1- EJV (Equity Joint Ventures)
KEY ISSUES REGARDING A JOINT VENTURE |
Nature of JV Project
(A) The principal differences between an EJV and a CJV can be simply summarized as follows:
- For an EJV:
1. Each party must make cash or permitted in¨Ckind contributions in proportion to its subscribed percentage of the EJV's registeredcapital.
2. Profit must be distributed strictly in accordance with the parties' respective percentage shareholding of the registeredcapital of the EJV.
3. Upon dissolution of the EJV at the expiry of the term of operation, the EJV's net assets are to be distributed to each party in accordance with its respective shareholding of the EJV's registeredcapital.
- For a CJV:
1. A party (typically, but not always, the Chinese party) may contribute non-cash intangibles in the form of "cooperative conditions". Such "cooperative conditions" may consist of market access rights, rights to use buildings or office space owned or leased by the party that are not subject to clear valuation. In exchange for such "cooperative conditions", the party is entitled to participate in the distributable earnings of the CJV.
2. Profit sharing in a CJV need not be made strictly in accordance with the parties' respective percentage shareholding of the registeredcapital of the CJV but can be made in accordance with the agreement of the parties (e.g. the Chinese party may be entitled to a fixed profit share with the balance to be distributed to the foreign party, or the parties may agree on a multi-tiered profit-sharing arrangement that permits the foreign party to recover an amount equal to its capital investment on a priority basis, following which the profit split will be changed, etc.).
3. Upon dissolution of the CJV at the expiry of the term of operation, the CJV's net assets may be transferred to the Chinese party without compensation (thus operating in many respects as a BOT project) so long as the foreign party has been able to recoup its capital contribution during the term of the CJV. Such recoupment typically is funded by excess cash flow generated by accelerated depreciation of the CJV's assets. Such arrangement requires approval of relevant finance and tax authorities in
Capitalization of JV
(A) The concepts of authorized and issued capital are not used in connection with Sino-foreign joint ventures. Instead, the concepts of "registered capital" and "total investment" are employed. Under applicable PRC law, registered capital is defined as the total amount of capital contributions subscribed to by the parties and registered with the Chinese authorities. Thus, the term "registered capital" refers to the parties' equity in the venture. The concept of "total investment", on the other hand, includes both registered capital and external borrowings.
(B) Pursuant to regulations promulgated by the SAIC, certain minimum equity requirementsare imposed on joint ventures. These are:
Minimum Equity
Total Investment | (% of Total Investment) |
<= US$3 Million | 70% |
US$3 - US$10 Million | 50% or US$2.1 Million (whichever is higher) |
US$10 - 30 Million | 40% or US$5 Million (whichever is higher) |
>US$30 Million | 33.3% or US$12 Million (whichever is higher) |
PRC laws governing joint ventures require that the foreign party contribute no less than 25% of the registered capital.
(C) The capital to be injected by the parties constituting their capital contribution may take a variety of forms including cash, machinery, equipment and intangible property, such as proprietary technology, trademarks and other industrial property rights. Pursuant to a circular promulgated by SAFE and effective as of 1 April 2003, subject to SAFE's approval, a foreign party may also use the assets obtained by way of early recoupment of investment, liquidation, share transferring, capital reduction etc. from FIEs it has previously invested in. In addition, the Chinese side may contribute the right to use a site and count this as part of its contribution.
There are, however, certain restrictions on in kind contribution by a party. For example, the technology contributed as registered capital by a party generally should not exceed 20% of the total registered capital (but this can be increased with approval for certain encouraged projects) or 50% of an individual investor's capital contribution. The issue of the appropriate valuation of in kind contribution can often be a major stumbling block in joint venture negotiations.
Once the joint venture contract is approved, the parties must inject their subscribed registered capital amounts within the time limits set out in the contract. If paid in one lump sum, the registered capital contributions must be made within six (6) months of the issuance of the businesslicense for the joint venture. If the subscribed registered capital is to be injected in instilments, the first instilments, which must not be less than 15% of the total subscribed registered capital, must be made within three (3) months following issuance of the businesslicense. The balance is to be contributed in accordance with a schedule agreed by the parties, provided that the parties must complete all such contributions within the following time limits (calculated from date of issuance of the businesslicense) depending on the total amount of registered capital of the joint venture company:
Registered Capital (US$M) | Contribution Time Limit |
<=0.5 | 1 year |
>0.5 but <=1.0 | 1.5 years |
>1.0 but <=3.0 | 2 years |
>3.0 but <=10.0 | 3 years |
>10.0 | subject to approval with reference to actual condition |
(D) Chinese law permits joint ventures to borrow funds from either Chinese or foreign banks in excess of the parties' capital contributions. Shareholder loans from the foreign party are also permitted. (Chinese partners likely will not have a sufficiently broad scope of businessto permit them to provide shareholders loans.) All such loans should be registered with SAFE and should not exceed the difference between the registered capital amount and the total investment amount.
Transfers of Equity Interests in Joint Ventures
If a party proposes to transfer all or part of its interest in the registered capital of the joint venture companyto a third party, then each other party has a pre-emptive right to purchase the equity interest proposed to be transferred. As an equity transfer also requires amendment of the joint venture contract and articles of association, which in turns requires the signature of each party, each party in effect holds absolute consent rights to any transfer generally. All transfers of registered capital additionally require a unanimous approval of the joint venture companyboard of directors and approval by the original government authority which approved the joint venture contract and articles of association.
Off-shore Structures
(A) Offshore Structures
The entity to be used by the foreign investor as the offshore investment holding company("OHC") for its investment in the EJV will be determined by a number of factors. One of the main considerations driving choice of OHC is tax-efficiency. In this respect the foreign party needs to ascertain whether there is a double tax treaty ("DTT") covering the types of revenue streams that are likely to be coming out of the EJV as between the PRC and the jurisdiction where the OHC is established? DTTs generally cover loan interest, dividends and distributions, income taxes, royalties and capital gains. The tax treatment of dividends tend to be less important in terms of determining the location of the OHC because, at present, China exempts dividends by FIEs to their foreign shareholders from withholding and other taxes (although this could change as the post-WTO leveling of the playing field progresses, as Chinese parties do not benefit from such an exemption). There are proprietary software programs for determining the most tax-efficient jurisdiction under the applicable DTTs, based on a specific set of input parameters which you provide.
Based on past experience, popular DTTs for investment in
A number of industries in China, notably the telecommunications, fund management, banking, venture capital and many others require foreign investors to meet certain qualification requirementswhich may preclude using a special purpose vehicle ("SPV") as the OHC. This needs to be considered on an industry-by-industry, case by case basis. It may be possible, in some cases, such as under the Foreign Invested Venture Investment Enterprise Administrative Regulations to use an affiliated entity to satisfy the qualification requirementswhere there is an express legal basis for doing so, whilst investing through an SPV located in a tax-efficient jurisdiction.
Another possibility to consider, when establishing an EJV in "special industries" with foreign investor qualification requirements, is whether the industry regulator would accept the use of an SPV backed up by a parent companyguarantee of the SPV's obligations in relation to the EJV or similar arrangement, based on an agreement negotiated with the regulator. Again there are no hard and fast rules as to what may or may not be possible as it depends on the position taken by the regulator. You should make telephone enquires to confirm.
Tax structuring of the foreign party's investment in an FIE does not, however, stop at the OHC level, as you also need to consider (where applicable) the tax implications of repatriating funds from the OHC to the foreign party's home jurisdiction, and the DTTs (if any) between OHC jurisdiction and the foreign investor's home jurisdiction.
(B) Tax Havens as OHCs
many foreign investors tend to favour the use of tax haven jurisdictions, typically the British Virgin Islands ("BVI"), the Cayman Islands and so forth as OHCs for
From the foreign investor perspective the main advantage is low or zero rates of tax on funds once they reach the tax haven or on disposals of shares in OHCs located in the tax haven. On the other hand, tax havens do not have any DTTs to reduce the tax withheld at the China end, so the tax requiredto be withheld in Chinabefore a remittance of funds out by EJV (other than for dividends) by way of payment of loan interest, royalties etc. will be the maximum applicable rate under Chinese law and policy at the time, thus giving a substantially reduced amount on arrival at the tax haven.
The location of OHCs, as can be seen from the above, is not always straightforward and is a decision that will be determined by a large number of variables on a case-by-case basis. Often foreign investors will make the decision based on internal policies or on the basis of advice from their own in-house or external tax advisers.
Miscellaneous
(A) Under PRC law, joint venture companies have a fixed term of operation. Currently, the most common term of operation approved is fifty (50) years. This term can be extended with the consent of all parties and approval of the relevant government authorities. In some instances, particularly in BOT-like CJVs, the term of operation agreed by the Chinese party and approved by the relevant government authorities will be much shorter.
(B) Depending on the nature of the operations of the proposed joint venture company, certain additional government approvals, permits or licenses may be required, e.g., sanitation certificates, environmental permits, production approvals, export licenses, value-added telecom services operating licenses, etc.
Certain other legal and practical considerations relating to the establishment of a Sino-foreign joint venture companyare set out in the notes at the end of the template Joint Venture Contract
