Starting business in China – in brief

8 min.

By Lily Gao and Richard Hoffmann, ECOVIS Beijing China

 

Setting up a business in China can cause a lot of anxiety for the unprepared. The following article addresses some of the possibilities for foreign investments in P.R. China and also features information regarding tax issues, the amount of registered capital and location.

1. Possible legal forms

1.1 Offshore (company) structures

An investor may consider setting up an offshore company first. An offshore company means that the business is registered in the British Virgin Islands or on the Caymans Islands (or other tax-free jurisdiction). The main advantages of using an offshore company to invest in China are 1) the dividend obtained from the Chinese company is tax free in such jurisdictions and 2) there are less stringent requirements regarding company formation and equity transfer.  In the case of a business registered and operating in Hong Kong Special Administrative Region, for instance, the dividend tax only amounts to 5%.

1.2 Investment structures in Mainland China

Common investment structures and their characteristics are as follows:

Wholly Foreign Owned Enterprise (WFOE): This is a limited liability company with 100% foreign ownership. The advantage of a WFOE is full control over the management and daily operations of the company. The WFOE is by far the most popular corporate structure.

Equity Joint Venture (EJV): An EJV is a limited liability company with both foreign and Chinese investors.  Both the ownership and profit distribution are subject to the equity distribution of the owners.  In accordance with the relevant Chinese laws, a Chinese individual is not allowed to set up an EJV with a foreign company or foreign individual; however Tianjin and Shanghai’s Pudong area have different practices regarding this issue.

Cooperative Joint Venture (CJV): A CJV can be incorporated as a limited liability company or an unincorporated venture based on the partnership agreement, but always has both foreign and Chinese investors. The ownership and the profit distribution could be set out in the CJV partnership agreement and does not need to follow the equity percentages of the owners.

Foreign Invested Company Listed by Shares (FICLS): This is a share issuing company with limited liability. To found a FICLS a registered capital of 5million RMB is necessary and at least 25% of the share capital should come from foreign investors.

Two other special foreign invested enterprises (FIE) are Foreign Invested Commercial Enterprises (FICE) and Foreign Invested Partnership Enterprises (FIPE).

A FICE has limited liability and is suitable for wholesale, retail, commission agencies or franchising businesses.

A FIPE has been possible since March 2010, and has such advantages as there being no minimum registered capital requirement, nor does it require approval from the Chinese Commission of Commerce. However, a FIPE should also follow the China Foreign Investment Industry Guidance Catalogue issued by the Ministry of Commerce.

1.3 Representative Office in China

One alternative to the FIE is to establish a representative office (RO) in China. In this case, one should be aware of the regulations applying within the field of business activities, registration requirements and tax implications for ROs.

The RO acts as a liaison office and may only act within the field of non-profit activities, market studies, research, product introduction and technological exchanges. Generally speaking, the RO fulfils indirect business activities on behalf of its head office.

The registration requirements for the RO include, among others, the legalized incorporation documents and bank reference letter of the investor, and the investor (company) needs to have existed for two years or more before it can establish an RO.  The employment of staff in the RO is restricted to four expatriates to receive a working visa under the RO.  Moreover, the residence term of the RO is restricted to one year and renewal must be applied for on a yearly basis.  In addition, an RO cannot hire local staff directly, and must go through a designated local HR agent.

An RO is also subject to special tax implications  based on different calculation methods – actual amount method, cost-plus method or the deemed profit based on gross revenue – depending on the accounting standards of the RO.  Lately, the tax burden for ROs has changed to a higher percentage.  Taking the cost-plus method as an example (the primary and common method for most ROs), the total percentage increased from 9.69% to 11.87%.  The cost-plus method means each penny spent by an RO is subject to tax.

Moreover, according to China’s Foreign Investment Industrial Guidance Catalogue, the business activities of the foreign invested enterprises are classified as encouraged, restricted and prohibited. An encouraged enterprise faces a simpler approval procedure. A restricted enterprise means that there will be shareholding restrictions, for example that  a WFOE is not permitted and only a JV can be set up, or even that a Chinese party must be a majority shareholder in some industry like value added telecom.

In addition, there may be specific industrial regulations that have to be reviewed and respected before setting up a company.

1.4 Example: How to set up a WFOE

After this overview of possible legal structures and their characteristics a step-by-step guide is given to illustrate the procedure of founding a business in China. This one is an example of a WFOE in Beijing.
1. Pre-license procedure:

Result: After finishing these pre-licence steps is legally set up.

2. Post-license procedure:

Result: After finishing the post-license steps, a WFOE is fully operational unless other special pre-approval licences are required subject to the business scope of the WFOE.

2. Further Considerations

Further essential questions are: ‘Where should the company be set up?’, ‘What should the amount of registered capital be?’ and ‘What tax payments need to be considered?’

2.1  The location finding process depends on a lot of different considerations, which may include availability of required infrastructure, proximity to suppliers and customers, availability of qualified staff, location of joint venture partner (if applicable), knowledge of relevant government authorities and special zones for tax advantages or governmental subsidy policies.

2.2 Registered Capital

Minimum amounts of registered capital are required by law depending on the legal structure of the company.

limited liability company with more than one shareholder30,000RMB
limited liability company with one shareholder100,000RMB
share issuing company with limited liability5,000,000RMB

Nevertheless, there may be different or higher requirements for the registered capital depending on the specific industry.  If the cash flow needs exceed the registered amount of capital, the amount of capital can be increased upon application to the relevant authorities, by loans from shareholders or local banks, or by intercompany service agreements.

2.2 The most important Chinese taxes

The Chinese tax system levies a wide range of different taxes, which includes income tax (corporate income tax and individual income tax), turnover tax (value added tax, business tax), taxes on real estate and other taxes such as stamp duty, custom duties and deed taxes.

Moreover one should be aware of the fact that there are two separate tax bureaux. One is the State Administration of Taxation (SAT) and the other the Local Tax Bureaux (LTB) with their local branches.

The main taxes for a business are described briefly below.

2.2.1 Corporate income tax
Corporate income tax (CIT) is levied on both foreign invested enterprises and domestic companies. It is levied on profits at a rate of 25%, but for small and thin profit enterprises the tax burden is reduced to 20%, and for high tech enterprises the tax rate is even reduced to 15%.  Industry-oriented incentives for the agricultural and fishery industries may cause CIT exemption or they may receive a reduction of 50%.

2.2.2 Business tax
Business tax (BT) is levied on the revenue for part of service activities. This includes the provision of taxable labour service if either the recipient or the provider of the service is located in China, the assignment of tangible products and the sale of immovable properties within China.  The BT ranges between 3% and 20% depending on the exact taxable activity. However, for services it is usually 5%.

2.2.3 Value added tax
Value added tax (VAT) distinguishes between general taxpayers, paying 17%, and small-scale taxpayers, paying only 3%. Taxable activities are the sale and import of goods as well as the provision of processing, repair or replacement services.

2.2.4 Other taxes
Two further taxes it is important to know of  are the education surcharge of 3%, and the city construction tax, which ranges between 1% and 7%. The legal basis for those taxes is the VAT, BT or the consumption tax, and is furthermore applicable to FIEs, non-tax resident enterprises and foreign individuals.

2.2.5 Withholding tax for non-taxresident enterprises
The withholding tax for non-tax resident enterprises (WHT) amounts to 10% but can, in the case of a tax treaty, be exempted. The WHT is applicable to indirect income, respectively to dividends, interest, rentals and royalties. Moreover, the WHT is also levied on any yields from the sale or transfer of real estate property land use rights and from yields on shares in a PRC company.

Overall, there are many legal and tax considerations to evaluate in order to have the perfect structure from day one of your China business. Therefore, it is suggested you consult (both) your tax and legal advisor initially to ensure the best structure. Restructuring at a later stage is always possible but can be complicated and taxes may apply. Therefore, it is better to get your business right from day one.
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Lawyer in Heidelberg, Richard Hoffmann
Richard Hoffmann
Lawyer in Heidelberg
Phone: +49 6221 9985 639
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