Doing Business in China

Establishing an entity

The main legal structures available for foreign businesses wishing to operate in China include: Wholly Foreign Owned Enterprise (WFOE), joint venture, branch office and representative office.

A WFOE is a limited liability company, wholly owned by a foreign investor(s). WFOE was originally introduced to promote manufacturing activities that were either export-oriented or encouraged advanced technology. Since China’s entry into the World Trade Organisation, the WFOE has also been increasingly used for consultancy and service, wholesale, retail and franchise activities.

A joint venture is an entity formed by a foreign investor(s) and a Chinese party. It could be a Limited Liability Entity (equity joint venture) or a co-operative entity (co-operative joint venture). For foreign investors new to the market, a Chinese partner offers the advantage of familiarity with the Chinese market and may help to shorten the learning curve. In some industries, the Chinese government prohibits the formation of WFOE and requires joint ventures to be formed.

The Company registration process for any structure requires a registered address, one legal representatives and one supervisor.

There is no minimum capital requirement except specific industry, however the capital must be sufficient to finance the working capital due to the foreign exchange control regulations in place in China. The Capital must be contributed as specified in the article of association.

If the investor wishes to establish a presence but does not wish to establish a separate legal entity in China, the investor may choose to establish a branch office or a representative office. These 2 arrangements are treated as extensions of the head office overseas.

Branch offices are rarely approved and a representative office can only be used to facilitate market entry and/or act as a liaison for the group. A representative office cannot carry on business transactions or provide services to other entities.

Foreign business restrictions

Foreign businesses are regulated by the Ministry of Commerce (MOC) under the Catalogue for the Guidance of Foreign Investment. This catalogue categorises business activities into 4 groups: Encouraged, Permitted, Restricted and Prohibited.

Companies established in the Free Trade Zone in Shanghai are only subject to the Prohibited List related to this zone. An activity is allowed as long as it is not classified as “prohibited”.

Each group includes a list of the sectors and the legal structures required in each case: some of the activities require a joint venture, some limit the maximum percentage of shares held by the foreign partner, whilst others can be engaged through a 100% foreign-owned company.

Investment incentives

Foreign investment incentives are focused on some key sectors and less developed areas. Specifically, incentives are offered for high-end manufacturing, high technology, new sources of energy, energy efficiency and environmental protection industries subject to certain conditions. Entities in these key sectors may qualify for a lower enterprise income tax rate of 15%, as compared to the regular enterprise income tax rate of 25%. Research and development activities are also incentivised with 150% of the related expenses deductible for corporate income tax purposes.

In addition, foreign enterprises are encouraged to increase investments in China’s central and western regions through tax incentives, policy support and other favourable policies. Enterprises operating in these regions may enjoy a lower enterprise income tax rate of 15%.

Notably, laws relating to investment incentives are constantly changing. Professional advice should be sought when considering an investment.

Work permits and visas

To obtain a work permit, in most of the situation the applicant must hold a bachelor’s degree, have at least 2 years of work experiences and a local labor contract in China. The application file includes the original college degrees and no criminal records translated in Chinese, notarized and legalized at the Chinese embassy or consulate.

Taxation

The main taxes in China are value-added tax (VAT), withholding tax, corporate income tax and individual income tax.

Starting from 1st May 2016, all taxable services provided by or provided to tax payers located in China shall be subjected to VAT and no longer to BT.

There are 2 VAT payer categories: general VAT payers and small-scale VAT payers. The VAT rates for general VAT payers are mainly: 17% for lease of movable tangible assets, 11% for transportation services and 6% for other taxable services. Small-scale VAT payers’ rate is 3% and they cannot offset input VAT with output VAT. In most cases, VAT returns and related payments must be submitted by the 15th day of the following month.

Payments made from China are generally subject to withholding tax. If the payments are in relation to passive income, such as dividends, interest or royalties, they are subject to a withholding tax of 10% (to be reduced by the relevant tax treaty). In addition, VAT may be charged on items such as interest or royalties. If the payments are in relation to the provision of services, depending on whether there is protection by virtue of tax treaties, profits on such services are subject to withholding corporate income tax at 10%. These kinds of services are subject to VAT, which are not covered by tax treaties.

Corporate income tax (sometimes called enterprise income tax) is generally applied at a rate of 25% on net profits. Two types of declarations are required: an annual declaration and a quarterly declaration.

These quarterly declarations represent a prepayment of the calculated tax payable on the forecasted net profit for the year. It is worth noting that whilst operating losses may be carried forward for up to 5 years, there is no provision for the carry back of losses or for group relief in respect of affiliates’ consolidated losses. The annual declaration must be submitted before May of the following year together with the statutory audit report.

Individual Income Tax (IIT) in China is withheld on a monthly basis by the employer. It is a progressive system and the responsibility for computation and declaration is shared between employee and employer.

In practice, however, employers would be held responsible by tax authorities and would be subject to penalties for failure to report and withhold by the employers. The penalty could be as high as 3 times the amount of IIT payable. The underpaid IIT remains the responsibility of the employee. It should also be noted that an annual declaration is also required for certain individual employees e.g. those with annual income exceeding RMB 120,000 and those with income from more than 1 source.

Social contributions

Since October 2011, foreign employees in China are required to register with the National Social Security Management Centre and contribute to all 5 contribution schemes: pension, medical, work-related injury, unemployment and maternity. German and South Korean employees are exempt from this requirement due to the social contribution treaties their governments have signed with China.

Social contributions are declared and paid for on a monthly basis. The rates and basis of calculation vary depending on the location of employment.

Foreign currency transaction controls

The State Administration of Foreign Exchange (SAFE) is tasked notably with the promulgation of rules and regulations governing foreign exchange transactions, monitoring foreign exchange activities and setting the Renminbi convertibility policy.

Foreign companies in China will typically have to deal, directly or indirectly, with SAFE when receiving funds from, or paying to, overseas parties. In the case of a loan with an overseas sister/mother company for instance, the China-based borrowing company would have to register the loan with SAFE prior to receiving the funds in a dedicated bank account.

Such procedures with SAFE should not be underestimated as they can be long and complex.

Audit and accounting

All Foreign Invested Entities (FIE) in China must have their accounts prepared by a registered Chinese accountant and audited by a registered Chinese CPA firm. The financial year-end date for all entities is the 31st of December. A financial and statutory report must be issued by a CPA firm.

People’s Republic of China’s (PRC) generally accepted accounting principles (GAAP) is broadly aligned to IFRS, although some of the more complex standards, such as IAS39 Financial Instruments, have yet to be adopted.

Country quirks

• Legal structure and capital required are sector dependent.
• Accounts must be prepared by a Chinese accountant and audited by a Chinese CPA Firm.
• All FIE in China must be audited.
• Four categories of business activities: Encouraged, Permitted, Restricted and Prohibited.
• Foreign exchange control exists on all transactions in and out of China.

Visit Mazars China for more information on the services available to help you set up your business.