expansion of business in China

In this article, Shikhar Shrivastava discusses Structuring advice to an Indian entrepreneur who is looking for business expansion in China.

An Indian Entrepreneur who has a well settled business in India and looking for a possible expansion in China may find this research paper to be of valuable assistance in making a well formed business expansion decision.

India is a Democratic Federal State with market based economy whereas China is a Communist State with a liberal economy relying largely on investment and export led growth. India is currently the fastest growing major economy of the world[1] and China is the second largest economy along with being the largest exporter and second largest importer of goods in the world[2]. Being the two biggest economy of Asia, it is a very good time for business expansion in these two countries for an entrepreneur.

In order to give a structuring advice to set up business in China following points should be considered:

Choosing Industrial Sector

In China there are three types of industrial sectors: firstly, those in which the government encourages foreign investment (usually by means of fiscal incentives), secondly, sectors restricted to foreigners (or in which a foreign partner can only operate by means of a Joint-Venture with a Chinese counterpart, and thirdly, sectors that are completely prohibited, and therefore inaccessible for foreigners.[3]

In general, the sectors that promote innovations in areas such as environmental protection, export or the development of the poorest regions of the country are encouraged. A restricted sector would be one of the industries that have a negative impact of the environment. Forbidden sectors include those considered politically sensitive, or that can be damaging to the country. If one’s industrial sector is not mentioned in the catalogue then it simply means that it is permitted.

Business Structures in China

Foreign investors can take up business structures like Representative offices (ROs), Wholly Foreign Owned Enterprises (WFOEs), Foreign Invested Partnership Enterprise (FIPE),  Joint- Ventures (JVs), Hong Kong Company,  Shanghai Free-Trade Zone Company (FTZ).

Representative Office is a structure whereby a foreign entity establishes its presence in another country for a very limited purpose and does not undertake any direct business activity. [4] It is established to get familiar with the new market, local conditions, and perform some preparatory activities like promotion/advertising of foreign company, gathering local information etc., so as to act as a medium between the local customers and the Head Office.

This structuring is faster, cheaper and easier than forming a Wholly Foreign Owned Entity (WFOE), but this is generally discouraged because “switching” from a RO to a WFOE involves both shutting down the RO and forming a WFOE which is considerably costlier than just forming a WFOE[5].

Basic requirements for forming a RO:[6]

  • There must be a registered lease for a period of at least one year beyond the approval date of the RO.
  • There must be a designated Chief Representative who will manage the affairs of the RO.
  • There must a foreign entity (typically a limited liability company or a corporation) that the local office represents; private individuals and partnerships cannot establish a RO in China.

There are two major issues in working as a RO; firstly, it is not permitted to earn income in China, nevertheless, they are subject to a 10% tax on the gross expenses and secondly, it can hire Chinese nationals only through Chinese employment agency but it can directly hire foreign nationals[7].

Foreign Invested Enterprise (FIE) is a company that has 25% or more foreign control and if the entity is completely owned by foreigners then it is called a  Wholly Foreign Owned Entity (WFOE). Usually, WFOEs are Limited Liability Company (LLC), where the liability of shareholders is limited to the capital invested in the company. Depending on the nature of the activity (manufacturing, consulting, services, etc) and the geographical location of registration of company, a different registered capital is required.[8]

Foreign Invested Partnership Enterprise (FIPE) for foreign investor refers to:

  1. 2 or more Foreign enterprises or individuals establish a Partnership Enterprise (PE) in China; and
  2. Foreign enterprise(s) or individual(s) with Chinese individual or company establish a Partnership Enterprise (PE) in China.

There is no minimum registered capital required for FIPE and like WFOE, FIPE could also generate revenue, hire local and foreign staffs and enter into contracts with local and overseas businesses in China.[9]

Joint-Venture (JV), or a company controlled by both foreign and Chinese partners is another common form of FIE. Usually it is a transfer of technology and foreign companies who intend to operate in a “restricted” industrial sector, a Joint-Venture is their only option.[10]

These investments are often structured as bilateral government to government investments in any event, with the partner companies merely executing the Government’s wishes. Many of these JV projects are very long term and may also carry government backed guarantees of investment.[11]

Hong Kong Company  is used as a Special Purpose vehicle (SPV) to invest in Mainland China. Although a HK company is not a legal entity in mainland China but many foreign investors choose to form a Hong Kong company as a SPV to invest in China because of the favourable tax treatment offered under the Hong Kong- China Comprehensive Double Tax Arrangement. More than 90% of Chinese-inbound investment adopts a Hong Kong company as an SPV. Hong Kong imposes no tax on capital gain and does not impose withholding tax on dividends and interest payable by a HKC to overseas.

In order to avail this HKC as SPV, the company must obtain a Hong Kong tax residency certificate. For a company that is incorporated in Hong Kong, a Certified Extract of Information on the Business Register or a copy of the certificate of incorporation is sufficient evidence.[12]

Shanghai Free-Trade Zone Company (FTZ) is a free-trade zone  integrates four existing bonded zones in the district of Pudong — Waigaoqiao Free Trade ZoneWaigaoqiao Free Trade Logistics ParkYangshan Free Trade Port Area and Pudong Airport Comprehensive Free Trade Zone. Customs formalities within the free-trade zone will be simple and convenient and the entry of goods will only require registration of the variety and value of the goods without any inspection and intervention.[13]

This free trade zone will provide world-class transport and communications facilities, as well as a tax-free environment for domestic and foreign enterprises, promote China’s interest-rate liberalization. The creation of a Shanghai free trade zone is the Chinese Government’s initiative is to further free trade with outside world.

Starting a Company

In order to start a company in China following is a list of documents which are required to be submitted namely, name of the company, list of Partners and  managerial structure, legal address of the companyrental contract, Articles of Association (AOA), number, citizenship, salary and benefits for employees, registered capital and the total investment, a business plan, any other document requested. If all documents in the application are not present then chances are that the proposal can be denied, and after the first denial, getting the necessary permits becomes even more difficult.

Thereafter, Approval Certificate and then Business License, can be received from the Ministry of Commerce (MOFCOM) and the State Administration of Industry and Commerce (SAIC) or with their local branches. Depending on the city, the forms and/or documents to submit may vary. After getting business license, a bank account deposited with registered capital has to be opened in order for the company to become active.

Other Factors

Geographic Location

The geographic location or the city or province in which to have your legal address depends upon factors namely, availability, quality and salary of local employees and workers; proximity to distributors, suppliers and customers, local rules, policy and government incentives such as tax reductions on profits or import/export duties [special zones such as the Special Economic Zones (SEZ), the Economic and Technological Development Zones (ETDZ), the High-tech Industrial Development Zones (HIDZ), the Free Trade Zones (FTZ) or the Export Processing Zones (EPZ) could be considered].

Corporate Taxes in China

Here’s a list of taxes to consider for a WFOE or Joint-Venture:

  • Corporate Income Tax of 25% on profits;
  • Turnover Tax (or Transaction Tax) of 3%-5% on sales;
  • Custom Duties;
  • VAT is uniform across the nation;
  • Individual Income Tax imposed on dividends.

Language and Local Hiring

English language use in China is concentrated more in first-tier cities but Chinese companies have started to recruit English speaking employees to help in the transactions.

Employing expatriates in senior management positions offers greater operational control, but is also costlier in terms of salary packages, relocation costs, insurance and other expenses.  Moreover, most expatriate managers have a very limited local knowledge of Chinese cultural and business practices, and very seldom have the Chinese language skills necessary for dealing with Chinese companies on a day-to-day basis.

A local managerial or executive person is required who can make proper and efficient management decisions while maintaining relationships with business partners, suppliers and vendors and government officials, local customers in a business transaction as risk taking-decision-making attitude in a transaction is related to the culture of the host country.

Market Research

A decision to setup in tried and tested locations or to take the risk of setting up in a less developed market depends on a various factors, and ultimately this decision will be based on having thoroughly research of the demand and supply of the market.

It is very critical to understand the ground reality of consumers and their buying habits along with exploring all the other regulatory barriers before going for a full fledged market entry. It is equally important to constantly monitor for any changes in the legislation or regulations and their probable effects on the business.

Tier 1 cities of China are most mature markets and offers efficient and skilled employees, lowest entry level risk but it will also results in higher operational costs and more competition. A new entrant should try to exploit economic growth and rising incomes in China’s Tier 2 cities which also have the advantage of lower set-up and operating costs. It can lead to a great long term investment success.

Conclusion

Choosing the right vehicle for entry is one of the most crucial decisions a business can make before entering China. This depends upon on a number of factors, including industry sector, scope of the market, local resources availability, technical support etc., along with the overall setting up and operational cost. Whichever market entry mode is chosen, thorough market research should precede any final decision on how and when to enter the market.  A growing number of market research companies now have operations in China, and their services should be resorted to in order to get the clear ground reality of the market.

A company could look at utilizing synergy of the Indian expertise in services, accounting, management, IT, software, consultancy etc., and with low cost mass production expertise of China to cater.

A thorough and well executed market research study can help prevent poor decision-making and lead to a better strategy for the future

References

[1] http://www.business-standard.com/article/economy-policy/at-7-6-in-fy16-india-is-now-the-fastest-growing-economy-116053101080_1.html Last accessed on 27/02/2017

[2] http://www.thefactspeak.com/china-largest-exporter-importer-goods/ Last accessed on 27/02/2017

[3] Catalogue for the Guidance of Foreign Investment Industries (Amended in 2011) accessiblehere:http://english.mofcom.gov.cn/article/policyrelease/aaa/201203/20120308027837.shtml

[4]Liaison Office – A Tax Efficient Structure, Shariq Contractor can be accessed at http://www.cnkindia.com/liaison_office.pdf

[5] http://www.chinalawblog.com/2010/01/how_to_form_a_representative_o.html Last accessed on 27/02/2017

[6] Id.

[7] Id.

[8] http://www.saporedicina.com/english/how-to-start-a-company-in-china/#Last accessed on 27/02/2017

[9] http://www.pathtochina.com/types_of_business_china.htmlLast accessed on 27/02/2017

[10] Id.

[11]http://www.china-briefing.com/news/2008/03/18/the-jv-vs-wfoe-debate-%E2%80%93-choosing-between-the-options.html Last accessed on 27/02/2017

[12] http://www.amicorp.com/AmiNews/HKSPV/English.html Last accessed on 27/02/2017

[13] supra note, 10

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