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Pre-establishment considerations

When establishing a company in China, it is highly advisable to seek professional assistance to guide you through the complex setup procedure and outline the roles and responsibilities of key positions in the company. This can be a critical factor in ensuring the success of the venture and avoiding time-consuming changes to the company later on down the line.

Business scope

In China, the intended scope of a business must be defined in advance of the business' establishment. It is an enumeration of the commercial activities in which a business is authorized to operate in. It is administered by two state bodies - the Ministry of Commerce (MOFCOM) and the local Administration for Market Regulation (local AMR)1 - and is printed on its business license along with other registered information such as its name, registered capital, and legal representative.

[video file='https://cdn.jwplayer.com/videos/6KFxBH7n-sZcHHUE7.mp4' image='https://resource.dezshira.com/resize/900x506/Misc/banners/web_2.jpg' title='Remotely Establishing Entities In Asia  China’s Mainland Vs. Hong Kong Vs. Singapore']

For foreign businesses, it’s imperative that the company operations must be reflected accurately in the business scope. Under the current laws and regulations, foreign investors are still restricted or prohibited to engage in certain sectors, as stipulated in the Special Administrative Measures on Access to Foreign Investment (2020 edition) (National Negative List) and the Free Trade Zone Special Administrative Measures on Access to Foreign Investment (2020 edition) (FTZ Negative List).

In addition to the legal risk of disingenuously operating in an unregistered domain, not keeping the company’s commercial operations within the range of activities set out in its registered business scope can also be detrimental to a company’s ability to issue official invoices (fapiao) to its clients. While a company still can issue fapiao for occasional activities out of the business scope, regular discrepancies may trigger potential tax investigations. It is therefore critical that companies carefully plan their business scope prior to initial incorporation in China, or else risk having to undergo the onerous and time-consuming process of changing this later.

Depending on the business scope, FIEs can be classified as being a manufacturing company, a service company, a foreign invested commercial enterprise (i.e. a trading company), regional headquarters, an R&D center, an investment company, or several others. Often, the capital requirements will differ depending on the type of company that is being incorporated.

Registered capital

Registered capital is the fund all the shareholders contribute or promise to contribute to the company when they apply to the local Administration of Market Regulation (AMR) for incorporation of the company. The amount of the registered capital depends on a range of factors, which include the region, the sector, the company’s business scope, the planned scale of operations, etc. It will show in the company’s business license, this information is available to the public to show the fund strength or capacity of a company to some extent.

[tips title="Did You Know"]The registered capital does not need to be paid completely up front. The previous system of paid-up capital has been replaced by a subscribed capital model, under which a schedule of contributions must be declared in the Article of Association and be registered with the local AMR in charge. The government will check whether the investors follow the capital injection plan.[/tips]

There is no minimum registered capital requirement for corporate establishment except few industries, such as banking, financing, insurance, etc. Despite this, in practice, the governing authorities will ensure that a company’s registered capital is sufficient to support its business operations for at least one year, including its rent, labor costs, and office expenses.

Moreover, the registered capital can affect the amount of offshore debt the FIE can borrow from other investors or foreign banks, if the FIE chooses to follow the ratio between registered capital and total investment as shown in the following chart. The upper limit of the offshore debt is the gap between the total investment and the registered capital.

Investment to Capital Ratios

Total investment (US$)

Minimum registered capital

3 million or less

7/10 of total investment

3 million - 4.2 million

US$2.1 million

4.2 million - 10 million

1/2 of total investment

10 million - 12.5 million

US$5 million

12.5 million - 30 million

2/5 of total investment

30 million - 36 million

US$12 million

36 million or greater

1/3 of total investment

 

Registered capital contributions can be made in cash, as a lump sum, or in installments. However, locally obtained RMB cannot be injected as registered capital – it must be contributed from outside China by the overseas investor. The company’s payment schedule for contributions must be specified in its Articles of Association, and once paid, the amount cannot be freely wired out again.

Expense and tax planning

When setting up a company in China, one inevitably incurs costs prior to the company being formally incorporated. The question then arises what part of these costs may be deducted from the company’s tax bill. This becomes especially relevant if the investment is a large project, such as setting up a factory and purchasing machinery, where the costs incurred prior to incorporation can be substantial.

At this point, it is important to note that a Representative Office (RO's) in China is taxed on its expenditures. It is therefore in the investor’s interest to, within reason, keep expenses allocated to the RO to a minimum. For this reason, it is advisable to allocate the RO’s pre-incorporation expenses to the foreign headquarters.

Foreign Invested Enterprise (FIE) meanwhile, being an independent legal entity registered in China, is taxed on its income, and may therefore deduct expenses from Chinese tax. As pre-incorporation expenses by definition have been incurred prior to the FIE formally existing, only some of these expenses can be taken on by the FIE. Of all the expenses made before formal incorporation, only the so-called pre- operation costs (开办费) may be allocated to the FIE and deducted. The key point in defining pre-operation costs is the time when they occurred.

In practice, the starting point of this period is seen as either the establishment date on the business license, or the day on which the investor gets the company name confirmation from the AIC. This is usually one month before the establishment date on the business license. The ending point of the pre-operation cost period is when the company issues its first invoice, or generates its first revenue.

Most of the costs incurred during this period, such as wages, training, printing, transport fees, registration fees, and purchases of items not considered fixed assets, may be deducted if relevant valid tax invoices can be provided. Up to 60 percent of advertising and business-related entertainment expenses (business dinners, gifts, baijiu, etc.) may be allocated to the FIE during this period.

It is often hard to predict what the establishment date of the company will be. This largely depends on how the incorporation process is conducted. However, the better the investor us able to manage its incorporation process from its side or with its agents, the more clarity and the better the positioning the company can achieve.

Before the company is incorporated, the foreign investor may open a temporary bank account in China. The investor may wire foreign currency into this account and spend these funds on pre-operation and other expenses.

After the company has been established, it needs to open a capital account. The funds from the temporary account can then be wired to this account.

In practice, the only cost incurred prior to the pre-operation cost period is office rent. Allocation to the FIE is accepted, as an office lease is a required step of the incorporation process.

Enterprises, especially manufacturing companies, which often have a long pre-operation period, should take careful consideration of when their pre-operation period ends. These companies in particular need to make sure costs incurred can be carried forward as a loss over the next five years. 

Types of business - What are my options for investing?

Foreign investment into the People’s Republic of China can be made via one of several types of investment vehicles. Choosing the appropriate investment structure for your business depends on several factors, including its planned activities, industry, and investment size.

Choosing the right corporate structure for setting up a company in China is paramount and can mitigate unnecessary business constraints, costs, and official scrutiny. These challenges handicap growth following market entry and can undermine a company’s plans to expand.

Investing in a market as complex and expansive as China comes with legal, regulatory, and cultural challenges. Many investors establish a local presence through a foreign invested enterprise (FIE), which helps limit the cost and increase the ease of doing business in China.

Investors need to be particularly careful in approaching how local authorities treat their industry, business objective, day-to-day operations, and the amount of domestic input they require. In addition, foreign investors should formulate how they would like to manage capital requirements, legal liability, tax, commercial and hiring capacity, and time needed to set up a company.

Establishing a business in China is not rocket science, but investors that want to save time and money should carefully consider the options and seek local expertise for best results – read this section to gain insights on the various types of companies in China.

Key considerations when opening a business

Choosing a location

Choosing a location is one of the first decisions that companies must make when entering a new market. Location and a strategic site selection plan can have a major impact on the success of the business, affecting production, operation, and sales. Therefore, companies must take steps to ensure they have the right information before committing their time and money.

Should you consider a holding company?

Many companies choose to establish holding companies, or “special purpose vehicles”, in jurisdictions, such as Hong Kong or Singapore, to hold their Chinese entity. Holding companies allow for an additional layer of distance between the Chinese subsidiary and parent company and can “ring-fence” the investment to an extent, protecting it from the potential risks and liabilities of the Chinese subsidiary. In the case that an investor wishes to sell their Chinese business or introduce a third-party partner/shareholder into the structure, the administrative changes can also be done at the holding company level, rather than at the China level, where the regulatory environment is tougher, and procedures are more time-consuming.

Personnel considerations for an FIE

The key positions in a foreign invested entity vary by the investment structure and size, with some overlap. ROs should designate a chief representative to sign documents on behalf of the company. In addition to a chief representative, an RO can also nominate three more general representatives. For WFOEs and JVs, key positions include shareholders, an executive director (or board of directors), supervisor(s), general manager, and legal representative.

Intellectual property protection 

Many FIEs in China have graduated from a manufacturing focus to a model where their real business value is now bound up in their intellectual property. Unfortunately, intellectual property rights (IPR) violations continue to pose a problem in the country, including via the infringement of copyrights, trademarks, patents, and designs.

These types of IPR must be registered with the appropriate Chinese agencies and authorities to be enforceable in China. To protect their IPR, most FIEs adopt measures to proactively search the internet for violations, in addition to sending staff to corporate functions and trade fairs. Companies can also apply to Chinese customs to have them monitor their trademarks and contact them if any violation is discovered.

How to open a bank account?

Once obtaining a business license in China, the newly established FIE must choose a specific bank to open the bank account, without which the entity will not be able to carry out its daily operation.

When opening a Foreign-Invested Enterprise in China, there will be a need to establish at minimum two bank accounts:

  • RMB Basic Account and
  • Foreign Currency Capital Contribution Account.

Foreign investors can establish the above accounts in China through international banks with a local presence, or through a local Chinese banking institution.

Gain more insights about these considerations in this section.

How to close a business?

Foreign investors may decide to close their business in China for multiple reasons, such as inability to compete with domestic rivals, a real or perceived slowdown in specific sectors, shifts in consumer behavior, rising costs of doing business, impact of geopolitical developments like recent trade tensions with the US or black swan events like the coronavirus pandemic, or local regulatory changes, such as new environmental compliances.

A combination of these factors may account for the decline of an enterprise’s financial viability, market presence, and appeal. This may result in terminal financial difficulties, bankruptcy, a reorganization or merger, relocation, or a change in strategy from the overseas parent company. In such situations, closing business operations and leaving the country may be in the best interest of the organization.

To legally close a business in China, the investors need to go through a series of procedures to liquidate and deregister the company, which involves dealing with multiple government agencies, including the respective industrial and commercial bureaus, market regulatory bureaus, tax departments, and banking authorities.

In this section, we provide a step-by-step guide to closing a business in China.

How to do business without an entity?

Setting up a company in China generally requires months to complete. During that period, the intended company is not operational, and the venture can require tens of thousands of dollars in running costs and investment capital before the business, financial, consumer, or local culture landscape in the foreign market is ever understood by the investing company.

Such a fixed market entry strategy might result in mistakes made, such as: choosing the wrong pricing model, launching the wrong initial service line or product, setting up in the wrong location, pursuing a misguided business model, or selecting the wrong business partners or suppliers to work with. Selecting well-known first tier cities or jumping onto the promise of opportunities in tier 2, 3, and 4 cities, may not prove to have been the best choice.

It is easy to make avoidable mistakes in the absence of on-the-ground information and practical experience in the market. Yet reversing strategies when investments have been made is more costly, time-consuming, and can even adversely affect the business’ reputation.

Given these considerations, an increasing number of firms today may find it better to first test out or target a smaller or shorter-term presence in China. Fortunately, a lesser-known model for businesses to hedge against the risks of market entry exists and is available across several Asian markets.

[tips title="Did You Know"]As an alternative, a new market entry model called Global Staffing enables foreign investors to do business in China for short-term durations without having a legal entity of their own.[/tips]

Find out more about how to do business in China without an entity.

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