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Chinese Partnership – A New Alternative… A Better One?
Thinking of investing in China? A new alternative is now available. The long-awaited Administrative Measures for Foreign Enterprise and Individuals to Establish Partnerships in China has been issued by the Chinese State Council. Taxand China investigates these changes and suggests possible structures for foreign investors to consider. Find out how you can take advantage.Effective from March 1, 2010 Chinese partnerships can be formed with:
- two or more foreign enterprises or individuals
- foreign enterprise(s) or individual(s) and Chinese individual(s)
- enterprise(s) or other organisation(s).
In addition foreign enterprises and individuals are allowed to become partners in a partnership formed by Chinese individuals, Chinese enterprises or other organisations. Good news for foreign investors?
Taxand China investigates these changes and suggests possible structures for foreign investors to consider. Find out how you can take advantage.
In the past, foreign investors could form Wholly Foreign Owned Enterprises ("WFOE"), Equity Joint Ventures ("EJV") or Corporative Joint Ventures ("CJV") in China to carry out business operations.
- The Measures state that the establishment of a foreign partnership only requires registration with the State Administration of Industry and Commerce ("SAIC"). People who are familiar with Chinese rules may be aware that the establishment of a WFOE, EJV or CJV requires the approval of the Ministry of Commerce ("MOFCOM") prior to the registration with SAIC.
- Special approvals from the relevant authorities are still required in special projects or industries.
- Partnerships whose main business is investment activities should be subject to the applicable rules and regulations.
- Taxation was not mentioned in the Measures. However, under the Partnership Law, the partners would be subject to income tax separately.
Compared to the existing foreign investment vehicles, a partnership may have the following advantages:
- Easy to set-up: The first headache encountered by many foreign companies when they come to China is the complicated set-up procedures and documentation requirements for a Chinese subsidiary. The procedures for setting-up a partnership are simpler than compared to WFOE or JVs.
- Income Tax: Although the current rules do not provide details on the taxation of partnerships, as a general principle under Chinese tax rules, the partnership would be transparent. Partners pay tax instead of the partnership itself.
- Indirect Tax: This may also open planning opportunities for indirect tax. For example, for business tax which is applicable on many inter-company charges, using a partnership with a specific distribution mechanism may help to achieve the same purpose while avoiding the business tax on inter-company charges.
- Investment/Operating Flexibility: A number of alternative structures are available for foreign investors in setting up their investment holding and operating structures.
More Questions Emerge
While the Measures have been welcomed by different interest groups, a number of questions have also emerged:
- Allowed activities: Article 14 of the new rules mentions that a partnership whose main business activity is to make investment should follow the other applicable rules and regulations.
- Funding: What can be used for funding except for cash? While the rules specifically mention that the partnership could be funded by RMB or freely convertible currency, it does not specifically mention if in-kind contributions are allowed, e.g. Intellectual Property (IP). In addition, a critical question is whether the equity shares in a Chinese resident company can be used as capital contribution.
Furthermore, what would be the loan capacity of a partnership with a foreign partner(s)? There are debt-to-equity ratio thresholds for a WFOE or JV therefore will a similar rule apply to a partnership with foreign partner(s)?
- Taxation: Article 6 of the Partnership Law sets out the fundamental taxing principle - each partner should pay income tax on its share of income derived from a partnership. However, there are still many uncertainties due to the lack of comprehensive taxation rules on partnerships, especially regarding foreign partners.
For instance, how will a foreign partner be taxed if the partnership is doing active business in China? How will a foreign partner be taxed when the partnership is limited to the function of investment holding? How will the Permanent Establishment (PE) rule apply to a foreign partner?
The new rules open up new alternatives for investors. Following are illustrations of possible new structures which could be considered by a foreign investor:
Using a Partnership as an Operating Vehicle
- Foreign Holdco as limited partner and Foreign Management Co as general partner.
- Foreign Holdco and management co. subject to PRC Withholding tax (WHT)/Income tax. directly, Opco not subject to PRC Income Tax.
- Possible easier repatriation of profits.
- Possible lower taxation (Foreign Holdco may be subject to WHT only).
- PE exposure limit to Foreign Management Co.
Using a Partnership as an Investment Holding Vehicle
- Foreign Holdco as limited partner and Chinese Management Co. as general partner.
- Minimise PE exposure on investment activities.
- Flexibility in raising local funding.
- Possible lower capitalisation requirement compared to existing investment vehicles.
- Flexibility in allocation of profits with Chinese party.
Using a Partnership as a Licensing Vehicle
- Foreign IP Co injects IP as the limited partner and Chinese Management Co. manages the licensing activities as the general partner.
- Allowing licensing in RMB, repatriation in hard currencies.
- Avoid double business tax in sublicensing.
- Minimise PE exposure in licensing activities.
Although the above are hypothetical scenarios, it can be seen that the new partnership rules open up a lot of alternatives for foreign investors to structure their Chinese investment and operations.
While there are still a lot of questions and uncertainties about the implication and future development of the partnership rule, in such a fast developing economy like China, time is of essence. An efficient business and tax structure is of key importance in today's global environment. We believe it won't be long till we see partnership structures start to evolve in China.
We will keep you updated.
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