Introduction to Investment in PRC
Investment Fields
Before entering the Chinese market, it is crucial to verify whether the field in which you wish to conduct business activities is open to foreign investments. Until recently, the Chinese National Development and Reform Commission (“NDRC”), together with the Chinese Ministry of Commerce (“MofCom”), periodically published the “Catalogue of Industries for Guiding Foreign Investment” (the “Catalogue”). This catalogue listed fields where foreign investments were encouraged, restricted, or forbidden. Any fields not expressly listed in the Catalogue were open to foreign investments, while restricted fields may be accessible upon special approvals or only in partnership with a local PRC co-investor.
Since 2015 (for the Free Trade Zones), 2018 (nationwide), and 2021 (Hainan Free Trade Port), NDRC and MofCom replaced the Catalogue with the Special Administrative Measures on Access to Foreign Investment (the “Negative List”). Unlike before, the Negative List not only enumerates forbidden and restricted fields of investment but also drastically reduces the number of restricted investment areas. Such Negative Lists (one related to the Free Trade Zones and one for the rest of PRC territory) are published annually.
Consulting the Negative List is the first step to undertake if you intend to invest in China. It is paramount to verify whether the field you want to invest in is freely accessible or forbidden, or if, for example, you require a Chinese partner or special approvals. Once you have ascertained the above, you can plan the next step in your investment, which is choosing the appropriate investment vehicle.
Investment Vehicles
Traditionally, Chinese law allowed three types of Foreign Investment Vehicles: the Representative Office (“Rep Office”), the Sino – Foreign Joint Venture Enterprise (“JV”), and the Wholly Foreign – Owned Enterprise (“WFOE”). Since the Foreign Investment Law became effective in 2020 and with the abrogation of the JV Laws and regulations and of the WFOE law and regulations, all foreign investment vehicles which are legal persons (namely, JV and WFOE) are equivalent to Chinese-owned legal persons and shall enjoy access to the market not less favorable than that reserved for Chinese-owned companies. The sole major exception is the access restrictions set forth in the Negative List.
After envisioning the fields or areas where you want to invest, it is equally important to select the most appropriate vehicle that can achieve your goals. Below is a brief description of the above-listed vehicles:
Representative Office
The Rep. Office was historically the first vehicle that allowed foreign investment in China. Initially, both profit-generating and nonprofit-generating Rep. Offices were allowed. Over time, however, the possibility to establish a profit-generating Rep. Office has been abrogated, and the Rep. Office retained its importance as a vehicle used by foreign investors to “test” and evaluate the Chinese market. With recent developments and reforms of the PRC Company Law, and changes in the regulations for the establishment of Rep. Offices (2018), however, the Rep. Office rapidly lost its appeal.
A Rep. Office is not a legal person and, as such, cannot directly hire local personnel in China. The hiring process shall be handled through PRC labor intermediary and dispatch companies. It can hire (through its headquarters) only up to three foreign employees as Representatives.
The Rep. Office cannot engage in profit-making activities, i.e., cannot become a center of profit, but can only operate as a liaison office for its foreign headquarters (for example, to facilitate communications and negotiations between the headquarters and its Chinese clients/suppliers) or for market research (for the benefit of its headquarters only), participation in fairs and exhibitions, and promotional activities on the headquarters’ goods/services.
On the other hand, a Rep. Office in China is subject to local taxation based on either the actual profit generated for the headquarters or, where such calculation is not possible, based on the deemed profits that it generates for the headquarters (either through a “cost-plus” method or a “deemed profit method”).
Traditionally, establishing a Rep. Office has always been faster than establishing a limited liability person. However, with recent changes in the companies’ establishment procedure, this is no longer the case. Establishing a Rep. Office can take the same time or even longer than establishing a WFOE or a JV. Additionally, in order to be allowed to establish a Rep. Office, the overseas headquarters shall be a legal person incorporated for two years or more.
Contrary to the WFOE or the JV, the foreign headquarters of a Rep. Office shall have no obligation to pay registered capital to the Rep. Office. However, it shall be highlighted here that, in any case, being the Rep. Office unable to independently generate income, its headquarters shall have the responsibility to cover all and any cost generated by the Rep. Office itself.
The governance of a Rep. Office is straightforward: it shall have a Chief Representative and can have up to three Representatives.
The liquidation of a Rep. Office can be as complex and lengthy as the liquidation of a company, and it could take months. In general, the longer the Rep. Office was in operation, the longer and more complex the liquidation procedure may become.
To summarize, a Rep. Office could still be a useful vehicle for investors who do not intend to carry out actual business and profit-generating activities in China in the short–medium term and require a simple structure to liaise with existing clients/suppliers or intend to expand their client/supplier base while keeping their actual operations overseas.
Sino – Foreign Joint Venture Companies
The JV (either Equity or Cooperative JV) was the preferred vehicle for investors who wanted to enter China sharing the risk with a Chinese partner while relying on its expertise and knowledge of the local market.
Traditionally, one of the main differences between a JV and a WFOE was in company governance: in the JV, some major decisions (set by the law itself) should have been unanimously taken, thus with a great risk of incurring in deadlock situations.
It has to be noted that currently, JVs are primarily selected by foreign investors either because they consider the support of a Chinese partner within the company (i.e., not as an external partner) absolutely indispensable for the success of the investment, or because the Negative List imposes the participation of a Chinese partner as a requirement.
With the PRC Investment Law and the abrogation of the JV laws and regulations, current legislation has unified JVs and WFOEs to Chinese domestic companies. For this reason, the use, governance, establishment, and liquidation procedures of JVs will be analyzed together with the WFOE below.
Wholly foreign – owned Enterprises
A WFOE is a limited liability company whose shareholder(s) are non-Chinese legal persons or individuals. As such, it can carry out all profit-making activities listed in its business scope, freely and directly hire Chinese and foreign individuals (provided that the foreign individual is eligible for employment in China, see chapter related to Labor and Employment), and bear its own obligations independently from its shareholder(s).
Previously, the establishment of a WFOE was a lengthy and complex procedure that could take up to 3 months or more from the initial submission of the documents required by local PRC authorities. Nowadays, however, national and local authorities have carried out reforms that simplified the establishment procedure and drastically cut the timing: in some municipalities, a WFOE can now be established in a few days and be in operation (legally speaking) in less than a month. To proceed with the incorporation, the foreign shareholder(s) shall provide some documents (among which its passport or certificate of incorporation, authenticated by the local notary office/overseas government office, and legalized by the competent PRC Embassy/Consulate), shall sign relevant PRC application forms, letters of appointment, the WFOE bylaws, and a lease agreement in China.
In this sense, it is very important to verify that the office/site selected for establishing the WFOE is suitable for the activities that the company shall carry out in China before signing the lease agreement: in fact, not only the office itself shall have an appropriate destination of use (for example, commercial for retail activities, office for consulting services and office usage, industrial for production activities, etc.), but in rare cases, we encounter cases in which the office building itself has been blacklisted, and while this blacklisting will not impact the incorporation procedure itself, it could cause inconveniences adversely impacting the operations of the company.
Contrary to previous legislation, currently, there are no minimum requirements of registered capital in order to establish a WFOE, so that in theory, a foreign shareholder could establish a Company even contributing 1 CNY. Furthermore, the previous timeframe to actually pay the registered capital has been canceled, and the contribution could be made at any time (either in a lump sum or with partial payments) during the life of the company. However, it shall be noted that PRC authorities have discretionary power to request foreign shareholder(s) to indicate an “adequate” level of registered capital to proceed with the establishment procedure.
We have also to highlight that contrary to what is common practice in many jurisdictions, once the registered capital has been spent it cannot be freely reconstituted but the Shareholder(s) shall apply for either an increase of the registered capital or a Shareholder(s) loan: considering that such procedures may take up time (in some cases up to few months) and represent an additional cost for the company, we always recommend determining the amount of registered capital in consideration of the actual operating costs of the WFOE and its forecasted cash flow.
The Shareholder/board of the Shareholders is the higher deciding body within the WFOE and their members, in general, will have voting powers in proportion to their capital contribution. The governance structure of a WFOE shall be comprised of at least three individuals: one Legal Representative (or CEO, who can also concurrently be the WFOE General Manager), one Supervisor, and one Chief Financial Manager, but it can be also more complex based on the needs of the shareholder(s), and can, therefore, possess a Board of Directors (from 3 to 13 members), a Board of Supervisors, a General Manager, and a Deputy General Manager.
The Legal Representative is a very important role within the WFOE: it is, in fact, not only the person authorized to sign all and any document binding the company towards third parties but also the person that represents the company under civil, administrative, and criminal law and that may prima facie be held liable for all the wrongdoing and breaches of the WFOE itself. It also means that it may be the recipient of all and any measures restricting its personal and civil rights (such as travel restrictions, restriction in covering future positions as a board member, other cautionary measures restricting personal freedoms, etc.).
For the actual operation of the WFOE, a special chapter shall be dedicated to the corporate seals/chops. Contrary to many jurisdictions, the corporate chops in China are very important as they may be compared to a notarized/authenticated signature: for this reason, any document bearing a corporate seal will bind the WFOE towards third parties, and it is, therefore, of utmost importance to carefully manage and keep custody of such chops to avoid risks and liabilities. A WFOE possesses at least 5 types of chops:
Company Chop: it is the most widely used: in general, it should be used in all and any documents related to corporate changes or activities (increase/reduction of registered capital, opening/closing of branches, liquidation, opening/closing of bank accounts, etc.) and to “certify” the authenticity of photocopied corporate documents (such as the copy of the company business license). In practice, it is often used also to stamp contracts and other documents. Contract Chop: in general, to be used for signing contracts and other bilateral and multilateral binding documents. Financial Chop: usually used together with the Company Chop and Legal Representative Chop in documents issued or pertaining to the company bank. Legal Representative Chop: this chop is used together with the Company Chop and Financial Chop in documents issued or pertaining to the company bank or can be used together with the Contract Chop for signing contracts and other bilateral and multilateral binding documents or can be used together with the Company Chop in documents pertaining to corporate activities or procedures. Tax Invoice Chop: it is used to stamp the paper tax invoices issued by the Company.
However, according to the actual operations of the WFOE, other chops may be issued, such as Customs Chop, Translation Chops, etc.
Another specific chapter shall be dedicated to the foreign currency operation of the WFOE: in principle, according to the Foreign Investment Law, WFOEs shall be freely allowed to remit in or out of China their capital contributions, profits, capital gains, income from asset disposal, intellectual property royalties, compensation, indemnity or liquidation income and so on lawfully acquired within the territory of China, in Renminbi or any other foreign currency. This means that by following relevant banking and State Administration for Foreign Exchange procedures, a WFOE is allowed to make such payment overseas to its Shareholder(s) or to third parties. In practice it has to be notices that, however, in some instances banking procedures can be quite time consuming and such remittances shall be planned considering and pondering the time factor in order to avoid problems.
Finally, we want to briefly analyze the procedure to liquidate a WFOE: in fact, while recent reforms shortened and simplified the procedure to establish a Company, the liquidation procedure has been only marginally simplified: the liquidation procedure involves the cancellation from all and any authorities where the WFOE has been previously registered (for example, AIC, Customs, Tax Bureau) and will be subject to an in-depth scrutiny from the tax bureau so to ascertain that all previous taxes have been correctly paid. Suffice to say that due to the need to make third parties aware of the shareholder(s) intention to liquidate (so that any creditors may submit its claims: it takes 45 days), the deregistration procedure, and the WFOE bank account closing, an average liquidation process averagely take at least 6 months from the moment where the documents have been submitted until the bank accounts have been closed and any outstanding funds have been remitted to the WFOE Shareholder(s), but it could take up to more than a year in case issues or irregularities will arise.
In order to shorten the time of a liquidation, it is very beneficial that the WFOE has been properly managed (so that no authorities will pose problems in the deregistration phase), that the accounting books have been properly kept and filed, and that the deregistration procedure (like any other procedure in China, for that matter) is followed to the letter.
