8 Things to consider before setting up a Chinese Company

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The Coronavirus epidemic struck the entire world very hard and it is yet uncertain when the crisis will be completely resolved. China, however, being the first country to suffer from the virus was also amongst the first to (relatively) recover.

People are adjusting to a mask-wearing, health QR-code dependent life. Specifically in Shanghai, life is pretty much back to normal. Certain sectors, such as medical devices, e-commerce and gaming, have even prospered under the epidemic, especially in the initial few months when people remained quarantined in their homes. With that said, and with the increasing return of economic activity and physical return of many foreign employees and business-owners to China, we would like to share with you certain points and insights a foreign investor should consider before setting up a company (or registered office) in China.

  1. Company or Rep Office?
  2. Business Scope and Licenses
  3. To JV or not to JV?
  4. Location
  5. Registered Capital
  6. Challenges of Employment
  7. IP Protection
  8. Taxation and Invoicing

1   Company or Rep Office?

One of the most important decisions for a foreign investor to take is the legal form of his or her Chinese enterprise. For most investors, the choice would be between setting up a Representative Office (“Rep Office) or a limited liability Company.

In summary, a Rep Office is relatively easy to set up and cheaper to maintain, but is limited in its scope of allowed activities and notoriously difficult to deregister or transform into a Company. A Company, on the other hand, offers investors a distinct limited liability legal entity and allows the foreign investor to do much more, such as engaging in profitable activities and hiring local employees.

Until 2020, the percentage of foreign-owned capital in a Chinese company determined its specific legal form (i.e. Wholly Foreign Owned Enterprise, Equity or Contractual Joint Venture). However, following the Foreign Investment Law’s entry into force on January 2020, the legal form of all privately-held Chinese limited liability Companies is now the same.

For investors operating in China above a certain volume of activity or to those without sufficient local connections like distributers acting on their behalf, our usual suggestion would be to set up a Company. However, every case has to be considered under its own circumstances, for example if the foreign investor intends to operate in a field which is only open to local Chinese companies (such as media).

2 Business Scope and Licenses

Unlike other jurisdictions, in China what is written in a company’s business scope truly matters. Simply put, if a certain sector or business activity is not in the scope, the Company cannot do it and may face severe sanctions and penalties otherwise. This means that you need to be careful and precise when determining the Company’s business scope that will appear in its Articles of Association and in its Business License (the Chinese equivalent of a Certificate of Incorporation). A legal feasibility check is often required before the incorporation process, to see if it is even possible or feasible for a foreign investor to directly operate in the field.

In addition, one always has to consider the Negative List published by the Chinese authorities. In the Negative List, certain sectors are completely prohibited to foreign participation (like postal services) or are restricted to only a certain percentage of foreign investment (for example: basic telecommunication services, requiring a Chinese majority partner). On the other hand, the Chinese government actually encourages foreign investment in other sectors (such as aerospace manufacturing and certain medical technologies), which are included in the Encouraged Industries Catalogue and may receive preferential tax treatment. Local governments may offer their own incentives as well, especially in high-tech sectors (including and not limited to tax, rent subsidies and friendly visa policies for foreign experts).

Finally, many business activities require licenses or other authority approvals to actually operate in, even if they are included in the Company’s Business Scope. These include approvals by the NMPA (National Medical Products Administration, the Chinese equivalent of the FDA) for the sale or manufacture of medical devices, a license requirement to operate in the HR field and the filing or licensing of the Company’s local website with MIIT (Ministry of Industry and Information Technology) and police.

3      To JV or not to JV?

Adding a Chinese partner to your soon-to-be-incorporated Company can offer many advantages, including being able to operate in restricted sectors, additional funding and local connections. However, even the most beautiful romances can go sour and one of the the last thing you want to do is going to court, especially in a relatively remote Chinese province that happens to be your former partner’s home… With that said, if a Chinese partner is not required by the Negative List, you should carefully consider whether you want to be the sole owner of your Company (working with local partners through agreements, instead) or to share it with a local partner.

The ideal partner should be one well-known to you, with whom you have years of relationship and trust. However, in any event you should pay close attention to the drafting of the joint venture agreement and articles of association to clarify and protect your legal rights.

4      Location

Choosing the right location for your Company is also a thing to consider. Unlike other jurisdictions (for example: Hong Kong), in China the registered address of your Company can only be used by a single registered entity. For certain types of businesses which don’t require a large working space more cost efficient solutions like virtual or shared office spaces may be considered, although this always has to be checked in relation to the business needs of your Company and the policies of local authorities, who may or may not accept such “grey area” solutions. 

Certain regions in China focus on specific sectors. For example: Shanghai focuses on (financial) services, Shenzhen on privately-run tech companies while Xian is considered a hub of sorts for government-run tech companies. Such specialized areas may offer easier access to employees and industry connections. In addition, incorporating your Company in a Pilot Free Trade Zone or an industrial park may offer additional benefits such as more lenient regulations and taxation and even reduced restrictions on the Business Scope that may be chosen by your Company, because the Pilot Free Trade Zones have their own shortened version of the Negative List. However, it is not uncommon for the more heavily-incentivized areas to still be at a developing stage or be quite far from the major hubs of industry and commerce.     

5      Registered Capital 

A standard Chinese limited liability Company doesn’t have shares. The shareholders’ (despite the lack of shares) ownership and eligibility to dividends and liquidation proceeds is instead determined by their percentage of the Company’s Registered Capital. In this aspect, you should consider how much you want to invest, in light of the Company’s sector and business needs, in what form (Registered Capital can be provided as cash, goods, real estate or IP rights) and until when. In the event you want to add an external investor without altering the ownership right, investing in the Company’s capital reserve (i.e. without affecting the Registered Capital) may also be an option.

6      Challenges of Employment 

Being an employer in China carries its unique challenges and many foreign investors looking to save costs at the early stage find themselves paying much more down the line. Claims like “this is how it works in China” are simply not true, not to say dangerous. You should have written fixed-term contracts with all your local employees and clearly state the workplace’s rules in your employee handbook, to have maximum flexibility in the event you consider dismissing them. In addition, employers in China must deduct individual income tax for their employees and pay part of their Social Insurance costs.

7      IP Protection

If you have any intellectual property that you wish to use in China, the general rule is that you should register it as soon as possible. China employs a “first to file” system, at least with regard to trademarks. On the other hand, copyrights and patents have different arrangements, which may give a measure of protection to foreign-registered IP.

However, because IP registration in China is often a long and arduous process (for example: while the authorities try to shorten it, it still takes 9 months in average to register a trademark in China), we also suggest undertaking other steps such as confidentiality, non-use and non-compete obligations by your employees and suppliers and disclosing the minimum amount of necessary information.

8      Taxation and Invoicing

The last thing you may want are problems with the tax authorities, which may impact your Company with administrative and even criminal sanctions and cause massive amounts of hurdle in the event you may want to deregister the Company in the future (the tax authorities don’t want to lose any taxpayers, and thus scrutinize any tax filing abnormalities). Because of this, and same as the employment aspects – you should ignore sayings such as “this is how it works in China” and do proper tax filing and invoicing, as well maintain organized records of everything. In the long run, it is much cheaper to maintain professional bookkeeping and duly pay taxes, rather than suffer the results of tax non-compliance. This is especially true due to the fact that in many cases, the Company’s officers (like the Legal Representative) are personally exposed to sanctions.

Feb 9, 2021 by Zach Lichtblau

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About Equasia

Equasia is an expert corporate advisory and business services firm with offices in Hong Kong and Shanghai, helping clients to access, operate and grow in China and other Asian markets. We partner with entrepreneurs, investors, corporates, financials, startups and private clients.