China: Will Tesla Be Given The Green Light To Build A WFOE In China?

Last Updated: 20 December 2017
Article by Claire Gu

Known for the prototype of the "Iron man", Elon Musk has the same global ambition as Tony Stark, a wealthy American business magnate under the mask of the "Iron Man." Mr. Musk, co-founder, CEO and Product Architect at Tesla, wishes to make electric cars the regular mode of transport worldwide.

Despite the company's low-key appearance, Tesla has managed to make the news by establishing a factory in the form of Wholly Foreign Owned Enterprise (WFOE) in the Shanghai Free Trade Area. 

The consequences of this are still unclear and numerous news outlets are speculating about the necessity for Tesla to enter into a joint venture partnership with a Chinese automaker to succeed in the Chinese market.

In practice, multinational companies and their business activities can easily form a monopoly on the market, and many countries interrupt the investment behaviors of these companies by setting up obstacles on equity. 

This is especially true of the automobile vehicle manufacturing field, which has a significant impact on the national economy and the citizens' living standards.

For example, Volkswagen, F.I.A.T., Ford and other big names of the industry have been collaborating with local companies to meet the Chinese governmental requirements.

Special administrative measures on Automobile Manufacturing Industry

Circular of the General Office of the State Council on Issuing the Special Administrative Measures (Negative List) for Foreign Investment Access to Pilot Free Trade Zones (2017 Edition)

14. In terms of investment in the manufacturing of finished automobile cars and special-purpose motor vehicles, the shares controlled by the Chinese party shall not be less than 50%, and a foreign company is allowed to establish up to two (including two) joint venture enterprises engaged in the manufacturing of similar finished automobile cars (passenger cars or commercial vehicles) in China. In the case of a merger of another domestic automobile manufacturing enterprise with a Chinese joint venture partner, it is free from such restriction.

Special Administrative Measures (Negative List) for Foreign Investment Access to China (Shanghai) Pilot Free Trade Zone (Revised in 2014):

  1. Investment   in the manufacturing of finished automobile cars, special-purpose motor   vehicles and agricultural trucks must be subject to joint venture or   cooperative operation, and shares controlled by Chinese party shall not be less than 50%; when a listed joint-stock company specializing in finished   automobile cars, special-purpose motor vehicles and agricultural trucks sells   its corporate shares, one of its Chinese legal persons shall be a relative   shareholder with an amount exceeding the sum of shares held by foreign legal   persons; one foreign company is allowed to establish up to two (including   two) joint ventures engaged in manufacturing of similar finished automobile   cars (passenger car or commercial vehicle) in China. In case of merger of   other domestic automobile manufacturing enterprises with the Chinese partner,   it is free from such restriction.
  1. Investment   in the manufacturing and research and development of automobile embodied   electronic integrated system must be subject to joint venture or cooperative   operation.
  1. In terms of the investment in energy-based power battery (energy density ≥ 110   Wh/kg; cycle life ≥ 2,000 times) of new-energy automobile, shares held by the   foreign party shall not be more than 50%.

In accordance with the "Special administrative measures on Automobile Manufacturing Industry", it is possible for Tesla to establish a WFOE. The WFOE could be a very convenient way to maintain confidentiality and, in addition, to maintain leading knowledge management technologies on the market.

However, if the news are confirmed, Tesla will have to settle a 25% custom duty and other added value taxes. When selling goods onto the Chinese market, one must take into consideration the nature of the free trade zone (it is under the customs' special supervision, and not a tariff-free zone). When compared to its transportation cost, it is quite a relief. We may estimate that this WFOE will help to reduce costs by 20%.

Yet, we must not lose sight of the many obstacles and challenges foreign companies face in pursuing market status in China. The shareholding restrictions on automobile manufacturing stem from 1994, when China promulgated the first "automobile industry development policy" thus regulating the proportion of joint ventures. Then another two revisions came in 2004 and 2009, issued by the National Development and Reform Commission. These restrictions are still enforced today.

In recent years though, the following statement was removed from the last version of the State Council's Negative List: "new all-electric battery passenger vehicle manufacturing enterprises must have their own product brands and proprietary intellectual property rights as well as authorized relevant patents for invention." It has been interpreted by many as a signal that China's market will open to those who can increase the production of environment – friendly vehicles.

This happens to coincide with the insider information on Tesla's WFOE gamble. It is reported that the Chinese government has considered changing its negative list to allow foreign companies to expand electric automobile production. This amendment may be enforced as early as next year. The current attitude of the Chinese government is they are cautious with such changes, but still leave some leeway.

After denying the news regarding Tesla's WFOE in China, the company's spokesman added: "For foreign investors, especially in high-tech, energy saving and environmental protection, strategic emerging industries and other fields, China has always taken a welcoming attitude."

For China, currently the world's largest electric automobile market, the growth prospects for electric vehicle manufacturers are bright. Whether or not Tesla will become the world's largest electric vehicle brand remains to be seen. Nevertheless, this much is clear: the electric vehicles have already changed the dynamics of the world we live in.

Previously published 16 November 2017

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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