Registered capital--the mechanics

Registered capital can be contributed in cash or in kind, the latter normally being imported equipment or perhaps intellectual property rights (although in-kind contributions cannot exceed 70 percent of the registered capital). Note that it can be time-consuming to inject equipment as registered capital, rather than buying it using the registered capital cash. Locally obtained renminbi cannot be injected as registered capital, it must be sent in from the overseas investor.

The ratio requirement between total investment and registered capital is indicated by the authorities and must be specified in the JV’s contract, articles of association and feasibility study report, if applicable. The payment schedule of the registered capital also needs to be specified in the contract and articles of association. The investor may choose to pay in a lump sum or through installments.

The difference between registered capital and total investment represents the debt of the investment and can be made up with loans from the foreign investor or from overseas financial institutions (again, there are regulatory ratios), but not domestic banks.

Note also that if you inject more money without it being marked as registered capital, it is assumed this is taxable income (registered capital is not taxable), so you lose quite a lot if you do reinject after running out.

Reclaiming registered capital

After the registered capital is wired into the registered capital account in China, this amount cannot be wired out again freely. The money will be used as operational costs. Some advisors may tell you that you do not need actually to wire the money into China, or they can help you wire the registered capital out of China after the capital is verified. This is totally illegal. Do not do this.

Specific JV structural issues

- Management

Many companies leave the entire operations up to the Chinese partner to run. This is a crucial mistake. A new business needs all the support it can get. You need to invest in a foreign manager to keep an eye on things, especially during the early stages. Correct systems, accounting and quality control issues all need to be taken care of. You have standards. Ensure these are implemented and operational in your JV. The ideal solution is an expat manager. However, the general manager is responsible for the operations of the business. It is wise to make this one of your personnel.

- Capital investment

When negotiating the amount here do be sure that the Chinese side’s investment really is worth that amount of money. It is a pre-requisite to have asset and stock valuations. Also, check the Land Use Rights Certificate. If they can show these are granted rights, with no administrative or judicial enforcement measures such as sealing-up, seizure or freezing in connection with the asset, then they own the land. If they are just allocated, they don’t own the land and the right to use it should just be the rental value. See also the Due Diligence section in the next issue.

- Royalties

This can be built in as part of your investment. Protect yourself. Patents and trademarks should be properly registered in China as being your property if you want to retain control over their use. Technology transfer can be paid in the form of royalties from the JV. Ensure contracts are in place and that you understand the legal and tax implications.

Don’t just assume it’ll be taken care of. Be smart. Get it looked after. Withholding tax applies to royalty contracts at a rate lower than profit tax in most cities in China, so get those agreements in there. It saves you money.

- Profits repatriation

Make sure this is adequately addressed. The Chinese partner is not so concerned about this, and won’t be familiar with the procedures or mechanisms in any event-they never had to do it before. You can pull money out of the business in pre-tax expenses. Also ensure you know the mechanisms and have enhanced your ability to repatriate funds as much as possible. As mentioned, don’t rely either on the basic draft contract or your Chinese partner to take care of this. They won’t know how to do so. It’s your problem, not theirs and they won’t have any experience in it. Get professional advice, it will save you money.

- Future mergers and acquisitions

Be sure to build into the contract and articles proper mechanisms outlining exactly the procedures and protocol for changing ownership, buying and selling shares in the company, share valuations and so on. These are not properly covered in basic drafts, and if the time comes you want to consider this you had better have them in place or you may be stuck. Amendments to articles require government approval. Highlighting your intentions later on may result in problems with getting amendments considered in your favor to be approved. Build the mechanisms in from the start.

- Exit strategy

Clearly define what are to be considered unacceptable levels of business (losses in consecutive years, production below targeted levels, etc.) and have these agreed upon and set in the contract and articles. Often they are not and this can lead to problems with getting you out of a JV if the government does not agree with your assessment of what is and is not a viable business. Make sure economic performance is properly identified as a clear reason to effect closure if things do not work out as planned.

In Issue 43, we will examine legal and financial due diligence as relating to JVs.