Hong Kong & Shanghai, Gateways to Asia

Jan V. M. Holthuis

6 June 2013, Moscow HIL International Lawyers & Advisers, Shanghai/Beijing

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Shanghai

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Pudong

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Shanghai

• Commercial Centre of China and home to China’s largest Stock Exchange

• Population of 16 million with average per capital GDP highest in China

• 1/12th of total industrial output value

• Shanghai port handles 1/4th of China’s total exports • 1/8th of China’s total financial revenue

• Shanghai should overtake Hong Kong at the time that the RMB will

become a freely convertible currency

The Chinese Market

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China GDP Growth 2011

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Business Climate

Source: The World Bank, Doing Business 2011

China ranks number 79 for “ease of doing business” among 183 countries. This indicates that China is not an easy place to do business, but it is still the top ranked economy among the BRIC countries.

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Private Consumption

Source: Economist intelligence Unit 2011; KPMG analysis © HIL 2013

Factors Chongqing (RMB) Shanghai (RMB)

Monthly wage (technical personnel)

1200-1600/m 3600-4000/m

Monthly wage (worker) 1000-1200/m 1700-2000/m

Social insurance 1177.6-17664/m 2338-11688/m

Electricity 0.551-0.843 0.815-0.885

Gas 1.8-2.4/m³ 3-3.8/m³

Salary Costs

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E-business

Source: PWC Analysis, Customers take control © HIL 2013

Rule by Law

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China’s Foreign Investment Law

• No direct business operations in China without prior government approval. Approvals are granted on the basis of the FI Catalogue

• The FI Catalogue encourages or restricts investment in specific economic sectors and protects China’s strategic industries (such as: automobile, media, banking and insurance)

• As the RMB is still not freely convertible, capital inflow and capital outflow is government controlled (State Administration of Foreign Exchange and State Banks approvals)

• Chinese law & regulations are an instrument to control FI and guide economic development

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FDI Catalogue

Source: Catalogue 2011

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China Policy Changes

1. Service Economy: change focus from fixed asset investment to “public goods” and “Made in China”

2. Green Economy: energy saving technologies, sustainable economy: important focus on agriculture and food safety

3. Development of Inland China regions: Chongqing (32 mio. inhabitants and world’s largest city) Chengdu (14 mio. inhabitants) are important inland metropole’s

China’s development has been a big success, but it has come at a price: environmental problems, growing gap between rich and poor, need for energy resources. Changes are necessary for China’s growth to be sustainable.

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Source: Ministry of Commerce 2013 Guiding Opinions on Attracting Foreign Investment, Shangzifa [2013] No.82 , issued on 14 March 2013

Encouraged Investment Sectors

1. Advanced manufacturing

2. High technology

3. Modern services

4. Energy-saving

5. New energy

6. Modern agriculture

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MOFCOM Opinion

FIE’s

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• Appoint a Chinese agent or distributor: Legally not too many restrictions. Difficulty is to find a reliable and committed Chinese counter-part. Contracts can be subjected to foreign law & arbitration. China International Economic Trade Arbitration Commission is an acceptable forum to settle trade disputes

• Set-up Rep Office in China. BUT: no invoicing, no direct sales, no Chinese bank account to be used for trading. The RO requires government approval. All business remains foreign business. Tax is levied on cost-plus

• Set-up a WFOE (wholly foreign owned entity) or joint venture with a Chinese party. Advantage is that all business becomes domestic (no need for international payment approvals): suppliers and customers can pay locally. Assembly of parts in WFOE can reduce VAT and import duty liabilities. CIT is 25%

Start Business in China

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FDI Ratio’s

Source: China Statistical Yearbook 2011 © HIL 2013

• A WFOE / JV do not have shares by registered capital. There are minimum registered capital requirements depending on the business activity

• Investors can not thin finance a WFOE / JV. There are capital ratio’s to be observed (next slide). Local financing by commercial banks is subject to local bank policy

• The decision making body in the WFOE / JV is the board of directors (minimum 3). Directors are appointed by the investors and appointment is regulated in the articles of association of the WFOE / JV or in joint venture agreements

• The directors of the board do not have power to represent the JV/WFOE towards third parties. This power is vested in the Legal Representative (LR). The appointment and dismissal of a LR is a burdensome affair (one of the flaws in Chinese law)

• The GM is appointed as an employee or service provider. More easily dismissed, but a crucial figure in the continuity of day-to-day operations

WFOE / JV

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Foreign Direct Investment

Verification and approval procedures

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Minimum Capital Requirements

Capital Requirement No possibility of thin financing. The following capital ratios need to be observed in FIE’s:

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Political Market Economy

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Judiciary

• Judges are appointed by People’s Congresses at corresponding level

• Trials system is inquisitorial, not adversarial

• Supreme Court is responsible to NPC Standing Committee (present chairman does not have a legal education)

• Interpretation Notices by SC, no legal precedent system

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People’s Prosecution Office

Chinese Courts

Hotlines Audit Office

National Bureau For Corruption Prevention NPC

CCDI Charged with

corruption of CCP-Members

Cooperates with Ministry of Supervision (unlimited

power to investigate, unlimited budget, shuang

gui (double rule)rule)

• CCDI responsible for investigating China’s 76 mio CP members discipline violations

Central Commission for Discipline Inspection

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China’s Legal System

• Becoming cornerstone for social stability

• Protect interests of the CCP

• Mixture of law and politics but becoming more professional in big cities

• Local economic interests influences decisions

• Enforcement can be problematic

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China – Russia Business

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• November 9, 2006, Agreement on the Promotion and Mutual Protection of Investment between China and Russia

- Mutual intention on promoting investment

• June 17, 2009, China-Russia Investment Cooperation Outline

- More specific implementations of the 2006 Agreement between China and Russia

- Preferential investment sectors: Machinery Manufacturing; Information Technology and Communication; Bank, Security and Insurance; Innovation and Applied Science Development; Fuel Energy Source; Chemical; Forestry; Mining; Regional Cooperation

• June 23, 2011, China-Russia Bilateral Agreement on Local Currency Settlement

- Use domestic currencies in bilateral trade (in the past, it was only applicable to the border trade, now the policy applies to general trade)

China & Russia Economic Cooperation

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• Advantages of the domestic currency settlement

– Example: money transfer from Russia to China on May 28th 2011 (same bank commission fee and received at the same time)

– Russian companies may hold the RMB deposit accounts in Russia

– Advantages: avoid the risk of foreign exchange rate (US dollar) changes; saving financing cost; less operational procedures to exchange currencies

RMB settlement

Transferred from Russia

RMB1,000 RUB 5,079.2 (equal to RMB 1,000)

USD 158.3 (equal to RMB 1,000)

Settled in China RMB 1,000 RMB 1,002 RMB 999.7

Source: http://newspaper.dbw.cn/jmsrb/html/2012-08/04/content_451971.htm

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Russian exports to China: recent deals:

• Petroleum – e.g. 2013 agreement between Roseneft and CNPC with respect to more petroleum

supplying (743,000 barrels per day starting from 2018)

• Natural Gas – e.g. 2013, memorandum between Gazprom and CNPC with respect to the natural gas

supplying (38 billion cubic meters starting from 2018)

• Coal – e.g. 2011, Winsway Coking Coal purchased 60% of the shares of Divalane who has the

mining right of the Apsatskoe coal mine. The exploited coals will be exported to China

Russia - China Trade

Source: http://online.wsj.com/article/SB10001424127887324557804578376510628682312.html http://news.xinhuanet.com/world/2011-05/05/c_121381497.htm; http://finance.eastmoney.com/news/1356,20130406283528016.html © HIL 2013

Maximum Foreign Shareholdings

Industry Maximum Foreign Shareholding

Limitation Source

Bank 100% (if WFOE foreign bank) 20% (if Chinese financial institution)

-- Administrative Regulations on Foreign-invested Banks (State Council [2006] No. 478) China Banking Regulatory Commission [2003] No. 6

Oil Processing 100% -- Catalogue of Industries for Guiding Foreign Investment 2011 edition

Exploitation 49% • limited to Sino-foreign equity/cooperative joint venture operations; • Maximum foreign shareholding is unclear based on the Catalogue. In practice, it will generally not be more than 50%

• Catalogue of Industries for Guiding Foreign Investment 2011 edition (encouraged sector); • verbally confirmed by MOFCOM

Mining 49% • limited to Sino-foreign equity/cooperative joint venture operations (excl: iron and manganese minerals exploitation) • Maximum foreign shareholding is unclear based on the Catalogue. In practice, it will generally not be more than 50%

• Catalogue of Industries for Guiding Foreign Investment 2011 edition (encouraged sector); • verbally confirmed by MOFCOM

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Hong Kong

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Hong Kong

Hong Kong has a common law system based on British law. The separation of the Hong Kong legal system to the PRC is guaranteed constitutionally until 2047.

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Hong Kong

Some facts: Hong Kong is one of the world's leading international trading and financial centers. Its port is one of the busiest and the HK dollar is one of the most traded currencies worldwide. These facts are due to: • Low corporate taxation • CEPA - preferential policy for investments in China • Free market policies • Well developed legal system, capital market and banking system • Corporate-friendly laws • Positioning: located close to China and Pearl River Delta

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Hong Kong

Low and simple tax system.

Corporate income tax is 16,5 % - levied on the Hong Kong-source profits of businesses carried on in Hong Kong.

No withholding tax on dividend distributions from a Hong Kong entity

No import or export duties (except for tobacco, liquor, etc)

Personal income tax is progressive up to max. 17% (on chargeable income less personal allowances)

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Why HK Route?

IN BRIEF:

• HK law more sophisticated for financing and exit scenarios for investments in Asia (no strict minimum capital requirements and share transfers can be easily executed)

• HK Ltd’s are structured as off-shore (zero CIT tax) and used for trading in Asia

BUT: Consider transfer pricing issues! Lack of substance in HK Ltd can create tax presence in shareholder’s home country!

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Hong Kong

Setting up a Hong Kong Limited (Ltd) Requirements: • No statutory minimum or maximum share capital • At least one shareholder (private or corporate) • At least one director (private or corporate) • One company secretary (Hong Kong resident) • Domiciliation in Hong Kong (through corporate services company)

A Hong Kong Limited can be incorporated within 7 working days.

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Thank you!

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