Out-Law Guide | 05 Jun 2019 | 3:20 pm | 22 min. read
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.
Over the years, China has steadily unified its regulatory regimes for domestic enterprises and FIEs. The Company Law, first published in 1993 and last amended in 2014, is applicable to both domestic enterprises and FIEs. However, various special rules governing EJVs, CJVs and WFOEs continue to subsist alongside the Company Law. As a result, FIEs are still treated differently than domestic companies in certain ways, although the areas of common treatment are steadily increasing between the two.
Structuring – offshore special purpose vehicles (SPVs): 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 above.
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.
Shareholder meetings: WFOEs and FICLSs must hold shareholder meetings at least once a year, and these constitute the company's highest authority.
Board of directors or executive director: the board of directors is the highest authority of EJVs and incorporated CJVs. Non-incorporated CJVs have a management committee, which is constituted and operates similarly to a board of directors. Board powers are specified partly by statute and partly by articles of association and, for JVs, in the JV contract.
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 WFOEs.
In EJVs and CJVs, board representation should reflect the equity ratio between the parties.
Board meetings must be held at least once a year for JVs, and 2/3 of the directors are required for a quorum. WFOE board meeting requirements and powers will be as provided for in the articles of association. FICLS board meetings must be held every six months, or on petition of 10% of the shareholders or 1/3 of directors. For a FICLS, 1/2 of the directors constitutes a quorum.
Chairman: in EJVs the chairman is generally appointed by the majority equity holder. The other party generally appoints the vice chairman. The chairman's position is one of prestige rather than of formal statutory powers. The chairman's real powers are as set out in the articles of association.
Legal representative: 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.
Supervisors: 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. Senior managers and directors of a company may not also serve as supervisors of the same company.
Management: companies are largely free to specify their management structures. This is typically done in the articles of association and, for JVs, the JV contract.
JVs must have a general manager, generally appointed by the majority party; and a financial manager. In LLCs, the general manager, executive director and legal representative may all be the same individual. This may be attractive in terms of efficiency and cost, but can raise conflict of interest concerns.
Company chops: each enterprise, subsequent to registration, will be issued with a company 'chop' - a stamp or seal that are generally presumed to be definitive proof of the company's approval of documents to which the chop is attached. Managing the chop will be a critical aspect of an enterprise's internal controls.
Organisation and governance requirements may be subject to fundamental change once the Foreign Investment Law comes into force, particularly in terms of the requirements for CJVs and EJVs.
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.
Company name reservation: done with the AMR business registration authorities in the target locality. An FIE will need to adopt a Chinese company name according to a standard form, normally consisting of four elements:
Only Chinese character names can be registered as company names. Trademark searches and registrations should be carried out at the time of company name selection. 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.
Project approval: the National Development and Reform Commission (NDRC) manages economic planning and industrial policy. Part of this is a regime of pre-establishment review and approval for new foreign-invested companies.
The extent of the review depends on the scale and sensitivity of the project. Smaller, less sensitive projects are subject to a simple 'filing for the record' process requiring only basic information on the project and its investors.
Larger and more sensitive projects are subject to verification and approval. This intensive review process involves the submission of large amounts of information by investors and official review of a range of project parameters. The extent of verification and approval required increases with the scale and sensitivity of the project, from local to provincial to a central level in Beijing.
The NDRC publishes and regularly updates the list of activities that need to go through this process, called the 'Verification and Approval Catalogue'. If a project is not covered by the catalogue it should only be subject to filing for the record with the NDRC.
MOFCOM filing or approval: MOFCOM also has a role approving projects. If a project is not included in the negative list it need only be filed for the record with MOFCOM. If it is included in the negative list then prior review and approval is required. This will entail pre-approval from the administration in charge of the industry and verification and approval by the NDRC.
Business license issuance: 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 licences for investments approved by or filed with MOFCOM. Filing for AMR registration should be carried out within 30 days of the conclusion of MOFCOM filing/approval. The date of issuance of the business licence is the date of establishment of the company.
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.
In theory, AMR registration may be applied for and issued on a conditional basis prior to MOFCOM filing or approval. However, in practice, the AMRs usually require MOFCOM filing or approval to be done first.
Ancillary registrations: Newly-registered businesses should file for registration with various government departments for a number of additional registration certificates within 30 days after the business license is issued.
Establishment procedures will be subject to fundamental changes once the Foreign Investment Law comes into force.
Foreign exchange controls are a critical factor in the planning of both investments and operations in China, and 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).
Liberalisation of foreign exchange controls was a significant element of the reforms introduced in the Pilot FTZs, and has for the most part been extended to the rest of the country. However, the freedom of cross-border fund flows for FIEs and domestic companies alike is still limited in many fundamental respects, especially in regard to capital account transactions.
Foreign exchange bank accounts: for FIEs, all foreign exchange transactions must be conducted through foreign exchange bank accounts opened at a designated foreign exchange bank. SAFE foreign exchange registration must generally be obtained before a bank will open a foreign exchange bank account for an FIE.
Capital account and current account: all foreign exchange payments and receipts must be based on a bona fide underlying transaction, so it is important to document cross-border transactions fully and accurately.
Foreign exchange transactions are categorised as either current account or capital account transactions and each is subject to different controls.
Current account items relate to day to day business operations such as interest payments, or payments received or made for goods and services. Higher scrutiny generally applies to transactions of over $50,000, and withholding tax obligations must be settled in advance.
Capital account items are transactions that increase or decrease the debt or equity of an enterprise through the inflow or outflow of capital. They are subject to SAFE registration or approval in advance.
Foreign borrowing: FIEs, unlike domestic enterprises, are generally free to undertake foreign currency loans from offshore lenders. However, these loans must be registered with SAFE.
Profit remittances: FIEs may declare profits on an annual basis after all taxes have been paid and previous years' losses have been made up. They must allocate 10% of after-tax profits to a statutory reserve up to the point where the reserve balance equals 50% of registered capital.
FIEs are in general allowed to remit dividends to offshore investors without case-by-case approval from SAFE. But the approval function lies with banks, which will review board resolutions; tax clearance certificates; audited accounts, and other documents as a condition to approving dividend payments. Also, foreign exchange policy continues to fluctuate with China's macro foreign exchange flows. For example in 2016, after a period of record currency outflows, SAFE introduced a new policy requiring case-by-case review for all fund outflows over $5 million, resulting in significant difficulties for many large multinational corporations in remitting dividends abroad.
The People's Republic of China (PRC) legal regime does not recognize 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.
Granted land use right: 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.
Allocated land use right: 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 recognize private ownership of land. As a result, the process of obtaining land and buildings is often complex and costly.
Leasing of buildings and land use rights: 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.
Environmental impact assessments (EIAs): an 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: these 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.
Waste discharge control: 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.
Ongoing supervision: 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 IPR, ranging from trade names and brands, to copyrights, patentable inventions, trade secrets and know-how. IPR strategy should be considered early in the investment planning process, and monitored, updated and implemented on a continuing basis.
Registrations: China has established registration regimes to recognise exclusive rights to use various forms of IPR. These include trademarks, trade names, patents, designs and integrated circuit layouts, new varieties of plant, copyright and software and domain names.
Practical measures: 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.
Treaties: 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.
Enforcement: several avenues are available for enforcing intellectual property rights against violators, with administrative rather than judicial action being most common.
The State Administration for Market Regulation (SAMR) and its local branches can take administrative actions including: investigation, seizure, confiscation, administrative injunctions, fines and even closing down infringing businesses.
The State Intellectual Property Office may investigate and issue administrative injunctions against patent infringement.
The Administration for Quality Supervision, Inspection and Quarantine may investigate and prosecute 'passing off' involving shoddy goods or violations of state standards.
The National Copyright Administration is empowered to issue administrative injunctions, confiscate goods and impose fines for copyright infringement.
The General Administration of Customs may confiscate products for export that infringe registered IP rights. Since customs officers are generally more free from local political and economic pressures than other agencies, customs enforcement can be very effective.
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 Anto-Unfair Competition Law.
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:
Representative Office Local Employees: 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).
Employee handbooks and company policies: 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.
It is also important to note that company policies will not be binding on employees unless the policies are properly circulated to the employees for comment. So circulation for comment is an important procedural step. Also, the employees must 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.
Social insurance: 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.
Hiring PRC employees from offshore: 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.
Trade unions: 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.
Expatriates and visas: the 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.
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.
Enterprise Income Tax Law: 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:
Taxation of representative offices: 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.
Income tax withholding and double taxation arrangements (DTAs): a foreign enterprise without an establishment in China, or with an establishment but with China source income not related to such establishment, is generally subject to withholding tax at a rate of 10% on such 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 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.
Hong Kong's tax arrangements with China were in the past particularly favourable, and may still be relevant given Hong Kong's strategic position as a hub for business in Asia and a gateway for Chinese investment. However, under the DTA between the UK and China effective from 2014, UK businesses enjoy tax treatment just as favourable, in most respects, as that enjoyed by Hong Kong companies.
Permanent establishment: 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.
Turnover taxes: sale of goods within China are generally subject to 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.
Other taxes: these include customs duty, land appreciation tax, resource tax, stamp duty, land use tax, deed tax, and vehicle and vessel tax.
The PRC's first generally applicable company bankruptcy law came into effect in 2007. The slow pace of development in this area reflects the PRC's early reluctance to sanction the failure of state-owned enterprises. The Enterprise Bankruptcy Law is broadly similar to the laws in western economies on the surface. However, it contains numerous loopholes which give courts significant discretion in accepting and settling bankruptcies.
05 Jun 2019
05 Jun 2019