Selecting the correct structure for a business in China is a crucial choice and can ease needless business restrictions, costs, and official scrutiny. These challenges often risk limiting growth for a company entering the market and can weaken business plans that create a viable long-term strategy. The complexity of investing, doing business and managing a healthy growth in China comes with legal, regulatory, and cultural challenges.
When China first opened to foreign companies, representative offices, wholly foreign owned enterprises and joint ventures were the primary entry vehicles into the Mainland. China’s new Foreign Investment Law, which will come into effect on 1 January 2020, is intended to consolidate and streamline China’s foreign investment framework and laws. The intent is to align foreign invested companies with domestic company laws and system will move from a government approval to a registration system. However, “negative lists” remain in place, implementing regulations are still being issued and there will be a transition period.
Early on, a Representative Office (RO) was the most common vehicle to establish a presence in China. A RO serves as a local extension of a foreign company. In fact it is not a separate legal entity, as the foreign company retains all legal liability and ownership of property in China. A RO however has limited capacity, as it cannot trade or earn income and is limited to activities such as market research and liaising with customers and suppliers. Local staff can only be hired through a qualified Labour Dispatch Agency.
Some foreign businesses use ROs to maintain quality control of products and services made by Chinese suppliers. Others use them as support for customers in China who purchase products or services from the foreign company. ROs have been very useful in improving the business, communication lines and technical support with Chinese customers and suppliers.
A RO, however, potentially exposes the foreign company entity to establishing a taxable presence and PRC taxes. Care must be exercised that the RO does not engage in transacting or engaging in certain business activities such as negotiating and signing contracts.
Equity and Cooperative Joint Ventures
Foreign companies and investors have established equity and cooperative joint ventures with Chinese partners under PRC laws. In the past and in many cases, a Chinese partner was necessary for both legal and business reasons and these joint ventures were the only realistic vehicles of entry into the China market. However, the applicable statutes and governing structure and regulations are cumbersome and inefficient.
Variable Interest Entities
Variable Interest Entities (VIE) have been used to control businesses in China in industries in which there are foreign ownership restrictions. Essentially, under a VIE, foreign companies or individuals obtain the rights and financial benefits of ownership through contractual arrangements with a PRC domestic company. VIEs were of questionable validity under PRC law and drafts of the new Foreign Investment Law directly prohibited VIE arrangements. However, the final version of the Foreign Investment Law does not contain such prohibitions.
Wholly Foreign Owned Enterprise
A Wholly Foreign Owned Enterprise (WFOE) is a limited liability company owned by foreign companies or investors.
WFOEs are permitted to conduct business and are a common and preferred vehicle to establish a presence in China. Originally intended to permit foreigners to establish manufacturing facilities in China, the law and regulations have been liberalized to permit WFOES to engage in trading, services, consulting and other areas. While PRC local governments have varying requirements, minimum capital requirements have significantly decreased and online registrations have been implemented.
China’s new Foreign Investment Law towards uniformity and greater transparency is another step to open up to foreign investment. Although the law is to come into effect in 2020, there still remain many questions on timing, interpretation and implementation of the new law.
In the meantime, setting up a business in China through a Hong Kong company is and remains a favored alternative. This could be investment in a PRC joint venture or preferably a WFOE. In the case of a joint venture, it could be established as a Hong Kong company with a WFOE, with the joint venture and ancillary agreements governed by the laws of Hong Kong and its courts or arbitration bodies. Even in the case of a PRC partner, Hong Kong joint ventures have been established with its WFOE operating in China. Proper structuring could also utilize the benefits of Hong Kong’s favorable tax system.
Our team at Hugill & Ip has extensive experience in dealing with commercial, investment and trade issues – so if you need further advice on these subject and other topics discussed, get in touch with us to find out how we can help.
This article is for information purposes only. Its contents do not constitute legal advice and readers should not regard this article as a substitute for detailed advice in individual instances.