On 1 March 2010, measures ((Administrative Measures on Foreign Enterprises and Individuals to Establish Partnerships in China)) came into effect enabling foreign companies and individuals in China (“Foreign Entities”) to enter Foreign Invested Partnerships (“FIP”). While the relevant authorities have yet to release certain updates to the measures (e.g., how FIP will be taxed), it is still useful to compare the FIP structure with other foreign invested enterprises (“FIE”) structures to highlight when an FIP should be considered.
Requirements and conditions that currently govern local partnerships will be extended to FIP, such as having at least two partners; executing a written partnership agreement which sets the timing, type and amount of capital contribution for each partner; having a registered name; and establishing a registered address. However, foreign partners are still subject to the same industry restrictions that apply to foreign investors in other FIE, such as those detailed in the Foreign Investment Catalogue regarding investment in ‘encouraged’, ‘restricted’ or ‘prohibited’ industry sectors.
Key points of comparison with other FIE structures follow.
The Ministry of Commerce (“MOC”) oversees and approves the establishment of FIE in China. Only after receiving approval from MOC is an FIE able to register with the State Administration of Industry and Commerce (“SAIC”) and receive its business license.
FIP establishment does not require MOC approval and can be achieved through direct application to the SAIC. Of course, if the business scope of the FIP requires additional licensing or approval from government bureaus or authorities, this must first be attained prior to SAIC registration ((For example, a manufacturing WFOE may require an environment assessment from the relevant Environmental Protection Bureau, or the manufacture of certain grade of goods (e.g., Class B elevators) may require a special license from the relevant supervising authority.)). Nevertheless, the removal of MOC approval is an attractive feature of FIP establishment.
When establishing a wholly foreign owned enterprise (“WFOE”) or a joint venture (“JV”), both FIE, there are usually very specific parameters and requirements regarding the capital contribution, including: the type of contribution (e.g., cash, in-kind, intellectual property), the timing of the contribution (e.g., 15 percent within 90 days, 85% within 2 years of attaining business license, etc.) and the proportion of cash contribution.
In terms of type of contribution, JV or WFOE investors are able to contribute freely convertible foreign currencies, machinery and equipment, intellectual property rights and proprietary technologies, though the proportion of non-cash contribution is capped.
In terms of timing of the contribution, JV or WFOE investors have deadlines imposed upon them which are set from the issuance of the business licenses and scaled according to the amount of capital injected, e.g. a one-year deadline is imposed for capital injections up to US$500,000 while there is a 3-year deadline for capital injections between US$3 million and US$10 million.
In comparison, FIP partners have no limitation in terms of timing or proportion of non-cash capital contribution and, furthermore, FIP general partners are able to contribute labor. The only requirement is that such terms are clearly addressed in the written partnership agreement.
Liability is a key concern when entering into any commercial engagement and is often an influential factor in ownership structure.
While JV can only register as a limited liability company, WFOE can, under exceptional circumstances that are approved by the Foreign Economic Commission, establish themselves as other enterprise types. Investors in both enterprise types are liable to the extent of their capital contribution, provided the corporate veil is not pierced due to certain exceptional conditions.
FIP, whether among foreign investors or a mix of foreign and domestic investors, require different liability options:
(i) A general partnership, where partners each hold unlimited joint and several liability;
(ii) A limited partnership, where there is (at least) one general partner holding unlimited joint liability and a remainder of limited partners liable for their respective capital contributions only; or
(iii) A special general partnership, which is restricted for specialized professional services, and in which each partner holds unlimited joint and several liability but under certain conditions the liability of each general partner is insulated against unlawful acts by other general partners.
Like liability, taxation is another key concern that influences ownership structure.
While FIE face a variety of tax liabilities (e.g., customs duties, stamp tax), revenue is directly taxed at 5 percent business tax (for services) and 25 percent of net profit at the end of each fiscal quarter in the case of a service FIE (while manufacturing FIEs are subject to the value added tax regime).
While the State Administration of Taxation is yet to release specific details regarding the taxation of FIP, consideration of how domestic partnerships have been taxed provides a useful reference point. An attractive feature of the domestic partnership structure is ‘pass through’ taxation, whereby partnership profits pass through to partners and are distributed pursuant to the terms of the partnership agreement. Each shared portion of the profit is treated as income and is taxed at the appropriate individual income or enterprise income rate for natural person partners or enterprises partners, respectively.
Generally speaking, partnerships suit long term commercial engagements where two or more parties share the resources and motivation to generate profit.
In considering whether to establish a FIP, one must balance the benefits gained from the flexible capital contribution and favorable taxation conditions against the risks associated with the liability undertaken.
Debt and damages are at the center of concerns over liability. As such, FIP may not be suitable for commercial engagements that are capital intensive (such as manufacturing) or for industries that carry a higher risk of damages claims (such as consumer products).
As such, this new structure is best suited for commercial engagements in service industries, where fixed costs are generally low and the risk of damages is usually limited to contract breaches.
A Note on Implications for Private Equity
There has been speculation about whether the introduction of FIP is a step toward finally providing foreign private equity funds a suitable vehicle with which they can set up an on-shore fund in China (also called an RMB fund). Foreign private equity funds in China have hitherto been hampered by rigorous approval processes and restrictions imposed by government bureaus for both fund raising and investment activities. Hopefully time will show whether FIP will play a relevant role in the development of RMB funds.
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