With the opening of special economic zones since 1978, China has transformed its sluggish planned economy system into a lively socialist market economy system. China has maintained strong and steady growth over recent years. With its gross domestic product (GDP) growing at an annual rate of 9.9% in 2005 to about US$2.26 trillion in 2005, China has become the sixth-largest economy in the world and is expected to rank second by 2030. Meanwhile, China has successfully maintained a low inflation rate – its consumer price index (CPI) grew by a modest 0.9% in September 2005 from a year earlier. China is opening its arms not only to tourists but also to international businesses and entrepreneurs.
Over 15 million foreigners enter China every year for leisure, business or to attend conferences. Among the world’s 500 biggest multinational enterprises, 450 have started operations in China. By 2005, about 550,000 foreign investment enterprises (FIEs) had set up operations in China. Foreign Direct Investment (FDI) exceeded US$60.3 billion in 2005. Domestic investments are relatively paltry as Chinese citizens are avid savers, leaving FDI to generate a substantial part of the country’s economic activities. Imports and exports soared by 23.2% to US$1,422.1 billion. The trade surplus for 2005 jumped to US$101.9 billion from $32 billion in 2004 mainly because of surging exports of mobile phones, textile products, and steel.
Like many other Asian countries, China’s foreign reserves have exceeded their optimum level in recent years. According to the International Monetary Fund, China now has about US$840 billion of foreign reserves (including Hong Kong), surpassing Japan to become the country with the highest foreign reserves in the world. In July 2005, China decided to peg its currency, the renminbi (RMB) or yuan, to a variety of currencies instead of linking it exclusively to the US dollar. The landmark policy change was made in order to ease the pressure China faced from its large foreign reserves and record trade surpluses.
General Overview of China
With an area of 9.6 million square kilometers and a population of more than 1.3 billion, China is one of the biggest countries in the world. Blessed with a beautiful landscape, 56 ethnic groups, and the oldest continuous civilization known to mankind, China has long been one of the world’s favourite travel destinations. The climate in China is very diverse, subarctic in its northern border and tropical in the south. North China typically has four distinct seasons – bitter cold winter, blazing hot summer, and short spring and autumn. In the south, in cities like Kunming, Guangzhou, and Shenzhen, spring-like weather prevails in all seasons with temperatures usually ranging between 15C and 30C.
East China and west China vary in terms of terrain. The majority of the landscape in west China comprises plateaus, mountains, and deserts while in the east, plains, deltas, and hills dominate, making the land suitable for cultivation.
Among China’s 56 ethnic groups, the Han people make up about 92% of the country’s total population. Over 50 languages are used throughout China, for example, Han, Tibetan, Urghur and Korean. The Han peopleuse many dialects in different parts of China, such as Cantonese, Shanghainese, Hokkien, etc, apart from Mandarin, which is China’s official language.
China is a large country and it is divided into 23 provinces, 5 autonomous regions, 4 municipalities directly under the Central Government, and 2 special administrative regions. The National People’s Congress is the highest organ of state power in China.The central and highest organ of State administration is the State Council. The Central People’s Government exercises unified leadership over the local state administrative organs at various levels throughout the country.
Currently, China is undergoing reforms to set up a three-level local administrative division system, namely at the provincial level (provinces, autonomous regions, and municipalities directly under the central government), county level (cities, counties, etc), and town level. These reforms seek to build a more efficient government, dismantle bureaucratic barriers and develop an effective socialist market economy.
The Communist Party is the sole party in power in China. A multi-party cooperation and political consultation political system is adopted under the leadership of the Communist Party of China.
China’s Constitution is the fundamental law of the state.
Different Types of Business Entities in China
China’s Company Law recognises two types of companies.
Limited Liability Company
This type of entity requires a minimum capital of RMB 30,000 with less than 50 shareholders.
The capital can be in the form of cash, industrial property or land use rights.
Company Limited by Shares
This type of entity is to be set up by promotion or share offer with a minimum share capital of RMB 5 million. For incorporation, no less than two promoters are required. Establishment by share offer is subject to the approval of China’s securities regulator.
Foreign Investment Entities
Foreign investors are allowed to set up the following types of business entities:
1. Cooperative Joint Venture (CJV)
A CJV has the option to register as a legal person with limited liability. The parties in a CJV have the flexibility of choosing whether to operate the enterprise as a limited liability company or to operate it as an unincorporated entity under which partners bear unlimited liability. The profits of a CJV are allowed to be shared by participants as specified in the joint venture contract, and not necessarily in proportion to their capital contribution. As a result, this type of venture is ideal when the foreign investor is only looking for a short-term project. After obtaining a fair or premium return on investment, the foreign investor returns the majority or full ownership of the enterprise to the Chinese partner.
- A cooperative venture does not require a new business licence if it is arranged in the contractual form under the auspices of an existing joint venture enterprise.
- There are no expiry periods or limitations on the length of the venture. The contractual terms can be renewed at any time and for an extended period, subject to the approval of the government.
- Investment contributions from each party are not limited to financial capital but may also include non-financial assets such as intellectual property rights, buildings, materials or machinery.
- Transfer or withdrawal of investments is not subject to the approval of the government. Foreign investors can deploy their registered capital as they see fit.
2. Equity Joint Venture (EJV)
An EJV is the most common and preferred method of doing business in China. It is a limited liability company and is required to be registered as a legal person. The main feature is that the joint venture parties take responsibility for losses and profits according to the ratio of their equity stake.
The minimum level of foreign participation in an EJV is 25% of the registered capital in general. The registered capital is not limited to financial capital but may also encompass non-financial assets such as intellectual property rights, buildings, materials, or machinery if approved by the government.
Where an EJV with less than 25% of capital contributed by foreign investor(s) is approved and registered, the business licence will indicate “foreign investment ratio below 25%” after the entry in the “Enterprise type” column. In such a case, the foreign investor is required to contribute all the investments within three months after obtaining the business licence if the investment is in the form of cash, or six months if the investment is in kind or industrial properties. Meanwhile, such an EJV cannot, when importing equipment or articles for its own use, enjoy tax reduction treatment and the treatment for foreign-funded enterprises in respect of other taxes.
Equity cannot be transferred or withdrawn under any scenario without the approval of the government.
There are registered capital/total investment ratio requirements that need to be fulfilled depending on the investment size of the venture.
3. Wholly Foreign-Owned Enterprise (WFOE)
A WFOE is a 100% wholly foreign-owned subsidiary doing business in China. The foreign company has sole responsibility for its profits and losses. It is required to register as a legal person who is restricted to certain businesses. The enterprise is able to implement strategies that effectively conform to the interests of the parent company abroad. Moreover, technology and know-how are given better protection. One effective use of a WFOE is to replace the foreign enterprise representative office (RO). Whereas foreign enterprises previously involved in a joint venture would establish ROs in China to manage the administrative aspects of the venture, some have resorted to setting up WFOEs to handle the same responsibilities.
The term varies according to the nature of the enterprise; any extension is subject to the approval of the relevant government authority.
There is a minimum capital contribution required, known as registered capital, which varies according to the business.
A WFOE is allowed to acquire land use rights in the form of land use rights certificates.
The establishment of export-oriented or high-tech WFOEs is encouraged.
Effective 11 December 2004, all foreign investors are able to establish WFOEs in commercial sectors, hence the term Foreign-Invested Commercial Enterprise (FICE). The development has affected the following types of business activities in China:
- Commission agency
- A wholesale FICE may carry out wholesaling, commission agency, import and export, and other auxiliary activities. FICEs may directly establish and operate new stores, and authorise others to open franchise stores. The development has reduced the minimum registered capital previously required, lifted the geographical limitations and also simplified the approval procedures. There are, however, certain restrictions on the products and business activities related to China’s commitments as a member of the World Trade Organisation.
4. Company Limited by Shares with Foreign Investment (CLSFI)
A CLSFI may adopt the promotional method or share float method for its establishment. A CLSFI set up by means of promotion shall have no fewer than two but no more than 200 initiators, of whom half or more shall have a domicile in China. At least one of the promoters has to be a foreign shareholder. An EJV, CJV or WFOE may apply to convert to a CLSFI through a share flotation. Other than the requirements in the preceding paragraph, a CLSFI established by a share flotation will need to have a track record of being profitable in the recent three consecutive years prior to the offer. The minimum registered capital is RMB 30 million. The minimum level of foreign participation in a CLSFI is 25%. A CLSFI can be listed either locally or abroad.
5. Build-Operate-Transfer Project (BOT)
BOT projects provide enterprises with concessions to key industrial or infrastructure projects in China, such as bridges, railways, industrial parks, power plants, airports, subways and expressways. After financing and building the project, the enterprise either immediately transfers the project to another party or continues to operate it for a number of years.
When the agreed-upon equitable return on investment is achieved, the enterprise is required to transfer full ownership and control to the government. The terms, limitations, rules and regulations pertaining to BOT projects are often established on an ad-hoc basis.
The enterprise undertaking the project must take the form of a limited liability company.
The registered capital should be at least 25% of the project’s total investment.
The projects are usually established through conditional franchise agreements which cannot exceed 30 years.
6. Holding Company
The number of approved holding companies in China is increasing. A holding company is an umbrella-structure arrangement that enables a foreign company to hold together its joint venture and WFOE investments in China. A holding company can be either an EJV or a WFOE. Generally, the government allows a foreign company to set up a wholly foreign-owned holding company in China if it has a good reputation, financial strength, high technology, and the projects it undertakes are in line with the state production plan.
- The total assets of the foreign company should be more than US$400 million and its capital contribution in China should exceed US$10 million, or the foreign company must have set up at least 10 FIEs in China with an aggregate capital contribution of more than US$30 million.
- The registered capital of a holding company in China should not be less than US$30 million.
A holding company has the right to import and sell products, and provide maintenance services.
- The One Hour China Book: Two Peking University Professors Explain All of China Business in Six Short Stories (Volume 1)The One Hour China Book: Two Peking University Professors Explain All of China Business in Six Short Stories (Volume 1)
Representative Office (RO)
Before actually investing in China, many foreign investors choose to set up representative offices (ROs) to engage in market research and to learn more about the country. An RO is optional before making an actual investment in China and is not an independent legal entity. It must confine its activities to promotion or acting as a liaison office on behalf of its parent company. An RO is not allowed to generate revenue, solicit business, engage in warehousing or sign contracts with customers. It can hire local staff through approved employment agencies. It should engage in activities that service the head office directly.
All companies in China, including Foreign Investment Enterprises, must appoint a China-registered Certified Public Accountant (CPA) firm to audit their financial statements at the end of the accounting year and to issue an auditor’s report. Audits are required under the company laws, accounting regulations and income tax laws in China. Audited financial statements are also used for tax reporting purposes. The annual financial statements should be submitted together with an auditors’ report issued by a CPA registered in China within four months of the end of the fiscal year. (However, local authorities may impose earlier deadlines in certain cases.) The independent Chinese auditor appointed by a foreign investment company should be qualified and registered with the Chinese Institute of Certified Public Accountants to practise in China.
Incorporation of Business Entities
Approval and Registration Procedure
The approval of a foreign investment enterprise (FIE) in China depends on the nature of the proposed project. In 2007, the National Development and Reform Commission and Ministry of Commerce in China released the updated “Catalogue for the Guidance of Foreign Investment Industries” circular, which took effect on 1 December 2007. Under the Catalogue, foreign investment projects come under four categories:
- Encouraged Projects
- Restricted Projects
- Prohibited Projects
- Permitted Projects
Investment projects that do not fall under the first three categories would be regarded as permitted projects. Different policies will apply to different categories of projects. Generally, it would be easier to set up an FIE within the Encouraged Projects or Permitted Projects category and the FIE could enjoy more preferential treatment from the business and tax perspectives.
Otherwise, there could be restrictions on the form of investment (e.g. requirements on the amount of investment coming from the Chinese party) for some of the restricted projects.
The Ministry of Commerce (MOFCOM) has overall responsibility for approving the formation of FIEs and for issuing approval certificates. The local MOFCOM authorities generally undertake the examination and approval procedures. Under normal circumstances, the following documents should be submitted to support the application: Project Proposal, Letter of Intent, Feasibility Study Report, Articles of Association, Joint Venture Contract etc. However, the list of documents required for submission may vary depending on the location and the type of operation.
After obtaining the approval certificate from the MOFCOM, the FIE has one month to register with the State Administration for Industry and Commerce(SAIC) in the relevant location to obtain a business licence. Within 30 days of the issuance of the business licence, the FIE must register with the local tax authorities.
Other authorities that the FIE would need to seek approval from including the Organisation Code Bureau, the Foreign Exchange Supervision Bureau, the Finance Bureau, the Statistics Bureau and the Customs Bureau.
Employment in China
Foreigners who travel to China for short periods for business purposes require visas but not the residence or employment permits. A foreigner who is to be stationed in China for employment is required to obtain an Employment Permit and Foreigner Residence Permit.
Employment Licence, Employment Permit and Residence Permit There are no restrictions on the number of foreign personnel that may be employed by a foreign investment enterprise or foreign business in China, nor is there a time period imposed on their employment. Foreign investment enterprises are required to submit resumes of their foreign employees to the local labour bureau for assessment. The application for employment permits for foreigners may not be approved should the labour bureau decide that there is a local talent with similar backgrounds and skills available to deliver comparable services.
If the application is approved, the local labour bureau will issue the Employment Licence and temporary “Z” visa notification letter to the foreign investment enterprise. The foreign personnel will submit an application to the Chinese Embassy in his country of origin for a temporary “Z” visa using the Employment Licence and temporary “Z” visa notification letter. With the issuance of the temporary “Z” visa and the foreign personnel’s arrival in China, the foreign investment enterprise will need to submit an application for Employment Permit to the local labour bureau within 30 days of the foreign personnel entering China. A medical examination report is required during the submission of the Employment Permit application.
The Employment Permit is issued with a validity of one year and subject to annual renewal with a valid employment contract. Senior management staff holding appointments such as the Chief Representative, General Manager or Legal Representative/Chairman will be granted an Employment Permit with a validity of two years or more. With the issuance of the Employment Permit, the foreign investment enterprise will then have to apply to the local Exit-Entry Administrative Bureau for a Foreigner Residence Permit for the foreign personnel. The validity period of the Foreigner Residence Permit will depend on the validity period of the Employment Permit as well as the enterprise itself.
Spouses, children under the age of 18 years and parents accompanying the foreign personnel may at the same time apply for residence permits for the same period of time. The application must be supported by a valid certification of family relationships.
An additional document required for foreign personnel working for a representative office is a Representative Card/Certificate from the local industry and commerce bureau.
China Labour Law
There are many regulations to specify general human resources aspects. The majority of them are Labour Law, Labour Contract Law, Social Contributions regulations and Salary Payment regulations etc. The? regulations include the sections of the labour contract, employee handbook, social contributions, salary payment, termination, severance payment and etc. It is a little different about social contributions and salary payment etc. in different cities of China. Under previous regulations, foreign investment enterprises were able to hire and fire staff and establish their own wages and incentive structures.
New labour laws, the most wide-ranging employment legislation ever issued in China, came into effect in January 1995. The laws are being implemented in various cities and provinces. The labour laws cover such areas as individual and collective labour contracts, working hours, holidays, wages, occupational health and safety, the protection of women and minors, vocational training, social insurance and welfare, labour disputes, and supervision and inspection. Provisions in Chinese laws and labour contracts regulate the employer-employee relationship in a foreign investment enterprise.
Any labour contracts should be separate contracts taken out with individual workers, although many sign one contract with the labour union which acts on behalf of all the workers [Ministry of Labour Social Security MOLSS (1994) No.485]. The latter procedure regulates the enterprise’s relationship with the labour union as well as with its employees.
Foreign investors in China should also be guided by the following labour laws and regulations:
- Rules for the Administration of Employment of Foreigners in China
- Trade Union Law of the People’s Republic of China
- Regulations Concerning Minimum Wages in Enterprises
- China Labour Contract Law
- The new Labour Contract Law (LCL) is adopted on June 29, 2007. It comes into effect on January 1, 2008.
All entities, regardless of the number of employees they have, will be required to comply with the new law and regulations.
Written Labour Contract
The LCL requires all labour contracts to be established in writing. It will impose significant penalties on employers, which fail to comply with new contract laws. Employees reserve a right to claim double payment for months worked without a written contract for up to 12 months’ payment. This rule is targeted at companies, which adopt “informal” employment relationships.
The LCL imposes severe restrictions on the use of probationary periods in employment relationships. Probationary periods are permitted, but the length is limited based on the term of the employment contract, with an absolute maximum set at six months. Furthermore, an employee is subject to one single probationary period by the same employer. Wages during the probationary period must also be at least 80% of the contractual wage.
Open Term Contract
Under Chinese law, an employee shall be discharged either at the expiration of a term contract or for a cause. To avoid the need to terminate an employee for a cause, employers can choose to continuously hire employees under a series of short-term contracts. This practice is no longer possible under the LCL. The employer is permitted only to enter into a maximum of two term contracts with the employee. If an employee continues on after the expiration of his second term contract, the subsequent employment contract is deemed to be an “open-term contract.” Under an open-term contract, the employee is employed until he chooses to terminate the contract or when he reaches retirement age. The employer can only terminate the employment contract by discharging the employee for breach.
Non-competition agreements are restricted. Many foreign employers require most or all of their Chinese employees to enter into non-competition agreements that restrict their right to work for a competitor after the termination of employment. The LCL imposes significant restrictions on the use of these agreements. The most important restriction is that non-competition agreements cannot be imposed on all employees. Only senior management and other employees with access to critical trade secrets can be required to enter into a non-competition agreement. The agreement must be limited in duration to two years. It must be limited in geographic scope to a reasonable area and the employer must pay compensation to the employee during the period that the non-competition restriction is in effect.
Written Regulations of Employment – Employee Handbook
All employers must maintain a written employee handbook setting out the basic rules and regulations of employment. This requirement applies to all companies regardless of size and number of employees. The failure to maintain an employee handbook means that an employer will effectively be unable to discharge employees for cause, since “cause” must be determined with reference to the employee handbook.
Termination of Employment
Foreign investment enterprises have the right to dismiss unqualified employees and those who violate the enterprises’ rules and regulations. However, they are not permitted to dismiss employees undergoing medical treatment for injuries incurred at work, women who are pregnant and women on maternity leave or he/she has been working for the Employer continuously for more than fifteen years and less than five years from retirement age. The notice must be given and compensation must be paid to employees who have been dismissed either within or after their contract period, according to the number of years they have served in the foreign investment enterprise.