China Joint Ventures: The Basics

August 8, 2011 Posted by China Briefing Reading Time: 6 minutes

Aug. 8 – What is a China joint venture (JV) and why should you choose it as your investment vehicle into the market? Specifically, the China JV is a limited liability company formed by a foreign investor(s), or a foreign individual, and a Chinese company in which the foreign party or parties own more than 25 percent of the shares. We should emphasize – as this point is sometimes misunderstood – that the JV is not a merger between a foreign and Chinese company or companies. The JV is a new entity, partly owned by both sides, in which liability of the shareholders is limited to the assets they brought to the business. Liability does not extend to the parent companies.

Meanwhile, “joint venture” sounds like a “warm and friendly” way of doing business, doesn’t it? You are likely to be offered many such deals, as 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 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.

You must first ask the question: “Why do I need a partner?” They should have something tangible to offer. The first main reason is usually because they can be an entry vehicle into an industrial sector where 100 percent foreign investment is restricted – the PRC government still requires Chinese company participation or control in some sectors.

Alternatively, they are used because they have assets such as a distribution network, brand reputation, a special manufacturing process, or other tangible assets such as land or special licenses.

Using a JV because you think it will lower your cost of market entry in China due to the so-called “shared costs” is a common mistake. It usually does not!

Think also “What does the partner expect or want?” during negotiations, and make sure you take time to understand their perspectives and ambitions, which may not match yours. Sometimes this does not matter, but sometimes it matters very much. As the saying goes, “fools rush in where angels fear to tread.” Take your time. Neither China, nor its opportunities, are going away.

Considering all this, it is no surprise to find that the popularity of JVs has been steadily decreasing. By 2004, JVs accounted for only 32.2 percent of total international investment, compared to 66.4 percent by WFOEs; and by the first half of 2010, the WFOE proportion had increased to 77.4 percent, compared to 27 percent in 1995.

On the other hand, it will not end up being zero. In some regions and industries, JVs are still hugely important. For example, in 2005 in Chongqing, 35.3 percent of newly established foreign-invested enterprises were JVs. This reflects the structure of local industry – with many more companies in the restricted sectors – as well as investors’ own strategies.

What to think about when creating your JV
Again, remember that strategy must lead structure, and it is important to choose to create a JV for the right reasons. But it is also equally important to choose the right structure for the JV itself for operational business reasons, not because the legal rules might imply a particular direction.

Here is a checklist containing some of the issues you will need to consider:

What will your business scope be? Foreign invested enterprises, and indeed all domestic companies, have to operate within their business scope– this is more critical than in most western countries.
Is your business in an “encouraged,” “permitted,” “restricted,” or “prohibited” industry for foreign investment? This will determine whether or not you can in fact create a JV, and the incentives available.
The texts of your “Articles of Association.” These will lead you into consideration of issues like board structure, profits repatriation, trade unions, M&A, and liquidation.
What should be your registered capital and total investment (cash, “in kind,” loan, etc.)? This is a very important issue, and you will need to focus on it from an operational, not regulatory, point of view – don’t be swayed by legal minimums, which may be too low to actually run the business! Your capital needs will be driven by your business model, not the law.
If you are manufacturing, what proportion of your production is for export and what proportion is for domestic sales? Again, a critical issue with major tax and operational proportion implications.
You also need to consider profit distributions and the sharing of responsibility for losses – these can complicate matters in JVs.
What taxes will you need to pay? These are likely to include business tax, foreign enterprise income tax, VAT, withholding tax, individual income tax, and customs duty. For specific rates, feel free to email tax@dezshira.com or check out our resources at the bottom of the article.
Where should your company be located? This will depend on your specific sectoral needs, but you may have several options around the country, including possibly several different development zones, with differing characteristics and available incentives.
Are there any additional issues relating to the specific characteristics of JVs, such as: Who will be the leading party in the daily running of the business? Who will be in charge of sales or export sales? Is it necessary to allow one party to unilaterally increase the registered capital which would dilute the shares of the other party?

General establishment procedures
Different authorities will be involved at different steps of the approval procedure for any foreign entity in China. Throughout the incorporation process you will become more and more familiar with departments like the Administration of Industry and Commerce, the Bureau of Foreign Trade and Economic Cooperation (called Foreign Investment Bureau in some cities), the state and local tax bureau, the administrative committees of development zones, customs and so forth.

The establishment procedure involves central, provincial and/or local level authority approvals depending on the sector involved, the amount of the total investment and the location. The Ministry of Commerce is the final approval authority for a JV or a WFOE, but it delegates part of its power to its local counterparts, the Bureau of Foreign Trade and Economic Cooperation at provincial and municipality levels. Some specific industries may require additional licensing, which needs to be obtained at the outset.

Furthermore, there are two types of JVs in China: the equity JV and the cooperative JV (which is also sometimes known as the contractual JV). They appear similar on the surface, but have different implications for the structuring of your entity. This point is not always understood by some of the more rural local governments. We explore the detailed differences between these two types, as well as all other issues regarding properly setting up and operating a JV in China, in our technical guide “Setting Up Joint Ventures in China.”

Readers interested in acquiring further information should stay tuned for the next issue of China Briefing Magazine coming out in September, titled “Reevaluating Joint Ventures in Mergers and Acquisitions.”

Dezan Shira & Associates is a boutique professional services firm providing foreign direct investment business advisory, tax, accounting, payroll and due diligence services for multinational clients in China, Hong Kong, Vietnam and India. For more information and advice regarding setting up and operating in any of these markets, please visit www.dezshira.com.

Dezan Shira & Associates Resource Library article: China Joint Venture
Setting Up Joint Ventures in China (Third Edition)
Starting with choosing a joint venture structure, assessing a potential partner, and conducting legal and financial due diligence, this guide walks you through, step-by-step, the key points of setting up a joint venture in China.

The China Tax Guide (Fifth Edition)
This popular book, fully updated with all recent tax changes and amendments, details all taxes in China affecting businesses and individuals, how to calculate the amounts due, tax registration and filing procedures, tax minimization techniques, and claiming VAT rebates. It also details good financial management techniques, handling negotiations with the tax bureau and annual audit and compliance procedures.

China Business Handbook (Second Edition)
This complimentary PDF download provides a market overview, regional insights, discussion of post-initial investment considerations and analysis of opportunities by industry sector to businesses looking to operate in or sell to China.