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JV contracts and articles of association JV contracts and articles of association(0)

Both the JV Contract and Articles of Association are legally binding documents, meaning you may resort to the Contract to assert a right or claim damages against your partner, or your partner may make a claim against you. However, the legal binding effect of the JV Contract and Articles of Association is only between the partners who enter into this agreement, and the documents cannot serve as a defence against any third party or government authority. That is to say, if the agreement vested the compliance issue to one party in the JV, and non-compliance is detected later, both parties shall be jointly held legally liable. Nevertheless, it is arguable that the party who is specifically vested with the responsible for compliance issue should be liable for the whole responsibility.

Contractual JVs vs Equity JVs

There are two types of JVs in China, the Equity JV (EJV) and the Co-operative JV (CJV) (sometimes known as the Contractual JV). They may appear similar on the surface but have different implications for the structuring of your entity in China. Here we explore the differences, provide practical advice on structuring, tips on investment drawbacks, land use rights and profit distribution.

An EJV is a joint venture between Chinese and foreign partners where the profits and losses are distributed between the parties in proportion to their respective equity interests in the EJV, but the foreign partner shall hold more than 25% of the equity interest in the registered capital of the EJV. The company enjoys limited liability is a ?Chinese legal person?.

The CJV is a very flexible FIE where Chinese and foreign investors have more contractual freedom to structure cooperation. It is a joint venture between Chinese and foreign investors where the profits and losses are distributed between the parties in accordance with the specific provisions in the CJV contract, not necessarily in proportion to their respective equity interests in the CJV.

In the past, CJVs took one of two different forms – a true CJV which did not involve the creation of a legal person that was separate and distinct from the contracting parties; and a legal person CJV in which a separate business entity was established and the parties? liability was generally limited to their capital contributions.

In the case of a true CJV, each party was responsible for making its own contributions to the venture, paying its own taxes on profit derived from the venture and bearing its own liability for risks and losses. In contrast, a legal person CJV, the more prevalent form today, shares more of the characteristics of an EJV. The true CJV is rare today as few investors are willing to entertain the prospect of unlimited liability and the rest of this discussion only refers to legal person CJVs.
To know more, the whole issue is available (after a free subscription) on China Briefing website with others archives
For more information on China’s legal and tax issues or to ask for professional advices in related matters, please write to info@dezshira.com

Legal and financial Due Diligence Legal and financial Due Diligence(0)

If you fail to do so, your entire China business may be at risk. Some of the basics you can actually do yourself ? other investigation may require professional assistance.

Due diligence can also extend to forensic accounting on a partners? books, as well as political risk and other issues, especially if the JV is sizable. However, this is unlikely to worry most SME JVs and may not be necessary for a simple production unit. Again, take advice.

Some potential partners may interpret such enquiries as intrusive, or infer that you do not believe them. If they are keen to close a deal quickly, they may try to skirt round such issues. This part of the negotiation process therefore needs to be handled with patience and some sensitivity. However, reliable and serious partners will understand your need, and that of your foreign parent, for these issues to be confirmed. Indeed, if they are doing their job properly, they should also require similar disclosure and transparency from you.

The bottom line here is ? take your time, know what you are getting into, and if you are uncomfortable, go elsewhere. Don?t be rushed.

Business licence

Details of who is actually who in the Chinese company, and details of their limited liability must be obtained.

Ask for a copy of their business licence. It will list (in Chinese) details of the legally responsible person (Legal Representative), the registered address, the amount of registered capital (which is also the limited liability) and the period of the licence. This basic information should be checked off against what you know. If there are any discrepancies, ask the reasons why. Sometimes the answer may be quite reasonable ? on other occasions it may alert you to potential difficulties.

It is quite common for the actual legally responsible person not to even be the person you?re dealing with. Licence periods may not be consistent with liabilities – such as the case of the ten year projected JV with a Chinese partner whose licence was due to expire in three months time! Check this out and make sure you know with whom you are really dealing, and that they can deliver what they say they can.

Capital verification report

This is issued by a Chinese independent CPA firm, confirming the fact that the registered capital as identified on the business licence was in fact paid up. If the registered capital has not been paid, not only does this mean your partner has not actually capitalised his business, but it also means he has not complied with limited liability requirements. As a consequence he will also be in breach of his own articles of association ? which could cause serious problems in the event of a failure or other legal issues.

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JV contracts and articles of association


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For more information on China’s legal and tax issues or to ask for professional advices in related matters, please write to info@dezshira.com

Specific JV structural issues Specific JV structural issues(0)

Many companies leave the entire operations up to the Chinese partner to run. This is a crucial mistake. A new business needs all the support it can get. You need to invest in a foreign manager to keep an eye on things, especially during the early stages. Correct systems, accounting and quality control issues all need to be taken care of. You have standards; ensure these are implemented and operational in your JV. The ideal solution is an expat manager – if not long term then certainly for the initial development stages. However, the General Manager is responsible for the operations of the business. It is wise to make this one of your personnel. Leaving both in the hands of the Chinese partner effectively hands them control of the business.

Capital investment

When negotiating the amount here do be sure that the Chinese side?s investment really is worth that amount of money. It is a pre-requisite to have asset and stock valuations. This means having proper valuations placed on machinery – the Chinese tend to quote the original purchase price with no depreciation – buildings often are valued at the price it would cost today to build and don?t actually reflect the fact that it may well be a 20 year old shack that cost US$10,000 to put up in 1987. Also, check the Land Use Rights certificate – if they can show these are granted rights, with no administrative or judicial enforcement measures such as sealing-up, seizure or freezing in connection with the asset, then they owns the land. If they are just allocated, they don?t and the right to use it should just be the rental value. See also the Due Diligence section below.

Next :
Legal and financial Due Diligence


To know more, the whole issue is available (after a free subscription) on China Briefing website with others archives
For more information on China’s legal and tax issues or to ask for professional advices in related matters, please write to info@dezshira.com

Structuring your JV – General issues Structuring your JV – General issues(0)

Some of the issues you need to consider apply to all types of foreign entities in China, while others relate specifically to JVs.

  • business scope ? what should yours be?
  • registered capital requirements ? these may vary depending on the industry and the location. It is also absolutely critical that you do not simply put in the minimum because the regulations say you can ? you may find the business is under-capitalised if you do so. This is an operational judgment for you, not the bureaucrats.
  • Are you manufacturing 100% for export, or part for export, part for domestic sales? Where are your clients located? Do they require an official local invoice? Would they require you to sell your goods to Hong Kong or other off-shore jurisdictions? ? they all have a fundamental impact on how you structure the business!
  • Agreement, Contract and Articles of Association ? these need detailed work by you to ensure you cover all the bases. You are setting up a company with a 10-15 year life span and you need to be sure you know what you are getting into.

We will now explore these in more detail.

Business scope

Having set up a limited company does not necessarily mean you can engage in any kind of business activity, as is the case in some Western countries. Like other entities in China, JVs can only be operated within the business scope approved by the authorities. Other activities are subject to further approval. So it is vital to determine what you want do right from the start.

Lazy, or deliberately disingenuous, business scopes, such as only using the phrase ?production of (product)?, will not necessarily qualify a JV 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.

Next :
Specific JV structural issues


To know more, the whole issue is available (after a free subscription) on China Briefing website with others archives
For more information on China’s legal and tax issues or to ask for professional advices in related matters, please write to info@dezshira.com

The JV is back! The JV is back!(0)

Joint Ventures (JVs) were the first business entity opened to foreigners and for a long time have been an unpopular vehicle for international investors looking to China for lower production costs or for market access. Yet recently, we notice more than ever before, there are an increasing number of foreign investors wanting to set up a JV in China. JVs are coming back!

The Joint Venture often sounds like a warm and friendly way of doing business, a marriage made in heaven. You are likely to be offered many such wonderful sounding deals. Many Chinese factories are looking for long-term security in foreign sales via an overseas partner, or to get access to western technology. And because this structure has been around for a long time, many foreigners who have not yet done business here have heard about it. It sounds much more attractive conceptually than the main alternative, a Wholly Foreign Owned Enterprise.

But wait, China?s business history is littered with thousands of cases of unhappy partnerships and broken dreams ? the analogy with human marriage is a common one, with the popular Chinese idiom ?same bed, different dreams? often quoted. One major Western oil company once told us, only partly in jest, their JV was a win-win situation ? meaning the Chinese won twice. Business is not about being warm and friendly; it is about making profit and running a successful company. You may well end up becoming close friends with a commercial partner, but it is not the primary objective.

Next :
Structuring your JV – General issues


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For more information on China’s legal and tax issues or to ask for professional advices in related matters, please write to info@dezshira.com

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Risks in just ?walking away? for foreign investors

As the saying goes – ?happy families are all alike; every unhappy family is unhappy in its own way?.

It is the same for foreign investment in China. Though most foreign investments here are successful and generate considerable profits for their investors, some investors do wish to close down their businesses either because of poor profitability, global restructuring, or for some other reasons. However, can a foreign investor choose to just ?walk away? if there are no substantial assets left in their business ? Will the investor who does so incur any liability that can be enforced against him or his other assets in China or elsewhere ?

So, can a foreign investor make a strategic retreat from their Chinese investment without being chased by the creditors ? The short answer, not surprisingly and quite properly, is ?no?. This is a critical issue that must be considered not only during the closing down of a business, but also in the process of running of the enterprise.

Limited liability of FIEs and potential liabilities for foreign investors

Foreign invested enterprises (FIEs) such as WFOEs and JVs are independent legal persons and own their own assets and properties. The foreign investors, in principle, only bear the limited liability for their investment to the extent of their registered capital originally brought into China. However, under certain circumstances, foreign investors may be held personally liable for their investment activities beyond the capital contribution obligation. The potential liabilities applying to those foreign investors who ?walk away? differ from those who face bankruptcy or voluntary liquidation.

Penalties for ?walking away?

According to business registration regulations in China, it is the investor?s obligation to register properly when the business is created and update the registration authority in the event of any significant changes of circumstances. If a foreign invested company is being wound up, the foreign investor is required to de-register the company before they may take back any remaining assets of the company. In other words, you must tell the authorities.

De-registration is, as we explained earlier, triggered by the approval, by the Ministry of Commerce, of the winding up the business. The de-registration can only take place after the company has gone through liquidation procedure, as described above, including a liquidation audit, and the payment of any liabilities to the tax authorities, Customs, employees, and creditors.
To know more, the whole issue is available (after a free subscription) on China Briefing website with others archives
For more information on China’s legal and tax issues or to ask for professional advices in related matters, please write to info@dezshira.com

Accurately assessing liabilities – Employees Accurately assessing liabilities – Employees(0)

[By Adam Livermore, Senior Associate, Dalian office, and Marie Bi, Manager, Beijing office, Dezan Shira & Associates]

As we have already explained, when liquidating a company, salaries, mandatory welfare benefits and severance payable to employees are paid second only to liquidation expenses themselves. For companies with a large workforce, this can be a large cost and needs to be quantified accurately.

Only once the ?workforce? has been clearly defined can the liability be assessed. Therefore the fi rst step should be to cross-reference the full list of employees with the corresponding labour contracts and information concerning salary payments. Employees should have been paid their salaries in full up to the end of the month preceding the announcement of the liquidation. The labour contracts will also tell you how long each employee has officially worked at the company ? compensation for termination of employment will be calculated based on the salary and length of employment. Finally, evidence of payment of the various mandatory welfare benefits should be checked to ensure there is no money owed.

Checking the contractual obligations should be a relatively straightforward task. The date of contract commencement and its term should be stated on the document. Most employment contracts will have a length of one year and there will be a section where the employee signs to extend the contract every year. For employees that have worked for the company less than ten years, there is effectively no severance pay because the liability for the company is limited to the period left on their employment contract.

Next :
Risks in just ?walking away? for foreign investors


To know more, the whole issue is available (after a free subscription) on China Briefing website with others archives
For more information on China’s legal and tax issues or to ask for professional advices in related matters, please write to info@dezshira.com

Financial & tax considerations when liquidating Financial & tax considerations when liquidating(0)

[ By Edward Ma, Manager, and Jessica Hou, Associate, Beijing office, Lynn Liu, Manager, Shanghai office, and Helen Liu, Senior Manager, Shenzhen office, Dezan Shira & Associates ]

Foreign invested enterprises in China that undergo liquidation will need to deal with two main tax issues. These are :

  • clearance of outstanding tax liabilities – the liquidation committee must meet any potential and actual tax liabilities. After confirmation, the liquidation committee will pay the outstanding tax liabilities to relevant departments.
  • new tax liabilities during liquidation – the liquidation itself may raise new tax liabilities – for example, fixed asset disposal may raise some turnover taxes, and employee compensation will be subject to Individual Income Tax.

We explore these in more detail in this section.

Clearance of outstanding tax liabilities

Clearance of outstanding Foreign Enterprise Income Tax (FEIT) liabilities

As regular readers will know, many foreign enterprises currently receive various incentives, which may include ?tax holidays? such as a two year exemption and three year 50% reduction of FEIT. Such ?tax holidays? normally only apply to companies on the assumption that they are expected to operate for at least ten years. Enterprises which are granted with this tax relief, but actually operate for less than ten years, are required to repay the amount of tax exempted or reduced.

Note, of course, that these ?tax holidays? arrangements are expected to change when the new Enterprise Income Tax Law takes effect.

Enterprise income tax refund for reinvestment of profits

Article 10 of the Income Tax Law of the PRC on Enterprises with Foreign Investment and Foreign Enterprises states that a foreign investor that directly reinvests its share of the profits distributable from a foreign investment enterprise, by either increasing the registered capital of that foreign investment enterprise before the profits were distributed or establishing another foreign investment if the profits were distributed, may obtain a refund of 40% of the tax paid on the reinvested amount, subject to approval of the tax authorities. In addition, if profits shall be reinvested for at least five years, and if the investor withdraws the reinvested profits within five years, the tax refunded shall be returned to the tax authorities.

Therefore, if a foreign investor reinvests its share of the profits distributable from a foreign investment to non-taxable project, and its operation period is less than five years, then 40% refundable tax amount or whole tax amount should be remitted back. The formula is :
Tax refund = A/[1 - (B + C)] x B x D
where

A = reinvested amount
B = original foreign enterprise income tax rate applicable to the enterprise
C = local income tax rate applicable to the enterprise
D = refund rate

If the operation period for foreign enterprise enjoying preferential treatment is less than ten years, then the tax refund should be remitted back to the local government when liquidating.

Next :
Accurately assessing liabilities – Employees


To know more, the whole issue is available (after a free subscription) on China Briefing website with others archives
For more information on China’s legal and tax issues or to ask for professional advices in related matters, please write to info@dezshira.com

Liquidating a China business Liquidating a China business(0)

In these circumstances, the interests of a number of ?stakeholders? need to be properly protected and balanced ? shareholders, of course ; employees ; customers, creditors and debtors ; and the local authorities as regulators and tax collectors. The closure of a company may often provoke strong emotions and feelings of uncertainty for many of those involved, too.

There are of course regulations under Chinese law for how these processes should properly be carried out, to ensure that the company?s final bills are settled, tax is paid, staff are properly handled, and all the company?s remaining liabilities and statutory responsibilities are correctly discharged. In this month?s issue of ?China Briefing?, we explain the procedures you would need to go through to close a foreign invested enterprise in China, and highlight the many related issues that you will need to address. We hope that you never have to go through the process, at least for negative reasons, but if you do, it must be done professionally and correctly.

COMPANY LAW AND THE LIQUIDATION PROCESS

[ By Zoe Zhou, Manager, Guangzhou office and Fiona Yuan, Manager, Shenzhen office, Dezan Shira & Associates ]

The procedures for closing a WFOE ? its dissolution and liquidation – are no easier or shorter than the process of setting up such a company, and normally take between six to nine months to complete.

According to PRC law, a WFOE must be dissolved if any of the following circumstances apply :

  1. Its term of operation expires.
  2. It experiences financial difficulties and the Board deems it necessary to dissolve the company.
  3. It is unable to carry out its business due to major losses caused by force majeure.
  4. It is bankrupt.
  5. It is terminated by the government, for example because it commits illegal acts damaging the public interest.
  6. Other reasons for dissolution stipulated in the original Articles of Association have occurred.

For circumstances (2), (3) and (4), dissolution will need the approval of the original approving authority. Upon the declaration of dissolution, the company is required to start the liquidation procedures.

Next :
Financial & tax considerations when liquidating


To know more, the whole issue is available (after a free subscription) on China Briefing website with others archives
For more information on China’s legal and tax issues or to ask for professional advices in related matters, please write to info@dezshira.com

Special tax treatment affecting Hong Kong residents Special tax treatment affecting Hong Kong residents(0)

The new Double Tax Agreement (DTA) was reached between the Central Government and the Government of the Hong Kong SAR on 21 August 2006. This replaces that signed in February 1998. At time of writing, this still had to be ratified by both sides. Assuming it is, it will go into force on or after 1 January 2007 for mainland taxpayers, and 1 April 2007 for Hong Kong taxpayers. There are a number of important elements worthy of note :

Income from Employment

There is an important change in the basis period for counting the number of days of presence in the mainland for Hong Kong employees who frequently visit the mainland, from a calendar year to a 12-month period. This will make it harder for tax residents on one side to claim exemption from taxes on the other side.

Under the new DTA, a resident of one side is exempt from tax on the other side if they satisfy all the following criteria :

  • They are present on the other side for period or periods not exceeding an aggregate of 183 days in any 12-month period commencing or ending in the taxable period concerned
  • The remuneration is paid by, or on behalf of, an employer who is not a resident of the other side
  • The remuneration is not borne by a permanent establishment that the employer has on the other side

This contrasts with the original Agreement, which used the time period ?calendar year?. The change will mean that people who travel frequently between Hong Kong and the mainland will need to monitor their travel pattern more carefully so as to be able to continue to meet the conditions.

For example, then, under the new DTA, to be exempt from China IIT in the tax year ending 31 December 2008, an individual would need to spend no more than 183 days in mainland China in any 12-month period between 2 January 2007 and 30 December 2009. Equally, to be exempt from Hong Kong salary tax for the tax year ending 31 March 2008, an individual would need to spend no more than 183 days in Hong Kong in any 12-month period between 2 April 2006 and 30 March 2009.

Next :
Special tax treatment affecting Hong Kong residents


To know more, the whole issue is available (after a free subscription) on China Briefing website with others archives
For more information on China’s legal and tax issues or to ask for professional advices in related matters, please write to info@dezshira.com

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