1. Doing Business with China
TAGLAW - Berlin 2008 AGM
Mark Ho & Blaine Turnacliff

2. Presentation Points Introduction Legal investment vehicles
Outbound investment
Real estate business in China

3. China: Big Numbers

4. Coming to Grips with the Numbers and therefore Potentials
1.3 billion people
0.7 billion peasants
0.2 billion migrant workers
200m aspiring middle class
100m middle class as now
14m engineers
140k lawyers

5. Courtesy of The McKinsey Quarterly 2006 special edition: Serving the Chinese consumer

6. China’s Comparative Disadvantages: the reality about this economic gorilla
25% of the world’s population, 6% of global economic activity (28% for US)
At current growth rates, by 2050 China will be the world’s largest economy, but the average Chinese will be poorer than the average American was in 2005
Excess labour
Innovation gap
Governance deficit
Commercial immaturity (SOEs)

7. Regional imbalances and movement

8. Six theatres for a China play

9. Foreign Investment Operating Structures in China
Representative Office
Equity Joint Venture
Cooperative Joint Venture
Wholly Foreign Owned Enterprise (WFOE)
Foreign Invested Commercial Enterprise (FICE)
Holding Companies

10. Representative Office
Quick (procedure to register is not complicated) and inexpensive way to establish a legal presence in China. Can carry out market research, render advice, collection of information, coordinate company activities in China and hire staff
No direct business activities permitted – cannot enter into sales contract, issue invoices, arrange for importing goods
no registered capital requirements
Do require a leased office before registration

11. Equity Joint Venture
In the 80s and early 90s, was the most commonly used foreign investment structure
First foreign investment structure allowed in China
Benefit to the Chinese economy - foreign party generally provides technology, management expertise & cash
Dividends / profits based on equity shareholding of each party

12. Cooperative Joint Venture
Similar to Equity Joint Venture in structure but with more flexibilities because
Sharing of profits may be governed mostly by JV contract
Foreign partner can obtain return of investment in priority to Chinese partner; or early recovery of investment

13. Wholly Foreign Owned Enterprise (“WFOE”)
100% owned by foreign investors
More and more industries are open to WFOEs (although still some restricted industries)
Complete control of operation – no local partner
It is becoming first choice of foreign companies
Approval and registration procedure similar to Joint Ventures
Minimum registered capital –4000 USD but should be proportional to scope of business plans

14. Foreign Invested Commercial Enterprise (FICE)
Allowed to engage in retail, distribution, agency and franchising
First time in modern history foreign companies could undertake trading
Become very popular
Franchisors need to own / operate two units for one year in order to begin franchise business
Lower minimum registered capital (4,000 USD legally but most companies invest much more)

15. Approval Procedures Feasibility study Letter of intent
JV contract (for JV only)
Audit report of investor
Articles of Association
Supervisory Board (new)
Capital investment requirements – generally 140,000 USD minimum for factory (less for consulting / trading co (new law now says 4,000 USD)

16. Exit Strategy
Need to have a plan in place that will allow you to pull out or sell your investment with minimum of difficulties and costs
Ten year minimum operational period to enjoy tax incentives
Wind up procedures are very onerous and time consuming
Offshore vehicle (SPV) enhances flexibility and presents options for both partners
liability, sale of company, tax considerations

17. Outbound Investment
Start of trend to invest overseas by Chinese companies that will continue for many years to come

18. The Chinese are Coming!
China’s appetite for commodities, natural resources, distribution networks for their products, desire to move up the value added chain
Over 1.5 trillion USD in foreign currency reserves
Fall of USD / appreciation of RMB
Government policy of “going global”
outbound M & A investment
4.3 billion USD in 2004
16 billion USD in 2006
24.6 billion outbound M & A in 2007

19. Outbound M & A Transactions
Notable Deals:
2.3 billion USD stake in Nigeria’s offshore oilfield by CNOOC
5.6 billion USD of Standard Bank (SA) by ICBC
4.3 billion USD of Canada’s Nations Energy’s Kazakhstan oil rights
Plus:
Recent purchase of 50 Airbus A320s for 3.3 billion
Expected 280 billion USD for 2,900 planes over next 20 years

20. Governmental Approval
Generally 3 or 4 step process
State Development and Reform Commission (SDRC)
Ministry of Commerce (MOFCOM)
State Administration of Foreign Exchange (SAFE)
If State Owned Enterprise, also State Assets Supervision and Administration Commission

21. Bank Financing Issues
Chinese domestic companies cannot borrow from offshore so must obtain funding in China
Can be easy if borrower is large co, but difficult if smaller
Foreign competitors often label the Chinese financing as government subsidies
In future, will likely see the rules on overseas borrowing loosen

22. Legal Services in China
Legal Services are relatively new in China
1989 was first year private law firms allowed
mainly very young, inexperienced lawyers, mostly 20 or 30s
Few have experience dealing with western companies

23. Real Estate Business in China

24. Real Estate Business in China
Chinese real estate sector is increasingly attracting foreign investment (300% property appreciation in the past 10 years or so); plus
Foreign business requires acquisition of real estate properties for operations

25. One Big Project

26. Property Ownership in China
No private land ownership, Only:
(i) State or (ii) Collective Ownership
Collective – rural areas or countryside
State – urban areas or cities
Concept that land ownership is separate from land use rights; types of use rights:
Allocated land use rights
Granted land use rights

27. Different Types of Land Use Rights
Allocated Land
Granted
Land (introduced post-1988)
Term
Indefinite term
Set term – usually 40 to 70 years
Use
Granted for designated purpose – usually agricultural or military or infrastructure use
Granted for a range of designated uses
Consideration
normal or nil consideration paid to the State
Land grant premium to be paid to the local Land and Property Bureau
Transferability
Not transferable (and therefore technically cannot be mortgaged)
Transferable subject to restrictions

28. Ownership of Buildings
May be privately owned
May be mortgaged, sold or leased
May be for an indefinite term
Subject to a term of land use rights
Subject to registration and certification
Subject to zoning regulations

29. Property Protection and Risks
Recording, Registration and Certificates
property ownership is recorded at different levels of government and there may be discrepancies in records for old buildings (municipal vs. district)
Most cities have open records to the public
Shanghai is at municipal level
Foreign ownership permitted but restricted

30. New Law
July 2006 Regulations– Opinion on Regulating Entry Requirements and Administration of Foreign Investment in the Real Estate Markets (Circular No. 171)

31. New Laws (July 2006)
Increased down payments (capital) to at least 30% for residential projects larger than 90 sq metre /unit
Business Tax of 5.5% of total transaction price for residential units sold within 5 years of date of purchase
Capital gains tax of 20%
Local Restrictions on Development Projects
set aside 70% of annual supply of residential land for low-rent housing
Ensure 70% of residential units built are not larger than 90 sq metres

32. Implications of New Laws
Can no longer use offshore company to directly purchase RE in China
So must pay China taxes on sale or transfer
If want to invest in Chinese RE, must set up a RE Development Company
Total Investment minimum – 10 million USD
5 million USD to be invested upfront

33. Establishing a Foreign Invested RE Development Company
Essentially two methods:
Project Development Company
bid and purchase land use rights
Acquire / merge with an existing Chinese Property Development Company

34. Project Development Company
Must participant in a public auction to obtain land
Generally pay bond to be eligible to participate
If win the bid, sign a Land Grant Contract with local government (Land Bureau)
Land Use Certificate is granted for a term depending on types of development purposes (40-70 years)
Set up WFOE / JV

35. Merge/Acquire Property Development Company
Due diligence and deal documentation
Financial and legal
Execution of M&A documentation
Application to Ministry of Commerce for approval
If approved, share transfer will be registered with local government
A Business license is issued

36. Use of non-RE FIE to Invest
Foreign Entities established in China can purchase RE only for “self use”
Self use means business or housing for staff/employees
Purchase of “excessive” residential units become grey area
Purchase of 100 units likely “excessive”

37. Lease of Chinese Real Estate
Office Lease: typical 2 year term
Facilities Lease: 20 year maximum
Retail Lease: 20 year maximum
Housing Lease: typical 1 year subject to renewal
Leasing Pitfalls: zoning, granted land; existing mortgage, etc.

39. Q & A Mark Ho mark.ho@jzfz.cn
Blaine Turnacliff
Address: 10/F, Longfeng Tower
No Yan’an W. Road
Shanghai , China Tel: (86 21)
Fax: (86 21) Website:
THANK YOU!