China question: Where should I form my WFOE?

Special customs zones

Special customs zones, also known as bonded areas, are areas that are considered outside the Chinese customs territory, although they are physically located within the legal boundaries of China. There are different types of special customs zones and their functions vary, such as bonded logistic parks, export processing zones, free trade zones and integrated bonded areas.

Due to the special features of these customs zones, goods sent from within the Chinese customs territory to special customs zones are deemed exported, while goods delivered from special customs zones to the Chinese customs territory are regarded as imported. This unique feature is beneficial to trading WFOEs that are engaged in international trade. Special customs zones are usually located near harbours or airports and have easy access to convenient transportation, which is critical to trading companies.

Other areas

The Qianhai Shenzhen-Hong Kong Modern Service Industry Cooperation Zone, which is located within the Shenzhen special economic zone, has been granted by the State Council the right to implement pilot policies focusing on innovative financial business, electronic commerce logistics, scientific and technological research and other modern service industries. The pilot policy includes the development of cross-border renminbi loans, easier market access for foreign investors in the modern service industry, as well as tax holidays and other tax incentives. Another case in point is Suzhou Industrial Park, which was also established under the authorisation of the State Council and attracts investment mainly in the high-tech industries. Suzhou Industrial Park offers, among others, special tax incentives as well as simplified incorporation procedures.

Ji Fang and Yang Huishan, Han Kun Law Offices, Beijing and Shenzhen

The international perspective

There are a number of factors to consider in setting up a wholly foreign-owned enterprise (WFOE) in China. One of the main factors for most foreign investors depends on the type of industry in which the WFOE will operate:

• Service: Foreign investors engaged in the service industry, such as finance, insurance, trading, and consulting, typically choose to set up their WFOEs in large cities and the more developed eastern regions of China. These areas offer greater access to a skilled labour pool and commercial resources.

• Technology, research and development: Foreign investors engaged in technology and research and development also tend to prefer setting up WFOEs in large cities and the more developed regions, such as the eastern regions of China, due to the greater availability of highly educated labour, greater concentration of education and research facilities and stronger enforcement of IP.

• Manufacturing: Foreign investors engaged in manufacturing, especially high-polluting or low-technology manufacturing, such as chemical and textiles, tend to prefer setting up WFOEs outside large cities and have recently looked towards the western and central regions of China. Foreign investment in these areas may benefit from government initiatives to attract manufacturing, such as a 15% preferential enterprise income tax rate for engaging in encouraged industries and tax-exemptions for medical institutions on certain imported self-use equipment. There remain, however, various challenges to setting up a WFOE in these areas of China, including, most significantly, lack of sufficient infrastructure to easily allow products to reach both domestic and foreign markets.

How do the legal systems vary?

China is organised under a centralised legal and governance system. As a result, local legislators do not have much room to formulate completely different regional laws and regulations. Local laws and regulations tend to supplement, rather than vary from, central laws and regulations. Certain practices, therefore, such as setting up a WFOE, tend to follow a fairly standard approach throughout China. At the local level, however, slight variations may emerge to reflect the interests of the local governments in attracting certain forms of investment. Indeed, some local rules and practices do conflict with the national laws, but such local rules can be challenged under China's legal framework.

How can labour regulations vary from city to city?

Although labour laws and regulations in China are centralised, at the local levels, slight variations may emerge through how the laws and regulations are implemented, and these variations may potentially influence a decision on where to set up a WFOE. Some instances of these variations include:

• In Shanghai, the Higher People's Court recently issued its interpretations of the PRC Employment Contract Law (中华人民共和国劳动合同法), indicating that after a fixed-term labour contract has been entered into twice, the third contract will be deemed a non-fixed term contract. In contrast, under local practice in Beijing, after a fixed-term labour contract has been entered into once, the second contract will be deemed a non-fixed term contract.

• For labour unions, the relevant Chinese law at the central level vests the power in the employees to establish a labour union within their organisation, only going so far as to require the company not to obstruct or resist and to support and assist the employees in establishing a labour union. In Jiangsu province, however, the local legislation further elaborates that a foreign invested enterprise, such as a WFOE, must establish a labour union and supports its operations within one year of the enterprise's establishment or commencement of operations.

Is it true that one city may be easier than another?

As mentioned above, the laws and regulations on setting up a WFOE are fairly standard throughout China, but the implementation rules adopted at the local levels may contain variations to reflect the interests of the local governments in attracting certain forms of investment.

In certain areas of central China, for instance, local authorities may offer a degree of support to facilitate the requisite approval and filing procedures for foreign investment. This does not mean, however, that setting up a WFOE in these central and western regions is necessarily easier. Some of the practical barriers to foreign investment in these areas may include additional layers of bureaucracy, as well as increased levels of corruption and lack of transparency.

Where to set up a WFOE in China will ultimately depend on the foreign investor's commercial objectives and the legal and practical realities of each locality in China.

Philip Cheng and Daniel Fogarty, Hogan Lovells, Shanghai