With the Chinese Government, on a regional basis, specifying "minimum amounts" for registered capital contributions in order to establish foreign-invested enterprises in China, and with a similar occurrence concerning total invested capital requirements, some confusion has arisen as to what these actually represent and how they should be allocated. Here we clarify this issue.
Types of capital
Capital obviously can take the form of cash, but beyond this basic type, the subject becomes slightly more complex. Equipment, machinery, in-kind contributions, intellectual property and technology are the most common forms, but each of these items will require specific review or approval.
Equipment and machinery, which are contributed, must be an integral element in the ongoing operation. Additionally, supportive documentation relating to the value of such goods must be supplied and be in accordance with global pricing benchmarks. Although there may be some flexibility with both of these requirements, they must be addressed and taken into consideration for planning purposes.
In relation to in-kind, intellectual property and technology injections, three points of order must be mentioned. First, similar to that of equipment, the items must be of significant importance to the underlying operation. Second, the value of such capital will be closely reviewed by a specific local government commission. This commission will likely have an understanding of the sector or specific technology and the asserted value should be carefully considered and documented. And third, which comes as a shock to many, the total recorded value of these items may not be in excess of 20 percent of the stipulated registered capital (with limited exceptions in hi-tech areas).
Registered capital
This amount is commonly stated as being a "minimum amount" and typically, figures such as the following are often quoted:
Minimum amounts of registered capital
Foreign-invested commercial enterprises
Retail: $36,000
Wholesale: $60,000
Wholly foreign-owned enterprises
Shenzhen: $100,000
Shanghai: $140,000
Elsewhere: $100,000 (or sometimes lower) to $200,000
Accordingly, many investors believe that this is the only amount required to be injected into the business and be planned for accordingly. However, this is not the case, and immediate cash flow problems and further unnecessary expense can be avoided if registered capital amounts are properly assessed and planned for.
Registered capital as operational cash flow
Although local governments and regulations may indeed specify "minimum amounts," the actual amount of registered capital to be injected into the business should be catered for on the basis of this being its initial operational capital needs-in short the amount of money required to sustain operational cashflow-until the business can support itself in China. Needless to say, this amount may very well differ from the "minimum amounts" specified by regional authorities and by uninformed consultants. Consequently, as in any professionally managed business plan, attention to detail should be taken when drafting cash flow projections to break even, as the shortfall in operational costs-whatever that is-is the amount that may be injected as registered capital.
Planning registered capital
This amount does not have to be injected upfront, although obviously a portion of it needs to be, as the business has cash needs from day one. Here, discussions with the local authorities and your advisors need to be frank and open, with amounts being dripped in over a period of time being permissible depending upon the business cash flow needs. This can take place over a 12-month period or longer. However, not paying up all identified registered capital does place restrictions on the business-not being able to repatriate profits for example, or sometimes certain other trading activities can be curtailed until the agreed amount has been received by the business.
Reinjecting renminbi profits ahead of capitalization
However, if your business has performed ahead of schedule and becomes profitable before the full capitalization has occurred, this can still be catered for without having to burden the parent company with this. Renminbi profits ahead of full capitalization can be retained by the business and reinjected as registered capital. Permission is required for this, however, the Chinese are actually also happy that the business has succeeded ahead of schedule-certain tax incentives are given to the company if it can achieve this. So not only is your head office happy, but also the China tax bureau is too.
Total investment
Using the understanding of registered capital we have developed, we can now begin to define the total investment. Total investment is the combination of registered capital and debt financing (debt financing can include loans from the parent company or from lending institutions). This debt financing portion is the vehicle by which an operation will enjoy some flexibility in working capital needs.
By making proper working capital/total investment projections, with the above table in mind, the stated registered capital can be derived through the following equation:
Total Investment = Registered Capital + Debt Financing
Although both the registered capital and total investment must be stated in the articles of association, only the registered capital portion must be injected. Thus, total investment may be merely limited to the registered capital amount.
Problems with low capitalization
If the business has been inadequately financed from day one-and this is a very common situation when being misled by the "minimum capital" amounts often quoted, then the impact can be serious. Obviously, the business is going to run out of cash. More money needs to be injected. This requires a relicensing application (costing money) to upgrade your business license and articles of association as well as another cash injection.
Chris Devonshire-Ellis is a senior partner at Dezan Shira & Associates, Business Consultants-www.dezhira.com |