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Copyright © International Chamber of Commerce (ICC). All rights reserved. ( Source of the document: ICC Digital Library )
by Paul-Emmanuel BENACHI
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In the fashion that has been archetypical of the reform movement launched by Deng Xiao Ping in 1978, the country’s opening to foreign investment was initiated on an experimental basis in 1980 when four coastal cities were transformed into Special Economic Zones offering foreign investors advantages for establishing export-manufacturing operations. Four years later, in the light of the success of these experiences with foreign investment, Economic and Technological development Zones (TEDZ) were opened in 14 coastal cities. By the 1990s, many more special zones had been opened in cities along the major river deltas and the Gulf of Boa. Currently there are over 4,000 zones1 in which foreign investors may find one or another of a large range of facilities and incentives.
In the process, China has become a world leader for the attraction of foreign investment.2
On June 5, 1986, the State Council promulgated the Provisions with respect to the Encouragement of Foreign Investment. These have played an important role in attracting foreign investment by offering a series of preferential and priority treatments as well as advantageous government guarantees.
In order to further improve the investment environment, the State Council approved on June 7, 1995 a provisional regulation with respect to foreign investment guidelines (the Foreign Investment Guidelines Regulation), to which is annexed a catalogue of industries. The purpose of the Foreign Investment Guidelines Regulation is to create a framework for foreign investment in China’s industries, to provide foreign companies with greater access to information about internal policies (neibu zhengce), and to orient foreign investment toward China’s priority industries and its underdeveloped central and western regions.
The Foreign Investment Guidelines of 1995 broadened the range of industries in which foreign investment was permitted. Industries that had been off limits to foreign participation, such as air transport, finance, insurance, investment services, accounting and commerce, were opened to foreign investment, though still under restrictive conditions.
In accordance with the Marrakech Agreement, the People’s Republic of China (PRC) officially became the 143rd full member of the World Trade Organization (WTO) on December 11, 2001.
In order to access the WTO, China accepted substantial commitments resulting primarily from a Working Party Report and a Protocol of Accession and Market Access Schedules for both goods and services. At that time, most foreign investors already established in China or prospecting the Chinese market thought that China was truly motivated to aggressively continue its economic and legal reforms in order to create a liberal and market-oriented economy but they also had doubts about China’s ability to honour its WTO commitments as quickly or as completely as agreed.
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Four years after its accession to the WTO, China has adopted major legal reforms (notably the reform of the banking and insurance sectors, the new regulations relating to mergers and acquisitions, the amendment of the Foreign Trade Law and the new regulations relating to distribution in China) and, consequently, offers wide opportunities to foreign investors. Driven by this liberalization process and industrial restructuring, foreign direct investments have sustained China’s growth in services and medium- and high-tech manufacturing industries.
As the Chinese economy has opened up to diversified foreign direct investments and the local authorities have increasingly committed to the liberalization of the market, the choice of location for opening a first establishment has broadened. The choice of venues is rendered even more difficult since specific tax incentives and other advantages are offered by free trade and development zones as well as by some Chinese cities.
In general, foreign investors choose the place of their first establishment in China on the basis of their individual business needs, the quality of the infrastructure, the size and specificities of the local market and the availability of local incentives.
Foreign investors might set up their registered office: close to their main suppliers if their main activities are the production of goods for export; near their main customers if their main activities are distribution of goods in China; or in the same area/district as their regulatory authorities if their activities require the obtaining of specific licences or recurrent authorizations.
In terms of infrastructure and quality of business environment, some cities have made greater efforts than others in building roads, tunnels, hotels, communication systems, power plants, high-tech offices, etc. For example, Shanghai has created 17 development zones3 and offers incentives such as tax reductions, subsidies and value added tax refunds.4
Nowadays, most multinational companies consider these incentives as “bonuses” rather than essential criteria in the choice of venue to establish their headquarters. Indeed, as a result of the amendment of the Foreign Trade Law and the new regulations on distribution, these development zones have lost some of their comparative advantages for companies in the commercial services industries.
China’s major economic regions are:
Each of these regions presents specific strengths and contributes in its own manner to the economy’s rapid growth.
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The Yangtze River Delta region is the foremost region in terms of gross domestic product (GDP) and in terms of fixed asset investments. In 2003, the region represented a GDP of RMB 2,379.8 billion, after a year-to-year increase of RMB 381.5 billion, and it had the highest level of fixed asset investments (RMB 1097.4 billion). It also possesses a dynamic retail market – in 2003, its retail sales amounted to RMB 718.6 billion, up 12.1% year on year.
The Pearl River Delta area, as well as the Beijing – Tianjin – Hebei cities and the North-eastern China cities also show fast and sustainable growth. In 2003, the Pearl River Delta area achieved the fastest average growth rate (15.5%) among the four regions and its GDP reached RMB 1,133.5 billion. The Beijing – Tianjin – Hebei cities have developed into one of the country’s largest and most modern logistics centres as well as one of its biggest consumption markets. In 2003, the three Northeastern provinces, total retail sales (RMB 481.7 billion) corresponded to 10.5% of the national market.
Under the policies applicable until January 1, 2009, foreign investors in specially constituted zones generally enjoy a favourable tax treatment consisting in an income tax rate of 15%6 as well as two years exemption and three years of half taxes after the first profit-making year for manufacturers.7
These policies played a key role in orienting foreign investment in the past, most notably in the foreign investor’s choice of place of establishment.
But the reform of business income taxation to come into effect on January 1, 2008 institutes a uniform national rate for the taxation of business income at 25%. This harmonization of domestic companies’ and foreign investors’ tax treatments will eliminate most of the preferential tax treatments hitherto enjoyed by FIEs.
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Despite having several projects in China, some foreign investors prefer not to establish a company unless the regulations so require.
Foreign investors may set up representation offices in China for promotion and liaison. Chinese law expressly provides that representative offices may not directly engage in operational activities. However, foreign law firms or accounting firms are authorized to engage in commercial operations via a representative office, and the tax regime of these types of representative offices is similar to that of FIEs.
The main rules governing resident representative offices (RROs) are:
RROs of foreign enterprises are strictly limited to indirect trade activities. Such indirect trade activities include liaison in the name of the foreign enterprise, such as trade contacts with Chinese or foreign enterprises, collecting information, product introduction, market studies and technical exchanges, as well as any other activities that are not deemed to constitute direct trading activities.
According to the SAIC, production, direct agency or selling activities are therefore prohibited for RROs.
The SAIC is authorized to impose penalties on representative offices engaging in direct trading activities, and in serious cases, it may order RROs to close.
In practice, certain trading activities are tolerated by the SAIC. The representative offices of foreign enterprises in China are usually equipped to carry on relations with clients, to initiate and pursue commercial relationships and administrative contacts, and to prepare and supervise investments in China. If such activities produce direct income, the RROs are liable to tax in China.
All activities of RROs and their staff must abide by the laws and regulations of China while their rights and interests are protected by the law.
RROs must entrust local service providers designated by the government with matters such as housing or employment of local Chinese personnel.8
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RROs may rent commercial communication lines or equipment for their business operations. Applications must be filed with the local telecommunications bureau and a commercial need must be demonstrated. RROs may not install radio stations on Chinese territory.
To set up an RRO in China, the following conditions must be met:
Prior to July 1, 2004, to register an RRO, foreign companies submitted their applications for approval to the local office of MOFCOM and, in case of approval, they had to register with the competent SAIC. Now, only registration with SAIC is required, though in certain sectors, such as in the insurance industry, the approval of special regulatory authorities may be requested.
The registration certificate of an RRO is issued by the SAIC for a period of three years and it may be renewed from year to year subject to notice 30 days prior to the date of expiration. The requirements for renewal are similar to those involved in the initial application.
In order to obtain their residence status, RROs’ foreign representatives and their families must register with the Public Security Bureau within 30 days following receipt of the registration certificate and the representative cards. The representative office’s seal is issued by the seal service of the Public Security Bureau.
RROs and their staff must be registered with the local tax authority and with the Customs Office within 30 days following the issue of the registration certificate. The list of goods to be imported by the representative office and the list of personal belongings imported by the representatives must be declared to the Customs Office.
RROs are required to open accounts with an authorized bank.
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The revised PRC Company Law leads to contradictions between RROs, branches and liaison offices of domestic companies (including FIEs), Foreign Company RROs and branches.
Under current laws and regulations of RROs in the PRC, a foreign company not willing to set up a limited company subsidiary may establish either RROs or branches in China, and neither constitutes a separate legal person. The distinctions between RROs and branches of a foreign company are similar to the distinctions stated above for liaison offices and branches of a domestic company. RROs are not allowed to engage in business activities unless authorized by special regulations, but branches are permitted to engage in business activities. The use of an RRO by a foreign company is explicitly authorized by a regulation promulgated by the State Council. Foreign companies use of branches are regulated under the Company Law.
Because the RRO of a foreign company is regulated by a special regulation but not governed by the Company Law, the Company Law’s revision does not affect the legal status or procedures for formation of RROs. On the other hand, branches of a foreign company are governed by the Company Law and the revision may affect their legal status and procedure of formation. However, a comparison of the old and new versions of the provision governing branches of a foreign company reveals no difference. In other words, the revision of the Company Law did not in fact change the rules and requirements regarding use of branches by a foreign company. Thus, the revision of the Company Law alone has no effect on either the use of RROs or branches by foreign companies. Whether subsequent change may be effected by promulgation of implementing regulations remains to be seen.
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The provisional regulation of May 15, 1985 with respect to taxation of the income of RROs, promulgated by the Ministry of Finance, defines the tax basis of RROs as including income derived from consulting services and commissions for agency services in China.
The Guoshuifa (2003) No. 28 issued by the PRC State Administration of Taxation tightens the tax administration of RROs in China. It is worth noting that the circular provides clear taxation guidelines for RROs engaging in consultancy services, such as general business consultancy, legal work, taxation, accounting and auditing, etc. The circular also clarifies the taxation basis for RROs and their head offices that engage in taxable activities in the PRC. According to the tax circular Guoshuifa (1996) No. 165, the State Administration of Taxation uses three methods for determining the taxes payable by RROs. The most common method is the cost-plus method. Under this method, the China-sourced gross income of an RRO is computed based on its operating expenses.
In general, RROs may not operate for profit and can only conduct ancillary and coordinating activities for their head offices. Accordingly, most RROs are cost centres and do not derive income.
Pursuant to the new tax circular issued in March 2006, the cost-plus method no longer applies to RROs that engage in business consultancy, legal work, taxation, accounting and auditing services. Instead, these RROs are required to keep proper books and accounts, and to compute the relevant taxable income tax for filing purposes.
For foreign companies that engage in trading (including direct trading or trading as an agent), advertising, and travel agency services, their RROs can still pay tax based on the cost-plus method. However, such RROs may not directly contract with customers, and all service income derived from China should be received by their head offices.
For those RROs that may engage in taxable activities in the PRC, such as those set up by the banks, financial institutions, transport companies, group companies or other investment holding companies, according to the new circular, these RROs should pay tax based on their actual income derived from China. Hence, the head offices of these RROs may be subject to increased PRC tax exposure upon enactment of the new circular.
Certain RROs are still eligible for tax exemption according to Guoshuifa (1996) No.165. These include RROs set up by foreign government agencies, international organizations, non-profit making institutions and community groups.
According to the Circular by State Administration of Taxation on Relevant Issues concerning the strengthening of the collection and management of taxes on permanent RROs of foreign enterprises issued on Sep 13, 2006, the taxation on RRO of foreign enterprises has been clarified with more legal certainty.
Pursuant to this Circular, the RRO shall only undertake preparatory and supplementary activities, such as gathering information on the Chinese market, providing business information and contracts on production and sales for their headquarters.
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Approvals of foreign investments are under the general administration of the MOFCOM and its locally competent offices.
On October 31, 2007 the National Development and Reform Commission and the MOFCOM jointly issued a revised Foreign Investment Industrial Guidance Catalogue that became effective as of December 1, 2007. The new Catalogue contains numerous significant changes of orientation compared with the previous version adopted in 2004.
Under the Guidelines, foreign investments are divided into four categories: encouraged industries, restricted industries, prohibited industries, permitted industries. The Regulation sets down in detail guidelines covering the first three types of industries.
Sectors in which foreign investment is encouraged include: new agricultural technology, development of agriculture and of specific industries such as energy, transportation and important raw materials; projects involving new and high technology, quality-improving and energy-efficient equipment and new materials; projects capable of upgrading product quality and increasing exports; projects capable of making full use of human and natural resources in the central and western regions of China.
Industries in which foreign investment is allowed but restricted include those in which foreign investment has already been developed in China and in which production capability is sufficient to satisfy domestic market demand, as well as projects involving exploitation of rare and valuable mineral resources and industries subject to State planning.
Industries and lines of business in which foreign investment is completely banned include projects that may endanger national security or harm public interest, that fail to protect the country’s land resources or that use techniques or technology indigenous to China and any other projects explicitly prohibited by the law and regulations.
The fourth category, which is not explicitly listed in the catalogue annexed to the Foreign Investment Guidelines Regulation, covers sectors in which foreign participation is permitted subject to neither restrictions nor encouragement. They include all other industries not falling into one of the above-mentioned first three categories of industries.
The Catalogue is a primary source for determining the legality of any foreign investment project as well as for its qualification in Chinese law (such as under tax and customs laws). All foreign investment, whatever its form, must comply with China’s industrial policies as reflected in the Guidelines.
The Foreign Investment Guidelines Regulation confers upon the State Planning Commission (to which has succeeded the NDRC), in conjunction with the competent State Council departments, the authority to update the list while taking account of the law and regulations as well as the country’s economic and technological development.9
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The 2004 amendments to the Catalogue reduce the number of restricted and prohibited categories. Sectors that remain prohibited to foreign investment are for the most part politically sensitive, such as those involved in national defence. In particular, the Chinese authorities have reformed the investment regulations in service sectors such as banking, insurance and distribution as well as in specific industries such as metallurgy in order to implement the openings stipulated in the WTO accession agreement.
For instance, since December 2003, foreign banks have been allowed to conduct local currency business.10 Under the terms of the WTO accession agreement, the Chinese banking sector will fully open to foreign competition by 2007.
In compliance with its WTO commitments to liberalize the trade and distribution sectors, China has adopted:
However, in practice, foreign investors frequently encounter inconsistencies in approval procedures for the setting up of Foreign Invested Commercial Enterprises (FICEs) and discrimination against manufacturing companies’ efforts to expand into distribution.
China does not encourage small investment projects.
In China, foreign investment is subject to a general procedure applicable to most FIEs and to specific procedures applicable to investments in the Restricted Category.
3.2.1. Main approval process
All foreign investment projects involving the establishment of a legal entity in China are subject to approval by the Chinese authorities. In most such cases, the approval process involves the MOFCOM (or its locally competent office17) and the locally competent office of the SAIC.
The Chinese authorities exercise their control based on project proposals, feasibility reports, joint venture contracts and/or articles of association of the future legal entity.
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3.2.2. Special approval processes
The Chinese government has also adopted specific regulations and charged specific authorities with the power to approve certain projects.
For example, all foreign investments in civil aviation projects are subject to the approval of the China Administration for Civil Aviation.
Projects involving infrastructure construction are submitted for approval by the State Development Planning Commission or, depending on the value of the project, by the local planning authority.18
The MOFCOM consults with the Ministry of Construction before granting any approval for the setting up of a company specialized in engineering design.
Foreign investors planning to set up a company specialized in advertising must submit a preliminary request to the SAIC.
The Urban Commercial Development Committee approves all foreign investments in the retail sector.
All projects for the establishment of foreign invested travel agencies are submitted to the Provincial Tourist Bureau, the Administration Authority of the Tourist Zone and the Local Tourist Bureau. The Provincial Tourist Bureau then submits the application to the State Tourist Administration for approval.
All foreign investments in medical projects are submitted to the Ministry of Health.
Projects involving telecommunications activities and electronic commerce in China are subject to approval by the Ministry of Information Industry (MII).
Foreign investments in the banking sector are reviewed by the China Banking Regulatory Commission (CBRC) and those in the securities industry by the China Securities Regulatory Commission (CSRC) whereas foreign invested insurance activities are regulated by the China Insurance Regulatory Commission (CIRC).
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At the beginning of the “Open Door Policy” launched in the late 1970s, the separation of the domestic and foreign investment legal systems served to promote economic development through the attraction of foreign investment. With its accession to the WTO, China confirmed its commitments gradually to unify the legal systems governing investments, accounting and taxation.
To this end, on October 27, 2005, major amendments to the Company Law were adopted.19 The principal amendments of the Company Law in 2005 will increase shareholder rights and improve corporate governance. In these respects, the amendments may be expected to promote foreign confidence and investment.
In addition, new regulations have been adopted to provide a framework for acquisitions by foreign investors of companies listed on the Chinese stock exchanges.
While Chinese legislators have frequently drawn inspiration from overseas models of enterprise regulation, the transposition into Chinese law of numerous foreign concepts and terms may give rise to confusion, as their use in China does not always perfectly replicate their original meanings.
4.1.1. Enterprises and companies
In Chinese legislation, the term enterprise (qiye) has a broader meaning than the term company (gongsi). The former includes companies as well as other forms of economic undertakings such as co-operatives (hezuozhi qiye) or partnerships (hehuo qiye), whether they are State-owned (guoyou), collectively owned (jiti suoyou) or privately owned (siyou).
Chinese enterprises are generally subdivided and analysed according to two criteria. The first classifies enterprises according to their type of ownership. In this manner, enterprises are divided into three categories: State-owned, or in other words, enterprises owned by the whole people, collectively owned enterprises and privately owned enterprises or entities. The second criterion classifies enterprises strictly according to their legal forms without taking into consideration their ownership structures. This criterion divides enterprises in two categories: entities with, and those without, legal person status, that is legal personality. The former can be further divided into companies, enterprises and cooperatives whereas the latter includes partnerships.
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4.1.2. Legal persons and legal representatives
The concept of legal person (faren) is basic to both civil and enterprise laws in China. It refers to all entities and organizations that have autonomous capacity to enjoy independent civil rights, to assume civil obligations and to exercise and conduct civil acts. According article 37 of the General Principles of Civil Law20 (the GPCL) the conditions to qualify as a legal person are the following:
A legal person’s domicile is the place where its main administrative office is located.
A legal person’s civil capacity begins when it is established and ends when its existence is terminated.
Enterprises, companies and other organizations may qualify to be registered as legal persons. The Company Law, the EJV Law and other enterprise regulations generally state that companies and enterprises are legal persons.
An enterprise as legal person must conduct operations within its approved and registered scope of business. It assumes civil liability for the conduct of its legal representatives and personnel toward other natural and legal persons.21
The responsible person who acts on behalf of any legal person in exercising its functions and powers is its legal representative (faren daibiao).22 The functions and powers of the legal representative of a legal person are defined by the law and complemented in its articles of association. Usually, the legal representative of a company is the chairman of its board of directors or its general manager.23
An enterprise as a legal person must conduct operations within its approved and registered scope of business. It assumes civil liability toward other individuals and legal persons for its activities and for those of its legal representatives in the conduct of its affairs.24
The objects of companies must be specified in their articles of association and are thus subject to review by the SAIC or its local branch, and all companies must carry on their operations in strict compliance therewith.
Business licences issued by the competent SAIC state the business scope of each enterprise in China and its date of issuance represents the date of creation of the concerned enterprise. Every change in the objects of an enterprise gives rise to an amendment of its business licence.
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4.1.3. Capital of FIEs
The minimum amount of registered capital of a Chinese company does not depend on the legal form of the company, like in most European countries or in the United States.
In China, the minimum amount of registered capital of enterprises is determined on a regional basis by the Chinese Government or by specific national regulations requiring higher or lower minimum amounts of registered capital.25 For example, the minimum registered capital required for the setting up of a manufacturing or consulting WFOE or EJV/CJV is USD 100,000 in Shenzhen and USD 140,000 in Shanghai.26 According to the Measures on Foreign Investment in the Commercial Sector dated April 16, 2004, the minimum amounts of registered capital of FICEs specialized in retailing and wholesaling are respectively USD 36,000 or USD 60,000.
Foreign investors may make their contributions to the registered capital of FIEs in cash or in kind.27 In particular, they may contribute in kind any tangible or intangible asset that is not prohibited by the applicable regulations, such as equipment, machinery, intellectual property, knowhow, technology, real estate (land use rights, leases), etc. Prices of machinery and equipment, industrial property rights and proprietary technology contributed as capital are, as a rule, set by reference to the international market; such prices should not be higher than the normal market price of similar machinery and equipment.28
Contributions in kind of intellectual property may not exceed 20% of the amount of a FIE’s registered capital.29 The value of contributions in kind must be assessed by authorized agents recognized by the Chinese approval authorities.30
According to the Company Law as amended in 2005, contributions in cash may not represent less than 30% of the amount of the FIE’s registered capital.31
In order to control the indebtedness of FIEs, the Chinese authorities oblige foreign investors to register both the registered capital of their FIEs and the total amount of the investments therein. The total amount of investment corresponds to the registered capital plus the FIE’s debt financing.32 The current regulations impose the following minimum ratios between the registered capital of FIEs and the total amounts invested:
The 2005 amendments to the Company Law encourage the establishment of companies with a registered capital higher than the minimum registered capital required by Chinese regulations.
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4.1.4. Principal forms of FIEs
Prior to the enactment of the Company Law, the Chinese authorities had already adopted a separate set of specific laws and regulations for foreign direct investment.
Foreign investors may choose to create any of the following vehicles:
These four main corporate vehicles are collectively referred to as Foreign Invested Enterprises (waishang touzi qiye) (FIEs).
The Company Law that became effective in 1994 supplemented the foreign investment laws by on the one hand creating new modes of setting up, such as limited liability companies (LLCs), companies limited by shares (CLSs), branches of foreign companies and foreign-invested companies limited by shares (FICLSs), and on the other hand by providing general corporate rules, which are applicable in a supplementary manner to all forms of companies, in particular those that also qualify as FIEs.
Article 18 of the Company Law states that:
“This Law shall apply to limited liability companies with foreign investment. If the provisions of relevant laws concerning sinoforeign joint equity enterprises, sino-foreign co-operative enterprises and wholly foreign owned enterprises stipulate otherwise, such provisions shall apply.”
Therefore, FIEs constitute a special category of companies defined by specific laws, implementation regulations and rules.
4.1.4.1. EJVs
Once established an EJV has legal personality.
Foreign investments, the profits thereon and other lawful rights and interests in EJVs are protected by Chinese law.
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EJVs are enterprises created in China jointly by both foreign investors, whether they are enterprises or individuals, and Chinese investors that must be Chinese legal persons whether in the form of companies, enterprises or other forms of economic entities. EJVs must be based on the principles of equality and mutual benefit.
In accordance with articles 3, 4 and 5 of the EJV Regulation, the constitution of an EJV in China supposes that one or several of the following general results may be expected:
More generally, the establishment of an EJV must contribute to the development of China’s economy or to scientific or technological progress.
In the following circumstances, applications to establish an EJV may not be approved:
EJVs must be constituted as limited liability companies.40
Parties to EJVs share profits, risks and losses in proportion to their contributions to the registered capital of the company.41
The EJV contract, its articles of association and, where relevant, any technology transfer agreement concluded between the Chinese and foreign parties enter into effect only after their approval by the competent authorities.
Under Chinese law, joint venture contracts within the scope of the EJV Law as well as the related articles of association are mandatorily governed by Chinese law.42
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4.1.4.2. CJVs
The CJV is subject to more flexible rules than the EJV.
In CJVs, general corporate rules governing issues such as registration, accounting and auditing, foreign exchange, taxes, labour, preferential tax and social treatments that are not stipulated in the CJV Law or its Implementation Rules are drawn from the Company Law as well as the EJV Law and relevant regulations.
Under Chinese law, a CJV is an association of two or more enterprises for the purpose of realising a common business objective.43 The relations, rights and obligations of the parties are defined in a contract.44 There are two types of CJVs: those with and those without legal person status.45
A CJV with legal personality has the characteristics of a limited liability company, and in this respect it has points in common with an EJV. A distinct organ must be created by the parties to be registered with the competent corporate registry as a Chinese legal person.46 The respective rights and responsibilities of the parties are limited to their contributions to the registered capital of the CJV.47
The CJV is liable for risks and losses to the extent of its total assets.48
Non-legal person CJVs function in accordance with the norms applicable to associations and partnerships.49 Each party is responsible, in proportions agreed upon in the CJV contract, for the losses and risks as well as for the payment of taxes arising during the operation of the CJV.50
This form of investment is a preferred vehicle for realising investment projects in the construction and exploitation of hotels, mines and offshore oil exploration and exploitation, and smallscale manufacturing. However, the number of CJVs is small in comparison with EJVs and WFOEs.
4.1.4.3. Negotiating JVs
Negotiating Chinese JVs is a process of mutual understanding in order to find a consensus (yizhi xieyi).
At a preliminary stage, the investors may enter into agreements guaranteeing the confidentiality of all exchanged information, such as know-how and information subject to intellectual property rights.
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Each stage of discussion will usually result in the adoption of a written document that records the propositions of each party and the points discussed. Such letters of intent are not legally binding documents except the clauses of confidentiality, if any, but they are important documents for the Chinese partners to obtain the approval of the supervisory authority(ies) in charge of their activities. They represent at least a commitment of the investors to negotiate in good faith. A letter of intent usually includes information relating to the objects of the future FIE, its financing, its intended activities, a description of the market, a deadline for the signing of the joint venture contract and/or articles of association, and a choice of applicable law.
During the negotiation of a JV, the following documentation is generally prepared:
The feasibility report is prepared by Chinese and foreign parties jointly. It is an important document on which the parties base their decisions to engage in the venture. The major points concerning establishment of the JV – such as the general principles of co-operation, investment proportions, composition of the capital, business scope, organizational structures, economic feasibility, market forecasts, profit and loss forecasts – should be stipulated.
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The JV contract contains provisions covering all the important matters relating to the JV and sets down procedures governing its establishment and operations. The joint venture contract of a JV must include the following information:
In most cases, investors will add other clauses, such as a force majeure clause, a hardship clause, an arbitration clause, etc.
In the event of differences between the JV contract and the articles of association and other contracts and agreements annexed, the JV contract prevails.52
Disputes arising among the parties to a JV, which the board of directors or the management committee is unable to settle through consultation, may, upon agreement of the parties, be settled through mediation or arbitration by an organization in China or in a foreign country, and/or through legal proceedings in a people’s court.
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4.1.4.4. WFOEs
WFOEs are a traditional form of foreign direct investment that was officially created for enterprises established by foreign investors in the territory of China, exclusively with their own capital. But this term does not include branches set up in China by foreign enterprises and other foreign economic organizations. Foreign investors may be foreign enterprises, economic organizations or individuals.
If a foreign investor wants to establish a WFOE in China. In general, the enterprise must contribute to the development of China’s national economy and it must satisfy at least one of the following conditions:
In choosing among vehicles for establishment, WFOEs have both advantages and disadvantages compared with EJVs and CJVs. The most important advantage is the control of the foreign investor over the business.
Neither the WFOE Law nor its Implementing Rules provide any mandatory management structure for WFOEs. In practice, however a management structure must be spelled out in considerable detail in the constituting documents including the duties and, limits of the authority of management personnel.
WFOEs may be established either as companies or in such other corporate form as is approved by the competent authority.53 The registered capital of a WFOE must be coherent with respect to its scope of business, and the proportion between the registered capital and the total amount of investment must comply with the provisions of the applicable Chinese laws and regulations.54 During its term of business operations, a WFOE may not decrease its capital, or increase or assign it without approval of the competent authority.55
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Foreign investors must make their investments within the time limits stipulated in the written application for their establishment and in the enterprise’s articles of association.56 Capital contributions may be paid in instalments, but contributions must be fully paid up within three years from the date of issue of the business licence.57 The initial instalment may not be less than 15% of the total contribution, and it must be paid within 90 days from the date of issue of the business licence.58 The certificate of approval for the establishment of the proposed WFOE is automatically void if the first instalment is not paid within the time limit.59 Each instalment must be verified by a Chinese registered accountant, who issues a verification report.60 In general, the term of operations of a WFOE must be fixed and is subject to approval by the competent authority. The duration of a WFOE is necessarily shorter than that of an equivalent EJV. WFOEs must terminate their business at the expiration of their approved term of operations or obtain an extension.
An application for extension of the WFOE must be filed with the original approving authority 180 days before the expiration of the current term of operations.61
4.1.4.5. LLCs and CLSs
The Company Law creates and regulates two principal types of company forms: limited liability companies (youxian zeren gongsi) (LLCs) and companies limited by shares (gufen youxian gongsi) (CLSs). LLCs have attributes of both:
CLSs also have attributes common to both private and public limited companies. What principally distinguishes CLSs from LLCs is that the former may opt, subject to obtaining the required authorizations, to issue shares to the public and have such shares listed on stock exchanges. Accordingly, they usually correspond to larger businesses than those conducted via LLCs. In both LLCs and CLSs, the liability of the investors is limited to the amount of their share of the total par value of the company’s capital.
In both LLCs and CLSs, investors are called shareholders. Investments in LLCs are evidenced by investment certificates, whereas CLSs investors receive shares.
According to the Company Law as amended in 2005, the minimum registered capital of limited liability companies is fixed at RMB 30,000 for LLCs, and at RMB 5,000,000 for CLSs.62
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4.1.4.6. Holding companies
In Chinese law, holding companies have legal personality.63
As a type of limited liability company, a holding company may be established with minority foreign participation of at least 25% of the capital up to 100% foreign capital.64 This vehicle is designed for multinational groups so that they may, under certain conditions, consolidate operations of their affiliates in China under the control of a single entity. The disadvantage of holding companies is that the conditions for approval are very strict.
The minimum amount of capital for creating a holding company is USD 30 million.65 Further, if the holding company is created solely with foreign capital, at least one of the following conditions must be met:
If the holding company is created in the form of an EJV, the total assets of the Chinese investor in the year prior to the creation of the holding must have been no less than RMB 100 million.67
The creation of a holding is first subject to approval by the authority in charge of foreign trade and investment in the province, the autonomous region or the municipality directly under the central government, and then to approval by the MOFCOM.68
The time limit within which capital contributions must be fully paid up is two years from the date of issue of the business licence.69
In accordance with article 5 of the Holding Company Regulation, a holding company may carry on activities consisting of investments in industry, agriculture, infrastructure, energy and all the other sectors in which foreign investments are encouraged or permitted by the State.
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Holding companies may also, in accordance with written agreements with their affiliated companies, supply the following services:
The investment activities of Holding Companies are not confined to the place where their headquarters are located.
4.1.4.7. FICLSs
In accordance with the FICLS Regulation, the rules in the Company Law that are applicable to CLSs apply equally to FICLSs.71 Similarly, FICLSs are subject to the policies and laws applicable to traditional FIEs.72
In addition, there are rules specific to the regulation of FICLSs. The total registered capital of an FICLS is divided into shares of equal value.73 The minimum amount of the paid-up capital of an FICLS is RMB 30 million.74 The fraction of capital held by foreign shareholders must not be less than 25% of the total amount of the company’s registered capital.75 At least one of the founders must be a shareholder of foreign nationality.76 The shares of an FICLS held by the founders may not be transferred within the first three years of its establishment.77 Such transfers of shares are subject to review by the original approval authority.78
An FICLS can be created by private financing or by issues of shares to the public.79
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If an FICLS is established by private financing, the application for establishment must be submitted to the competent department of the local government at the level of the provinces, the autonomous regions, or the municipalities directly under the central government.80
If an FICLS is established through public issue of shares, the application for establishment must first be approved by the competent local government and further by the MOFCOM.81 The latter must indicate its decision within 45 days from receipt of the application.82
FIEs already established in China may apply for conversion into FICLSs. To qualify, the FIE must have earned profits during the last three consecutive years.83 Other forms of enterprise or companies, such as State-owned or collectively owned enterprises, CLSs, CLSs having listed B shares and/or having listed shares overseas may also apply to be transformed into FICLSs.
In all cases, the minimum equity held by foreign investors must correspond to at least 25% of the registered capital.84
4.1.4.8. Single-person FIEs
The 2005 amendments to the Company Law authorize the constitution of limited liability companies by a sole individual or legal person. 85 The minimum registered capital of such companies is RMB 100,000 and it must be fully paid up before the issue of the business licence.
All foreign investment projects are subject to approval by Chinese authorities.
The main legal documents to be submitted to the approval authorities are:
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The feasibility report must demonstrate that the project can be implemented, while the articles of association must include all the main principles that will govern the FIE’s life, termination and liquidation. The feasibility report includes information relating to the activities of the FIE to be set up, its technology, its intellectual property rights and its equipment, the presentation of the investors, the total amount of investment of the project and the registered capital, a market study, the financing of the project, the number of employees, the expected cash flow and turnover, the operation of the business and its premises.87
If the intended activities of a FIE are subject to any specific approval pursuant to any law or administrative regulation, such approval must be obtained before the enterprise can be registered.
An FIE may set up branches and, in such cases, it must file an application with the company registration authority to obtain a business licence. A branch does not enjoy legal personality and all civil liabilities deriving from its activities are borne by its parent company.
The procedures for setting up of a FIE (EJV, CJV, WFOE) consist of four main phases:
Prior to registering a FIE, foreign investors must enter into a lease agreement for their premises.88 In some sectors, such as retailing, the location of the registered office is a key issue and may dramatically delay the process of registration. Chinese landlords can be reluctant to rent their premises to a company in the process of registration and may require the signature of a lease agreement with the parent company or the foreign investors.90 Some legal entities’ registered offices, such as the premises of representative offices or manufacturing companies, can only be located in authorized locations.
4.3.1. Pre-registration of the FIE’s name with the SAIC
Applicants must apply in advance to register their future FIE’s name with the local SAIC. The local SAIC will examine and, as the case may be, suggest corrections to the contemplated company name. The name of an enterprise must contain the name of the Chinese city where its registered office will be located, and its commercial name, its main activity or sector of activity (for example, trading, manufacturing, distribution, etc.).90
Within ten days following the receipt of such application, the local SAIC delivers an Enterprise Name Registration Certificate and reserves the company name for a six-month period renewable once. The reserved company name will become invalid if the applicants do not register the commencement of their FIE’s activities within the reservation period.
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4.3.2. Registration with the SAIC
After obtaining the approval of authorities exercising subject matter competence, the application for registration of the FIE must be filed with the local SAIC within 30 days from the date of issue of the approval certificate. If the registration procedure is not started within this period, the FIE is not entitled to engage in any business activities.
Within 15 days of receipt of the completed registration application, the local SAIC delivers a business licence, which invests the FIE with legal personality. The date of issue of the business licence is the date of establishment of the FIE.
4.3.3. Subsequent formalities and registrations with various administrations
After obtaining their business licences, FIEs must register with the competent Tax Bureau, the Bureau of Statistics, the Public Security Bureau, the Foreign Exchange Bureau, the Customs Office, and the Labour Bureau. FIEs must also open corporate bank accounts.
In filing with the Public Security Bureau, JVs present a letter from the Chinese partner and WFOEs present a copy of the passport of the chairman of the board of directors, together with a copy of the personal identification card of the person carrying out the formalities.
Registration of a FIE with the Labour Bureau entails filing of the enterprise’s labour contracts and a review of the compliance of its salary structure.
To open a bank account in renminbi, an enterprise must present a letter from its legal representative and proof of registration of its chop. To open a foreign currency account, an applicant must also provide an Operation Certificate of Foreign Currency Business that can only be obtained if the company’s registered capital is fully paid-up.
A newly opened FIE must file with the competent tax office copies of:
JVs must also file:
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Chinese regulations contain various mandatory provisions relating to the internal organization of FIEs. Within the framework of the regulations’ mandatory provisions, FIEs can freely decide their management structure and internal organization.
The Chinese regulations do not contain any specific provisions relating to the management and internal organizational structure of a WFOE. In practice, the absence of regulations on this matter and the very few comments made by the Chinese authorities in charge of the registration confirm that foreign investors can freely organize the management and internal organizational structure of their WFOEs.
The boards of directors of EJVs and the joint management committees of CJVs are their highest corporate authorities91 and they should be convened at least once a year subject to at least 10 days prior notice.92 They are comprised of at least three members93 and each party appoints a number of directors proportionate with its share of the registered capital.94 Their terms of office are three years.95 Their powers and functions are defined in the articles of association or founding contracts.96
Chinese law includes compulsory provisions relating to their specific powers and functions. According to these compulsory provisions, any decision relating to the following matters has to be reviewed and unanimously approved by the board of directors of an EJV or by the joint management committee of a CJV:
A meeting of the board of directors or of the joint management committee can only be held when at least two thirds of the members are present.98 Shareholders may impose higher quorums.99
According to the EJV Law and its Implementation Regulations and to the CJV Law and its Implementing Regulations, the general manager of an EJV or of a CJV is responsible for its daily management under the supervision of the board of directors or the joint management committee, as the case may be.
The CJV Law permits the Chinese and foreign parties to share earnings or proceeds, and to share risks and losses in accordance with the CJV contract.100 For instance, the parties may agree in the contract that, upon its expiration, all the fixed assets will belong to the Chinese party, or the parties may prescribe that the foreign party recovers its investment prior to the term of the operation. The distribution of profits need not be proportional to the parties’ contributions to the CJV.101 This is one respect in which CJVs differ from EJVs, in which distributions of profit as well as sharing of risks and losses must be proportional to each party’s capital contribution.
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According to the Implementation Regulations of the EJV and CJV Laws, where a member of the board of directors or of the joint management committee does not attend a meeting of the board or of the committee without justification and does not designate a proxy, the absent member is deemed to have attended the meeting and to have abstained from voting.102
Subject to the approval of the competent authorities, renminbi profits earned from another company invested by the same investors may be contributed on account of registered capital of the WFOE.
Whereas in an EJV or CJV, the Chinese participant frequently contributes land-use rights to the project, WFOEs must negotiate access to premises. To acquire land-use rights, a WFOE would apply to the land administration department under the local people’s government in the place where the enterprise is to be located.103 Once it has obtained the land-use certificate, the WFOE must pay land-use fees to the land administration department in accordance with the applicable national and local regulations. To use developed land, WFOEs must pay land development fees. If the land used is undeveloped, the WFOE may develop the land by itself, or entrust its development to qualified Chinese operators.
All companies are required to establish a financial and accounting system in accordance with the laws, regulations and rules adopted by the financial departments of the State Council.104
At the end of each fiscal year, companies must prepare financial and accounting reports and submit them for auditing.105 Such reports should consist of:
LLCs must submit their financial and accounting reports to all their shareholders within the time limit stipulated in their articles of association.107
CLSs make financial and accounting reports available for annual inspection by their shareholders no later than 20 days prior to the shareholders’ meeting. A company may not have any other account books in addition to its official account books. It is prohibited to deposit the company’s assets in an account opened in the name of any individual.
A company must allocate 10% of its annual after-tax profit to a statutory reserve fund, and 5–10% to a public welfare fund. Once the accumulated statutory reserve fund exceeds 50% of the company’s registered capital, allocations to the statutory reserve fund may cease.108
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In principle, the duration of Chinese enterprises is stipulated in their articles of association.
However, specific regulations may limit the duration of enterprises carrying on activities in certain sectors or which are located in areas to be developed.
In accordance with article 100 of the EJV Regulation, the duration of an EJV may be determined pursuant to specific sector backgrounds.
Since October 22, 1990, the parties to an EJV may decide through consultation not to stipulate a fixed duration, except where the EJV falls into one of the following categories:
Article 181 of the Company Law provides that a company may be dissolved upon the occurrence of any of the following events:
A liquidation committee is constituted within 15 days of the occurrence of the event of dissolution.110 If the liquidation committee has not been created within the time limit, the creditors may apply to the people’s courts to obtain the formation of a committee.111 Where a company is dissolved because of violations of laws, the competent department forms a liquidation committee on which it is joined by shareholders and professional liquidators.112
Prior to any distribution of assets among the shareholders, the order of priority for disposing of and distributing the assets is: salaries of employees, labour insurance, then taxes due to the State, and finally other debts and obligations.113 After such items are satisfied, the remaining assets are distributed among shareholders in proportion to their respective contributions to the capital of the company.114
Upon completion of the liquidation proceeding, the committee prepares a liquidation report and submits it for approval to the shareholders’ meeting or the relevant authority.115
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If the company’s assets are insufficient to satisfy its debts, the liquidation committee must apply to the competent people’s court for a declaration of bankruptcy and the committee will transmit the liquidation proceeding to the people’s court.116 While the above general rules of company law apply to all types of companies including FIEs, the relevant laws and regulations governing FIEs have provided separate detailed measures for the dissolution and liquidation of each type of FIE.
Most of these rules are specified in succinct terms, and indeed some are not sufficiently clear.
For the purpose of clarifying and supplementing the provisions governing liquidation of FIEs, the MOFCOM has promulgated the FIE Liquidation Measures. Liquidation proceedings are conducted in either of two ways: ordinary and special liquidations.
An ordinary liquidation is conducted on a voluntary basis, where a liquidation committee is established by the shareholders without any difficulty. Where such a liquidation committee cannot be formed or where there are other serious impediments to the completion of an ordinary liquidation, an application can be made to the original authority having approved the establishment of the FIE for the opening of a special liquidation proceeding.
The principle is that an ordinary liquidation must be completed within 180 days following the creation of the liquidation committee. In their chapter 2, the FIE Liquidation Measures set down the functions and powers of the committee. During the liquidation period, the original approval authority may attend meetings or otherwise supervise the liquidation process.117 A liquidation committee must be composed of at least three members.118 The chairman of the liquidation committee is appointed by the shareholders, meeting or the board of directors.119
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Since the mid-90s, as foreign investors have become increasingly familiar with the local market and with the financial and legal environments, a strong trend has emerged toward acquisition of Chinese enterprises as an alternative to investing in the establishment of new enterprises as vehicles for foreign investment. Foreign investors may directly purchase assets of a Chinese company and contribute them to a FIE or they may buy equity interests in a Chinese domestic enterprise, including State-owned enterprises (SOEs) and private domestic enterprises such as FIEs.
Direct acquisitions of domestic Chinese companies are governed by a regulation of March 7, 2003 which came into force on April 12, 2003120 and acquisitions of FIEs (or part of FIEs’ equity interests) are subject to a regulation with respect to transfers of FIEs’ equity interests dated, May 28, 1997.121
There is also a specific regulation dated September 28, 2002 with respect to changes of control of companies listed on the Shanghai and Shenzhen Stock Exchanges.122
The Provisional Rules relating to the Acquisition of Chinese Domestic Companies by Foreign Investors of April 12, 2003 (the Foreign Acquisition Provisional Rules) confirm that the acquisition of Chinese domestic companies can be carried out via equity or asset acquisitions.123
Upon the purchase of the shares of, or subscription to a share capital increase of, a Chinese domestic company, the latter is transformed into a FIE and the entire receivables and debts of the former Chinese domestic company are transferred to the newly created FIE.124 The parties to this new FIE can freely decide to limit this transfer of receivables and debts if such limitation does not go against any third party’s rights.125
In asset transfers, foreign investors may either set up a FIE that will purchase part or all the domestic company’s assets and will operate them, or they may directly purchase the assets of the Chinese company and contribute them in kind to a new FIE.
In both cases, the new FIE bears no liability for the debts of the target company upon purchase of part or all of its assets.126 According to article 15 of the Company Law as amended in 2005, a company may invest in other enterprises. Unless it is stipulated otherwise by law, it does not thereby bear liability for the debts of the seller. However, a number of safeguards that originally appeared in the Merger and Division of FIEs Provisions of 1999127 have been extended to acquisitions of domestic enterprises by foreign investors or FIEs. For example, the creditors of a Chinese domestic target company selling its assets must be given both direct and generally published notices128 and they may require the target company to post security for its debts.129
The Circular of November 1, 2002130 concerning several matters in respect of transferring State-owned shares and non-traded shares of publicly listed companies allows foreign companies to purchase Chinese companies’ stock listed on a Chinese stock exchange.
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The Regulations on Transfers of Holdings in FIEs dated May 28, 1997131 provide a strict control by the Chinese authorities over any change in a FIE’s registered capital. Such changes include changes of investors by transfers of equity interests to third parties or to an affiliated company as well as changes of the shareholdings by transfers of equity interests among shareholders.
Any change in a FIE’s registered capital must abide by the regulations governing FIEs, notably those relating to prior approval procedures and the Foreign Investment Guidelines and Catalogue.
The main innovation of these regulations consists in the authorization of pledges of equity interests.132 Such pledges are only allowed if the registered capital of the FIE has been fully paid up and if all shareholders have given their consent.133 The pledge of equity interests has to be reviewed and approved by the FIE’s initial approval authorities or, as the case may be, by the MOFCOM.134
In accordance with the applicable Chinese regulations, contemplated acquisitions must be submitted for prior approval by the Chinese authorities, whose jurisdiction depends on the total amount of investment and type of FIE involved.
In equity acquisitions, the investors submit:
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In asset acquisitions, the investors submit:
In addition to the basic approval procedures mentioned above and the ones applicable to any setting up of a new FIE, the Foreign Acquisition Provisional Rules extend the approval jurisdiction of the MOFCOM and its local offices to certain situations not previously covered.137
Valuations of assets to be acquired must be based on an audit report prepared by auditing firms lawfully registered in China in accordance with appraisal methods generally accepted in international practice.138 The requirement of an appraisal was initially limited to acquisitions of SOEs’ assets.139 It is forbidden to assign equity or sell assets at a price that is manifestly lower than the appraised value.140 Whenever SOEs’ assets are concerned, an official valuation organization must issue a first appraisal of the Chinese shareholding and such appraisal should be confirmed by the Administration of State Owned Assets.141 The transfer price must be based on such valuation.142
Furthermore, acquisitions of shareholdings of less than 25% in a Chinese domestic company now clearly require approval.143 A general regulation jointly adopted by the MOFCOM, the State Administration of Tax (the SAT), the SAIC and the State Administration of Foreign Exchange (the SAFE) confirmed that a joint venture with foreign investors holding less than 25% of its registered capital is a FIE and it must respect the general regulations governing FIEs, notably the Foreign Investment Guidelines and Guidance Catalogue, as well as the specific regulations relating to prior approval procedures. However, the Foreign Acquisition Provisional Rules stipulate exceptions to this principle:
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For example, Chinese authorities have already confirmed such an exception in the insurance brokerage business. According to the Department of Supervision of the CIRC,144 as a matter of practice, the restrictions would not be applied to foreign investors purporting to hold less than 25% of the registered capital of insurance brokerage companies. This practice has been confirmed by the International Department.145 However, no official legal ground supports such a practice, and there is only an internal regulation providing that insurance brokerage companies with a foreign investor holding less than 25% of the registered capital should be considered as domestic companies. On January 19, 2005, the CIRC approved the modification of the shareholding of Huatai Insurance Agency & Consultant Service Ltd. The registered capital of Huatai was initially held by two Chinese domestic companies: China Reinsurance Group (75%) and China Insurance (Holding) Company Ltd (25%). China Reinsurance Group planned to sell part of its shareholding to two foreign investors: 10% of the share capital to Singapore Reinsurance Ltd and 12.5% of the share capital to IBL Ltd. However, IBL Ltd, an Australian company, did not fulfil the legal requirements, as it had not set up any representative office in China. The CIRC nevertheless approved the transaction. Still, it can change its interpretation or stop such projects at any time as no official and public legal ground seems to justify its position.
The Foreign Acquisition Provisional Rules contain anti-monopoly rules and provide for review of both proposed onshore acquisitions and overseas mergers and acquisitions involving Chinese holdings. If a contemplated acquisition of a Chinese domestic company meets one of the following criteria, the foreign investor must file a report with the MOFCOM and the SAIC:
Even though none of the aforementioned criteria is met, the MOFCOM or SAIC may still require the foreign investor to file a report at the request of a Chinese domestic competitor, concerned governmental agencies or industry associations, if the MOFCOM or SAIC believes a substantial market share is involved or that there are factors that seriously affect market competition, social welfare or the economic security of the State.147
In any of these situations, the MOFCOM and the SAIC approve or disapprove the transaction, depending on whether they consider that its completion might cause excessive concentration, hinder proper market competition or harm consumers’ interests.148 Prior to their decision, they should jointly or separately convene a hearing open to concerned departments, organizations, enterprises and other interested parties within 90 days after receipt of all required documents.149
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A party to a contemplated acquisition may apply to the MOFCOM and the SAIC for an exemption from antitrust review, if the acquisition:
Subject to prior SAFE approval, the acquisition price may be paid by exchange of shares or by payment in kind.151 The method by which the price is paid must comply with laws and administrative regulations. Where foreign investors make payment in the form of stock or in form of renminbi assets that it lawfully owns, the approval of the foreign exchange control authority is required.152
In principle, the acquisition price must be fully paid to the sellers within three months following the issue of the FIE’s business licence.153 In “special circumstances” and subject to specific approvals, the foreign investor may pay only 60% of the acquisition price within six months following the issue of the FIE’s business licence and the balance within one year.154
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Currently, China is bound into bilateral treaties with more than eighty-eight countries in order to avoid double taxation. These countries notably include Austria, Australia, Belgium, Brazil, Canada, Denmark, Finland, France, Germany, Italy, India, Japan, Korea, Malaysia, Mexico, Netherlands, Norway, New Zealand, Pakistan, Singapore, Spain, Sweden, Switzerland, Thailand, the United Kingdom, Vietnam and the United States.
Income in its meaning in these treaties is generally classified into four types:
Each type of income is governed by different taxation principles.
According to relevant Chinese laws and regulations, net business profits may be distributed to foreign investors.
According to these treaties, taxes are levied on such repatriations only by the tax authorities of the foreign investors’ home countries.
If the country where the foreign investor is registered has not signed an agreement on avoidance of double taxation with China, foreign investors face double taxation when they distribute their net profits from their subsidiaries registered in China.
Since July 1, 2005, any Chinese taxpayer encountering such a situation may apply to the Chinese tax authorities to seek their intervention to resolve the problem.155
Some foreign investors may consider going through an offshore company structure in order to finance their projects in China. They would set up or purchase an offshore company to act as the holding company of the operating company to be set up in China. Chinese authorities may be reluctant to issue business licences to Chinese subsidiaries of holding companies or legal entities incorporated in jurisdictions that are not sovereign states and/or which do not have official diplomatic relations with China (such as the British Virgin Islands and the Cayman Islands). In addition, the procedure of registration of such a legal entity in China can become expensive on account of the additional administrative costs.
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In acquisitions of Chinese domestic companies by foreign investors, some foreign investors have encountered obstacles in the implementation of their plans to distribute all dividends deriving from the purchased companies. The SAFE has issued a Circular on Issues relevant to Improving Foreign Exchange Control on Foreign Direct Investment (the Circular on Foreign Exchange Control)156 to provide new solutions for authorizing dividend payments from purchased companies. According to the Circular on Foreign Exchange Control, foreign investors that are planning to distribute dividends from acquired domestic companies must register their acquisitions with the SAFE after payment of the purchase consideration. The SAFE then issues a registration certificate that represents official proof of payment of the purchase consideration and entitles the foreign investors to remit dividends and other returns from the acquired company in proportion with the paid up purchase consideration registered with the SAFE.
Article 2 clause 4 of this Circular states that, when a foreign investor and/or investment FIE intends to purchase an equity interest in an onshore enterprise, such investor and/or FIE must pay the consideration for the equity interest in accordance with the provisions of laws and regulations and the equity transfer agreement. The consideration may take the form of eauity of the foreign investor and/or FIE, RMB profits generated by its other FIEs or other property. The formalities of equity transfer foreign exchange registration must be carried out at the foreign exchange bureau where the transferor is located. If the consideration will be paid in a lump sum, the registration must be completed within five days from receipt of such payment. If the consideration will be paid in instalment, the said registration must be carried out within five days upon the receipt of each instalment payment.
Before the payment in full of consideration for an equity interest, and for the purposes of foreign exchange regulations governing equity transfer, decreases of capital liquidations and profit repatriations, the shareholder ownership in the purchased enterprise of the foreign investor is determined with reference to the proportion of paid-in capital.
Foreign investors intending to withdraw their investments in China, for instance in their joint ventures with Chinese partners, face different situations depending on the type of investment. In EJVs, the foreign partners may choose to sell their stakes in the EJV or to negotiate with the Chinese partner(s) an early liquidation of the EJV in accordance with the EJV contract, the articles of association and the Chinese Equity Joint Venture law. However, for a long time, the Chinese regulations did not provide any clear procedure for carrying out advance recovery of foreign investments in CJVs.
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After consultation between the MOFCOM and the SAFE, the Ministry of Finance promulgated on June 9, 2005 the Measures for the Examination and Approval of the Advance Recovery of the Investments of Foreign Partners in Sino-foreign Cooperative Joint Ventures (the Measures on Advance Recovery of Foreign Investments), which came into force on September 1st, 2005. They describe the approval procedures applicable to advance recovery of the investments of foreign partners in a CJV and provide a definition of such advance recovery. According to these new measures, an advance recovery is:
In order to qualify for advance recovery of its investment, a foreign partner must demonstrate that the CJV fulfils the following conditions:
The foreign investor submits its request for advance recovery of its investment to the finance authority at provincial or municipal level depending, on the location of the CJV’s registered office. The application should include the following documents:
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The probability of nationalization has been diminishing as economic reform spreads and the PRC becomes increasingly involved in the international commercial community, including as an international trade partner and investor. The general attitude of the Chinese authorities toward foreign investment has evolved from hostility to increasing receptiveness. Indeed, the tendency of enterprise reform is toward privatization of more sectors and enterprises owned by the State. In pursuit of improved performance of loss-ridden SOEs and to increase fiscal revenues, the Chinese government has taken ever-bolder steps to experiment with the sale of all or part of SOEs to foreign investors.
In fact, no foreign investment has been nationalized since 1978.
In institutional terms, domestic and international legal structures providing protection for foreign investors already exist. Under Chinese law, the government may not nationalize or expropriate FIEs, except under special circumstances where the public interest so requires. In such circumstances, the expropriation must be effected in accordance with procedures stipulated by law and reasonable compensation must be paid.
The third paragraph of article 2 of the EJV Law states that:
The State may not nationalize or requisition any equity joint ventures. Under special circumstances, where the public interest requires, equity joint ventures may be requisitioned in accordance with the applicable legal procedures and appropriate compensation must be paid.
Article 5 of the WFOE Law reiterates this principle.
Article 13 of the Constitution, as amended in 2004, provides that:
Citizens’ lawful private property is inviolable.
The State, in accordance with law, protects the rights of citizens to private property and to its inheritance.
When it is necessary in the public interest, the State may, subject to providing compensation and subject to acting in accordance with the law, expropriate or requisition private property for its use.
Additionally, China has signed some 30 bilateral agreements providing reciprocal protection of investments that generally guarantee foreign investors against expropriation or promise compensation in the event of expropriation and define the methods and procedures of settling disputes arising out of any nationalization.160
Furthermore, the PRC has acceded to the Convention of October 1956 with respect to the settlement of investment disputes between States and nationals of other states, also called the Washington Convention. The rules of the Convention would apply to the settlement of disputes arising between Chinese government and a private foreign investor over nationalization of the latter’s investments in the country.
1 The authorities call them: Economic & Technological Development Zones (ETDZs), Free Trade Zones (FTZs or Bonded Zones), Export Processing Zones (EPZs), High and New Technological Development Zones (or High-tech Parks).
2 China attracted USD 52.7 billion of foreign direct investment in 2002, USD 58 billion in 2003 and USD 62 billion in 2004. Over the next few years, the Chinese government is likely to continue its proactive fiscal policy and increase public sector capital expenditures that will sustain economic growth.
3 Waigaoqiao Free Trade Zone (WGQ) is the most famous of these 17 development zones. The other development zones are: Minhang Economic & Technological Development Zone, Caohejing New Technology Development Zone, Songjiang Industrial Zone, Jiading Industrial Zone, Pudong Kangqiao Industrial Zone, Pudong Xinghuo Industrial Zone, Xinzhuang Industrial Zone, Jinshanzui Industrial Zone, Chongming Industrial Zone, Fengpu Industrial Zone, Baoshan Industrial Zone, China Textile International Science & Technology Industry City, Hongqiao Economic & Technological Development Zone, Lujiazui Finance & Trade Zone, Zhangjiang Hi-tech Park, Jinqiao Export Processing Zone, Hefei Economic & Technological Development Zone, Hefei New Station Comprehensive Development Experimental Zone and Bozhou Economic & Technological Development Zone.
4 For a comparative evaluation of Chinese cities in this regard, see Asian Development Bank, The Development of Private Enterprise in the People’s Republic of China, April 2002.
5 Sometimes the two Special Administrative Regions of Hong Kong and Macao are included in the Pearl River Delta area.
6 The income tax rate applicable to manufacturing companies is 24% in some municipalities such as Shanghai (Puxi) and Guangzhou while the standard national income tax rate is 33%.
7 They also enjoy exemptions from Valued Added Taxes (VAT) for exported and goods sold within the bonded zones whereas in general operators would have to wait for refunds at a later date.
8 In Beijing, Foreign Enterprises Services Corporation (FESCO) is the designated exclusive supplier of labour services to all RROs of foreign companies.
9 This is common practice in PRC, as the foreign investment Guidelines must reflect the open door policies of PRC accurately.
10 By June 2004, 100 foreign institutions had received licences for RMB operations. Their total RMB assets at that time had reached RMB 84.4 billion, i.e. a 49% year-on-year increase.
11 Many breakthroughs and landmark transformations have been brought to the table via this amendment, such as the permission to set up WFOE in commercial sectors and relaxed restrictions on opening certain outlets in PRC.
12 These measures have reduced the difficulty of fulfilling of the set-up requirements of Foreign Invested Commercial Enterprises. For example, the minimum registered capital of an FICE has been reduced from RMB 50.000.000 to RMB 300.000 in retailing and to RMB 500.000 in wholesaling.
13 These provisions allow holding companies to include distribution activities in their business scope.
14 The purpose of these rules is to give a legal frame to franchising for foreign investors and specify in detail the definition of franchiser, franchisee and all related issues.
15 Upon satisfying the prescribed threshold, foreign invested non-commercial enterprises can apply for expansion of their respective business scope for the purpose of including the distribution business.
16 It provides that any enterprise or individual within a bonded zone or bonded logistic park may obtain the trading right and application right for distribution. FIEs that have obtained distribution rights may undertake distribution activities according to law.
17 Foreign investments in manufacturing equal to or greater than USD 30,000,000, as well as activities that are otherwise stipulated as subject to approval by the central authorities are be submitted to the MOFCOM. Projects amounting to less than USD 30,000,000 may be approved by local authorities.
18 Except for projects in the encouraged category such as raw materials, transportation, and power that can be approved by local authorities.
19 The amendments to the Company Law were adopted by the 18th Session of the Standing Committee of the 10th NPC on October 27, 2005 and entered into effect on January 1, 2006.
20 The GPCL were adopted at the Fourth Session of the Sixth NPC and promulgated on April 12,1986 with effect as of January 1, 1987.
21 These requirements are according to General Principals of civil law. But the ultra vires doctrine will not be strictly applied in the same manner as in Western countries, especially the UK and US.
22 Under the new PRC company law, the legal representative will not necessarily be the chairman of the board. It could be the president or general manager, resulting in greater flexibility.
23 Where an enterprise does not have legal personality, its manager cannot in principle contract on its behalf. However, some specific Chinese regulations designate a responsible person of a legal entity without legal personality. For example, the Chinese regulations relating to representative offices in China provide that the chief representative of a representative office of a foreign company in China is its responsible person. Consequently, the chief representative of a representative office in China can legitimately enter into contracts and perform legal acts on its behalf.
24 Articles 42 and 43 of the GPCL.
25 The differentiated treatments are often intended to restrict or encourage foreign investments in specific sectors.
26 This is based on our past experiences.
27 Article 24 of the PRC company law. Also see the relevant articles of EJV,CJV, WFOE law and its implementation rules.
28 Article 40 of the CJV Implementation Rules and article 48 of the WFOE Implementing Rules.
29 Article 24 clause 2 of the PRC company law.
30 It is a general requirement under PRC law. The contribution involving any state-owned assets shall also be assessed.
31 Article 37 of the PRC company law.
32 Debt financing can include loans from the parent company or from local financial institutions in accordance with the PRC regulations.
33 The EJV law and its implementation rules. This EJV law is still in full force.
34 The Regulations were promulgated on September 20, 1983 by the State Council and were revised on January 15, 1986, December 21, 1987 and July 22, 2001 by the State Council in accordance with the Decision of the State Council to Revise the Law on Sino-foreign Equity Joint Ventures). Article 4 of the EJV Law provides that an EJV must be a limited liability company.
35 The Law was adopted on April 30, 1988 at the First Session of the Seventh NPC and was revised on October 31, 2000 at the 18th Meeting of the Standing Committee of the NPC by the Decision on the Revision of the Law on Sino-foreign Cooperative Enterprises.
36 Although the CJV was approved as early as 1979, it was not until April 13, 1988, that the CJV Law was officially adopted by the First Session of the Seventh NPC. Rules for the implementation of the CJV Law (the CJV Implementation Rules) were adopted by the State Council on August 7, 1995 and promulgated by MOFTEC on September 4,1995.
37 The Law was adopted on April 12, 1986 at the Fourth Session of the Sixth NPC and was revised on October 31, 2000 at the 18th Meeting of the Standing Committee of the NPC by the Decision on Revision of the Law Concerning Enterprises with Sole Foreign Investment.
38 The Law was adopted on October 28, 1990 by the State Council, issued December 12, 1990 by the Ministry of Foreign Economic Relations and Trade, revised April 12, 2001 in accordance with the Decision of the State Council to revise the Detailed Rules for the Implementation of the Law of the People’s Republic of China on Sole Foreign Investment Enterprise, and re-promulgated April 12, 2001 by Order No. 301 of the State Council.
39 The provisions relating to the Establishment of Investment companies by foreign investors was issued by the Ministry of Commerce and came into effect as from July 1, 2006.
40 Article 4 of the EJV Law. Usually, the capital contribution by foreign investor shall not be less than 25% of the total capital contribution.
41 Article 4 of the EJV Law.
42 See article 12 of the Regulation for the Implementation of the law of PRC on EJV.
43 See articles 2 and 3 of the CJV law.
44 Article 2 of the CJV law.
45 See article 2 of the CJV law. But in practice, CJV is usually incorporated with legal person status.
46 It is based on our experience.
47 See article 14 clause 1 of the Implementation Rule of the CJV Law.
48 See article 14 clause 2 of the Implementation Rule of the CJV Law.
49 Article 50 of the CJV Law.
50 Article 50 of the CJV Law.
51 It is based on our experience.
52 This can be seen from Article 10 clause 2 of the Implementation Rules of EJV Law.
53 Article 8 of WFOE law and article 18 of Implementation Rules of WFOE Law.
54 Article 20 of Implementation Rules of WFOE Law.
55 Articles 21 and 22 of Implementation Rules of WFOE Law.
56 Article 30 of Implementation Rules of WFOE Law.
57 Article 30 of Implementation Rules of WFOE Law.
58 Article 30 of Implementation Rules of WFOE Law.
59 Article 30 of Implementation Rules of WFOE Law.
60 Article 32 of Implementation Rules of WFOE Law.
61 Article 71 of Implementation Rules of WFOE Law.
62 Articles 26 and 81 of Company Law.
63 Article 2 of the Provisions on the Establishment of Investment Companies by Foreign Investors.
64 Article 3 of the Provisions on the Establishment of Investment Companies by Foreign Investors.
65 Article 3 clause 3 of the Provisions on the Establishment of Investment Companies by Foreign Investors.
66 Article 3 clause 1 of the Provisions on the Establishment of Investment Companies by Foreign Investors.
67 Article 3 clause 2 of the Provisions on the Establishment of Investment Companies by Foreign Investors.
68 Article 6 of the Provisions on the Establishment of Investment Companies by Foreign Investors.
69 Article 7 of the Provisions on the Establishment of Investment Companies by Foreign Investors.
70 Article 10 of the Provisions on the Establishment of Investment Companies by Foreign Investors.
71 Article 25 of the Provisional Regulations on the Establishment of FICLSs.
72 Article 3 of the Provisional Regulations on the Establishment of FICLSs.
73 Article 2 of the Provisional Regulations on the Establishment of FICLSs.
74 Article 7 of the Provisional Regulations on the Establishment of FICLSs.
75 Article 7 of the Provisional Regulations on the Establishment of FICLSs.
76 Article 6 of the Provisional Regulations on the Establishment of FICLSs.
77 Article 8 of the Provisional Regulations on the Establishment of FICLSs.
78 Article 8 of the Provisional Regulations on the Establishment of FICLSs.
79 Article 5 of the Provisional Regulations on the Establishment of FICLSs.
80 Article 6 of the Provisional Regulations on the Establishment of FICLSs.
81 Article 9 of the Provisional Regulations on the Establishment of FICLSs.
82 Article 9 of the Provisional Regulations on the Establishment of FICLSs.
83 Article 15 of the Provisional Regulations on the Establishment of FICLSs.
84 Article 18 of the Provisional Regulations on the Establishment of FICLSs.
85 An individual can only set up one limited liability company with one shareholder.
86 See the relevant articles of the EJV, CJV and WFOE laws.
87 See relevant articles of CJV, EJV and WFOE law. This is the suggested version.
88 Foreign investors should verify the right of the landlord to rent the premises. The use of a local and experienced real estate agent is recommended for the search of premises and the negotiation of the terms and conditions of the lease.
89 Foreign investors propose, and Chinese landlords accept in most cases, to sign a lease agreement including a specific provision for the automatic transfer of lease to the company in process of registration as of the date of issue of its business licence.
90 In practice, Chinese authorities ask to be provided with three proposals in order to avoid delay and refusals of applications.
91 This principle is in contradiction with the provisions of the former Company Law, which provides that the shareholder’s meeting is the highest corporate authority of a limited liability company. Since the introduction of the new PRC company law, which took effect on Jan 1, 2006, this is no longer the case.
92 Article 32 of the Implementation Rules of the EJV law and article 28 of the Implementation Rules of the CJV Law.
93 Article 31 of the implementation Rules of the EJV law and article 25 of the Implementation Rules of the CJV Law.
94 Article 31 of the Implementation Rules of the EJV law and article 25 of the Implementation Rules of the CJV Law. In the case of CJV, the allocation of the number of the director/manager can also be determined with reference to the cooperation conditions set forth by the parties.
95 In the case of EJVs, the term is four years.
96 See article 23 of the Implementation Rules of the EJV law and article 30 of the Implementation Rules of the CJV Law.
97 Article 29 of the Implementation Rules of the CJV Law and article 33 of the Implementation Rules of EJV Law.
98 Article 32 clause 2 of the Implementation Rules of CJV Law and article 28 clause 2 of the Implementation Rules of the EJV Law.
99 Article 32 clause 2 of the Implementation Rules of CJV Law and article 28 clause 2 of the Implementation Rules of the EJV Law.
100 Article 12 of the Implementation Rules of CJV Law.
101 Article 44 of the Implementation Rules of CJV Law.
102 Article 28 clause 20 of the Implementation Rules of EJV Law.
103 Article 33 of the Implementation Rules of WFOE Law.
104 Article 164 of Company Law.
105 Article 165 of Company Law.
106 See Accounting Standards for Enterprises, articles 59 and 60.
107 Article 106 of the Company Law.
108 Article 107 of the Company Law.
109 According to article 183 of the Company Law, if a company is in serious difficulty and the continuance of the company’s business will incur serious losses, upon application by shareholders with more than 10% of the voting power, the people’s court may order the company’s dissolution.
110 Article 184 of the Company Law.
111 Article 184 of the Company Law.
112 Article 184 of the Company Law.
113 Article 185 of the Company Law.
114 Article 187 of the Company Law.
115 Article 189 of the Company Law.
116 Article 188 of the Company Law.
117 Article 15 of the Procedures for Liquidation of EJVs.
118 Article 9 of the Procedures for Liquidation of EJVs.
119 Article 9 of the Procedures for Liquidation of EJVs.
120 Thes interim Regulations have been replaced by M&A Regulations of Foreign Investors, effective as of September 8, 2006.
121 Namely, changes of investors in FIEs.
122 The PRC Takeover Code. This code came into effect as of September 1, 2006.
123 The new M&A Regulations have the same attitude in this regard.
124 Article 13 of the M&A Regulations.
125 Article 13 clause 3 of the M&A Regulations.
126 Article 13 clause 2 of the M&A Regulations.
127 Amended in November 2001.
128 Article 27 of the Provisions of 1999.
129 Article 28 of the Provisions of 1999.
130 Effective since January 1, 2006. The strategic investment by foreign investment in A shares is permitted.
131 This Regulations concerns the transfer of the equity interest in FIEs.
132 Article 6 of the 1997 Provisions.
133 The equity interest formed by paid contribution can also be pledged. But the unpaid part of equity interest shall not be pledged.
134 Article 7 of the M&A Regulations.
135 Article 21 of the M&A Regulations.
136 Article 23 of the M&A Regulations.
137 This is the common practice in China.
138 It is suggested that valuations be based on income projections and not on book value.
139 Chinese authorities have extended its application to any type of acquisition in order to avoid fraud, such as payment of part of the acquisition price abroad.
140 Article 14 of the M&A Regulations.
141 Article 14 of the M&A Regulations.
142 Article 14 of the M&A Regulations.
143 The business licences of such FIEs are issued with the legend “FIE with less than 25% foreign investment”.
144 The Department of Supervision of Insurance Brokers of the CIRC is in charge of the approval of insurance brokerage companies with a foreign investor shareholding of less than 25% of the insurance brokerage company’s registered capital.
145 The International Department of the CIRC is in charge of the approval of foreign invested insurance brokerage companies with a foreign investor’s shareholding of more than 25% of registered capital.
146 Article 51 of the M&A Regulations.
147 Article 51 clause 2 of the M&A Regulations. The SEB and Supol case triggers the anti-monopoly report duties.
148 Article 52 of the M&A Regulations.
149 Article 52 of the M&A Regulations.
150 Article 54 of the M&A Regulations.
151 Article 17 of the M&A Regulations.
152 Article 17 of the M&A Regulations.
153 The pre-conditions are: the foreign shareholding ratio is below 25% of the total registered capital and investors make capital contributions in cash.
154 The pre-condition is: investors make the capital contributions in kind or industry property.
155 Also subject to the bilateral agreement on avoiding double tax between China and the country concerned.
156 The Circular on Foreign Exchange Control came into force on March 3, 2003.
157 Article 3 of the Measures for the Examination and Approval of the Advance Recovery of the Investment of Foreign Investors in CJV.
158 Article 4 of the Measures for the Examination and Approval of the Advance Recovery of the Investment of Foreign Investors in CJV.
159 Article 6 of the Measures for the Examination and Approval of the Advance Recovery of the Investment of Foreign Investors in CJV.
160 For example, the Sino-French Agreement on the Protection of Investments provides for the possibility of an agreement for the settlement of investment disputes between either State and an investor from the other State.