Shanghai Bound: New Regulations Seek to Attract Regional HQs

Partly as a result of the Chinese national government's conservative approach, many multinational companies have chosen to keep their China or regional headquarters in Hong Kong or Singapore. Although there have been several highly publicized regional headquarter relocations to China, most multinational companies are not attracted by the current environment in China.

The reasons include:

(a) foreign exchange control requirements on regional headquarters are as strict as those on any other types of companies;

(b) import and export control, customs clearance, immigration and visa processes are highly restrictive and complicated;

(c) tax and import duties are still very high compared with Hong Kong or Singapore; and

(d) infrastructure, freedom of information, the rule of law and quality of life in mainland cities are still inferior to either Hong Kong or Singapore.

While MOFTEC has taken a conservative approach on holding companies, some local governments have been offering special policies or waivers to accommodate multinational companies' needs to consolidate some of the administrative and financial activities for their subsidiaries in China.

Beijing, Shanghai and Shenzhen, where most of the multinational companies are located, are all studying the above issues. Beijing so far has attracted the most multinational holding companies. Shanghai, however, arguably has the best chance to compete with Hong Kong and Singapore for regional headquarters due to the concentration of new foreign investment in Shanghai and its nearby region, and better quality of infrastructure, work and living environments for foreign employees. In recent months, several multinational companies, including GE Plastics, moved their regional headquarters to Shanghai. In the past year, the Shanghai municipal government has set up a special task force to study the feasibility of policies on regional headquarters. The task force sent delegations overseas, including to Singapore. The Tentative Provisions are presumably a result of the findings of the task force and the Shanghai government's determination to make a move ahead of the national government and the other cities.

Requirements for a Regional Headquarters

Definition

Under the Tentantive Provisions, "regional headquarters" means:

(a) an investment or management FIE (typically in the form of a WFOE) established in Shanghai municipality;

(b) one that is invested by a multinational company;

(c) one that becomes the only organization in the region authorized by the multinational company to exercise overall management and service authority over such multinational company's other subsidiaries in the region; and

(d) the authority of which is obtained through its investment in such subsidiaries or through delegation of power by the multinational company.

Conditions and Requirements

A regional headquarters needs to meet the following conditions and requirements:

(a) It should be a FIE with independent legal status
(i.e., an incorporated entity). It is, however, unclear whether a multinational company can convert one of its existing FIEs in Shanghai into a regional headquarters.

(b) Such a FIE generally will be in the form of an investment company or management company. It is unclear whether an investment company set up under the Tentative Provisions should also satisfy the conditions and requirements set by MOFTEC's rules on investment companies. If the answer is positive (which appears to be implied in Article 5), then it is foreseeable that many multinational companies will use the form of a management company, rather than "investment company", to circumvent the high requirements (US$30 million in new investment) set by MOFTEC.

One further question in this regard is whether an investment company or management company can be engaged in manufacturing or other profit making activities. This question is related to the issue of whether a multinational company can convert an existing FIE into a regional headquarters. Currently many multinational companies have been using one of their existing FIEs in China to act as a de facto administrative and support centre.

(c) The multinational company's total assets must be no less than US$400 million. This can be proved by a copy of the multinational company's financial statement.

(d) The multinational company's total investment in China shall be no less than US$30 million. In China, there are two distinctive terms in foreign investment-related laws: registered capital (equity investment) and total investment amount (equity plus shareholder loans or third party debts that are typically guaranteed pro rata by shareholders). Here the amount arguably referred to is the accumulation of the multinational company's total investment amounts in its FIEs in China. It is unclear whether the new investment of US$2 million can be included in the US$30 million benchmark.

(e) The regional headquarter should invest in, or manage, no less than three FIEs in China and should have the authority to manage and provide services to these FIEs. It is unclear whether Taiwan, Hong Kong and Macao are considered parts of China in the Tentative Provisions. However, reading from the context of the new legislation (Article 15 in particular), it appears that its subsidiaries or affiliates in Taiwan, Hong Kong and Macao would not be counted for the purpose of the Tentative Provisions.

Interestingly, other than the general requirement that a regional headquarters should manage and provide services to its subsidiaries in more than one country, the Tentative Provisions have no reference to the regional headquarters' required activities or functions outside of mainland China. Article 5 does not even ask for evidence to show such regional functions as a condition for the approval.

(f) If the regional headquarters is in the form of a management company, the management company should have a registered capital of no less than US$2 million. Assuming an existing FIE in Shanghai can be converted into a regional headquarters, then the question becomes whether such a FIE can satisfy this capital requirement by showing its existing capital, or does it have to show a US$2 million increase in capital.

The Tentative Provisions also provide that those multinational companies that do not satisfy all of the conditions listed in (a) through (e) above, but have made extraordinary contributions to the region's economy, may also be approved to set up regional headquarters in Shanghai. What "extraordinary" actually means is not clear.

Benefits as a Regional Headquarters

Permitted Activities

A regional headquarters may engage in the following management and services to/for its subsidiaries:

(a) investment and operational decision making;

(b) marketing and sales services;

(c) capital (i.e., treasury functions) and financial management (i.e., accounting functions);

(d) technical support, research and development;

(e) information support and services;

(f) employee training and management; and

(g) other operational, management and service activities as permitted by law.

Other Benefits

Other benefits include:

(a) a regional headquarters that is also engaged in research and development can enjoy preferential treatments as a hi-tech enterprise;

(b) regional headquarters set up in Pudong will enjoy preferential tax treatments all other FIEs in Pudong enjoy;

(c) regional headquarters that provide employees with training in critical job skills may be qualified for government subsidies for the training;

(d) foreign employees and visitors sent to the regional headquarters will be able to obtain employment visas or business visitor visas for from one to five years;

(e) if a regional headquarters establishes a purchase or distribution centre in Shanghai, such a centre will enjoy import and export rights, and its exported goods will enjoy VAT rebates. It is unclear whether such regional headquarter can qualify itself as a purchase or distribution centre.

Outstanding Problems

Like investment companies under the current MOFTEC regulations, regional headquarters in Shanghai will likely find that some of the benefits important to multinational companies in China are still not provided. The unsolved problems include:

(a) The US$2 million registered capital requirement is still too much for some multinational companies. This is particularly true if Shanghai COFTEC will require regional headquarters to be in the form of a new FIE rather than allowing conversion of an existing FIE.

(b) The government needs to offer low corporate and personal income taxes or tax rebates to match the low taxes in Hong Kong and Singapore. As the tax rates are set by the national tax authority, local governments, including the Shanghai municipality, are not in a position to lower the tax rates. Some local government authorities, however, acknowledge that personal income tax in China is excessive and may be willing to negotiate with some foreign investors on tax liabilities as a package deal.

(c) The government needs to lower or waive the business and income tax on regional headquarters' business income (or cost sharing) derived from its subsidiaries for financial and administrative support. Multinational companies have complained that tax on cost sharing effectively increases the operational costs of multinational companies, making holding companies or regional headquarters unattractive. Again, it is unclear whether the Shanghai municipal government is in a position to offer such a tax concession.

(d) Like the MOFTEC regulations, the Tentative Provisions allow regional headquarters to manage inter-company loans among the FIE subsidiaries. However, the People's Bank of China (PBOC), the central bank, has never allowed investment companies set up under the MOFTEC regulations to actually lend money to their subsidiaries or to allow those subsidiaries to lend money to each other. Instead they need to find a bank to handle such transactions as an intermediary. The bank will charge service fees and use its own loan documents. Thus this PBOC restriction effectively renders such benefits meaningless.

(e) It appears that a regional headquarters will not be able to enjoy import and export rights unless it is also qualified as an investment company under the MOFTEC regulations, or unless it sets up a purchase or distribution centre. Thus, it is unclear whether a regional headquarters will be able to assemble or integrate semi-finished products from subsidiaries or suppliers in both China and other countries.

The Tentative Provisions are a clear signal from the Shanghai municipal government that it seeks to compete with other cities in Asia as a regional business and financial centre. Whether the new legislation will be effective in helping Shanghai attract multinational companies in the immediate future will, to a large extent, depend on whether Shanghai can persuade the tax, customs, foreign exchange administration, central bank, border control authorities and other central government authorities to recognize the need to provide incentives to multinational companies that may be interested in establishing regional headquarters in Shanghai.

1 MOFTEC, Establishment of Companies with an Investment Nature Tentative Provisions, promulgated and effective April 4 1995.