Setting up a Business in China by Thibaut Minot

Presentation by Thibaut Minot

The Chinese Ministry of Commerce maintains a Catalogue of Industries for Guiding Foreign Investment, which stipulates the degree of openness of China’s industry sectors to foreign direct investment (FDI). According to the Catalogue, industries are sorted into three categories: those in which FDI is ‘encouraged’; those in which FDI is ‘restricted’; and those in which FDI is ‘prohibited’.

Depending on which industry they operate in, and depending on their business model, foreign investors looking to establish a formal presence in China will typically choose from one of the following investment vehicles:

1.The Sino-Foreign Joint Venture (JV)

The Sino-Foreign Joint Venture (JV) is a legal entity co-invested by foreign and domestic shareholders. Among notable advantages of the JV, this vehicle allows for risk and cost sharing, investment in the industries ‘restricted’ to FDI, and the foreign party to leverage the local partner’s hard and soft assets. However, the co-management of a JV in China is notoriously difficult and the structure is prone to deadlock in the event that disagreement arises between the shareholders. Exiting out of a JV that has gone wrong, and recovering the investment, can be difficult.

 
2. The Representative Office (RO)

The Representative Office (RO) is essentially a branch of the parent company overseas, with little legal identity of its own. An RO’s business scope is typically limited to engaging in liaison, marketing, and quality control activities on behalf of its parent, and the RO cannot engage directly in business transactions or profit-generating activities. As such, though it is attractive in the sense that it requires only limited financial commitment, the RO is not suitable for investors looking to set up a full-scale commercial operation in China.

3. The Wholly Foreign-Owned Enterprise (WFOE) 

The Wholly Foreign-Owned Enterprise (WFOE), which is an independent legal entity fully invested and controlled by foreign shareholders, is the most popular foreign investment vehicle in China. There are three types of WFOEs, depending on the scope of business activities conducted by the company: the Consulting WFOE (also known as a Service WFOE); the Trading WFOE (also known as a Foreign Invested Commercial Enterprise); and the Manufacturing WFOE. The WFOE is attractive in the sense that it allows for full ownership and control, a broader business scope than the RO structure, as well as the issuance of invoices and collection of revenue locally. On the other hand, it is still lengthy and costly to incorporate a WFOE in China, while the vehicle is only appropriate for investing into the industries in which FDI is ‘encouraged’.

It is important to note that some foreign investors choose to do business in China on a cross-border basis, without setting up a formal presence in the country. However, many distributors and suppliers would refuse to do business with a foreign investor that lacks a presence onshore, and any company looking to employ staff in China will need a legal entity there to do it compliantly over the long term.