Lehman, Lee

1
Lehman, Lee XuGordiano Casas Herrera
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• Macau University of Science and Technology
• ??????
• November 2006
• 2006?11?

Lehman, Lee Xu - www.lehmanlaw.com
2
Investment Vehicles

• Foreign Direct Investment

3
Market Statistics

• In 2003, China surpassed US as leading
  destination for FDI
  
• In 2006, China and India were main destinations
  for FDI in the world
  
• first time for developing countries
• FDI will exceed USD 60 billion in 2006
• Between 1978 and 2006, average GDP growth rate
  over 9.5

4
Market Entry Essentials

• Have a clear entry strategy
• what
• where
• how
• Have a clear exit strategy
• Have full knowledge of the risks
• market research/due diligence
• local and foreign competition
• regulatory/legal issues (national, provincial and
  municipal)
  
• Long-term commitment is key.

5
Taxation

• Foreign Enterprise Income Tax
• Flat rate of 30
• Plus 3 local tax on the taxable profit.
• Manufacturing special treatment
• First 2 years no tax
• Next 2 years 50
• Can enjoy 50 reduction for further 3 years if
  export more than 70 of production
  
• In some SEZs can enjoy even further tax reduction
  if export 100

6
Preferential Taxation

• Open Economic Zones
• Taxed at a rate of 24
• Eligible for tax holiday 3 year reduced rate.
• Special Economic Zones
• Taxed at a rate of 15
• Shenzhen, Zhuhai, Xiamen, Shantou and Hainan
  Island.
  
• Eligible for tax holiday 3 year reduced rate.
• Soon will be eliminated and general rate 27

7
FDI Legal Framework

• The legal framework guiding foreign investment in
  China is contained in two sets of regulations
  
• State Council, Guidance of Direction of Foreign
  Investment Provisions (the "Guidance
  Provisions")
  
• Foreign Investment Industrial Guidance Catalogue
  (the "Catalogue")
  
• Since China's World Trade Organization (WTO)
  entry, government has relaxed investment
  regulations

8
FDI Divisions

• Encouraged (262)
• Agriculture
• New/high technology
• Industries which develop Western/Central
  regions
  
• Restricted (92)
• Resource-intensive/wasteful enterprises
• Approval according to the amount of Investment
• Prohibited (33)
• Industries which cause pollution and ruin
  natural resources
  
• Projects which utilize processes/technologies
  which are unique to China
  
• Permitted
• All other industries not listed in the
  Catalogue.
  

9
Investment in PRC

• Business enterprises must
• obtain state approval on a project-by-project
  basis
  
• comply with numerous regulations
• Each particular business scope requires a minimum
  amount of Registered Capital, which must be
  contributed in formation of the company.
  
• Depending on the proposed investment vehicle and
  industry, the requirements for approval will vary

10
Foreign Investment Operating Structures

• Representative Office
• Equity Joint Venture
• Cooperative Joint Venture
• Wholly Foreign Owned Enterprise
• Holding Company

11
Representative Office

• Straightforward and inexpensive way to establish
  a commercial presence in China
  
• Over 35,000 foreign companies have established
  Rep Offices in China
  
• RO allow foreign companies to
• further understand the Chinese market,
• promote their products and services,
• develop new contacts,
• examine the feasibility of an investment project
• For certain industries (insurance and banking), a
  RO is a legal prerequisite to establish an
  operating entity in China

12
Representative Office

• A RO is an "extension" of foreign company (not a
  separate legal entity)  
  
• Restrictions on business activities
• Once established, RO may
• lease premises,
• employ local and expatriate staff (approval)
• conduct business liaison activities on behalf of
  its overseas parent company. 

13
Legal Framework

• People's Republic of China State Council Interim
  Provisions on the Administration of Resident
  Representative Offices of Foreign Enterprises
  (?????????????????????????????)
• Measures for the Administration of Registration
  of Resident Representative Offices of Foreign
  Enterprises (????????????????)
  
• Detailed Rules for the Implementation of the
  Examination, Approval and Administration of the
  Resident Representative Offices of Foreign
  Enterprises in China (????????????????????????)

14
Establishment Criteria

• Applicant must comply with stipulated
  establishment criteria
  
• be lawfully registered in the country in which it
  is located,
  
• enjoy a "good business reputation"
• supply true and reliable information to approval
  and registration authorities
  
• handle establishment procedures in accordance
  with Chinese law.
  
• applicant has been in business for a specified
  period of time
  
• evidence of prior business with China

15
Permitted Scope of Business

• A RO may only engage in "non-direct business
  activities
  
• business liaison,
• product presentation,
• market surveying,
• technical exchange
• "..... under no circumstances may a Rep Office
  sign contracts, receive income or in any way
  engage in direct profit-making activities ...."
  
• Serious consequences
• warning,
• hefty fines,
• confiscation of any illegally-generated income
• cancellation of its business registration!

16
Taxation

• Although permitted activities do not generate
  income, ROs must pay
  
• foreign enterprise income tax
• RO tax is based on turnover at a rate around 10
  over expenses

17
How to Establish a Rep Office

• Two separate stages
• applying for approval
• applying for registration  
• Upon registration, Registration Certificate (???)
  will be issued (fully established) 
  
• Post-registration formalities within 30 days.
• Parent company is responsible for all activities
  conducted by the RO in China. 
  
• RO under a newly incorporated subsidiary company
• in existence for at least one year
• minimum capital US10,000

18
Approval Process

• Approval Authority
• MOFCOM or its local bureau (provincial or
  municipal level) 
  
• In specialised industries, the relevant Chinese
  government authority (Ministry of Justice)
  
• Designated Sponsor
• application submitted to MOFCOM through a
  government-authorised "sponsor" organisation
  
• role of the sponsor is to submit application
  documents on behalf of the Applicant for
  approval.
  
• renewal or change in Business Registration
  Certificate must be effected through the original
  sponsor 

19
Application Documents

• Documents to be submitted
• application form and application letter (Chinese)
  
  
• copy of Applicant's constitutional documents
  (also Chinese translation)
  
• reference letter from bank
• lease agreement of the premises
• letter of appointment of the Chief Representative
  
  
• passport copies
• any other documents which may be required.   
• Approval authorities will grant approval within
  20 working days (Certificate of Approval (????))

20
Registration

• With the State Administration for Industry and
  Commerce (SAIC) or its local bureau (AIC)
  
• Within 30 days from date of issuance of the
  Certificate of Approval 
  
• Documents to be submitted
• original Certificate of Approval,
• copies of all documents submitted at the approval
  stage,
  
• registration form and a prescribed fee
  (RMB2,000).
  
• SAIC (or local AIC) issues Business Registration
  Certificate, within 20 days.
  
• Registration Certificate valid for one year
  (renewed annually)

21
Post-Establishment Registrations

• Once Registration Certificate has been issued
• Registration  with various  official
  departments
  
• public security bureau,
• local and state tax authorities,
• customs authorities
• local bank 
• Also apply for work permits, employment visas and
  residence permits for expatriate staff

22
Employment of Local Chinese Employees

• RO may not directly employ local Chinese
  employees (not independent legal entities) 
  
• Must use local service agencies" (FESCO)
• Impose
• service charge on RO
• administration fee on employee
• Takes care of labour and social insurance
  contributions on behalf of the employee. 

23
RO Summary

• Advantages
• Quick and simple.
• Inexpensive
• No minimum registered capital.
• Allows for collection of market information and
  preparation for direct market entry.
  
• Easy to dismantle
• Disadvantages
• Cannot engage in revenue generation.
• Taxation regardless of prohibition on profit
  making activities.
  

24
Joint Ventures

• First structure established by PRC to facilitate
  foreign investment in the country.
  
• Two JV structures available
• equity joint venture (EJV)
• cooperative or contractual joint venture
  (CJV).
  
• In some sectors JVs are the only means for
  foreign firms to get a foothold into the market
  (aviation, telecoms..)
  
• The larger the project, the more likely the
  Chinese government will require a EJV structure
  to be used

25
Reasons for entering into JV

• Lack of viable options
• JV is often the only investment vehicle
  permitted
  
• Real estate acquisition
• JV partner can provide land in crowded or
  expensive development areas
  
• Investors must make sure that land-use rights
  have been converted into granted rights and have
  been legally transferred to the JV
  
• Guanxi or brand
• Network of connections, sales and distribution
  clientele, or its strength as a brand name
  

26
also for Chinese partner

• Chinese partner looks to a foreign investor for
  the following
  
• Capital
• Management expertise and techniques
• Training opportunities for Chinese staff
• Financial engineering and rescue skills

27
Disadvantages of JV

• Inflexibility
• JV operations are governed by the initial JV
  contract
  
• Changes in the contract require
• unanimous vote of the board of directors
  (includes representatives of local and foreign
  partners)
  
• government approval
• creates difficulties in adapting to market
  changes
  
• Difficulties in expanding investment
• chinese party unable to contribute additional
  capital
  
• increase equity stake in the venture (requires
  unanimous vote by the board)
  
• Conflict of interest between partners
• management philosophies of Chinese and foreign JV
  partners may differ

28
Setup Process

• Divided into 4 stages
• Project approval
• Feasibility study approval
• JV contract/AOA approval
• Enterprise registration

29
Equity Joint Ventures

• Most common type of foreign business structure in
  China
  
• Method of transferring cash and expertise to
  domestic enterprises
  
• Independent chinese legal person with
  limited-liability
  
• EJVs are associations of one or more companies
  jointly undertaking a commercial enterprise with
  a Chinese partner
  
• Established for a fixed term (usually 10 50
  years)

30
Equity Joint Ventures

• Profits, risks and looses shared in proportion to
  the partners equity stakes
  
• determined by capital contributions
• Foreign participation must be at least 25 for
  the JV to enjoy preferential tax treatment
  afforded to FIEs.
  
• Equity can be contributed in the form of
• foreign currency,
• equipment,
• buildings
• intangible assets (industrial property)

31
Capitalization

• Parties must make their contributions in
  proportion to their equity stakes in the venture
  
• Parties may pay
• in a single lump sum within six months after
  license issued
  
• by installments
• 15 within three months
• 85 within one to three years
• If registered capital over US10m can negotiate a
  longer schedule
  
• Failure to meet the capital payment schedule
• revocation of business license
• payment of damages

32
EJV Management Structure

• Two tier structure
• Board of Directors
• appointed by investors
• Management organization
• responsible for day to day operation

33
Summary EJV

• Advantages
• Chinese partner will bring connections and an
  established sales and distribution network
  
• Local partner will bring local and particularized
  knowledge of both market and bureaucracy.
  
• Chinese partner will usually have or can easily
  obtain an operational site, which aides in
  efficient start-up
  
• Disadvantages
• JV contract often difficult to negotiate
• Differing objectives and management styles often
  result in conflict.
  
• Lack of control by foreign party
• Difficulty in selling shares in venture.

34
Cooperative Joint Venture

• Offer more flexibility
• Organized in a very similar manner to an EJV
• Profits, risk and looses distributed according to
  the JV contract
  
• can specify an accelerated return on investment
  for the foreign investor
  
• Mainly used in ventures
• involving large fixed assets (real estate and
  infrastructure projects)
  
• Where desired Chinese partner does not have
  sufficient cash/assets to contribute to an EJV

35
Kinds of CJVs

• Purely contractual arrangement
• each party agrees to
• undertake certain obligations
• provide certain capital (cooperative conditions)
• agreement sets out the objectives of the venture
  
  
• rights and obligations flow strictly from the
  contract
  
• no separate legal entity and therefore unlimited
  liability
  
• Independent Chinese legal person
• liability limited to the amount of capital of the
  JV
  
• sharing of profits and risks governed by
  agreement between the parties

36
CJV Agreement

• Parties should provide in the CJV contract
• investment or cooperation conditions,
• distribution of earnings or products,
• sharing of risks and losses,
• form of operation and management
• title to property upon termination of the CJV
• Since CJV is based on a contractual relationship,
  it leaves much room for negotiating profit
  sharing, management etc

37
Contributions

• Investment or cooperation conditions provided by
  parties may be in the form of
  
• cash,
• material objects,
• land-use rights,
• industrial property rights,
• non-patented technology
• other property rights.

38
Summary on CJV

• Similar to Equity Joint Venture in structure but
  with more flexibility because of the following
  
• Sharing profits is governed entirely by contract
• Foreign partner can obtain return of investment
  in priority to Chinese partner.
  
• Setup requirements similar to that of Equity
  Joint Venture.
  

39
EJV vs. CJV
40
Wholly Foreign Owned Enterprise

• Enterprises established by foreign investors in
  accordance with relevant Chinese law, exclusively
  with their own capital (Law of PRC on WFOEs)
  
• WFOE structure can only be used in certain
  business sectors (restrictions)
  
• Not authorized in PRC until 1986
• In 1997, WFOEs largest number of approved FIEs,
  eclipsing EJV
  
• WFOEs can better achieve business goals
• WTO accession made it easier to establish WFOE

41
Advantages of WFOE

• Complete management control (no chinese partner)
• avoid disputes and conflicts (common in JV)
• business decisions more flexibly and quickly to
  adjust operations to the demands of markets
  
• Simpler establishment procedures
• quicker negotiation and approval process (no JV
  contract)
  
• Easier to terminate
• JV can only be liquidated on agreement of both
  parties or through a court order
  
• Dissolution of a WFOE requires government approval

42
Advantages of WFOEs

• Foreign investors are entitled to all the
  profits
  
• reinvest or repatriate
• Greater control over
• confidentiality of technology
• IPRs
• Flexibility of location
• JVs located where local partner has an existing
  plant
  
• WFOEs are free to build on green field land

43
Potential Drawbacks

• Foreign investors may need more time and energy
  to develop their businesses (no Chinese partner)
  
• More legal restrictions on the establishment and
  operation of WFOEs (restricted in sensible areas)
  
  
• Foreign investor cannot rely on a Chinese partner
  to provide a site for operations.
  
• will have to make its own arrangements for land
  use

44
WFOE Registration Procedures

• WFOEs are established in three stages
• preparation,
• examination and approval,
• registration.

45
Preparation

• Prior to application for establishment, submit a
  report to the local government where enterprise
  is to be established
  
• Report shall include
• aim of the establishment
• scope and scale of business operation
• products to be produced
• technology and equipment to be used
• area of land to be used
• quantities of water, electricity, coal, gas and
  other forms of energy resources required
  
• requirement of public facilities.

46
Application

• WFOE application must be submitted to MOFCOM
  (local)
  
• Include following documents
• written application form (in chinese)
• feasibility study report
• articles of association of the WFOE (in chinese)
• name list of the legal representative
• legal and credit certifying documents
• inventory of goods and materials to be imported
• any other documents required
• Business License 90 days
• Registration (SAIC) within 30 days
• Secondary filings (tax, customs and SAFE) 30
  days

47
Articles of Association

• Most important document
• Must include
• name and location of the enterprise
• aim and scope of business operations
• total amount of investment, registered capital,
  and time limit for contributing investment
  
• form of organization
• internal organizational structures and functions,
  duties and limits of powers of legal
  representative, general manager, chief accountant
  and other staff members
• system of financial affairs, accounting and
  auditing
  
• labor administration
• term of business operations, termination, and
  provisions for liquidation
  
• procedures for the amendment of the articles of
  association.

48
Capitalization

• Capital contributions can be made in
• currency
• machinery
• equipment
• technology
• Capital paid according to schedule set forth in
  AOA
  
• Payment can be made in installments
• 15 or more within 90 days
• remaining within three years of establishment
• If not met, business license may be revoked
• FIEs may not reduce registered capital
• Increases or reassignment must be
• approved by original approval authorities
• registered with SAIC

49
Total Investment and Capitalization

• Ratio between registered capital and total
  capital investment
  
• Total investments up to 3,000,000, registered
  capital must be a minimum of 70 of this amount
  
• Total investments over 3,000,000 to 10,000,000,
  registered capital must be a minimum of 50 of
  this amount
  
• Total investments over 10,000,000 to
  30,000,000, registered capital must be a minimum
  of 40 of this amount
  
• Total investments over 30,000,000, registered
  capital must be a minimum of one third of this
  amount.

50
Summary on WFOE

• Advantages
• Quicker setup as there is no Chinese partner
• Simpler management structure and objectives which
  are simply those of the parent organization.
  
• Disadvantages
• Independence is often, in itself, a shortcoming
  because of lack of connections, established
  markets, and local knowledge.
  
• WFOEs cannot operate in some sensitive areas such
  as securities.

51
Liquidation of JVs and WFOEs

• Liquidation can occur voluntarily and
  involuntarily.
  
• FIEs declared in bankrupt liquidated in
  accordance with laws and regulations on
  liquidation due to bankruptcy.
  
• Solvent FIEs who wish to liquidate, may proceed
• in accordance with constituting documentation
  (AOA)
  
• procedures set out in laws
• appointment of a liquidation committee to oversee
  the process

52
Restructuring the Joint venture

• Restructuring FIEs through M A
• need to rationalize investments
• create new investment opportunities
• Transforming EJV to a WFOE.
• not possible to use the restructuring of a JV to
  circumvent WFOE restrictions
  
• relevant authorities must approve the new created
  WFOE
  
• creation of WFOE only allowed if not restricted
  or forbidden sector

53
Holding Companies

• Established as JVs or WFOEs
• Allows to consolidate all China projects under
  one corporate umbrella
  
• No direct involvement in production activities
• Minimum registered capital US30m
• Latest changes in 2004 regulations
• allow to provide after-sales service for all
  products that it imports (before limited to
  parents company)
  
• sell imports made by its overseas parent company
  (no retail)
  
• entrust other enterprises to manufacture its
  products or the products of its parent company
  and sell them on the domestic and overseas
  markets

54
Holding Companies

• Over 250 foreign investors have established
  holding companies
  
• Examples
• Unilever,
• Rhone-Poulenc,
• Philips,
• Motorola,
• General Electric,
• Siemens
• BOSCH

55
Establishment Requirements

• Total asset value of US400m in the year prior to
  application, have established FIEs with a paid-up
  capital of over US10m and plans for three or
  more investment projects.
• Ten or more FIEs established in China with
  paid-up capital of at least US30m.
  
• If established as JV, Chinese partner must have
  assets of at least Rmb100m

56
Establishment Procedure

• Holding company must be approved (both)
• by commercial department of the city or province
  in which it is to be established
  
• by MOFCOM
• Registration with SAIC, tax bureau, customs
  bureau and SAFE are required
  
• Registered capital must be paid in full within
  two years of approval
  
• must be paid in cash
• existing paid-in capital of FIEs in China may not
  be used to capitalize the holding company.
  

57
Acquiring Control

• Holding company acquires control over existing
  FIE by
  
• assign the equity interests to the holding
  company as a gift
  
• use the holding companys earnings to purchase
  the equity from the foreign investor
  
• increase the holding companys registered capital
  (US30m) as necessary to acquire the FIE

58
Offshore Holding Companies

• Valuable tool to manage China investments
• Established in tax free Jurisdictions (HK, BVI,
  Mauritius)
  
• Benefits
• Exit Strategy
• easy transfer of interests in the China operation
  (offshore transfer)
  
• no approval needed from SAIC, MOFCOM or SAFE
• Limiting Liability
• liabilities incurred by the China entity will be
  the liability of the holding company
  
• Transfer Pricing
• lower taxes for products made in China but sold
  elsewhere

59
Offshore Holding Company

• Tax Benefits
• Offshore money held by holding company will be
  tax free
  
• In China impact of China taxation can be managed
  by licensing the IP from parent company
  
• In Home Jurisdiction, money can be
• repatriated at a tax advantageous time
• reinvested in international ventures

Parent Company
Offshore Company
Chinese Company
IP
IP