Summary: There are plenty of things to consider when you invest in China. Spencer Jan shares ten tips for anyone considering investments there.
There are plenty of things to consider when you invest in China. Are you're a serious investor with money burning a hole in your pocket? Or perhaps you are just the average China business traveller curious to know a little more. Regardless of your situation, a little more knowledge won't hurt. Here's a few key points to consider when dealing with investments into China:
- Opportunities to invest in China
FDI in China has grown steadily and significantly for over two decades. China is now the world’s leading recipient of foreign capital. China’s legal framework for FDI has also made substantial progress and there is a growing predictability for investments in China.
- Guiding foreign investment in China
As an economy in the middle of transforming from a planned regime to a primarily market-oriented regime, the government still plays key roles in directing and regulating foreign investments.
In China, foreign investments are categorized as “encouraged”, “permitted”, “restricted” or “prohibited” depending on the nature or sectors of the business being invested. How an investment is categorized affects its structure and determines the level of governmental approval required or, for some sectors, limits on foreign equity participation.
- Representative offices and investment vehicles
The most common investment vehicles under the Chinese foreign investment regime include representative offices, or a foreign investment enterprise (FIE). Regardless of the choice of investment vehicle, governmental approval is required. While setting up a representative office is comparatively straightforward, it cannot engage in direct business activities – which, except for certain financial institutions, requires an FIE.
Wholly foreign owned enterprises (WFOEs) and Sinoforeign joint ventures (JVs) are the two main forms of FIE. Broadly speaking, WFOEs offer control (preferred by many foreign investors) and JVs offer the Chinese partner’s local knowledge. Foreign investment companies limited by shares and holding companies can also offer benefits to the larger investor.
- Selecting a location
With many special zones and various incentives on offer, determining where to set up can be a rather hard choice. While China’s coastal provinces are more developed and offer better infrastructure, labour and land are less costly in central and western China. Development zones, many of which are located in the coastal provinces, typically offer special tax incentives to FIEs. Free trade zones can offer particular benefits to trading companies and FIEs manufacturing for export.
- Tax considerations before you invest in China
Under the applicable Chinese law, FIEs are subject to a basic corporate income tax. However, various tax breaks and reduced rates are also available depending on the industry and location. Basic incentives for exportoriented or technology-oriented FIEs consist of a twoyear holiday and three years of a 50% reduction in income tax before 2010. Other relevant taxes include business tax (typically at 5%) and value-added tax (typically at 13% or 17%). Further incentives can often be obtained from local governments.
- Foreign exchange control
Chinese currency, the Renminbi, may be converted for current account purposes with relative ease for those that invest in China. Stringent controls apply to capital account items. These controls are likely to continue for the foreseeable future, although China has promised to eventually lift its foreign exchange control. Generally, funds flowing out of China are subject to stricter control compared to funds flowing into China. Repatriating dividends on equity investments, interest and principal on a loan or royalty on licence or technology transfer, for example, are subject to official approval or registration of the underlying contract.
- Protection of intellectual property rights
Intellectual property protection in China requires a co-ordinated strategy involving registration of various rights, workplace security, contractual protections, anticounterfeiting measures, periodic audits and, in some cases, industry co-ordination. Governmental enforcement of intellectual property rights continues to improve, but unregistered rights afford limited protection in China.
Accordingly, it is generally advisable that registerable intellectual property rights be properly registered when you invest in China. Technology licenses into China will typically require registration, and, in the case of restricted technology, advance governmental approval.
- Enforcement of contracts
Disputes can be settled informally, by litigation or arbitration in China. The predictability and consistency of judicial decisions has improved in recent years, although concerns about court adjudication persist. Arbitration – especially arbitration in a neutral locale outside of China - is therefore generally preferred by foreign investors in China, although it can be costly and the enforcement records in China can also be further improved. A well drafted dispute resolution clause would help investors exit their investment effectively.
China has a national legal regime on employment, and an array of supplemental local rules. Certain employee rights are statutorily protected. In June 2007, the new People’s Republic of China Labour Contract Law was passed, which will take effect in January 2008. The mandatory social security regime can be complex and adds additional cost and administrative burdens, especially in first tier cities such as Beijing, Shanghai, Guangzhou and Shenzhen. Laying off staff is quite challenging without a proper reason. Work and residence permits are required for foreign nationals to work in China. Individual income tax rates are progressive and range from 5% to 45%.
- M&A and due diligence
Key issues for successful M&A include thorough due diligence and careful planning, particularly with respect to contractual relationships and human resources. The lack of publicly available information on non-listed companies, different corporate governance values and standards, and quality of information flow between foreign investors and the local counterparts or partners, mean that involvement of experienced professionals is often the safer approach with important investments.