Do it like a boss: setting up your business in China -the different types of business entities for foreign investors

Whether you are an enthusiastic entrepreneur, or company appointed agent to browse the Chinese foreign investment market, you have a common goal: establish a foreign business entity in China. You may already have sufficient funds, a solid supporting overseas business, an exciting business plan and etc.; in other words: you are ready to roll! However, in order to avoid a cumbersome trial-and-error process, it is important to understand what options foreign investors have to set up a company or extend their business into China. In the following blog, we will introduce the various types of foreign business entities, their characteristics and whether or not they accommodate your needs.

Representative Office (RO)

What is it?

Representative offices are non-legal entities that are viable foreign investment vehicles. They are “non-legal” in the sense that any direct profit generating activities are strictly prohibited. Indirect business operations permissible for ROs are:

–          Head office liaison with clients in China

–          Product or service introduction

–          Market research

–          Data & information collection

Needless to say, contracts cannot be concluded between ROs and other parties in China. Furthermore, ROCs must recruit their staff via local agencies and are treated as permanent establishments in China, which means that they have to pay corporate income tax, business tax and VAT.

What’s in it for you?

If you are a trade agency or in the service industry and you have little initial investment funds, you may opt for ROs. The set up process and capital requirement for ROs are more easily obtained compared to that of foreign invested enterprises.

Branch of a foreign corporation

What is it?

Branches are also non-legal entities for foreign investment and thus cannot engage in direct profit making operations. A liable Chinese legal representative must be appointed to the branch. Unfortunately, as an extension of their overseas head offices, branches are not eligible to the legal rights and protection that Chinese business entities are entitled to.

What’s in it for you?

If you are in the financial services sector or oil exploration industry, you may opt for branches. Theoretically, all foreign enterprises can apply for branches in China, but in practice only branch applications from companies in the fields mentioned above are processed.

Foreign Investment Enterprise (FIE)

What is it?

A FIE is essentially a Chinese entity with 25% minimum foreign investment. In other words, as opposed to non-legal entities described above, FIEs are legal entities entitled to Chinese company law rights and protection. FIEs can conduct profit generating business activities in compliance to their government approved business scope. In general, FIEs encompass industries such as manufacturing, processing, trading and/or service activities. However, a fundamental legal document for FDIs in China is the “Catalogue for the Guidance of Foreign Investment Industries”, which places FDIs in four separate categories: “permitted”, “encouraged”, “restricted”, and “prohibited”. In accordance with the “Catalogue”, companies have to clarify which types of FIEs apply to their industry specific sector. Currently FDI regulations are under revision in China, which also applies for the 2015 “Catalogue”. It is expected that the revised  “Catalogue” will be implemented in 2018.

There are three types of FIEs, depending on ownership and shares of profits:

  1. Equity Joint Venture (EJV)

An EJV is an independent legal entity with at least one foreign investor and at least one Chinese investor. Ownership and profit division depend on each party’s respective contributions to registered capital. Investors hold equity interests instead of stock shares from public issuing (more information from Joint Stock Company section). Equity can be cash, capital, intellectual property rights, materials and etc with the exception of labor. Directors, who are assigned by the investors, have voting power instead of the shareholders in western country enterprises. In accordance with the “Catalogue”, companies are also required to set up joint ventures in the predefined industry sectors.

What’s in it for you?

The advantages of Chinese partners are: domestic financing, sharing financial risks, larger or deeper access to domestic markets, and easier contact with domestic social networks. Since foreign companies are not familiar with the Chinese markets and its characteristics, they often face problems when they enter the market. Hence, a JV partner may also provide China-specific knowledge. Furthermore, as a holding company, an EJV can benefit from economies of scale in operations and management via collective investments under one corporate identity. More specifically, EJVs may implement centralized purchasing, personnel training, project management coordination and product marketing.

  1. Cooperative Joint Venture or Contractual Joint Venture (CJV)

Besides the EJV, it is also possible to establish a CJV. There are two characteristic differences between an EJV and a CJV. Firstly, while an EJV is always a limited liability company, a CJV can be a legal as well as a non-legal person. The latter option is not very common though because it would mean that the partners of the joint venture would be personally liable for any losses the company might make in the future. Secondly, in an EJV the distribution of profits must be proportionally equivalent to each party’s capital contributions ratio. However, in a CJV the distribution of profits may be decided more flexibly by the parties.

What’s in it for you?

Since CJVs can be more short-term and project-oriented, they can serve as flexible instruments for economic cooperation between foreign and Chinese companies. Moreover, a minimum stake in the company is not required and contributions do not necessarily have to be through financial means.

  1. Wholly Foreign-owned Enterprise (WFOE)

A WFOE, quite self-explanatorily, offers foreign investors exclusive control of the enterprise. In general, WFOEs are guided by the “Law on Wholly Foreign-Owned Enterprises”, with the implementation of the WFOE law in 1986, entirely foreign owned subsidiaries were allowed to be set up in China for the first time. In 2016, the Law was revised for the second time.

What’s in it for you?

Chinese partner involvement is not mandatory or required under investment regulations for WFOEs, thus WFOEs show a faster and more flexible decision-making process in comparison to JVs. Furthermore, WFOEs are sometimes used to protect technology, innovations and intellectual property. Additionally, the approval process is simpler and the limitations on business expense payment and local sales volume are more lenient for WFOEs.

Other Option:

–          Joint Stock Company (JSC)

A JSC is the only form of FIE that is eligible for public listing on a Chinese stock market. Other types of FIEs can be transformed into JSCs by converting registered capital into stock of the company. On the downside, in order to set up a JSC, a large initial capital investment is required.

What’s in it for you?

JSCs can invite shareholders in the company to increase capital and establish connections with other legal entities in China. Furthermore, JSCs do not require prior authorization from other partners to dispose or transfer interests.

So now that you have an overview of the various types of foreign investment entities in China, you have a head start on choosing which form is most appropriate for your start-up, your extension business from an overseas establishment, your potential collaboration with Chinese business partners and etc. You even have a good idea of what to put in that Chinese market report for your boss who wants to expand your company into China!

For more details on regulations, application process and tax systems, Maxxelli Consulting services can provide you with further information upon request. Send us an email to find out more.[:]

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