China Business Structures for Foreign Investment
However, legally the concept of FIE is more complicated than the literal meaning might imply; not least because Chinese law fails to expressly define the theory of FIE, and the expression is only loosely referred to in Chinese laws and regulations.
What are the different types of FIE? For foreign companies, there are three main forms that such business establishments in China can take. The most common form is the Representative Office, but the activities they may carry out are very limited. For example, an RO may not carry out direct business (sales/profit making) activities and is limited to activities such as market research and liaison. In practice, representative offices often exceed their business scope, but if a foreign investor wants to carry out legitimate profit making business activities in China, then they will need to set up a Joint Venture (JV) with a Chinese partner or choose to establish a Wholly Foreign Owned Enterprise (WFOE).
Which form is chosen by a foreign investor is dependent on many factors: how active the investor wants to be in China; the industry to be invested in; and whether or not a Chinese partner is desirable (e.g. benefit from the partner's experience in and access to the Chinese market) or necessary (required by law). Many investors prefer WFOEs to JVs, because this gives them full control over their business (albeit with increased capital and other requirements); and they are easier to establish now than in the past. However, there are certain industries in which a WFOE cannot be established (although this list is getting shorter).
It is worth noting here that the focus of Chinese business is changing from that of wanting to attract foreign investment to that of wanting to either undertake a joint venture or invest in foreign businesses outside China. China’s very high trade surplus has meant that while it still needs to develop many areas of business skills, it is no longer dependent on foreign investment for growth. This can be seen in recent changes to the PRC tax system, which is seeking to level the playing field for domestic and foreign companies (many of whom may have enjoyed tax breaks and other concessions which are now being phased out).
Below is a more detailed look at each of these structures.
1) REPRESENTATIVE OFFICES (RO)
- A China RO, also known as a Permanent Representative Office, is an office of a foreign enterprise set up in China for liaison with Chinese businesses and customers on behalf of its parent company. A RO is not considered to be a separate legal entity.
A RO must not carry out direct revenue earning business activities. For example, it cannot enter into purchase/sales contracts and cannot receive payment for services, issue invoices or repatriate monies overseas. However, a RO can open bank accounts and employ staff to maintain liaison with customers and suppliers. Its head office can also enter into contracts with its supplier/customers in China in its own name, but not in the name of its RO. Therefore, before a foreign investor establishes its presence in China using FIE such as a joint venture or a wholly foreign owned enterprise, it could first set up a representative office to test the Chinese market. Many foreign companies use a RO to assist with sourcing products from China and liaising with factories (contract manufacturing or traditional purchase and export).
Despite not being able to conduct business (i.e. sell), PRC tax authorities collect business tax from these ROs. Also, bilateral treaties provide that certain types of RO are permitted to engage in operational activities, but such bilateral treaties do not prevail over Chinese domestic law.
Representative Office Registration Procedures
The procedures for establishing a RO vary slightly in different provinces of China and also depend on where the foreign company is itself located. However, the basic procedures are much the same, namely:
Step 1: Examination and Approval
Step 2: Registration and Post-establishment Registrations
Step 3: Post-establishment Registrations
After a RO is registered with the relevant government authorities, it must handle registration and other procedures with banks, customs, tax authorities, public security bureau and other authorities.
2) JOINT VENTURES
- At least one Chinese investor and at least one foreign investor are required to form a JV. The partners to an equity joint venture jointly manage the venture. Foreign companies, enterprises, other economic organisations and individuals may act as foreign investors. Chinese companies, enterprises and other economic organisations may act as Chinese investors. The Chinese investors and the foreign investors should enter into a Joint Venture Contract and contribute capital subscribed by them as set forth in the Joint Venture Contract. The investors share profits and losses pursuant to the ratio of capital subscribed by them. The capital subscribed by the foreign investors should not be less than 25% of the registered capital and the procedures for registration are similar to those of a Wholly Foreign Owned Enterprise (WFOE).
Parties may contribute their respective capital to the equity joint venture in the form of cash, capital goods, industrial property rights, and other assets. Commonly, the Chinese partner will contribute cash, land development or clearance fees and land use rights while the foreign partner commonly contributes cash, construction materials, technology, equipment and machinery. All contributions must first be approved by the relevant Chinese authorities and later certified in a report from a Chinese-registered CPA firm.
Note: many foreign companies will use a Hong Kong company as their joint venture partner, usually newly established for that purpose, for risk management and to take advantage of Hong Kong’s legal and open banking infrastructure.
3) Wholly FOREIGN OWNED Enterprise (WFOE or WOFE)
- The WFOE is a limited liability company wholly owned by a foreign investor(s). In China, WFOEs were originally conceived for encouraged manufacturing activities that were either export orientated or which introduced advanced technology. However, with China's entry into the WTO, these conditions have been gradually abolished and the WFOE is increasingly used by service providers, including a variety of consulting and management services, software development and trading firms. The registered capital of a WFOE should be subscribed and contributed solely by foreign investors.
- independence and freedom to implement the global strategies of its parent company without having to consider the involvement of a local Chinese partner;
- ability to formally carry on business and capable of issuing invoices to their customers (and receive revenues) in RMB;
- capable of converting RMB profits to foreign currency for remittance to their parent company outside China;
- better protection of intellectual property;
- opportunities for efficiency, better management and future development.
For the WFOE, the minimum amount of registered capital required starts from around RMB100,000 (note: under PRC Company Law, paid-up capital is equal to registered capital). Investors or shareholders must pay for the shares subscribed and deposit the money into a specified bank account.
In China, terms of 15 to 30 years are typical for a manufacturing WFOE (although some may have a longer term, up to 50 years). Conversely, the WFOE may be terminated under certain conditions - for example, the inability of the WFOE to operate due to heavy losses.
There are three main steps to registering a WFOE:
Step 1: Project Proposal and Approval
Step 2: Registration for Business License
Step 3: Registrations with other Government Authorities
Note: A WFOE does not include branches established in China by foreign enterprises and other foreign economic organisations. In fact, Chinese laws on WFOEs do not have a clear definition of the term "branches" and the term usually includes both the branch companies (engaged in operational activities) and representative offices (which are not engaged in direct business activities).
The advantages of establishing a WFOE include:
With the enormous growth in the PRC over recent years, it is clear that the focus for Chinese business is changing from that of wanting to attract foreign investment to that of looking for opportunities to invest in foreign businesses outside China. And the PRC government has been systematically changing the tax system to level the playing field for domestic and foreign companies operating in China.
Nevertheless, many foreign companies are still undertaking business ventures in China to exploit business opportunities in its huge domestic marketplace – or to source products from China to sell to overseas/home markets, often using Hong Kong as a base to manage operational matters, banking (including letters of credit) and trade documentation. ATC is able to assist with all parts of the process, whichever method of investment is chosen.