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The establishment of operations in Shenzhen

The establishment of operations in Shenzhen

6. CO-OPERATIVE/CONTRACTUAL JOINT VENTURES

6.1 Introduction

Broadly speaking, the aim of a co-operative or contractual joint venture (“CJV”) is to expand economic co-operation and technological exchange between China and foreign countries: export-oriented or technologically advanced CJVs are actively encouraged.

CJVs are governed by the PRC Contractual Joint Venture Law and its implementing rules, and must abide by Chinese laws and regulations and must not operate contrary to the public interests. Any transfer of rights to the CJV must be agreed by the other party to the CJV and approved by the SMFIB.

6.2 Legal Status

A CJV may be of limited liability with the status of a Chinese legal person, or alternatively, of unlimited liability in a non-legal person form, akin to a partnership.

The limited liability CJV in many ways resembles the structure of an EJV, with a joint venture agreement and an articles of association setting out the relationship between the parties and the internal organisation of the CJV respectively. However, there is a key difference being that in an EJV, profit distribution must be in proportion to the registered capital contributions of the parties to EJV, whereas for a CJV, profit distribution may be determined by contractual arrangements irrespective of the proportion of capital contributed by the parties. This allows for a more flexible schedule for return on investment where one investor provides cash while the other party’s investment is primarily in kind.

The unlimited liability CJV is similar to a partnership whereby the parties jointly incur unlimited liability for the debts and obligations of the CJV. No separate legal personality is created. The precise division of liability and profit share is agreed between the parties in the joint venture agreement. Management, technical and marketing functions are also allocated contractually. A joint management committee is formed by representatives (delegated by the parties) to manage the joint venture. There are no articles of association for this kind of CJV.

6.3 Capital Contribution

Like an EJV, the investment contribution or the conditions of co-operation provided by each of the parties to the CJV may be in cash, in kind, or property rights such as industrial property rights, know-how and land-use rights.

For a limited liability CJV, the investment made by the Overseas Corporation must be at least 25% of the registered capital of the CJV. For an unlimited liability CJV, the specific requirements for the investment made are subject to Ministry of Foreign Trade and Economic Co-operation (“MOFTEC”) regulations.

Similar to an EJV, it is usually the foreign investor provides the majority of the funding, whilst the Chinese party provides land, equipment, industrial property rights, non-patent technology, and other facilities.

6.4 Specific Requirements

The SMFIB authorised by the State Council to grant approvals for the establishment of CJVs, which may approve CJVs in the following, amongst other, circumstances:

  1. the total amount of investment is within the authorisation for approval as set by the State Council;
  2. the capital will be raised by the applicants themselves; and
  3. export quotas are not imposed upon the exportation of the CJV’s products and do not require licences, or if they do, the consents of relevant competent departments have been obtained prior to submitting the application for establishing the CJV.

Approval will not be granted if the CJV:

  1. is of detriment to PRC’s sovereignty or public interests;
  2. would jeopardise State security;
  3. pollutes or damages the environment; or
  4. violates any laws, administrative rules or State industrial policies.

The steps and procedures described under the section “General Establishment Procedures” applies to the establishment of a CJV. Further, the considerations involved when preparing the feasibility study report, the joint venture agreement and the articles of association for an EJV (please see subsection “Specific Requirements” under “Sino-Foreign Equity Joint Ventures”) applies equally to the establishment of a CJV. But emphasis must be place upon the joint venture agreement. This should contain details of the registered capital (which may be in Renminbi or any other freely convertible currency), investment contributions and/or the conditions for co-operation, management structure, ownership of property, and termination events. The parties shall stipulate in the joint venture agreement, based on the production and operation requirements of the CJV, the duration of the investment and/or the co-operation. Most importantly, it must provide for the distribution of earnings and sharing of risks and losses given that with CJVs such matters do not commensurate with each of the parties’ contributions. Any future modifications to the joint venture agreement will require further approval from the SMFIB.

6.5 Time

Normally, it may take up to 45 working days for the SMFIB to approve the application for the CJV. Upon approval, the SMFIB will grant a certificate of approval and then in turn submit the approval documents to MOFTEC within 30 days of approval being granted. Thereafter, the CJV should apply to the administrative authority for industry and commerce for registration and obtain a business licence.

6.6 Management And Operation

Once established, a CJV may, by presenting its business license, open a foreign exchange account, obtain loans from financial institutions, and purchase insurance. If within its approved scope of operation, the CJV may import its raw material requirements and, as strongly encouraged by the PRC State Government, export its products.

The board of directors (comprising of at least 3 members), which is the governing body of the CJV, shall meet at least once a year. Decisions which require unanimous resolution by the board of directors, including:

  1. amendments to the CJV’s articles of association;
  2. increase or reduction of the CJV’s registered capital;
  3. dissolution of the CJV;
  4. mortgage of CJV’s assets;
  5. merger or change in the form of the CJV; and
  6. any other matters previously agreed upon by the parties.

For unlimited liability CJVs, a joint management committee, which essentially has the same functions as a board of directors, must be established.

With unanimous consent from the board of directors or the joint management committee and approval from the SMFIB, a limited liability CJV or an unlimited liability CJV respectively, may entrust a third party with the management and operation of the CJV. This type of arrangement is common, for example, in the hotel and hospitality industry, where an outside hotel management team is often appointed.

6.7 Taxation

For unlimited liability CJVs, each party may either compute and pay its own income tax in accordance with the relevant tax laws and regulations or alternatively may, with the approval of the local tax authority, compute and pay their taxes collectively as an entity.

Limited liability CJVs are required to pay a national income tax of 30% and a local income tax of 3%. Depending on its locality and business activities, there are several concessions that allow for either reductions or complete exemptions from taxation.

All CJVs are also subject to value-added tax, business tax, consumption tax, capital appreciation tax, customs duties, and import taxes.

6.8 Duration

The parties shall stipulate in the joint venture agreement, based on the production and operation requirements of the CJV, the duration of the investment and/or the co-operation. Any transfer of rights to the CJV must be agreed by the other party to the CJV and approved by the SMFIB.

Where there is no time limit as to the term of the CJV, the Overseas Corporation is allowed to withdraw its registered capital at any time. On the expiration of the joint venture, all the fixed assets belong to the Chinese party on a gratuitous basis. The Overseas Corporation may apply to the SMFIB for early recovery of its investment, provided that any losses have been fully paid. The profits it receives as its share, other legitimate income, and any equity returned as its share upon the termination of the venture, may be sent abroad by the Overseas Corporation.

6.9 Advantages of CJVs

In many instances, establishing a CJV can be a better option for a foreign investor rather than establishing an EJV. As a starting point, the Overseas Corporation does not need to set up a new corporation in China – the Overseas Corporation and the Chinese partner participate in the CJV by relying heavily on the Chinese party’s existing business license, under a contractual arrangement. Often such an arrangement is used in land and hotel projects due to the tax advantages. If the business vehicle is a straightforward EJV, upon the Chinese party transferring the land to the EJV, a liability to transfer tax will arise. However, under a CJV, the land stays in the possession of the Chinese partner and therefore no transfer taxes are payable. Also, where the Chinese partner is in possession of the land but does not have clear legal title (a common occurrence in China) – under an EJV the land would have to be bought from the Chinese Bureau of Land Control if the title was to be transferred to the EJV entity. Whereas under a CJV, provided that the status of the Chinese partner is high enough to maintain possession of the land, no such transfer will be required.

Flexibility is another key factor in choosing a CJV. The percentage of the CJV owned by each partner can change throughout the CJV’s life, with the idea being that the Overseas Corporation can receive a faster return on their investment whilst ensuring that the Chinese partner maintains long term control. A Overseas Corporation usually want control over the joint venture at its inception because of the capital amount it has injected, such control being transferred over to the Chinese party as and when the CJV becomes profitable. The Chinese party is safe with the knowledge that even though initial changes may be made, they will maintain control in the long term and, in all likelihood, benefit from seeing modern management and marketing techniques being utilised by their foreign partner.

7. TERMINATION OF EJVs AND CJVs

The duration of an EJV or a CJV must be stated in the joint venture agreement. For most EJVs and CJVs, the approved term is usually between 10 to 30 years, although in cases where the amount of investment is large, or the construction time is long, the term may be extended to 50 years (with prior approval of the State Council). If an extension is required, a formal application must be made to the SMFIB 180 days before expiry of the current term. However, the duration will not be extended if the joint venture agreement allows the Overseas Corporation to first recover its investment and the said investment has been fully recovered.

An EJV or a CJV may be dissolved in the following situations:

  1. end of its contractual term;
  2. inability to continue operations due to financial losses or heavy losses caused by force majeure;
  3. inability to continue operations due to the failure of one party to fulfil its contractual obligations under the joint venture agreement;
  4. for any other reasons stipulated in the joint venture agreement and its articles of association; or
  5. revocation ordered by PRC authorities according to law due to violation of laws and/or administrative regulations.

8. WHOLLY FOREIGN-OWNED ENTERPRISES

8.1 Introduction

Wholly foreign-owned enterprises (“WFOEs”) are governed by the PRC Wholly Foreign-Owned Enterprise Law and its implementing rules. Its investment are solely contributed the Overseas Corporation and takes profits and risks all on its own account. Although most WFOEs are established by one foreign investor, there are no legal restrictions on the number of foreign investors participating in such enterprises.

8.2 Legal Status

WFOEs are usually set up as limited liability companies with separate legal person status. Only upon general approval may a WFOE be established with other forms of liability. Its status as a limited liability company is confirmed in its articles of association.

The liability of the Overseas Corporation is limited to the amount of capital it contributed. However, the limited liability nature of the company should be distinguished from the unlimited potential liability of a WFOE’s directors, managers, advisors or suppliers under product liability, worker safety or environmental protection regulations.

A WFOE must abide by all Chinese laws, decrees, rules and regulations. Given its separate legal entity status, it is allowed to enter into contracts with appropriate government authorities or Chinese business entities in order to acquire land use rights, rent buildings, and receive utility services etc. Labour must be employed in accordance with the applicable PRC labour laws.

8.3 Advantages Of WFOEs

The most striking difference between a WFOE and an EJV is the absence of a Chinese party, which brings about its own advantages and disadvantages. The procedures for the establishment of a WFOE is greatly shortened and simplified, as lengthy negotiations with a Chinese party are not required. As long as the relevant law and rules have been are complied with, the Overseas Corporation is free to determine the scope of the WFOE’s operation, the number of its employees, the percentage of its exports as compared to its imports etc.

A further advantage is the Overseas Corporation’s technologies and commercially sensitive information remains confidential. Given the co-operative nature of an EJV or a CJV, the technologies, know how and commercial information of the Overseas Corporation must, to certain extent be disclosed and/or shared with its Chinese partner, which in turn may be tempted to make use of such information without the prior consent of the Overseas Corporation.

The other side to this argument is that its knowledge of China and the Chinese culture and its social connections, a Chinese partner may prove useful in dealings with PRC officials and maintaining good relations with the relevant local authorities. However, WFOEs often solve or ameliorate the disadvantages of not having a Chinese partner by hiring PRC nationals to assist with its interactions with the various authorities.

8.4 Specific Requirements

The underlying principle of the PRC Wholly Foreign-Owned Enterprise Law is that a WFOE must be conducive to the development of China’s national economy and yield notable economic benefits, and accordingly must meet at least one of the following criteria:

  1. use internationally advanced technology, the application of which is of benefit to China;
  2. develop new products, save energy and raw materials, and upgrade and replace existing products that can be substituted for imports; or
  3. export at least 50% of the total value of all its products manufactured and maintain a positive balance of foreign exchange in Renminbi.

There are also limitations in the types of business in which a WFOE may engage in. The following types of business are absolute prohibitions:

  1. news, publishing, radio broadcasting or movie making;
  2. postal industries; and
  3. any other industry prohibited from time to time by the relevant authorities.

In general, the establishment of a WFOE engaged in the following businesses requires special approval from MOFTEC:

  1. public utilities;
  2. transportation;
  3. real estate;
  4. trust and investment; and
  5. leasing

Documentary requirements for the establishment of a WFOE vary slightly from those of an EJV or a CJV. The main difference being the requirement of a project proposal.

8.5 Approval

Approvals for WFOEs are granted more sparingly than for EJVs or CJVs. This is mainly due the fact that WFOEs enjoy exclusive management control of their business activities and are autonomous in their management, with little interference from the PRC government. The application process is usually also more expensive and lengthier due to the absence of a Chinese partner to guide the project through the approval process and regulatory issues.

REPRESENTATIVE OFFICES AND BRANCH OFFICES

9. REPRESENTATIVE OFFICES

9.1 Introduction

Representative offices are a favoured option for Overseas Corporations with a genuine need for a permanent presence in the PRC. Such offices may engage in non-direct business activities within the PRC. Their function is limited to representing an Overseas Corporation in conducting business liaison with trade organisations or related industries, product introduction, market surveys and research, and technological exchange within the business scope of the Overseas Corporation.

A representative office is a good way for the Overseas Corporation to gain experience and acquire a better understanding of the size and potential of the PRC market. The representative office is a means for the Overseas Corporation to work out its long-term PRC objectives, oversee its business operations running in the PRC (for example a CJV), and forge stronger links with the domestic PRC market.

It is important for Overseas Corporations to establish representative offices to signal their intention in conducting businesses in the PRC and that they view China as a long term investment. The presence of a representative office is often a good bargaining tool in subsequent joint venture negotiations, showing that the Overseas Corporation intends to further invest in the PRC.

9.2 Specific Requirements

To set up its representative office, the Overseas Corporation must:

  1. be legally registered in its country of incorporation;
  2. have good commercial credibility;
  3. provide various “true and reliable” materials required by the implementation rules of the PRC; and
  4. complete the application procedures in accordance with the implementation rules.

There are a number of prohibitions in relation to representative offices: only certain specified activities may be undertaken in the representative office, and the representative office cannot generate income including any fees received for services rendered or sign contracts that generate income. However, a representative office is allowed to negotiate contracts which are later executed in the name of the Overseas Corporation.

Under rules of the State Administration of Industry and Commerce, a Overseas Corporation must register a representative office within six months of establishing a business presence in China. Failure to comply, will result in a fine (around US$1,150) and, in serious cases, the Overseas Corporation may be banned from engaging in further business activity in the PRC. The State Administration of Industry and Commerce enforces this requirement by carrying out random checks and using informants.

Unless a representative office is registered, the company will be unable to employ Chinese nationals, open a bank account, import duty-free personal effects, import office equipment without an import licence, obtain telephone lines, display company signs, or use business cards identifying the Overseas Corporation’s presence in China. Further, the Overseas Corporation’s representative will only be able to obtain a multiple entry visa for the PRC and legally rent accommodation once its representative office has been registered.

10. BRANCH OFFICES

A branch office does not have Chinese legal person status, but is permitted to carry out certain manufacturing and selling activities, as allowed by the Company Law of the PRC (enacted on 29 December 1993 and effective 1 July 1994). The Company Law was enacted for the purpose of allowing Overseas Corporations to conduct sales and manufacturing businesses in China without requiring them to make sizeable investments, as is required when setting up a WFOE.

Given that its lack of legal entity status, the branch office instead relies upon the separate legal entity status of the Overseas Corporation. Accordingly, the Overseas Corporation would be liable for all obligation, liabilities and wrongdoings of the branch office.

A representative office is unable to import products or sell samples, whereas under the Company Law, a branch office may do so and representatives of a branch office can engage in sales negotiations. However, a representative from the Overseas Corporation must execute and sign any sales agreements entered into in the PRC. All sales must be invoiced and imported from overseas.

11. HOW WE CAN HELP YOU?

If you are considering establishing business operations in Shenzhen, whether by way of an Equity Joint Venture, Contractual Joint Venture, or a Wholly Foreign-Owned Enterprise as outlined above, or otherwise, we can assist you in choosing on the structure best suited to your proposed business.

And, in consultation with PRC law firm with whom we are affiliated, we can:

  • obtain advice on the formalities to be observed when establishing the business
  • oversee the preparation of the necessary documents (both Chinese documents and their English translations) including submissions for any approvals and authorisations required to be obtained by the business, and liaise with the relevant authorities on your behalf
  • obtain advice on commercial, company, property, intellectual property, tax, employment, immigration, pensions, insurance, banking and financial services law
  • provide practical advice on ancillary matters that need to be considered when setting up a business

April 2003

This note is provided for information purposes only and does not constitute legal advice. Specific advice should be sought in relation to any particular situation. This note has been prepared based on the laws and regulations in force at the date of this note which may be subsequently amended, modified, re-enacted, restated or replaced.

Business operations in Shenzhen

Foreign investment in Shenzhen

Industrial Catalogue for Foreign Investment

The Income Tax Law of the People’s Republic of China for Enterprises with Foreign Investment and Foreign Enterprises

Foreign Investment Enterprise in Shenzhen

PRC Contractual Joint Venture Law

PRC Equity Joint Venture Law

PRC Wholly Foreign-Owned Enterprise Law

Company Law of the PRC

Sino-foreign equity joint venture

Wholly foreign-owned enterprises
Foreign investment in China
Foreign direct investments
Joint venture contracts
Joint venture partnerships
Business operations definition

Skills

Posted on

2003-04-21