China’s Foreign Investment Law: what you should know about WFOE in 2019 and beyond

In March 2019, the government of the People’s Republic of China passed legislation to better accommodate overseas investors and improve the level of competition within the domestic market by creating a more level playing field as it develops its domestic consumer economy. In the past year and a half, non-residents have invested US$75 billion in the PRC stock market, while overseas ownership of bonds is projected to expand to five times the current amount of $265 billion.* Once the new legislation takes effect, setting up a corporate structure in China is expected to become more common.

 

However, Mainland China’s ease of doing business ranking remains low, far beneath Hong Kong and Singapore. Investor confidence has fallen in the wake of the trade war, particularly with regard to the technology sector. At the same time, foreign direct investment in manufacturing and real estate have been slowing. In order to address these challenges and the longstanding international perception of the country’s inaccessibility, the government has expedited legislation to extend national treatment (same market access and regulations as domestic entities) to overseas entities and replace the WFOE (Wholly Foreign Owned Enterprise) CJV (Sino-Foreign Cooperative Joint Ventures) and EJV (Sino foreign Equity Joint Ventures) laws with a single Foreign Investment Law (FIL) on January 1, 2020. There will be a five-year grace period for established investors and enterprises to continue under their existing China company setup. The law also proposes to ban the practice of forced technology transfer, protect intellectual property rights and prevent local governments from setting discriminatory restrictions, abusing their administrative oversight or enacting policies that go against the principles of equal treatment.

 

Despite this, few implementation details have been specified and the law itself, while clear about its intent, is vaguely worded. As such, the ideal strategy for most people seeking to start a business in China is to first form a Hong Kong holding company while continuing to follow developments in the mainland because of the ease of company setup in Hong Kong, the free flow of capital, and strategic opportunities unique to the region. This strategy puts companies in a position to enjoy the benefits of investing in China without the restrictions and risks.

 

Hong Kong company formation is far more efficient than in Mainland China because of the services sector dedicated to the process, including accounting services and China Appointed Attesting Officers. Capitalization is also a relatively simple process because Hong Kong companies, in addition to facing no minimum requirement for paid up capital, also benefit from the doctrine of separate legal entity. These insulating layers provide enterprises and investors with flexibility in their fiscal planning, and a measure of reassurance and control over their investment in China.

 

Wholly Foreign Owned Enterprises (WFOE) in China will continue to be regulated under China’s existing Companies Law for Limited Liability Companies. However, WFOE’s can now operate as joint stock companies. Aside from this flexibility, WFOE’s will have to contribute 10% of their profits to statutory surplus reserve funds until their reserve amounts total half of their registered capital. They are no longer required to contribute a specific amount to welfare and bonus funds for their employees.  WFOE liquidation will be handled by a group formed by the shareholders.

 

To sum up, operating through a WFOE in China is expected to become easier and more flexible down the road, although for now the process is still heavily regulated with a considerable administrative burden.

 

Under China’s new Foreign Investment Law, Equity Joint Ventures and Cooperative Joint Ventures will be required to appoint a board of shareholders in addition to the board of directors, with the board of shareholders reviewing and voting on matters of importance (such as mergers and changes in corporate structuring) instead of complete control by the board of directors. Most joint ventures will no longer face any limitations on the shareholding ratio for foreign investors.

 

China’s Foreign Investment Law also legally formalizes the Negative List, areas where foreign investment is restricted. Under the new law, only the State Council can designate areas of investment under the Negative List, while local governments and ministries will have to follow the principles of equal treatment. The Negative List has also been updated in 2019, removing some restrictions in the transportation, mining and manufacturing sectors, opening up new investment opportunities in China.

 

Hong Kong is poised to benefit from the development of the Greater Bay Area as an elite financial services portal for China’s developing technology sector. Currently, the P.R.C’s technology industry and foreign investment climate are both experiencing transition periods with a degree of uncertainty for foreign investors. Shenzhen missed its economic growth target for 2018, while international enthusiasm for the technology sector’s short-term development has been muted. Although there is cautious optimism about the practical implementation of China’s Foreign Investment Law’s stated principles, the general consensus is to wait and see.

 

Operating in Hong Kong is still the most ideal China market entry strategy today, because of its free market economy and interfaces with the China fiscal ecosystem, such as easy conversion from HKD to RMB, and close ties between the two legal systems. As a primary beneficiary of the Greater Bay Area initiative, company registration in Hong Kong poses far reaching prospects for investment in China over the long term.

 

Should you have any questions about what China’s Foreign Investment Law means for your company setup in either Hong Kong or the Mainland, you can contact us for a consultation. If you plan to open a WFOE or set up a business in China, our advisory services specialize in international and cross border corporate solutions. With over 50 years of regional experience, we are committed to guiding our clients towards new horizons and a brighter future.

 

References:* https://www.economist.com/finance-and-economics/2019/07/06/foreign-financiers-look-past-the-trade-war-and-ramp-up-in-china

 

 

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