Structuring Investments and Operations – Practical Tips: China and Hong Kong www.rhklegal.cn RHK Legal Corporate Advisors

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 wholly-owned 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 .

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 wholly-owned 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)

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

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

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?

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 HK – PRC tax treaty China’s New Company Law New Enterprise Income Tax Law (Implementation Rules)

HK – PRC tax treaty

China’s New Company Law

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….”

“…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 No Protection 10% 10% 10% Netherlands Treaty Rate 0% 10% 10% 5% Barbados Treaty Rate 0% 10% 10% 5% Mauritius Treaty Rate No Protection 10% 10% 10% UK Treaty Rate No Protection 10% 10% 10% Germany Treaty Rate No Protection 7% 7% 5% Hong Kong Arrangement Rate 10% (post-reform: possibly 20%) 10% (post-reform: possibly 20%) 10% (post-reform: possibly 20%) Zero (post-reform: possibly 20% ) Standard China Income Tax Withholding Rate Share sale gain Royalty Interest Dividends Payment Type

ABC Holding Company (Offshore/Hong Kong) Parent Company ABC Trading Co. (ABC China) Outside China Inside China T R A D E M A R K L I C E N S E T e c n n o l o g y T r a n s f e r A g r e e m e n t Agreement Loan

Repatriation of Income Annual Dividends I.P. license fees (trade mark / patent) Technology Transfer / Service Agreement Interest payment to ABC Holding Co. -- interest is not taxable -- no withholding tax on interest distribution to parent company

Annual Dividends

I.P. license fees (trade mark / patent)

Technology Transfer / Service Agreement

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

-- broad definition of IP rights.

They include (i) copyrights

(ii) patents

(iii) trademarks

(iv) secret formulae/processes

Royalty Structure PRC Subsidiary Hong Kong (License Company) Client (Offshore Company & Owner of the IP) IP Use IP Use Royalties Royalties 7% WHT (PRC) 0% Corporate Tax 0% WHT 0% Corporate Tax

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?” Examples at key threshold levels Note: Calculate your Registered Capital requirement -- then double it. US$24,000,000 US$36,000,000 US$12,000,000 US$7,500,000 US$12,500,000 US$5,000,000 US$2,100,000 US$4,200,000 US$2,100,000 US$85,714 US$285.714 US$200,000 FIE resulting max’ debt limit FIE max’ approvable total investment FIE approved egistered capital

The restriction on capital return

“ After investment of a certain amount into a FIE, what amount will the FIE be permitted to borrow?”

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

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.

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

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 : 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; Trading WFOE with distribution rights (FICE): USD 200,000 – 250,000 Retail WFOE: USD 36,000 Manufacturing WFOE: USD 140,000 (minimum required in order to apply for VAT invoice when selling goods onto the local market); and Service WFOE: Varies from USD 12,500 in Shenzhen/Beijing to USD 50,000 in Shanghai.

On average approval authorities “recommend” the following minimum registered capital :

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;

Trading WFOE with distribution rights (FICE): USD 200,000 – 250,000

Retail WFOE: USD 36,000

Manufacturing WFOE: USD 140,000 (minimum required in order to apply for VAT invoice when selling goods onto the local market); and

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.

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.

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 1 st January 2008

-- effective 1 st January 2008

Unified EIT Tax Rate 25% Small scale/low profit 20% enterprises High/New Technology 15% enterprises

Unified EIT Tax Rate 25%

Small scale/low profit 20%

enterprises

High/New Technology 15%

enterprises

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

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

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

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.

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

Identification of legal issues early in the process will head off problems that can either affect your strategy or delay its implementation

RHK LEGAL Add: Suite 507, Jingan China Tower, No. 1701, Beijing West road, Jingan District, Shanghai T: (8621)62888821 F: (8621) 62888823 Thank You ! www.rhklegal.cn RHK Legal Corporate Advisors