China has become a global economic powerhouse over the past 30 years. Such immense change does not happen by chance – policy and new laws have paved the way. As a result, China's legal framework is a work in progress. There are gaps and ambiguities in the law, policy can sometimes change quite quickly and without warning and the changes are not always ones that everyone would prefer. Therefore, although economic opportunities are real and the legal framework backing up those opportunities quite solid, the legal environment remains challenging.
This guide provides basic information on the legal framework for foreign investment and operations in China, in three parts:
For more detail request a full version of the Pinsent Masons guide to doing business in China.
Legal system in China
The legal system of the People's Republic of China (PRC) is based on the PRC Constitution and is made up on a hierarchy of written laws, regulations and administrative directives. The Constitution formally stipulates that political power is exercised by the people, from the bottom up, through representative people's congresses from the local up to the provincial and national levels.
In practice, policymaking and administration can at times be highly centralised and uniform in nature, and at others highly decentralised and diverse.
Legislative function: the National People's Congress (NPC) and its Standing Committee have the power to pass laws on behalf of the state. The NPC can amend the Constitution and enact and amend basic laws governing state departments and public civil and criminal matters. The Standing Committee of the NPC has the power to interpret, enact and amend laws other than those which must be enacted by the NPC.
The Party: although it is not granted any formal legal status or powers in the Constitution and is technically separate from the government, the Chinese Communist Party (Party) parallels, overlaps with and controls the government at all levels. This system helps the Party to ensure a high degree of national uniformity and cohesion, but it also sets the Party above the government which can make it difficult in practice to subject the Party itself and its individual members to the rule of law.
Executive/administrative function: the State Council of the PRC (State Council) is the highest level of state executive administration and has the power to enact administrative rules and regulations consistent with law. Ministries and commissions under the State Council are also vested with the power to issue orders, directives and regulations within their respective areas of competence. The State Council also submits legislative proposals to the NPC or its Standing Committee for enactment into law.
Foreign investment is approved by the Ministry of Commerce (MOFCOM) and the National Development and Reform Commission (NDRC). The State Administration of Industry and Commerce (SAIC or local AIC) is also important, as it is responsible for business registration and also a number of business oversight functions.
Judicial function: the judicial power to apply the law in civil and criminal matters is vested in the people's courts at various levels – from the central Supreme People's Court (SPC), provincial High People's Court, municipal Intermediate People's Courts and local Basic People's Courts. People's courts at different levels are not independent, but carry out the judicial function in fairly close coordination with the courts, government and Party at the same and higher levels.
In the PRC's civil law system, court cases do not act as binding precedents. However, many court opinions are published annually and may provide useful guidance for outcomes in similar cases. SPC decisions also provide non-binding judicial guidance for lower courts, and the SPC's detailed interpretations on the application of national laws are considered to have the force of law.
Localities: the Party-controlled central legislative/executive/judicial structure is repeated at lower levels. The people's congresses of provinces and their municipalities may enact local rules and regulations. Administrative bodies at those sub national levels, such as local offices of the central state ministries and administrations, enforce local and central enactments and may make administrative rules and directives applicable to their respective administrative areas. People's courts at lower levels look to courts at higher levels and to government and Party at the same and higher levels for guidance.
Laws and regulations made at lower levels must not conflict with those made at higher levels, and generally only serve to implement central-level enactments. However regulations, rules or directives are occasionally enacted or issued at the provincial level in the first instance on a trial basis, later enacted on a national basis after sufficient experience has been gained.
Despite the uniformity attributable to centralisation, there is a great deal of variation in local practice and interpretation where central policy is silent or unclear.
Sectors open to foreign investment
Direct foreign investment is not permitted across the board in China. When planning to make an investment, the first step is to ascertain whether and under what conditions the contemplated activity is open to foreign investment. Those conditions may also include more favourable policy treatment for activities in which the government is eager to encourage foreign investment.
Companies registered in Hong Kong, Taiwan and Macao are treated as 'foreign' for the purposes of most PRC regulations governing foreign investment.
Business licensing: All companies, including foreign invested enterprises (FIEs) receive a business licence permitting them to operate only within a specific, narrow area of business. It is not usually possible to ccombine unrelated activities in the same licence, such as property management and manufacturing.
Foreign investment industrial guidance catalogue: issued by the PRC National Development and Reform Commission (NDRC) and MOFCOM, the guidance catalogue classifies foreign direct investment in various business activities as encouraged, restricted, prohibited or permitted. Activities not listed are, in the absence of other rules to the contrary, considered to be permitted to foreign investment. The different categories have the following characteristics:
- permitted: the standard category, with no particular restrictive or favourable treatment;
- encouraged: subject to approval at lower administrative levels. Traditionally able to enjoy certain tax and other benefits, most of which are now mainly relevant only to investments in the central and western regions (see below);
- restricted: subject to higher levels of scrutiny, approval at higher levels of administration and in essence may be denied at the discretion of the approval authorities;
- prohibited: foreign investment not permitted.
The guidance catalogue also identifies activities and sectors for which a Chinese partner is required - a form of joint venture. In such cases, the guidance catalogue may also specify the maximum permissible foreign shareholding in the joint venture.
Negative list of the Shanghai Pilot Free Trade Zone (FTZ)
The Shanghai FTZ is intended to pioneer a more liberal approach to foreign investment, an approach now also adopted in FTZs in Fujian, Guangdong and Tianjin. Only activities on the negative list need prior approval, other activities must only be subject to record-filing with the local municipal government. This will significantly decrease the administrative burdens of establishing a large range of common trading and service activities.
Now that this approach has been adopted nationwide, the FTZ Negative Lists have been superseded by the unified approach using the Special Management Measures for Foreign Investment negative list under the Guidance Catalogue. However, the FTZs continue to have in place preferential access policies for certain trading functions, like customs clearance and foreign exchange cash pooling. For a time, they will also continue to enable foreign investment in certain areas first liberalised there, but not yet generally open elsewhere, such as training schools and internet data centre business, in the Shanghai FTZ.
Central-western catalogue: the guidance catalogue is supplemented by the catalogue of priority industries for foreign investment in the central-western region listing activities and sectors in which foreign investment is encouraged in China's less-developed central and western regions. Activities that are encouraged under the guidance catalogue are also eligible for preferential treatment under a range of policies when undertaken in these regions.
Preferences for Hong Kong companies – the Closer Economic Partnership Arrangement: the PRC and Hong Kong entered into the first phase of the Closer Economic Partnership Arrangement (CEPA) in June 2003. Macao also has a similar arrangement in place. Among other things, CEPA provides eligible Hong Kong resident companies with more liberal investment access to the mainland than is available to companies from other jurisdictions. This means that eligible Hong Kong companies can enter into certain activities before companies from elsewhere.
Geography and location
The choice of location is a fundamental step in establishment planning. Since different geographic areas are developing at different rates, some of the most fundamental geographic distinctions are economic. Probably the most basic division in the country is that between the eastern coastal regions and the less developed Western and central regions, but there are similar distinctions between heavy industry in the north and the newer, more dynamic light industrial economies of the south.
Special zones: Apart from these broad geographical variables, any location search should also take into account the possibility of gaining benefits offered by a variety of different development and trade zones. The range of zones includes:
- national level high-tech industrial development zones
- regular economic and technology development zones
- free trade zones
- export processing zones
For simple economic and industrial development zones, the principal benefits can include access to land and infrastructure, proximity to a community of peers and talent and perhaps even certain tax and fiscal incentives.
The Shanghai FTZ: The China (Shanghai) Pilot Free Trade Zone launched on 29 September 2013 to much local and international attention. The Shanghai FTZ consolidates four existing free trade zones in Shanghai, with an area of 28.78 square kilometers.
The Shanghai FTZ is billed as a crucial step towards China's next wave of reform and opening up. But not all of the reforms are primarily intended to benefit foreign companies – many are directed at domestic companies. Some of the key reforms include:
- increased opening to foreign investment in certain activities
- streamlined company establishment requirements and procedures for a range of activities
- liberalised access to foreign exchange
The Tianjin FTZ is located in the central area of the Bohai Economic Rim, Tianjin has a regional advantage as a transportation hub for North China.
There are three parts of the Tianjin FTZ: the Tianjin Port district, the Tianjin Airport district and the Binhai New Area Central Business District. The total area is about 119.9 square kilometers.
Elements of the Tianjin FTZ include:
- Financial innovations focusing on trial run of free conversion of the RMB, with quotas under capital items, voluntary settlement of foreign currency capital, innovation on usage of cross-border RMB and financial leasing;
- Further opening-up of several areas of investment to foreigners, including international shipping management, international shipping agency service, financial services, ship financing, shipping, operating lease business, financial leasing, e-commerce, professional services, culture services, advanced manufacturing and high-end equipment repairs;
- Application of 'one window' procedure and foreign investment special entry administration to all enterprises incorporated in the Tianjin FTZ.
The Guangdong FTZ covers an area of 116.2 square kilometers and consists of three zones: the Guangzhou Nansha New Area, the Shenzhen Qianhai Development Zone and the Zhuhai Hengqin New Area.
Measures which distinguish the Guangdong FTZ from other FTZs are:
- Further promotion of the liberalisation of trade in services between Guangdong and Hong Kong and Macao;
- Deepening of the liberalisation of the financial sector in these three locations;
- Allowing the set up of bonded exhibition and trading platforms in the special customs supervision area.
The Fujian FTZ covers 118.04 square kilometers, comprising three independent areas: Pingtan Area, Xiamen Area and Fuzhou Area. The Fujian FTZ sets forth specific functions for each of the three areas.
- The Pingtan Area focuses on the development of a cross-strait tourism, investment and commerce.
- The Xiamen Area will develop as a demonstration zone for cross-strait emerging industries and modern service industries, a southeast international shipping centre, as well as a cross-strait regional financial service centre and trading centre.
- The Fuzhou Area focuses on establishing an advanced manufacturing base, serving as a platform for communication and collaboration among countries and regions in SE Asia, as well as a demonstration zone for cross-strait cooperation in trade in services and financial services.
The pilot FTZs are intended to serve as a model for further national reforms along the same lines. But in the short to medium term, procedures and requirements in the Pilot FTZs will not be quite as settled and predictable as elsewhere, and there may be some extra elements of administrative uncertainty in doing business there.
Foreigners should consider the pilot FTZs as a target for any new establishment. For activities opened to foreign investment only in the pilot FTZs, foreign investors may have no choice but to locate there.