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

Comparison of Different Investment Options

Investment Options

Common Purpose(s)

Pros

Cons

 RO
  • Market research
  • Liaise with overseas headquarters
  • Easiest foreign
    investment structure to set up
  • Paves way for future investment
  • Cannot invoice locally in RMB
  • Must recruit staff from local agency; no more than four representatives
  • Heavily taxed if expenses are high

 WFOE*

  • Manufacturing Servicing Trading (if a FICE)
  • Greater freedom in business activities than RO
  • 100% ownership and management control
  • Registered capital requirement (for select industries)
  • Lengthy establishment process

JV

  • Entering industries that by law
    require a local partner
  • Leveraging a partner's existing facilities, workforce, sales/ distribution channels
  • See common purposes
  • Split profits
  • Less management control than a WFOE
  • Technology transfer/IP risks
  • Inheriting partner liabilities

FIP

  • Investment vehicle Servicing
  • Allows for domestic and foreign ownership
  • Easier setup
  • Unlimited liability of the general partner
  • Newness of structure (potential challenges with taxation or foreign currency exchange)
*Under the FIL, the terms of the WFOE Law and the JV Law are no longer binding. Nevertheless, we still use WFOE and JV to refer to relevant investment forms for consistency and easier communication
  See table: Comparison-of-Different-Investment-Options

Representative Office ("RO")

An RO is an attractive way for foreign investors to get a feel for the Chinese market as it is the easiest type of foreign investment structure to set up. Unlike more robust vehicles, such as the WFOE, an RO is an extension of the foreign company without independent legal personality. That is to say, it does not possess the capacity for civil rights and cannot independently assume civil liability. When an RO signs a contract, it is the foreign company that is bound by the agreement.

Besides, there are only a limited number of activities an RO is permitted to be engaged in. ROs are generally forbidden from engaging in any profit-seeking activities and may only be used to facilitate the activities of the foreign company in China. These are:

  • Market research, display, and publicity activities that relate to company products or services; and
  • Liaison activities that relate to product sales or services and domestic procurement and

ROs acting in violation of their allowed activities will be fined, and their illegitimate income will be confiscated.

In addition, as an RO is not a capitalized legal entity in China, it is limited in its hiring ability. An RO cannot directly hire Chinese employees. Instead, it is required to employ local staff through a qualified labor dispatch agency. The agency acts as the employer for legal purposes, and sends employees to work at the RO for a fee. An RO may directly hire up to four foreign nationals as the representatives, and these do not need to go through the agency.

Even though an RO does not earn revenue, it is still subject to Chinese tax. ROs are taxed as a permanent establishment in China, which usually amounts to a liability of approximately eight percent of the total expenses of the RO.

RO is generally a good solution for companies that are procuring from China and want to keep staff on the ground for quality control, or for maintaining short communication lines with China-based suppliers, agents, and distributors.

Wholly Foreign-Owned Enterprise ("WFOE")

A WFOE is a limited liability company wholly owned by one or more foreign investor(s), which offers a very straightforward management structure.

Unlike an RO, a WFOE can make profits and issue local invoices in RMB to its suppliers. A WFOE can employ local staff directly, without any obligations to employ the services of an employment agency. A WFOE can also expand to create subsidiaries in China.

And compared to a JV, a WFOE has better autonomy and flexibility to execute the company policies intended by the investors without considering the Chinese partner. It is also believed to be better at protecting the company’s intellectual property and technology.

However, the set-up procedure of a WFOE is more complicated. And WFOE is not feasible if the targeted sector is listed as “restrictive” in the Special Administrative Measures on Access to Foreign Investment (“National Negative List”) or the Free Trade Zone Special Administrative Measures on Access to Foreign Investment (“2020 FTZ Negative list”), where foreign investors need to have a Chinese equity partner to form the business. In other words, incorporating a WFOE to engage in these sectors would not be permitted. Investors that try to do so will see their application denied. WFOEs that engage in these activities illegally after being incorporated face fines or even the cancellation of their business license.

There are three distinct WFOE setups available:

  • Service (or consulting) WFOE;
  • Trading WFOE (or foreign invested commercial enterprise [FICE]); and
  • Manufacturing

While all three structures share the same legal identity, they differ significantly in terms of their setup procedures, costs, and the range of commercial activities in which they are allowed to engage. Trading WFOEs and manufacturing WFOEs must derive the majority of their revenue from their namesake business, but can also provide associated services. Service WFOEs are additionally permitted to conduct trading activities related to their services.

Joint Venture ("JV")

A JV is formed by one or more foreign investor(s), along with one or more Chinese party(-ties). Previously, Chinese individuals are explicitly excluded to be the shareholders in a JV with few exceptions. However, under the new FIL, which took effect from January 1, 2020, this limitation was no longer existed. Chinese individuals could jointly invest with foreign investors, which offers more flexibility in choosing business partners.

There are mainly two reasons for foreign investors to choose a JV structure:

  • The foreign investor wants to invest in a restricted industry sector, where the law permits foreign investment only via a JV with a Chinese partner; and
  • The foreign investor wants to make use of the sales channels and network of a Chinese partner who has local market knowledge and established

Before the FIL enacted, there were two types of JVs in China, and they differ primarily in terms of how profits and losses are distributed:

 1. Equity Joint Venture (EJV):

  • Profits and losses are distributed between parties in proportion to their respective equity interests in the EJV;
  • Generally, the foreign partner should hold at least 25 percent equity interest in the registered capital of the EJV; and
  • An EJV should be a limited liability

 2. Cooperative Joint Venture (CJV):

  • Profits and losses are distributed between parties in accordance with the specific provisions of the CJV contract; and
  • A CJV can be operated either as a limited liability company or as a non-legal

With the new FIL coming into force, the newly established JVs will be subject to the provisions of the Company Law, which implies changes in many aspects, such as governing structure and operating rules. However, JVs established before January 1, 2020 following the old EJV Law or CJV Law will have a five-year transitional period to arrange relevant transitions to be compliant with the new requirements.

Foreign Invested Commercial Enterprise ("FICE")

A FICE, which can be set up either as a WFOE or a JV, is a type of company for retail, franchising, or distribution operations. A WFOE or JV can be established exclusively as a FICE, or can combine FICE activities with other business activities, such as manufacturing and services.

Generally, a FICE is inexpensive to establish and can be of great assistance to foreign investors because it combines sourcing and quality control activities with purchasing and export facilities, thus providing more control and a quicker reaction time compared to sourcing exclusively via an overseas headquarters.

FICEs are also the ideal choice for foreign companies that need to source in China in order to resell to its domestic consumer market. Without a Chinese trading company, the alternative would be to buy from overseas, and have the goods shipped out of China before then reselling them back to China (which would mean additional logistical costs, customs duties, and value-added tax).

Other Entity Options

Foreign Invested Partnership ("FIP")

An often-overlooked option is the FIP, which was introduced in 2010. As the name suggests, this entity requires two or more investors to conduct business together. The option would therefore not work for foreign investors looking to set up an entity over which they have 100 percent control. In addition, foreign investors cannot engage in sectors subject to equity limitations as provided in the negative lists via an FIP.

An FIP can be newly established by foreign investors contributing to the partnership, or by acquiring the equity interests in an existing domestic partnership.

A partnership is not a separate legal entity, but a contractual arrangement between two or more parties to do business together under a common name, and is registered as such with the government. Instead of having to stay within the boundaries of the Company Law, a partnership affords investors broad freedoms to make internal arrangements as they see fit. For example, the profit shares and voting rights need not be aligned with the investor’s capital contribution.

While the Partnership Enterprise Law says that, in principle, the unanimous approval of all other partners is needed when a partner sells their share in the partnership, investors are free to stipulate otherwise in the agreement. It can therefore be much easier to transfer one’s participation in a venture this way.

In practice, FIPs sometimes are used by foreign private equity funds to manage money in China through limited partnerships.

Variable Interest Entity ("VIE")

VIE structures are adopted by many foreign investors to engage in sectors that are restricted or prohibited to foreign investment in China as provided in the negative lists, such as telecommunication and education.

Under this model, foreign investors retain final control over the China domestic operating entities through a series of contractual arrangements rather than direct shareholding. Consequently, there are risks that the investors’ control over the structure might be threatened by the intentional breach of the contractual arrangements.

In addition, the government’s attitude towards VIE structure remains vague. There is no clarification in the new FIL whether it is legitimate and whether it falls within the scope of ‘foreign investment’. However, in a recent legislative draft regarding pre-school education, VIE structure is explicitly prohibited in the sector. VIE structure could be regarded as illegal in such sectors that are not yet open to foreign investment. Moreover, some recent cases show that the SAMR is strengthening the anti-monopoly review for merger and acquisition with a VIE structure.

 

 

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