Out-Law Guide | 11 May 2022 | 1:11 pm | 27 min. read
Although the FIL provides a transitional period of five years, it would be prudent to make the revisions as soon as possible so as to bring governance into line with current law.
This is the third part of our three-part guide providing basic information on the legal framework for foreign investment and operations in China:
Part 1 – Overview;
Part 2 – Establishing a business in China;
Part 3 – Practical considerations.
For more detail request a full version of the Pinsent Masons guide to doing business in China.
There are significant differences between standard LLCs under China's Company Law and two of the most common forms of FIE under the previous regime: Sino-foreign equity joint ventures (EJVs) and Sino-foreign cooperative joint ventures (CJVs).
|Governance matter||Company Law||EJV Law||CJV Law|
|Highest authority||Shareholders' meeting||Board meeting||Board meeting or Joint Management Committee (JMC)|
|Members||1-13||At least 3||At least 3|
|Board quorum||n/a||2/3 or more||2/3 or more|
|Legal representative||Chair of the board, executive director or general manager||Chair of the board||Chair of the board or head of JMC|
|Director term||Not exceeding three years||Four years||Not exceeding three years|
|Requirements for major resolutions||2/3 or more of shareholder voting rights||Unanimous board decision||Unanimous board/JMC decision|
|External share transfer||Approval from more than half of other shareholders, unless otherwise agreed in company articles||Approval from all other shareholders||Approval from other parties|
|Distribution ratio||Ratio of paid-in capital contribution||Ratio of registered capital contribution||Arrangement in the CJV contract|
Foreign investors should considering structuring their investment through an offshore SPV. The basic advantage of this is that, if the offshore SPV owns the equity of a PRC investee, transfers of ownership in the PRC investee can be cleanly completed by a transfer of shares in the offshore SPV, thus generally avoiding the need for the onshore PRC transfer procedures set out in part 2 of this guide. This will not, however, necessarily avoid PRC capital gains tax on such sale, because China has in place rules requiring payment of China CIT on offshore indirect transfers of interests in domestic entities.
If PRC-domiciled parties invest in such an SPV, the PRC investors should first obtain relevant offshore investment approvals and foreign exchange registrations for this 'round trip' investment.
The shareholder meeting is the highest authority of a Company Law LLC.
Shareholder meetings are classified as either regular meetings or interim meetings. Regular meetings are held according to the company articles of association and interim meetings are held following a proposal by a certain number of the shareholders, directors or supervisors.
Directors of LLCs are elected by the shareholders. LLCs with relatively few shareholders may appoint a single executive director in lieu of a full board. Given the control dynamics, this is most likely to be feasible for single-owner wholly foreign-owned enterprises (WFOEs). The directors' term of office is set out in the articles of association but should not exceed three years.
Before the FIL came into force, board meetings were required to be held at least once a year for JVs, with 2/3 of the directors required for a quorum. Under the Company Law, it is left to the shareholders to specify the quorum in the articles of association.
The appointment of the board chair should be subject to the articles of association.
The chair's position is one of prestige rather than of formal statutory powers, other than to call and preside over board meetings. The chair's real powers are as set out in the articles of association.
The legal representative of an LLC or company limited by shares is an individual who is legally accountable for the company and its acts, and who generally has the power to contractually bind the company. The role therefore raises sensitive issues of both internal control and personal liability. It should be noted that, in the event of alleged violations of law or even civil suits, the authorities can prevent a foreign legal representative from leaving the country and even restrict their movement within China.
The legal representative of an LLC should be either the chair of the board, the executive director or the general manager, as set out in the articles of association.
Given their statutory powers, legal representatives should be chosen for their integrity, loyalty and accountability to the parent organisation – preferably someone with a strong record of service with the organisation. Internal controls and limitations on the legal representatives' powers are also important.
Supervisors are responsible for general oversight of company finances and compliance. A board of three supervisors is in principle generally required, but smaller LLCs may appoint a single supervisor or two supervisors. Senior managers and directors of a company may not also serve as supervisors of the same company.
Companies are largely free to specify their management structures. This is typically done in the articles of association and, for JVs, the JV contract.
Senior managers should be appointed by the board of directors or executive director. In a JV, other positions are also generally allocated in accordance with the parties’ respective investment ratios.
In LLCs, the general manager, executive director and legal representative may all be the same individual. While this may be attractive in terms of efficiency and costs, the concentration of so much power in a single person should only be contemplated with the most loyal and trusted individual.
Each enterprise, subsequent to registration, will be issued with a company 'chop' - a stamp or seal that is generally presumed to be definitive proof of the company's approval of documents to which the chop is attached. Other chops might include a financial chop (for tax and bank filings), contract chop (for contract signing), and a legal representative's chop (for use in lieu of their signature).
Careful planning and management of signing authority, signing procedures, chopping records and physical custody of the chops are all critical aspects of internal control.
Establishing a business in China is more complex and time-consuming than in many western jurisdictions. The process is even more burdensome for foreign than for domestic investors. Procedures will vary depending on the type and characteristics of the project so should be confirmed on a case-by-case basis, in relation to the specific target locality.
The timing for approvals depends in large part on the nature of the investment, and whether pre-approvals are required. In the simplest scenario, the basic approval and registration process will normally take about a month or two, assuming there is no problem with the documents. More time will be required depending on the number of documents which must be prepared.
Business names should be reserved with the Administration for Market Regulation (AMR) in the target locality. An FIE will need to adopt a Chinese company name according to a standard form, normally consisting of four elements:
Certain FIEs registered with the SAMR at the central level may have a company name with the word “China” or without mention of a specific administrative region.
Given the importance for branding, and the interaction with trademarks, care is required in selecting company names. Trademark searches and registrations should be carried out at the time of company name selection. 'Offensive' trademark registration will be critical in order to prevent passing off by competitors, and to guard against squatters maliciously registering one's company or brand name as a trademark.
Only Chinese character names can be registered as company names, and foreign companies in China are most commonly known by their Chinese brands.
The SAMR issues business licences as proof of the company's due legal establishment. It is the equivalent of the certificate of incorporation in other countries. The SAMR and its local branches are responsible for registering and issuing business licenses for foreign-invested and domestic companies alike.
Establishing a business in China is more complex and time-consuming than in many western jurisdictions. The process is even more burdensome for foreign than for domestic investors.
Some of the documents that must be submitted for AMR registration include:
All documents must be submitted in Chinese, translated where necessary, and in several cases must be notarised and legalised at a PRC embassy or consulate abroad. This can add significantly to the time required to complete the application.
Newly registered businesses must file for registration with various government departments for a number of additional registration certificates including:
Foreign exchange controls are a critical factor in the planning of both investments and operations in China. Any proposed cross-border fund flow of any type should be evaluated from this perspective early in the planning process.
Foreign exchange controls are principally administered by the State Administration of Foreign Exchange (SAFE). SAFE now requires case-by-case review of all fund outflows over US$5,000,000, resulting in significant difficulties for many large MNCs in remitting dividends abroad.
Under the PRC Enterprise Income Tax Law, dividends paid by FlEs to their offshore investors are generally taxed at a rate of 10%. This rate is decreased to 5% for shareholdings over 25% under many double tax treaties, such as that with the UK.
The People's Republic of China (PRC) legal regime does not recognise private ownership of land. All land is owned by the state or by collectives. Collectively owned land is generally for agricultural purposes and can only be used for construction after undergoing a complex conversion process.
Because of animosity to private property ownership during Mao's time, China's land registration and transfer infrastructure are still fairly imperfectly and irregularly developed. As a result, the process of obtaining land and buildings is often complex and costly. The situation is usually better on the developed east coast, in urban areas and in segregated economic development or industrial zones.
Because of this, new facility builds by FIEs are almost always located in development zones.
FIEs can own buildings and structures on land by purchasing or being granted a 'land use right', which is a right to use land for a specific purpose and period of time. Land use rights do not include the right to use natural resources, minerals or treasure under the land. In general, buildings on land must be owned by the same party that holds the land use right.
There are three types of land use right in China.
This is the most common type of land use right, and is initially obtained directly from local authorities by paying a fixed fee. The maximum use period varies depending on the use of the land:
Granted land use rights can generally be freely transferred, let or mortgaged without having to obtain formal approval from the authorities. However, all such changes should be registered with the land management authorities.
An application to extend a granted land use right must be made no later than one year before its expiry.
This is a land use right allocated by the state free of payment for an indefinite period, normally for restricted uses such as governmental use, military use, infrastructure projects and public facilities.
The law does not expressly prohibit foreign companies or individuals from obtaining allocated land use rights. However, because of the restrictions on use and transfer, these rights are not normally held by foreign companies or individuals. Utility or infrastructure projects are the most common exceptions.
Generally, allocated land use rights should first be converted to granted rights in order to be transferred. The process is cumbersome and difficult.
The People's Republic of China legal regime does not recognise private ownership of land. As a result, the process of obtaining land and buildings is often complex and costly.
It is quite common for FIEs to lease premises such as offices and factories, rather than buying the right for a one-off payment. The maximum term of leases is 20 years, and they may be renewed upon expiry.
Various legal requirements apply to company registered offices including: that the registered address match the property ownership certificate; that the premises should be zoned for the contemplated activity; and, in some areas including Beijing, that the premises should not be owned by a foreign national. Therefore, when considering office premises, investors should confirm with the landlord in detail that the office is suitable for use as a registered office, and incorporate a condition into the lease.
China has increasingly emphasised environmental protection in recent years, and continues to legislate actively in this area. The importance that China now places on environmental issues is reflected in the upgrade in March 2008 of the original State Environmental Protection Administration to full ministerial status, becoming the Ministry of Environmental Protection.
Major amendments to the Environmental Protection Law came into effect on 1 January 2015 that significantly strengthened the enforcement regime. These included potentially unlimited fines for polluters, strengthened private rights of action, and strengthened punishments for local environmental authorities failing to enforce the law.
Although PRC law currently lays the burden of environmental remediation on the polluter, liability is gradually being extended to non-culpable successor occupants. Environmental due diligence is therefore of critical importance in any greenfield project or acquisition of existing facilities.
An environmental impact assessment (EIA) is required before a construction project and related investment can be approved.
The EIA, either in the form of a full report or simpler registration form, must be prepared by a qualified environmental engineering firm and approved by the competent environmental protection authority.
A re-assessment report is required where major changes are made to a project's nature, scale, location, production process or waste treatment measures; or where construction of the project has not commenced within five years after approval.
Environmental protection facilities are required for projects where pollutants are handled on site. They must be designed, engineered and operated simultaneously with the main body of the construction project.
Local environmental protection authorities will carry out examination of environmental protection facilities upon completion of construction. Projects can be put into formal operation only after issuance of an Inspection and Acceptance Letter confirming that the project has passed examination. This typically follows a period of trial operation lasting about six months.
A system of waste discharge control permits is in effect for air, water and noise.
A project may not discharge waste without a discharge permit or exceed the permitted discharge volumes. To obtain a discharge permit, an enterprise must have passed examination by the environmental protection authority by demonstrating that suitable waste treatment facilities have been installed and that the waste to be discharged after treatment complies with both national and local standards.
Local environmental protection authorities exercise ongoing supervision on all operating projects through waste discharge sampling.
Foreign businesses operating in China must take care to protect their valuable intellectual property (IP) rights: trade names and brands; copyrights; patentable inventions; trade secrets and know-how. IP strategy should be considered early in the investment planning process, and monitored, updated and implemented on a continuing basis.
China has established registration regimes to recognise exclusive rights to use various forms of IP right. These include trademarks, trade names, patents, designs and integrated circuit layouts, new varieties of plant, copyright and software and domain names.
Unregistered trade secrets are protected under the Anti-Unfair Competition Law, on terms similar to other jurisdictions: information must be commercially valuable non-public information, and efforts must be made to protect its confidentiality.
Companies must take steps to protect their trade secrets, including: segregating know-how, with important elements being retained offshore; access controls on IT systems and paper files; physical security at sites; monitoring of compliance, detailed IT policies, handbooks, and training.
China is a signatory to a range of key international treaties on IPR, including the Paris Convention (patents and trademarks); Patent Cooperation Treaty (patents); Berne Convention (copyrights); WIPO Copyright Treaty (copyrights); the Madrid Treaty and Protocol (trademarks); and TRIPS under WTO.
Several avenues are available for enforcing intellectual property rights against violators, with administrative rather than judicial action being most common:
Litigation for IPR owners and criminal prosecution are other possibilities. Although damages awards have been low by western standards they have been increasing to more realistic levels over the past several years. Preliminary injunctive orders and orders for preservation of evidence may be available. Trade secret related enforcement requires litigation under the Anti-Unfair Competition Law.
Criminal sanctions can include imprisonment for up to seven years for certain infringing activities. Although criminal prosecutions remain rare, police involvement can be helpful, e.g., to facilitate evidence collection or enforcement of court orders.
In spite of progress in recent years, none of these avenues are very satisfactory by the standards of foreign rights holders. In light of this, the practical measures discussed above are particularly important.
Chinese law is very protective of employee rights. The Employment Contract Law governs the rights of employees in China but there is a great deal of variability in many details of labour policy between different parts of China.
Important elements of the law include:
There is a fundamental distinction between representative offices (ROs) and foreign-invested enterprises in respect of employment relations. While JVs, WFOEs and others can directly hire local employees, ROs must hire local employees through a government sanctioned labour outsource services company such as the Beijing Foreign Enterprises Human Resources Service Co., Ltd. (FESCO) or China International Intellectech Co. (CIIC).
A unique feature of the Employment Contract Law is that it makes it permissible to unilaterally terminate an employee for a serious violation of company policies, but not for breach of the employment contract itself. It is therefore critical that a company put in place comprehensive employee handbooks and policies spelling out in detail the company's rules and regulations, and the conditions under which employees' violation of the policies can constitute grounds for unilateral termination.
Company policies will not be binding on employees unless the policies are properly circulated to the employees for comment and notified to, and preferably acknowledged in writing by, each individual employee. Employees must also be in a position to understand the policies, so Chinese-language versions of the policies should be put in place unless all employees are fluent in English.
Employers and employees are both required to make payments into various social insurance schemes including for unemployment, medical, work-related injury, maternity, pension and housing funds. Although the rates vary in different parts of the country, total contributions average around 35% to 40% of the wage bill within the range of average salary levels. However, contributions are subject to caps based on average local wages, resulting in proportionately lower contributions for high salary employees.
Under the Social Insurance Law, foreign national expatriates are included in China's social insurance system in principle, although they are not included in the housing fund system. However, in practice, contributions by foreigners are still not uniformly required in all jurisdictions. Therefore, the situation should be confirmed dependent on the target location.
Contribution requirements vary from place to place, but generally amount to around 35% of salary payable by the employer and 10% payable by, or on behalf of, the employee. The calculations are subject to a minimum salary floor of 60% and a maximum salary cap of 300% of the local average monthly salary. This will serve to limit the cost of social insurance contributions for high-salary employees.
There are two basic options by which foreign companies new to the market may hire just one or a few Chinese nationals onshore without setting up a Chinese entity: hiring the individual directly from offshore, and hiring the individual through a local labour outsourcer.
There are advantages and disadvantages to each approach. In addition, both approaches could be considered to violate rules prohibiting foreign entities from operating an unregistered representative office in China. If the arrangement is deemed to constitute an unregistered representative office, the authorities could impose a fine and order cessation of the activity. Both approaches also carry a significant risk of being deemed to constitute a permanent establishment if discovered by the tax authorities.
Employees in China have the right to set up a workplace labour union. If employees request to set up a union, the employer must offer assistance and allocate 2% of the monthly payroll to the union. All unions are subordinate to the All-China Federation of Trade Unions, which is currently actively advocating the unionisation of FIEs.
Current PRC regulations allow unions a role in major decisions by FIEs including the right to review dismissals, participate in board meetings and review company rules involving salaries or work conditions.
Hiring of foreign nationals is permitted, but only subject to approval, and only for qualifying employees. In particular, the regulations stipulate that foreigners can only be hired to fill posts with special needs, and which cannot be satisfied by domestic candidates. Foreign employees must be above the age of 18 and be healthy, and must possess relevant professional skills.
All foreign nationals must have a valid visa in order to enter and stay in China. Different types of visas are available depending on the intended purpose and duration of the stay, and subject to satisfaction of relevant approval requirements.
Forms of visa most commonly relevant to foreign nationals working in or visiting China include:
The requirements for obtaining work visas are complex. For new work applications, the submission requirements include notarised and legalised copies of diplomas and home country criminal record checks, which can be very burdensome to obtain. Some steps must be carried out in advance by the employer in China, while others can only be carried out with PRC embassies or consulates overseas. Detailed advice should therefore be obtained from an experienced visa agent or one’s local HR department and tax advisors prior to coming to China for a first visit – especially if you intend to stay for an extended period, or be employed by a local enterprise.
China's tax system is growing in sophistication and detail along with the rest of its institutional infrastructure. The laws are complex, fast changing and subject to varying interpretation. Professional tax advice should be sought at the planning stage of any contemplated transaction.
China's Enterprise Income Tax Law (EITL) came into force on 1 January 2008. Unlike previous corporate income tax laws, the EITL applies equally to both FIEs and domestic enterprises.
Features of the law include:
Although they are not permitted to earn income, ROs are nevertheless required to pay income tax on the basis that they ultimately generate economic value. The taxation of ROs is generally based on a deemed profit method, with tax calculated as a percentage of RO operating costs. Under this method, the minimum deemed profit rate is 15% of operating costs. The standard 25% corporate income tax is payable on the amount of deemed profit, and no deductions are allowed.
A foreign enterprise without an establishment in China, or with an establishment but with China source income not related to that establishment, is generally subject to withholding tax at a rate of 10% on that China source income. The domestic payer is the withholding agent for these taxes.
Deductions to reduce taxable income are generally not allowed in the withholding context.
China has bilateral treaties for the avoidance of double taxation (DTAs) in place with many foreign jurisdictions, including arrangements with Hong Kong and Macao. These may reduce withholding rates even further. Access to DTA tax benefits is now restricted to offshore companies that qualify as beneficial owner under PRC tax rules, meaning entities which have control over the profits or rights or assets generating the profits, and which have a bona fide business purpose and presence in the foreign jurisdiction. This means that it is no longer possible to enjoy favourable PRC tax treaty treatment merely by setting up a shell company in a foreign jurisdiction for that purpose. In addition, favourable tax treatment under DTAs is not granted automatically, but can only be enjoyed on application to the Chinese tax authorities.
Foreign companies that do not have a subsidiary company or RO in China may nevertheless be deemed to have a permanent establishment (PE) in China, and subject to PRC tax on income attributable to the PE. The factors triggering a PE are generally spelled out in the DTA between China and the investor's home country. In general, under the DTAs, PE can be deemed to have been established by a foreign company where:
If PE is deemed to be established, the foreign party must register the PE with the local tax authorities and file to pay taxes. Tax will generally be assessed on a deemed profit basis, calculated based on the expenses attributable to the PE. The deemed profit rate varies from 15% to 50% of expenses, depending on the activity involved.
Sales of goods within China are generally subject to value added tax (VAT) at rates of either 13% or 17%. Provision of repair and replacement services may also be subject to VAT at 17%. Certain services, such as design services, are now subject to VAT at either 6% or 3%, depending on the status of the VAT taxpayer. In addition, local governments often levy surcharges that are collected along with VAT, typically less than 1% of the transaction value.
Certain luxury and "unhealthy" goods are subject to a consumption tax ranging from 3% to 45%, paid by the VAT payer at the same time as payment of VAT.
These include customs duty, land appreciation tax, resource tax, stamp duty, land use tax, deed tax, and vehicle and vessel tax.
The PRC Individual Income Tax Law imposes taxes on individuals’ receipt of all types of income, including salaries and wages, rents and royalties, personal service income and dividends. The tax also extends to foreign nationals earning income from work or other activities in China. Expert tax advice, with reference to local practice, should be sought in structuring both domestic and expatriate salary and compensation packages.
For expatriates, under the revised Individual Income Tax Law in effect from 1 January 2019, the tax burdens on foreign nationals chiefly depend on their time in country, the source of income, paying party, and the individual's position (whether senior management or not). These rules may be modified by dual tax arrangements, so any relevant DTA must also be consulted in determining expats' PRC tax liability. Contributions made by expatriates to the PRC social insurance scheme may be deducted from taxable income; however, their contribution to foreign social insurance, whether mandatory or not, may not be deducted in China.
Bankruptcy is one area of law-making where China has most notably lagged behind more developed countries. The PRC’s first generally applicable enterprise bankruptcy law, the Enterprise Bankruptcy Law, came into effect on 1 June 2007. Prior to that, the PRC had in place narrow regulations governing FIE termination and dissolution, as well as separate and rarely used rules on state-owned enterprise (SOE) bankruptcy. Today, the PRC still does not have a personal bankruptcy law, leaving a very large gap in the creditor-debtor regulatory framework. The slow pace of bankruptcy law development reflects the PRC leadership’s early - and continuing - reluctance to sanction the failure of SOEs.
On the surface, the Enterprise Bankruptcy Law is broadly similar to that in western economies. However, it is unique in key respects and contains numerous loopholes, giving courts significant discretion in accepting and settling bankruptcies. At the same time, the courts are themselves subject to oversight and direction by the local government, which simply does not welcome bankruptcies with all of the associated layoffs, write-offs, and loss of face. The PRC courts therefore remain quite reluctant to let the process take its own course, and still prefer informal court- sponsored accommodation/settlement over formal bankruptcy procedures and possible liquidation.
The Enterprise Bankruptcy Law adopts, in rudimentary form, procedures long established in the West. In general:
06 May 2022
10 May 2022