly Owned Foreign Enterprises

These also refer to wholly foreign owned enterprises. They are enterprises set up in China by foreign companies or economic bodies in accordance with Chinese law with the investment entirely provided by foreign investors.
Such enterprises must be conducive to the development of China's national economy; they must also meet one of the following requirements:
1. The application of internationally advanced technology
2. The orientation of most of the products for export
The corporate form of foreign enterprises in China is generally the limited liability company. Although China has been late on the scene in terms of providing a system of establishment for foreign enterprises, they have grown in number rapidly over the past few years.
Chinese Holding Companies
Approval has recently been given to multinational corporations by China's Ministry of Foreign Trade and Economic Cooperation (MOFTEC) to establish foreign-invested holding companies. Though mostly analogous to Western Holding Companies, there are a couple of differences. Multinational companies may wish to set up holding companies in order to increase investment or reinvestment in China, as well as to coordinate investment companies already established in China.A Holding Company in China may invest in such fields as industry, agriculture, infrastructure and energy, provided that the State encourages foreign investment in these sectors.
Typical work undertaken by a Holding Company might include action as a purchasing agent, distribution or the provision of after sales service, amongst other things. Provisional Regulations dictate that a Chinese Holding Company may enjoy the preferential treatment of a foreign- invested enterprise, and as such is awarded both a foreign- invested enterprise certificate and licence.
B Shares
Chinese government allows foreign investment to acquire shares of special category, B shares, of approved list companies in the Stock Exchange. However, ownership and management are separated. Chinese government is considering allowing foreign invested entity in China to be listed in the Stock Exchange, but it takes time for the government to come at this decision.
Special approved foreign Joint Venture
Foreign nationals are generally not allowed to hold equity of private companies in China unless with special consent from the government. A merger and acquisition exercise involving foreign fund will convert a private company into a foreign JV.

             

How to establish a foreign- funded enterprise in China?

It is naturally most important that foreign investors understand the procedures which need to be followed in order to establish foreign- funded enterprises in China. The regular steps which must be taken in this regard shall now be examined.
(1) Choice of Projects, Co- operation of Partners and Relevant Office Approval
The logical first step for foreign investors to take is to decide upon a project to undertake. Foreign investors have two options to choose from in this respect; they may choose a project proposed by enterprises or institutions across China or they may propose investment projects by themselves.
If the first option is taken, it should be noted that institutions and enterprises across China have proposed numerous projects, some of which have government approval and some that do not. It is therefore best to select those projects which have been officially approved in order to secure the approval of the relevant authorities.
The second option requires awareness as to whether the chosen project conforms to China's industrial policies, and whether the project belongs to a field which they are officially allowed to invest in.
In addition to this, attention should be paid to attaining reliable Chinese partners for investment. When applying for joint ventures or co-operative ventures, it is the responsibility of the Chinese partner to submit the application for the establishment of investment projects to the competent authorities for approval.
For wholly-owned foreign ventures, investors should seek assistance from the consultants who shall assist in the establishment of the presence in China.
(2) Submission of Feasibility Study Reports and Relevant Official Approval
Investors in a joint venture or a co- operative joint venture can only mount a feasibility study on a project once the application for establishment has been approved. A feasibility study report usually needs to contain the following 10 items:
a Outline of implementation
b Background and history of the project
c Marketing and production capacity
d Materials and inputs
e Site location
f Design of Project
g Organisational costs
h Construction arrangements
i Financial and economic assessments
j Foreign exchange equalization and assessment of risks
Once again, in equity and co-operative joint ventures it is the Chinese partner to submit the feasibility report. However, the foreign party should maintain an effective channel of consultancy to screen through the papers and process. For investors in a wholly foreign- owned venture, the report should be submitted along with the application for establishment by consultants to the relevant local government authority.
(3) The Signing of Contracts and Charters of Association in addition to Relevant Official Approval
Once the feasibility study is approved, the respective partners in equity or co-operative joint ventures can get down to the matter of addressing contracts, charters of association and other legal documents. Competent government authorities require these charters, contracts and documents to conform to the following principles:
a. The content must be complete, with specific terms and precise language used. The responsibilities of all parties must have been clearly defined
b. The rights and obligations of all the parties concerned with the contracts must have been provided on an equal footing
c. The content of the contracts and charters of association must conform to the relevant provisions of Chinese law and Regulations
d. Liabilities to third party should be limited to the amount of registered capital
It is possible to refer to standardized contracts and charters of association which have been prepared by the Chinese government for reference during the negotiation and drafting of contracts.
In the case of equity and co-operative joint ventures, it is the responsibility of the Chinese partner to submit the contracts and charters of association for approval by the competent authorities. When the charters are approved, the authorities will issue a certificate of approval for the foreign- funded enterprise.
In the case of wholly-owned foreign enterprises, a formal submission of the charters and other documents may be made after the initial application has been approved. Once again, certificates will be issued if this formal application is successful.
The Chinese government has recently moved to simplify matters for small ventures of all the varieties mentioned, allowing all the applications, feasibility reports and legal document to be submitted in unison.
(4) RegistrationTwo steps should be followed by foreign investors and their Chinese partners during the application stage:
a. The name of the foreign- funded enterprise must be registered after the establishment application is fully approved
b. The establishment of the foreign- funded enterprise must be registered after the contract and charter of association are fully approved.
The registration of the name of the venture serves to protect the use of the name. No party concerned with the project is allowed to use the name registered to conduct business before the registration of the venture itself is completed.
After the contract and charter of association have gained approval, foreign investors and their co- operation partners should proceed to apply for registration to the administrative authorities for industry and commerce within 30 days. A business license will be issued to all parties when the registration is made and checked.
Once all this has been done, the procedure for the establishment of a foreign- funded enterprise in China is completed.
Time Limit for Operation and Enterprise Termination
The time limit for foreign investment enterprises is usually 20 years at the longest, and may be stipulated by investors through negotiation. Where a time limit is appointed, termination of the enterprise comes with the expiration of the time period.
Prolongation may be sought at least 180 days before the expiration date from the relevant approving authorities.

             

How to establish a wholly foreign owned enterprise in China?

Wholly foreign owned enterprises are permitted to register in cases where at least half of their annual output is exported or if the nature of their operations relies heavily on advanced technology and the application of this high technology is beneficial to China. Approval to establish a wholly foreign owned enterprise is granted much more sparingly when compared to joint ventures.
Like joint ventures, wholly foreign owned enterprises are in most cases required to balance their foreign exchange and are allowed to occupy facilities other than those managed by the Foreign Management Bureau. As a Chinese legal entity they may sign separate contracts with the appropriate government authorities or Chinese business entities to acquire land use rights, rent buildings, and receive utility services.
Wholly foreign owned enterprises enjoy exclusive management control of their business activities and have autonomy in their operation and management with less interference from the Chinese government. Because there is no Chinese partner to guide the project through the approval process and through the other regulatory issues associated with construction and operation of the enterprise, the logistics of establishing a wholly foreign owned enterprise can be difficult and costly.
A wholly foreign owned enterprise is considered a Chinese legal entity and must abide by all Chinese laws. They must employ Chinese labor in accordance with local and central government labor laws and are encouraged to establish trade unions but not required to do so.
Traditionally the wholly foreign owned enterprise has rarely been the chosen method for investment in China. The independence offered to the foreign investor is often outweighed by the lack of direct links to the domestic economy. Most international corporations choose to establish joint ventures for the relationships and connections provided by the Chinese partners.
Recently some major international players in China's telecommunications industry including AT&T and Ericsson have set up wholly owned enterprises to handle much of the domestic management originally handled by their representative office. They have done so only after years of business experience in China and despite their registration as a wholly foreign owned enterprise, maintain the registration of their representative office.

             

How to set up a resident representative office in Beijing, P.R. China?

Foreign traders, manufacturers, shipping agents, economic organizations and other groups shall report, according to their nature of the business, to the Ministry of Commerce (Mofcom) or other relevant ministries, committees or bureaus which are authorized for the examination and approval of the setup of resident offices. Proxy authorized by Mofcom will go through the examination and approval procedures for the above-mentioned companies. The business activities of the established institutions can only be in the range of business connection, products introduction, marketing, technology exchange and consulting service and etc. Direct business activities are prohibited.

Documents Required and Necessary Procedures

(1) Application for setting up the office: The application shall include background of the enterprise, business conditions, purpose of the office to be established, name of the office, person in charge, scope of business, location and operational term. Application shall be signed by the chairman or president of the enterprise together with the enterprise's seal. (original)
(2) A certificate of authorization to the representative accredited to the office issued by the chairman or president of the enterprise. (original)
(3) Copy of certificate of legal operation or copy of certificate of registration provided by the proper authorities of the country or region where the enterprise comes.
(4) Bank reference provided by the bank of the country or region where the enterprise comes: The bank reference, to be signed by the person in charge or business manager of the bank, shall state clearly the enterprise's registered capital and present amount of deposit, as well as the reputation of its flexing capitals after the opening of the account. (original)
(5) Resume of representative accredited to the office. The resume, including both educational and working background, should be detailed, specific and true. Disconnection is not allowed. Two photographs of each representative are required.
(6) Identification paper of the representatives. For representatives of foreign nationality, copy of passport of the country he holds should be submitted. For compatriots from Hong Kong and Macao, copy of certification for his returning to his hometown and permanent resident identification should be submitted. If a domestic personnel is to take the post of representative or chief representative, approval and identification from Beijing Foreign Enterprise Service Corporation (FESCO) are needed.

             

How to establish an equity joint venture in China?

Equity joint ventures are the second most common manner in which foreign companies enter the China market and the preferred manner for cooperation where the Chinese government and Chinese businesses are concerned. Joint ventures are usually established to exploit the market knowledge, preferential market treatment, and manufacturing capability of the Chinese side along with the technology, manufacturing know-how, and marketing experience of the foreign partner.
Normally operation of a joint venture is limited to a fixed period of time from thirty to fifty years. In some cases an unlimited period of operation can be approved, especially when the transfer of advanced technology is involved. Profit and risk sharing in a joint venture are proportionate to the equity of each partner in the joint venture, except in cases of a breach of the joint venture contract.
Share holdings in a joint venture are usually non-negotiable and cannot be transferred without approval from the Chinese government. Investors are restricted from withdrawing registered capital during the live of the joint venture contract. Regulations surrounding the transfer of shares with only the approval of the board of directors and without approval from government authorities will probably evolve over time as the size and number of international joint ventures grow.
There are specific requirements for the management structure of a joint venture but either party can hold the position as chairman of the board of directors. A minimum of 25% of the capital must be contributed by the foreign partner(s). There is no minimum investment for the Chinese partner(s).
It is preferable that foreign exchange accounts are balanced in order to remit profits abroad so that the repatriated foreign exchange is offset by exports from the joint venture. With the elimination of foreign exchange certificates and the further opening of the China market, this requirement is becoming more and more relaxed.
The permissible debt to equity ratio of a joint venture is regulated depending on the size of the joint venture. In situations where the sum of debt and equity is less than US$ 3 million, equity must constitute 70% of the total investment. In joint ventures where the sum of the debt and equity is more than US$ 3 million but less than US$ 10 million, equity must constitute at least half of the total investment. In cases where the sum of the debt and equity is more than US$ 10 million but less than US$ 30 million, 40% of the total investment must be in the form of equity. When the total investment exceeds US$ 30 million, at least a third of the sum of the debt and equity must be equity.
Equity can include cash, buildings, equipment, materials, intellectual property rights, and land-use rights but cannot include labor. The value of any equipment, materials, intellectual property rights, or land-use rights must be approved by government authorities before the joint venture can be approved.
After a joint venture is registered, the entity is considered a Chinese legal entity and must abide by all Chinese laws. As a Chinese legal entity, a joint venture is free to hire Chinese nationals without the interference from government employment industries as long as they abide by Chinese labor law. Joint ventures are also able to purchase land and build their own buildings, privileges prevented to representative offices.

             

How to set up a cooperative joint venture in China?

In a cooperative venture, the parties involved may operate as separate legal entities and bear liabilities independently rather than as a single entity. A cooperative venture may also be registered as a limited liability entity resembling an equity joint venture in operation, structure, and status as a Chinese legal entity.
There is no minimum foreign contribution required to initiate a cooperative venture, allowing a foreign company to take part in an enterprise where they preferred to remain a minor shareholder. The contributions made by the investors are not required to be expressed in a monetary value and can include excluded in the equity joint venture process can be contributed such as labor, resources, and services. Profits in a cooperative venture are divided according to the terms of the cooperative venture contract rather than by investment share, allowing a more flexible schedule for return on investment in cases where one investor provides cash while the other party's investment is primarily in kind.
Greater flexibility in the structuring of a cooperative venture is also permissible including the structure of the organization, management, and assets. There is no term for unlimited terms in cooperative ventures, but also no provisions for the term of the duration. The term of the cooperative venture contract may be renewed subject to the consent of the parties involved and approval from the examination and approval authorities. The foreign investor is permitted to withdraw their registered capital or a portion thereof from the cooperative venture during the duration of the cooperative venture contract.
Because of the unique privileges and added features offered to the foreign party in a cooperative venture, trade unions must be allowed to represent the employees in employment matters to protect the interests of the employees.

             

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

For foreign companies, there are four main forms business establishments in China can take: 1) representative offices 2) branches of foreign companies 3) joint ventures and 4) wholly foreign owned enterprises. The avenue chosen by a foreign investor is dependent on many factors: How active one wants to be in China; the industry one is investing in; and whether or not a Chinese partner is necessary, either because it is required by law or in order to benefit from the partner's experience in and access to the Chinese market.

The most popular form of establishment is a representative office, but they are very limited in the activities they may carry out. They may 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 flirt with negative legal ramifications.

If one wants to legitimately carry out profit making business activities, one must set up a Joint Venture with a Chinese partner or a wholly foreign owned enterprise.

As for branches of foreign enterprises, they are allowed only in theory and, therefore, there exist no implementing regulations.

Many investors prefer Wholly Foreign Owned Enterprises to Joint Ventures, because this 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 shorter and shorter. Also, some investors choose to cooperate with a Chinese partner to 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.

             

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

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, general collection of information and liaising with authorities and business partners. Representative Offices may not bill clients or sign contracts. In other words, they may promote, but they must not sell.

One can argue that such activities do not directly generate income and therefore representative offices should not have to pay income tax. However, the tax bureau takes a different view. It levies business tax and foreign enterprise income tax on representative offices. There are various ways of calculating income tax for representative offices. Typically, it is based on the office's turnover. Income tax is paid at a rate of a little less than ten percent of the office's overhead. In some cases the representative office can obtain an exemption if the representative office can prove that the parent company is a manufacturing company and is using the representative office for purchases in China.

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.

What is an equity joint venture?

First, it is necessary to clarify that there exist two types of Joint Ventures - Equity Joint Ventures and Cooperative Joint Ventures. The equity joint venture is the older and less flexible type. 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 total profits.

Equity joint ventures are the preferred investment vehicle for most manufacturing Joint Ventures. This being said, potential investors still must be clear about their purpose before deciding which form of Joint Venture they will use.

             

What is a cooperative joint venture?

Cooperative joint ventures allow for more flexible agreements between the joint venture parties. Cooperative Joint Ventures have the choice to organize themselves either as a limited liability company or as a non-legal person in which the partners are subject to unlimited liability, which 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.

The Wholly Foreign Owned Enterprise Regulations were recently amended. What are the most significant changes?

The most significant change is the lifting of the requirement that a wholly foreign-owned enterprise, or WFOE, must either meet advanced technology requirements or export 50%, or more, of its product output. Therefore, establishing a WFOE will be open to more industries.

In the past, export requirements restricted existing WFOEs in their marketing and sales strategy, since they could increase their domestic sales only if their exports were equally as high.

A main driving force of foreign investment in China continues to be the prospect of selling to a consumer market that has a quarter of the world's population. After the regulations are amended and export restrictions are curbed, the incentive to partner up with a Chinese company will wane. Therefore, we will likely see an increase of wholly foreign owned enterprises.

There still may be reasons to seek a local partner, but foreign investors will enjoy more freedom in structuring their investments in China.

             

Specifically, what type of businesses will the changes to the Wholly Foreign Owned Enterprise regulations affect?

In the past, foreign investors in some industries that were not High Technology or export oriented needed to find a Chinese partner and establish a joint venture instead of a Wholly Foreign Owned Enterprise, or WFOE. This set limits to establishing WFOEs in the service sector. In theory, WFOE enterprises in the service sector could not be established, since they did not manufacture goods that could be exported and typically did not use advanced technology. Having said that, exceptions certainly did exist in the past, but now the possibility of setting up a WFOE will definitely be open to more businesses in the service sector.

In anticipation of China's WTO accession, the Joint Venture Law was amended. How will these amendments affect Joint Ventures in China?

The recent amendments to the Equity Joint Venture law have been hailed by the media as a step towards China's compliance with WTO rules and an incentive to attract more foreign investment. The most significant amendment in the Equity Joint Venture Law gives joint ventures more freedom in their procurement of raw materials and equipment. The "old" law stipulated that joint ventures must give priority to domestic suppliers and that imported materials and equipment must be purchased with foreign exchange raised by the joint ventures themselves. However, in practice, joint ventures could already buy most materials internationally. Priority to Chinese products was necessary if the foreign equivalent was more expensive or inferior in quality, and the government rarely intervened. Thus, the amendment adopts the current practice as a rule, which will provide Equity Joint Ventures with more confidence and certainty.

Any scheme that favors local products is contrary to WTO rules, because it potentially distorts trade. To give you an example, plans made by the Chinese Ministry of Foreign Trade and Economic Cooperation and the Ministry of Information Technology would require mobile telephone manufacturers to export at least 60% of their output, or that at least 50% of the total value of the telephones come from locally produced components. Such rules cannot be implemented under the new regulations.

Again, by amending the Joint Venture law, China has made another step towards compliance with WTO rules.

             

Some foreign companies invest in China using an offshore company. What are the advantages of structuring an investment in this way?

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. Corporate law of offshore jurisdictions is often very flexible. Sale of the investment in China can be made by transferring the offshore entity, rather than the stake in the Chinese entity, which 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 -- but 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, however, that removing the administration 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 in China.

             

Recently, there has been a lot of discussion regarding the current trend of foreign joint venture partners buying out their Chinese counterparts. What are the major obstacles in these restructurings?

In recent years we have seen a growing number of restructured joint ventures. There is a trend to reduce the role of the Chinese partner in a joint venture by having the foreign partner acquire its shares. In a few cases, the Chinese partner takes over shares from the foreign party. Reasons for these separations vary. Often, the view of foreign investors and their Chinese partners differ in the way business should be conducted, and expectations are often not met. That's not unique to China. Just look at all the problems the German-American merger, Daimler-Chrysler, has had to endure since they tried to bring together their two different firm cultures - and they are both Western companies!

In China, the changing legal framework and business climate is not only more favorable to wholly foreign enterprises than in the past, but also facilitates the restructuring of joint ventures. Typically, the joint venture is restructured into a WFOE or the equity stake of the Chinese partner is reduced to transform the Chinese side into a "silent partner" without significant decision-making powers. Sometimes the equity structure is changed because the foreign investors pour in additional capital, whereas the Chinese partner does not increase its original contribution.

However, it should be noted that any type of equity change must be approved by the Ministry of Foreign Trade and Economic Cooperation. In a few sensitive industries, the Chinese partner must hold a majority and 100% foreign ownership is not permitted. These restrictions must still be observed. But, again, the number of WFOEs and restructurings are still definitely increasing.

             

When forming a joint venture in China, what are some IP issues that I should be concerned about?

Because Intellectual Property is becoming more and more important in today's information-based economy, one must protect oneself when entering into new business relationships. 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 JV, new IPRs will come about, and these will be regarded as belonging to the Joint Venture. Therefore, it is also up to the JV to assign it or to apply for protection. If the foreign investor only holds a minority stake in the JV, then s/he may find themselves in a weak position regarding control over new IPRs. It is recommended to deal with these matters in the joint venture agreement before they become problems.

Investment Capital Contribution

The transfer of technology or IPRs of a foreign investor into a joint venture can serve as a contribution of capital. Depending on the investment sector of the JV, the transfer can make up a certain percentage of the JV. Although there are some exceptions, the maximum limit is usually 20%.

License/Royalty Fees

Licensing or Royalty fees from the transfer of IPRs in a joint venture deserves close attention. In China, royalties are subject to income withholding tax and business tax. Also, in some sectors, the royalty rate may have a ceiling, such as the 0.3% royalty rate ceiling of sales revenue in the retail sector for the use of a trademark.

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.

             

When obtaining a company through mergers and acquisitions, what sort of IPR-related issues should I think about?

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 kind of IPRs and how integral those IPRs are to the business under acquisition is necessary to know. An IPR-specific due diligence can be very useful.

Registered IPRs, such as trademarks and patents, could be simply checked with the relevant office. Not yet registered IPRs can prove difficult and in some cases, require in depth investigation of the business history, including employment contracts, confidentiality agreements and other documents that can determine the security of an IPR. When acquiring a company that has licensed its IPRs from another company, it can not be stressed enough that one must first review these license agreements to guarantee that the licensing contracts are in fact transferable.

             

What are the different types of FIE acquisition?

For foreign companies, there are four main forms business establishments in China can take: 1) representative offices 2) branches of foreign companies 3) joint ventures and 4) wholly foreign owned enterprises. The avenue chosen by a foreign investor is dependent on many factors: How active one wants to be in China; the industry one is investing in; and whether or not a Chinese partner is necessary, either because it is required by law or in order to benefit from the partner's experience in and access to the Chinese market.

The most popular form of establishment is a representative office, but they are very limited in the activities they may carry out. They may 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 flirt with negative legal ramifications.

If one wants to legitimately carry out profit making business activities, one must set up a Joint Venture with a Chinese partner or a wholly foreign owned enterprise.

As for branches of foreign enterprises, they are allowed only in theory and, therefore, there exist no implementing regulations.

Many investors prefer Wholly Foreign Owned Enterprises to Joint Ventures, because this 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 shorter and shorter. Also, some investors choose to cooperate with a Chinese partner to 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.

             

Which issues should be considered when effecting an equity acquisition in an FIE?

In order to gain approval of the acquisition, important issues to bear in mind are: 1. If it is an acquisition that is in the shape of a JV, the foreign ownership must be at least 25%. 2. Debt/equity ratios should be complied with. 3. If the acquisition creates a WFOE, the business scope may not be in area prohibited to foreign undertakings. 4. If PRC law demands that a majority stake is reserved for the Chinese party, a foreign party may 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. First, the investigation should include background and history of the project and a preliminary project approval. Second, 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 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, d) land use documentation, e) construction permits, f) technology and intellectual property rights, g) environmental requirements and assessments.

Are there any limitations on the duration of operating a joint venture?

Normally an operation of a joint venture is limited to a fixed period of time from thirty to fifty years. In some cases, however, an unlimited period of operation can be approved, especially when the transfer of advanced technology is involved. Profit and risk-sharing in a joint venture are proportionate to the equity of each partner in the joint venture, except in cases where there is a breach of the joint venture contract.

             

Are there any limitations on foreign exchange accounts in China?

It is preferable that foreign exchange accounts are balanced in order to remit profits abroad, so that the repatriated foreign exchange is then offset by exports from the joint venture. According to the Regulations on Foreign Exchange Control and the currencies stipulated by the equity joint venture contract, the foreign investors may remit abroad the net profits they received, the funds they received at the time of the expiration or termination of the duration of the equity joint venture, and other funds after they fulfill their obligations required by laws, the agreement or contract. Foreign investors are encouraged to deposit all of their foreign exchange into the banks of China. With the elimination of foreign exchange certificates and the further opening of the China market, this requirement is becoming increasingly relaxed.

Are there any limitations on the transfer of shares in a joint venture?

If there is a transfer of registered capital to or from an investor of an equity joint venture, then the other investors of the said venture must consent. Share holdings in a joint venture are usually non-negotiable and cannot be transferred without approval from the Chinese government. Investors are restricted from withdrawing registered capital during the existence of the joint venture contract. Regulations concerning the transfer of shares with only the approval of the board of directors and without approval from government authorities will evolve over time as the size and number of international joint ventures expands.

             

How is the management of an equity joint venture structured?

There are specific requirements for the management structure of an equity joint venture. Every equity joint venture shall set up a board of directors, of which the number of members of shall be determined through negotiation by the parties involved in the venture and shall be stipulated in the equity joint venture contract and articles of association. The members of the board of directors shall be chosen and replaced by the parties to the venture. The chairman and the vice-chairman (vice-chairmen) shall be decided through negotiation by the parties to the venture or shall be elected by members of the board of directors. If the Chinese investor assumes the office of the chairman, then the foreign investor, or the other party, will assume the office of the vice-chairman and vice versa.

The board of directors shall decide the major issues of the equity joint venture in accordance with the principle of equality and mutual benefit. The offices of general manager and vice-general manager(s) (or factory director and vice director(s)) shall be assumed separately by the parties to the venture.

What is the difference between the terms registered capital and "total investment"?

In summary, registered capital is defined above as "the total amount of capital registered with the registration authority for establishing the joint venture." Total investment can be described as the sum of capital construction funds and the operating funds needed for the joint venture's production as stipulated in the joint venture contract. In practice the total investment is considered the aggregate of the sum of the registered capital and the sum of the loans obtained for the operation of the enterprise. Total investment can also be described as the sum of the enterprise's equity and debt.

             

What are the new requirements of Foreign-Invested Enterprises?

Many provisions of China’s Company Law (including recent amendments summarized in the February 2006 China Country File) have since been confirmed to govern ‘foreign-invested enterprises’ (FIEs), mostly now being referred to as ‘foreign invested companies’ (FICs). FICs are now subject to clearer
Requirements and procedures for key matters including establishment, classification, capitalization, internal structure, equity pledges and onward investments.
The main government document clarifying these matters (not all based on the Company Law) is the ‘Implementation Opinion for Several Issues on Application of Laws Concerning Foreign-Invested Company Examination, Approval and Registration Administration’. Issued by several ministries and departments on April 24, 2006. Also important is a related implementation circular issued by the State Administration of Industry and Commerce on May 26, 2006.

Notarization and consularisation: Applications for government approval of a FIC’s establishment or amendment require both notarization and (except in Hong Kong, Macao and Taiwan) consularisation of each foreign investor’s status documents.

Single-owner companies: A single-owner Wholly Foreign-Owned Enterprise (WFOE), like a domestic single-owner company, must have registered capital of at least 100,000 renminbi (US$12,608) and, if its single owner is an individual, is not permitted to establish or invest in another single-owner company. Unlike a domestic single-owner company, a single-owner WFOE may receive contribution of its registered capital in multiple installments.

             

What are the Liabilities of Foreign Invested Companies?

 Liability limitation of a FIC, like a domestically owned company, is subject to the amended law’s statement that limited liability is not to be ‘misused’ for the purpose of evading liabilities and causing ‘severe harm’ to the interests of creditors. Also like for a domestically owned company, the position of a FIC’s ‘legal representative’ – bearing certain vaguely defined types of personal liability for the company’s conduct, which historically was filled by the company’s chairman or executive director – now may alternatively be filled by a company manager.

Can Foreign-Invested Companies be capitalized?

Capitalization: A FIC, like a domestically owned company, can be capitalized through contribution of any ‘non-cash asset that can be monetarily valued and legally transferred’. ‘Ownership’ of such assets is no longer required, which suggests that contributions can be made through sub-licenses of intellectual property rights. Cash must make up at least 30 percent of contributions to a FIC’s or a domestically owned company’s registered capital, while there is no longer any limit on the percentage made up by intellectual property rights. Capitalization cannot be accomplished by contribution of labor services, credit standing, goodwill, franchising rights, mortgaged property (whether movable or immovable), or individuals’ (as opposed to enterprises’) names. Valuation is required of non-cash contributed assets, by a (PRC-licensed) appraisal entity or, also permitted for a Sino-foreign equity joint venture, by agreement between the parties.

Pledges: FIC equity pledges have become more reliable, through provisions for issuance of pledge registration certificates and through prohibitions against transfer or re-pledge of the pledged equity – or reduction of the ‘corresponding-invested capital’ –except with the consent of pledges.
Onward investment: A FIC’s investment in other companies is no longer limited to 50 percent of its net asset value. Tax next: The next major convergence step, expected to be rolled out in 2007, will be reform and unification of corporate income tax.

             

Will Foreign Investment increase in china’s foreign market?

Investments from China into foreign markets will increase, along with opportunities for various financial institutions, based on China's recent liberalization of foreign exchange. In addition to further relaxation of controls on foreign exchange current accounts, China has taken its biggest step towards freeing outbound restrictions on capital accounts, by giving Chinese commercial banks, mutual funds, securities institutions and insurers greater opportunities to invest in overseas financial products.

These opportunities are likely to become part of a Qualified Domestic Institutional Investor programmed (QDII), which has been rumored for several years, and which would build upon the PRC's experience with the Qualified Foreign Institutional Investor programmed (QFII) that was formally introduced in 2002 as a liberalization of inbound investment into the PRC by qualified foreign investors. Beneficiaries in the short term will include not only PRC portfolio investors and financial institutions but also foreign financial institutions, which can expect expanded joint venture opportunities as well as instructions to act as investment managers and custodians. In the long term, these changes are likely to increase the ability of PRC financial institutions to compete on the global stage.

What are the regulations regarding the registration of an FIE in China?

An FIE should apply to the financial authority for financial registration within 30 days after submission of application for business registration or change of registration details. To apply for financial registration, an enterprise should complete the Financial Registration Form for Foreign-invested Enterprises, supported by the following documents: approval certificate for establishment of an enterprise; feasibility study report and its approval document; FIE contract (agreement), articles of association (copy) and their respective approval documents; business licence (copy); and information on the FIE's financial management system and related rules formulated in accordance with the relevant state regulations.

An FIE should submit its financial accounting statements and status report of its financial position to the competent financial or administrative authority and local tax office on a regular basis. The format, content and schedule for submission should follow the relevant stipulations by MOF. Annual financial statements and liquidation reports should be accompanied by an auditor's report prepared by Chinese certified public accountants (CPAs).

             

What are the capital requirements for investment in China?

To establish am enterprise, a certain amount of capital is required as stipulated in the relevant regulations and application for business registration at the industry and commerce administration departments is also necessary.

(a) Forms of Investment

Investors may make contribution to the registered capital of an enterprise in cash, in kind, or in intangible assets. Investors making contribution in kind and in intangible assets must provide proof of ownership and right of disposal, or other proof of their validity as required by law. Investors are not allowed to contribute leased assets or collateral assets.

Investors making contribution in intangible assets (excluding land-use rights) should provide asset appraisal or valuation reports. In general, the value of the contribution may not exceed 20% of the total registered capital of the enterprise. Under special circumstances, the ratio may be allowed to reach a maximum 30% upon asset appraisal done by Chinese CPAs and approval granted by the industry and commerce administration departments.

If foreign investors are making contribution in cash, it should be in foreign currencies. However, profits in renminbi made from investment in other FIEs within the Chinese territory may be used as contribution in cash.

When the full amount of registered capital has been paid up, the FIE should appoint a Chinese CPA to compile a capital verification report.

(b) Investment Recovery

In general, during the operation period of the enterprise, investors are not allowed to withdraw their share capital by any means except through transfer of business as provided by law.

For Sino-foreign contractual joint ventures (JVs) whose contract stipulates that all the fixed assets should be handed over to the Chinese party upon expiry of the JV, provisions can be made in the JV contract that the foreign party may recover its investment during the term of the JV.

However, the foreign party should still be jointly responsible for the JV's liabilities in accordance with the relevant laws and regulations as well as the provisions of the contract. Any pre-tax investment recovery should be reported to the competent financial authority for examination and approval.

(c) Sources and Uses of Capital Reserve

The sources of an enterprise's capital reserve include: the balance from investors' capital contribution in excess of the prescribed amount of registered capital; the balance resulting from the different conversion/exchange rates used in the assets account and the paid-up capital account; income in the form of donations.

The designated uses of an enterprise's capital reserve include: in the event of heavy losses where the un-allocated profits of the previous year, the reserve funds and development funds of the enterprise are inadequate to make up for the shortfall, the board of directors may pass a resolution authorizing the use of such funds in making up for the losses; upon the board of directors' decisions and completion of the relevant procedures, the funds may be used to increase the capitalization of the enterprise.

             

What are the management measures and procedures concerning the usage and upkeep of assets?

The management measures and procedures concerning the usage and upkeep of assets are as follows:

(a) Management of Floating Assets

-Cash and bank deposits

The cash of an enterprise should be handled by designated personnel and an income and expenditure account must be set up to record all cash transactions. Bank deposits should be credited to accounts set up under the name of the enterprise.

-Advance payments and accounts receivable

Advance payments and accounts receivable should be handled and recovered in accordance with the relevant provisions in the contract or agreement.

-Foreign currency capital

The collection, payment and custody of foreign currency capital should comply with the relevant state regulations concerning foreign exchange management. The conversion between foreign currency and the bookkeeping base currency should be dealt with in accordance with MOF regulations.

-Inventories

Inventories should be properly itemised, reasonably valued, and well maintained. There should also be a well-established system for the receipt, issuance, requisition and return of inventories as well as for physical stock taking on a regular basis.

When an enterprise issues or requisitions merchandise, semi-manufactures, raw materials and finished goods, or requisitions low-value consumables and packaging materials, the actual costs should be calculated according to stipulated accounting methods or amortised.

Where the book value and the net realisable value of the inventories differ significantly, necessitating adjustment of the book value, adjustment can be made upon approval by the competent financial authority or central administrative authority.

-Investment in kind or in intangible assets

When an enterprise invests in another enterprise in kind or in intangible assets, the assets involved have to undergo appraisal. If the investment is intended to be a short-term one, the difference between the book value and the appraised value should be treated as current profit/loss. If it is intended to be a long-term investment, it should be treated as deferred investment profit/loss which should be accounted for as non-operating income or expenses over the investment period by equal annual instalments.

(b) Fixed Assets

-Contribution in fixed assets

When fixed assets are used as capital contribution, their book value should be set at reasonable levels as stipulated in the contract or agreement, or by adding up their appraised value based on market price with other fees incurred before contribution. In the case where an investor makes contribution to the enterprise in equipment, the original invoice issued by the manufacturer should be provided in order to ascertain its value.

-Depreciation

The depreciation of fixed assets is generally calculated by using the straight-line method or production/service output method on a monthly basis starting from the second month after the fixed assets are put into use. When the fixed assets cease to be used, depreciation would stop starting from the following month. If other depreciation methods or modifications to the existing method are preferred, application for approval has to be made to the relevant authorities pursuant to the law.

-Construction projects

Before a construction project starts, the enterprise should prepare a budget, procure the necessary equipment and materials at reasonable prices, accurately estimate costs, strictly control expenses, and determine the total costs as soon as possible.

(c) Intangible Assets

Where capital contribution is made in intangible assets, it should be accompanied by documents such as copies of proof of ownership, and detailed information such as the basis and standards of evaluation. Among these, the evaluation of proprietary technologies, franchise and goodwill should be conducted by authorized certification organizations or Chinese CPAs.

             

 


 
 
 
 
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