Partnership Enterprise Law of PRC (17/04/2007)
1. What is the new limited partnership system?
Limited Partnerships may be established under the new law, which, on the condition that there is at least one partner willing to assume unlimited liability, allows the other partners to benefit from limited liability. In addition, the New Partnership Law specifically sets out the type of capital contribution which may be made by limited partners, including contribution in money or in kind – for example, in intellectual property rights, land use rights or other property assets. The contribution must also be recorded in the registration of the enterprise in order to protect the rights and interests of creditors.
The limited partnership system is designed to be conducive to the development of risk carrying investments by allowing the institutions or individuals with experience in management and abilities in technology research and development to combine effectively with investment institutions.
2. What is the new special general partnership?
The New Partnership Law contains a section entitled “Special General Partnership Enterprises”, which specifies that, subject to a general condition that partners will assume unlimited liabilities for the debts of the partnership, partners would not assume unlimited liabilities on a joint and several basis for liabilities incurred to the partnership due to reasons attributable to any other partner(s). At the same time, the New Partnership Law narrowly defines the scope of the exemption to liabilities incurred by the partnership due to other Partners’ willful misconduct or gross negligence.
In addition, to supplement the limitation on the scope of partners’ assumption of unlimited liabilities for liabilities of the partnership, the New Partnership Law has introduced a protection system for clients and third parties. It requires special general partnership enterprises to maintain a risk reserve fund and obtain malpractice insurance to cover potential risks incurred by partners.
3. Can legal persons participate in the partnership?
The new law expressly defines the partnership enterprise, so that legal persons may participate in partnerships. This system is intended to allow legal persons, including companies, to realize their intended target undertaking using the advantages of partnership enterprises – including a flexible form, effective cooperation, and relatively low costs. This system is also intended to be conducive to the cooperation between large size enterprises and innovative middle and small-size enterprises. Meanwhile, in order to prevent the risks that state-owned enterprises and listed companies may assume due to participating in the partnership, and to protect the national interests, public interests, and the interests of shareholders, the New Partnership Law stipulates that such institutions may not become general partners.
4. Can partnership enterprise go bankrupt?
The New Law permits creditors of partnership enterprises to make choices under different circumstances, namely that the creditors may apply to the people's court for bankruptcy liquidation or may demand the partners to make repayments. Where a partnership enterprise is declared bankrupt, the general partners will still bear unlimited joint and several liabilities for the debts of the partnership enterprise.
The new system ensures that all creditors are repaid in proportion, which helps the creditors’ interests. Meanwhile the act of illegal transfer of property within the year prior to the bankruptcy of the enterprise may be withdrawn, and the transferred property may be recovered, so that the bankruptcy property is increased and the creditor’s interests are
protected.
5. Does partnership enterprise need to pay income tax?
In order to prevent partners from evading the obligation to pay taxes by not distributing the profits of the enterprise, the New Law sets forth, “for production and business operation incomes and other incomes of a partnership enterprise, partners must pay their respective income tax in accordance with the relevant tax provisions.”
6. How does the law prevent the issue of illegally raising funds?
In order to prevent raising funds illegally through the limited partnership system, the New Law, by reference to the relevant provisions of the Company Law of the PRC, provides that a limited partnership enterprise must be established by not less than 2 but not more than 50 partners, unless it is otherwise provided by law.
What are the options for foreign enterprises to establish a permanent presence in China?
For foreign companies, there are four main forms business establishments in China can take: 1) representative offices 2) branches of foreign companies 3) joint ventures and 4) wholly foreign owned enterprises. The avenue chosen by a foreign investor is dependent on many factors: How active one wants to be in China; the industry one is investing in; and whether or not a Chinese partner is necessary, either because it is required by law or in order to benefit from the partner's experience in and access to the Chinese market.
The most popular form of establishment is a representative office, but they are very limited in the activities they may carry out. They may not carry out direct business activities and are limited to activities such as market research and liaison. In practice, some representative offices exceed their business scope and thus flirt with negative legal ramifications.
If one wants to legitimately carry out profit making business activities, one must set up a Joint Venture with a Chinese partner or a wholly foreign owned enterprise.
As for branches of foreign enterprises, they are allowed only in theory and, therefore, there exist no implementing regulations.
Many investors prefer Wholly Foreign Owned Enterprises to Joint Ventures, because this gives them full control over their business. However, there are certain industries in which a Wholly Foreign Owned Enterprise cannot be established - although this list is getting shorter and shorter. Also, some investors choose to cooperate with a Chinese partner to form a Joint Venture for strategic reasons. In general, though, WFOEs are gaining popularity, mainly because they are easier to establish now than in the past.
Representative offices may not carry out direct business activities. What does this mean and are representative offices subject to taxation?
Under Chinese law, Representative Offices may not engage in direct business activities and therefore should not directly generate profits. Permitted activities include establishing and arranging contacts, rendering advice, preparation of market studies, general collection of information and liaising with authorities and business partners. Representative Offices may not bill clients or sign contracts. In other words, they may promote, but they must not sell.
One can argue that such activities do not directly generate income and therefore representative offices should not have to pay income tax. However, the tax bureau takes a different view. It levies business tax and foreign enterprise income tax on representative offices. There are various ways of calculating income tax for representative offices. Typically, it is based on the office's turnover. Income tax is paid at a rate of a little less than ten percent of the office's overhead. In some cases the representative office can obtain an exemption if the representative office can prove that the parent company is a manufacturing company and is using the representative office for purchases in China.
It should be noted, however, that it is advisable to seek professional advice before opening a representative office in order to ensure that its activities fall within the permitted scope and that all tax benefits are applied.
What is an equity joint venture?
First, it is necessary to clarify that there exist two types of Joint Ventures - Equity Joint Ventures and Cooperative Joint Ventures. The equity joint venture is the older and less flexible type. Equity Joint Ventures must operate in the form of a Limited Liability Company, which means that the personal wealth and property of the actual individuals who are responsible for the company are shielded from corporate loss.
The most significant difference between Equity Joint Ventures and Cooperative Joint Ventures is the allocation of profits. In Equity Joint Ventures, profits must be allocated according to the ratio of the capital contributions made by the partners. In other words, if one party puts in 40% of the capital investment, they will reap 40% of total profits.
Equity joint ventures are the preferred investment vehicle for most manufacturing Joint Ventures. This being said, potential investors still must be clear about their purpose before deciding which form of Joint Venture they will use.
What is a cooperative joint venture?
Cooperative joint ventures allow for more flexible agreements between the joint venture parties. Cooperative Joint Ventures have the choice to organize themselves either as a limited liability company or as a non-legal person in which the partners are subject to unlimited liability, which means that the partners are entirely liable for losses the Joint Venture may incur. In practice, the majority of Cooperative joint ventures are set up as limited liability companies.
The other major difference between a cooperative joint venture and an equity joint venture is that, in a cooperative joint venture, profits can be allocated according to the partners' discretion and do not have to be proportional to the investments made by the partners. The parties may also agree that one party recovers its investment through an accelerated repayment structure, whereas the other party will become the owner of the Joint Venture's assets after termination of the joint venture.
The Wholly Foreign Owned Enterprise Regulations were recently amended. What are the most significant changes?
The most significant change is the lifting of the requirement that a wholly foreign-owned enterprise, or WFOE, must either meet advanced technology requirements or export 50%, or more, of its product output. Therefore, establishing a WFOE will be open to more industries.
In the past, export requirements restricted existing WFOEs in their marketing and sales strategy, since they could increase their domestic sales only if their exports were equally as high.
A main driving force of foreign investment in China continues to be the prospect of selling to a consumer market that has a quarter of the world's population. After the regulations are amended and export restrictions are curbed, the incentive to partner up with a Chinese company will wane. Therefore, we will likely see an increase of wholly foreign owned enterprises.
There still may be reasons to seek a local partner, but foreign investors will enjoy more freedom in structuring their investments in China.
Specifically, what type of businesses will the changes to the Wholly Foreign Owned Enterprise regulations affect?
In the past, foreign investors in some industries that were not High Technology or export oriented needed to find a Chinese partner and establish a joint venture instead of a Wholly Foreign Owned Enterprise, or WFOE. This set limits to establishing WFOEs in the service sector. In theory, WFOE enterprises in the service sector could not be established, since they did not manufacture goods that could be exported and typically did not use advanced technology. Having said that, exceptions certainly did exist in the past, but now the possibility of setting up a WFOE will definitely be open to more businesses in the service sector.
To give you an example, one specific type of business that will now be able to set up WFOEs are consulting companies. In a conference sponsored by the Beijing Foreign Investment Service Center in which Lehman, Lee & Xu participated, Dr. Chen Gang, Deputy Director of the Beijing Ministry of Foreign Trade and Economic Cooperation announced that, under the new policy, foreign consulting companies are now allowed to set up WFOEs in Beijing.
In anticipation of China's WTO accession, the Joint Venture Law was amended. How will these amendments affect Joint Ventures in China?
The recent amendments to the Equity Joint Venture law have been hailed by the media as a step towards China's compliance with WTO rules and an incentive to attract more foreign investment. The most significant amendment in the Equity Joint Venture Law gives joint ventures more freedom in their procurement of raw materials and equipment. The "old" law stipulated that joint ventures must give priority to domestic suppliers and that imported materials and equipment must be purchased with foreign exchange raised by the joint ventures themselves. However, in practice, joint ventures could already buy most materials internationally. Priority to Chinese products was necessary if the foreign equivalent was more expensive or inferior in quality, and the government rarely intervened. Thus, the amendment adopts the current practice as a rule, which will provide Equity Joint Ventures with more confidence and certainty.
Any scheme that favors local products is contrary to WTO rules, because it potentially distorts trade. To give you an example, plans made by the Chinese Ministry of Foreign Trade and Economic Cooperation and the Ministry of Information Technology would require mobile telephone manufacturers to export at least 60% of their output, or that at least 50% of the total value of the telephones come from locally produced components. Such rules cannot be implemented under the new regulations.
Again, by amending the Joint Venture law, China has made another step towards compliance with WTO rules.
Some foreign companies invest in China using an offshore company. What are the advantages of structuring an investment in this way?
There are various reasons why foreign investors use offshore companies to structure their investment in China. Offshore companies add an additional layer of limited liability, removing risk from its valuable parent company. Corporate law of offshore jurisdictions is often very flexible. Sale of the investment in China can be made by transferring the offshore entity, rather than the stake in the Chinese entity, which saves bureaucratic hassles in China.
Most importantly, offshore corporations can be used for tax planning purposes. By correctly arranging financial affairs, significant tax savings can be achieved -- but it should be noted that some schemes may constitute illegal tax evasion, rather than legal tax planning, so great care should be taken before setting up in one of these jurisdictions. Offshore jurisdictions are typically small islands in exotic locations. Examples are the Cayman Islands, British Virgin Islands, Samoa and Mauritius. Hong Kong is also a popular jurisdiction, due to its special status and proximity to the mainland.
It should be noted, however, that removing the administration of a company far from China causes practical difficulties, for instance when opening a bank account or when verifying documents.
All in all, offshore companies offer many advantages to investors, but there are many traps one could fall into. Therefore, sound legal advice should be sought before setting up an offshore company as an investment vehicle in China.
Recently, there has been a lot of discussion regarding the current trend of foreign joint venture partners buying out their Chinese counterparts. What are the major obstacles in these restructurings?
In recent years we have seen a growing number of restructured joint ventures. There is a trend to reduce the role of the Chinese partner in a joint venture by having the foreign partner acquire its shares. In a few cases, the Chinese partner takes over shares from the foreign party. Reasons for these separations vary. Often, the view of foreign investors and their Chinese partners differ in the way business should be conducted, and expectations are often not met. That's not unique to China. Just look at all the problems the German-American merger, Daimler-Chrysler, has had to endure since they tried to bring together their two different firm cultures - and they are both Western companies!
In China, the changing legal framework and business climate is not only more favorable to wholly foreign enterprises than in the past, but also facilitates the restructuring of joint ventures. Typically, the joint venture is restructured into a WFOE or the equity stake of the Chinese partner is reduced to transform the Chinese side into a "silent partner" without significant decision-making powers. Sometimes the equity structure is changed because the foreign investors pour in additional capital, whereas the Chinese partner does not increase its original contribution.
However, it should be noted that any type of equity change must be approved by the Ministry of Foreign Trade and Economic Cooperation. In a few sensitive industries, the Chinese partner must hold a majority and 100% foreign ownership is not permitted. These restrictions must still be observed. But, again, the number of WFOEs and restructurings are still definitely increasing.
When forming a joint venture in China, what are some IP issues that I should be concerned about?
Because Intellectual Property is becoming more and more important in today's information-based economy, one must protect oneself when entering into new business relationships. Following are some areas that deserve extra attention when setting up a JV:
Improved and New Intellectual Property
In the growth and development of a JV, new IPRs will come about, and these will be regarded as belonging to the Joint Venture. Therefore, it is also up to the JV to assign it or to apply for protection. If the foreign investor only holds a minority stake in the JV, then s/he may find themselves in a weak position regarding control over new IPRs. It is recommended to deal with these matters in the joint venture agreement before they become problems.
Investment Capital Contribution
The transfer of technology or IPRs of a foreign investor into a joint venture can serve as a contribution of capital. Depending on the investment sector of the JV, the transfer can make up a certain percentage of the JV. Although there are some exceptions, the maximum limit is usually 20%.
License/Royalty Fees
Licensing or Royalty fees from the transfer of IPRs in a joint venture deserves close attention. In China, royalties are subject to income withholding tax and business tax. Also, in some sectors, the royalty rate may have a ceiling, such as the 0.3% royalty rate ceiling of sales revenue in the retail sector for the use of a trademark.
Control
Probably the most important question to take into account is control of the IPRs after being transferred or licensed to a joint venture. If the IPR holder is a minority shareholder, it is even more of a concern.
Although IPRs can be controlled through a detailed joint venture agreement, control also depends on the investment sector, the type of IPR and the size of the investment among other things. However, in China, it is very important to select a partner that you can trust to not misuse or misappropriate your IPRs.
When obtaining a company through mergers and acquisitions, what sort of IPR-related issues should I think about?
As the investment market in China is becoming more and more deregulated, the practice of acquiring a company is becoming popular. One of the most important things to determine in an acquisition is the structure of the transaction. This may be dictated by investment regulations. However, whether an asset or share purchase transaction structure is used will greatly affect how the IPR involved will be affected.
It is very important to carry out a due diligence check before following through on a merger or acquisition. The majority of enterprises have some kind of IPRs and how integral those IPRs are to the business under acquisition is necessary to know. An IPR-specific due diligence can be very useful.
Registered IPRs, such as trademarks and patents, could be simply checked with the relevant office. Not yet registered IPRs can prove difficult and in some cases, require in depth investigation of the business history, including employment contracts, confidentiality agreements and other documents that can determine the security of an IPR. When acquiring a company that has licensed its IPRs from another company, it can not be stressed enough that one must first review these license agreements to guarantee that the licensing contracts are in fact transferable.
What are the different types of FIE acquisition?
For foreign companies, there are four main forms business establishments in China can take: 1) representative offices 2) branches of foreign companies 3) joint ventures and 4) wholly foreign owned enterprises. The avenue chosen by a foreign investor is dependent on many factors: How active one wants to be in China; the industry one is investing in; and whether or not a Chinese partner is necessary, either because it is required by law or in order to benefit from the partner's experience in and access to the Chinese market.
The most popular form of establishment is a representative office, but they are very limited in the activities they may carry out. They may not carry out direct business activities and are limited to activities such as market research and liaison. In practice, some representative offices exceed their business scope and thus flirt with negative legal ramifications.
If one wants to legitimately carry out profit making business activities, one must set up a Joint Venture with a Chinese partner or a wholly foreign owned enterprise.
As for branches of foreign enterprises, they are allowed only in theory and, therefore, there exist no implementing regulations.
Many investors prefer Wholly Foreign Owned Enterprises to Joint Ventures, because this gives them full control over their business. However, there are certain industries in which a Wholly Foreign Owned Enterprise cannot be established - although this list is getting shorter and shorter. Also, some investors choose to cooperate with a Chinese partner to form a Joint Venture for strategic reasons. In general, though, WFOEs are gaining popularity, mainly because they are easier to establish now than in the past.
Which issues should be considered when effecting an equity acquisition in an FIE?
In order to gain approval of the acquisition, important issues to bear in mind are: 1. If it is an acquisition that is in the shape of a JV, the foreign ownership must be at least 25%. 2. Debt/equity ratios should be complied with. 3. If the acquisition creates a WFOE, the business scope may not be in area prohibited to foreign undertakings. 4. If PRC law demands that a majority stake is reserved for the Chinese party, a foreign party may not gain control. 5. The MOFTEC Foreign Investment Guidelines must be complied with, as well as the Several Provisions on Changes in Equity Interests of Investors in Foreign Invested Enterprises.
Furthermore, legal due diligence is highly advisable. First, the investigation should include background and history of the project and a preliminary project approval. Second, the joint venture contract and/or articles of association are important documents to consider since they contain regulations concerning the rights of the parties as well as rules concerning mutual rights and obligations of the parties to the FIE. The investor should also ensure that the FIE has been duly approved. Other important to consider are a) the formulation of the business license, b) the need for any special permits or licenses, c) the capital verification report and investment certificates in order to see the amounts of capital injection of the parties, d) if any conditions are imposed on the parties equity interests, d) land use documentation, e) construction permits, f) technology and intellectual property rights, g) environmental requirements and assessments.
Are there any limitations on the duration of operating a joint venture?
Normally an operation of a joint venture is limited to a fixed period of time from thirty to fifty years. In some cases, however, an unlimited period of operation can be approved, especially when the transfer of advanced technology is involved. Profit and risk-sharing in a joint venture are proportionate to the equity of each partner in the joint venture, except in cases where there is a breach of the joint venture contract.
Are there any limitations on foreign exchange accounts in China?
It is preferable that foreign exchange accounts are balanced in order to remit profits abroad, so that the repatriated foreign exchange is then offset by exports from the joint venture. According to the Regulations on Foreign Exchange Control and the currencies stipulated by the equity joint venture contract, the foreign investors may remit abroad the net profits they received, the funds they received at the time of the expiration or termination of the duration of the equity joint venture, and other funds after they fulfill their obligations required by laws, the agreement or contract. Foreign investors are encouraged to deposit all of their foreign exchange into the banks of China. With the elimination of foreign exchange certificates and the further opening of the China market, this requirement is becoming increasingly relaxed.
Are there any limitations on the transfer of shares in a joint venture?
If there is a transfer of registered capital to or from an investor of an equity joint venture, then the other investors of the said venture must consent. Share holdings in a joint venture are usually non-negotiable and cannot be transferred without approval from the Chinese government. Investors are restricted from withdrawing registered capital during the existence of the joint venture contract. Regulations concerning the transfer of shares with only the approval of the board of directors and without approval from government authorities will evolve over time as the size and number of international joint ventures expands.
How is the management of an equity joint venture structured?
There are specific requirements for the management structure of an equity joint venture. Every equity joint venture shall set up a board of directors, of which the number of members of shall be determined through negotiation by the parties involved in the venture and shall be stipulated in the equity joint venture contract and articles of association. The members of the board of directors shall be chosen and replaced by the parties to the venture. The chairman and the vice-chairman (vice-chairmen) shall be decided through negotiation by the parties to the venture or shall be elected by members of the board of directors. If the Chinese investor assumes the office of the chairman, then the foreign investor, or the other party, will assume the office of the vice-chairman and vice versa.
The board of directors shall decide the major issues of the equity joint venture in accordance with the principle of equality and mutual benefit. The offices of general manager and vice-general manager(s) (or factory director and vice director(s)) shall be assumed separately by the parties to the venture.
What is the difference between the terms registered capital and "total investment"?
In summary, registered capital is defined above as "the total amount of capital registered with the registration authority for establishing the joint venture." Total investment can be described as the sum of capital construction funds and the operating funds needed for the joint venture's production as stipulated in the joint venture contract. In practice the total investment is considered the aggregate of the sum of the registered capital and the sum of the loans obtained for the operation of the enterprise. Total investment can also be described as the sum of the enterprise's equity and debt.
