Setting Up Chinese Domestic Companies as a Foreigner: It’s a Huge Risk

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Op-Ed Commentary: Chris Devonshire-Ellis

Dec. 12 – One of the prevailing issues concerning corporate establishment in China is still that of small consultants suggesting setting up a local Chinese company as a vehicle for a foreigner to get started in China. By a domestic Chinese company we refer not to a FICE, WFOE, or any of the foreign-invested vehicles, but to the practice of setting up a local company with Chinese directors and shareholders, with the foreigner effectively believing he is running the show. It is a false assumption.

There are several reasons why the establishment of a Chinese domestic company as a vehicle to enter the Chinese market may appear attractive. Firstly, the capitalization costs are low, and often licenses for specific scopes of business can be easier to obtain than for a foreign-invested entity. Consequently, for cash-strapped foreigners in China, the opportunity to perhaps get involved with such a company, even to the extent of funding it, may appear attractive at face value. However, the reality is very different.

Foreigners are not permitted to be either directors or shareholders of Chinese domestic companies, so you are effectively signing away any rights to any value in the business completely. It may well be that Chinese “friends” or those linked romantically may suggest such an arrangement. There are also Chinese consultants “offering” services to act as your directors in such businesses. Yet China does not recognize the concept of nominee directors or shareholders, and such promises are not supported under Chinese law.

Unfortunately, over the years we have seen many disputes arise from foreigners working in and having “set up” what then turn out to be Chinese-owned businesses. These have ranged from highly successful bars and restaurants in Shanghai, to entire factories with a workforce of thousands in South China. Despite the foreign party providing the initial investment, hard work, and effort, they have ended up with nothing following the breakdown of the relationship. I have even had divorcing couples screaming at each other in our offices over such disputes. Yet the foreign party has no recourse, and remains at the mercy of the Chinese directors and shareholders. Many have simply been dumped, and seen their efforts come to naught. The message is clear – don’t get involved with such entities if asked to fund them unless you are in a marriage with a Chinese partner that is 100 percent secure.

In any event, foreigners investing in Chinese companies as a front for business activities in the country is something of a false economy. The establishment of a foreign-invested commercial enterprise (FICE) – which allows for a myriad of trading activities at minimal capitalization – is the correct way ahead. They are not expensive to set up and enshrine the foreign party as a shareholder and director in the business. And, to be quite candid, if as a foreigner in China you can’t afford the capitalization costs of a FICE then you shouldn’t be considering setting up a business anyway.

In the end, common sense prevails. Either properly fund a FICE, or steer clear of getting involved as an investor in a Chinese domestic company. If your China consultant suggests you do – go find a better one to discuss business with in China.

Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.

For further details or to contact the firm, please email china@dezshira.com, visit www.dezshira.com, or download the company brochure.

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