Administration Matters as a Structural Concern

Here are some of the key articles and issues that need to be identified.

Scope of Business Article
This defines exactly what your company is going to do, and should be detailed. Lazy, or deliberately disingenuous, business scopes, such as only using the phrase ?production of (product)?, will not necessarily qualify a WFOE as a production company. You will also fail to qualify for tax holidays, even if the local government approves it, as the tax bureau may require a more detailed and specific explanation. We have encountered numerous problems of this nature, all requiring a scope of business change on the licence before the tax bureau is satisfied with exemption status. You need to ensure your business scope is accurate. Attempts to fool the tax bureau into thinking you are one thing, while in fact you are another ? even if you can get it past the approvals process – inevitably end in failure. Play the game and say what it is you are really doing.

Production Scale Article
This can be useful if terms of expressing an exit strategy. If you link production (and profitability) scales to what you would consider unacceptable levels of business, thus requiring liquidation, it makes it far easier to obtain approval for closure if this eventuality occurs. Link Production and Profitability scales to the Liquidation Articles later in the document.

Total Investment Article
There is a relationship between ?total investment? and registered capital, and you need to get this correctly balanced. An imbalance here can affect your ability to obtain further debt or other financing from both your holding company and other financial institutions, so pay attention to this if your business may require additional capitalisation funding later. Please see the table below for the required ratios between registered capital and total investment capital.

Board of Directors Article
We recommend keeping the board of directors small, and allowing for board meetings to be held outside China or even by telephone conference. Emergency board meetings should be just that ? an emergency ? and called at 24 hours notice, not one month ! Pay attention to the duties and responsibilities of directors.

General Manager Article
This is a legally responsible position so put it in the hands of someone you trust ? ideally your expat manager in charge of production. Limit the term of office to a year to give you some leeway. GM?s can be notoriously difficult to fire if under the long terms often used in standard articles.

Profits Repatriation Article
Can?t find it in the basic draft ? That?s because it?s not there. This needs to be built in ? essentially giving your parent company the right to bill the WFOE for services for management expertise, royalties, licencing agreements, interest on loans, R&D cost allocations, sales and marketing cost allocations and so on. If you don?t have these drafted in it becomes difficult to overlay the service contracts into the articles and obtain approval for this mechanism. It could save you between 4-13% on your profits tax bill. Get it in there.

Trade Union Article
Again, standard clauses in the articles that appear innocuous. However if not dealt with and redrafted, these can lead to interference at the highest level in the way in which you operate your business. This is additionally compounded by the fact that new regulations are due to be issued that strengthen the role and responsibilities of the labour union.

All companies in China have the right to form a ?grass roots? labour union if there are at least 25 employees (including foreign workers). This structure is part of a massive national reporting and monitoring union that has its ultimate powerbase firmly within the National People?s Congress, so this is a powerful organization.

If a union is formed, then the elected representative has the right to attend company management meetings, and the company must fund also the union, with 2% of all employees? salaries, each month (staff must also make a small contribution). It is not uncommon for these funds to be misused, and for the union representative to become a bit of a nuisance as well. Funds should be used for workers education, welfare and entertainment, and many of the factory basketball courts you see in China have been funded in this manner. Funds may also be used to provide legal support to employees with grievances against the company.

Management interference can be minimized by restricting the union representative access only to the portion of meetings during which staff and workers rights are to be discussed, while budgets for the use of union funds can also be agreed upon and implemented. We recall a case a few years ago when union funds were used to buy the representative air conditioning at his home and a car !
So, some measures of control can be exercised via the articles of association as concerns the role of the labour union ? however, we are still wait confirmation of changes to their powers that may also need to be taken into account.

Mergers & Acquisition Articles
Again, not in basic drafts. So if you want to sell the business how can you value it ? It?s easier to identify a set of rules beforehand. Identify asset valuers, accountants and industry professionals who can value the business. Make their decision final and binding with a time limit for offers to be accepted or bettered, and a mechanism for payment and share transfer itself. You never know what will happen down the road, and who can tell what China or your business will be like in five years ?

Next :
Post Registration Matters as a Structural Concern

To know more, the whole issue is available (after a free subscription) on China Briefing website with others archives
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