Lehman, Lee & Xu

雷曼律师事务所 Edward E. Lehman Macau University of Science and Technology 澳门科技大学

November 2007 2007 年 11 月

Foreign Direct Investment Investment Vehicles

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Market Statistics

    In 2003, China surpassed US as leading destination for FDI In 2007, China and India were main destinations for FDI in the world FDI will exceed USD 70 billion in 2006 Between 1978 and 2007, average GDP growth rate over 9.5% Lehman, Lee & Xu - www.lehmanlaw.com

Market Entry Essentials

    

Have a clear entry strategy

what   how where

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.

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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 3 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% (

To be modified when the new Income Tax Law enters into effect on January 2008

) Lehman, Lee & Xu - www.lehmanlaw.com

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 25%

( To be modified when the new Income Tax Law enters into effect on January 2008 )

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New Income Tax

   To be effective on Jan. 1, 2008 Introduce the concept of "Tax Resident Enterprise" ("TRE")  Tax Resident Enterprise" ("TRE") concept is introduced whereby TREs are subject to China income tax on worldwide income, and non-TREs on China source income.

 FIEs registered in China are always TRE.

 Foreign Enterprise ("FE") whose effective management institute is based in China is regarded as a "TRE".

Tax Rate – FIEs

 Standardised rate of 25%, with reduced rate of 20% for qualified small and thin profit companies.

 15% for encouraged high/new-tech enterprises.

 FIEs approved before the publication date of the CIT Law and currently taxed at 15% or 24% will be offered a gradual increase to 25% within 5 years.

 High/new tech enterprises no longer need to be located within so called high-tech parks and can enjoy tax incentives wherever located.

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New Income Tax

 

Tax Rate – FEs

 20% withholding tax ("WHT") rate for passive income derived by Non-TREs.

 Foreign investors may explore potential use of a Special Purpose Vehicle resident in treaty countries/regions to do WHT planning .

Tax Incentive Policy

 The tax incentive policy is shifting from "Geography based" tax incentives to "Pre-dominantly Industry oriented, Limited Geography-based" tax incentive policy.  The new tax incentive policy is focused on high/new technology which is critical to China's future success.

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New Income Tax

 

Previous preferential tax treatments

 Unused tax holiday of FIEs approved to be established before CIT Law is grandfathered till the expiry. Where the tax holiday has not yet started because of tax losses, it shall be deemed to commence from the first effective year of Unified CIT Law.

 New FIEs which engage in high/new-tech industries encouraged by the State and located in SEZs and Pudong may enjoy transitional preferential treatments (to be defined).

 Enterprises in encouraged industries located in Western regions would continue to enjoy the existing tax incentives.

Tax Deductions

   Most rules similar to current law for FIEs.

Charitable donation is limited with a cap.

Non-deductible expenses have been expanded to include sponsorship expenses, and unverified provisions and reserves.

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FDI Legal Framework

 Legal framework guiding foreign investment in China: 

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 Lehman, Lee & Xu - www.lehmanlaw.com

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.

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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 Lehman, Lee & Xu - www.lehmanlaw.com

Foreign Investment Operating Structures

 Representative Office  Equity Joint Venture  Cooperative Joint Venture  Wholly Foreign Owned Enterprise  Holding Company Lehman, Lee & Xu - www.lehmanlaw.com

Representative Office

 Straightforward and i nexpensive 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 Lehman, Lee & Xu - www.lehmanlaw.com

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.

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Legal Framework

   People's Republic of China State Council Interim Provisions on the Administration of Resident Representative Offices of Foreign Enterprises ( 中華人民共和國國務院關於管理外國企業常駐代 表機構的暫行規定 ) Measures for the Administration of Registration of Resident Representative Offices of Foreign Enterprises ( 外國企業常駐代 表機構登記管理辦法 ) Detailed Rules for the Implementation of the Examination, Approval and Administration of the Resident Representative Offices of Foreign Enterprises in China ( 關於審批和管理外國 企業在華常駐代表機構的實施細則 ) Lehman, Lee & Xu - www.lehmanlaw.com

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 Lehman, Lee & Xu - www.lehmanlaw.com

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!

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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 Lehman, Lee & Xu - www.lehmanlaw.com

How to Establish a Rep Office

 

Two separate stages:

  applying for approval applying for registration

Upon registration, Registration Certificate (

登記証

) 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 US$10,000 Lehman, Lee & Xu - www.lehmanlaw.com

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 Lehman, Lee & Xu - www.lehmanlaw.com

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 ( 批準証書 )) Lehman, Lee & Xu - www.lehmanlaw.com

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) Lehman, Lee & Xu - www.lehmanlaw.com

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 Lehman, Lee & Xu - www.lehmanlaw.com

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.

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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.

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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 Lehman, Lee & Xu - www.lehmanlaw.com

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 Lehman, Lee & Xu - www.lehmanlaw.com

…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 Lehman, Lee & Xu - www.lehmanlaw.com

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 Lehman, Lee & Xu - www.lehmanlaw.com

Setup Process

 Divided into 4 stages: 

Project approval

 

Feasibility study approval JV contract/AOA approval



Enterprise registration

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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) Lehman, Lee & Xu - www.lehmanlaw.com

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) Lehman, Lee & Xu - www.lehmanlaw.com

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 two years (five years for investment companies)

If registered capital over US$10m can negotiate a longer schedule Failure to meet the capital payment schedule:   revocation of business license payment of damages Lehman, Lee & Xu - www.lehmanlaw.com

EJV Management Structure



Two tier structure:

 Board of Directors  appointed by investors  Management organization  responsible for day to day operation Lehman, Lee & Xu - www.lehmanlaw.com

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 .

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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 Lehman, Lee & Xu - www.lehmanlaw.com

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 Lehman, Lee & Xu - www.lehmanlaw.com

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… Lehman, Lee & Xu - www.lehmanlaw.com

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.

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Summary on CJV

  Similar to Equity Joint Venture in structure but with more flexibility because of the following: 1.

2.

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.

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EJV vs. CJV

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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 Lehman, Lee & Xu - www.lehmanlaw.com

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 Lehman, Lee & Xu - www.lehmanlaw.com

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 Lehman, Lee & Xu - www.lehmanlaw.com

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 Lehman, Lee & Xu - www.lehmanlaw.com

WFOE Registration Procedures



WFOEs are established in three stages:



preparation,

 

examination and approval, registration.

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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.

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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 Lehman, Lee & Xu - www.lehmanlaw.com

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.

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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 two 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 Lehman, Lee & Xu - www.lehmanlaw.com

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.

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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.

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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 Lehman, Lee & Xu - www.lehmanlaw.com

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 Lehman, Lee & Xu - www.lehmanlaw.com

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 US$30m Latest changes in 2004 regulations:  allow to provide after-sales service for all products that it imports (before limited to parent’s 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 Lehman, Lee & Xu - www.lehmanlaw.com

Holding Companies

 Over 250 foreign investors have established holding companies  Examples:        Unilever, Rhone-Poulenc, Philips, Motorola, General Electric, Siemens BOSCH Lehman, Lee & Xu - www.lehmanlaw.com

Establishment Requirements

 Total asset value of US$400m in the year prior to application, have established FIEs with a paid-up capital of over US$10m and plans for three or more investment projects.  Ten or more FIEs established in China with paid-up capital of at least US$30m.

 If established as JV, Chinese partner must have assets of at least Rmb100m Lehman, Lee & Xu - www.lehmanlaw.com

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.

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Acquiring Control

 Holding company acquires control over existing FIE by:  assign the equity interests to the holding company as a gift;  use the holding company’s earnings to purchase the equity from the foreign investor;  increase the holding company’s registered capital (US$30m) as necessary to acquire the FIE Lehman, Lee & Xu - www.lehmanlaw.com

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 Lehman, Lee & Xu - www.lehmanlaw.com

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 Parent Company IP Offshore Company IP Chinese Company  In Home Jurisdiction, money can be: 

repatriated at a tax advantageous time



reinvested in international ventures

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Two Relevant Case Studies of Direct Investment in China



1) Carrefour



2) Microsoft

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Carrefour Case Study

 

Entering into the Chinese market:

  China partially opened its retail for foreign investment in 1992.

Carrefour entered China in 1995 by forming a joint venture with the Chinese firm Zhong Chuang, establishing a firm named “Jia Chuang” to hold the majority of shares.

 To set up its stores the company entered into direct deals with different local governments.

Local approach to the Chinese market

:  Carrefour considered the country to be comprised of several small markets.

 Most of the products were procured from China.

 Store formats, location, and the products sold were customized according to the local preferences.

 Store managers were empowered to run the stores according to the local requirements Lehman, Lee & Xu - www.lehmanlaw.com

Carrefour Case Study

 

Descentralized management.

 Store managers operate stores with complete freedom.

 Freshness ensured by procuring the majority of its products locally (a well valued atribute by chinese consumers).

Results of Carrefour strategy

 In China, where vast economic, social, and cultural differences existed among different provinces, Carrefour has been able to cater to the needs of different customers successfully.

 As of 2007, Carrefour operates in China through its 80 hypermarkets and around 250 hard discount stores.

 China is Carrefour's sixth largest market, with sales of over € 2.06

billion.

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Microsoft Case Study

  

Chinese market arrival: 1992

 In 1992 Microsoft entered in the Chinese Market by setting up a Rep. Office.

 Wrong pricing strategy: Microsoft charged same prices as elsewhere in the world.

Piracy:

 Counterfeit copies available on the street at very cheap prices.

 The problem was not brand acceptance. Everyone was using Windows but no one was paying.

 Microsoft fought unsuccessfully to protect its intellectual property.

Another problem was:  The promotion and implementation of Linux operating systems by the Bejing Government.

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Microsoft Case Study



Tolerating piracy as strategy:

 By 2001, Microsoft realized that usual pricing strategies were going to fail due to China ´ s weak IP enforcement.

 Tolerating piracy turned out to be Microsoft's best long term strategy:  Windows is used on an estimated 90% of China's 120 million PCs.

 Piracy helped to compete with Linux. A counterfeit copy of windows is cheaper. The latter requires less discs.

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Microsoft Case Study

 

Local Investment and Institutional cooperation.

 Microsoft set up a long-term vision strategy that matches with the government's development agenda to get their support.

 Launching extensive training programs for teachers and software developers.

  Microsoft computing initiatives in rural areas of China.

Making officials participate to decide in which local software and outsourcing companies should invest.

Chinese government started thinking more like Microsoft:

 It required central, provincial, and local governments to begin using legal software.

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Microsoft Case Study



Microsoft's strategy outcome

 In 2006 the Chinese government required local PC manufacturers to load legal software on their computers  Microsoft Corp. and Lenovo announced in 2007 a global agreement to pre-load Windows Live services on Lenovo PCs sold worldwide.

 More than 24 million PCs will be sold in 2007, adding to the 120 million already in place.

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