Details matter, particularly in a complex business environment like China, and we hope to see foreign investors avoid these pitfalls.
At the 3rd China International Import Expo held in November 2020, the Bureau of Foreign Investment of the Ministry of Commerce and the Bureau of Investment Promotion of the Ministry of Commerce jointly issued the Statistical Bulletin of FDI in China 2020. According to the Bulletin, there are 41,000 new foreign-invested enterprises registered in China in 2019, with the actual influx of foreign capital reaching USD 141.23 billion. This is an increase of 2.1% compared to 2018 reaching another record high and ranking second worldwide. As of December 2019, a total of 1.002 million foreign-invested enterprises have been set up in China, contributing USD 2.29 trillion in foreign investment. The figure may be surprising, but these foreign companies are often faced with a variety of challenges in their daily operation, many of which are caused by some common mistakes.
- Failing to properly disclose business scope
Unlike companies registered under the Company Law in Commonwealth countries, companies registered in China must describe their current or planned future business activities in “one sentence” and incorporate this into the company’s articles of association and business license. At present, the Chinese government is phasing out the requirement to list the scope of business on the business license. However, the company is still obliged to carry out its business activities within the business scope approved by the government authorities. Moreover, for certain regulated industries, it is necessary to apply for a special business license from the relevant government department while obtaining business scope approval. It can be a serious offence for a company to operate its business activities outside its approved business scope or without the necessary license. The maximum fine can be as much as the equivalent of one year’s income and/or the revocation of the business license. Therefore, we recommend that companies list their present and tentative business activities for the next 3 to 5 years in its articles of association and clearly explain their intended activities to service providers in order to identify specific licensing requirements. For example, an ICP (Internet Content Provider) license may be required for online businesses.
- Choosing the wrong business address
Finding the right location to register the company is one of the most critical decisions that investors must make. In China, not all addresses can be used for company registration, and one address can only be registered for one company. Only those addresses identified by the government as commercial or office usage purposes is eligible for registration.
Using one of our US client as example: they sourced a unit in a residential building to register a WFOE, and the landlord claimed that the unit could be used for company registration purposes, so without further enquiry, they paid the initial deposit. However, when they submitted the lease contract to the government for approval, they were told that the premises is only restricted to residential purpose and accordingly not eligible to be used as an address for company registration.
This client had to find a new address for registration, and required additional time. Accordingly, whenever we sign a new lease contract with the landlord for company registration purpose, we should ask the landlord to provide their real estate registration certificate. Only premises which state their usages are for commercial or office purpose can be accepted by the government for company registration.
- Appointment of legal representative
The legal representative is the most important position in any company in China. According to the Company Law of PRC, the legal representative holds the ultimate authority for operating a company. It always poses risks for overseas investors to nominally employ a local person who does not truly manage the company to be the legal representative. As the authority of the company’s daily operation lies in the hand of the legal representative, the legal representative can sign any legally binding documents, including opening a company bank account and using company funds.
Foreign investors should be aware that the company seal (also known as company chop) is more widely recognized than signatures in China. It is almost impossible to overturn or rectify the legal representative’s decision within a short period of time even if it differs from the investors’ wishes. Accordingly, the choice of legal representative should be made with caution.
In many previous cases, our overseas clients appointed a local junior employee as legal representative without careful consideration, and the decision often went on to cause extensive problems. Nowadays we generally advise our clients to appoint an appropriate individual such as CEO of the company or president of Asia Pacific Region to serve as legal representative.
- Starting with insufficient registered capital
To set up a company in China, the investor has to pay up the share capital. In accordance with the current Company Law of PRC, the registered capital can be injected in instalments during the lifespan of the company. Accordingly some investors want to set up a company with a minimum registered capital. However, chances are they may often find that the operating costs higher than initially anticipated after they have started the business, which leads to the company quickly exhausted the paid-up capital.
Inevitably, the exhaustion of paid-up capital will results in a business hiccups for the company’s operations, and because the approval of different government departments needs to be obtained if they want to inject registered capital again from overseas, which takes at least a few weeks or even months.
It is therefore crucial for newly established foreign companies to reasonably estimate the amount of initial paid-up capital, such as using the total amount of expenditure required for at least six months’ operation as the initial paid-up capital.
- Free Trade Area: the best location to set up?
In August 2013, the State Council of the PRC established the first Pilot Free Trade Zone in Shanghai. As of September 2020, China has set up 21 pilot free trade zones around the country. Although the free trade zone has adopted many appealing measures to attract foreign investors, it will definitely require sometime before these policies are fully implemented.
When a foreign investor decides whether to set up their company in the free trade zone or in another area, they need to consider carefully whether the industry they operate in falls within the definition of applicable industries stipulated by the State Council, because only those industries included on the government approved list are eligible to enjoy the preferential treatment intended for the free trade zone.
In addition, office rent in the free trade zones are generally much higher than in other areas of the same city. Therefore, before deciding whether to settle in the free trade zone or not, Clients are advised to check whether their industry are on the approved list and comprehensively evaluate whether the benefits justify the costs.
As a professional service provider, we have helped many multinational companies and start-ups to begin their operations in China. The business environment in China is changing rapidly, while the policies are also constantly being updated. In order to lay a good foundation for business in China, we must first clearly understand the needs, and then consider the most suitable set up and structure based on the latest policy.
We ensure that every consultation is thorough and that every business we work with has a customized plan. As a matter of our decades old practice every planning for each client are tailor made and customized, as we know no 2 businesses are the same and understanding their needs and wants are the most important steps to help our client to succeed and excel.
Should you have any enquiries about developing your business and operating a company in China, please feel free to contact us for a free initial consultation.