Setting up a Business in Mainland China
Given China’s vast population and emerging middle class, its market potentials are a huge opportunity for a having a business in China. Better still, China is maintaining its commitment to further open up its market and boost inbound foreign investments.
Whilst China’s economic reform and opening-up policies began 40 years ago, its economic performance is still remarkable. Due to the impact of COVID-19, China’s economy grew a 2.3% in 2020, which is the lowest annual growth rate in decades. That being said, China’s economic performance is seen by many countries as a “miracle” as most other major economies have been shrinking.
One of the major reasons of China’s transformation from being a sourcing country into becoming a open market country is the economic reforms implemented by the Chinese government. In 2019 the introduction of a new Foreign Investment Law was one of the measures implemented that show China’s commitment to open up its market to the world to an even greater degree.
The Foreign Investment Law (“FIL”)
Prior to the enactment of the FIL, most of the foreign invested enterprises (“FIE”) were established under the following three traditional enterprise laws (collectively referred to as “Three Laws”).
- Wholly Foreign Owned Enterprise Law (commonly known as “WFOE” or “WOFE”) – A WFOE is a limited liability company wholly owned by foreign investor(s).
- Chinese-Foreign Equity Joint Venture Enterprise Law (“EJV”) – An EJV is a limited liability company jointly owned by Chinese and foreign investors. In general, the foreign investment should not own less than 25% interest in the EJV.
- Chinese-Foreign Cooperative Joint Venture Enterprise Law (“CJV”) – A CJV is a partnership enterprise formed by foreign and Chinese partners. In the partnership agreement, the partners would specify their respective investment contribution, cooperative conditions, sharing of profits and risks, governing structure, operational procedures, management structure and distribution on assets upon termination.
The new FIL and its Implementing Regulations took effect on 1 January 2020 to repeal the Three Laws. The main objective of the FIL is to establish a framework for equal treatments between FIEs and Chinese domestic enterprises in terms of market entry, organisational formation, corporate governance and business operation. This is achieved by removing the different treatments developed between the Three Laws and the domestic practices under the Chinese Company Law and Partnership Law.
Under the FIL, “foreign investment” is defined as any direct or indirect investment made by any foreign individuals, enterprises or organisations, including the following situations:
- Where a foreign investor, either alone or jointly with other investors, establishes a FIE in China.
- Where a foreign investor acquires shares, equity right, property interest or any other similar rights and interests of an enterprise in China.
- Where a foreign investor invests, either alone or jointly, with other investors in any new project in China.
- Where a foreign investor invests in any other ways stipulated under the laws, administrative regulations or the State Council’s regulations.
Pursuant to the FIL, FIEs should follow the Chinese Company Law, Partnership Enterprise Law and other applicable laws that equally apply to other Chinese domestic enterprises. The most common types of enterprises established under the prevailing laws in China are limited liability companies (“LLC”), companies limited by shares and partnership enterprises.
FIEs that were previously established under the Three Laws have a 5-year transition period to convert to the appropriate organisational form and revise their article of association, shareholders’ agreement or partnership agreements relating to the highest decision-making organ, method for electing directors/legal representatives, voting mechanisms, rules of procedures, etc. to comply with the Chinese Company Law or Partnership Law.
Generally speaking, as the previous WFOE Enterprise Law is already largely in line with the Chinese Company Law, there will be a limited impact for existing WFOEs. On the other hand, EJV and CJV will more likely be required to amend their article of association / partnership agreement in view of the difference between the previous EJV / CJV Laws and the prevailing Company / Partnership Law.
One of the examples is that the highest decision-making organ of an EJV will be changed from the board of director’s meeting to the shareholders’ meeting under the new FIL and the Company Law (e.g. the approval of major issues will be given by shareholders holding two-thirds of voting rights).
Favourable Treatments Provided by the FIL
In addition, the FIL also aims to promote fair competition, equal application of supporting policies and equal participation in government procurement activities. More specifically, the FIL and the Implementing Regulations provide the followings:
- Subject to the Negative List for Market Entry (which sets out those sectors that are not allowed for foreign investment or subject to restrictions), foreign investors should be treated no less favorably than domestic investors during the investment access stage;
- FIEs and domestic enterprises should be treated equally in the areas of access to government funding, land supply, tax reduction and exemption, qualification licensing, standards formulation, project applications, labour market and so on;
- FIEs should be consulted appropriately on the introduction of new legislations and administrative rules concerning foreign investments;
- The Chinese authorities shall publish their administrative rules in a timely manner and should only exercise their administrative authority in accordance with those published documents;
- FIEs may participate in bidding Chinese government’s procurement through fair competition and should be treated equally as domestic enterprises with respect to products manufactured and services provided in China;
- FIEs can raise funds by means of public offerings of securities, debentures or by any other similar means;
- Foreign investors can freely remit their capital contributions, profits, capital gains, disposal gains of assets, royalty income, lawful compensations or indemnities received and liquidation distributions in or out of China, in RMB or other foreign currencies, in accordance with the Chinese laws and regulations.
- No restrictions should be imposed on the currency, amount and frequency of such remittances;
- The Chinese authorities shall strengthen the protection of intellectual property (“IP”) rights, the enforcement of IP infringement and introducing effective mechanism for IP disputes;
- Government officials are prohibited from compelling FIEs to transfer their technology by administrative measures, and should keep confidential FIEs’ trade and commercial secrets, which they come across while performing their duties and are not allowed to disclosing this information to other persons; and
- Local governments shall fulfil their policy commitments made to foreign investors and their obligations made in agreements entered into with foreign investors. Changes in policy commitments and contractual agreements due to national interests and social public interests shall be carried out in accordance with statutory powers and procedures. In such case, foreign investors shall be compensated for their losses in accordance with the laws.
Most Common Forms of Foreign Investment Businesses in China
With the repeal of the Three Laws, all foreign-invested enterprises shall be formed under the Chinese Company Law or Partnership Law and the most common one is limited liabilities company (“LLC”) under the Company Law.
Depending on whether domestic investment is involved, the type of foreign investment can be broadly categorised into wholly foreign owned enterprise (i.e. a WFOE in essence under the old law) and joint venture in the form of a LLC (i.e. an EJV under the old law).
That said, as both of them are now governed under the same law i.e. the Chinese Company Law, their characteristics in term of organisation formation, highest decision-making organ, corporate governance structure, rule of procedures and voting mechanisms should be the same.
In addition, foreign investors may choose a representative office (“RO”) to enter into China to lay a foundation for future investment. However, as opposed to a LLC, a RO is not a separate legal entity in China and its capacity of conducting business activities in China is very limited. Summarised below are the features of a LLC versus a RO.
Features of Mainland China LLC
- A separate legal entity.
Liabilities of shareholders
- Limited to the amount of subscribed capital contribution.
- No minimum investment requirement in general unless laws or administrative regulations otherwise stipulate. But in practice, LLCs should have sufficient funds for their intended business operations.
- Generally allowed to conduct direct business activities including trading, service (including consultancy) and manufacturing, provided that they are not illegal, prohibited and restricted by the Chinese government and the business is within the approved business scope stipulated in the business license.
Legal representative and management team
- Required to appoint a legal representative who should hold the position of Executive Director (or Chairman of the board if there is a board of directors) or the general manager of the company
- A board of directors consisting 3-13 directors or an executive director (in case of a small-scale limited company) should be appointed by shareholders
- The legal representative and directors can be a foreigner or a Chinese
- Can employ both foreigners and local Chinese directly.
- No limitation on the number of foreigners to be employed.
Invoicing and contracting
- Have legal capacity to issue invoices to customers and enter into business contracts under its own name.
Set up cost
Estimated set up time
- About two months in general provided that everything goes smoothly.
Features of Mainland China RO
- Not a separate legal entity but an extension of its foreign parent company
- The parent company needs to be established for more than two years
Liabilities of shareholders
- Unlimited liabilities to its foreign parent company.
- Registered capital is not required.
- Limited to carry out market research, product or service display, promotion and business liaison activities on behalf of its foreign parent company.
- NOT allowed to engage in profit making activities, including signing business contracts, selling goods, providing services, collecting money and issuing invoices, etc.
Legal representative and management team
- Required to appoint a chief representative, who can be a foreigner or a Chinese.
- Can employ not more than four foreigners by foreign parent company, including one chief representative and three general representatives.
- Employment of local Chinese has to be made through foreign enterprise service corporation (FESCO) in China.
- In practice, ROs in China should normally have a minimal number of employees given their limited permitted business scope.
Invoicing and contracting
- Not allowed
Set up cost
Estimated set up time
- About one month in general provided that everything goes smoothly.
Other Considerations Regarding Having a Business in China
Before setting up any business presence in China, it is common that potential foreign investors are already doing businesses with Chinese customers or suppliers. But as their business volume gradually grows, they would consider whether to set up a business presence in China.
In addition to the favorable treatments provided by FIE as mentioned above, the following factors may also be relevant in their consideration.
Claiming input Value-Added Tax (“VAT”)
All enterprises and individuals that engage in the sale or import of goods, provision of processing, repair or maintenance services, sale of services, intangible assets and real properties in China are liable to pay VAT. Various VAT rates (e.g. 13%, 9%, 6% and 0%) apply to different business activities or different types of taxpayers.
There are generally two types of VAT payers, namely general VAT payer and small-scale VAT payer. For a general VAT payer, the VAT payable is calculated as Output VAT minus Input VAT. A Chinese company can register as a general VAT payer and credit Input VAT from Output VAT.
In addition, VAT export refund may also be available for a general VAT payer. Depending on the taxpayer’s business model, the amount of potential VAT savings can be substantial.
Issue of VAT invoice
Chinese customers may wish to have VAT invoices from their suppliers in order to claim input VAT credit as explained above. A Chinese company will be able to issue VAT invoices. This capacity may create more business opportunities and/or increase bargaining power with customers.
Most of the companies in China prefer to transact businesses with a Chinese company instead of an overseas company because tax and foreign exchange clearance (which must be completed before Chinese clients can remit fees to an overseas entity) can be cumbersome in some cases.
As such, conducting business in China by a Chinese company may also create more business opportunity and/or increase bargaining power with customers.
When setting up a Chinese company, one may consider choosing a Hong Kong company as the parent company. This may facilitate a smoother incorporation process e.g. the submission of the parent company documents to the Chinese authorities.
In addition, under the tax treaty between Hong Kong and the Mainland China, the withholding tax rate on dividend distribution may be reduced to 5% as compared to 10% (for most other jurisdictions) if certain conditions are satisfied.
One of our clients had an investment opportunity in a Chinese entity with initial public offering potential. Due to the complex holding structure and a number of potential investors involved (both foreigners and domestic), the client had concerns and questions on how to best structure their investments and the possible implications at each investment stage from acquisition, lock-up period, subsequent holding to future exit.
In that case, we assisted the client to evaluate each of the possible investment options, advised them on the different legal and tax implications and provided recommendations on how to achieve the most efficient outcome.
How Can Assist Your Future Business in China
The business registration in China generally involves the following procedures:
- Application for the name pre-approval with local Administration Bureau of Industry and Commerce (“AIC”)
- Application for Business License with local AIC
- Registration with local Bureau of Commerce
- Application for engraving the company stamp and finance stamp of the company, and signatory stamp of the legal representative with local Public Security Bureau
- Tax registration and assessment with the State and Local Tax Bureaus
- Registration with the Customs
- Registration with the Foreign Exchange Bureau
- Set up a basic and capital bank accounts with a bank in China
Our sister company Triple Eight Limited, part of the HKWJ Group, can assist and guide you through each of the required steps and provide you with a stress-free setting up process of your business in China. In addition, our China tax services also include but are not limited to:
- Analysing and evaluating the possible forms of investments into China and the different legal and tax implications on the intended holding structure
- Advising on the Chinese tax implications of your current business operation mode as compared to setting up a business presence in China such as any preferential tax treatment, VAT implications, customs duties, etc.
- Providing any other consultation on doing business in China
At HKWJ Tax Law & Partners we can assist with your entry into the Chinese market in several areas besides company formation such as taxation, business consultancy, marketing among others.