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Since December 2004, foreign investors have been allowed to establish wholly foreign-owned wholesaling and retailing enterprises in China with significantly relaxed entrance requirements. Dickson Leung and Carl Poon of MSI's Chinese accounting firm member, LehmanBrown, raise a few practical considerations that foreign investors should keep in mind before making any investment decision.
China, with its large population, represents one of the largest consumer markets in the world. Whilst foreign investors have been finding opportunities for penetrating into such a huge domestic market, the PRC government had, in the past, imposed onerous restrictions on foreign investors who wished to enter into the wholesaling and retailing markets. Even if the high entrance threshold was met, foreign investors were only permitted to establish joint venture trading enterprises with Chinese partners and could at most hold 49% equity interests in these ventures. In other words, it was impossible for foreign investors to become the controlling stakeholders.
Because of these stringent requirements, it is not uncommon to find aggressive foreign investors carrying out trading activities that are not in compliance with the PRC business regulations. For example, local Chinese citizens might be used as nominees to circumvent the rigid business entrance requirements, or representative offices may negotiate and conclude trading contracts as well as collecting business receipts from customers. Individual Hong Kong investors, particularly those operating in the Guangdong Province, would even infiltrate the trading market by establishing domestic companies in the form of individual households to carry out their wholesaling and retailing businesses in the PRC. These activities, however, contravene PRC business regulations. For example, the operation of representative offices beyond their permitted business scope can result in fines and, in more serious cases, the revocation of business licenses. Violations such as these can cause foreign investors to be blacklisted, leading to adverse impact on future business expansion in the PRC.
Furthermore, there are practical pitfalls. For example, how can the interests of the foreign investors be safeguarded if these wholesaling and retailing businesses are operated through local Chinese citizens? Who is, or are, the legal owner(s) of the business? Can the financial results of these PRC establishments and the nominee arrangement be consolidated into the foreign investors’ financial statements in their home countries? Last but not least, the establishment of individual households in the PRC is not buttressed on solid legal grounds; this would lead to unnecessary legal disputes. These represent only some of the many questions that have to be considered.
Since China’s accession to the WTO in 2001, the government has promised to gradually ease the restrictions on foreign investment in trading businesses within three years. Finally, the Ministry of Commerce officially announced that foreign investors would be allowed to establish wholly foreign-owned wholesaling and retailing enterprises in the PRC (hereafter referred to as the “WFOTEs”) from 11 December 2004. The minimum registered capital for establishing a WFOTE has been significantly reduced to RMB 500,000. This announcement is definite good news to foreign investors contemplating to expand their trading operations in the PRC.
From a practical standpoint, the relaxation of the entrance requirements benefits foreign investors in many ways: greater discretion, as WFOT
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