China has been active in lifting restrictions on foreign investments in the past years, with a goal to make the market more attractive.
One example is the Negative List, a list of industry sectors that prohibit foreign investments, which had 117 items in 2022, down from 151 items in 2018. The government also removed restrictions on foreign ownership in automotive manufacturing in 2022, as well as on foreign shareholding ratios of securities/investment fund companies in 2021.
Even if we’ve seen easing of restrictions, setting up or divesting a company in China is often challenging, considering red tape and local regulations. In this article, we review the company types available in China, the registration processes, and explain common pitfalls.
Company Types in China
Foreigners can set up three company types in China, including Wholly Foreign-Owned Enterprises (WFOE), Sino-Foreign Cooperative Joint Venture (JV), and Representative Offices (RO).
The following table summarizes the three options:
Let’s review the options in greater detail below.
Wholly Foreign Owned Enterprise (WFOE)
WFOE refers to a limited liability company that is 100% invested, owned by foreign investors, and independently operated. Almost 60% of foreign-owned companies are WFOEs, making it the most adopted business type. Famous multinational companies such as Apple, Amazon, Oracle, and General Electric are all examples of WFOEs.
Setting up a WFOE can bring more risks compared to the other company types due to the higher investment requirements, and if foreign companies lack knowledge of the Chinese market. With that said, there’s also a reason why this is the most popular option among foreigners.
Foreign companies can maintain complete ownership of the companies, convert RMB income into USD, and remit profits to parent companies overseas. As WFOEs give foreign enterprises total ownership, there are also no restrictions relating to the company’s internal operating structure.
Worth mentioning is also that WFOEs must have a board of directors with three to thirteen members.
Sino-Foreign Cooperative Joint Ventures (JV)
A JV refers to an enterprise in which a Chinese partner and a foreign partner jointly invest and share company stakes in proportion to the investment. JV is another common business type for foreign companies, with over 35% of the one million foreign enterprises in China operating as JVs.
SAIC Volkswagen, SAIC General Motors, and BMW Brilliance are household names that have local JVs in China.
JV, in common terms, would have no mandatory registered capital requirements for foreign investors. However, foreign investors’ general capital investment ratio should be at least 25% of the total investment.
This company formation type has many preferential treatments depending on the different regions in China. For example, foreign JVs headquartered in Shandong’s designated development zones can all have 15% reductions on corporate income taxes.
Other benefits can be gained with the help of your Chinese partner as they provide more marketing channels and utilize business connections, build a stronger brand image, and offer investment support.
Common pitfalls with JVs in China
Conflict of interests and imbalances of contribution are potential issues when foreign companies set up JVs with local Chinese partners. You should also fully evaluate the local laws as JVs are scrutinized harder and with more reporting obligations.
Additional reporting obligations can be related to annual capital contribution ratios, the structure of the board of directors, and methods of hiring/firing the company’s top management. You must maintain a positive relationship with your Chinese partner to fulfill all the reporting obligations and have smooth business operations.
As a result, it’s crucial to carefully screen your potential Chinese partner before signing a full-on JV agreement.
When the JV is established, a board of directors must be set up to manage and oversee the operations. Representatives from both the foreign and Chinese parties can serve as the board’s chairperson, where the chairperson would then become the legal representative of the JV. The chairman is also responsible for selecting managing directors for the JV’s operation and management.
Representative Office (RO)
An RO is a liaison agency representing the parent company established by a foreign-invested enterprise in China. Since ROs are not recognized as independent legal entities, they cannot conduct standard business operations, generate profits, and send money abroad. Non-direct business activities, including liaison work, product promotion, market research, and setting up bank accounts, are all permitted.
You can consider RO as a market-entry option with fewer initial risks. Foreign enterprises commonly use ROs to study the Chinese market and build business connections, to “test the water” and before entering the market with full force. This is possible as enterprises have no capital limits when investing in and registering ROs in China.
Enterprises should beware that ROs can only recruit employees through government-recognized HR agencies and can only set up offices in a foreign-related office building (buildings designated by the government that can have foreign enterprises as tenants).
The current RO’s license period is three years, yet ROs can extend their license unlimited times.
Foreign Invested Commercial Enterprise (FICE)
FICE is also called trading WOFE which allows foreign companies to import and export franchise brands, sell products, open an E-commerce store, get export tax refunds, and deliver related consultation services in China. A FICE can also operate storage, warehousing, inventory management, repair maintenance, training, and delivery services.
Apart from the FICE (trading WOFE), you can also choose other types of WOFE according to your business scope, such as technology WFOE, food & beverage WFOE, and manufacturing WFOE that the company can manufacture industrial products in China, etc. There are some limitations that you should know about FICE. You can only do trading business, and VAT(Fapiao) issues can be complex. Also, you must apply for separate licenses before any import-export activities.
Before setting up a FICE, you should confirm three things during document preparation: company name, business scope, and registered address. The company must have a lease agreement of at least 12 months for the registered address and cannot share with other companies. Online pre-approval application with the provincial bureau of the Ministry of Commerce (MOFCOM) and the Administrative Committee of Economic and Technological Developments Zones (for FICE set up in economic and technological development zones) is necessary for the license, and you should upload identification documents of the registered personnel.
Once approved, you can proceed with the procedures to obtain your Import-Export License Record with the Customs Bureau, State Administration of Foreign Exchange (SAFE), and the local MOFCOM and required Import-Export license depending on your business scopes, such as Foreign Trade Operator Filing Record, Customs Registration Certificate, China E-port IC Card Application, and Goods Trade Foreign Exchange Administration Service Activation. For business owners who think FICE is the most suitable legal entity type, the processing time is around six months, and there is no minimum capital requirement.
National Enterprise Credit Information Publicity System
The Chinese government has an online platform where you can find information related to business credit information, abnormal/illegal operations, and other company information.
The platform is handy for companies that want to know more about potential Chinese business partners. You can receive information regarding untrustworthy business activities, which often result from delayed or missing payments from previous business activities. Simply input the company name, company registration number, or the Unified Social Credit Code of the company.
Companies should carefully look for reporting deadlines required by the government. Late reporting on information such as company equity transfer, outbound investment activities, and change of company address have all resulted in serious consequences in the past.
Wrongful reporting activities may likely appear in the company’s information page under the National Enterprise System, which would seriously hurt the company image, particularly for new entrants in the Chinese market.
The Importance of Stamps and Business Licenses in China
Business licenses and stamps might have less importance in other countries, yet they have entirely different levels of power in China.
Business license and copies
The government issues the original business license, and enterprises can print copies of them. However, the original and copies of the business license have the same legal power. The original must be hung in a noticeable place in your office. In contrast, the copies are generally used for activities such as opening bank accounts and signing contracts requiring traveling.
The company stamp is the most important stamp of an enterprise, as it is the stamp used for internal and external business activities. The stamp is often controlled by the legal person and can be used to verify documents, contracts, certificates, and other materials.
Used only for accounting and bank settlement purposes.
Contract stamps are mainly used to sign contracts with clients, which can also be replaced by using the company stamp.
The importance of stamps and business licenses must be recognized as stamps are more important than signatures. It’s better to have a standardized process in case of any misconducted risks, including the dedicated person is responsible for the stamp custody and the strict approval process for using the stamps
Application documents notarization
Sometimes, the authenticity of the foreign applicants’ documents may not be identified by the Industry and Commerce Bureau, which can waste much time during the application process. In one previous case, we helped a client who encountered a problem as the Industry and Commerce Bureau could not identify his passport without China travel records.
The passport therefore had to be sent back, which resulted in the client losing weeks of time. Before you submit your documents, it’s therefore recommended to notarize them locally in advance.
Foreigners must often ship documents several times due to issues with failed identifications. For example, that you can not travel freely while the authorities use your passport during the application process.
As a result, it’s important to understand the process in advance and effectively coordinate the shipping of documents, including passports.
How ARC Consulting Helped a European Client in Setting Up a Company in China
During the project, we assisted the client with research on local regulatory requirements, preparation of application materials, materials translation, format alignment, and more. The client also benefitted much from our local presence, as we were able to visit related agencies on-site.
ARC Consulting ultimately helped the client to complete the establishment of a Chinese legal entity by developing a thorough company analysis, evaluating local regulatory requirements, and efficiently submitting required documentation.
Before setting up a company in China, it’s crucial to understand the regional and provincial benefits across China. You should also carefully review the Catalogue for the Guidance of Foreign Investment Industries. Chinese economic zones, preferential policies on foreign-owned entities from provincial and regional levels, and industry-specific incentives can be identified and leveraged through initial research.
In this article, we have reviewed the process of setting up a company in China in brief. However, it’s recommended to seek company formation consultancy services, to save time and costs. Without adequate knowledge of the company types and setup processes, the processing time can take months, with additional work such as visiting local registration offices, as well as document verifications.
With different regional benefits on provincial and district levels, as well as economic zones’, foreign companies can enjoy tax discounts, financial awards, and foreign employee benefits.