Foreign Direct Investment in the 
People's Republic of China
Principal Foreign Investment Vehicles

SUMMARY OF CONTENTS

Foreword

This overview briefly describes the following principal vehicles for foreign investment in the People's Republic of China (PRC or China): the Sino-foreign equity joint venture enterprise, the Sino-foreign cooperative joint venture enterprise and the wholly foreign-owned enterprise.  These investment vehicles are collectively referred to as foreign investment enterprises (FIEs).

We wish to emphasise that the legislation affecting foreign investment in the PRC is still developing.  The latest revisions to the Company Law of the People’s Republic of China, which entered into effect on 1 January 2006, state clearly for the first time that the Company Law is also applicable to FIEs.  Uncertainty as to the application of certain provisions of the revised law to FIEs has yet to be resolved and this has caused some local variations in implementation.  It is expected that a more uniform interpretation and implementation will develop in time.  The information in this overview is based upon our experience with, and understanding of, publicly available PRC investment laws as of 1 December 2006.

This overview is not intended as an exhaustive discussion of foreign investment in the PRC, but rather to provide general information for reference purposes on three major types of investment vehicle. Because Chinese law is constantly evolving, readers are advised to seek further information and advice when considering any investment in the PRC.

Equity joint ventures

Introduction

The term “joint venture” is often used to refer to a variety of different types of business arrangements in the PRC.  However, within the context of Chinese law, an equity joint venture is a specific form of business organisation created through the joint investment by at least one Chinese party and at least one foreign party.  The establishment and operation of an equity joint venture are governed by the Law of the People's Republic of China on Sino-Foreign Equity Joint Ventures (Equity JV Law), effective as of 7 July 1979, and the Implementing Regulations for the Law of the People's Republic of China on Sino-Foreign Equity Joint Ventures (Equity JV Regulations), effective as of 20 September 1983.

Back to Top

Nature of equity joint ventures

(a) Legal status: An equity joint venture is a limited liability company with its own registered capital and a legal identity distinct from its investors.  An equity joint venture is an independent legal person capable of contracting and bearing liability on its own behalf.

(b) Scope of operation: The scope of business of an equity joint venture must be clearly set out in the project documentation.  An equity joint venture may operate only within its approved scope of operation and any change in this scope requires the approval of the original approval authority and re-registration.

(c) Registered capital: Each equity joint venture has a registered capital amount which represents the equity investment contributed by the parties to the joint venture.  It may be denominated in Renminbi (the national currency of the PRC) or in foreign currency.  The parties' contributions to the registered capital may be made in cash or in kind pursuant to a schedule approved by the PRC examination and approval authorities. In-kind contributions such as equipment and raw materials invested by the foreign party must be necessary for production and may not be priced above international market prices.  In-kind contributions must be reasonably and realistically valued by the parties.  Specific valuation requirements apply to some types of in-kind contributions, such as the right to use land.  A Chinese-registered accountant must verify all contributions.

(d) Debt to equity ratio: On 1 March 1987, the State Administration for Industry and Commerce (SAIC) promulgated the Provisional Regulations on the Ratio between the Registered Capital and Total Investment of Sino-Foreign Equity Joint Ventures (Ratio Regulations).  The total investment refers to the total amount of funds required for the establishment and operation of a joint venture.  The total investment amount is composed of both registered capital (equity) and debt (typically composed of shareholder loans and bank loans).  The following table sets out the minimum ratio of registered capital to total investment:

For example, if the total investment in a particular project is $15 million, the registered capital of the joint venture must be at least $6 million and the joint venture may raise the balance of $9 million by way of loans.

Article 6 of the Ratio Regulations provides that the ratio of the registered capital to the total investment amount of cooperative joint ventures and wholly foreign-owned enterprises should be determined by reference to the Ratio Regulations.

Different debt to equity ratios apply in case a foreign investor establishes an equity joint venture after purchasing the interest of a shareholder or subscribing to the capital increase of a domestic company.  Pursuant to the Regulations Regarding the Acquisition of Domestic Enterprises by Foreign Investors (Acquisition Regulations), effective from 8 August 2006, the equity joint venture (or other type of FIE) established subsequently through the conversion of a domestic company must comply with the following debt to equity ratios:

(e) Regulations on capital contributions by joint venture partners:

i. The capital contributed by a joint venture partner should belong to that partner and be free from any encumbrance.

ii. A joint venture partner may use loans raised on behalf of itself as contribution, but it may not use loans raised on behalf of the joint venture as its contribution, nor may its contribution be guaranteed by the assets of the joint venture or those of the other joint venture party.

iii. If the joint venture contract stipulates that the parties should make their contribution in full in a single instalment, the contribution should be made within six months of the date of the issuance of the joint venture's business licence.  If the contract provides that the contribution shall be made in instalments, then the parties must make the first instalment within three months after issuance of the joint venture's business licence.  The initial instalment must be at least 15% of the total amount of the registered capital or at least RMB30,000, whichever is higher.  The balance must be paid within two years after issuance of the business licence except for joint ventures that are investment companies, which have five years to pay up the balance.

iv. If the parties fail to comply with the foregoing requirements, the joint venture's business licence will become invalid.

The timing of the contributions may differ in the case of an acquisition of a domestic enterprise and the relevant regulations should be consulted.

The above requirements are also applicable to cooperative joint ventures that are limited liability companies.

(f) Foreign investment share: Foreign investment must normally account for at least 25% of the registered capital of an equity joint venture.  However, foreign investment in an FIE may be less than 25% of the registered capital provided it is established in accordance with existing FIE establishment procedures.  FIEs with foreign investment of less than 25% will not be eligible for any form of preferential treatment applicable to FIEs.  They are also subject to a stricter schedule for making capital contributions than FIEs with a foreign investment share of 25% or more.  If the foreign investor in an FIE with foreign investment of less than 25% contributes capital in cash, it must make its capital contribution within three months of the issuance of the enterprise’s business licence.  If the foreign investor in such an FIE contributes capital in kind or in the form of industrial property rights, it must make its capital contribution within six months of the issuance of the business licence.

(g) Shareholder loans: Foreign investors may make shareholder loans to their joint ventures.  However, when a foreign investor provides cash assistance to the joint venture, the nature of such advance should be clearly identified in the documentation, i.e. whether it is a loan by the foreign party or an equity contribution.  Due to China's foreign exchange controls, failure to classify such advance as a loan and to undertake the necessary registrations may preclude recovery of the amount by the foreign party.

(h) Liability of joint venture parties: The parties to an equity joint venture share the profits, risks and losses of the joint venture in proportion to their relative contributions to the registered capital of the joint venture.  The joint venture company is independently liable for its debts and liabilities, and the parties' liability is limited to the obligation to contribute the full amount of their subscribed portion of the registered capital.  Absent express written agreement to the contrary, investors are not liable for a joint venture's debts.  Although there is a statutory basis for this limitation of liability, it is usually also expressly set forth in the joint venture contract for the sake of greater clarity.

(i) Incorporation: An equity joint venture must be approved by the Ministry of Commerce (MOFCOM) or its designated local bureau and registered with the SAIC or its designated local bureau before it may legally conduct business.  A joint venture is officially incorporated on the date its business licence is issued by the SAIC or its designated local bureau.

(j) Term of operation: The term of operation of an equity joint venture may be determined by the joint venture parties, subject to the approval of the PRC examination and approval authorities, and are set forth in the joint venture contract.  The Equity JV Regulations provide that such term should comply with the Provisional Regulations on the Term of Sino-Foreign Equity Joint Ventures (Term Regulations), effective as of 22 October 1990.  The Term Regulations theoretically permit joint ventures with unspecified terms, but such terms have thus far been extremely rare.  FIEs (including equity joint ventures) in certain specified sectors are subject to a maximum limit on their term of operation.  This is, for instance, the case for those operating wholesale or retail operations which may generally not have a term of more than 30 years.

The vast majority of equity joint ventures have been incorporated to operate for 10 years or more.  Equity joint ventures with a term of less than 10 years are not entitled to tax exemptions and reductions currently provided for under the applicable income tax laws and regulations.

(k) Management: Under the Equity JV Law, the highest authority of a joint venture is its board of directors.  The board of directors has a chairman and a vice chairman, one of whom is generally appointed by the Chinese party and the other by the foreign party.  The chairman of the board of directors is usually appointed to serve as the legal representative of the joint venture.  The legal representative has extensive authority and responsibilities with respect to the operations of the joint venture.

While major policy decisions must be made by the board, day-to-day operational management of the joint venture is delegated by the board to a general manager.  In practice, it is advisable to agree at the outset and set forth in the joint venture contract which issues require approval by the board and which operating decisions may be left entirely to the discretion of the general manager.  Thus, appointment of the general manager is often a key element of operational control of the joint venture and therefore, many foreign investors insist upon making such appointment.  Generally speaking, the same considerations regarding management decisions also apply to a cooperative joint venture.

In addition to the board of directors, FIEs are required to appoint a company supervisor or supervisory committee independent of the board of directors and senior management.  The supervisor does not need to have any specific qualifications, nor does he need to be a Chinese national or reside in China.  His powers include inspecting the company finances, supervising the performance of the directors and senior management, and taking action against directors or senior management who are acting against the interests of the company.

Part of the supervisor’s role is to act as advisor, and he may attend meetings of the board of directors, questioning their resolutions or otherwise offering suggestions.  He may also be held liable for damages if he is found to be harming the company’s interests or violating the law or articles of association and thereby causing the company to suffer damages.

(l) Treatment of assets upon dissolution: Upon the expiration or early termination of an equity joint venture, after payment of all the company's debts and obligations, the remaining assets are to be distributed to the joint venture parties in proportion to their respective contributions to the registered capital of the joint venture, unless otherwise agreed in the joint venture contract.

Back to Top

Procedure for setting up equity joint ventures

(a) Documentation: After initial discussions, the parties may sign a letter of intent or a memorandum of understanding.  Such preliminary documents are generally not legally binding but are intended to establish a framework for further discussions and negotiations.  They will, however, be used for obtaining a preliminary approval setting the parameters of the project.  After preliminary approval is obtained, the parties should jointly prepare a feasibility study.  If after analysis, the findings of the feasibility study are considered acceptable, the parties may advance to negotiate and sign a formal joint venture contract and articles of association for the joint venture company.

(b) Approval: The establishment process commences with the application for name pre-approval with the SAIC or its designated local bureau.  Following the name pre-approval, the joint venture contract, articles of association, feasibility study and other specified application documents should be submitted to MOFCOM or its designated local bureau in the relevant province, autonomous region or municipality for approval.  Smaller projects may be approved by the local authorities, while larger projects must proceed through channels for approval by the provincial or national authorities.  Larger encouraged projects may in some instances be approved locally.  When a project is approved, MOFCOM or its designated local bureau will issue an approval certificate.  FIEs (including equity joint ventures) in certain specified sectors also require the approval of the government authority in charge of their industry.  If the establishment of an equity joint venture involves the acquisition of a domestic enterprise it is subject to the Acquisition Regulations and additional approval and documentation requirements will apply.

(c) Registration: The joint venture parties must register with the SAIC or its designated local bureau within 90 days of the date of receipt of the certificate of approval.  A joint venture is deemed formally established on the date of issuance of its business license by the SAIC or its designated local bureau.

Back to Top

Cooperative joint ventures

Introduction

The establishment and operation of a cooperative joint venture are governed by the Law of the People's Republic of China on Sino-Foreign Cooperative Joint Ventures, effective as of 13 April 1988, and the Detailed Implementing Rules for the Law of the People's Republic of China on Sino-Foreign Cooperative Joint Ventures (Cooperative JV Rules), effective as of 4 September 1995.  While the equity joint venture is the more common form of foreign investment vehicle as compared to the cooperative joint venture, the latter is generally preferred by certain types of business (see section (g) “Reasons for choosing cooperative joint ventures” below).

Back to Top

Nature of cooperative joint ventures

(a) Legal status: Under the Cooperative JV Rules, there are two types of cooperative joint ventures, those that have legal person status (separate corporate existence) and those that have not.  Legal person status is the norm and the Cooperative JV Rules contain certain special regulations which apply to cooperative joint ventures that do not obtain legal person status.

Under the General Principles of Civil Law of the People's Republic of China (China does not yet have a complete civil code), the requirements for an entity to obtain legal person status are as follows:

i. it is established in accordance with the law;

ii. it has the necessary capital or property;

iii. it has its own name, an organisational structure and premises; and 

iv. it is capable of independently assuming civil liability.

The Cooperative JV Rules recognise that most cooperative joint ventures satisfy the foregoing conditions and therefore should acquire the status of a separate legal entity once approved and registered by the relevant authorities.

(b) Liability of cooperative joint venture parties: The Cooperative JV Rules provides that a cooperative joint venture which obtains legal person status shall be a limited liability company.  In such case, the liability of the joint venture investors is limited to the extent of their investment in the cooperative joint venture company (unless otherwise stipulated in the contract).

(c) Similarity with equity joint ventures: Under the Cooperative JV Rules, limited liability cooperative joint ventures share most of the characteristics of equity joint ventures, and in particular they have a registered capital and the liability of the joint venture partners is limited to their respective contributions to the registered capital.

(d) Distinguishing feature from equity joint ventures: A distinguishing feature of cooperative joint ventures from equity joint ventures is that the parties may agree on an arrangement for sharing profits and losses which need not correspond with the ratio of the parties' respective contributions to the registered capital (as is in the case of equity joint ventures).  Greater flexibility is also allowed in the form of permitted capital contributions.

(e) Contractual rights and obligations: As with equity joint ventures, it is advisable to stipulate in the joint venture contract the exact rights and obligations of the parties, particularly in relation to the ownership of the assets contributed by the parties both during the term of their cooperation and upon its expiration or termination.

(f) Treatment of assets upon dissolution: Under the Cooperative JV Implementing Regulations, the foreign party is permitted to take a larger share of the profits relative to its contribution to the capital and/or to recover its investment during the period of cooperation.  Under such an arrangement the fixed assets of the cooperative joint venture pass to the Chinese party at the end of the period of cooperation.  If this option is not stipulated in the contract, the treatment of assets upon dissolution is similar to that of equity joint ventures.

(g) Reasons for choosing cooperative joint ventures: Generally speaking, a foreign party may wish to consider a cooperative joint venture if the Chinese joint venture partner's role is very limited and the foreign investor wants to stipulate a profit distribution ratio in the joint venture contract allowing the foreign investor to take a larger profit relative to its share of equity ownership in the joint venture.

Back to Top

Procedure for setting up cooperative joint ventures

The examination and approval procedure for forming a cooperative joint venture is basically similar to that for an equity joint venture.  The parties are required to register with the SAIC or its designated local bureau within 30 days of the date of receipt of the certificate of approval.

Back to Top

Wholly foreign-owned enterprises

Introduction

The Law of the People's Republic of China on Wholly Foreign-Owned Enterprises (WFOE Law), effective as of 12 April 1986, permits foreign investors to establish and operate wholly foreign-owned enterprises in the PRC and thus provides an opportunity for foreign investors to make independent investments in the PRC without the participation of a Chinese partner.  In addition to the WFOE Law, the other key statute governing the establishment and operation of a wholly foreign-owned enterprise is the Detailed Implementing Rules for the Law of the People's Republic of China on Wholly Foreign-Owned Enterprises (WFOE Law Implementing Rules) effective as of 12 December 1990.

Back to Top

Nature of wholly foreign-owned enterprises

(a) Legal status: A wholly foreign-owned enterprise is usually a limited liability company although the WFOE Law Implementing Rules permit other liability structures subject to approval.  A wholly foreign-owned enterprise with limited liability has its own registered capital and a legal identity distinct from its foreign investor.  It is an independent legal person capable of contracting and bearing liability on its own behalf.

(b) Scope of operation: The scope of business of a wholly foreign-owned enterprise must be specified in its articles of association.  A wholly foreign-owned enterprise may operate only within its approved scope of operation and any change in this scope requires the approval of the original approval authority and re-registration.

(c) Approval criteria: Wholly foreign-owned enterprises are prohibited in certain industry sectors.  More industry sectors are gradually being opened up to wholly foreign-owned investment in connection with China's WTO accession but certain sectors will remain off limits to this type of investment for the foreseeable future.

Back to Top

Procedure for setting up wholly foreign-owned enterprises

(a) Approval procedure: The procedure for establishing a wholly foreign-owned enterprise is similar to the procedure for a joint venture.  The first step in the establishment process is name pre-approval with the SAIC or its designated local bureau.  Following the name pre-approval, the investor or investors shall submit the required application documents to MOFCOM or its designated local bureau.  The documents include a feasibility study report, articles of association of the enterprise to be established, the applicant's certificate of incorporation, a letter of creditworthiness from the applicant's bank and other required documents.  In addition to MOFCOM (or the designated affiliate) approval, wholly foreign-owned enterprises in certain specified sectors require the approval of the government authority in charge of their industry.  If the establishment of a wholly foreign-owned enterprise involves the acquisition of a domestic enterprise it is subject to the Acquisition Regulations and additional approval and documentation requirements will apply.

(b) Registration requirements: Within 30 days of obtaining the approval from MOFCOM or its designated local bureau, the applicant must register with the SAIC or its designated local bureau.  The date of issuance of the business licence by the SAIC or its designated local bureau is the date of establishment of the wholly foreign-owned enterprise.

Investors in wholly foreign-owned enterprises must make their investments within the period stipulated in the articles of association, otherwise the business licence may be revoked.  An initial instalment of at least 15% of the total subscribed amount (subject to a minimum of RMB30,000 in case of two or more foreign investors, or RMB100,000 in case of a single foreign investor) must be contributed within 90 days of issuance of the business licence, and the full amount must be paid within two years.

Back to Top

Comparison of wholly foreign-owned enterprises with joint ventures

(a) Potential advantages: Without a Chinese partner, the often protracted and sometimes difficult negotiation of a joint venture contract is avoided.  Thus, the establishment of a wholly foreign-owned enterprise may be simpler and faster.  Furthermore, because a wholly foreign-owned enterprise is wholly owned by the foreign investor, management decisions may be made - and day-to-day operations conducted - unilaterally without the need for a partner's agreement.  Proprietary technology is also less widely exposed, since there is no partner who may be able to use the technology in its own operations.  Thus, management and operational issues may be simplified.

(b) Potential disadvantages: Investors new to China may find it difficult going it alone. Knowledge of local conditions is important and good local contacts, particularly with government and administrative authorities, are often essential in China.  A good joint venture partner may be able to supply these attributes. In the absence of PRC experience and qualified personnel, a foreign investor may find it difficult to acquire such tools without a local partner.

Back to Top

Whilst every effort has been made to ensure the accuracy of this publication, it is for general guidance only and should not be treated as a substitute for specific advice.