Leveraging the CEPA to enter the Chinese market

By Manuela Reintgen, ECOVIS Beijing

The Closer Economic Partnership Agreement (CEPA) between Hong Kong and Mainland China was signed in 2003, designed to forge better relationships between the two economies. In certain situations, it can be advantageous for a foreign firm looking to expand into the Chinese market to leverage CEPA and incorporate in Hong Kong to eventually establish a Wholly Owned Foreign Enterprise (WFOE) in Mainland China.

If a foreign firm operates in certain industries that are restricted or forbidden to foreign owners in Mainland China but allowed to foreign firms in Hong Kong, the foreign firm can come to China by means of Hong Kong. To do so, the firm must apply in Hong Kong to become a Hong Kong Service Provider (HKSP), a special type of incorporation in Hong Kong. An HKSP must include same business scope as the foreign firm and the same scope as the desired expansion into Mainland China.

The HKSP must be in business for three years, hire local employees, and pay taxes in Hong Kong. Then, the HKSP will fall under the provisions of the CEPA that allows the firm to establish a WFOE in the same business scope that can operate in Mainland China.

The decision of establishing a HKSP to enter China through the CEPA can be difficult. The foreign firm must weigh how long it will take to establish operations in China (to enter into a Restricted Industry (RI) in Mainland China requires a Joint Venture (JV) with a domestic Chinese firm and can take over a year to begin operations). If the foreign firm places a premium on establishing a WFOE instead of a JV they should consider entering China via the CEPA.

Example

A German company manufactures auxiliary power supply devices for the aviation industry. Per The Catalogue for the Guidance of Foreign Investment, this type of manufacturing is a restricted industry, restricted to incorporation as a JV in Mainland China. Thus, the firm has two options. They can find a partner in China and go through to process of incorporating a JV in China. Or, they can form a HKSP in Hong Kong and run their business for three years. After those three years they would be able to expand their operations into Mainland China as a WFOE.

Taking into consideration the time it takes to search for a compatible partner for a JV, the time that it takes to incorporate, and the time it takes to begin operations, the ultimate time it would take our German firm to start operations in China may be essentially the same if the firm enters through CEPA. In addition, the firm that goes through Hong Kong will be able to incorporate as a WE in an industry otherwise forbidden to full ownership by a foreign firm.

As a WFOE formed through a HKSP, the foreign firm was able to incorporate in China in the same amount of time that it would take to form a JV, but as a WFOE the firm has total control over their business operations.

Benefits of Operating as a WFOE

Compared to a JV, a WFOE has many advantages. First, a WFOE has significantly more control of a business than a JV. A JV requires two partners—even if they are fully compatible, it can be difficult to operate with a partner. The question of trust taints a business relationship if partners are not perfectly compatible. Finally, there is a time investment to find a partner in a JV aside for the formal business incorporation process that must be accounted for.

Of course, a WFOE comes with its own risks, but for many firms, a WFOE provides time, control, and ownership that foreign firms desire.

If you have any questions regarding JV, WFOE, or HKSP incorporation or other legal and tax needs, please contact Ecovis-Beijing at Beijing@ecovis.com.