U.S. and Chinese commerce are closely aligned (try to find something that isn’t “Made in China”) and many small businesses are tapping into these resources half way around the world. From raw materials to man power to textiles, Americans are looking overseas for a variety of ways to lower their costs and to find economic partnerships. However, doing business in China can be quite complex.
China has six recognized types of business organizations available to foreign investors who wish to register their companies: Wholly Foreign Owned Enterprise (WFOE), Partnership Enterprise (PE or FIPE), Representative Office, Joint Venture, a Hong Kong company, or a Shanghai Free-Trade Zone company.
A Wholly Foreign Owned Enterprise is a limited liability company owned solely by the foreign investor. It is under foreign control and does not have any formal Chinese ownership. WFOE’s usually have their own governance through the articles of association and the normal minimum paid up share capital starts from 1 million RMB (approximately US$140,000), but some provinces offer lower capital requirements in order to draw more foreign investors. John Frisbie, president of the U.S.-China Business Council based in Washington, D.C, states that “75 percent of American investment in China these days is 100 percent American-owned facilities,” because it gives business owners maximum quality control.
A Foreign Invested Partnership Enterprise (FIPE) has three subcategories: a general partnership enterprise (GPE) may be formed by general partners who bear unlimited joint and several liability for the debts of the partnership; a limited partnership enterprise (LPE) is formed by a combination of general partners and limited partners where the limited partners bear the liabilities for the partnership’s debts to the extent of their capital contributions; or a special general partnership enterprise (SGPE) which resembles a general partnership except that it must be a professional service institution offering services requiring professional knowledge and special skills. The structure shields co-partners from liabilities due to the willful misconduct or gross negligence of one partner or a group of partners. It is very similar to limited liability partnership in Europe and America.
Establishing a FIPE corporation has many advantages: there are no requirements on minimum registered capital; there are fewer procedures compared to Wholly Foreign Owned Enterprise or Joint Venture entities; you gain the capability of converting RMB profits to US dollars for remittance to its parent company outside of China; foreign entrepreneurs are allowed to establish a Partnership Enterprise with a Chinese individual, while the Chinese individual is not allowed to have Joint Venture with foreign investors; lastly, the profit distribution of a PE could follow an informal negotiated agreement adopted in the partnership agreement while an LLC profit distribution is according to the percentage of investment shareholders.
A Representative Office or “Rep Office” is the simplest and most cost-effective method of establishing a useful business presence in China. Shanghai, Beijing, Guangzhou, and Shenzhen are the most likely choices for the Rep Office since they are centers of industry. A Rep Office is an entity involved in business activities which does not result in direct profits being made. They cannot operate as partnerships or sole proprietorships in China since they are not recognized as “legal persons”. However, they can conduct “indirect operational activities” such as liaison for business purposes, introduction of products, market research, and technology exchanges. These activities should be preliminary and supplementary activities for the market to provide business information and supplying sales for their headquarters. The foreign entities applying for the Rep Office must be legally registered in its country of origin for at least 12 months. “A representative office is just there to represent your offshore entity,” advises Thomas Yang, former judge and corporate lawyer from China. Yang explains that with a Rep Office, you’ll be in China to basically show your face and build your brand name.
A Joint Venture or “JV” is a limited liability company formed between a Chinese company investor and the foreign investor. The parties agree to create an entity by contributing equity followed by sharing in the revenue, expenses, and control of the enterprise. A JV has usually been used by foreign investors to enter the restricted industries such as education, entertainment, or mining. But be warned. “They fail nine out of 10 times,” says Chinese legal expert Dan Harris. “You’re working with someone who’s familiar with the territory on their turf, and they will end up with the business.”
A Hong Kong Company was formerly used as a Special Purpose Vehicle or “SPV” to invest in Mainland China. Hong Kong is one of the quickest locations to incorporate a business. Although a HK Company is not a legal entity in mainland China, many foreign investors (especially from Europe and North America) choose to form a Hong Kong company as a SPV to invest in China.
A Shanghai Free-Trade Zone company or “FTZ” can be established in this free-trade zone which involves three bonded zones: Waigaoqiao port, Yangshan Deep-Water Port, and Pudong International Airport totaling 28 square kilometers. This is still in its experimental period and is estimated to take ten years to complete. “The purpose is to create tax-friendly facilities for trade and investment, promote China’s interest-rate liberalization and, eventually, Renminbi convertibility,” according to PathtoChina.com. “It will also encourage financial product innovation and promote the development of offshore businesses. The program is set to play an important part in the negotiations for the Trans-Pacific Partnership Agreement (TPP) and become the first open window to help China join the TPP.”
China is a land of great opportunity for business owners to partner with others who are like-minded to broaden their industry and manufacturing contacts. However, this is just the tip of the iceberg. Now that you know which type of entity you want to file for in China, a follow up blog of ours will focus on creating a business presence in this diverse land abroad.