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How to set up a business in China
June, 14th 2007
The differences between domestic-invested enterprises and foreign-invested enterprises have been diminishing.


Ms Shirley Chin (Left), Partner, and Ms Yuhua Yang, Specialist in M&A, Alliance Law Firm, Beijing.

As one of the world's fastest growing economies and a major low-cost manufacturing destination, China is too important a market to be ignored by any multinational. But doing business in China remains an area fraught with various speed-breakers.

The country's entry into the WTO has brought a tremendous change in the Chinese legal system, especially in the field of foreign investment, according to Ms Shirley Chin, Partner of the Beijing-based Alliance Law Firm, and Ms Yuhua Yang (of the same firm), who specialises in corporate restructuring, mergers and acquisitions, banking and financing and securities.

Alliance Law Firm, which is authorised and licensed by the China Securities Regulatory Commission (CSRC) and the Ministry of Justice, enables transactions with respect to Chinese securities law and offers specific legal advice to clients through its diversified practice.

In an e-mail interview, on a broad range of issues concerning doing business in China, to Business Line, they said that for a foreign investor seeking to set up a manufacturing base in the People's Republic of China (PRC), the most common practice is to set up a foreign-invested enterprise, of which there are three kinds: Chinese-Foreign Equity Joint Venture (EJV), Chinese-Foreign Contractual Joint Ventures (CJV) and Wholly-Foreign Owned Enterprises (WFOE).

"Foreign investment industries are currently divided into encouraged category, permitted category, restricted category and prohibited category," said Ms Chin, adding that the investors' nationality does not substantively affect investment processes and results.

"At present, PRC encourages foreign investors to set up enterprises providing BPO services. Therefore, the steps to establish a BPO enterprise are similar to general foreign-invested enterprises."

According to her, from a legal perspective setting up a foreign-invested enterprise entails a number of steps, such as selecting the investment orientation from the Catalogue for the Guidance of Foreign Investment Industries (Amended in 2004) and the investment project and partner (that is, Chinese companies, enterprises or other economic organisations); obtaining notice of advance approval of enterprise name; submitting project proposal to departments concerned and obtaining approval; and submitting required documents and obtaining approval from the Ministry of Commerce or local authorities, depending on how large the investment is.

These need to be followed up with other formalities such as registering in the State Administration of Industry and Commerce or the local departments of industry and commerce and obtaining business licence; scribe seals of the enterprise; obtaining legal person code card, registration card of foreign currency and tax registration card from the departments concerned.

Besides, there are other steps such as opening foreign currency and RMB bank account, registering with the Customs and completing the procedure of recruitment and foreign personnel employment with approval from the labour and social security departments concerned.

On the laws governing the reporting and filings of foreign companies, Ms Chin said that there are three separate sets of laws and regulations governing the three kinds of foreign-invested enterprises mentioned earlier.

"In addition, foreign-invested enterprises should observe the general laws of PRC regulating the organisation and operation of companies, such as the Company Law."

And according to the laws and regulations, foreign entities may set up only one kind of non-company organisation in the PRC the Representative Office (or Rep Office).

According to Ms Chin, unless specially approved, the Rep Office of a foreign entity is only allowed to conduct indirect commercial activities for the foreign entity within its business scope.

These include business liaison/contact, introduction of products, market research, business information gathering, technology information exchange and other preparatory and auxiliary work.

"A Rep Office is usually not allowed to conduct direct business activities, such as purchase or sale of goods in its own name. The laws and regulations that govern the foreign-invested enterprises are not applicable to Rep Offices, but some special regulations are bearing on the Rep Office's establishment and operation."

On other issues surrounding such foreign-invested enterprises, she said that these enterprises must first register elementary items such as scope of business, registered capital, shareholders, amount and manner of investors' contributions. Any change of these items must be submitted to the original examining and approving authorities for approval.

"As per the tax laws and relevant regulations of the PRC, foreign-invested enterprises should undertake the tax liability and complete the tax declaration as per the request of authorised revenue departments."

And once the foreign-invested enterprise becomes a listed company of PRC, it should "lawfully, promptly and accurately" release relevant information according to the Securities Law and the rules of CSRC.

According to her, the differences between domestic-invested enterprises and foreign-invested enterprises have been diminishing.

Ms Yang added that the rapid development of China's economy has increased the demand for legal professionals, and more and more Universities have established law schools offering primary legal courses to all students.

"The curriculum is also being improved. For example, to strengthen students' practice skill, the law school of Peking University started a vocational course in 2000."

According to her, China's WTO entry is bringing about amendments to existing laws and numerous regulations governing foreign investments, taxation, exchange controls, labour and personnel management, and intellectual property protection, at the central and local levels.

The Company Law was also amended comprehensively in 2005 to enable opening up of the Chinese market. "In addition, the PRC has adopted several measures to improve the efficiency of courts."

The biggest challenge before any foreign enterprise is protecting the investor's profits, rights and interests.

Ms Chin said that the PRC protects foreign investors' profits and other legitimate rights and interests of foreign-invested enterprises according to law.

"Foreign-invested enterprises shall not be nationalised and expropriated. Therefore, most disputes faced by foreign investors relate to the agreement among the investors, such as validity of contract for EJV and CJV, amount and manner of investors' contributions, business management right, duration and liquidation of EJV and CJV."

According to the Implementation Rules, disputes that cannot be settled through consultation can be arbitrated by Chinese arbitration institutions or by other foreign arbitration institutions in accordance with the written arbitration agreement.

In the event of no written arbitration clause in the contract for EJV and CJV, or no arbitration agreement reached afterwards, legal proceeding can be instituted with PRC courts.

"PRC courts and Chinese arbitration institutions will solve such disputes justly according to laws and regulations, and will not be partial to native investors."

She cited a precedent confirming this statement. "In July 2001, a foreign investor signed an agreement with a Chinese company to establish an EJV. They deposited $20,000 into the account of the EJV according to the agreement, but the Chinese party did not keep its end of the bargain, as a result of which the EJV was not established. The court ruled that the Chinese party should return the invested monies."

Speaking on mergers and acquisitions, Ms Chin said that it is not easy to compare the Chinese example with other countries.

"China's M&A market does have its unique characters and features. The new M&A Rules seem to be sweeping in its reach and are likely to have a great impact on different types of M&A transactions in China. Foreign investors need to carefully consider the impact of the New Rules before deciding on a transaction structure."

D. Murali
C. Ramesh

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