China has made great strides in its reforms to open up its market for foreign direct investment. Among developing countries, China is now the largest recipient of foreign capital. Foreign-invested firms have played an increasingly important role in Chinese economic progress. It is also a large part of China’s trading activities with the rest of the
world. While there may be some differences in interpretations with respect to the role of foreign investment in raising China’s GDP, few would deny that without foreign investment, China’ reform will eventually suffocate.
Legal Forms of Foreign Investment in China
Before starting up a business in China, you have to know what the options are. Foreign Investors generally establish a business presence in China in one of three modes: Wholly Foreign-Owned Enterprise (WFOE), Joint Venture(JV), Representative Office (RO); the definition difference between each of these are summarized below.
The Wholly Foreign-Owned Enterprise (WFOE) is a Limited liability company wholly owned by the foreign investor(s). In China, WOFEs were originally conceived for encouraged manufacturing activities that were either export orientated or introduced advanced technology. However, with China’s entry into the WTO, these conditions were gradually abolished and the WFOE is increasingly being used for service providers such as a variety of consulting and management services, software development and trading as well. The advantages of establishing a WFOE include: Independence and freedom to implement the worldwide strategies of its parent company without having to deal with the Chinese partner; Capable of converting RMB profits to US dollars for remittance to their parent company outside China; Greater flexibility in its operations, management and future development. However, its disadvantages are also obvious, such as subject to more stringent investment restrictions, not permitted in some sensitive industries.
Joint Venture (JV) is a Limited liability company formed between Chinese investor and foreign investor. The parties agree to create an entity by both contributing equity, and they then share in the revenues, expenses, and control of the enterprise. JV has usually been used by foreign investor to engage in the so called restricted areas such as education, mining, hospital etc.
There are 2 types of Joint Venture: Entity Joint Venture (EJV) and Cooperative (or contractual) Joint Venture (CJV). EJV is a legal entity limited by liability, whose financial rights are allocated by their respective contribution ratios of investment, whereas CJV can be legal or non-legal entity, and the parties’ rights and liabilities are allocated by their contract. Therefore, CJV has more freedom in structuring profit distribution ratios.
The Representative Office (RO) is a non-legal entity operating representing its parent company overseas. It is allowed to engage in business liaisons, quality control, product promotion, market research, exchange of technology and other permitted activities in China, but not allowed to directly engage in operational activities. Therefore, strictly speaking, it’s not a form of foreign direct investment in China. However, some ROs are engaged in operations in a lawful or tacitly permitted way and constitute one of the direct foreign Investment forms in China, for instance: ROs of foreign law firms, ROs of foreign airlines etc.
Besides the three main modes mentioned above, there are also other forms often adopted by foreign investors, such as BOT (Build-Operate-Transfer), setting up Hong Kong companies, Mergers&Acquisitions etc.
Legal protection for foreign inventors
It is no bluff to say that there has been a great revolution in China’s legislation over recent years. Old laws act more as a roadblock for economic prosperity than a proper mechanism for advancing social welfare.
In order to keep to promises made during negotiations to join the WTO, by the end of the year 2004, Chinese government has cleaned up and amended more than 2300 prevailing laws and regulations and has begun implementing the revised Catalogue for the Guidance of Foreign Investment Industries and some other important laws and regulations. Recent events illustrate a legislation boom ongoing in the field of commercial law.
In China, the amended Foreign Trade Law of the People’s Republic of China came into effect in July 1st, 2004, which means Chinese government performed its commitment in advance. In this new Foreign Trade Law, it is not only changed the system of examination and approval for qualification of dealing foreign trade into the system of registration, but also stipulated that all Chinese enterprises, foreign enterprises and individual including any other solely owned enterprises in WTO parties have right to deal with import and export within the territory of China and they should enjoy preference no less than Chinese enterprises.
The Law of Real Right has been coming into effect on Oct. 1, 2007, which is purposed to perfect the legal system of protecting private properties so as to promote all sources of the wealth to follow fluently and adequately.
The Antimonopoly Law has been coming into effect on August 1, 2008, which is considered to be the Constitution of the market economy.
The Labor Contract Law entered into force on Jan 1, 2008 which improves the labor contract system, specifies the rights and obligations of both parties to the labor contracts, protects the legitimate rights and interests of the workers and constructs and develops a harmonious and steady employment relationship.
The Enterprise Income Tax Law came into effect on Jan 1, 2008 which is applicable to all the enterprises and other organizations that obtain income within PRC. Enterprises are divided into “resident enterprises” and “non-resident enterprises” rather than Chinese invested company and foreign invested company as before.
The recent boom in commercial legislation has fundamentally changed the commercial law environment in China, and the boom is not yet at an end. The legal space for foreign investors living has sharply changed after law revision or issuance. In general, with continuing changes and revisions, more legal risks will blossom beyond anyone’s expectations. Foreign investors need to seek innovative rules in the newly changed commercial environment. In particular, foreign investors must learn to adapt to the continuously evolving legal environment.
David Zhang/ SHANDONG YOUHUA LAW FIRM