China is the second biggest economy in the world and is experiencing extraordinary growth of around 9% per annum. It is also a key trading partner for the UK which is the largest EU investor in China. As such, a special relationship exists between the two countries and help and advice with entering the market is easy to access. UK Trade & Investment says that ‘Chinese demand increasingly meets UK business strengths’ and the current government has committed substantial political resources to strengthening relationships between the two countries.
However, Chinese business infrastructure is still lacking and China ranks 83rd in the World Bank ease of doing business tables. Starting a business and employing workers are ranked as particularly difficult. The legal environment is difficult and the China British Business Council points out that although the Chinese legal system is based broadly on civil law, ’judicial decisions do not have the force of law.
Key economic sectors
Manufacturing is clearly the main growth sector in China. However, as Chinese companies mature and international companies reinforce their intial investment in China, financial services, banking regulation, environment, design and engineering are coming increasingly to the fore. In terms of the the financial sector and banking, Ghanzhou in Southern China aims to be an international standard financial centre by 2020 and the Chinese government is opening the banking market to encourage both more sophisticated international standard banking services and the development of rural banking. Regulation and development of capital markets are also on the agenda.
In terms of the environment, the UK has committed £ 50 million to workng with China on improving energy efficiency through the UK China Working Group on Climate Change. This will create significant opportunities for British business.
The World Bank assess that China’s fiscal policy is prudent. The yuan is stable with the Government exercising tight control over monetary policy.
The banking sector is regulated by the People’s Bank of China and comprises a number of state owned commercial banks as well as private commercial banks. The PBOC has many of the same regulatory functions as western central banks and since China’s membership of the WTO in 2001 much progress has been made with opening up the banking sector. 74 international banks are active in the Chinese market and are permitted to offer the same services as domestic banks.
The securities market is regulated by the China Securities Regulation Commission and the regulatory system is compatible with a market economy. However problems of culture and corporate governance mean that the market is not geared to long term investment and is dominated by speculative trading.
Corporation tax in China was reduced from 33% to 25% for foreign companies in 2008 and preferential tax rates exist in certain zones and for companies which invest in priority sectors such as the environment and agriculture. A double taxation treaty is in place between the UK and China.
The Law on Wholly Owned Foreign Enterprises permits foreign investment in China in sectors deemed beneficial to the state. The law provides that foreign enterprises cannot be nationalised or expropriated except in the public interest, in which case compensation will be made. China specifies the sectors which are open to foreign direct investment and those which are closed to foreigners.
Sectors in which foreign direct investment is encouraged include high tech, manufacturing, logistics and the environment, while luxury property investment is being increasingly closed to foreigners, alongside industries that are considered strategic such as exploitation of mineral resources.
Possible business vehicles
Foreigners may operate in China by establishing either a representative office, a Joint Venture, or a Wholly Owned Foreign Enterprise (WOFI):
- Foreign businesses may establish a representative office in China for the purpose of marketing, collecting information etc., however the office must be non-profit making.
- Businesses wishing to establish a representative office must register with the appropriate authority in order to obtain approval and a business registration certificate.
- Representative offices must also register with the tax and customs authorities.
- Joint Ventures take the form of limited liability companies, with the partners contributing in real terms or in kind.
- The Law on Chinese-Foreign Joint Ventures provides that they must seek the approval of the relevant government department and a license to trade.
- Joint Ventures are encouraged to export their production and profits of the foreign investor can be repatriated.
- Liabilities and profits are shared in accordance with the initial investment.
Wholly Foreign-Owned Enterprises
- The procedure for establishing a WFOE is similar to that for a joint venture.
- The approval of the relevant government department must be sought and a license to do business obtained.
- Accounts must be maintained in China and the busness must register with the tax authorities.
- Profits may be remitted abroad and investments are protected by the law of China.
- Chinese labour law must be observed and it is specifically provided that the Chinese government may not interfere in the operation of the business.
On the face of it, China is moving forward, opening its doors to foreign law firms, developing a modern court system, particularly for commercial matters, training lawyers and establishing the rule of law. A significant number of foreign law firms have now opened representative offices in the major Chinese cities, taking advantage of the law of 2002 on representative agencies of law firms.
However, the legal profession and the courts are not truly independent and can suffer from government interference, particularly in politically sensitive cases. Law enforcement is complex and the World Bank points out that it takes, on average 406 days to enforce a contract in China. Corruption is an ongoing problem and courts may act inconsistently. There is no system of precedent in China and prior decisions are not binding leading to an atmosphere of uncertainty. Businesses are well advised to do all in their power to avoid commercial disputes or to try to settle them out of court. As foreign judgements are not enforceable in China, there is little point in suing a Chinese entity in a foreign court.
Laws are in place to regulate commercial activity and a network of economic courts deals with commercial cases. There are some encouraging signs that the courts are doing more to protect international business. In particular, in a recent case involving intellectual property, a Shanghai court found in favour of the international complainer and awarded substantial damages against the Chinese company involved. Court officials have announced that they hope that harsher penalties will help with intellectual property problems and that ‘ more international firms are suing and being sued’.
Alternative dispute resolution
Arbitration has had a place in the resolution of commercial and economic disputes in China since 1956. International arbitrations are now conducted through the China International Economic and Trade Arbitration Commission (CIETAC) which is apparently one of the busiest arbitration centres in the world. CIETAC has centres in three cities and liason officers throughout China. Arbitrations are conducted in accordance with a set of arbitration rules and China is a signatory to the UN Convention on the Recognition and Enforcement of Foreign Arbitral Awards. As a result, arbitral awards made in China may be enforced in the courts of other signatory states and China is bound to enforce awards made against Chinese residents.
Mediation and conciliation are deeply ingrained in Chinese culture and mediation is the chosen method to settle most labour disputes. It is becoming increasingly common in commercial disputes too.
The human rights situation in China is delicate despite an increasingly open attitude on the part of the authorities. Lack of respect for human rights can have an impact on doing business in China. Human Rights Watch has recently published a report on the situation of lawyers in China in which it identifies a high number of instances where lawyers face ‘violence, intimidation and threats’ because of their involvement in sensitive cases.
The problem arises from the fact that while China has made a commitment to observe international human rights standards and to improve the functionning of the courts and respect for the rule of law, the Party remains the supreme power in China.
The same problems can directly affect businesses seeking to trade in China as government interference and corruption can affect their day-to-day business, particularly if they are working in sectors which are in any way politically sensitive.
China has created a number of development zones which benefit from favourable tax regimes for foreign investors. In general , businesses established in these zones benefit from a 50% cut in corporation tax and around 2 years’ total exemption from corporation tax for the first two years of trading.
There are also tax refunds in respect of profits invested back into the business in China or other businesses in Enterprize Zones.
UKTI can provide support to British businesses investing in China.
For further information contact
Ben Stevenson , International Policy Advisor
Sonam Khan , International Policy Assistant