Foreign Direct Investment, Equity Joint Ventures, Cooperative Joint Ventures, Wholly Foreign Owned Enterprises

Q1. What preferential taxation policies foreign-funded enterprise enjoy in China?

(1) Income Tax
Income tax rate: The current rate of income tax imposed upon foreign investment enterprises is 33%, though it is set at the lower rate of 15% in special economic zones, national hi-tech industrial zones and national grade economic and technical development zones. In coastal regions and provincial capitals the rate is 24%.

Tax-reducing policy: Foreign investment enterprises may enjoy the benefit of business income tax not being collected during the first two years after the beneficial year; a half income tax may then be imposed for the succeeding 3 years.

Foreign investment enterprises in the central and western regions are also encouraged by the State via 5 years' of tax reductions, with the possibility of a further 3 years' half income tax thereafter.

In the case of advanced technology enterprises, they are exempted from income tax for two years and are then subject to a half income tax for the following six. Export enterprises enjoy the benefits of two years' exemption and three years at half rate.

(2) Turnover Tax (Valued Added Tax, Business Tax)
From 1 January 1994, China started to implement unified Value Added Tax, Consumption Tax and Business Tax in foreign invested enterprises whilst simultaneously abolishing industrial and commercial consolidated tax. Foreign enterprises and foreign invested enterprises are exempted from business tax in technological transfer. If the foreign invested enterprise purchases equipment made domestically within the volume of total investment, there is a benefit of a refund of value added tax on domestically-made equipment.

(3) Import Tax
Tariff Rate: The Chinese government has lowered import tariff rates several times; the current rate is 12% and China's WTO concession will render the tariff to lower further according to the agreed time line.

Tariff Exemption Policy for Equipment Import
The importation of equipment for foreign or domestic-invested projects which are both encouraged and supported by the State shall be granted tariff and import- stage value-added tariff exemption. Provided that the foreign-invested product is subject to the Category of Encouragement, all equipment imported for its use within the aggregated investment shall be exempted from tariff and import-stage value-added tax (unless the project comes under the heading of those not entitled to Tariff Exemption). The aims of this policy are to expand the use of foreign investment and to encourage the influx of foreign technology whilst maintaining a healthy and developing domestic economy.

Q2. What are the projects foreign investors are prohibited to invest in China?

In accordance with the "Provisions on Guiding Foreign Investment Direction", any of the following projects is prohibited to be invested in：
(1) those that harm the national security and social public interests;
(2) those that cause environmental pollution, or do great damage to natural resources and wealth or people's health;
(3) those that occupy a great deal of farm land, do not do favor to the protection and development of land resources;
(4) those that harm the security of military infrastructures and its efficiency of application;
(5) those that make use of the unique technique or technology that the P. R. China possesses in purpose of production of products;
(6) The other cases stated in the laws and relevant administrative regulations.

Q3. What are the projects foreign investors restricted to invest in the P.R. China?

In accordance with the "Provisions on Guiding Foreign Investment Direction", any of the following projects is restricted：
(1) those that lag behind in technology;
(2) those that does not do favor to the frugality of power and improvement of ecological environment;
(3) those that are concerned with special exploration and mining protected by the state and in accordance with the state provision;
(4) those industries that are opened by the state gradually;
(5) other cases stated in the laws and relevant administrative regulations

Q4. What are the projects China encourages foreign investors to invest in?

In accordance with the provision of the "Guiding Directions for Foreign Investor to Invest", the projects China encourages foreign investors to invest in are listed as follows principally：
1. those that are categorized as advanced new technology for agriculture, agriculture integrated development, power, traffic transportation, and important raw materials;

2. those that are categorized as advanced new technology and appropriate technology which could improve performance of products and enterprise's economic and technological performance, or produce new equipment and new materials that domestic production capacity can not meet;

3. those that can improve and update the product's quality level and explore new market, or enhance the competence of the product in the international market, pursuant to the requirement of marketing;

4. those that are categorized as advanced new technology and new equipment which can save power and raw material, make comprehensive use of resource and renewable resource, prevent from and bring environmental pollution under control;

5. those that can give full play to the advantages of human resources and natural resources of the China western region, and accord with the state's industrial policies;

6. those that are prescribed by other laws, administrative regulations, and measures.

Q5. What types of foreign investment are allowed in China?

Branch Offices
A branch office in China is one that is used for business purposes for which the main company office holds responsibility. It is not a legal entity and it can only carries out liaison and coordination work. Such a situation would involve the existence of an offshore "parent", the People's Republic of China would be denied control of the entity - a situation which it seeks to avoid. In this way, China does not officially recognise branch offices, nor does it officially allow them to operate. Therefore, the difficulties posed by such restrictions and lack of legal standing mean that the branch office cannot be recommended as a vehicle for investment.

Sino- Foreign Equity Joint Ventures
These are enterprises established in China with joint investment from foreign companies, enterprises or other economic bodies and Chinese economic bodies. As the name suggests, such enterprises involve joint investment, operation and share of risk in proportion to the amount of investment inputted by the respective parties. Each party is accordingly jointly responsible for the profits and losses of the enterprise. Investment can come in the form of (amongst other things) currency, buildings, industrial property or equipment. In general, the level of investment offered by the foreign company should not be less than 25%.

The corporate form of such joint ventures is the limited liability company, with a Board of Directors as its supreme body of power. Some joint ventures in China have now adopted this corporate form.

Sino-Foreign Co-operative Joint Ventures
Sino-foreign co-operative joint ventures also refer to Chinese- foreign contractual joint ventures. They are enterprises established in China with investment or conditions for co- operation jointly offered by foreign companies, enterprises or other economic bodies as well as by Chinese economic bodies.

The main difference from the equity joint venture we have just discussed is that the investment of the parties involved will not necessarily be converted into ratios of investment.

The rights and obligations of the parties involved with regards to such issues as distribution, investment, operation and sharing of risks and profits is determined by the contracts signed by the parties from the outset of the venture. These ventures tend to involve the foreign partner providing most or all of the funds whilst the Chinese partner contribute land, facilities and a perhaps a limited amount of funding. The usual approach is to stipulate in the contract that the Chinese party will own all the assets of the venture once the date of expiry of the venture is reached, with the foreign party recouping its investment within the duration of the venture.

Such forms of co-operative joint venture are universally attractive, for they allow the Chinese partner to have a source of investment whilst permitting the foreign company to recoup its investment.

Wholly Owned Foreign Enterprises
These also refer to wholly foreign owned enterprises. They are enterprises set up in China by foreign companies or economic bodies in accordance with Chinese law with the investment entirely provided by foreign investors.

Such enterprises must be conducive to the development of China's national economy; they must also meet one of the following requirements：
1. The application of internationally advanced technology
2. The orientation of most of the products for export

The corporate form of foreign enterprises in China is generally the limited liability company. Although China has been late on the scene in terms of providing a system of establishment for foreign enterprises, they have grown in number rapidly over the past few years.

Chinese Holding Companies
Approval has recently been given to multinational corporations by China's Ministry of Foreign Trade and Economic Cooperation (MOFTEC) to establish foreign-invested holding companies. Though mostly analogous to Western Holding Companies, there are a couple of differences. Multinational companies may wish to set up holding companies in order to increase investment or reinvestment in China, as well as to coordinate investment companies already established in China.

A Holding Company in China may invest in such fields as industry, agriculture, infrastructure and energy, provided that the State encourages foreign investment in these sectors.

Typical work undertaken by a Holding Company might include action as a purchasing agent, distribution or the provision of after sales service, amongst other things. Provisional Regulations dictate that a Chinese Holding Company may enjoy the preferential treatment of a foreign- invested enterprise, and as such is awarded both a foreign- invested enterprise certificate and licence.

B Shares
Chinese government allows foreign investment to acquire shares of special category, B shares, of approved list companies in the Stock Exchange. However, ownership and management are separated. Chinese government is considering allowing foreign invested entity in China to be listed in the Stock Exchange, but it takes time for the government to come at this decision.

Special approved foreign Joint Venture
Foreign nationals are generally not allowed to hold equity of private companies in China unless with special consent from the government. A merger and acquisition exercise involving foreign fund will convert a private company into a foreign JV.

Q6. How to establish a foreign- funded enterprise in China?

It is naturally most important that foreign investors understand the procedures which need to be followed in order to establish foreign- funded enterprises in China. The regular steps which must be taken in this regard shall now be examined.

(1) Choice of Projects, Co- operation of Partners and Relevant Office Approval
The logical first step for foreign investors to take is to decide upon a project to undertake. Foreign investors have two options to choose from in this respect; they may chose a project proposed by enterprises or institutions across China or they may propose investment projects by themselves.

If the first option is taken, it should be noted that institutions and enterprises across China have proposed numerous projects, some of which have government approval and some that do not. It is therefore best to select those projects which have been officially approved in order to secure the approval of the relevant authorities.

The second option requires awareness as to whether the chosen project conforms to China's industrial policies, and whether the project belongs to a field which they are officially allowed to invest in.

In addition to this, attention should be paid to attaining reliable Chinese partners for investment. When applying for joint ventures or co-operative ventures, it is the responsibility of the Chinese partner to submit the application for the establishment of investment projects to the competent authorities for approval.

For wholly-owned foreign ventures, investors should seek assistance from the consultants who shall assist in the establishment of the presence in China.

(2) Submission of Feasibility Study Reports and Relevant Official Approval
Investors in a joint venture or a co- operative joint venture can only mount a feasibility study on a project once the application for establishment has been approved. A feasibility study report usually needs to contain the following 10 items：
a Outline of implementation
b Background and history of the project
c Marketing and production capacity
d Materials and inputs
e Site location
f Design of Project
g Organisational costs
h Construction arrangements
i Financial and economic assessments
j Foreign exchange equalisation and assessment of risks

Once again, in equity and co-operative joint ventures it is the Chinese partner to submit the feasibility report. However, the foreign party should maintain an effective channel of consultancy to screen through the papers and process. For investors in a wholly foreign- owned venture, the report should be submitted along with the application for establishment by consultants to the relevant local government authority.

(3) The Signing of Contracts and Charters of Association in addition to Relevant Official Approval
Once the feasibility study is approved, the respective partners in equity or co-operative joint ventures can get down to the matter of addressing contracts, charters of association and other legal documents. Competent government authorities require these charters, contracts and documents to conform to the following principles：
a. The content must be complete, with specific terms and precise language used. The responsibilities of all parties must have been clearly defined
b. The rights and obligations of all the parties concerned with the contracts must have been provided on an equal footing
c. The content of the contracts and charters of association must conform to the relevant provisions of Chinese law and Regulations
d. Liabilities to third party should be limited to the amount of registered capital

It is possible to refer to standardised contracts and charters of association which have been prepared by the Chinese government for reference during the negotiation and drafting of contracts.

In the case of equity and co-operative joint ventures, it is the responsibility of the Chinese partner to submit the contracts and charters of association for approval by the competent authorities. When the charters are approved, the authorities will issue a certificate of approval for the foreign- funded enterprise.

In the case of wholly-owned foreign enterprises, a formal submission of the charters and other documents may be made after the initial application has been approved. Once again, certificates will be issued if this formal application is successful.

The Chinese government has recently moved to simplify matters for small ventures of all the varieties mentioned, allowing all the applications, feasibility reports and legal document to be submitted in unison.

(4) Registration
Two steps should be followed by foreign investors and their Chinese partners during the application stage：
a. The name of the foreign- funded enterprise must be registered after the establishment application is fully approved
b. The establishment of the foreign- funded enterprise must be registered after the contract and charter of association are fully approved.

The registration of the name of the venture serves to protect the use of the name. No party concerned with the project is allowed to use the name registered to conduct business before the registration of the venture itself is completed.

After the contract and charter of association have gained approval, foreign investors and their co- operation partners should proceed to apply for registration to the administrative authorities for industry and commerce within 30 days. A business licence will be issued to all parties when the registration is made and checked.

Once all this has been done, the procedure for the establishment of a foreign- funded enterprise in China is completed.

Time Limit for Operation and Enterprise Termination
The time limit for foreign investment enterprises is usually 20 years at the longest, and may be stipulated by investors through negotiation. Where a time limit is appointed, termination of the enterprise comes with the expiration of the time period.

Prolongation may be sought at least 180 days before the expiration date from the relevant approving authorities.

Q7. How to establish a wholly foreign owned enterprise in China?

Wholly foreign owned enterprises are permitted to register in cases where at least half of their annual output is exported or if the nature of their operations relies heavily on advanced technology and the application of this high technology is beneficial to China. Approval to establish a wholly foreign owned enterprise is granted much more sparingly when compared to joint ventures.

Like joint ventures, wholly foreign owned enterprises are in most cases required to balance their foreign exchange and are allowed to occupy facilities other than those managed by the Foreign Management Bureau. As a Chinese legal entity they may sign separate contracts with the appropriate government authorities or Chinese business entities to acquire land use rights, rent buildings, and receive utility services.

Wholly foreign owned enterprises enjoy exclusive management control of their business activities and have autonomy in their operation and management with less interference from the Chinese government. Because there is no Chinese partner to guide the project through the approval process and through the other regulatory issues associated with construction and operation of the enterprise, the logistics of establishing a wholly foreign owned enterprise can be difficult and costly.

A wholly foreign owned enterprise is considered a Chinese legal entity and must abide by all Chinese laws. They must employ Chinese labor in accordance with local and central government labor laws and are encouraged to establish trade unions (but not required to do so.

Traditionally the wholly foreign owned enterprise has rarely been the chosen method for investment in China. The independence offered to the foreign investor is often outweighed by the lack of direct links to the domestic economy. Most international corporations choose to establish joint ventures for the relationships and connections provided by the Chinese partners.

Recently some major international players in China's telecommunications industry including AT&T and Ericsson have set up wholly owned enterprises to handle much of the domestic management originally handled by their representative office. They have done so only after years of business experience in China and despite their registration as a wholly foreign owned enterprise, maintain the registration of their representative office.

Q8. How to set up a resident representative office in Beijing, P.R. China?

Foreign traders, manufacturers, shipping agents, economic organizations and other groups shall report, according to their nature of the business, to the Ministry of Commerce (Mofcom) or other relevant ministries, committees or bureaus which are authorized for the examination and approval of the setup of resident offices. Proxy authorized by Mofcom will go through the examination and approval procedures for the above-mentioned companies. The business activities of the established institutions can only be in the range of business connection, products introduction, marketing, technology exchange and consulting service and etc. Direct business activities are prohibited.

Documents Required and Necessary Procedures
(1) Application for setting up the office： The application shall include background of the enterprise, business conditions, purpose of the office to be established, name of the office, person in charge, scope of business, location and operational term. Application shall be signed by the chairman or president of the enterprise together with the enterprise's seal. (original)
(2) A certificate of authorization to the representative accredited to the office issued by the chairman or president of the enterprise. (original)
(3) Copy of certificate of legal operation or copy of certificate of registration provided by the proper authorities of the country or region where the enterprise comes.
(4) Bank reference provided by the bank of the country or region where the enterprise comes： The bank reference, to be signed by the person in charge or business manager of the bank, shall state clearly the enterprise's registered capital and present amount of deposit, as well as the reputation of its flexing capitals after the opening of the account. (original)
(5) Resume of representative accredited to the office. The resume, including both educational and working background, should be detailed, specific and true. Disconnection is not allowed. Two photographs of each representative are required.
(6) Identification paper of the representatives. For representatives of foreign nationality, copy of passport of the country he holds should be submitted. For compatriots from Hong Kong and Macao, copy of certification for his returning to his hometown and permanent resident identification should be submitted. If a domestic personnel is to take the post of representative or chief representative, approval and identification from Beijing Foreign Enterprise Service Corporation (FESCO) are needed.

Q9. How to establish an equity joint venture in China?

Equity joint ventures are the second most common manner in which foreign companies enter the China market and the preferred manner for cooperation where the Chinese government and Chinese businesses are concerned. Joint ventures are usually established to exploit the market knowledge, preferential market treatment, and manufacturing capability of the Chinese side along with the technology, manufacturing know-how, and marketing experience of the foreign partner.

Normally operation of a joint venture is limited to a fixed period of time from thirty to fifty years. In some cases an unlimited period of operation can be approved, especially when the transfer of advanced technology is involved. Profit and risk sharing in a joint venture are proportionate to the equity of each partner in the joint venture, except in cases of a breach of the joint venture contract.

Share holdings in a joint venture are usually non-negotiable and cannot be transferred without approval from the Chinese government. Investors are restricted from withdrawing registered capital during the live of the joint venture contract. Regulations surrounding the transfer of shares with only the approval of the board of directors and without approval from government authorities will probably evolve over time as the size and number of international joint ventures grow.

There are specific requirements for the management structure of a joint venture but either party can hold the position as chairman of the board of directors. A minimum of 25% of the capital must be contributed by the foreign partner(s). There is no minimum investment for the Chinese partner(s).

It is preferable that foreign exchange accounts are balanced in order to remit profits abroad so that the repatriated foreign exchange is offset by exports from the joint venture. With the elimination of foreign exchange certificates and the further opening of the China market, this requirement is becoming more and more relaxed.

The permissible debt to equity ratio of a joint venture is regulated depending on the size of the joint venture. In situations where the sum of debt and equity is less than US$ 3 million, equity must constitute 70% of the total investment. In joint ventures where the sum of the debt and equity is more than US$ 3 million but less than US$ 10 million, equity must constitute at least half of the total investment. In cases where the sum of the debt and equity is more than US$ 10 million but less than US$ 30 million, 40% of the total investment must be in the form of equity. When the total investment exceeds US$ 30 million, at least a third of the sum of the debt and equity must be equity.

Equity can include cash, buildings, equipment, materials, intellectual property rights, and land-use rights but cannot include labor. The value of any equipment, materials, intellectual property rights, or land-use rights must be approved by government authorities before the joint venture can be approved.

After a joint venture is registered, the entity is considered a Chinese legal entity and must abide by all Chinese laws. As a Chinese legal entity, a joint venture is free to hire Chinese nationals without the interference from government employment industries as long as they abide by Chinese labor law. Joint ventures are also able to purchase land and build their own buildings, privileges prevented to representative offices.

Q10. How to set up a cooperative joint venture in China?

In a cooperative venture, the parties involved may operate as separate legal entities and bear liabilities independently rather than as a single entity. A cooperative venture may also be registered as a limited liability entity resembling an equity joint venture in operation, structure, and status as a Chinese legal entity.

There is no minimum foreign contribution required to initiate a cooperative venture, allowing a foreign company to take part in an enterprise where they preferred to remain a minor shareholder. The contributions made by the investors are not required to be expressed in a monetary value and can include excluded in the equity joint venture process can be contributed such as labor, resources, and services. Profits in a cooperative venture are divided according to the terms of the cooperative venture contract rather than by investment share, allowing a more flexible schedule for return on investment in cases where one investor provides cash while the other party's investment is primarily in kind.

Greater flexibility in the structuring of a cooperative venture is also permissible including the structure of the organization, management, and assets. There is no term for unlimited terms in cooperative ventures, but also no provisions for the term of the duration. The term of the cooperative venture contract may be renewed subject to the consent of the parties involved and approval from the examination and approval authorities. The foreign investor is permitted to withdraw their registered capital or a portion thereof from the cooperative venture during the duration of the cooperative venture contract.

Because of the unique privileges and added features offered to the foreign party in a cooperative venture, trade unions must be allowed to represent the employees in employment matters to protect the interests of the employees.