Opening an office in China
Foreign companies when opening an office in China often make two common mistakes: first, entering China without a carefully planned risk mitigation strategy and secondly, failing to develop an exit strategy for the worst case scenario – the death of a venture.
There are many implications for those opening an office in China, these include:
- Exposure to potential legal and financial risk arising from China’s tightening monetary and tax controls;
- Entrapment in complex and unfamiliar corporate compliance procedures;
- Trying to keep up to date with the forever changing laws; or simply
- Repatriating profits out of China.
With no exit strategy, companies that open an office in China find themselves waiting months or even years to rationalize assets and repatriate capital. Many companies are stunned by heavy taxes which could have been avoided with appropriate early tax planning to minimize liabilities both in China and in the home country.
Both large and small companies face similar risks, although large multinational corporations tend to have greater financing capabilities and therefore a larger tolerance for bearing such risk. This unfortunately is not the case for the majority of SMEs.A wrong move may mean a very expensive and time-consuming fix.
Nevertheless, regardless of whether organisations opening an office in China are a large multinational corporation or an entrepreneurial SME, the question remains, why take unnecessary risks, when these can be managed from an early stage?
Opening an office in China
Foreign investors who are opening an office in China have a number of options available when deciding on the type of FIE they use. Different FIEs provide varying levels of flexibility and enable the business to conduct a broad spectrum of commercial activities in China. A business decision on which investment vehicle to use should effectively be centered on its intended commercial objectives and the industry sector in which the business is engaged.
The more commonly used types of FIEs available in China and the relevant capabilities and restrictions of each are outlined below:
1. Opening a China China Representative Office (RO)
Representative offices opening an office in China are relatively easy to establish when compared to other FIEs. ROs can provide the foreign company with a presence in China but are not separate legal entities from the parent. In fact, the Chinese government does not recognize ROs as formal structures and as such, these forms of FIEs are quite restricted.
ROs can conduct indirect business activities such as serving as a local support centre for Chinese customers, quality control, sourcing, or as a liaison for Chinese suppliers. It is important to note that ROs are restricted from direct trading or distribution activities in China and are not allowed to issue invoices or receive payments.
It should be noted however that due to cost increases and new tax and reporting obligations within China for such ROs, their popularity has waned in recent years and they are no longer the cheap entry option to the Chinese market that they used to be.
2. Opening a China Wholly Foreign-Owned Enterprise (WFOE)
WFOEs are legal entities in China that are 100% funded by foreign investors. A WFOE can provide the foreign investor with full autonomy as well as increased protection of trade secrets. However, there are still many industry sectors that currently restrict the establishment of WFOEs. These restrictions are loosening as the Chinese government continues to liberalize the country’s investment environment for foreign capital.
WFOEs provide investors with a whole host of retail, manufacturing, service and distribution rights and remove the need for a Chinese partner/investor in many industry sectors. As a consequence, WFOEs have become the most popular FIE currently being used by international investors.
For foreign-investment purposes, in June 1995 the Chinese government promulgated the ‘Interim Provisions for Guiding Foreign Investment’ and the ‘Industrial Catalogue for Foreign Investment’. Investment projects are divided into four categories: prohibited, restricted, permitted and encouraged. Foreign investment projects that fall within the “permitted’ and “encouraged” categories will be prioritized for approval as long as government financing is not required for the project. Projects that fall within the “restricted” category are subject to more stringent scrutiny and must pass through the government’s assessment and approval system before being established. The “prohibited” category accounts for industry sectors that are still closed to foreign investors.
Those foreign investment projects under one of the following headings will be listed as “prohibited”:
- Those projects that endanger state security and damage the public interest;
- That cause environmental pollution and damage natural resources and public health;
- That use large farmland and are unfavorable to the protection and development of land resources;
- That endanger the security and normal function of military facilities
- That adopt the unique craftsmanship or technology of the country to make products; and
- Other cases that are regulated by the laws and administrative regulations of the State.
3. Opening a China Equity Joint Venture (EJV)
EJVs formed between a foreign and Chinese partner are often set up with specific objectives such as manufacturing and are typically used for long-term projects. EJVs are limited liability companies with liabilities limited by the amount of the investment. They must be registered as a legal entity in China, which gives them specific abilities including the right to legal action against other entities or persons in a Chinese court. In common practice, both partners contribute capital to acquire equity of the EJV and the relevant equity contributions will determine their share of the results, with the foreign partner contributing at least 25% of total equity.
EJVs have full domestic retail and wholesale distribution rights in China, but since China fulfilled its WTO obligations by allowing wholly foreign-owned enterprises (WFOEs) to fully engage in domestic retail and wholesale operations, there continues to be a decline in the popularity of EJV setups.
4. Opening a China Co-operative Joint Venture (CJV)
CJVs are also commonly referred to as contractual joint ventures. They are used for shorter-term projects, and can be registered as legal entities with limited liability although there is no obligation to do so. If the company does decide to register as a legal entity, the foreign partner must contribute at least 25% of the registered capital. CJVs are similar to EJVs but differ in that the obligations of each party are established by contract which provides the partners with more flexibility in negotiating the terms of the agreement. In common practice, the foreign partner provides funding, production technology and management skills while the Chinese partner contributes resources such as land and buildings.
CJVs also have full domestic retail and wholesale distribution rights in China, but as with other forms of joint ventures, they are waning in popularity as WFOEs with full distributional capabilities gain popularity.
Please note that no liability is accepted for inaccuracies or omissions when opening an office in China, pursuant to our terms.