According to World Investment Report 2022 issued by United Nations Conference on Trade and Development (UNCTAD), the global foreign direct investment (FDI) reached 1.6 trillion USD in 2021, returning to pre-pandemic levels. As one of the major destinations of the global investment market in recent years, China is still favored by investors from all over the world. China's FDI continued to grow to 181 billion USD in 2021, remained the second recipient of FDI in the world for five years. According to the 2022 China Business Climate Survey released by the China-Us Chamber of Commerce, 60 percent of its member enterprises said they would further increase their investment in China. As of 2021, there are 1.04 million foreign-invested enterprises in China and they actually utilized FDI over 2.4 trillion USD.

With the deepening of China's economic structural reform and the steady progress in the joint pursuit of the Belt and Road Initiative, China will further open its arms, lighten administrative supervision and introduce preferential policies. China’s market has significant potential and unlimited business opportunities, but it also contains various risks.

This series of articles aims to briefly introduce laws and regulations regarding foreign-related business, sort out the problems that international friends may encounter when investing in China, especially in Hunan, and provide some risk prevention and control measures. Our team sincerely hopes to help foreign investors to avoid risks and achieve profits. And this first article will introduce the legal requirements of initiating an enterprise in China, some preferential policies in Hunan, and type of enterprises that foreign investors can choose.

Legal Requirements

The Foreign Investment Law of the People's Republic of China and its Implementing Regulation are the current valid fundamental law to clarify the legal right and obligation of foreign investors. The core mechanism is “pre-establishment national treatment plus negative list”, which means foreign investors can invest the industry and enjoy the same treatment as Chinese as long as the industry is not in the negative list.

The negative list normally changes annually and it specifies what kind of business that foreign investors cannot do or their equity proportion shall be limited. Along with that China’s market opens more and more, the negative list gets shorter year after year. The current valid list is the 2021 version which was issued in 27^th, December, 2021 and came into force in 1^st, January, 2022. The restricted items reduced to 31 kinds. This new version cancels the restrictions over automobile manufacture industry. Since then, foreign investors can freely initiate whole vehicle manufactural enterprises without equity proportion and enterprises’ amount limit. Most remained limitations are set out of national security or special resource protection. For instance, Chinese equity in the new wheat varieties selective breeding and seed production business shall be no less than 34%, and the new maize varieties selective breeding and seed production business shall be controlled by Chinese. Medical institutions are limited to joint ventures. You are welcomed to consult us for other detailed limitations.

Preferential Policies in Hunan

President Xi came up with “three highlands and four new missions”strategy when he inspected in Hunan province, which means he hopes that Hunan will become a national important advanced manufacturing highland, scientific and technological innovation highland with core competitiveness and reform and opening-up highland in inland areas. Following this instruction, Hunan has introduced many regulations and policies to promote open economic, which provides foreign investors more convenience and chance to making profit.

First, Hunan has most open platforms in middle provinces of China. China-Africa Economic and Trade Expo is a remarkable example. The exhibitors will be exempted from import duties, VAT and consumption tax for the import link for their imported exhibits sold within the tax-free quota during the exhibition period. The exhibits that enjoy import tax incentives includes 20 categories of commodities including animal and plant products, handcrafts, rubber products, carpets, and jewelry.

Second, Hunan designated China (Hunan) Pilot Free Trade Zone with three regions, which are Changsha region, Yueyang region and Chenzhou region. In Free Trade Zone, enterprises may be benefit from those special lightened regulation policy and innovation system. For instance, Changsha region is the first one in China to adopt 1×1×1 blending mode, which means intensive development of international mail, international express, cross-border e-commerce business. Based on this mode, the clearance time is reduced by 50% averagely. And e-commerce enterprises’ operation cost was reduced by 30% according to data of 2021. In Chenzhou region, thanks to the facilitation of foreign exchange receipts and payments in cross-border trade, the time needed is reduced to only one day from one week. More detail governmental preferential policies will be introduced one region by one region in our later articles.

Third, China's National Development and Reform Commission and the Ministry of Commerce issued the Catalogue of Industries for Encouraging Foreign Investment (2022 Version) draft in 10th, May, 2022, which adds 238 more items and extends applicable scope for 114 items compared to the 2020 version. In that draft, Hunan lists 44 items that local government recommends and encourages to invest according to the above mentioned “three highlands and four new missions”strategy. The encouraging industries mainly focus on manufacture (clothes production, manganese zinc deep processing, key components of large construction machinery manufacture, etc.), technology R&D (special high-quality glass technology development, thermal management system and control system of new energy vehicle R&D, optoelectronics materials, electronic materials, electronic components development and processing, etc.) and industries related to culture (comic creation, production and derivative development, etc.). Hunan also introduced preferential policies especially targeting those industries for encouraging foreign investment. For instance, the export tax rebates of those new initiated manufactural foreign trade enterprises in Free Trade Zone can be accelerated according to the upper management category after the export enterprises’ management category is assessed. For advanced manufacturing industries, and film and television culture enterprises, their export tax rebate claims shall be done within 2 working days. And enterprises can claim it online. These policies will lower enterprises’ cash and operation burden greatly.

Investment Forms Comparation

Natural person, enterprise and other organization can invest in China in their own name. Foreign investors can get equity, shares, property shares or other rights of existing enterprises within China by merger, acquisition, or other means. Investing the existing enterprises definitely has some advantages. First, there is no need to wait for the registration process and the basic structure of the company was established already. Second, normally the company is running for a period. Therefore, investors can do business directly and utilize the existing devices and customer resources. However, on the bad side, the financial situation might not be real and clear. And the old shareholders may cheat investors in other aspects, such as employee situation, legal compliance situation, etc. Inconsideration of that, we normally recommend investors to do due diligence targeting the company, at least.

Foreign investors can initiate new enterprises, too. They may initiate companies and partnerships in China in accordance with law. As for company, there are limited liability companies or joint-stock limited companies for choice. The differences of these two kinds are as fellow.

We can clearly see that joint-stock limited companies suffer more strict restrictions. Therefore, we normally recommend our clients to choose limited liability companies and design the articles of association elaborately at the beginning of their business.

The detailed registry and modification process are as follow.

Partnership enterprise is also a common business form in China. Chinese law has lower requirement on partnership. If the application material is sufficient and suitable, the enterprise registration department normally will issue the license on the spot. It includes two kinds, which are general partnership enterprises and limited liability partnership enterprises. In general partnership enterprises, every partner shall bear unlimited joint and several liabilities for the debts of the partnership enterprise, which means a creditor can ask any partner to clean all debts at his. After the partner setting the compensation, he has the right to recover from other partners on the part exceeding his proportion. A limited liability partnership enterprise shall be formed by at least one general partner and limited partners. In limited liability partnership enterprise, the general partners shall bear unlimited joint and several liabilities for the debts and the limited partners bear the liabilities only to the extent of their capital contributions. A written partnership agreement is also needed to establish a partnership enterprise, which shall include the name and address of the main business operation place, the purpose and business scope of partnership, the ways and amount of capital contribution by partners and the time limit for payment, the profit distribution and loss sharing, etc.

Besides difference in liability burden, another difference between limited liability companies and partnership enterprises is the initiator amount. One person (natural or legal, domestic or foreign) can initiate one-person limited liability company, which means the company only has one shareholder, though one natural person is allowed to establish merely a one-person limited liability company, and this company shall not establish any more one-person limited liability company. There shall be at least two people to initiate a limited liability company, though the decision rights and the profit distribution rights of some partners can be restricted by the partnership agreement.

Another important difference is the tax burden. The limited liability companies registered in China is a resident of China, which shall pay enterprise income tax before profit distribution (except one-person limited liability company). The basic tax rate is 25%. In the recent years, China’s government has introduced some preferential policies. For example, there are common preferential policies for small and low-profit enterprises as fellow, who engaged in non-restricted and non-prohibited industries, and meet these three conditions at the same time: the annual taxable income does not exceed 3 million RMB, the number of employees does not exceed 300, and the total assets do not exceed 50 million RMB.

In detail, if a limited liability company’s annual taxable income is 2.6 million RMB, the enterprise income tax shall be paid is 0.105 million RMB [112.5%20%+（2.6-1）25%20%]. If there are no such preferential policies, the tax shall be paid is 0.65 million RMB [2.625%]. Apart from these common policies, there also are other preferential policies for small-scale taxpayer, technology SMEs, etc.

After paying enterprise income tax, the company can distribute profit in accordance with law and articles of association. Normally, the investor who maintain profit distribution which is not based on shares of listed company shall pay individual income tax at 20% rate. However, a good news is that currently natural foreign investors are exempted from paying individual income tax for stock dividend and bonus share from foreign invested companies. 

One-person limited liability company and partnership enterprise are similar when paying tax. Both of them shall divide the profit according to the agreed proportion or capital contribution proportion after deducting the cost and fees and before paying tax. Every partner shall respectively pay his own tax for his business income using excess progressive rates between 5%～35%。Because this kind of income shall be regarded as business income, instead of stock dividend or bonus share, foreign investors cannot enjoy the exemption.

In conclusion, invest forms in China is various, and each form has its own advantages and unfavorable aspects. The final decision shall comply with investors’ business plan and style. We are delight to give you professional advice according to your personal need. 

Epilogue

China’s market is full of potential and risk, our team is committed to help you in your international business with comprehensive and full-process legal services. In next article of this series, we will introduce the risk in distribution business and how can the contract be designed. Please stay turn.