China has become the best destination for business owners looking to expand their business operations overseas. Being one of the rapidly progressing BRIC economies with a large consumer base, China offers a lot of investment potential.
In the span of just two decades, the Chinese economy has displayed impressive growth. The country's emergent role in the international growth engine presents a lot of opportunity for foreign investors. The consumer-oriented diverse economy makes it an attractive destination for international businesses.
The governments' Made in China 2025 plan has placed increased emphasis on foreign direct investment. Key sectors for setting up a business in China include healthcare, e-commerce, transportation, and urban development.
If you plan to set up a business in China, you should consider different types of business formation. In this article, we have listed five types of businesses that can help foreign investors enter the Chinese market.
1. Wholly Foreign Owned Enterprises (WFOE)
A WFOE is a private liability company that is wholly owned by foreign investors. All the shareholders of WFOE are foreign investors. The process of establishing this type of business generally takes three to six months. However, sometimes it takes just under 30 working days to establish this type of business in China. The exact duration depends on the type of business that you set up such as trading, manufacturing, or service.
To set up a WFOE in China, you need to specify the scope of the business. The process of setting up a business in China consists of two parts: pre-registration and post-registration. In the former stage, you need to submit required documents regarding the business formation in China. In the latter stage, you need to formally register your business with government agencies in China.
Previously, the requirement for establishing a WFOE was RMB 100,000. However, this requirement was abolished in 2014. Now you can set up a WFOE business in China by investing as little as RMB 10,000.
A WFOE is completely owned by a foreign investor. They control all aspects of the business, including establishing policies and managing daily operations. Setting a WFOE in China helps protect trademarks, business processes, and trade secrets.
The Ultimate Guide for China WFOE Formation in 2018
2. Joint Venture
Another option for setting up a business in China is joint venture (JV). A JV is a company with at least one Chinese and one foreign investor. The business formation entails foreign company having at least a 25 percent share in the business.
An important thing to keep in mind regarding JV is that it does not represent a merger between a local and foreign company, Instead, it's a new entity that with ownership shared by the local and foreign company. The partners invest money, share responsibilities, and receive profits based on an agreed ratio. Liability of the company is limited to the contributed assets of the new company, and does not extend to assets of the private company.
The process of establishing a JV is more complicated as compared to establishing a WFOE in China. You need to locate a suitable Chinese business partner and then negotiate the relationship terms. Some of the things you need to consider when selecting a partner when setting up a JV in China include the following.
Alignment of strategic priorities
Tangible contributions by partners
Safeguard of intellectual property rights
Access to local talent
One of the benefits of partnering with a local company is that it allows sharing of business contacts and networks. In addition, it greatly reduces the effort required to establish a business in China. However, there are also certain dangers in selecting this type of business. The foremost risk is theft or exploitation of intellectual property in case frictions develops with the local partner. This is particularly the case there is no written agreement between the partners.
You need to contribute a minimum of RMB 100,000 to set up a JV in China. However, if you are investing in addition to another foreign investor, the registered capital that must be contributed by each partner is RMB 30,000. The exact contribution required for setting up a JV depends on the type of JV you want to set up in China.
3. Representative Office (RO)
Setting a representative office (RO) is yet another way of forming a business in China. The office serves as a headquarter from where you can manage relationships with local firms. This is the best option for foreign investors who want to setup a base for investment in China.
Of the different types of business formations in China, this is the by far the easiest to set up. Recent amendments have made it easy for foreign investors to establish an RO in the country. The main requirement for establishing this type of business in China is that the parent company must be formed at least 2 years prior to the formation of the RO. Also, the parent company needs to keep accounting records.
The application process of forming an RO in China is simple. You need to submit certain documents, and then register with the government agencies. There is no requirement for a minimum registered capital. The application processing duration is relatively short taking anywhere between 30 to 90 days.
You should remember that ROs are not allowed to carry on significant business operations. ROs are not allowed to issue invoices or enter into a commercial contract. They are commonly used for research, marketing, liaison, or publicity activities in China. You can engage in any business that does not involve direct profit generation. In addition, you cannot employ more than three representatives and one chief representative.
Unlike WFOE and JV, RO is not considered a separate legal entity. As a result, the parent company will be liable for its actions. It's important to comply with local requirements to avoid paying fines or having your certificate revoked. Also, while ROs have no operational income, any value that is created by them is taxable.
For instance, if your RO has earned commission or service fees from agency business or liaison activities, you need to pay taxes. Additionally, you have to pay taxes on income from business intelligence collection, market research, or consulting and coordination services. The tax rate is 33 percent of deemed income that reduces to 15 percent if the RO is a situation in a special economic zone in China.
4. Foreign Invested Partnership Enterprise (FIPE)
Yet another way to establish a business in China is through a foreign-invested partnership enterprise (FIPE). This is a relatively new form of business that was introduced in 2010. A Partnership Enterprise (PE) can be formed by two or more foreign companies. Also, it can be formed by a foreign company or individual with a local company.
The best thing about establishing a FIPE in China is that it can be established with very little investment of capital. Similar to a WFOE and RO, there are no minimum capital requirements for establishing a FIPE in China. In addition, similar to a WFOE in China, FIPE could engage in profit-generating activities. You can enter into contracts with local or foreign businesses and hire staff.
Partnership laws in China allow the formation of three different types of FIPEs. These include the following.
General partnership enterprise (GPE) — All partners have unlimited liability for the debts taken by the FIPE.
Limited partnership enterprise (LPE) — At least one general partner has unlimited liability while the rest have limited liability. Limited partners are not allowed to carry on daily management of affairs and are liable only to the extent of their contributions.
Special General Partnership Enterprise (SGPE) —The partnership is similar to a general partnership except that its operations are restricted to providing professional knowledge or specialized skills.
This structure protects co-partners from liabilities due to negligence or willful misconduct of one partner.
An important point to remember regarding FIPE is that income generated by the partnership is taxed similar to other enterprises. While partnerships are only taxed at an individual level, FIPE is not considered a partnership per se and therefore taxed as an enterprise.
5. Hong Kong Company
Setting up a Hong Kong (HK) Company is another way to tap into the Chinese market. While this type of business won't allow you to operate in China, many foreign companies register as an HK Ltd. company for convenience in setting up a business in China. Due to agreements between China and Hong Kong, this strategy will also provide certain tax benefits.
Now that you know the different ways you can set up a business in China, the next important question is which one is the best one for you. You need to consider pros and cons of each type before selecting oneto enter the Chinese market.
Which is the Best Way to Enter into the Chinese Market?
While the cost of setting an RO is lower as compared to other types, the business activities that are allowed is very limited. You should select this type only if you want to conduct market research, publicity, or liaison activities. If you want more flexibility in carrying out business operations, you should select WFOE, JV, or FIPE.
WFOE is the preferred option for setting up a business in China if you want more control over business operations and profits. With a WFOE, you will be able to safeguard intellectual property rights. In addition, you will face fewer restrictions when it comes to transferring of profits.
On the other hand, if you want to benefit from the expertise, network, and market share of a local company, you should go for a JV or FIPE. These two business types expedite the process of establishing a business presence in China. You can share the risks when you select either a JV or FIPE to create a business presence in China.
Lastly, you can opt for an HK Ltd. company in order to make it easier to form the above types of businesses. This will result in less paperwork and accelerated approval process.
When it comes to entering the Chinese market, you should not target the entire country in your initial efforts. The reason is that China is huge with a large population.
Targeting the entire country will require a significant investment of money and time. Instead, you should select a specific region such as a large city as your initial base. You need to narrow your focus as a region in China is the same size as a country elsewhere. Consider targeting developed areas at the initial stage and then expand your operations over time.
Deciding the business structure is a critical decision for expanding your presence in the Chinese market. Every option has its own benefits and you should select one based on the organizational goals.
An RO is the best business structure if you want to research before establishing a base in China. This will allow you to network, gain insights, and create a presence for doing business in China.
A WFOE will allow you to create a more tangible business presence and benefit from lower tax rates as well exercise as more control over the operations of the company.
A JV and FIPE is a great option if you want to benefit from the market presence, experience, and contacts of the local company.
Establishing a business in China is difficult as compared to establishing a business in the US or other western nations. You need to comply with regulatory requirements and follow specific rules. Noncompliance with the rules can result in delays and additional costs. Getting the help of a local consultant is important if you want to accelerate the process of setting up a business in China.
Remember that creating a business presence in China requires a commitment of resources. You need to make sure that you have done your market research before investing in China. You also need to adapt to the Chinese way of doing business. This means adapting your product or marketing campaigns to local or national regulatory requirements.