China: Types of Company
Nature of a Joint Venture (JV)
Joint Ventures used to be the most widely used business form for a foreign company making a business investment in China, but they have largely been superseded by the Wholly Foreign-Owned Enterprise, particularly since company law was extensively revised in 2006. Many companies in fact experienced problems with Joint Ventures due to legal uncertainties and failure to understand Chinese business culture. Although the Joint Venture form seems to be fading out, it still has its uses, particularly perhaps when dealing with a large Chinese state organization.
Originally, Joint Ventures were seen by the Chinese themselves as being a vehicle for generating exports, and as a means of encouraging high technology manufacturing. The first JV law was framed in those terms; but as time went by JVs became used for much wider purposes.
There are two types of JV: Equity Joint Ventures and Cooperative Joint Ventures. The former is always structured as a limited company and the parties may be individuals or corporates; profits are shared in proportion to the capital contributions of the partners. The latter may be structured as a limited company or more rarely may be a partnership in which the partners have unlimited liability. In a Cooperative Partnership profits can be distributed in any way that may be agreed between the partners.
The original law governing Joint Ventures, which has been amended a number of times since, is The Law of the PRC on Joint Venture Using Chinese and Foreign Investment, 1979. There are also numerous sets of detailed regulations.
Joint Ventures are usually set up to last from 30 to 50 years, but can be unlimited in duration. As is the case with other business forms, the capital required for a Joint Venture must be established at the outset. At least 25% of the agreed capital must be provided by the foreign partner. Once paid in, the capital cannot be repaid during the life of the partnership. Originally, share structures set up for a Joint Venture were highly inflexible, but over time the regulations have become somewhat more accommodating.
Capital can take the form either of cash or can be represented by business assets, including intellectual property. Equity must represent a minimum proportion of the financing of a Joint Venture, ranging from 33% to 70% depending on size; the remainder can be debt. There is a minimum of three directors in a JV, with at least one director being appointed by each party.
The problems experienced by Western investors with the Joint Venture form have often resulted from failure to understand the structure of power within a Chinese limited liability company: it is not enough to have a majority of the shares in order to control operations, it is also necessary to control the two key management positions of General Manager and (Representative) Director, and also to have physical possession of the Chop. Of course, for an absentee investor, it is convenient to allow Chinese staff to run the business, but that may be fatal in the event of dissension.
Naturally, a Chinese partner is going to be reluctant to allow the Western partner to have total control of the business, and it is this factor which has increasingly come to be seen as a fundamental flaw in the concept of the Joint Venture.
Formation of a Joint Venture
Initial approval for formation of a Joint Venture in China must be obtained from MOFTEC (The Ministry of Foreign Trade and Economic Cooperation) or one of its regional branch offices, based on a proposal by the prospective partners. MOFTEC is required to give an answer to a proposal within three months. If the proposal is approved, MOFTEC issues an Approval Certificate for Enterprises with Foreign Investment, following which the remaining stages of business formation are conducted through the local Administration of Industry and Commerce (AIC).
With the difference of this division of the approval process into two stages, if a Joint Venture is going to be formed on the basis of a limited company, the formation procedures and documentation requirements are similar to those required for a Wholly Foreign-Owned Enterprise, described here.
If the JV is to be formed on the basis of a partnership (with unlimited liability for the partners), approval by MOFTEC is still required, and the business must still be registered with the AIC, but more attention will fall upon the contract between the partners which will govern most aspects of the running of the business, since there will be no formal articles of association.
Ongoing Formalities for a Joint Venture
Books of account must be set up within 15 days of approval of registration, and must be kept in the Chinese language. Audited accounts must be prepared by a domestic accounting firm on an annual basis which must be submitted to the tax authority. These are not publicly available.
The JV's Business License and Enterprise Code Certificate must be renewed annually. Renewal applications must be submitted one month before the date of expiry.
Remittances overseas will almost certainly be subject to foreign exchange controls, and specific permission will probably have to be obtained on every occasion, although this process can very often be administered by local banks. Many types of overseas remittance incur withholding tax.
If a JV ceases operations in China it must apply for de-registration and return its tax certificate to the tax authorities.
Employing Staff For A Joint Venture
Under Chinese law a JV may employ both Chinese and foreign workers. Individual labour contracts are required and must be submitted for approval to the local labour bureau.
The contract, which needless to say must be in Chinese, must include at least a minimum seven clauses as prescribed by Article 19 of the Labour Act, and must follow a format prescribed by the local labour administration.
PRC labour law permits the termination of a direct employment on 30 days' notice, but if there is no demonstrable cause, there is a definite possibility of legal action. For this reason it may be better in some circumstances to recruit Chinese workers through an official 'labour service' office since there is no direct legal relationship with the employees. For Representative Offices it is obligatory to hire staff in this way, but for WFOEs and JVs it is optional.
Taxation of a Joint Venture
There is a great variety of different taxes in China, and a JV may have to file various different types of tax return, monthly, quarterly or annually, covering Enterprise Income Tax, Value Added Tax, Business Tax, Consumption Tax, Stamp Duty, Land Appreciation Tax, Withholding Tax (on foreign remittances), and, if there are employees, Income Tax and social security contributions, which are withheld from pay on a 'PAYE' basis.
The headline rate of taxation for a JV on its profits is 25%, the same as for Chinese-owned companies since 2008. Some JVs may be able to take advantage of a 15% tax rate if they have successfully 'grandfathered' their previous status; and there are regional and national incentive schemes in particular sectors which allow for lower rates.