China's industrial output raced ahead through March and April as factories continued to increase their production of almost everything from steel plates to cell phones. Factory output from January to April was 18.2 percent higher than a year earlier. Any sharp downturn is unlikely, given the strong global demand for inexpensive Chinese exports and the ever-increasing foreign investment flowing into the country. China is the world's leading destination for foreign funds. Most of the foreign capital coming into China takes the form of direct investment, i.e. establishing a foreign invested enterprise. In 2003, China's foreign direct investment hit US$ 53.5 billion. According to the Chinese Ministry of Commerce, the country approved more than 41,000 foreign-invested firms last year, a 20 percent jump from 2002. 70 percent of the inward foreign investment goes to the manufacturing sector.

Legal structures for foreign invested manufacturing entities

When setting up a manufacturing entity in China, foreign investors can either establish a wholly foreign owned Chinese subsidiary or team up with a Chinese partner and form a Joint Venture. Some industries are subject to certain restrictions, in which case a Wholly Foreign Owned Enterprise (WFOE) cannot be established and a Chinese partner is required by law. Some investors may choose to cooperate with a Chinese partner for strategic reasons, such as a local partner's experience and knowledge of the Chinese market. Most investors, however, prefer Wholly Foreign Owned Enterprises to Joint Ventures, because they can retain full control of their business and avoid potential conflict with a local partner due to differing business goals and operational styles.

Wholly Foreign Owned Enterprises

Wholly Foreign Owned Manufacturing Enterprises allow foreign investors to manufacture, process, assemble, and distribute in China, without joining together with a Chinese partner. Under Chinese Company Law, WFOE's are limited liability companies. The liability of the shareholders is limited to the amount invested. The minimum registered capital varies from industry to industry and by region. Generally, WFOEs require a minimum amount of US$ 140,000 to US$ 200,000, which can be divided into cash and assets. Cash can be legally used as operational capital. The WFOE application process includes submitting a feasibility study and a formal application with the articles of association as well as other legal documents. After the application documents have been approved, the WFOE business license will be issued.

Joint Ventures

There are two types of Joint Ventures in China, the Equity Joint Venture, and the Co-Operative (or Contractual) Joint Venture. They appear similar on the surface but have different implications for the structuring of the entity. Equity Joint Ventures tend to be far more rigid in their contractual structure than Cooperative Joint Ventures, which allow for more flexible agreements between the joint venture parties.

Equity Joint Ventures
Equity joint ventures are usually structured as limited liability companies with the foreign partner contributing a minimum of 25% of the registered capital. The profit and risk sharing of Equity Joint Ventures is proportionate to the equity of each partner. Investment can take the form of cash, buildings, industrial property or equipment. A Board of Directors is the supreme body of power.

Cooperative Joint Ventures
Profits of a Cooperative Joint Venture are divided according to the terms of the Joint Venture contract rather than by investment share. This allows for a more flexible return on investment schedule in cases where one investor provides cash while the other party's investment is primarily in kind. Greater flexibility in the structuring of a cooperative venture is also permissible including the structure of the organization, management, and assets.

The documents required for the Joint Venture application process include a project proposal, a feasibility study report, the Joint Venture contract and articles of association as well as other legal documents. Upon approval by the relevant authority the Joint Venture business license will be issued.

Offshore holding company for China investment

When structuring an investment into China, investors may use their existing company or set up a separate holding company to apply for the China business registration on behalf of the parent company. Many foreign investors use offshore companies for this purpose in order to add an additional layer of limited liability and remove the risk from the valuable parent company. Offshore holding corporations may also be used for tax planning, trading and re-invoicing.

Hong Kong is a popular jurisdiction among China investors for many reasons. The region's proximity to China, both geographically and politically, facilitates administration and management of a China investment. Legal documents are bi-lingual, which saves cost and time for translations. Whereas the Chinese authorities are familiar with Hong Kong corporations, they are increasingly reluctant to approve registration for traditional offshore holding companies.

Most importantly, however, Hong Kong holding companies of China manufacturing entities can enjoy significant tax benefits. If a Hong Kong company enters into a processing arrangement with their China subsidiary and the China entity exports the completed goods to the Hong Kong holding company, usually only 50% of the profits derived from the sale of the manufactured goods will be taxed in Hong Kong.

Priority Investment Areas

Foreign investors need to consider various factors when selecting a location for their manufacturing plant in China. These factors may include availability and cost of land, raw materials and resources, proximity to potential clients, partners and suppliers, as well as tax rates and investment incentives. Since the late 1970s, China has established various priority investment areas offering foreign investors favorable terms such as tax concessions, tariff exemptions, administrative support, and a modern infrastructure.

Special economic zones (SEZs)
There are five Special Economic Zones in China. Hainan, Shantou, Shenzhen, Xiamen and Zhuhai Special Economic Zones offer foreign investors a flat corporate profits tax rate of 15 percent (compared with 33 percent outside the zone). Corporate tax for production industries is waived for the first two years of profitable operation, and reduced by 50 percent for the following three years. There are preferential tax rates beyond the two- to five-year tax reduction period subject to specific certification or industry-specific exemptions.

Shanghai's Pudong area
Pudong is an open zone for foreign investment, which enjoys similar autonomy as the Special Economic Zones. Five state-level development zones have been established in Pudong specializing in export processing, hi-tech industries, agriculture, financial services and bonded trade. Foreign businesses operating in Pudong are charged a flat corporate tax rate of 15 percent.

Economic and Technological Development Zones (ETDZs)
Economic and Technological Development Zones offer favorable infrastructure facilities as well as a reduced corporate tax rate of 15 percent for production industries. The corporate tax is waived for the first two years of operation and reduced by 50 percent for the next three for those entities with terms of operation of more than 10 years.

New and High-Technology Development Zones
China has established over 50 new and high-technology development zones to encourage the research and development of new and hi-tech products. Foreign businesses are offered extensive infrastructure facilities and are charged a flat 15 percent corporate profits tax rate. As in the ETDZs, the corporate tax is waived for the first two years of operation and reduced by 50 percent for the next three for those entities with terms of operation of more than 10 years.

Open coastal cities
To attract foreign investors interested in establishing capital- and technology-intensive projects, 14 coastal cities - Beihai, Dalian, Fuzhou, Guangzhou, Lianyungang, Nantong, Ningbo, Qingdao, Qinhuangdao, Shanghai, Tianjin, Wenzhou, Yantai and Zhanjiang - were opened for foreign investment. Some 20 inland cities offer investment incentives similar to those available in the open coastal cities. Three regions are designated open coastal economic zones: the Guangdong Pearl River Delta, the South Fujian Min River Delta and the Yangtze River Delta. Currently there are more than 250 such designated cities and counties. Production-oriented foreign investment projects in these zones enjoy a reduced corporate profits tax rate of 24 percent (15 percent for priority projects).

Bonded zones
Some 14 bonded zones for export processing industries and trading companies offer duty-free import rights while treating exports stored in the zone as being outside the jurisdiction of China's customs. Bonded zones are located at Dalian, Futian (Shenzhen), Guangzhou, Haikou, Ningbo, Qingdao, Shantou, Shatoujiao, Tianjin, Waigaoqiao (Shanghai), Xiamen, Yangpu, Zhangjiagong and Zhuhai.

Export Processing Areas
Some 15 export processing areas promote export-oriented foreign investment in China. These areas provide more attractive investment incentives than bonded areas including duty-free importation of raw materials and equipment, and exemption from non-tariff import and export controls, such as licenses and quotas.

If you require assistance with the above subject, please contact us at info@klako.com with your detailed questions.

All information in this report is verified to the best of our ability and is assumed to be correct at time of release; however, Klako Group does not accept responsibility for any losses arising from reliance on the information provided within.