Doing business in China part 2 - establishing a business in China

Out-Law Guide | 05 Jun 2019 | 3:12 pm | 17 min. read

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.

The Foreign Investment Law, which takes effect on 1 January 2020, will eliminate some of the traditional forms of foreign-invested enterprise (FIE) in China and, with that, much of the formal distinction between foreign-invested and domestic companies. However, it is not yet clear what will replace the well-established, if onerous, old framework.

Until 2020, foreign investors wishing to establish a presence to do business within the People's Republic of China (PRC) must establish one of the several different statutory forms of FIE. Some limited business may be done in the country without a formal establishment - for example, through an agent - but an establishment will be required for any significant operations such as leasing premises, opening bank accounts, buying and selling in local currency or hiring more than a few employees.

The choice of FIE form depends on the category of the intended activity in the negative lists, as well as on the particular operational needs or objectives of the foreign investor. Forms of FIE include:

  • Wholly foreign-owned enterprise (WFOE): a limited liability company 100% owned by one or more individual or corporate foreign investors. The liability of the investors is limited to their subscribed registered capital. WFOEs are the most popular form of FIE;
  • Equity joint venture (EJV): the most common of the two types of statutory joint venture. An EJV is a legal person company invested in together by both foreign and domestic corporate investors. The equity interests of the investors, and the division of profits, is strictly proportional to their shares of contributed registered capital;
  • Cooperative joint venture (CJV): CJVs are normally established as legal person limited companies, but may also be established as a non-incorporated contractual cooperation. The liability of the partners in an unincorporated CJV is unlimited, and investors tend to have greater flexibility. Non-incorporated CJVs are typically only established for specific limited purposes and activities such as collaboration in natural resources exploration;
  • Foreign invested company limited by shares (FICLS): a joint Chinese and foreign-invested company, hence a form of joint venture (JV), limited by shares. An investor's liability is limited to its individual subscription. Companies seeking listing on the Chinese stock market must be in the form of a FICLS. A WFOE, EJV or CJV may convert to an FICLS in accordance with PRC law;
  • Foreign invested partnership enterprise (FIPE): available since 2010. Except for market access and related differences, FIPEs function under the same rules as domestic partnerships and generally much the same as partnerships in the west. Given the still fairly limited experience with this form of entity, partnerships still face many more legal, tax and administrative uncertainties relative to other, more mature forms of enterprise.

Significant changes in the Foreign Investment Law: as discussed in part 1, the Foreign Investment Law aims to complete the unification of law governing domestic and foreign enterprises. Part of the way it does this is by expressly terminating the original standalone enabling laws governing WFOEs, EJVs and CJVs and stipulating that the Company Law and Partnership Law will instead apply to all FIEs. From 2020, foreign investors will presumably be required to set up a standard LLC or FIPE under the Company Law or Partnership Law.

Like their domestic counterparts, FIEs should then only require registration with the State Administration for Market Regulation (SAMR) in the vast majority of cases where the negative list or other standard pre-approval requirement does not apply. However, there is already a vast bureaucracy dedicated to approving and registering FIEs, so it seems more likely that a whole new set of much more limited procedures will be required.

The change in the law could also create significant confusion for existing entities. This is not likely to be much of an issue for WFOEs, which are similar to standard LLCs under the Company Law. However, the tens of thousands of existing JVs simply do not fit within the Company Law framework. JVs could therefore face significant complexity while these issues are worked out.

Special types of FIEs: in addition to the different basic forms of FIE, special types of FIE also exist to carry out certain specific business activities. Some notable examples include:

  • Foreign Invested Commercial Enterprise (FICE) -  a CJV, EJV or WFOE approved to carry out domestic agency, wholesale, import-export and perhaps retail activities;
  • Foreign Invested Venture Capital Investment Enterprise (FIVCIE) - a CJV, EJV or WFOE specifically approved to undertake VC-type RMB equity investments in non-listed PRC high-tech companies, but only such companies. The limitation to high tech portfolio companies means that the FIVCIE is not a general-purpose RMB foreign-invested onshore PE/VC fund vehicle. It is however possible to establish general-purpose wholly foreign owned fund management companies;
  • Joint universities. There are generally two types of higher education JV - JV Programmes and JV Institutions. Neither of these falls under the standard rules for EJVs or CJVs. A JV Programme is a short term collaboration by contract, normally for three years. A JV Institution can be established for long term cooperation, up to 50 years, and must have a least three programmes.  JV Institutions are generally set up as dependent colleges of the Chinese partner institution, and not as independent legal persons, except in the case of a limited number of large-scale Sino-foreign joint venture universities;
  • Holding company and regional headquarters. Investors which already have major operations in the country may wish to consider applying for holding company or a regional headquarters status, to help consolidate certain group treasury, support services and trading functions. There are significant minimum investment thresholds, and operations are limited to holding company functions.

Representative offices and branches: Where more limited activities are contemplated or limited liability is not required or permitted, foreign investors may establish a representative office or branch in China:

  • Representative office (RO) - an entity that may conduct some restricted activities on behalf of a foreign parent company, but generally cannot engage in direct profit-making activities itself;
  • Foreign company branch - a branch of a foreign company is permitted to engage in direct business activities, however this is only available for certain businesses such as commercial banking and oil exploration;
  • Domestic company branch - a company already established in China may set up branches to operate its business at places different from its registered address. Such a branch does not have independent legal personality or limited liability, and its parent therefore has unlimited liability for its debts. The scope of business of a branch may not exceed that of its parent.
The Foreign Investment Law, which takes effect on 1 January 2020, will eliminate some of the traditional forms of foreign-invested enterprise (FIE) in China and, with that, much of the formal distinction between foreign-invested and domestic companies. However, it is not yet clear what will replace the well-established, if onerous, old framework.

VIE structures: China's restrictions on foreign investment in different sectors have not entirely prevented foreign investment in those sectors.

The most common way around the restrictions has been the so-called variable interest entity (VIE) structure. This is a US accounting term for a subsidiary entity that is not controlled by voting rights but is subject to contractual controls functionally equivalent to voting rights that allow the subsidiary's accounts to be consolidated with the parent.

Under a typical VIE structure the domestic business restricted to foreign investment will be carried out by a purely domestic operating company, with only PRC shareholders;  the foreign investors will set up a WFOE in a permitted sector, typically technical or management consulting; there will be a series of contracts between the WFOE, the operating company, and the operating company's shareholders, basically giving the WFOE and foreign investor the right to control and take the profits of the operating company. The structure will typically include management contracts, IP licenses, share pledges, share purchase options, nominee shareholder agreements and loan agreements. Typically the Chinese parties owning the domestic operating company will also own equity in the offshore group parent, and will also own equity in the offshore group parent, and will look to be compensated at that level.

Because the purpose and effect of the structure is to permit foreign investment in areas prohibited to foreign investment, VIE structures inhabit a grey area of PRC law. There are a number of risks to the VIE structure, and the risks are probably greater for companies that are ultimately owned by foreign investors.

Those risks include:

  • complex contractual structure makes contingency planning difficult, and future outcomes unpredictable.
  • the VIE contracts could be deemed invalid and unenforceable, as against public policy.
  • multiplication of entities is tax inefficient under transfer pricing requirements.
  • regulators could expressly deem the structure illegal in general in future, or could crack down on any particular VIE structure.

Because of these risks you should not enter in to a VIE lightly, and should consider whether there any viable alternatives; and if the structure is adopted, plan and document it carefully.

The introduction of the Foreign Investment Law does not appear to materially increase the risks around VIEs, and may even decrease them. It does provide additional legal grounds for acting against VIEs, by providing a general definition of "foreign investment" that could include VIE contractual controls. However, it omits an important distinction between ultimate foreign and Chinese control, which appeared in earlier drafts. This would have allowed a selective crackdown on foreign-controlled VIEs, while sparing the many prominent foreign-listed VIEs under ultimate Chinese control.


Equity ownership in WFIEs and JVs is expressed as a percentage of 'registered capital'. Registered capital has the following features:

  • registered capital is defined as subscribed capital, rather than paid-in capital;
  • there is no general requirement to pay in registered capital, although there are consequences for failure to do so, such as limits on the company's ability to take foreign exchange loans;
  • there are no general minimum registered capital requirements, although specific limits are prescribed in national law or State Council regulations for certain activities;
  • there are no fixed time limits for paying in registered capital, although a company's articles of association should require that it be paid in before the end of the term of the company;
  • there are no minimum ratios of cash to other forms of registered capital, although there are limits on the types of permissible non-cash contributions.

An FIE's registered capital can be stated in either foreign currency or Chinese currency (RMB).

It is generally quite easy to increase registered capital but this can be a time consuming process. The recommended approach to capital planning is that investors should fix initial total investment at an amount required to fund capital expenditures and working capital until the enterprise reaches operating break even.

However, it may be less easy to reduce registered capital, so any excess could become trapped in the company. The use of some amount of debt financing to satisfy total funding requirements helps avoid a cash trap for excess registered capital.

Forms of capital contribution: registered capital can be contributed in the form of cash, capital equipment, land use rights, debt and share rights and intellectual property rights.

In general, title to contributed non-cash assets should pass to the enterprise. Accordingly, revocable licenses, future services and other such contingent interests are generally not permissible as contributions to registered capital. There is however an exception in the case of CJVs, where it is permitted to contribute "cooperative conditions" that may include contractual performance.  Mortgaged assets may not be contributed to registered capital in any event.

Cash and in-kind contributions to registered capital should be verified by certified PRC accountant. The valuation of non-cash contributions must be confirmed by a licensed PRC appraiser.

Debt ceilings: in order to help ensure corporate financial strength, FIEs and domestic enterprises alike are limited in the amount of foreign exchange borrowing that they can undertake.

Traditionally, FIE borrowing was limited by certain statutory ratios of paid in capital to total investment. First in May 2016, and then with new regulations in January 2017, a new system was put in place nationally, whereby FIEs could opt to calculate debt ceilings based on a more flexible multi-factor test. The multi-factor test had previously been trialled in the FTZs.

The ability to choose between the old or new system was made available only for a limited transitional period of one year, to January 2018. If an FIE made an election during that time, it must use the same method going forward. If not, it may elect to use either method.

Under the traditional debt ceiling regime, the debt-to-equity ratios of FIEs are limited by specifying minimum ratios of registered capital relative to "total investment", defined to include registered capital plus long-term borrowing by the enterprise over one year. In practice, only foreign exchange borrowing is counted. However, there are lifetime limits for the enterprise, so no more can be borrowed once the thresholds are exceeded even if earlier loans are paid down. The ratios of total investment to registered capital, and therefore the levels of permissible borrowing, increase with the scale of the enterprise, subject to additional rules governing special industries.

Under the new regime introduced from 2016, non-bank FIEs can borrow foreign debt up to a risk-weighted balance.

Timing of capital contributions: there is no specific time limit for completion of the full capital contribution. However, in practice, the AMRs in many areas may still require that a fixed contribution deadline be included in the company's articles of association. In practice, there is no longer any clear mechanism to require compliance with the articles of association payment deadlines. But because certain consequences can result from non-payment, such as inability to make forex loans, it is prudent to pay in the registered capital in accordance with the articles of association.

Complex China Securities Regulatory Commission and MOFCOM approval requirements apply to major acquisitions and changes of control of listed companies.

Transfers of and changes in registered capital: any change in the amount or ownership of LLC registered capital must be filed or approved, and re-registered with the competent authorities. Co-investor consents are also required for different transactions.

  • Transfers of interest in registered capital - co-investors have a statutory right of first refusal to purchase registered capital in the event of transfer to a new investor. Their consent for such transfers is required in advance. MOFCOM filing is sufficient for most activities, but its approval is required for companies involved in activities on the negative list. Resulting changes in the company's articles of association and registration details must be registered with the AMR.
  • Pledge of interest in registered capital - investors may pledge their interests in registered capital only with the approval of the original co-investors and provided it is not otherwise prohibited by the company's articles of association. Pledges should be filed with or approved by MOFCOM and registered at the AMR with jurisdiction over the company.
  • Increase in registered capital: investors have a statutory right to subscribe to new capital in the same proportion as their original equity shares, although this may be waived or varied in the articles of association. MOFCOM approval or filing is required for capital increases, but approval, if required, is normally granted as a matter of course. However, where the original registered capital has not already been contributed in full, MOFCOM may require that this be done before approving a capital increase.
  • Decrease in registered capital: this may only be done under fairly limited circumstances, generally related to a decrease in the scale of the business. Previously, MOFCOM approval was required in all cases. For companies not involved in activities on the negative list, capital reduction is now subject to MOFCOM filing rather than approval. However, MOFCOM still has wide discretion in administering filings, and it may use heightened scrutiny in reviewing applications to reduce capital.

The law governing transfers of and changes to registered capital may be subject to fundamental change once the Foreign Investment Law comes into force in 2020.


Rather than establishing a new wholly-owned or joint venture (JV) company in China, foreign investors may wish to acquire the equity or assets of an existing company. As in other jurisdictions, acquiring the equity of a company will normally mean acquiring it with all of its liabilities, whereas in an assets acquisition there is generally a choice whether or not to acquire any of the target company's liabilities.

Acquisitions and joint ventures: any acquisition of less than 100% of the equity of a domestic limited liability company (LLC) will result in the target being converted into a JV which will be subject to the more conservative legal regime governing JVs.

Particular care is required in structuring JVs with individual shareholders continuing post-acquisition. The JV regulations assume that a JV will have only a few corporate entities as investors. For instance, each party normally has the right to terminate the JV under certain circumstances, and to appoint board members. This will not be appropriate in situations where there are multiple individual shareholders. Special care is required to balance the investors' rights and interests in these circumstances.

Basic acquisition methods: subject to the broad rules applicable to all foreign investments, foreign investors may acquire an existing domestic business through either asset or equity acquisition.

Under these broad rules acquisitions are subject to approval, are only possible in sectors open to foreign investment, and should result in at least 25% foreign equity in order for the target to be classified and treated as an FIE after the transaction is complete.

Equity acquisitions can be accomplished either by purchasing existing equity or subscribing to a capital increase.

Asset acquisitions can be accomplished by injecting the assets into an onshore vehicle, which will then operate them. In the latter case, the assets can either be purchased by the new company itself after establishment, or may be purchased by the investor of the newco and then contributed to the new registered capital of the newco.

Asset acquisitions are less common than equity acquisitions. This is in part because it is often difficult to transfer key assets free of encumbrances, and impossible to transfer key licences in heavily regulated industries. Also, from the perspective of the sellers, asset transfers may leave cash assets trapped in a predecessor company, rather than in the pockets of the controlling shareholders.

Approvals: as with greenfield investments, the approval procedures for acquisitions have been simplified and streamlined in recent years. Filing or approval with the PRC National Development and Reform Commission (NDRC) applies in the same way as for greenfield ventures, as set out above. Also, as with greenfield sites, only filing for the record with MOFCOM is required for business activity not on the negative list. 

Additional or higher-level approvals may be required where the target is a state-owned enterprise or a listed company.

Central MOFCOM approval is required where the target company has traditional brands or a well known trademark or is doing business in an industry key to national security and national economic security; or where shares are used as consideration. Use of shares is only permitted if the consideration shares are already listed on a stock market, or are those of an overseas special purpose vehicle to be used as a listing vehicle for the PRC target company's business.

M&A anti-monopoly review: under the PCR Anti-Monopoly Law (AML), the parties must report and notify any acquisition or merger to the Anti-Monopoly Office of MOFCOM for merger review if the transaction meets certain thresholds relating to global and PRC revenue and presence.

A transaction that does not meet the thresholds may still be subject to review should the Anti-Monopoly Office consider that the transaction is likely to result in the, 'elimination or restriction of competition', though use of this approach has not been reported.

The Anti-Monopoly Office can stop the transaction or require divestitures, undertakings or other measures to address anti-competitive effects. It also imposes rules prohibiting a range of anti-competitive practices along lines similar to European competition law.

National security review: in addition to the standard approval regime, China also has in place a national security prior review requirement for foreign acquisitions of domestic companies' equity or assets. The requirement applies to any transaction targeting domestic military industrial enterprises and tertiary enterprises, enterprises located near major and sensitive military facilities, other entities related to national defence or security, or in other sectors related to national security such as major agricultural products, major energy and resources, infrastructure, transportation services, key technologies and key equipment manufacture. Proposed transactions may be ordered to be modified or prohibited as a result of the review.

The rules do not expressly apply to JVs, although an analogous informal review may take place in those cases.

State-owned enterprises and state-owned assets: foreign investors can acquire the equity or assets of State-owned Enterprises (SOEs) or their subsidiaries. However, the process is designed to ensure that state assets are not undervalued and to minimise the impact on employees. Therefore, the process is quite cumbersome and burdensome. It is administered primarily by the state-owned Assets Supervision and Administration Commission (SASAC) at central and lower levels.

In any transaction involving SOEs or state assets, it is critical to confirm that the seller has complied with the mandatory procedures for state asset transfers. These include use of a local state asset clearinghouse, internal approval and approval by the relevant SASAC, auditing, evaluation, publication of and invitation to bid, and undertaking a bidding process if two or more interested parties respond.

Acquisition of companies listed on PRC domestic stock markets: only companies limited by shares established in China (not LLCs, and not foreign companies) can be listed on the Shanghai and Shenzhen Stock Exchanges. Foreign investors may purchase the shares of domestic listed companies in three principal ways:

  • acquire B shares - foreign investors may trade 'B shares' denominated in US$ listed on the Shanghai Stock Exchange or in HK$ listed on the Shenzhen Stock Exchange.
  • acquire A shares through a Qualified Foreign Institutional Investor - the shares of most companies listed in China are 'A shares', meaning Chinese currency (RMB) ordinary shares. Foreign investors may trade A shares through a Qualified Foreign Institutional Investor, large foreign asset managers who are specifically approved for this purpose, and highly regulated by the State Administration of Foreign Exchange (SAFE).
  • acquire A shares as a strategic investor - a foreign investor may qualify as a strategic investor if it has net assets of more than US$100 million or manages overseas assets of more than US$500 million. Once approved by MOFCOM a strategic investor can, either directly or through a wholly-owned subsidiary, invest in A shares with a lock-up period of three years by acquiring existing A shares by written agreement from an existing shareholder, or subscribing to newly issued A shares directly from a listed company.

Complex China Securities Regulatory Commission and MOFCOM approval requirements apply to major acquisitions and changes of control of listed companies. Particular care may be required to avoid the need to make a general tender offer when acquiring more than 30% of the shares of a listed company.

It is also possible for an onshore foreign invested enterprise(FIE) to undertake limited purchases of A shares for its own account provided that this does not constitute a significant component of its income and therefore causes it to exceed its approved scope of business.

Existing FIEs – onward onshore acquisitions: existing FIEs may engage in acquisitions of domestic companies operating in areas of business open to foreign investment, subject to conditions established at law and in the companies' articles of association.

For such onward investments, only registration with the AMR is required to record the change in shareholding of the target. MOFCOM approval in advance is required only if the target company is operating in a restricted sector. Any subsidiaries of the target company should not be engaged in activities prohibited to foreign investment.

Again, a domestic subsidiary of an existing FIE generally does not enjoy FIE treatment for foreign exchange and other purposes, except in the Central-Western region or for holding company investments.

There are certain restrictions on the permitted sources of funds for onward investments. For existing companies, the reinvestment of RMB retained profits requires SAFE prior approval. For newly established and funded enterprises, it is prohibited to use foreign exchange registered capital to acquire equity interests in a domestic company.