Five Things to Consider Before Expanding into China

Five Things to Consider Before Expanding into China

1. Is the investment allowed under Chinese law?

Although China has become increasingly receptive to different types of foreign investment, not all foreign investments are currently welcome or allowed.

In 2017, China published a “catalogue” which contains guidance for different foreign investment industries. The catalogue divides China’s domestic industry sectors into two categories: (1) the encouraged category, which lists the foreign investments that are allowed; and (2) the “Negative List” category. The Negative List is further divided into two parts: (1) the restricted category, which consists of 35 items in total where foreign investments are restricted; and (2) the prohibited category, which consists of 28 items in total where foreign investments are prohibited. Accordingly, the catalogue reflects China’s approach to liberalizing foreign investment by restricting fewer sectors.

Related Article: Current Issues in Early Stage Investments from China

Notwithstanding the catalogue from 2017, China still uses a different and shorter “Negative List” for foreign investments in its free trade zones (discussed in part 3), which is officially named the “Free Trade Zone (FTZ) Foreign Investment Entry Special Administrative Measures (Negative List) (2017 Version).” Thus, the first thing to consider before expanding into China is the category in which your contemplated investment might belong.

2. Does my investment need to be approved by Chinese authorities?

China has moved from a case-by-case approval system to a simpler recording-filing system for foreign investments, except for foreign investments involving businesses on the Negative List. Foreign investments that are eligible for recording-filing can be filed (i.e., approved) after 3 working days on average, which is a huge administrative improvement compared to the 20 working days that approval previously took.

Further, on July 30, 2017, the Chinese Ministry of Commerce issued two additional regulations which provide that the merger and acquisition of domestic companies (that are not in business sectors on the Negative List) and strategic investments in listed companies by foreign investors (also not on the Negative List) are eligible for recording-filing.

3. Should I invest in a free trade zone? If so, which one?

China’s free trade zones (“FTZs”) allow investors to sell goods and provide services that may be prohibited or restricted elsewhere. Authorities can also use these zones to test market liberalization measures before nationwide implementation. There are currently 11 FTZs and 12 additional cross-border e-commerce FTZs in China, with different industry focuses and matching incentives (e.g., tax incentives, customs clearance, industry-specific liberalizations, etc.) to attract their targeted investments.

FTZs in China include but are not limited to the following: (1) the Shanghai free trade zone which focuses on financial services, advanced services, and pharmaceuticals, and is a testing ground for new free trade zone regulations of China; and (2) the Shenzhen (which is a city close to Hong Kong and a top technology hub in China) free-trade zone that focuses on logistics, technology services, and financial services.

In 2016, China implemented a new cross-border financing management regime, which liberalizes offshore financing in four free trade zones: (1) the Shanghai Free Trade Zone; (2) the Guangdong Free Trade Zone; (3) the Tianjin Free Trade Zone; and (4) the Fujian Free Trade Zone.

4. Which structure should I use to conduct my business in China?

If you’re on the fence about forming a business or investment vehicle in China, you may consider conducting your business via product sales or contractual agreements to test the waters. However, if you decide to form an entity in China, the following are the main forms of foreign investment enterprises that are used for investing in greenfield projects in China:

(1) Equity Joint Venture (“EJV”): This is the most commonly adopted structure for joint Chinese and foreign ownership.

(2) Cooperative Joint Venture (“CJV”): Similar to an EJV, the CJV provides more flexibility in terms of what an investor may contribute as registered capital, cooperative conditions, distribution of profits and liability, and return of investment, which may be agreed upon in the joint venture document.

(3) Wholly Foreign Owned Enterprise (“WFOE”): A limited liability company with 100% foreign ownership, this is the investment vehicle of choice for most foreign investors in industries where there are no restrictions on foreign investment and where there are no strategic reasons for engaging a Chinese partner.

(4) Representative Office (“RO”): Opening an office can provide basic market entry without a formal legal establishment. However, restrictions on direct business activities make ROs unattractive as an entry vehicle in most cases.

5. How do I get my funds out of China?

The Chinese State Administration of Foreign Exchange (the “State Administration”) now requires approval for offshore payments that total over 5 million U.S. dollars. Further, companies are being encouraged to delay making offshore payments to help the authorities preserve the value of the Chinese currency. However, the capital controls mainly focus on outbound investment transfers instead of normal profits repatriation. Still, foreign investors should be aware of the capital controls by the Chinese authorities and plan ahead.

In terms of profits repatriation, in March 2017, the State Administration announced that foreign companies are free to remit profits out of the country using normal procedures to reassure investors that new capital controls are not overly restrictive. Investors can repatriate dividends to their shareholders in any financial year provided that the company has met statutory financial obligations to settle previous years’ losses, pay requisite taxes, and allocate sufficient monies to its reserve fund and employee bonus and welfare fund.

Moreover, U.S. investors should take advantage of the U.S.–China Income Tax Treaty (1984). In addition, China recently announced that, subject to certain conditions being met, foreign investors from resident companies in China can defer income tax on the eligible distributed profits provided that the profits are directly reinvested in areas being promoted by the Chinese government (e.g., businesses in the encouraged category of the 2017 catalogue).

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[1] Huang Jianwen. “The New “Negative List” for Foreign Investment.”

[2] Wu Ye. “What will Become of Foreign Investment in China under the New Record-filing System?”

[3] Dezan Shira & Associates. “Investing in China’s Free Trade Zones.” China Briefing.

[4] King & Wood Mallesons, “Doing business in China”, 2017 Edition, page 13.

[5] King & Wood Mallesons, “Doing business in China”, 2017 Edition, page 45-46.

[6] KPMG China, “WHT Deferral Incentive for Profit Reinvestment in China.”

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Jia Liu