China WFOEs Rising: the Official Explanation vs. the Real Explanation

Shanghai Daily is out with an article detailing increased foreign investment into China, both in terms of foreign companies having established more new enterprises in China (WFOEs and Joint Ventures and Representative Offices) and in terms of the amount of foreign direct investment in dollars:

China’s foreign direct investment last year rose 6.4 percent to 781.3 billion yuan (US$126.2 billion) compared to 2014’s increase of just 1.7 percent, Ministry of Commerce data released yesterday showed.

Foreign investors set up 26,575 new enterprises on the Chinese mainland in 2015, 11.8 percent more than the year before and taking the number of foreign-invested firms to 836,404 by the end of the year with a total investment of US$1.64 trillion.

Why is this happening when China’s economy has been anything but robust? The Shanghai Daily version is that China’s reform  efforts is whetting the desires of foreign companies to do business in China:

“China attracted record-high foreign investment last year, thanks to our strengthening reform efforts, which enabled investment to become bigger in size and better in quality,” the ministry [of Commerce] said in a statement.

It is unclear what is meant by reform in the above quote, but the sense we get from the implication both in the above English language story and in the Chinese press is that reform means an opening up of business to foreigners.

From my perspective and that of the China lawyers I know who actually spend much of their time counseling foreign companies seeking to do business in China, the “reform” actually driving foreign companies to choose to open more companies in China and to send more money to those companies is more due to the following, some of which can be called “reforms”:

1. China has gotten really really good at taxing foreign businesses on the income those businesses receive on their sales to China from outside China, taking away an advantage in not having a company in China. This is particularly true of taxing foreign service companies that provide services to Chinese companies from outside China. See Service Companies in China: How to Get Paid.

2. It is getting more difficult for Chinese companies to send money outside China. Setting up a WFOE in China is one way to better ensure payment. Just yesterday, we wrote about how the problem of getting money out of China is accelerating. See Getting Money Out of China: What the Heck is Happening?

3. It is becoming increasingly necessary to be in China to make money in China. Though it remains possible for select companies to be able to sell into China from the United States or Europe with no presence whatsoever in China, both competition and Chinese government pressure are reducing the situations where this makes sense. Our China lawyers are getting way more calls from American and European businesses that have thrived by selling into China from their own countries, but whose China sales are now declining. These companies are looking either to form a China WFOE to sell to China on their own, or are looking to cut deals with China distributers or resellers or simply to license out their name and/or their technology to a Chinese company. For more on these non-WFOE options, check out the following:

• How to Form a WFOE in China, Part 12: Do You Really Even Need One?
• China Distributor Agreements: A Relatively Easy Way to Sell Your Products into China
• China Licensing Agreements: The Extreme Basics
• Foreign SaaS in China: Get off of my cloud (on reseller relationships)

Bearing out exactly what our China attorneys are seeing/experiencing, the biggest jump in China FDI growth has come from the service sector:

Foreign capital channeled into the service sector rose 17.3 percent to US$77.2 billion, leading FDI growth and making up 61.1 percent of the total.

Also not surprisingly, investment in high-tech manufacturing is also booming, while investment in cyclical industries is on the decline:

Investment in high-tech manufacturing grew 9.5 percent. Industries with serious overcapacity, such as steel, cement, shipbuilding and glass, had almost no foreign investment, the ministry said.

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Foreign-invested companies produced almost half of China’s outbound trade, a quarter of its industrial output, a seventh of its urban employment and a fifth of the taxes, the ministry said.

The explanation for the increase in foreign investment in high-technology manufacturing likely stems more from the massive demand for high-tech goods than to any China reforms. High-technology is booming worldwide and virtually no matter what happens to China’s economy, China (in particular, Shenzhen) is going to remain the center of that. In fact, with the RMB falling, China’s attractiveness as a high-technology center will likely only increase. And as foreign high technology companies become more comfortable with manufacturing their products via OEM/outsourcing to Chinese factories, they will correspondingly become more comfortable with forming WFOEs in China to oversee their OEM operations in China or sometimes even to begin doing their own manufacturing in China. We also are increasingly seeing foreign companies that have gone into China to manufacture now looking to form China WFOEs to sell the China-manufactured products within China.

What are you seeing out there?

The post China WFOEs Rising: the Official Explanation vs. the Real Explanation appeared first on China Law Blog.

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.