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Shanghai Bound: New Regulations Seek to
Attract Regional HQs
By Ron
(Rongwei) Cai
[August 2002]
On July 20 2002, the Shanghai municipal government
issued the Encouragement for Foreign Multinational Companies
Establishing Regional Headquarters Tentative Provisions (the
Tentative Provisions). With their issuance, Shanghai seeks to make
itself attractive as a centre for international business, but how
inviting are the provisions in the new law?
Many multinational companies, particularly those that
have multiple investment projects in China, have long asked the
Chinese government to recognize their need for in-country holding
companies. Ideally, such holding companies should be able to consolidate
their financial support, IT support, HR management, sales and marketing,
technology support, general administrative support, import and export,
R&D and other functions.
In response to such demands, the Ministry of Foreign
Trade and Economic Cooperation (MOFTEC) has, since 1995, allowed
about 180 multinational companies to set up their holding companies
(termed "investment companies" by MOFTEC) in China 1.
However, in spite of several amendments to the 1995 regulations,
the current MOFTEC regulations are still very conservative, and
many multinational companies still do not feel an investment company
is worth its price tag: the MOFTEC regulations require US$30 million
in new investment for investment companies, and the benefits are
still very limited.
Competition at Home and Abroad
By comparison, investment environments, including
legal requirements, for holding companies in Singapore and Hong
Kong are much more attractive to multinational companies. Since
1997, Singapore has enacted several laws to attract multinational
companies to set up their regional headquarters in Singapore. The
regulations set different benchmarks for "Operational Headquarters",
"Business Headquarters" and "Manufacturing Headquarters,
among others. The requirements set by the Singapore government are
much less stringent than those for investment companies in China,
and the benefits are greater.
Partly as a result of the Chinese national government's
conservative approach, many multinational companies have chosen
to keep their China or regional headquarters in Hong Kong or Singapore.
Although there have been several highly publicized regional headquarter
relocations to China, most multinational companies are not attracted
by the current environment in. The reasons include:
(a) foreign exchange control requirements
on regional headquarters are as strict as those on any other types
of companies;
(b) import and export control, customs clearance,
immigration and visa processes are highly restrictive and complicated;
(c) tax and import duties are still very high
compared with Hong Kong or Singapore; and
(d) infrastructure, freedom of information, the
rule of law, and quality of life in mainland cities are still inferior
to either Hong Kong or Singapore.
While MOFTEC has taken
a conservative approach on holding companies, some local
governments have been offering special policies or waivers to accommodate
multinational companies' needs to consolidate some of the administrative
and financial activities for their subsidiaries in China.
Beijing, Shanghai and Shenzhen, where most of
the multinational companies are located, are all studying the above
issues. Beijing so far has attracted the most multinational holding
companies. Shanghai, however, arguably has the best chance to compete
with Hong Kong and Singapore for regional headquarters due to the
concentration of new foreign investment in Shanghai and its nearby
region, and better quality of infrastructure, work and living environments
for foreign employees. In recent months, several multinational companies,
including GE Plastics, moved their regional headquarters to Shanghai.
In the past year, the Shanghai municipal government set up a special
task force to study the feasibility of policies on regional headquarters.
The task force sent delegations overseas, including to Singapore.
The Tentative Provisions are presumably a result of the findings
of the task force and the Shanghai government's determination to
make a move ahead of the national government and the other cities.
Requirements for a Regional Headquarters
Definition
Under the Rules, "regional headquarters"
means:
(a) an investment or management FIE (typically
in the form of a WFOE) established in Shanghai municipality;
(b) one that is invested by a multinational company;
(c) one that becomes the only organization in
the region authorized by the multinational company to exercise overall
management and service authorities over such multinational company's
other subsidiaries in the region; and
(d) the authority of which is obtained through
its investment in such subsidiaries or through delegation of power
by the multinational company.
Conditions and Requirements
A regional headquarters needs to meet the following
conditions and requirements:
(a) It should be an FIE with independent legal
status (i.e., an incorporated entity). It is, however, unclear whether
a multinational company can convert one of its existing FIEs in
Shanghai into a regional headquarters.
(b) Such an FIE generally will be in the form
of an investment company or management company. It is unclear whether
an investment company set up under the Tentative Provisions should
also satisfy the conditions and requirements set by MOFTEC's rules
on investment companies. If the answer is positive (which appears
to be implied in Article 5), then it is foreseeable that many multinational
companies will use the form of a management company, rather than
"investment company", to circumvent the high requirements
(US$30 million in new investment) set by MOFTEC.
One further question in this regard is whether
an investment company or management company can be engaged in manufacturing
or other profit making activities. This question is related to the
issue of whether a multinational company can convert an existing
FIE into a regional headquarters. Currently many multinational companies
have been using one of their existing FIEs in China to act as a
de facto administrative and support centre.
(c) The multinational company's total assets must
be no less than US$400 million. This can be proved by a copy of
the multinational company's financial statement.
(d) The multinational company's total investment
in China shall be no less than US$30 million. In China, there are
two distinctive terms in foreign investment- related laws: registered
capital (equity investment) and total investment amount (equity
plus shareholder loans or third party debts that are typically guaranteed
pro rata by shareholders). Here the amount arguably referred to
is the accumulation of the multinational company's total investment
amounts in its FIEs in China. It is unclear whether the new investment
of US$2 million can be included in the US$30 million benchmark.
(e) The regional headquarter should invest in,
or manage, no less than three FIEs in China and should have the
authority to manage and provide services to these FIEs. It is unclear
whether Taiwan, Hong Kong and Macao are considered parts of China
in the Tentative Provisions. However, reading from the context of
the new legislation (Article 15 in particular), it appears that
its subsidiaries or affiliates in Taiwan, Hong Kong and Macao would
not be counted for the purpose of the Tentative Provisions.
Interestingly, other than the general requirement
that a regional headquarters should manage and provide services
to its subsidiaries in more than one country, the Tentative Provisions
have no reference to the regional headquarters' required activities
or functions outside of mainland China. Article 5 does not even
ask for evidence to show such regional functions as a condition
for the approval.
(f) If the regional headquarters is in the form
of a management company, the management company should have a registered
capital of no less than US$2 million. Assuming an existing FIE in
Shanghai can be converted into a regional headquarters, then the
question becomes whether such a FIE can satisfy this capital requirement
by showing its existing capital, or does it have to show a US$2
million increase in capital.
The Tentative Provisions also provide that those multinational companies
that do not satisfy all of the conditions listed in (a) through
(e) above, but have made extraordinary contributions to the region's
economy, may also be approved to set up regional headquarters in
Shanghai. What "extraordinary" actually means is not clear.
Benefits as a Regional Headquarters
Permitted Activities
A regional headquarters may engage in the following
management and services to/for its subsidiaries:
(a) investment and operational decision making;
(b) marketing and sales services;
(c) capital (i.e., treasury functions) and financial
management (i.e., accounting functions);
(d) technical support, research and development;
(e) information support and services;
(f) employee training and management; and
(g) other operational, management and service
activities as permitted by law.
Other Benefits
Other benefits include:
(a) a regional headquarters that is also engaged
in research and development can enjoy preferential treatments as
a hi-tech enterprise;
(b) regional headquarters set up in Pudong will
enjoy preferential tax treatments all other FIEs in Pudong enjoy;
(c) regional headquarters that provide employees
with training in critical job skills may be qualified for government
subsidies for the training;
(d) foreign employees and visitors sent to the
regional headquarters will be able to obtain employment visas or
business visitor visas for from one to five years;
(e) if a regional headquarters establish a purchase
or distribution centre in Shanghai, such centres will enjoy import
and export rights, and its exported goods will enjoy VAT rebates.
It is unclear whether such regional headquarter can qualify itself
as a purchase or distribution centre.
Outstanding Problems
Like investment companies
under the current MOFTEC Regulations, regional headquarters in Shanghai
will likely find that some of the benefits important to multinational
companies in China are still not provided. The unsolved problems
include:
(a) The US$2 million
registered capital requirement is still too much for some multinational
companies. This is particularly true if Shanghai COFTEC will require
regional headquarters to be in the form of a new FIE rather than
allowing conversion of an existing FIE.
(b) The government
needs to offer low corporate and personal income taxes or tax rebates
to match the low taxes in Hong Kong and Singapore. As the tax rates
are set by the national tax authority, local governments, including
the Shanghai municipality, are not in a position to lower the tax
rates. Some local government authorities, however, acknowledge that
personal income tax in China is excessive and may be willing to
negotiate with some foreign investors on tax liabilities as a package
deal.
(c) The government
needs to lower or waive the business and income tax on regional
headquarters' business income (or cost sharing) derived from its
subsidiaries for financial and administrative support, etc. Multinational
companies have complained that tax on cost sharing effectively increases
the operational costs of multinational companies, making holding
companies or regional headquarters unattractive. Again, it is unclear
whether the Shanghai municipal government is in a position to offer
such a tax concession.
(d) Like the MOFTEC
regulations, the Tentative Provisions allow regional headquarters
to manage inter-company loans among the FIE subsidiaries. However,
the People's Bank of China (PBOC), the central bank, has never allowed
investment companies set up under the MOFTEC Regulations to actually
lend money to their subsidiaries or to allow those subsidiaries
to lend money to each other. Instead they need to find a bank to
handle such transactions as an intermediary. The bank will charge
service fees and use its own loan documents. Thus this PBOC restriction
effectively renders such benefits meaningless.
(e) It appears that
a regional headquarters will not be able to enjoy import and export
rights unless it is also qualified as an investment company under
the MOFTEC Regulations, or unless it sets up a purchase or distribution
centre. Thus, it is unclear whether a regional headquarters will
be able to assemble or integrate semi-finished products from subsidiaries
or suppliers in both China and other countries.
The Tentative Provisions are a clear signal
from the Shanghai municipal government that it seeks to compete
with other cities in Asia as a regional business and financial centre.
Whether the new legislation will be effective in helping Shanghai
attract multinational companies in the immediate future will, to
a large extent, depend on whether Shanghai can persuade the tax,
customs, foreign exchange administration, central bank, border control
authorities and other central government authorities to recognize
the need to provide incentives to multinational companies that may
be interested in establishing regional headquarters in Shanghai.
FOOTNOTES:
1
MOFTEC, Establishment of Companies with an Investment Nature
Tentative Provisions, promulgated and effective April 4 1995.
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