Structuring Investments and Operations � Practical Tips

Corporate Advisors RHK Legal Structuring Investments and Operations – Practical Tips: China and Hong Kong Common Options for Local Presence in China  Contractual Alliances: Contract with local partner –no local presence.  Representative Offices. Basically a marketing and sales office for a foreign company in China  Wholly Foreign Owned Entities (WFOE's).A whollyowned corporate subsidiary of a foreign investor in China  Joint Ventures: Equity joint ventures with local partners Note: Regulatory requirements may affect options for structuring local presence. Early Stage PRC Presence • Foreign Representative Office (ROs) • • • • A RO’s parent is liable for all of the RO’s obligations. Higher administrative costs and tax liability Non-direct business activities only. Limitation on employment of a PRC resident national  An alternative way– Foreign-Invested Enterprise (FIE) Structuring Local Operations  Wholly Foreign-Owned Enterprise (“WFOE”)  A wholly-owned corporate subsidiary of a foreign investor in China  A WFOE can operate in China as a stand-alone entity with full control over the business (as opposed to a joint venture) and the ability to hire its own employees  Representatives of a WFOE can execute contracts and a WFOE can own assets and property  A WFOE can generate income and engage in profit making activities Structuring Local Operations  A WFOE can have full trading rights allowing them to import and export goods and technologies into and out of China  WFOE must have a defined business scope (e.g., manufacturing, distribution, trading)  The process to establish a WFOE can take approximately 2 to 4 months  Registered capital requirements vary, according to the scope of the business and can range from as little as U.S. $50,000 to millions of dollars. Typical capital requirements fall in the U.S.$200,000 –U.S.$800,000+ range Joint Ventures  Two basic questions: Pursue a joint venture or Enter into a contractual relationship with the local party?  Basis for the Joint Venture: Business model --create value and profits or cost saver? Bring together technologies, product lines, market presence, distribution channels or other business assets?  Sharing Profits: Are you prepared to share the profits with the JV Partner? New Developments 1) HK – PRC tax treaty 2) China’s New Company Law 3) New Enterprise Income Tax Law (Implementation Rules) 1. Cross-border tax incentives “…Hong Kong residents now enjoy low rates of withholding on interest, royalties and dividends from the PRC….” Tax Treaties/Arrangements of selected jurisdictions for receipt of payments from China Subsidiary Payment Type Standard China Income Tax Withholding Rate Dividends Zero (postreform: possibly 20% ) 5% Interest 10% (postreform: possibly 20%) 7% Royalty 10% (postreform: possibly 20%) 7% Share sale gain 10% (postreform: possibly 20%) No Protection No Protection No Protection No Protection 0% Hong Kong Arrangement Rate Germany Treaty Rate UK Treaty Rate Netherlands Treaty Rate Mauritius Treaty Rate Barbados Treaty Rate 10% 10% 10% 5% 10% 10% 10% 10% 10% 10% 10% 10% 5% 10% 10% 0% Parent Company ABC Holding Company (Offshore/Hong Kong) Loan Agreement ABC Trading Co. (ABC China) Repatriation of Income a. Annual Dividends b. I.P. license fees (trade mark / patent) c. Technology Transfer / Service Agreement d. Interest payment to ABC Holding Co. -- interest is not taxable -- no withholding tax on interest distribution to parent company HK/PRC tax treaty -- broad definition of IP rights. They include (i) copyrights (ii) patents (iii) trademarks (iv) secret formulae/processes Royalty Structure IP Use PRC Subsidiary Royalties 7% WHT (PRC) Hong Kong (License Company) IP Use Royalties Client (Offshore Company & Owner of the IP) 0% Corporate Tax 0% Corporate Tax 0% WHT FIE Capital & Debt Restriction  The restriction on capital return  “After investment of a certain amount into a FIE, what amount will the FIE be permitted to borrow?” FIE approved egistered capital US$200,000 US$2,100,000 US$5,000,000 US$12,000,000 FIE max’ approvable total investment US$285.714 US$4,200,000 US$12,500,000 US$36,000,000 FIE resulting max’ debt limit US$85,714 US$2,100,000 US$7,500,000 US$24,000,000 CEPA Privileges for Hong Kong companies China-Hong Kong Closer Economic Partnership Agreement (CEPA) PRC market access privileges for Hong Kong residents CEPA Ⅴ– just released 2. China’s new company law The revised Company Law, lowers the minimum registered capital requirements to RMB 30,000 where a minimum of 2 shareholders. Where 1 natural person or 1 corporate shareholder – minimum is RMB 100,000. However, for the registered capital for either LLC’s or companies limited by shares is also subject to specific laws and regulations which may set higher thresholds for different industries. Feasibility Study – Important  On average approval authorities “recommend” the following minimum registered capital : (i) Trading WFOE (within a Free Trade Zone): USD 140,000 (minimum required in order to apply for VAT invoices when selling goods onto the local market) or USD 62,000; (ii) Trading WFOE with distribution rights (FICE): USD 200,000 – 250,000 (iii) Retail WFOE: USD 36,000 (iv) Manufacturing WFOE: USD 140,000 (minimum required in order to apply for VAT invoice when selling goods onto the local market); and (v) Service WFOE: Varies from USD 12,500 in Shenzhen/Beijing to USD 50,000 in Shanghai. Injection of the Registered Capital Although local governments specify “minimum amounts” – the actual amount of registered capital to be injected into the business should be sufficient for its initial operational capital needs – the amount of money required to sustain operational cash flow until the business can support itself in China Furthermore, certain Chinese laws and regulations, such as three laws on foreign-invested enterprises (which include Wholly Foreign Owned Enterprises, Contractual Joint Ventures and Equity Joint Ventures), and the Regulation on Proportion between Registered Capital and Total Investment, impose a separate set of capital requirements on foreign invested companies, by providing that the registered capital of a foreign-invested company must be in proportion to its scale of operations and its total investment.  The revised Company Law provides that cash contributions shall not be less than 30 percent of a company’s registered capital.  The revised Company Law specifically uses the concept of “intellectual property” as contributable assets (70% maximum)  As a result, intellectual property such as copyrights/patents will now be allowed to be contributed under the revised Company Law. 3. New enterprise tax law -- effective 1st January 2008 Unified EIT Tax Rate 25% Small scale/low profit enterprises High/New Technology enterprises 20% 15% New tax incentives High/New Technology Enterprises Venture Capital Enterprises Encouraged Projects Extra deduction on R+D costs Tax Credits for acquisition of energy or water saving equipment. High/New Technology Enterprises 6 Zones 5 economic zones (Shenzhen, Zhuhai, Shantou, Xiamen, Hainan and Pudong New Area,Shanghai) Tax Incentive: 2 years exemption from EIT then 3 years – 50% reduction of EIT Encouraged Projects Agricultural, forestry, animal husbandry, fishery projects. Infrastructure projects Environmental protection, energy and water conservation -- 2 years exemption from EIT then 3 years of 50% deduction of EIT Final Tips  Consider Hong Kong holding structure to maximize PRC/HK tax treaty benefits and profits.  Protect your I.P. first, register IP rights in China to a S.P.V to protect your brands and enable licensing and repatriation of income  Do not underestimate your registered capital requirements and understand debt limits.  Location – Shanghai, Beijing, Guangzhou, -- find a trusted local from each province – local relationships are important, as is a knowledge of dialects and employ locals early in negotiations vis a vis lease agreements, property acquisition, contract negotiations.  Apply for the broadest “business scope” possible.  Feasibility Study/Business Plan – ensure that projections of business turnover are consistent with proposed registered capital/total investment. Final Thoughts  Identification of legal issues early in the process will head off problems that can either affect your strategy or delay its implementation Corporate Advisors RHK Legal RHK LEGAL Add: Suite 507, Jingan China Tower, No. 1701, Beijing West road, Jingan District, Shanghai T: (8621)62888821 F: (8621) 62888823