Forms of business establishment
This guide provides basic information on the legal framework for foreign investment and operations in China, in three parts:
Foreign invested enterprises (FIEs): foreign investors wishing to establish a presence to do business within the People's Republic of China (PRC) must establish one of the several different statutory forms of FIE. These are regulated under stricter laws than domestic companies, and are also subject to the same generally-applicable laws and regulations. In general, only companies with 25% foreign equity or more can be considered as FIEs.
The choice of FIE form depends on the category of the intended activity in the Guidance Catalogue, as well as on the particular operational needs or objectives of the foreign investor. Under China's strict sectoral approach to regulating business activities, FIEs will receive a business license permitting operations only within a relatively narrow scope of business, rather than for any lawful purpose. Forms of FIE include:
- Wholly foreign-owned enterprise (WFOE): a limited liability company 100% owned by one or more individual or corporate foreign investors. The liability of the investors is limited to their subscribed registered capital. WFOEs are the most popular form of FIE;
- Equity joint venture (EJV): the most common of the two types of statutory joint venture. An EJV is a legal person company invested in together by both foreign and domestic corporate investors. The equity interests of the investors, and the division of profits, is strictly proportional to their shares of contributed registered capital;
- Cooperative joint venture (CJV): CJVs are normally established as legal person limited companies, but may also be established as a non-incorporated contractual cooperation. The liability of the partners in an unincorporated CJV is unlimited, and investors tend to have greater flexibility. Non-incorporated CJVs are typically only established for specific limited purposes and activities such as collaboration in natural resources exploration and venture capital investments;
- Foreign invested company limited by shares (FICLS): a joint Chinese and foreign-invested company, hence a form of joint venture (JV), limited by shares. An investor's liability is limited to its individual subscription. Companies seeking listing on the Chinese stock market must be in the form of a FICLS. A WFOE, EJV or CJV may convert to an FICLS in accordance with PRC law;
- Holding company and regional headquarters: investors with major operations already in the country may wish to consider establishing a holding company or a regional headquarters to help consolidate certain group treasury, support services and trading functions. There are significant minimum investment thresholds, and operations are limited to holding company functions;
- Foreign invested partnership enterprise (FIPE): available since 2010. Except for market access and other key differences, FIPEs function under the same rules as domestic partnerships and generally much the same as partnerships in the West.
In addition to the different basic forms of FIE, special types of FIE also exist to carry out certain specific business activities.
Representative offices and branches: Where more limited activities are contemplated or limited liability is not required or permitted, foreign investors may establish a representative office or branch in China:
- Representative office (RO): an entity that may conduct some restricted activities on behalf of a foreign parent company, but cannot engage in direct profit-making activities itself;
- Foreign company branch: a branch of a foreign company is permitted to engage in direct business activities, however this is only available for certain businesses such as commercial banking and oil exploration;
- Domestic company branch: a company already established in China may set up branches to operate its business at places different from its registered address. Such a branch does not have independent legal personality or limited liability, and its parent therefore has unlimited liability for its debts.
PRC regulations previously contained strict requirements for registered (paid in) capital, and these controls were seen as an important means of ensuring the soundness and integrity of domestic business.
In early 2014, these rules were liberalized with amendments to the PRC Company Law and related regulations.
The key thrust of the reforms was to:
- remove the general requirement to pay in registered capital, by redefining registered capital as subscribed capital rather than paid in capital
- remove the general minimum registered capital requirement (though specific limits prescribed in national law or State Council regulations will remain)
- remove the fixed time limits for paying in registered capital
- remove the required minimum ratio of cash to other forms of registered capital (though limits on the types of permissible non-cash contributions remain)
- remove the formal requirement for capital verification (though it may still be advisable to do this in practice)
As before, an FIE's registered capital can be stated in either foreign currency or Chinese currency (RMB).
In practice, the recommended approach to fixing registered capital has not changed: investors should fix the amount of registered capital and borrowing should be fixed at the amount required to fund capital expenditures and working capital until the enterprise reaches operating break even.
However, it is remains quite difficult to reduce registered capital, so any excess could become trapped in the company. The use of some amount of discretionary debt financing to satisfy total funding requirements helps avoid a cash trap for excess registered capital. But a cash trap might be unavoidable, if the remaining local registered capital minimums exceed the amount actually required for the project.
Forms of capital contribution: registered capital can be contributed in the form of cash, capital equipment, land use rights, debt and share rights and intellectual property rights.
In general, title to contributed non-cash asset should pass to the enterprise. Accordingly, revocable licenses, future services and other such contingent interests are generally not permissible as contributions to registered capital. There is however an exception in the case of CJVs, where it is permitted to contribute "cooperative conditions" that may include contractual performance. Mortgaged assets also may not be contributed to registered capital in any event.
Debt to equity ratio: in order to help ensure corporate financial strength, PRC policies limit the debt-to-equity rations of FIEs by specifying statutory minimum ratios of registered capital to 'total investment.' This is defined to include registered capital plus any long-term borrowing by the enterprise. Subject to exceptions for particular industries, such as property development, the ratios increase with the scale of the enterprise.
Timing of capital contributions: Under the amended PRC Company Law, there is no specific requirement on the time limit for completion of the full capital contribution. However, in practice, the AICs in many areas may still require that a fixed contribution deadline be included in the company's articles of association. In principle, the deadline can be extended by amendment of the articles of association. And in practice, there is no longer any clear mechanism to require compliance with the article payment deadlines. But because the consequences of non-payment cannot be fully predicted, it would be most prudent to pay in the registered capital in accordance with the articles.
Transfers of interest in registered capital: co-investors have a statutory right of first refusal to purchase registered capital in the event of transfer to a new investor. Their consent for such transfers is required, as is consent from the Ministry of Commerce (MOFCOM).
Pledge of interest in registered capital: to do this, investors require the approval of the original co-investors and MOFCOM.
Increase in registered capital: this must be approved by the original approval authorities and investors have a statutory pre-emptive right to subscribe to new capital in the same proportion as their original equity shares.
Decrease in registered capital: this may only be done under fairly limited circumstances, generally related to a decrease in the scale of the business and with the approval of MOFCOM.
Organisation and governance
In the wake of its accession to the World Trade Organisation, China has steadily unified the regulatory regimes for domestic and foreign-invested enterprises. However, original regulations and various special rules subsist. As a result, FIEs are still treated differently than domestic companies in certain key respects, although the areas of common treatment are steadily increasing between the two.
Structuring – offshore special purpose vehicle (SPV): the basic advantage of an SPV is that, if the offshore SPV owns the equity of a PRC investee, transfers of ownership in the PRC investee can be cleanly completed by a transfer of shares in the offshore SPV, thus generally avoiding the need for the onshore PRC transfer approvals (see above).
If PRC-domiciled parties invest in such an SPV, the PRC investors should first obtain relevant MOFCOM approvals and foreign exchange registrations.
Board of directors or executive director: the board of directors is the highest authority of EJVs and incorporated CJVs. Non-incorporated CJVs have a management committee, which is constituted and operates similarly to a board of directors. Board powers are specified partly by statute and partly by articles of association of (for JVs) in the JV contract.
In EJVs board representation should reflect the equity ratio between the shareholders.
Chairman: in EJVs the chairman is generally appointed by the majority equity holder.
Legal representative (LR): the LR of an LLC or company limited by shares is an individual who is legally accountable for the company and its acts, and who has the power to contractually bind the company. This is therefore a sensitive position.
Supervisors: this role involves general oversight of company finances and compliance. Senior managers and directors of a company may not also serve as supervisors of the same company.
Management: companies are largely free to specify their management structures. JVs must have a general manager and a financial manager.
Company chops: each enterprise, subsequent to registration, will be issued with certain chops (a stamp or seal) that are generally presumed to be definitive proof of the company's approval of documents to which the chop is attached.
Establishing a business in China is more complex and time-consuming than in many Western jurisdictions. The process is even more burdensome for foreign than for domestic investors.
Company name reservation: done with State Administration of Industry and Commerce (SAIC or local AIC) business registration authorities in the target locality. Company names in foreign languages cannot be registered in China, although foreign trade names may be registered as trademarks on a first-to-file basis. An FIE investor will need to choose a Chinese business name according to the standard form, normally consisting of four elements:
- name of the administrative region where the FIE will be located;
- trade name consisting of at least two Chinese characters;
- business or industry;
- organisational form.
Project approval: MOFCOM is the main approval authority for foreign investment projects. Its Approval Certificate serves to confirm that the project complies with relevant legal and approval requirements, and also serves as the basis for issuing a Business Licence.
In theory, approval from the PRC National Development and Reform Commission (NDRC) is required for setting up any new FIE as well as for any offshore acquisition. In practice, NDRC approval is generally only required for investments in fixed assets, manufacturing or specific energy or resource sectors. State Council approval is required for encouraged or permitted projects with a total investment of $500 million or more, or for restricted projects with a total investment of $100 million or more. Central approval is also required for certain specific types of major projects, such as metro lines and new airports.
Business license issuance: this acts as proof of due legal establishment in the same way that a certificate of incorporation will in other jurisdictions. It is issued by the SAIC as a matter of course, based on the MOFCOM approval certificate.
Ancillary registrations: Newly-registered businesses should file for registration with various government departments for a number of additional registration certificates within 30 days after the business license is issued.
Foreign exchange controls
Foreign exchange controls are principally administered by the State Administration of Foreign Exchange (SAFE), and FIEs with greater than 25% foreign investment in some respects have more liberal access to foreign exchange than domestic enterprises.
Foreign exchange cannot readily be moved between territories within China through banks, because China prohibits circulation of foreign currency within its territory.
Foreign exchange bank accounts: for all FIEs, foreign exchange transactions must be opened at a designated foreign exchange bank.
Foreign borrowing: FIEs, unlike domestic enterprises, are generally free to undertake currency loans from offshore lenders. However, these loans must be registered with SAFE.
Profit remittances: FIEs may declare profits on an annual basis after all taxes have been paid and previous years' losses have been made up. FIEs may apply to SAFE for remittance of such amounts in freely convertible foreign currency.