Highlights

(as on September 30, 2008)

In order to direct foreign investment into certain priority industry sectors while restricting or prohibiting investment in other sectors, Chinese law broadly classifies all foreign investment projects into one of the following four categories: prohibited projects, restricted projects, encouraged projects and permitted projects. The classification of an investment project in turn determines the feasibility and establishment method of the project and whether a project can enjoy certain tax benefits such as an exemption from VAT and customs duties on the import of capital equipment. Individual sectors failing into each category can be checked from the Foreign Investment Industry Guidance Catalogue issued by the Ministry of Commerce from time to time. The Government modifies the individual sectors in each category in accordance with changing circumstances. For example, social surveys by foreign entities have been added in the prohibited category in 2004 and it appears that in the near future, foreign companies can invest in, but would be prevented from, acquiring controlling stakes in domestic steel companies and nuclear power generating projects. It may also be noted that given the relative underdevelopment of the western and central regions of China, foreign investors operating for over ten years in the manufacturing sector and investing in these regions enjoy a complete corporate income tax holiday for the first two years of making profits and a reduction of 50% of income tax from the third year to the fifth year.

In accordance with the “Provisions on Guiding Foreign Investment Direction”, the following projects fall in the prohibited category:

1. those that harm national security and public interest;
2. those that cause environmental pollution, or do great damage to natural resources and wealth or to people’s health;
3. those that occupy a great deal of farm land and/or do not afford protection to and/or promote development of land resources;
4. those that harm the security of military infrastructure and its efficiency;
5. production methods that make use of unique techniques or technologies that China possesses (i.e., use of indigenous knowledge);
6. Other cases stated in the law and relevant administrative regulations.

The following projects fall in the restricted category:

• those that lag behind in technology, i.e., use outdated or inefficient production methods;
• those that does not do conserve energy and improve the environment;
• those that are concerned with special exploration and mining protected by the State;
• those industries that are being opened by the State gradually; and
• other case stated in the law and relevant administrative regulations.

China encourages foreign investors to invest in the following projects:

• those that utilize advanced new technology for agriculture, power, transportation, and important raw materials;
• those that utilize advanced new technology which could improve the performance of products and the enterprise’s economic and technological performance, or produce new equipment and new materials that domestic production capacity cannot produce;
• those that can improve and update the product’s quality level and open new markets, or enhance the competence of the product in the international market;
• those that are categorised as using advanced new technology and new equipment which can save power and raw materials, make comprehensive use of resources including renewable resources and do not pollute the environment;
• those that can give full play to the advantages of human resources and natural resources of China's western region and be in accord with the State’s industrial policies; and
• those that are prescribed by other laws, administrative regulations, and measures.

Investment projects under the permitted category are not specifically listed. Investment projects other than those listed as prohibited, restricted and encouraged categories will fall under the permitted category.

Types of corporate presence in China

Branch/Representative Offices

A branch/representative office in China is one that is used for business purposes for which the head office holds responsibility. It is not a legal entity and can only carryout liaison and coordination work.

Sino – Foreign Equity Joint Ventures

These are enterprises established in China with joint investment from foreign companies, enterprises or other economic bodies with Chinese corporate entities. As the name suggests, such enterprises involve joint investment, operation and share of profit/risk in proportion to the amount of investment of the respective parties. Investment can come in any form including capital, buildings, industrial property or equipment. In general, the level of investment offered by the foreign company should not be less than 25%.

The corporate form of such joint ventures is the limited liability company, with a Board of Directors as the governing and managing body. Sino – Foreign Co-operative Joint Ventures are alternatively termed as Chinese-foreign contractual joint ventures. Again, these are enterprises established in China with joint investment from foreign companies, enterprises or other economic bodies with Chinese corporate entities. The main difference between these entities and the equity joint venture is that the investment of the parties involved will not necessarily be converted into ratios of investment. In other words, the rights and obligations of the parties involved with regards to such issues as distribution, investment, operation and sharing of risks and profits are determined by the contracts signed by the parties from the outset of the venture. These ventures tend to involve the foreign partner providing most or all of the funds whilst the Chinese partner contributes land, facilities and perhaps a limited amount of funding. The usual approach is to stipulate in the contract that the Chinese party will own all the assets of the venture once the date of expiry of the venture is reached, with the foreign party recouping its investment within the duration of the venture. Such forms of co-operative joint ventures are considered attractive, for they allow the Chinese partner to have a source of investment whilst permitting the foreign company to recoup its investment in a given time frame.

Wholly-Owned Foreign Enterprises

These are enterprises set up in China by foreign companies or corporate entities in accordance with Chinese law with investment provided entirely by foreign investors. The corporate form of foreign enterprises in China is generally a limited liability company. Chinese law requires that such enterprises are to be conducive to the development of China’s national economy and they must also meet one of the following requirements:

1. The application of international advanced technology.
2. The orientation of most of the products should be for export.

Chinese Holding Companies

Approval has recently been given to multinational corporations by China’s Ministry of Foreign Trade and Economic Cooperation (MOFTEC) to establish foreign-invested holding companies. Though mostly analogous to holding companies in other parts of the world, there are some differences. Multinational companies may wish to set up holding companies in order to increase investment or reinvestment in China, as well as to coordinate between investment companies already established in China. A holding company in China may invest in such fields as industry, agriculture, infrastructure and energy, provided that the State encourages foreign investment in these sectors. Typical work undertaken by a holding company might include acting as a purchasing or a distribution agent or providing after sales services, amongst other things. Provisional Regulations dictate that a Chinese holding company may enjoy the preferential treatment accorded to foreign-invested enterprises, and as such is awarded both a foreign-invested enterprise certificate and a licence. B. Shares Chinese government allows foreign investment to acquire shares of special category “B shares” of an approved listed company in the Stock Exchange. However, ownerships and management are separated. Moreover, Chinese government is considering allowing foreign invested entities in China to be listed in the Stock Exchange. Special approved foreign Joint Venture Foreign nationals are generally not allowed to hold equity of private companies in China unless the Government gives special permission. It may be noted that a merger and acquisition exercise involving foreign funds can convert a private company into a foreign JV.