7 Steps to Set Up a Joint Venture

By Richard Hoffmann, ECOVIS Beijing China

For a long time, setting up a  Joint Venture was the only option for foreign investors wishing to enter the Chinese market.  A Joint Venture consists of a Chinese and a foreign investor.

In China two different kinds of Joint Ventures exist: Equity Joint Ventures (EJVs) and Cooperative Joint Ventures (CJVs).

An Equity Joint Venture is a company with limited liability. Parties of the Joint Venture may include one or several Chinese entities, and one or more foreign companies or individuals.  In an Equity Joint Venture at least 25% of the shares have to be held by a foreign investor.  It is a limited liability company and will be managed by a Board of Directors, whose members are foreign or Chinese.

A Cooperative Joint Venture can be found as a limited liability company but it is not necessary to set it up as a new legal entity, unless the cooperative contract stipulates otherwise. A cooperative Joint Venture (CJV) can be established in a format similar to a partnership where both parties incur unlimited liabilities. For CJVs there is no minimum capital required for foreign investors. Chinese and foreign investors can decide on the amount of capital injected by each investor and decide how to distribute profits. Investors may contribute other non-capital assets such as factories or land use rights.

Business Scope:

When setting up a joint venture a business scope needs to be defined and stipulated in the Articles of Association. The business scope specifies the range of business activities in which the joint venture is allowed to engage and is subject to approval by administrative government offices as well as the state and local tax bureaus. Companies are only permitted to operate within the approved business scope. Specific and not general terms should be used to describe the business scope. Otherwise, it might not be accepted by the tax authorities.

Given the tax implications of different business scopes, it might seem to be tempting for some investors to state a business scope that is similar to the core business activities but not actually accurate. However, this is not advisable and cannot be recommended. Sooner or later government authorities are likely to discover the truth.

Business Term:

Depending on the business scope a Joint Venture, usually has a business term of 10- 30 years. Up until 6 months before the expiration date, it is possible to apply for an extension.

Capitalization of a JV:

Generally the absolute minimum of registered capital is RMB 30 000 for each investor in a company with multiple shareholders and RMB 100 000 for a company with one shareholder.

However, these requirements may vary depending on the business scope.

Also, registered capital requirements can change considerably if debt-financing is used due to the fact that minimum capital requirements also depend on the debt-to-equity ratio. Hence the total amounts of loans cannot be too high compared to the registered capital (total amount of equity).

To be able to calculate the amount of registered capital needed in this case, it is important to distinguish between total investment and registered capital. As the name implies, registered capital is the amount of capital registered with the Chinese authorities and is the shareholders’ equity in the JV.  Total investment is defined as the sum of registered capital and loans.

The following table shows how much minimum registered capital is needed depending on total investment:

Total investment and its financing should also be included in the Article of Associations (AoAs) and it should be differentiated between total investment and registered capital in the AoAs.

Although it is sufficient (and compliant with Chinese laws) to inject merely the minimum amount of registered capital required, this is not advisable. Until the Joint Venture is able to fund itself registered capital is needed to fund the companies’ operations. Also, if the business is viewed to be underfunded by government authorities this might lead to problems. Therefore it is recommended to carry out a feasibility study to determine the level of capital needed before deciding on any amount.

IP Protection:

Intellectual property protection is a crucial step when entering the Chinese market. This especially applies to Joint Ventures. Trademarks, copyrights and patents should be registered as soon as possible. Also, it might be advisable to keep certain intellectual property out of the Joint Venture or give the Joint Venture partner only limited access to it.  For more information on trademark registration please go to:  https://www.ecovis.com/focus-china/5-steps-to-successful-trademark-registration/

Profit repatriation:

There are different ways to repatriate profits from China in a cost effective way. It is recommended to consider profit repatriation methods when drafting the Articles of Association. An expert should be consulted for further help. For more information about profit repatriation please go to:  https://www.ecovis.com/focus-china/an-overview-of-profit-repatriation/

Due- Diligence Check:

Before starting a Joint Venture with a Chinese company it is important to carry out a thorough due diligence check of the target company.

Things that should be checked when conducting a due diligence check include:

• Business license
• Amount of registered capital
• Company Accounts
• Land use rights

In the following paragraph a brief overview of the most important due diligence steps will be given.

Business License:

A business license should include details about the legal representative, term of operation, the amount of registered capital, the registered address an  the validity period as well as a registration number. All of these items need to be checked carefully. The term of operation should be sufficiently long and it should be verified that the person who is acting on behalf of the company is actually the legal representative. Also, it is advisable to conduct a background check on that person.

Amount of registered capital:

It is important to verify that the target partner has actually met the registered capital requirement and has injected the amount of capital stated on the business license. This can be checked by a qualified Certified Public Accountant (CPA) firm.

Company Accounts:

Unfortunately accounts of Chinese companies have often been incorrectly prepared and it might be difficult to obtain the correct numbers.

When examining a companies’ accounts special attention should be drawn to the following:

Accounts receivables:

A Company might attempt to reduce taxable income by hiding sales. Alternatively money owed by debtors to the company is sometimes overstated to impress potential investors.

Accounts payable:

Fake or irrelevant transactions might be recorded to reduce taxable income.  If the aim is to leave investors with a good impression, transactions might be hidden.

Land use rights:

Assets of Chinese business partners often consist of land. It needs to be carefully examined whether

• the Chinese business partner is the rightful owner of the land or merely has the rights of use
• the land is contaminated or polluted and therefore unusable
• the price for the land is estimated correctly.
• the land has a mortgage or other liabilities

Letter of Intent:

A letter of intent outlines the intention of a foreign company and a Chinese company to create a Joint Venture. Although it is generally non-binding it might include legally binding provisions that specify for example that the negotiations between the parties  are exclusive. It is usually drafted before a Joint Venture is set up and sometimes referred to as a memorandum of understanding.

Most important Set-Up Steps:

Setting up a Joint Venture requires the help of an expert. This is a brief overview of the most important steps:

1. Due Diligence Check.

Before setting up a Joint Venture, the potential business partner needs to be analyzed thoroughly (see above).  Once the right business partner has been found a letter of intention may be written (see above).

2. Draft  Pre-establishment documents for setting up a Joint Venture.

(e.g. MOU, JV Contract, Articles of Association, Feasibility Study Report etc.) in English and Chinese . Also employment contracts should be reviewed by an expert.

Articles of Asociation (AoAs):  The AoAs will outline how the company will operate. As mentioned before the specific business scope has to be stated. The AoAs must be written in Chinese and signed by all partners.

Feasibility Study Report:

A feasibility study report should  include among others: background of the project, marketing and production capacity,  estimated capital needed and assessment of risks.

3. File and receive Approval Certificate and Business License at the MOFCOM and AIC.

Note:  Once the above pre-license steps are completed, the Joint Venture is legally set up. However at this point it is still non-operational. Therefore several post- license steps have to be taken.

The most important post-license steps:

4. Register company chops (financial and legal stamp) at the Public Security Bureau (PSB) and carving seals.

Every company in China is required to have a red chop.

5. Tax registration at the Local and National Bureau

As the name implies, the National Tax Bureaus (and its offices) are responsible for collecting taxes for the PRC government, while the local tax bureaus (and offices) are responsible for collecting taxes for local governments.

6. Registration with State Administration of Foreign Exchange (SAFE).

SAFE is responsible for rules and regulations concerning the forex market.

7. Open Capital Bank Account and contribute registered capital.

Obviously this is a very crucial step.

Ecovis can help your company with all the steps above. Also, our one-stop-concept ensures all-around support in legal, fiscal, managerial and administrative issues.