JV (Joint Venture)

"Joint ventures are usually established to exploit the market knowledge, preferential market treatment, and manufacturing capability of the Chinese side along with the technology, manufacturing know-how, and marketing experience of the foreign partner."

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EJV (Equity Joint Ventures)

Profit and risk sharing in a joint venture are proportionate to the equity of each partner in the joint venture, except in cases of a breach of the joint venture contract. Share holdings in a joint venture are usually non-negotiable and cannot be transferred without approval from the Chinese government. Investors are restricted from withdrawing registered capital during the life of the joint venture contract.

It is preferable that foreign exchange accounts are balanced in order to remit profits abroad so that the repatriated foreign exchange is offset by exports from the joint venture. With the elimination of foreign exchange certificates and the further opening of the China market, this requirement is becoming more and more relaxed.

The permissible debt to equity ratio of a joint venture is regulated depending on the size of the joint venture. In situations where the sum of debt and equity is less than US$ 3 million, equity must constitute 70% of the total investment. In joint ventures where the sum of the debt and equity is more than US$ 3 million but less than US$ 10 million, equity must constitute at least half of the total investment. In cases where the sum of the debt and equity is more than US$ 10 million but less than US$ 30 million, 40% of the total investment must be in the form of equity. When the total investment exceeds US$ 30 million, at least a third of the sum of the debt and equity must be equity.

Equity can include cash, buildings, equipment, materials, intellectual property rights, and land-use rights but cannot include labor. The value of any equipment, materials, intellectual property rights, or land-use rights must be approved by government authorities before the joint venture can be approved.

CJV (Cooperative Joint Venture)

There is no minimum foreign contribution required to initiate a cooperative venture, allowing a foreign company to take part in an enterprise where they preferred to remain a minor shareholder. The contributions made by the investors are not required to be expressed in a monetary value and can include labor, resources, and services. Profits in a cooperative venture are divided according to the terms of the cooperative venture contract rather than by investment share, allowing a more flexible schedule for return on investment in cases where one investor provides cash while the other party’s investment is primarily in kind.

Greater flexibility in the structuring of a cooperative venture is also permissible including the structure of the organization, management, and assets. There are no conditions for unlimited terms in cooperative ventures, and also no provisions for the terms of the duration. The term of the cooperative venture contract may be renewed subject to the consent of the parties involved and approval from the examination and approval authorities. The foreign investor is permitted to withdraw their registered capital or a portion thereof from the cooperative venture during the duration of the cooperative venture contract.

Because of the unique privileges and added features offered to the foreign party in a cooperative venture, trade unions must be allowed to represent the employees in employment matters to protect the interests of the employees.

Key Issues Regarding Joint Ventures

(i) Nature of JV Project

The principal differences between an EJV and a CJV can be simply summarized as follows -

EJV:
Each party must make cash or permitted contributions in proportion to its subscribed percentage of the EJV’s registered capital.
Profit must be distributed strictly in accordance with the parties’ respective percentage shareholding of the registered capital of the EJV.
Upon dissolution of the EJV at the expiry of the term of operation, the EJV’s net assets are to be distributed to each party in accordance with its respective shareholding of the EJV’s registered capital.

CJV:
A party (typically, but not always, the Chinese party) may contribute non-cash intangibles in the form of “cooperative conditions”. Such “cooperative conditions” may consist of market access rights, rights to use buildings or office space owned or leased by the party that are not subject to clear valuation. In exchange for such “cooperative conditions”, the party is entitled to participate in the distributable earnings of the CJV.
Profit sharing in a CJV need not be made strictly in accordance with the parties’ respective percentage shareholding of the registered capital of the CJV but can be made in accordance with the agreement of the parties (e.g. the Chinese party may be entitled to a fixed profit share with the balance to be distributed to the foreign party, or the parties may agree on a multi-tiered profit-sharing arrangement that permits the foreign party to recover an amount equal to its capital investment on a priority basis, following which the profit split will be changed, etc.).
 Upon dissolution of the CJV at the expiry of the term of operation, the CJV’s net assets may be transferred to the Chinese party without compensation so long as the foreign party has been able to recoup its capital contribution during the term of the CJV. Such recoupment typically is funded by excess cash flow generated by accelerated depreciation of the CJV’s assets. Such arrangements require the approval of relevant finance and tax authorities in China. Note that this capital recoupment is separate and distinct from priority rights to receive after-tax net profit distributions.

(ii) Capitalization of JV
The concepts of authorized and issued capital are not used in connection with Sino-foreign joint ventures. Instead, the concepts of “registered capital” and “total investment” are employed. Under applicable PRC law, registered capital is defined as the total amount of capital contributions subscribed to by the parties and registered with the Chinese authorities. Thus, the term “registered capital” refers to the parties’ equity in the venture. The concept of “total investment”, on the other hand, includes both registered capital and external borrowings. Pursuant to regulations promulgated by the SAIC, certain minimum equity requirements are imposed on joint ventures. PRC laws governing joint ventures require that the foreign party contribute no less than 25% of the registered capital.
The capital to be injected by the parties constituting their capital contribution may take a variety of forms including cash, machinery, equipment and intangible property, such as proprietary technology, trademarks and other industrial property rights. Once the joint venture contract is approved, the parties must inject their subscribed registered capital amounts within the time limits set out in the contract. If paid in one lump sum, the registered capital contributions must be made within 6 months of the issuance of the business license for the joint venture. If the subscribed registered capital is to be injected in installments, the first installments, which must not be less than 15% of the total subscribed registered capital, must be made within 3 months following issuance of the business license.
Chinese law permits joint ventures to borrow funds from either Chinese or foreign banks in excess of the parties’ capital contributions. Shareholder loans from the foreign party are also permitted. (Chinese partners will likely not have a sufficiently broad scope of business to permit them to provide shareholders loans.) All such loans should be registered with SAFE and should not exceed the difference between the registered capital amount and the total investment amount.

(iii) Transfers of Equity Interests in Joint Ventures

If a party proposes to transfer all or part of its interest in the registered capital of the joint venture company to a third party, then each other party has a pre-emptive right to purchase the equity interest proposed to be transferred. As equity transfer also requires amendment of the joint venture contract and articles of association (AOA), which in turns requires the signature of each party, each party in effect holds absolute consent rights to any transfer generally. All transfers of registered capital additionally require a unanimous approval from the joint venture company board of directors and approval by the original government authority which approved the joint venture contract and articles of association.

(iv) Off-shore Structures

The entity to be used by the foreign investor as the offshore investment holding company (”OHC”) for its investment in the EJV will be determined by a number of factors. One of the main considerations driving the choice of OHC is tax-efficiency. In this respect the foreign party will need to ascertain whether there is a double tax treaty (”DTT”) covering the types of revenue streams that are likely to be coming out of the EJV between the PRC and the jurisdiction where the OHC is established.

(v) Tax Havens as OHCs

Many foreign investors tend to favor the use of tax haven jurisdictions, typically the British Virgin Islands, the Cayman Islands as OHCs for China investments. From the foreign investor perspective the main advantage is low or zero rates of tax on funds once they reach the tax haven. On the other hand, tax havens do not have any DTTs to reduce the tax withheld at the China end, so the tax required to be withheld in China before a remittance of funds out by EJV (other than for dividends) by way of payment of loan interest, royalties etc. will be the maximum applicable rate under Chinese law and policy at the time, thus giving a substantially reduced amount on arrival at the tax haven.

(vi) Miscellaneous

Under PRC law, joint venture companies have a fixed term of operation. Currently, the most common term of operation approved is 50 years. This term can be extended with the consent of all parties and approval of the relevant government authorities.

Depending on the nature of the operations of the proposed joint venture company, certain additional government approvals, permits or licenses may be required, e.g., sanitation certificates, environmental permits, production approvals, export licenses, value-added telecom services operating licenses, etc.

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