UK: A Summary of the Various Forms of Doing Business in China

In this note, we cover the vehicles most commonly used by foreign companies for doing business in China, namely, 1) representative offices, 2) processing and assembly operations, 3) technology transfer, 4) equity joint ventures, 5) co-operative joint ventures, 6) wholly foreign-owned enterprises, 7) joint stock limited companies, 8) holding companies and 9) additional operating vehicles.

Representative offices allow a foreign company to engage in certain limited business activities. A foreign company may find it useful to register a representative office in China in order to create a permanent base from which its resident personnel may conduct local sales and purchasing activities, to have a contact location in China for the convenience of its Chinese buyers and sellers and to signify its commitment to the Chinese parties with which it has business dealings.

The most common locations for a foreign company to register a representative office in China are Beijing, Shanghai or Guangzhou, although representative offices may be opened in other cities as well.

Representative offices are prohibited from engaging in 'direct business operations'. Permitted operations are: liaison for business purposes within the enterprise's scope of business, introduction of products, market research and technical exchanges.

As labour costs continue to rise in South Korea, Taiwan and Singapore, companies from Japan, Taiwan, the United States and the UK are now entering into processing and assembly transactions with Chinese companies with greater frequency.

The Chinese government has recognised the important role that processing can play in the development of the country, in terms of foreign exchange earnings, foreign equipment imports and production and management technology. As a result of the expansion in processing operations in China, national and regional legislation has been promulgated to regulate and encourage Chinese processing and assembly. Incentives include no requirement for import licenses for parts, materials and equipment used directly in the processing and assembly operation, no import taxes upon importation and no export permission required for the export of products processed with supplied materials assembled with supplied parts.

There are two types of processing and assembly operations: processing with supplied materials and processing with imported materials. Under the 'processing with supplied materials' arrangement, raw materials or semi-processed goods are shipped to a Chinese workshop or factory which then processes them and re-exports the finished products back to the foreign party. Typically, the Chinese factory receives a fee for its work, computed on a unit or lot basis. The foreign party will usually agree to supply certain production equipment, which is either sold, leased or provided to the Chinese party without charge. 'Processing with imported materials' is a new arrangement that has emerged in the last decade-or-so. Local enterprises set up to import their own materials to manufacture goods for export. The cost of purchasing and importing materials is borne entirely by the local enterprise and is exclusively in foreign exchange.

China's policy of co-operation with foreigners emphasises the transfer of technology to Chinese enterprises. Specific regulations stipulate the required contents and maximum term of technology transfer contracts and set out the centralised approval procedures. They also prohibit the imposition of various restrictions by the licensor on the use of technology by the Chinese licensee and provide assurances regarding the protection of the licensor's technology in China.

Transactions subject to these regulations include the transfer and licensing of patents, the right to apply for a patent, licence for patent exploitation and unpatented know-how and other forms of proprietary technology, as well as the provision of technical services.

The key feature of an equity joint venture is that profits, risks and losses are shared in proportion to the parties' respective contributions to the registered share capital. Equity joint ventures must take the form of a non-share issuing 'limited liability company' incorporated and registered in China and are seen as Chinese legal persons in Chinese law. A substantial body of law governs the establishment and running of equity joint venture companies.

Although the co-operative joint venture law (1988) does not explicitly recognise the distinction, in practice, there continues to exist two types of co-operative joint venture: the 'true co-operative joint venture' and the 'hybrid co-operative joint venture'.

The 'true co-operative joint venture' doesn't involve the creation of a legal person that is separate and distinct from the contracting parties. Each party is responsible for making its own contributions to the venture, paying its own taxes derived from the venture and bearing its own liability for risks and losses. Each party's rights, liabilities and risks are clearly stipulated in the underlying contract.

The 'hybrid co-operative joint venture' combines the characteristics of the true co-operative joint venture and the equity joint venture. A separate business entity is established and each party's liability is generally limited to their capital contributions.

Since 2000, the law has changed regarding the establishment of wholly foreign-owned enterprises ('WFOE's') and the law no longer requires WFOEs to favour domestic suppliers when sourcing their raw materials. This, coupled with the fact that a WFOE may be easier to establish than a joint venture (as no negotiation with a Chinese party is required), means there has been a significant increase in the number of WFOEs established in China over recent years.

As with other forms of foreign investment, restricted or prohibited investment categories are outlined in the 'Catalogue for the Guidance of Foreign Investment Industries'.

China adopted its first national 'Company Law' in 1993 which provides foreign investors with an additional form of investment vehicle: the joint stock limited company (also known as a company limited by shares). The aim of the Company Law is to transform China's state-owned enterprises into limited liability companies and joint stock limited companies that are commercially viable in an emerging market economy.

The key difference between joint stock limited companies and other common forms of direct investment is the fact that joint stock limited companies are able to issue shares.

Recently, a 'New Company Law' (replacing the old law) was promulgated and came into force in October 2005, (see http://www.pinsentmasons.com/media/1186002219.pdf and http://www.pinsentmasons.com/media/729151186.pdf for Pinsent Masons updates on this law).

In recent years, a number of foreign companies have established wholly foreign-owned or Chinese/foreign joint venture companies, the main purpose of which is to hold equity interests in subsidiary enterprises in China and to provide a range of centralised services to these subsidiaries. These are formally known as 'investment companies' and informally as 'holding companies'.

A holding company may be established as an equity joint venture or wholly foreign-owned enterprise, meaning the laws that apply to each also apply to holding companies, as do the general provisions of the Company Law.

Branch offices: In many countries, it is possible for foreign companies to establish brand offices engaging in business activities without the need to establish a foreign subsidiary. However, in China, the situation is different. The Company Law introduces the legal possibility of foreign brand offices but no specific regulations have yet been promulgated. Currently, only foreign companies in a limited number of business sectors, such as banking and insurance have been permitted to open branches in China.

Service centres: Foreign parties may enter into agreements with Chinese counterparts where the Chinese party is authorised to establish a service centre in China. These centres may provide after-sales service, maintenance and spare parts for machinery and equipment sold to end-users in China. They may not, however, market the main products they service.

Bonded zone and export processing zone enterprises: The Chinese government has set up these zones to facilitate import and export trade and encourage activities such as trading, warehousing, trade financing, transportation, packaging and export processing. Goods can be imported into and exported from these zones duty-free and are subject to very few import and export licensing restrictions.