China 2001 February Issue

Joint Venture or Wholly Foreign-owned Enterprise?

 

As China moves closer to WTO membership, one question which arises is whether a company contemplating an investment in China should choose a joint venture or a wholly foreign-owned enterprise (WFOE) as its investment vehicle.  There are still restrictions on the establishment of WFOEs but these can usually be avoided with the help of a friendly local government (and they usually are well-disposed because they want to attract foreign investment).  It might be a little more difficult at the national level where larger projects are subject to closer scrutiny, but providing the WFOE is structured correctly, approval will be granted in most cases. 

Whether to choose a JV or WFOE really depends upon the western partner.  The only valid reasons for entering into a joint venture are either; because local legislation insists upon it; or because the local partner brings tangible benefits to the project in terms of existing plant and equipment, access to raw materials, market or process knowledge, guanxi etc.  As China has developed many of these reasons have become less important and most of what a partner offers can be bought-in, including knowledge.  But each case is different and we would recommend a formal appraisal to consider the advantages and disadvantages of each structure before making a final decision. 

All things being equal, we would opt for a WFOE.  Even the best partners have the potential to be troublesome and it is our long-held view that a joint venture is an intrinsically unstable structure and that someday one partner will have to buy out the other.  Even if a WFOE causes a few more problems initially, this is out-weighed by the long-term benefits of not having to consult a partner and obtain his approval.

 Tax Incentives after WTO Entry 

China is expected to continue to offer tax incentives to specific industries, particularly high-tech, after its entry into WTO.  Domestic and foreign companies will be treated in a similar manner.  At present, foreign invested companies pay a tax rate of 15%, whereas domestic companies pay 33% with a reduction to 24% in Special Economic Zones.  However, China has long wanted to have a unified tax treatment for all companies. 

In the past, China has always applied a “grandfather” clause to companies who invested before the rules were changed and this approach is expected to apply in this case.  It is therefore strongly recommended that any company contemplating an investment in China should start the approval process without delay as China’s accession to WTO, whilst delayed, will almost certainly be completed by the end of this year and perhaps by the Autumn. Please contact us for more information about the options open to you.

Non-tariff barriers 

We have long maintained that China’s accession to WTO will not necessarily man that all protective barriers will come down.  Nobody really believes that China will become a level playing field overnight.  It will remain the case that if you want to sell in China, you must have a local presence in the country and play by their rules. 

Let’s take car imports as an example.  Over the first five years after China’s accession tariffs will be reduced by 75%.  But what will change much more slowly is the baffling array of provincial regulations such as restricting taxi licences to locally made cars, adding as much as US$ 10,000 to the prices of other cars and other bureaucratic hurdles to deter buyers.  Michael Dunne, president of Automotive Resources Asia said recently, “China is the master of building walls. Drop import duties to zero tomorrow, they’ll still find a way to keep imports out!” 

Any new barriers will be put into position by local authorities, rather than by Beijing, many of which already erect formidable barriers to out-of-province products, not to mention foreign manufactures.  Local protectionism is deeply entrenched.  This will enable the central government to profess to be maintaining its WTO commitment whilst turning a blind eye to local abuses.  Contravention of WTO rules at the local level is also more difficult to detect and to enforce. 

But that’s not all!  You might think that a lowering of tariff barriers would deter new investment but this is not the case in the motor industry.  Many of the world’s major manufacturers are falling over each other to build plants in China.  Once these plants come on stream, there is no way that they will want imports to come into the country and imports from abroad will find their market shrinking until only a limited number of luxury cars are imported.  The major manufacturers know that they will get protection and privileges from the Chinese government, that’s why they are in a hurry! 

A consensus has been reached between the government and the car manufacturers and they will act in concert to circumvent the rules of WTO and protect local industry.  Could a variation of this scenario be a template for your industry?  What threats will China’s accession to WTO bring to your company?  How can you capitalise on new opportunities? 

Big Changes in Trademark Law 

Trademarks have long been a bone of contention for western companies in China, mainly because China has operated a “first to file” system over the past eighteen years. A remedy is now at hand.  As part of preparations for entry into WTO, the State Council has revised the Trademark Law. 

The key revision is that those who use the trademark first, now get the rights to use it.  The new law is claimed to be in line with the International Trade Mark Treaty and other commonly accepted practices for the protection of intellectual property.  The change to a “first to use, first to own” rule is aimed at preventing opportunistic trademark registrations which have been widespread. 

Prior to the revision, trademarks could only be registered by a registered company, now any legal person is permitted to register a trademark and this is expected to lead to a major increase in trademark registrations.

 China’s Tenth Five Year Plan 

We are beginning to get some information concerning the Tenth Five Year Plan, due to be discussed at the forthcoming session of the National People’s Congress in March.  China will aim to achieve an average GDP growth of 7.2% over the period of the Plan.  One of the main sources of productivity improvement will be the shift of labour from the countryside to the towns.  This will be done in a controlled fashion through the establishment of a large number of small and medium-sized cities and towns. 

MNCs optimistic about FDI 

Multinational companies are becoming very optimistic about the prospect of a large, fast growing, domestic market in China coupled with expanding export demand.  The grounds for this optimism are: entry to WTO; China’s relative stability during the Asian financial crisis; and a pool of good engineering talent.  All this is leading to an increase in foreign direct investment. 

FDI will remain strong in the next few years, as indicated by the figure for January 2001, which was 21% up on the previous period last year.  What we are seeing is a repeat of the FDI rush in the early 90s, though this time, hopefully, companies will make more profit!