Trade and Foreign Investment in China

China is called the world’s factory, but foreign investors redirect their funds from the country’s manufacturing sector, putting them in the growing service sector. In the recent years, an increasing strategic importance was attached to the development of the economy of the central and western regions of the country. The Chinese government is interested in the inflow of foreign capital in these areas and has developed a system of benefits for these regions in creating investment zones in China. All laws and regulations designed to guarantee that foreign investment in China is expanding, aimed at ensuring transparency and simplicity of design and implementation of projects. Legal relations dramatically and directly affect the country’s attractiveness to investors, because enterprises with the foreign capital share in the authorized capital more than 25% of a similar tax benefits reinvestment of funds in projects of central and western regions of the country. A service industry has become the ‘powerful magnet’ for attracting the capital, and experts say, linking it with the ability to save Shanghai investment attractiveness in very complex changes in the global economic environment.

Alternative Forms of Foreign Investment

The limit on the total investment is $125 million. What are the alternative forms of the structure, financing and management of the hotel project, manufacturing project, and the advantages and disadvantages of each alternative? What is your recommended alternative for the projects and why?

Rapid population growth has a huge impact on the existing infrastructural facilities of Shanghai. As a result, transport systems are overloaded, clean water is difficult to get, problematic wastewater treatment and air pollution level is high due to the activities of enterprises engaged in heavy industry and coal-fired power plants. In addition, the city has the lowest freedom of speech. At one time, the Chinese government shut down access to Western social networks and online media.

This metropolis also has the low capacity to adapt to change. However, Shanghai is the economic giant whose GDP shows double-digit growth over the past 11 years. The city has a good estimate in terms of access to finance – as a result of high credit quality and availability in the budget. In recent years, Shanghai has invested heavily in new infrastructure and expansion of existing facilities. For instance, the Metro that was opened in 1993 today is the second largest transport system in the world. The investment of money in its further development has not kept pace with the rapid growth of the metropolis.

From an economic point of view, Shanghai is an attractive place for investment. It has a high rate of return, but the high vulnerability and low adaptive capacity, which are peculiar to the city today, may endanger the money in the long run.

Since there is a certain budget, which cannot be exceeded, one is required to look for the alternative solution for project development of the company. The best option is to create a joint venture. Thus, it will be possible to use a certain range of benefits that China and Shanghai provide for legal persons who pour their capital into the national economy. I suggest a few alternatives that have different conditions for the control and investment.

Types of Joint Ventures

Equity Joint Ventures. The joint venture is an international company created by two or more national enterprises to make full use of the potential of each of the parties to maximize the useful economic impact of their activities. It is a kind of enterprises with foreign investment that is defined as a company with equity participation of national and foreign investors. An important feature of the joint venture is that it should be regarded as the presence among its founders (participants), along with the national and at least one foreign investor.

Joint ventures have become the means of attracting foreign advanced technology and modern management experience. Due to them, the export of capital was facilitated, including its productive form; investment projects that were not under the force of a single company were implemented. In addition, it is easier to learn the markets in new regions with the help of local partners. Apart from that, the enterprises with participation of foreign and domestic investors often enjoy tax benefits.

Contractual Joint Venture. Contractual joint venture does not involve the creation of a new company to carry out joint activities. The framework of the relationship between all participating parties is regulated by treaties. When organizing a contractual joint venture, corporate structure is not used, and the legal basis of joint business parties based on their contractual obligations is enshrined in the treaty on joint activities (Joint Operation Agreement).

While talking about the joint venture, it is important to take into account the position of the potential partners. For example, a firm that is seeking the source of funding is a small business. It enters into a partnership with a large company that has a financial and operational performance. Operational capabilities for the small partner who is seeking to expand the scope of one’s activities are sometimes more important than money.

Large firm partner, participating in joint ventures, is not so much interested in money, but in a particular commodity that a partner produces in the market segment. Therefore, it invests its capital in ordinary shares and joint ventures.

Wholly Foreign Owned Enterprise. The enterprise with foreign investment is any legal form of business in which foreign investors participate during the year. It has an average 20% of the authorized share capital or share value of not less than 100 thousand US dollars to banks. The other financial institutions should have 50 thousand dollars for individual enterprises.

Cooperative Development. Cooperative is a legal entity established by individuals and / or entities that voluntarily united on the basis of membership for the conduct of joint economic and other activities to meet their economic, social and other needs on the principles of self-government. Cooperatives, as organizational structure, ensure the free choice of economic activity, autonomy in decision-making on all matters of life cooperators, as well as the activity, volume and structure of production, development plan, production, internal order, sales, and distribution of income.

The cooperative operates on the principles of self-sufficiency and self-financing. The intervention in economic or other cooperative activities (if they do not contradict the legislation), public and cooperative management of the establishment of any problems to it, issues within the competence of the cooperative and its agencies are not allowed.

Technology Transfer. It is the process of commercialization of scientific knowledge and technology through collaboration between science and business, with the creation of innovative products and services. This technology transfer occurs through the transfer of industrial and organizational experience. Also, most of the processes of technological exchange are carried out by the use of qualified consultants – technology transfer centers.

Compensation Trade. The compensatory trade foreign entity transfers technologies and equipment to the Chinese side. Chinese enterprise uses them to produce and to repay the debt of the technology and equipment produced products. There are two types of compensation trade: direct and indirect. For the benefit of a foreign enterprise compensation trade is to minimize the investment and at the same time to ensure a stable production base. However, there are risks associated with product quality and delivery times, as well as the disadvantages associated with an increase in the cost of treatment.

In recent years, along with the rapid growth of China’s foreign exchange earnings the number of equipment purchased by Chinese enterprises abroad directly for the currency increased. Laws and legislation governing foreign direct investment and the processing of raw materials of the customer have also been improved.

Leasing. Leasing is a set of economic and legal relations, according to which the lessor undertakes to acquire the property specified by the lessee from a particular seller and give the lessee the property for payment for temporary use and possession with the right to repurchase. The leasing agreement may provide the choice of the seller and the property to be acquired by the lessor.

This is an investment tool that allows the company to carry out the modernization of fixed assets and obtain new necessary equipment or other non-consumable items without involving their own resources.

Since there is a limited amount of money it is important to choose the most advantageous form of a joint venture. It is important to note that we need to create the appropriate infrastructure for full function of our hotel. In this situation the best choice is Equity Joint Venture. This form of the joint venture is the most profitable for the services sector. We need a large amount of various supporting infrastructure, it is possible to create an enterprise with a firm that has the appropriate conditions for doing business. In some cases, when entering the Chinese market is very advantageous it is better to use the already known and well-established Chinese brand instead of creating your own. Then the owner of such brand can be a highly beneficial partner. Apart from that, the main advantage of a joint venture in China is the fact that the Chinese partner has spent the supply chain. Selling anything in China requires certain relationships, and your partner could become the source of it. Thus, a functioning supply chain is the main argument for the creation of a joint venture. Another argument for the creation of a joint venture is that Chinese partner knows tastes, consumer behavior and characteristics of product promotion in China. These factors can greatly vary in different regions of China. In this case, it would be beneficial to open a joint venture in each region. Using the knowledge and capacity of a local partner, one can create a regional network, and then gradually buy back shares from partners.

The Conditions for Investment in China and Shanghai

Reasons for joint cooperation are different, however, in general, they are based on the same principles: a) increasing production; b) improving the efficiency of work; c) expansion of the powers and actions; g) decreasing the risk of developing new products; d) achieve operating results due to investment and the use of modern technologies. Each partner is trying to achieve maximum control, get “superiority” over others, which can be evaluated as a contribution to their own resources, knowledge of local market trends, experience in the implementation of innovations and technologies.

Traditional legal mechanism for regulating the interests of partners in joint business is a shareholder agreement. Such agreement usually provides the rights and obligations of shareholders and provides a balance of interests. In particular, a shareholder agreement allows the individual to resolve the structure of corporate governance, financing, distribution of profits, as well as resolve the deadlock, a way out of the joint business and more. It should also be noted that under the current jurisprudence it is prohibited to use the foreign law for the purposes of regulation of shareholder agreements (in particular, if one of the partners is a foreign investor).

Of what other concerns/issues should be aware in bringing this alternative into operation, including legal measures to protect its intellectual property interests in the projects?

When deciding to launch a new investment project in China, one will need to carefully approach the question of the place of registration of the newly created company. Therefore, in order to avoid surprises it is recommended to find out all the issues related to taxation, local restrictions on particular activities and rules of exporting products from China.

The main objectives of the enterprise with foreign investment are:

• Tackling the world market;
• Reduction of capital investment in the creation of new production capacity;
• Expansion of raw materials;
• Expansion of existing production facilities;
• Reduction of production costs;
• Features and eliminate cyclical volatility of production;
• Improving the efficiency of marketing in business;
• Acquisition of managerial experience;
• Reduced commercial and foreign exchange risk;

Polishing Your Writing to Make it Shine

Characteristic features of the joint venture (or enterprises with foreign investment) are:

• The presence of a long-term agreement on economic cooperation;
• Combine and valuations of both parties, their joint investment;
• Implementation of agreed objectives by creating independent authorities;
• Participating partners in the distribution of profits and damages under the invested capital;

Companies providing services in the PRC and transmission rights to intellectual property are payers of the economic activity. The tax rate is 5% or 3% for the majority of services provided, the basis for calculating the tax is the amount of revenue from the sale of services.

The distribution is conducted after the payment of income tax at the rate applicable for this type of enterprise. In the distribution of the net profit of the company registered in the PRC it is required to contribute 10% of the profits to a special fund whose assets are in the possession of the company and can be used if it is necessary to cover the losses. When the fund reaches the amount of 50% of the share capital of the company, the deductions may be terminated.

During the practice a model of intellectual property protection has developed in China, characterized by a parallel implementation of administrative and legal protection. In China, there are several agencies that perform the function of intellectual property protection.

It includes the Government Office for Intellectual Property, State Industrial and Commercial Administration, State Administration of Press and Publication, the State Administration of Copyright, the Ministry of Culture, Ministry of Agriculture, State Administration of Forestry, Ministry of Public Security, the General Customs, Supreme People’s Court and Supreme People’s Procurator.

Despite the extensive work of the Chinese authorities in the field of intellectual property protection, the current situation of implementation and protection of intellectual property rights in China is not so favorable, and the protection of intellectual property is a long and arduous task for China. To solve this problem a long period of time and a clear legal framework for intellectual property protection is required, as well as the joint efforts of the government and the public.

What kind of investment incentives could the Shanghai city government provide to DFW for the hotel and manufacturing projects?

Shanghai Free Trade Zone, created last year as a pilot project of the Chinese government is becoming more accessible to foreign investors: recently the number of restrictions and prohibitions for foreign investment in Shanghai FTZ has been decreased. Government services also do not stand on the same place: Instant identification numbers to taxpayers are already running online.

The pace at which China is developing a pilot project to ensure greater openness to innovation, investment and weakening of foreign exchange controls, makes one to wonder about the chances of Shanghai to become a rival of Hong Kong, the traditional entry point for foreign investors in China’s economy. Administrative Pudong New Area is one of the areas of Shanghai, but benefits and privileges legislated for them as a whole are not inferior benefits provided to SEZ.

Special legislation to Pudong provides, inter alia, the following benefits for foreign investors and enterprises with foreign participation:

• reduction of income tax to 15%;
• exemption enterprises established for a period of not less than 10 years, from income tax during the first two years of profit, reducing the size of the tax in the next three years by 50%;
• exemption from corporate income tax in the field of infrastructure and energy facilities (airports, ports, roads, power plants, and so on. d.) during the first five years of the profit and reducing the size of the tax to 50% in the next five years;
• reduction of income tax to 10% for companies, the share of exports of not less than 70%;
• reduction of income tax to 10% for businesses using modern technology, within three years after the expiration of the benefits outlined above;
• the release of financial institutions with foreign capital and branches of foreign banks with assets of at least 10 million dollars and created a period of not less than 10 years from the payment of income tax for one year from the receipt of income and tax reduction of 50% in the next two years;
• 40% refund of taxes previously made with the amount of reinvestment foreign entrepreneurs who invest part of their profits in Pudong for a period of not less than five years;
• full refund of taxes from the amount of reinvestment, if they are implemented in production, export-oriented or using advanced technology;
• exemption from customs duties exported products;
• exemption from customs duties of imported technological equipment, raw materials, components, vehicles and equipment of premises and offices of investors;
• authorization to issue visas for multiple entry (exit) in the Pudong New Area for the main foreign personnel.

Due to the need to attract foreign capital to the interior of China, as well as to meet the requirements of the WTO in Pudong as in other areas of development, there is a tendency to reduce the scope of benefits provided to investors. One of the most important factors in attracting foreign investment at this stage is the forefront of Pudong in the field of market reforms and openness, including easier access of foreign entrepreneurs in areas such as domestic and foreign trade, banking and insurance.

If a controversy arises in respect of all of the alternatives considered in question (1), what dispute resolution mechanisms would be available to DFW to resolve the matter?

The investment disputes between foreign investors and the contracting party, as a rule, have the character of public law aspects of the relationship of the host State and the foreign investor, as far as the disputes related to the unilateral acts of the sovereign state intervention in investment activities.

State regulation in relation to joint ventures in China has a strict regulation that gives a high degree of safety of capital management. Contractual enterprises have greater freedom in determining the obligations of each party.

Disputes addressed in international arbitration procedure can be divided into two groups: the international foreign investment arbitration and international arbitration. The first group should include disputes arising from purely commercial, commercial relations, such as international treaties – the sale of goods, equipment, etc. The international investment arbitration includes disputes arising between the parties to joint ventures, as well as the implementation of investment activity in another country by a foreign investor. This mechanism is highly important in the structure of the international legal regime for the resolution of disputes. One reason is that many bilateral agreements on investment indicate it as a consultative body or provide arbitration rules that will be applied to arbitration ad hoc. Under international investment, arbitration disputes are considered among such foreign investor and his partners and investor-state in which the investment is located. Specificity of international investment arbitration is, in most cases, an arbitration clause that actually provides respective bilateral international agreement with another state on the promotion and protection of foreign investment.

Conclusion

The Chinese government has taken into account that the economic and political stability in the country affects the attractiveness to investors. Therefore, every effort is made to ensure the reduction of crime, ensuring peace of mind in political terms, as well as the stability of the social level. The opening of services is necessary for the implementation of plans to transform Shanghai into a financial and shipping center of world level. Moreover, this year the city has made a number of important steps in this direction, including the opening of the country’s first futures brokerage transactions with foreign participation. Attraction of foreign investment also contributes to start of the Disneyland project, which is the second in China and the sixth in the world.

Joint business serves as a specific subject of international business, a way to enter the international market, a variety of foreign investment, one of the forms of management for countries that are actively being transformed on the basis of market principles. Thus, it can be concluded that the joint venture helps to use resources efficiently, facilitates the process of taxation, as well as gives the opportunity to save on building the necessary infrastructure.