JOINT VENTURES AND
WHOLLY OWNED ENTERPRISES IN CHINA
FOREIGN INVESTMENT ENTERPRISES IN CHINA
A. SINO-FOREIGN EQUITY JOINT VENTURE ("EJV")
1.1 EJV’s have been a very popular form of foreign investment in China for over 2 decades since the promulgation of the Law of the People's Republic of China on Sino-foreign Equity Joint Ventures in 1979 (amended respectively in 1990 and 2001) and its implementation regulations in 1983 (amended respectively in 1986, 1987 and 2001) (collectively the "EJV Law"). One reason why many foreign parties favor EJV’s is that the published Chinese laws and practices in this area are much more comprehensive, extensive and established than those of the other forms of investment.
1.2 An approved EJV is deemed to be a legal person under the EJV Law, and the parties' liability is therefore limited to amounts of their respective capital contributions in the registered capital of the EJV.
2 APPROVAL REQUIREMENTS AND LIMITATIONS
2.1 Establishment of EJV’s in China must, in each case, be approved by the Chinese relevant authorities. This usually means China's State Development and Reform Commission ("SDRC") (formerly State Development Planning Commission) and Ministry of Commerce ("MOFCOM") (formerly Ministry of Foreign Trade and Economic Co-operation ("MOFTEC")), or MOFCOM's local or designated bodies
This memorandum outlines the 3 forms of foreign investment that are currently most commonly adopted by foreign investors in China, namely:
1. Sino-foreign Equity Joint Venture;
2. Sino-foreign Co-operative Joint Venture; and
3. Wholly Foreign-Owned Enterprise.
(individually a "FIE", and collectively "FIE’s")
It is only intended as a general introduction to foreign investment enterprises, and should not be relied on in substitution for specific legal advice. In particular local rules and regulations may be applicable which are not considered here.
2.2 Under the Provisions on Direction Guide to Foreign Investment which was issued by China's State Development Planning Commission (SDRC since March 2003), MOFTEC (MOFCOM since March 2003) and the State Economic and Trade Commission (which was abolished and merged into MOFCOM in March 2003) on 11 February 2002 and took effect on 1 April 2002 (the "Direction Guide"), foreign-funded projects in China are divided into those that are (1) encouraged, (2) restricted and (3) prohibited. Foreign-funded projects which are (1) encouraged, (2) restricted and (3) prohibited are listed in the Guiding Catalogue of Industries for Foreign Investment attached to the Direction Guide which was revised by SDRC and MOFCOM on 30 November 2004 and took effect on 1 January 2005 (the "Guiding Catalogue"). Those projects which are not listed in the Guiding Catalogue are permitted.
2.3 The Guiding Catalogue also imposes certain mandatory maximum percentages on foreign parties' capital contributions in certain projects.
2.4 An important issue is whether central examination and approval are required for foreign-funded projects. Provincial authorities, autonomous regions, municipalities directly under the State Council or enjoying a status with separate planning as a province are generally delegated by MOFCOM to approve projects which are (1) encouraged (2) permitted or (3) restricted, each with a total investment of less than US$30,000,000.
2.5 Generally, project proposals and Feasibility Study Reports for EJVs with total investment exceeding the above thresholds must be examined and approved by SDRC while the Joint Venture Contracts and Articles of Association must be examined and approved by MOFCOM. Further, depending on the nature of the EJV and/or its products or services, MOFCOM and/or certain specialized approval(s) can be required regardless of any monetary thresholds.
2.6 Obtaining the required approvals can take up to three (3) months in certain cases, but often can be accomplished within one (1) month. In any event, within one (1) month of approval, an EJV must register with the local branch of the State Administration for Industry and Commerce (the "SAIC") and will then be issued a business license.
3 NEGOTIATION AND DOCUMENTATION
3.1 While foreign parties often are introduced to potential Chinese partners in connection with other business dealings with them or through "middlemen", it is generally considered to be important for independent "due diligence" to be undertaken in order to ascertain the ability and trustworthiness of any given partner. There are Chinese and foreign organizations which can help foreign parties to identify potential EJV partners in China.
3.2 Normally, the foreign and Chinese parties enter into a non-binding Letter of Intent with regard to a proposed EJV as a preliminary to a formal contract. It is usually advisable to have as much detail as possible in the Letter of Intent. This is not only to prevent misunderstandings between the parties in the course of negotiating the formal contract, but also to provide allowance for later variation in other project documentation.
3.3 A written Feasibility Study Report of the proposed project, which is required to be submitted to the Approval Authorities along with the Joint Venture Contract, is usually the next step. While this document is usually not binding, it should nevertheless be given sufficient consideration by both parties from a practical point of view.
3.4 In addition to the usual market, supply, production, engineering, labor, environmental and other considerations, certain foreign currency concerns (some of which are unique to doing business in China, as described below) should be carefully addressed in the Feasibility Study Report.
3.5 The Joint Venture Contract contains the agreement between the parties on the fundamental aspect of the EJV, including purpose and scope of business, total amount of investment and registered capital, main production equipment and technology to be adopted, capital contributions, the respective obligations of the parties, decision making and management, finance, accounting and taxation, labor, term, termination and liquidation, as well as dispute resolution.
3.6 MOFCOM has issued a sample joint venture contract. Although this still forms the backbone of many contracts entered into today it does not cover many important issues which should be included in a joint venture contract in order to protect the interests of the foreign party.
3.7 It is important that the parties reach agreement early on the specific products to be produced or services to be rendered by the EJV (and exactly how this will be done) to avoid unnecessary expense as well as unrealizable expectations on both sides.
3.8 While production-oriented EJV’s are encouraged under Chinese policies and rules, approval for service-oriented EJV’s can be obtained as well. Foreign Trade EJV’s and Commercial (including retail and wholesale) EJV’s are, however, permitted to be established (subject to fulfillment of various stringent requirements and central government approvals) in a limited number of pilot test areas.
3.9 Registered capital (a concept akin to equity) can generally take the form of cash, machinery, land or intangible property. However, the Approval Authorities will usually not allow a party's technology contribution to comprise more than 20% of an EJV's registered capital (see paragraph 3.15 below). There are also particular concerns with regard to the valuation of in-kind contributions as well as the exchange of any foreign currency contributed as capital into Renminbi. The investment of the foreign party to a EJV generally must not be less than 25% of the registered capital of the EJV.
3.10 SAIC and MOFCOM regulations provide that the joint venture contract should include specific capital contribution schedules. Where the subscription is a single full payment, the parties generally have 6 months from issuance of the EJV's business license to make the payment. In the case of subscription by installments, they have a maximum of 90 days to contribute at least 15% of their respective capital contributions where they are to be provided by way of installments. SAIC has also stipulated mandatory ratios between the total investment and the registered capital which must be complied with by all EJV’s. The ratios between registered capital and total investment are as follows:
Total Investment (US$)
at least 70%
at least 50%
(N.B. if total investment is less than US$4,200,000, registered capital should be at least US$2,100,000)
at least 40%
(N.B. if total investment is less than US$12,500,000, registered capital should be at least US$5,000,000)
at least 33.3%
(N.B. if total investment is less than US$36,000,000, registered capital should be at least US$12,000,000)
3.11 Where capital is subscribed in installments, SAIC may issue a business license to a joint venture with an effective period corresponding to the verification report for each installment of capital contribution. SAIC will not issue the final business license to a joint venture unless and until it receives the verification report evidencing the payment of the last installment of contributions by both parties. The maximum time limits for making capital contributions to EJV’s by installments are as follows:
Registered Capital (US$)
Total Contribution to be made within the following time limits from date of issuance of Business License of EJV
>500,000 & ≤ 1,000,000
>1,000,000 & ≤ 3, 000,000
>3,000,000 & ≤ 10,000,000
To be considered on a case by case basis
3.12 Given currency fluctuations and other variables in China, the valuation of the parties' respective capital contributions can be difficult. For these and other reasons, it is generally advisable that the parties use United States dollars (or another acceptable hard currency) as the denominating currency for capital contributions.
3.13 As a matter of policy and of negotiation, the Chinese party generally attempts to obtain relatively free use of the foreign party's latest and best technology (on an ongoing basis), as well as the ultimate transfer of the same to the EJV. In addition, there are detailed laws and rules which apply to technology import contracts (as well as additional tax holidays which apply to certain technologically-advanced enterprises).
3.14 The proprietary rights of the foreign party in any technology should be protected to the maximum extent possible, both by contract and by registration in China of the applicable intellectual property rights.
3.15 Care should be taken so that training and other costs which can be incurred in connection with implementing the technology transfer or license are carefully limited by contract.
3.16 Under China's revised foreign enterprise tax regime, royalties remitted by an EJV from China are generally subject to a 10% withholding tax.
3.17 Many of the same concerns outlined above with regard to technology transfer or license also apply to transfers or licenses of patents, copyrights, trademarks and other forms of intellectual property.
3.18 As the tax treatment of an EJV bears heavily on the profits the foreign party can obtain from its investment, issue of any tax treatment should be clarified by the parties and the relevant authorities early. As is the case with many other required approvals in China, it is often important that confirmation of tax treatment be done at the highest possible approval level.
3.19 There are government regulations applicable to the accounting policies and practices of foreign investment enterprises. The accounting principles and practices to be adopted by the EJV may need to be considered carefully by the foreign party.
3.20 Land use rights are often of fundamental importance to an EJV. Land use rights can be acquired by FIE’s. If the Chinese joint venture partner has the right to do so, it may contribute the right to use the required land as capital contribution, or lease it, to the EJV. The EJV can also acquire land use rights by way of a grant from the relevant local competent government authorities in charge of land.
3.21 EJV’s are generally free to export (and set the related prices for their products) through the foreign party's distribution network, by themselves, or through a Chinese entity authorized to do so. It is usually preferable that the export arrangement be an exclusive one with the foreign party. If not, sales by the EJV outside the foreign party's international sales channels may negatively affect the foreign party's worldwide markets and reputation. Please note that certain tax and customs advantages apply to EJV’s which export more than 70% of their production.
3.22 Subject to paragraph 3.21 above and to certain other restrictions, products produced by an EJV can be sold within China.
3.23 As with many matters, concerns with regard to distribution can obviously be lessened with the foreign party controlling the Board of Directors of the EJV.
3.24 For quality control and other reasons, foreign parties often seek to lock-up sourcing channels for certain raw materials and equipment to be supplied to the EJV from outside China. Again, control of the EJV's Board by the foreign party helps to ameliorate many concerns here. With regard to capital equipment, the related contracts are often quite detailed. Among other issues, pre and post shipment inspections by the Chinese party and/or governmental authorities may be required.
3.25 Resolution of disputes under the Joint Venture Contract and the other related agreements is usually conducted through consultation or conciliation first and then, if that is unsuccessful, through arbitration or the courts. The Chinese party will often allow contracts to provide that arbitration may take place outside China (e.g. Sweden and Switzerland are often venues acceptable to the Chinese).
4 APPROVAL AUTHORITIES
4.1 It is important that the appropriate level(s) of governmental approval(s) for a given project be determined in its early stages. In this connection, it can be helpful for appropriately high-level officials to get involved early in the negotiation of an EJV. While they can often be tougher negotiators than the principals, their presence helps to provide some assurance that the relevant Approval Authorities will not seek to impose additional terms at the approval stage (which is sometimes encouraged by the Chinese partner in order to obtain further concessions from the foreign party). In any event, officials at some levels will almost always be involved in many stages of the negotiation process. There have been instances where a practice or contractual provision which was wholly or partly unlawful had been approved by a low level authority and was later called into question.
5 BANK ACCOUNTS AND FINANCING
5.1 Having obtained a business license, EJV’s are required to open Renminbi account(s) and foreign exchange account(s) with bank(s) in China. If an EJV wants to open a foreign exchange account with an overseas bank or one in Hong Kong or Macao, it must obtain permission from China’s State Administration for Foreign Exchange (the "SAFE") or one of its branches and report to SAFE or one of its branches its foreign exchange receipts and expenditures, and provide accounting records.
5.2 EJV’s are generally permitted to apply for and obtain Renminbi and foreign exchange loan(s) from financial institutions in China and also to borrow foreign exchange loan(s) from banks abroad or in Hong Kong or Macao to meet their working capital and other financial needs above and beyond their registered capital amounts. In this connection, a Joint Venture Contract should provide for a total investment amount appropriately greater than the amount of total registered capital.
6.1 The after tax (where applicable) net profits of an EJV, following deduction of amounts for the reserve fund, the employee incentive and welfare fund and the enterprise expansion fund (collectively the "Three Funds") in accordance with the EJV law, may be retained by the EJV for expansion and/or further investment or distributed to the parties in proportion to their capital contributions.
6.2 In the event that the parties to an EJV are to contribute their respective capital contributions by installments, the EJV may distribute, after deducting the amounts for the Three Funds and even prior to the completion of the capital contributions of the parties to the EJV, its after tax net profit in proportion to the actual capital contributions of the parties as at the end of the fiscal year.
7.1 The highest authority of an EJV is its Board of Directors. Day-to-day management is carried out by the General Manager and Deputy General Manager, among others. Board members are appointed by the parties to the EJV, usually for four-year terms. The Chairman (who is also the legal representative of an EJV) can be appointed by either party and, in any case, the Vice-Chairman is appointed by the party which does not appoint the Chairman. In any event, the Board must have at least three members and the proportional representation of the parties generally relates to their respective capital contributions.
7.2 The Board of Directors is required to meet at least once a year and members can generally attend meetings in person or by proxy. While majority voting is the norm, two-thirds (2/3) of the Directors are required for a quorum under the EJV Law. According to the EJV Law, four fundamental decisions must be made unanimously (including (1) amendments to the Articles of Association, (2) termination and dissolution of the EJV, (3) the increase or reduction of the registered capital of the EJV and (4) merger or division of the EJV). Other matters can be designated in the Joint Venture Contract and Article of Association as decisions requiring unanimous or super-majority approval which obviously can be a good idea in a case where the foreign party does not control the Board.
8 FOREIGN EXCHANGE
8.1 An EJV is required to attend to the formalities of foreign exchange registration with the local branch of SAFE within 30 days of acquiring its business license. After acquiring the Foreign Exchange Registration Certificate and the Notice for Opening Accounts from SAFE, an EJV is then able to apply for its foreign exchange accounts with designated foreign exchange banks. EJV’s may open different accounts according to its different funding sources (such as current account(s), capital account(s), and external debt account). EJV’s may also make international payments and transfers of a recurring nature without foreign exchange restrictions.
8.2 All EJV’s must produce to SAFE an annual foreign exchange report prepared by a registered accounting firm authorized by SAFE by 31st March of the following year, and have its Foreign Exchange Registration Certificate stamped by SAFE by 30th April. This report gives SAFE sufficient information concerning the compliance of all EJV’s with their contractual obligations and with the foreign exchange control regulations.
9.1 Under the applicable laws, an EJV may hire staff and workers locally or employ personnel recommended by the local labor authority (in either case, pursuant to either a collective labor contract with the trade union or individual employment contracts). While EJV’s have the legal authority to discipline and/or to dismiss employees, in practice, it is sometimes difficult to do so when, for example, the employees are present or former employees of the Chinese partner.
9.2 Unless a local exception applies, EJV’s must contribute to the unemployment insurance and other medical, social welfare, housing and other subsidies typically accorded to employees in Chinese enterprises.
9.3 EJV employees have the right to establish a labor union and a union representative may attend certain Board of Directors' meetings (such representative has no right to vote though). The labor union is entitled to have support from the EJV, including the provision of office space and facilities and other help with cultural, educational, athletic and other social activities. Finally, 2% of the total monthly wages of the staff and workers must be contributed by the EJV’s to a labor union fund. In practice to date, however, not too many EJV’s have actually been unionized.
10 TERM AND TERMINATION
10.1 EJV’s falling within the category of the investment projects encouraged and permitted by the State, may or may not stipulate the term in the Joint Venture Contract, save for certain exceptions which require EJV’s engaging in certain business to have a fixed term. EJV’s falling within the restricted category under the Guiding Catalogue must have an agreed operational term.
10.2 When a term is fixed, however, the usual maximum is 30 years, with 50 years possible in certain circumstances with appropriate approval(s). A fixed term may be extended near its end if the EJV parties so agree, subject to government approval. Applications for extension of the term must be submitted to the original Approval Authorities 6 months prior to the expiry of the term.
10.3 Early dissolution of an EJV is permitted if it is unable to continue its operations due to heavy losses, a breach of contract by one of the parties (in which case, damages usually can be imposed under the Joint Venture Contract) or upon an event of force majeure. In addition, an EJV can be terminated if it is unable to attain its business purpose, or, generally, as otherwise may be provided in its Joint Venture Contract (and/or Articles of Association).
10.4 Upon termination of an EJV, its Board of Directors usually forms a liquidation committee to take inventory of the EJV's assets and liabilities and to prepare a liquidation plan (which, in any event, is subject to Board verification and implementation under the supervision of the relevant State department). When the debts of the EJV have been settled, remaining assets may be distributed to the parties in proportion to their capital contributions (or as otherwise specified in the Joint Venture Contract or Articles of Association). Valuation and exit mechanism can be important. Accordingly, they should be clearly set out in the Joint Venture Contract. Among other things, if the net assets amount or remaining assets (after deducting the undistributed profits, the Three Funds and other funds and the liquidation expenses etc.) exceed the actually paid-up capital, the difference is taxable.
11.1 EJV’s are subject to a flat income tax rate of 33%, which is made up of a national tax rate of 30% and a local income tax rate of 3%.
11.2 All EJV’s engaged in production and scheduled to operate for a term of 10 years or more are entitled to a two-year national income tax exemption, commencing from the first profit-making year, followed by a three-year 50% reduction in income tax.
11.3 Further reduction and exemption periods are available to EJV’s engaged in agriculture or forestry, or established in remote economically underdeveloped areas. EJV’s are also subject to the other taxes including but not limited to Value-Added Tax, Consumption Tax, Business Tax, Customs Duties, Import Taxes, Stamp Tax and, depending upon the type of venture, the Urban Real Estate Tax and the Vehicle and Vessel License Tax (where applicable).
B. SINO-FOREIGN COOPERATIVE JOINT VENTURE ("CJV")
1.1 CJV’s have been considered the preferred vehicle for joint construction and management of hotels and commercial complexes and the provision of offshore oilfield services.
1.2 Unlike an EJV, a CJV may or may not be a separate legal entity with limited liability. Before the promulgation of the Law of the People's Republic of China on Sino-foreign Co-operative Enterprises (the "CJV Law") in 1988 (which was subsequently amended on 31 October 2000), CJV’s had taken one of the following two forms.
1.3 One form did not create a separate legal entity that was distinct from the contracting parties. The parties were in partnership and were responsible for making their own contributions to the CJV, paying their own taxes on profits derived from the CJV and bearing their own liabilities for risks and losses in respect of their respective involvement in the CJV. This arrangement worked as a true CJV because the parties' rights, liabilities, risks, responsibilities and obligations were clearly stipulated in the Joint Venture Contract between the parties.
1.4 The other form was a hybrid combining the features of both the true CJV and the EJV in that a separate legal entity was established and registered and the parties' liabilities were generally limited to their capital contributions.
1.5 The CJV Law recognized the distinction between these two types of CJV’s, and both types of CJV may continue to be established in China.
1.6 In September 1995, MOFCOM promulgated the Detailed Rules for the Implementation of the Law of the People’s Republic of China on Sino-foreign Cooperative Enterprises (the "CJV Implementation Rules"), which confirm and standardize most of the current legal requirements applied to CJV’s in practice.
1.7 The CJV Implementation Rules confirm that a CJV can either be an enterprise with Chinese legal person status or an enterprise without Chinese legal person status. A CJV which has acquired Chinese legal person status in accordance with the law is a limited liability company. Unless the CJV Contract stipulates otherwise, each party to the CJV will assume an amount of liability towards the CJV equivalent to the amount of investment contributed or cooperation terms provided by the party.
1.8 The CJV Implementation Rules provide that a CJV without legal person status and the joint venture parties will assume civil liability in accordance with the relevant provisions of the civil law of China. It is however not clear as to whether the provisions governing "joint operation" in the General Principles of Civil Law of the People’s Republic of China will apply as the same reveal nothing specifically on the questions of the liabilities and legal nature of a CJV without legal person status.
2 CAPITAL CONTRIBUTIONS
2.1 The investment or cooperation terms contributed by the parties to a CJV may be in the form of cash and may also be in kind, industrial property rights, proprietary technology, land use rights and other property rights.
2.2 The investment of the foreign party to a CJV with Chinese legal person status generally must not be less than 25% of the registered capital of the CJV.
2.3 For a CJV without legal person status, the specific requirements for investment or cooperation terms to be contributed by the parties to the CJV will be stipulated by MOFCOM.
2.4 The assets or cooperation terms to be contributed by the parties to a CJV must be owned by the parties free of encumbrances. In the event that the investment or cooperation terms to be contributed by the Chinese party are State assets, the valuation of such assets will be conducted in accordance with the provisions of the relevant laws and statutory regulations.
2.5 The parties’ contributions must be verified and evaluated by a Chinese registered certified public accountant. A CJV without legal person status will also have to register the investment or cooperation terms contributed by the parties to the CJV with the local SAIC. Any transfer of the interests and rights and in the CJV by a party is subject to the written consent of the other party(ies) the approval of the original Approval Authority.
2.6 Unlike the case of an EJV, the foreign party may enjoy priority in recovering its investment prior to the expiration of the term of a CJV, but only if the Joint Venture Contract provides that ownership of all the assets of the CJV shall automatically pass (without compensation to the foreign party) to the Chinese party upon expiration of the term of the CJV. The foreign party may apply to recover its investment during the term of the CJV in the following ways:-
2.6.1 The inclusion of provisions in the Joint Venture Contract for the increase of the proportion of profits to be distributed to the foreign party;
2.6.2 The recovery of the investment of the foreign party prior to payment of income tax by the CJV following the examination and approval by the finance and tax authorities in accordance with the relevant regulations; and
2.6.3 Other means of recovery of the investment of the foreign party approved by the finance and tax authorities as well as the Approval Authorities.
2.7 Where the foreign party recovers its investment according to the above methods, both the Chinese and foreign parties will still have to bear the liabilities of the CJV in accordance with the relevant laws and the Joint Venture Contract.
3 MANAGEMENT AND OPERATION
3.1 A CJV can either have a Board of Directors or a Joint Management Committee. A CJV without legal person status must establish a Joint Management Committee. The authority of the CJV is its Board of Directors or Joint Management Committee which is empowered to make decisions on major matters of the CJV in accordance with the Articles of Association of the CJV.
3.2 According to the CJV Implementation Rules, decisions in respect of the following matters must be made unanimously by all the directors or committee members present at the meeting of the Board of Directors or Joint Management Committee:-
3.2.1 Amendment(s) to the Articles of Association of the CJV;
3.2.2 Increase or reduction of the registered capital of the CJV;
3.2.3 Dissolution of the CJV;
3.2.4 The grant of a mortgage over any asset of the CJV;
3.2.5 Any merger, division and restructuring of the CJV; and
3.2.6 Other matters which the parties to the CJV have stipulated as requiring unanimous approval of the Board of Directors or the Joint Management Committee.
3.3 A Board of Directors or Joint Management Committee will consist of not less than 3 members. The membership and representation of the parties may be decided by agreement between the parties with reference to their respective investment or cooperation terms in the CJV.
3.4 The term of office for members of the Board of Directors or the Joint Management Committee may be stipulated by Articles of Association but may not exceed 3 years. All CJV’s are required to designate a general manager to be responsible for the daily management of the CJV’s operation.
3.5 Subject to the unanimous consent of the Board of Directors or Joint Management Committee and the approval of the Approval Authorities, a CJV can also delegate its management to a third party.
4 FOREIGN EXCHANGE, LABOR AND LAND
4.1 CJV’s are generally subject to the same foreign exchange rules as those governing EJV’s.
4.2 Matters relating to employees of a CJV may be handled as per the rules applicable to FIE’s.
4.3 CJV’s may obtain their right(s) to use land and/or factory buildings in accordance with those rules and procedures applicable to EJVs.
5 ACCOUNTING AND DISTRIBUTION OF PROFITS
5.1 The accounting matters of a CJV may generally be subject to the rules applied to EJV’s. The accounting of the foreign party's share of the profits of a CJV is also subject to the provisions in the Income Tax Law of the People's Republic of China for Enterprises with Foreign Investment and Foreign Enterprises and its Implementation Rules.
5.2 Distribution of profits of a CJV may be agreed at a ratio which is different from the ratio of the parties' capital contributions and this makes CJV’s much more flexible than EJV’s as profit-sharing between the parties is not necessarily tied to the value of their respective capital contributions.
5.3 The foreign party is also permitted to recover its investment from pre-tax income which means that the foreign party may provide for recovery of its investment from pre-tax cash flow freed up by depreciation (see paragraph 2.6.2 above). CJV’s with legal person status are, however, required to allocate funds to a reserve fund, an enterprise expansion fund and an incentive and welfare fund for staff and workers as in the case of an EJV.
6 TERM AND TERMINATION
6.1 The term of a CJV may be decided by agreement between the parties and must be stipulated in the Joint Venture Contract. CJV’s with legal person status are essentially subject to the same restrictions as those applicable to EJV’s.
6.2 The term of a CJV may be extended. Where the foreign party to a CJV has already recovered all of its investment or cooperation terms from the CJV during its term, the term of the CJV may however not be extended without the unanimous consent of all the parties to the CJV and the agreement of the foreign party to contribute new investment or provide cooperation terms to the CJV. An application for extension must then be made to the Approval Authorities 180 days prior to the expiry of the term of the CJV.
C. WHOLLY FOREIGN OWNED ENTERPRISE ("WFOE")
1.1 Unlike a joint venture enterprise, a WFOE offers a higher degree of independence for a foreign investor who needs not look for or accommodate the wishes and business objectives of a Chinese counterpart and thus avoids the difficulties that may arise as a result of being in "partnership".
1.2 Due to the fact that the foreign investors need not negotiate with a mainland Chinese party with respect to enterprise matters such as the scope of operation, number of workers and distribution arrangements, a WFOE may be simple to establish compared to joint ventures. Under the relevant Chinese law, foreign parties may do their own research, decide what they want in China (within certain guidelines) and then file the application for the establishment of the WFOE.
1.3 Subject to compliance with the appropriate prerequisites and the approval of the competent approval authorities which are provided in the Law on the People’s Republic of China on Wholly Foreign Owned Enterprises promulgated on 12 April 1986 and amended on 31 October 2000 and its implementation rules promulgated on 12 December 1990 and amended on 12 April 2001 (collectively "WFOE Law"), a WFOE can be organized as a limited liability company. Other forms of liability structure are also permitted in principle under the relevant Chinese law but are not specified.
2 APPROVAL FOR ESTABLISHMENT
2.1 The Approval Authorities have the authority to review applications for the establishment of WFOE’s. Local governments may approve WFOE’s in certain circumstances. The relevant Chinese laws, rules and regulations however provide that an application for establishment of a WFOE may be approved locally only when the State will not be required to allocate raw materials and where supplies of energy, communications, transportation, foreign trade export quotas, and other planned economic allocations are not unduly affected. All approvals for establishment of WFOE’s must be reported to MOFCOM.
3 INITIAL CONTACTS, PROJECT PROPOSAL AND FEASIBILITY STUDY
3.1 Before submitting formal application for the establishment of a WFOE, foreign investors are usually required to provide the Approval Authorities with a report on matters, including but not limited to, the purpose and aims of the WFOE, scope and scale of operation, products to be manufactured, technology and equipment to be used, area of land to be used and land requirements, conditions and amounts in relation to water, electricity, coal, gas and other fuel requirements and public utility requirements.
3.2 Please note that such a report is not a preliminary project approval report. Instead, the report proposing to establish the WFOE is a report advising the Approval Authorities of the WFOE's requirement in terms of whether or not facilities, for instance, land, water, electricity, gas and communications, need to be provided.
3.3 Within 30 days of receipt of the report (as referred to in paragraphs 3.1 and 3.2 above), the Approval Authorities will give a written response as to whether it is able to satisfy the requirements as set out in the report and give its response as to whether the investment may be considered as likely to harm China's sovereignty or public interest, to jeopardize China's national security, to violate any of China's laws and regulations, to interfere with the Chinese government's program for the development of China's national economy, or to cause environmental pollution and whether, based on the information as set out in the report, the WFOE has attained the pre-requisites for its establishment.
3.4 Upon receipt of an affirmative written response, foreign investors may submit a formal application to the Approval Authorities together with the following documents:
3.4.1 Written Response of the Approval Authorities in respect of the WFOE;
3.4.2 Application Form for the establishment of the WFOE;
3.4.3 Articles of Association of the WFOE;
3.4.5 Feasibility Study Report;
3.4.6 If more than 1 investor jointly applies for the establishment of the WFOE, a copy of the contract among the joint investors must be filed with the Approval Authorities;
3.4.7 List of legal representatives and proof of identities of legal representatives; or list of candidates for membership of the Board of Directors and letters of appointment of the Directors;
3.4.8 Testimony of the legal certification and credit standing of the investor, including but not limited to, the foreign investor's certificate of registration of its status as a legal person, list of members of Board of Directors of the foreign investor, credentials of the legal representative(s) of the investor, and its balance sheets and/or profit and loss accounts of the previous 3 years;
3.4.9 Bank certificates and/or statements in respect of the foreign investor's credit standing;
3.4.10 Report on environment impact, that is, the environmental pollution likely to be caused and the combative measures. In this connection, if the foreign investor can prove to the Approval Authorities that its products will not cause environmental pollution in the locality and/or the production process of the products will reduce the degree of environmental pollution in the locality, it will enhance its chance of getting approval from the Approval Authorities even though the proposed WFOE will mainly engage in domestic sales of its products in China;
3.4.11 Proof of likelihood of acquisition of factory premises or site for the WFOE;
3.4.12 Detailed list of goods, materials and equipment required to be imported;
3.4.13 Report on infrastructure, provision of capital, energy, raw materials and measures to resolve these issues; and
3.4.14 Other necessary documents that are required to be submitted.
3.5 Although the Approval Authorities must decide whether to approve or disapprove the application within 90 days from the date of receipt of all of the documents required to accompany the application, the Approval Authorities may request additional documents and thereby extend the ninety-day period.
4.1 Within 30 days of the date of receipt of the approval documents issued by the Approval Authorities, the foreign investor must applied to the local office of SAIC for registration and obtain a business license. The date of issuance of the business license is the date of establishment of the WFOE. The approval certificate of the Approval Authorities becomes null and void if the registration with the local office of the SAIC is not effected within 30 days of the date of issuance of the approval certificate.
4.2 The relevant Chinese laws and regulations also specify that a WFOE is required to register with the tax authorities within 30 days of the date of issue of the business license.
5 FORMS OF CAPITAL CONTRIBUTION
5.1 As is in the case with an EJV, capital may be contributed in the form of foreign currency, machinery, equipment, industrial property, proprietary technology, and, on approval, Renminbi.
5.2 Please note that where machinery and equipment are contributed, they must be necessary for use in the proposed business of the WFOE. Valuation must be consistent with the international market value of similar equipment. A detailed description of the machinery and equipment for contribution must be submitted along with the application for the establishment of the WFOE.
5.3 Where industrial property and proprietary technology are contributed, they must be owned by the foreign investor itself. Valuation of the industrial property and proprietary technology must be consistent with international principles. This form of contribution may not exceed 20% of the registered capital of the WFOE.
5.4 Industrial property and proprietary technology must be accompanied by certificates of proof of ownership and validity, together with information on technical performance and practical value. The basis and standard used for valuation must be specified, along with any other information requested by the Approval Authorities. This information must also be included with the application for the establishment of the WFOE.
6 TOTAL INVESTMENT AND REGISTERED CAPITAL
6.1 The total investment of a WFOE is defined as the total amount of funds required to set up the WFOE and equal to the sum of the infrastructure funds and production circulating funds required according to the WFOE’s production scale.
6.2 The registered capital of a WFOE refers to the total amount of capital registered with SAIC for establishing the WFOE, namely, the total amount of capital subscribed by the foreign investor as distinguished from moneys borrowed or otherwise raised.
6.3 Registered capital may not be reduced, but if due to changes in the total investment and the scale of production, and it really needs to be reduced, the WFOE must obtain the approval of the Approval Authorities. Registered capital may be increased upon approval by the Approval Authorities. Any such change must be registered with the local office of SAIC. Mortgages or assignments of property by a WFOE must also be approved by the Approval Authorities and reported to the local office of SAIC. The ratio between registered capital and total investment must conform to the relevant Chinese regulations, as set out in paragraph A. 3.9 above.
7 INSTALMENTS OF CAPITAL CONTRIBUTIONS
7.1 When capital is contributed by installments, the final installment must be made within 3 years of the issuance of the business license. The first installment must be in an amount of not less than 15% of the total contributed capital and be contributed within 90 days from the date of issuance of the business license.
7.2 Failure to contribute in full the first installment of capital within the statutory time limit will render the approval certificate null and void. The registration with the local office of SAIC must then be cancelled and the business license be returned. After making the first installment, the foreign investor must make the remaining installments of contribution strictly as scheduled. An extension of time may however be requested for a legitimate reason and, if granted by the Approval Authorities, must be reported to the local office of SAIC.
8 ACCOUNTS, FOREIGN EXCHANGE, TAXATION
8.1 A WFOE must establish an accounting system in accordance with the Chinese laws and regulations and the procedures of the Chinese financial authorities. The system must be reported for approval to the financial and taxation authorities at the place where the WFOE is located.
8.2 The relevant Chinese laws provide that the foreign investor has the right to remit profits abroad. It is however required to allocate a reserve fund of at least 10% of the after-tax profits up to a cumulative amount equal to 50% of its registered capital. Allocations to a bonus and welfare fund for employees may be determined by the WFOE itself in coordination with its labor union.
8.3 Furthermore, profits may not be distributed until losses from the preceding years have been made up. Retained profit from previous years may be distributed together with the distributable profits of a subsequent financial year.
8.4 Foreign exchange must be kept in an account with an approved bank in China, thereby enabling or permitting the bank to supervise payments into and out of the account. Special approval must be obtained from the exchange control authorities in order to open foreign exchange account with a bank outside of China. Where such approval is given, detailed reports of the activities of such accounts are required to be filed.
8.5 A WFOE is required to pay taxes in accordance with the relevant tax regulations. Tax holidays and exemptions and reductions from taxes and customs duties similar to those available to EJV’s are also applicable to WFOE’s, although generally on a more limited basis.
8.6 Generally speaking, WFOE’s engaged in production and scheduled to operate for a term of 10 years or more are entitled to a two-year national income tax exemption, commencing from the first profit making year, followed by a three-year 50% tax reduction.
8.7 Further reductions and exemptions in national income tax are available to WFOE’s engaged in agriculture or forestry, or established in remote and economically underdeveloped areas.
9.1 The land used by a WFOE must be arranged with the local people's government at or above county level at the location of the WFOE. The procedures for obtaining land use rights must be carried out within 30 days of the date issuance of the business license.
9.2 A WFOE may not use land without a land use certificate, and may not assign use land rights without approval.
9.3 A land use fee must be paid to the Land Administration Bureau upon collection of the land use certificate and additional fees may also be required, such as land development fees for the use of the developed land, which may be charged as a lump sum or in annual installments. If undeveloped land is used, the WFOE may develop the land itself or entrust a Chinese unit to undertake the development.
9.4 The term of land use right granted to a WFOE must be the same as the WFOE's term of operation. There is no specific provision of extending the land use right term in case the term of the WFOE is extended, and such extensions should be negotiated on a case by case basis.
10.1 Employees of a WFOE are hired on the basis of labor contracts covering matters such as employment, dismissal, remuneration, welfare, labor protection, labor insurance and other matters required by the authorities to be contained in the employment contract.
10.2 A WFOE is responsible for business and technical training necessary to ensure sufficient production and business development.
10.3 In order to fulfill its labor needs, a WFOE may openly recruit workers within its locality or select workers recommended by the local labor bureau.
10.4 Employees of a WFOE, like the employees of EJV’s, are entitled to establish labor union and its union representative may attend the Board of Directors' meetings (such representative has no right to vote) to discuss matters such as rewards, punishment, wage systems, welfare benefits, labor protection, labor insurance and other staff and worker-related matters. A WFOE is required to consult the labor union and to obtain co-operation on such matters.
10.5 A WFOE must also allocate monthly an amount equal to 2% of total remuneration paid to staff and workers for the labor union's expenditures. The use of such funds by the labor union is governed by the All China Federation of Trade Unions' procedures for the use of labor union funds.
11 TERMINATION AND LIQUIDATION
11.1 A WFOE must have a specific term, approved by the Approval Authorities. There is no limitation under Chinese law as to how long such a term must be, although WFOE’s typically have a term of 15 to 25 years.
11.2 A WFOE may be dissolved upon the expiration of the term or when the WFOE suffers losses due to mismanagement, force majeure, or when the WFOE becomes bankrupt or is lawfully closed because of a violation of Chinese laws or regulations with the result that public interest has been harmed, or for any reasons specified in the WFOE's Articles of Association.
11.3 In case of termination due to mismanagement, force majeure or bankruptcy, the WFOE must submit a written application for termination to the Approval Authorities. The date of approval of termination is the official date of termination.
11.4 In case of termination due to expiration of the term, the WFOE suffering losses from mismanagement, force majeure, or to a reason specified in the Articles of the Association, a public announcement is required, in addition to notification of creditors, within 15 days of the date of termination. A proposal must be submitted to the Approval Authorities within 15 days of issuance of public announcement of termination, together with a statement of the procedures and principles for liquidation, the candidates for the liquidation committee and other details, all of which must be approved by the Approval Authorities prior to commencement of liquidation.
11.5 Liquidation expenses are paid out of the property owned by the WFOE with priority over other claims.
D. CHINA’S ACCESSION TO WTO
On the 11th December 2001, China became a formal member of the WTO, and the Protocol on the Accession of the People’s Republic of China provides more equitable conditions for foreign investors. China will, from time to time, amend the existing rules and formulate new laws and regulations to fulfill its commitments to the WTO. So the legal environment for foreign investors will be changed fundamentally as well as more favorably.
This memorandum is prepared on the basis of our analysis of the Chinese published statutes available to us and should therefore not be taken as a comprehensive or authoritative statement of the relevant Chinese laws in force in this area.
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