China investment updates

• Chinese Investment Structures
•  Shenzhen as an Investor Entry Point to China
•  China permits increased foreign participation in the Entertainment and Leisure Industries.

In this article the author provides an overview of the legal company structures in China available to foreign investors and their differing requirements as well as the advantages and disadvantages associated with these investment vehicles.

We also highlight the streamlined company registration procedures introduced in the Shenzhen Special Economic Zone to facilitate foreign direct investment and the new opportunities for foreign investment into China’s entertainment industries.

Disclaimer: This article is for general information purposes only and does not constitute legal or professional advice.  It should not be used as a substitute for legal advice relating to your particular circumstances.  Please also note that the law may have changed since the date of this article.

1. Foreign Investment into China

Historically China has permitted foreign investment in most industry sectors while reserving certain strategic industries, such as mining, gas or resources to domestic participation only, or requiring foreign investment in the automotive, media or publishing sectors to be on a Sino-Foreign joint venture basis with majority control remaining with the Chinese partner.

In 2001, China’s admission to the WTO came with commitments to open up other industries such as telecommunications, banking and finance, insurance, education etc to foreign investment but progress has been slow.

2. New Foreign Investment Law

The new Foreign Investment Law (FIL) which came into force in January 2020 now states that foreign investment into China will be based on the principle of “National Treatment”, which provides that the Chinese authorities should treat foreign investors equally to domestic investors.

The FIL still has to be read together with the “Negative List for Foreign Investment into China”. The Negative List is updated every 6 or 12 months and lists those business sectors where restrictions on foreign investment still exist. It is encouraging that with each passing year, the restricted industries on this Negative List are smaller in number.

The company structure which a foreign investor will choose to enter the Chinese market therefore depends on whether a particular industry is mentioned in the Negative List, as restricted or prohibited. For example, if a particular industry is included in the Negative List it may only be accessible through a Joint Venture instead of a WFOE. 

3. Company Structures in China

The three common company structures include a Wholly Foreign-Owned Enterprise (WFOE or WOFE), a Joint-Venture (JV) and a Representative Office (RO). Other forms of investment vehicles such as Partnerships are permitted, however this latter structure has not been popular, largely because Chinese taxation of partnerships has been a grey area with little legislative and policy guidance.

(a) Wholly Foreign-Owned Entity (WFOE)

A Wholly Foreign-Owned Enterprise or WFOE is the most common investment vehicle for foreign investors who desire 100% ownership and control.

A WFOE is a Limited Liability Company (LLC) established by a foreign investor’s capital (hence “wholly foreign-owned”) and allows foreign investors to retain the greatest level of control and independence in matters of the company’s operations, strategy and human resources.

The following are some of the important features of a WFOE:

• A Wholly Foreign-Owned Entity is a separate legal entity and being a Limited Liability Company the foreign investor liability is limited to the amount of registered capital contributed by its shareholders.
• The shareholders of a WFOE must contribute an amount of registered capital to the company, however, the law does not stipulate a required minimum and the registered capital can be contributed over up to a 30-year period.

 Note: In practice, local authorities (at provincial or district level) may have specific requirements as to the amount of capital they wish to see contributed during the initial years of operation.

It is not uncommon for approvals to be blocked or proceed slowly where the local government is not satisfied there is sufficient capital in the proposed WFOE to pay for operations.

There are broadly speaking three types of WFOE:

1. The Consulting WFOE: licensed to operate as a consulting business within the service industry.
2. A Trading WFOE: which in addition to providing services is licensed to conduct trading, wholesale, retail and franchising activities in China. This type of WFOE can additionally also apply for a customs license to independently import/export goods in/from China.
3. Manufacturing WFOE: in addition to consulting and trading activities, the manufacturing WFOE can legally also engage in manufacturing and assembling processes.

 Note: In practice, additional permits or licenses may be required depending on the exact business scope of a WFOE.   For example, a WFOE operating in the food preparation or catering sector will need specific CFDA permits and those who intend to operate a WFOE or JV in the schools or online education sector will need licenses from the Ministry of Education / Provincial Education Bureau.   Manufacturing WFOEs will need to undergo environmental assessments and automotive component manufacturers must complete China MIIT testing of their products.

 (b) Joint Venture (JV)

Similar to a WFOE, a Joint Venture is a Limited Liability Company (LLC), however, it is an entity in which the foreign investor and a Chinese company have equity (hence it is referred to as a “Sino-Foreign Joint Venture”).

The important features of a Joint Venture in China are as follows:

• As the management of a Joint Venture is more complex due to the involvement of several shareholders with diverging interests, the shareholder agreement plays a crucial role in defining the rights and responsibilities of the parties involved in the partnership. This constitutional document must be additionally prepared during the incorporation phase as compared to the establishment of a WFOE.
• Similar to a WFOE, in a Joint Venture, the investors liability is limited to the amount of registered capital they each contribute.
• Joint Ventures can engage in any commercial activities in China provided they are not prohibited industries in the Negative List and are a common structure for business activities which would be off limits to WFOEs.
• A Joint Venture can also hire both foreign and Chinese employees without direct limitations in the hiring process.

It is not uncommon for retailing entities or distribution enterprises to be in the form of Joint Ventures to capitalise on the Chinese partner’s local market knowledge or business connections or customer database, or in circumstances where the Chinese side’s participation may assist in the obtaining of the required permits or approvals.

Nevertheless, Joint Ventures remain more complex to manage due to potentially diverging interests of the shareholders, cultural differences as well as the methods in which shareholders can exercise control over the operations of a Joint Venture.

These types of entities will require detailed provisions in the Joint Venture Agreement and Articles of Association to delineate each shareholders rights and responsibilities during its establishment phase, business operations and on liquidation.

(c) Representative Office (RO)

Whereas the above company structures are separate legal entities, a Representative Office is considered an extension of the foreign company’s headquarters and operates as a type of “marketing or liaison office”.

A Representative Office is limited by the following important features:

• A Representative Office is only allowed to conduct marketing and research activities for its headquarters and to act as a liaison to coordinate with business contacts on behalf of its parent company. This means that the Representative Office cannot engage in any commercial activities, including profit making activities.
• Although a foreign investor does not have to contribute any capital to a Representative Office, the headquarter bears full responsibility for the actions or omissions of its Representative Office.
• The Representative Office can directly employ up to 4 foreigners (“representatives”, including one Chief Representative and up to three General Representatives). However, a Representative Office cannot directly employ Chinese staff and instead must rely on a third-party HR service provider to hire Chinese staff on its behalf.

A Representative Office must also pay Chinese taxes based on its expenses and has largely fallen out of favour as an effective mode of entry into the Chinese market.

Because a Representative Office cannot be converted into another structure such as a WFOE or JV, foreign investors should consider whether on balance it is better and more cost effective to establish a WFOE or JV.

4. Shenzhen as an entry point to China

Shenzhen which sits next to Hong Kong and close to Macau has historically been a centre for innovation, high tech manufacturing and e-commerce. After the passing of the new FIL, Shenzhen has also streamlined its company registration procedures for its Shenzhen Special Economic Zone.

On 1 March 2021 it enacted the new Rules of Shenzhen Special Economic Zone on Commercial Registration (the “2020 Rules”). The 2020 Rules have simplified the documentation process for company establishment registration.

It no longer requires applicants to submit “Notice of Name Pre-Approval”, “Information Materials of Domicile or Business Site” and “Documents of Appointment of the Responsible Persons, Senior Managers, and other relevant members”. All registration applications can be filed online, saving time and cost.

5. Green channel for Hong Kong and Macau Investors

The 2020 Rules also provide a green channel for Hong Kong and Macao investors to directly enter the Shenzhen market, for the first time.

It allows Hong Kong and Macau based investors to directly complete registration formalities (account opening with bank, tax affairs, Customs, foreign exchange account, examination/approval, and other matters) for engaging in manufacturing or business activities in Shenzhen, provided their activities are not those included in the Negative List (see above).

A Hong Kong or Macau investor can apply for and obtain a Shenzhen business license for its Shenzhen operations based on its original corporate registration in Hong Kong or Macau (see Article 14 of the 2020 Rules).

Companies established in Shenzhen which later have financial difficulties or are later undergoing re-structuring can also apply to become dormant for a specific period, avoiding the expenses of de-registration (Article 25 of the 2020 Rules) and later resume business operations. The one business license will now enable them to operate branch offices in Shenzhen without the need to apply for separate branch licenses.

6. China further opens up its entertainment sector to foreign direct investment

New regulations now permit increased foreign investment in entertainment industries. Previously foreign investors could only operate as minority partners in cinemas, theme parks and entertainment venues.

On May 27^th, 2021, the Ministry for Culture and Tourism issued a new policy permitting investment in the form of “wholly foreign owned” entities. Previously the Negative List had restricted foreign investment to minority stakes. Applications can be made at a provincial level to the Culture Bureau and there will be vetting of applications and geographical limits to ensure venues are not permitted near schools or kindergartens.

With the easing of these restrictions we may see existing investors buy out their domestic partners in entertainment businesses such as theme parks where they have previously operated as joint ventures. The theme park industry is expected to experience year on year 20% growth over the next five years and it is estimated that a further 50 parks will open in the next decade.  This sector has been one of the fastest growing in China as white collar workers look for new outlets of entertainment.

7. Summary

When foreign investors are considering establishing a company in China, deciding on the right company structure to start operations in China is crucial and will depend on several factors such as the intended business activities and industry in which the investor wishes to operate.

Furthermore, foreign investors should carefully consider the precise location to establish operations. The Shenzhen regulations, illustrate the advantages or disadvantages of certain geographical locations for establishment and the ease of set up for those wanting to take advantage of a free trade zone for export, processing or import activities.

Finally, increased access into the China entertainment industry will in turn benefit those businesses that supply materials, products and services to this sector.

The author has advised numerous companies on their Hong Kong and China market entry strategy, re-structuring advice and the legal structures of their investment, which has enabled clients to remain equipped for doing business in China.

If you are considering setting up a company in China and require any advice or support regarding the different investment vehicles, or strategies for this market, please feel free to contact the author:

Richard Kimber, Consulting Principal, Keypoint Law

E: richard.kimber@keypointlaw.com.au

P: 08 8155 6200

M: +61 499 722 880