China is notorious for its bureaucracy and the business registration process is no exception to the country’s penchant for regulation. Unlike many other countries, registering a business in China may require the assistance of an agency authorized by the government to assist with the process. Prior to October 2004 companies were not allowed to register themselves but were required by law to use an authorized agent. With China’s constantly changing regulations, inconstancies with interpretation and enforcement, and general lack of transparency, the process of properly establishing an entity to ensure against encountering problems in the future is far more complicated than in more developed markets. Engaging the services of a qualified consultant can substantially improve on chances of avoiding problems with compliance and decrease the time to get established.

Even when using a consultant for registration, understanding the fundamentals of the process and how the investment and business categories affect the operations of a company, is essential for any foreign company with an interest in conducting business in China

 Section 1: Nature of the Investment
 Section 2: Registration Steps
 Section 3: Registered Capital
 Section 4: Nature of the Business

 

 Section 1: Nature of the Investment

When a foreign investor decides to launch a business venture in China they will need to decide either to launch their business in the form of an actual capital investment or to start out more cautiously by scanning the market, building networks and using local representatives.

Foreign investors without a comprehensive understanding of the China market may wish to test the market first to see if it is worth to establishing a legal entity in China and invest a large sum of capital.  

 

Foreign investors with more experience and understanding of the China market who intend to conduct a full range of business activities should consider establishing a legal entity. In the case that a legal entity is preferred, the form of the entity chosen is quite crucial. Aspects that have to be considered are the sector of business and amount of money invested, as well as if a Chinese partner is desirable or even mandatory for the business, along with other general commercial and strategic considerations. Along with the level of financial risk and control a company prefers for its China operations, government restrictions on specific industries affect the investment type made. Media, automotive and telecom industries are examples of industries that require foreign invested enterprises to have local partners.

 

A Representative Office (Rep. Office) represents the interests of the foreign investor by acting as a liaison office for the parent company. Rep. Offices may conduct market research, develop partnerships and business channels; however, all business transactions, including issuance of invoices, are managed by the parent company. Furthermore, Rep. Offices may not directly hire local employees but must rely on a government-authorized employment agency. Since Rep. Offices do not have a minimum investment requirement, they are not considered a Foreign Invested Enterprise. Rep. Offices are the least complicated way for a foreign firm to have a legal presence in China and is often the choice for foreign companies with little or no previous experience in the country. However, given the restrictions on direct employment of local employees, transactions and taxation on expenses, Wholly Foreign Owned Enterprises may be a better option for entrants seeking to develop their business domestically.

 

Wholly Foreign Owned Enterprise (WFOE), the most popular Foreign Invested Enterprise (FIE), is a limited liability company fully invested by one or more foreign investors. Along with the rights afforded to a Rep. Office, a WFOE may also legally conduct business transactions within China and hire local employees on its own accord. However they do have a minimum investment requirement that is dependent upon the locality and nature of the business. WFOEs are becoming more and more common and have begun to outpace Joint Ventures as the most popular vehicle for a China presence

 

Equity Joint Venture (EJV) companies have capital investments from both local and foreign firms. The percentage of the capital investment determines the amount of profit and risk that both the foreign and local company assumes. Foreign firms entering industries where WFOE’s cannot operate, often use JV’s although this is becoming less prevalent as more and more industries begin to gradually open up to WFOE’s.

 

The risk associated with entering into partnerships with other companies applies in China and is often exacerbated by disparities in culture and business practices between the foreign and local partners. Foreign Companies should enter into JV’s only when both parties have reached a clear understanding of the business objectives and appropriate exit strategies have been developed.

 

Cooperative Joint Ventures (CJV) are also partnerships with a local company; however, the amount of risk and profit shared by each party is not determined by capital investment but rather agreed upon at the beginning of the partnership. CJVs were used more in the 1990’s when the Chinese economy was not as developed. International companies often injected funds while the local Chinese companies provided equipment and other necessities. Laws and regulations can vary substantially between industries and procedures vary accordingly.

 

Recent years have shown a trend towards investing in China through mergers & acquisitions (M&As). There are many options for M&As in China including equity and asset acquisitions as well as mergers. As a form of foreign direct investment, the general rules on establishment of FIEs also apply to M&As.

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 Section 2: Registration Steps

Below is the typical process for setting up both foreign invested enterprises and Rep. Offices. The government offices involved in this process include the Ministry of Commerce, the Administrative Bureau for Industry and Commerce, State Administration of Foreign Currency, Taxation Bureau, the Customs Office, and the Statistics Bureau.

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 Section 3: Registered Capital

FIEs- WFOE’s and JV’s- require the foreign investor to establish a minimum amount of funds from abroad within China; called Registered Capital. The amount of registered capital must be declared during the licensing phase of the registration process. The total investment figure is represented by a ratio between foreign contributed capital and debt. The registered capital should cover all the initial investment expenses that the foreign entity will have and may be used immediately for the newly formed company’s expenses. This may include paying rents, salaries and purchasing products etc. It is considered a felony to state a specific amount of funds and then not contribute. It is also a felony to inject the funds as stated and then withdraw the injection. One purpose of the registered capital is to provide confirmation to creditors of the company’s financial adequacy.

In theory most small to medium sized companies entering the market are required to invest a minimum of US$ 3,700 (30,000 RMB) for a multiple investor WFOE. In practice, however, this kind of a capital injection would rarely cover the start up expenses of any company. Furthermore, in order to receive government approval the required amount is usually substantially more. Overall it can be stated that the investment required is dependent upon the scope of business, volume of sales, company size, location of setup and judged on a case by case basis. Chinese authorities will consider what would be a reasonable capital injection for each specific project in question. 

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 Section 4: Nature of the Business

For Foreign Invested Enterprises- WFOE’s, EJV’s and CJV’s- must declare the nature of their business during the licensing phase of the registration process. The intended scope of operations in China and the capital investment the company is willing to make, determines the category of business that a foreign company declares. The following categories are by far not exhaustive but represent the most common forms of foreign invested enterprises operating in China today. Other categories of business include Purchasing Centers, Research and Development Centers, Investment (Holding) Companies and Regional Headquarters. 

Service Company 

As the name implies, the foreign firm provides services to either companies or consumers. In most cases, the Company may not manufacture or trade goods. Examples of service companies include consulting, training, restaurants and management service companies.

 

Manufacturing Company

 

The nature of this business allows the foreign company to produce goods for sale on premises as well as sell finished goods domestically and internationally. Manufacturing companies do not require an intermediary to sell goods locally or internationally and may import raw materials for production. The registration process, however, might be more complicated than other business categories as manufacturing plants may require additional certifications.

 

Foreign Invested Commercial Enterprise – (FICE)

 

A FICE allows foreign companies greater flexibility in terms of business activities. These activities include retail, wholesale and franchising operations. Once established, a FICE is granted both import and export rights. FICE’s may also buy and sell products freely in China without an intermediary. It is also possible for manufacturing FIE’s to apply to extend their business scope to include FICE capabilities and vice versa.

 

As foreign companies entering the market begin to navigate the bureaucratic landscape, having a clear understanding of the investment and business options available will be crucial to successfully establish a business and operating in China. With China’s gradual compliance with its WTO membership obligations, the business registration process should also continue to improve while more industries open to foreign investment.

 

When choosing a business registration agency, foreign companies should consider the agency’s knowledge of recent policy changes, transparency on the registration process and its track record of successful registrations. Selecting an appropriate service provider that can effectively guide foreign investors through the complicated process will go a long way in insuring a smooth entry into the market.

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For more information, please contact Katja Friendrich: katja.friedrich@jljgroup.com