Due to China’s increasing importance in the global economy, companies should examine the possibility of establishing operations inside its boundaries. Foreign investors, particularly financial investors and entrepreneurs, should consider establishing a subsidiary in China in order to effectively conduct business in China or with Chinese companies, according to the World Bank.
This page offers basic information on the process of establishing a subsidiary by foreign investors in order to assist in providing advice and demystifying the procedure. The purpose of establishing a subsidiary in China is to provide a local presence for the parent company. It is recommended that individuals who have long-term commercial goals in China explore the establishment of a subsidiary in the country.
Foreign companies are permitted to enter into certain commercial contracts with Chinese enterprises, such as sales contracts, licence agreements, and distribution agreements, but they are not permitted to conduct direct business in China without first obtaining an approved business licence from the Chinese government.
Doing business in China via a subsidiary is at the very least advantageous—and in some cases, a requirement—for international businesses seeking to overcome certain legal and commercial limitations in the country. Some international businesses may already have a representative office in China, which is known as a resident representative office.
Representative offices serve as internal liaisons for the parent business in which they are located. However, they are not permitted to do direct business in China. The fact that resident representatives are not recognised as independent legal persons under Chinese law means that they are not permitted to assume independent civil liabilities to a third party, which prevents them from engaging in significant commercial activities such as signing commercial contracts with third parties. They are also not permitted to recruit directly from the local Chinese population. There are certain exceptions, such as a lease deal for office space, which are strictly enforced. If your company is looking to invest directly in China, recruit local employees, conduct research and development, produce goods, and sell your products or services directly to the Chinese market, you should consider creating a subsidiary there.
A “subsidiary in China” is defined as a company in which at least one of the shareholders is a foreign corporation or person (“foreign investor”), which was formed or has citizenship outside of China, as defined in this document. In China, a subsidiary is often referred to as a “Foreign Invested Enterprise” (FIE). The proportion of equity shares held by foreign investors in a foreign-owned enterprise (FIE) shall not be less than 25% 1. It is preferable for a business to be classified as a domestic company rather than a FIE if all of its shareholders are Chinese registered companies or residents of the People’s Republic of China.
The Company Law of China governs both foreign-owned enterprises and domestic corporations, although foreign-owned enterprises are subject to extra or different rules and regulations than domestic corporations in a number of aspects. For example, in some industries where foreign investors are prohibited, such as telecommunication services and online content providers, even if a foreign enterprise is permitted, it is subject to restrictions such as a maximum equity ownership by foreign investors (which means that the foreign investor must enter into a joint venture with a Chinese partner), additional requirements for the qualification of its investors, and/or a lengthy approval process before it can operate. As a result, it is not uncommon for a foreign investor to instruct connected Chinese individuals or organisations to create a pure domestic business in place of or concurrently with the establishment of a FIE in an authorised sector.
This structure allows the establishment of contractual agreements between the foreign investor, its non-restricted foreign investment enterprise in China, and the local business. Such agreements with connected domestic businesses may offer flexibility, which may enable foreign investors to achieve their business goals more swiftly and effectively than they would otherwise be able to accomplish.
In China, the first three businesses are referred to be limited liability corporations, but the obligations of shareholders in joint-stock companies are likewise restricted by the number of shares they have subscribed for. Joint-stock limited companies (JSCs), in which foreign investors own more than 25% of the shares, are not as popular among foreign investors as the first three types of corporations. The most important reason is that a foreign investment enterprise joint-stock company limited must be authorized by the Ministry of Commerce at the national level. A larger minimum investment amount is needed, and the approval period is considerably longer.
Furthermore, until three years following the formation of a joint-stock company, the promoters’ shares in the company may not be transferred to a third party. In order to avoid this, most foreign investors would opt for a WFOE, CJV, or EJV unless the Chinese subsidiary itself plans to go public on the Chinese stock market in the near future (which is rare). Unless the sector in which the FIE operates precludes it from operating as a WFOE, foreign investors should take their own business strategy and circumstances into consideration when deciding between a WFOE and a JV. At the moment, more foreign investors are opting to do business via WFOEs if they are operating in an industry that allows them.
A joint venture (JV) structure may be considered if a foreign investor must rely heavily on local support, such as land, factories, equipment, or access to local sales and market channels. If the foreign investor’s Chinese partner is able to assist the JV with these items, the JV structure may also be considered. But since many foreign investors are now more acquainted with China’s markets and business environment, a WFOE is suitable for foreign investors who can provide local assistance on their own by employing qualified locals. Aside from that, many Chinese government officials are getting more used to communicating directly with international corporations.
Therefore, a WFOE is not always a disadvantage for FIEs that depend significantly on local resources and channels to do their business. Furthermore, the parent business of a WFOE often has greater freedom in terms of managing the administration of a FIE, regulating its intellectual property problems, entering into contractual agreements with the WFOE, and withdrawing from a FIE. Instead than establishing a new FIE from the ground up, a foreign investor may establish a subsidiary by purchasing an existing FIE or a domestic business, with the acquired operation becoming a WFOE or a JV, rather than starting from scratch. Who Establishes a Subsidiary and Where Should It Be Located? According to Chinese legislation, the foreign investor’s place of origin has no bearing on the approval process or treatment of his or her foreign-owned enterprise (FIE) in China. Foreign investors, regardless of whether they are registered in the Cayman Islands or the United States, are subject to the same approval procedures, rules, and treatment as domestic investors. For the purposes of FIEs, foreign investors from special economic zones such as Hong Kong, Taiwan, and Macao are also considered foreign investors. It goes without saying that various nations will have varied tax consequences for foreign investors, depending on whether or not there is a bilateral taxation agreement between China and the investor’s home country. Additionally, while choosing who will set up the subsidiary and where it will be situated, the investor should take into account its future plans to leave the FIE, as well as tax planning from the viewpoint of other relevant countries, when making the decision. When choosing where to establish a subsidiary, one of the most important considerations is the availability of a competent personnel pool.
The presence of neighbouring universities and colleges facilitates the recruitment of competent research and development personnel for high-tech companies. It should come as no surprise that many high-tech firms are based in Beijing and Shanghai, the two most populous cities in the country. City centres in a variety of other industrialised areas, including as Jiangsu, Zhejiang, Sichuan and Guangdong Provinces, also offer significant numbers of high-tech workers. Manufacturing subsidiary investors would also want to locate manufacturing plants and distribution centres in locations where there is a sufficient supply of skilled personnel to support manufacturing operations. It is also critical to have positive relationships with local Chinese government officials and businesses (known as “Guanxi”). An area where they may maintain regular and close touch with local government officials, as well as small companies, is attractive to many prospective investors. Alternatively, they may choose to choose a place.
However, there are significant distinctions between an EJV and a CJV, both of which need the foreign investor to collaborate with a local Chinese partner in order to establish the business. Shareholders in an EJV should have their obligations and rights assigned in accordance with their equity percentage, whereas shareholders in a CJV should be able to organise the company in a more flexible manner. This allows them to engage capable managerial personnel who already have established local relationships. A good Guanxi, which now stresses communication rather than under-the-table transactions, will usually assist the subsidiary in getting its company up and running more quickly and efficiently.
Many towns and regions have created industrial and high-tech parks in order to entice investors to locate their businesses inside the park by offering a variety of advantages. The nature of the park and the type of its FIEs determines the tax advantages available, which are primarily those related to income tax and importation taxes. With the exception of a few municipal taxes and fees, the majority of significant FIE taxes and fees are governed at the federal level. Investors should make certain that the park they choose has been formally recognised by the government of the state in which they live. When deciding which city to locate in, foreign investors must take into account a variety of other key variables, such as job pools, local support, Guanxi, transportation, and infrastructure.
Table of Contents
The Incorporation Procedure and the Approximate Investment
Approval authorities include the Ministry of Commerce or its equivalent authority at the province or municipal level (collectively, “approval authorities”). Approval authorities are also required for foreign investment enterprises (FIEs). The capacity of a local government to authorize a foreign investment enterprise (FIE) is dependent on the amount of total investment and the type of industry in which the FIE wants to operate. In most cases, approval by the central approval authority takes much longer, and many investors prefer to have the subsidiary authorized by the local approval authority. Currently, the majority of FIEs may only be authorized at the municipal or provincial levels of government. Many foreign-owned enterprises (FIEs) that are not subject to particular legislative limitations may be authorized and registered within one month provided all of the necessary papers are completed and submitted immediately to the local approval authority.
When a foreign investment enterprise (FIE) is authorised, it must register with the State Administration for Industry and Commerce or its equivalents at the province or municipal level (together, the “registration authority”). In exchange for receiving its business licence, the FIE is deemed to be legally formed and incorporated by the registration authorities.
For the sake of foreign investment, Chinese legislation separates industries into four categories: those that are
1) encouraged,
2) permitted,
3) limited, and
4) banned.
As a result of the World Trade Organization, China has become less restrictive in terms of the number of sectors that may accept international investment.The registration charge, the announcement fee, and the registered capital are the primary expenses associated with forming a FIE. The registration authority collects the registration fee and the announcement charge, which are both calculated depending on the amount of registered capital. These two costs will often range from US$1,000 to US$3,000 in total. Even while costs for foreign-owned enterprises (FIEs) with more investment may be higher, they are often less than US$8,000.
“Registered capital” is the single most significant expense element for foreign investors in general (which also determines the amount of the government-collected registered fee and announcement fee). According to Chinese legislation, shareholders must invest actual money (either in cash or in kind) into the business. All shareholders of a foreign investment entity (FIE) are required to contribute to the registered capital of the invested company in proportion to their respective ownership percentages. This contribution must be made in full by the shareholders within a specified time period after the FIE is established, as described in the incorporation documents. In order to qualify for a business licence, the initial contribution to registered capital must be no less than 15 percent of the total registered capital and must be made within 90 days of the company licence being issued.
Local governments have varying regulations regarding the minimum registered capital of foreign-owned enterprises (FIEs). If you want to start a manufacturing FIE in Shanghai, you will need US $200,000, and if you want to start a service FIE in Beijing, you will need US $140,000. In Shanghai, you will need US $200,000, and in Beijing you will need RMB 500,000 (a little more than US $60,000). Nonetheless, since the registered capital is paid within the time frame specified in the incorporation papers, it still allows investors to contribute capital at their own speed, as long as they do so within the specified time frame. Within three years of a WFOE’s establishment, investors in the company are obliged to transfer all of their registered capital to the company.
Using Local Service Providers to Complete Your Project
There are several approved agencies that specialise in assisting foreign investors in the establishment of foreign-owned enterprises (FIEs). They may assist with the preparation of incorporation papers as well as communication with approval and registration authorities. With their assistance, the incorporation procedure may be sped up considerably. However, since many local governments are eager to welcome foreign investment, the approval of a typical foreign-owned enterprise (FIE) is quite straightforward. Many investors discover that they can manage the approval procedure on their own, without the help of an agency.
Lawyers may also assist their clients in obtaining permission and registration from the appropriate government agencies. Sometimes attorneys collaborate with authorised agents, which may be more cost-effective for the client since the agent streamlines routine work with the authorities while the lawyer ensures that all legal papers and approval processes are completed correctly.
In order to save money, many start-ups choose to handle all elements of the FIE formation on their own, without the help of an attorney. The cost of employing a lawyer or a service agent is not always prohibitive, and obtaining legal advice from a Chinese lawyer on the most advantageous legal structure can help to expedite future negotiations and funding—particularly if the investors intend to enter into special contractual arrangements with the FIE or have specific requirements for the FIE.
Having Control Over a Subsidiary
In contrast to ordinary domestic limited liability corporations, whose highest power authority is the shareholders’ meeting, the board of directors of a foreign investment enterprise (FIE) is the highest power authority, which determines all important issues of the joint venture. This was usually the case until 2006, when a number of local approval or registration authorities began forcing foreign-owned enterprises (FIEs), even WFOEs with just one shareholder, to conduct a shareholders meeting in accordance with Company Law. The shareholders appoint the members of the board of directors. The incorporation papers may be tailored to meet the specific needs of the organisation in terms of how to control and balance power between the board of directors and senior management. WFOEs have more latitude in establishing and controlling the distribution of power and the composition of the management team.
In addition to the control provided by the board of directors, agreements between the parent and its subsidiary may be made to exercise control over the subsidiary. It is not uncommon for the parent business to hold the key intellectual property and provide a licence to the subsidiary to use it. The subsidiary’s goods may also only be promoted, distributed, and sold via the parent business, which is another typical structure. In other instances, the investor retains some influence over the operation of the subsidiary as a result of loan agreement covenants that restrict the operation of the subsidiary.
Implications for Business Operations
Each firm in China, whether it is a local corporation or a foreign-invested enterprise (FIE), is required to conduct its operations within the limits of its business licence. In general, domestic businesses are authorised for a considerably wider range of economic activities than foreign-owned enterprises (FIEs). It is possible for domestic businesses to be given carte blanche “to conduct any business as authorised by law, save those that are needed to be specifically permitted by law and must only be done after receiving the special permission.” Currently, FIEs that are supposed to be set up for a particular company cannot be given this kind of catch-all business scope since it would violate the law. Because each sector is classified as either encouraged, permitted, limited, or banned for foreign investment, each foreign-owned enterprise (FIE) is expected to engage in a particular line of activity. If a foreign investment entity (FIE) is approved to manufacture semiconductor products, it will not be granted business scope to manufacture chemical products; a non-retail or wholesale FIE should not sell a third party’s products (because a retail or wholesale FIE is subject to specific legal requirements), but the FIE may sell products that it “manufactures” itself. Depending on the circumstances, it may be difficult to determine whether a FIE has gone beyond the boundaries of its authorised commercial operations. The registration authority has the freedom to decide whether the activity performed by the FIE is outside of the authorised business scope, which may make implementation a little more complicated.
Furthermore, certain commercial operations, even those that are within the scope of the company, are nevertheless only permitted to be carried out with the approval of a special permission. To provide an example, a fundamental or value-added telecommunication company may only be performed with a permission granted by the Ministry of Information Technology (MII) or one of the ministry’s regional offices.
While in operation, a foreign investment enterprise (FIE) may conduct business with other domestic and international organisations, including signing commercial contracts, obtaining licences from government agencies and borrowing money from banks, as long as the activities are compliant with Chinese law. As a limited liability corporation, a foreign investment enterprise (FIE) is a legally distinct legal entity that bears the obligations of any third party with whom it enters into a contract. The responsibility of a FIE to a third party is limited to the amount of its assets. The contribution made by shareholders to the FIE serves to minimise their obligations. Shareholders are not responsible to third parties with whom a FIE does business, with the exception of the need to pay in full the registered capital contributed to the FIE.
Intellectual Property
In China, intellectual property may be safeguarded both administratively and judicially, depending on the circumstances. Intellectual property rights in China may be asserted in court by the owner of intellectual property rights who can also be fined by the appropriate administrative governmental body for infringement occurring within its jurisdiction. China is a signatory to the major international intellectual property conventions, including the Berne Convention (for copyright protection), the Universal Copyright Convention, the Paris Convention (for patent protection), the Patent Cooperation Treaty, and the Madrid Protocol. China is a member of the World Intellectual Property Organization (for trademark protection). Trade secrets are primarily protected under the laws of unfair competition and contract law. The validity and enforceability of confidentiality and non-competition agreements in China may also be determined by the Chinese courts. IP rights may also serve as the basis for an equity investment in a FIE, although the proportion of IP rights to registered capital should not exceed 20% of the registered capital (for advanced technology, this percentage can be up to 30 percent ).
When it comes to judicial enforcement of intellectual property rights, courts may issue injunction orders, compel infringers to pay monetary penalties, and order infringers to issue public apologies. Although monetary damages may include reasonable costs, real damages, and, in certain cases, constructive damages, the monetary damages awarded by courts are usually insufficient to deter infringers. In general, the monetary damages awarded by courts are insufficient to deter infringers. Despite this, the current trend is toward higher damage judgments for plaintiffs. Furthermore, infringers who commit significant infringements of intellectual property rights may be sentenced to prison under criminal laws that are increasingly being implemented with greater rigour.
Foreign Exchange (often known as FX) is a kind of currency that is traded internationally.
Within China’s boundaries, foreign money cannot be freely exchanged since the government prohibits it. Except for the permitted maximum amount for foreign exchange reserves in its bank account, a FIE’s income in foreign exchange must be changed into RMB. Otherwise, the revenue in foreign exchange must be converted into RMB (Renminbi, Chinese lawful currency). Lawful payments made outside of China, on the other hand, are permitted to be changed into foreign money. Upon receipt of each transfer, the necessary papers will be examined by banks that are authorised to conduct relevant foreign exchange transactions. In order to be sent out of China, shareholders’ dividends, licencing fees, and purchase costs for imported equipment and supplies must be reported to the bank and the appropriate withholding taxes subtracted from the amount of money being sent out. In certain cases, prior permission from the State Administration for Foreign Exchange (SAFE) or one of its regional offices may be needed to complete the transaction.
Having a job and having stock options
The Chinese Labor Law and associated laws apply to the employment practises of foreign-owned enterprises (FIEs). Medical insurance, pensions, unemployment insurance, and housing funds are all required by law, as are other types of social insurance benefits. In order to protect their intellectual property, employers may demand nondisclosure agreements, non-competition agreements, and intellectual property ownership agreements from their employees, as long as the terms of these agreements are in accordance with applicable laws and regulations.
For Chinese workers, the issuance of stock options has become increasingly acceptable in recent years as well. Employees’ stock options may be exercised in a variety of ways, and there is no set procedure for doing so. However, some Chinese workers may use the option by having money (or assets belonging to their family members or relatives) placed in a bank account outside of China. A cashless exercise may be arranged between the employee and the company since most Chinese workers do not have bank accounts outside of China.
Exits and liquidity are important considerations.
Foreign investors may leave subsidiaries by selling their interests in the foreign investment company (FIC) or transferring their shares in the parent business, respectively. It is necessary to get permission from the initial approving authority before transferring shares in a FIE, but this kind of approval is usually routine. If the share transfer is made from foreign investors to a Chinese investor, who then converts the FIE into a domestic company, the later-formed domestic company should meet the requirements for establishing a domestic company under Company Law rather than the requirements for establishing a foreign investment enterprise under FIE law, according to the law.
Some acquirers may require that a seller enter into liquidation and dissolution if they want to buy the assets and operations of a for-profit enterprise (FIE). If a liquidated FIE is able to pay out its wages, taxes, and obligations due to third parties in that order, the residual assets may be transferred to the shareholders in proportion to their equity stake. It is possible that the acquirer will avoid taking on the seller’s obligations to third parties if the purchase is structured in this manner.
It is also possible for investors to choose to have the parent business, or a subsidiary of the parent company, registered in a foreign nation and become publicly traded so that their shares may be sold on the open market.