Print this issue
Send your comments

Introduction

China and India are currently the fastest growing economic regions of the world. While China is often seen as the larger and brighter of the two economies, due its heavy investment in infrastructure, India is also making impressive strides using its former colonial heritage and institutions (English language skills, common law tradition) to attract substantial investment from the United States, Japan and Europe.

Yet despite their massive population and their growing economic and political importance, both countries are quite different. The economic structures, sources of growth, areas of competitive advantage, the political structure and other intangible factors will cause each to grow in different ways in the twenty-first century.

Today, many global business leaders believe that they must have one strategy for Asia and do not differentiate between the countries in the region. One business leader recently commented upon entering India that, "Why should it take a month to set up an entity in India when we were able to complete it in Japan in a week?" It is general assumptions like the one just mentioned that cause companies to have difficulties in navigating the business environment in China and India. This is why it is important to have several strategies when doing business in China and India. A separate strategy for each country, recognizing each country's strengths and weaknesses is the best way to be successful in the long run in this international environment.

The following article will give some basic guidelines for doing business in each country and will attempt to provide information regarding the basic economic and business conditions that will be found in each country. Finally, the article will conclude with a high level comparison of these two emerging countries in Asia.

Doing Business in China

Before commencing business in any new jurisdiction it is important to decide on the type of activities that will be conducted in the foreign jurisdiction and the type of legal entity that can best accomplish the goals of the organization. Since China is not a free market like the U.S. and Europe it is important before commencing any business investment in China, that proper legal and business advice be obtained to ensure that all government requirements have been met. If not, severe penalties can result and any investment could be forfeited or greatly impaired.

Once the proper approvals have been secured the proper entity should be chosen. The four most commonly used forms of foreign (direct) investments in China are the Wholly Foreign Owned Enterprise ("WFO"), the Equity Joint Venture ("EJV"), the Contractual or Co-operative Joint Venture ("CJV") and Representative Offices ("RO"). All foreign entities seeking to invest in China must obtain pre-approval by the government.

The WFO

The WFO is a limited liability company wholly owned by the foreign investor(s). These entities were originally created to encourage manufacturing activities that were either export related or brought high-tech processes into China but are now used by a variety of service providers such as consulting, management services, software development and general trading activities.

The advantages of the WFO are no maximum or minimum limits regarding the amount of foreign investment, independence from the involvement of a Chinese partner, use of local courts, ability to employ local staff, and the limited protection of intangible property such as intellectual know-how and trademarks. The WFO also has full business functions rather than just a representative office function. These entities can issue invoices to their customers in RMB (Chinese Currency) and receive RMB revenues and convert these RMB profits to any foreign currency for remittance to their parent company outside China.

Finally, it should be noted, that while a specific management structure is not mandatory, the WFO's articles of association need to contain detailed information of the scope of the business (which must be approved by the government) and must also specify procedures for distributions, termination and liquidation of the company. Generally WFO's have a specific term (15 to 30 years), which can be extended by the regulatory authorities in China.

The EJV

An EJV is a limited liability company formed with the joint capital of both foreign and Chinese investors that can be corporations, partnerships, other types of business organizations and individuals (Chinese partner cannot be an individual). Such an entity is formed with the purpose that the joint partners will invest together, operate together, and share the risks and participate in all losses and profits of the entity. An EJV is required to have at least a 25% minimum level of foreign participation and the statutory minimum capital is determined by the amount of total capital invested (declining ratio of statutory capital and total capital invested).

Investments in an EJV can take the form of cash, equipment, industrial property or intangible property. Generally, the Chinese partners will contribute cash, land development rights and obtain all government approvals and the foreign partner will contribute cash, equipment, industrial property and/or intangible property.

Finally it should be noted that under the Joint Venture Law of China both parties have to manage the business operations of the EJV together. The EJV is operated by at least a three members board of directors that are selected by both members of the EJV, together. In addition, both parties of the joint venture are required to elect the President, and if one party takes the post as the President, another party can appoint the vice-president. Therefore, it is important to select the correct Chinese partner since their rights of management may outweigh their financial involvement in the entity.

The CJV

A third very important investment vehicle especially for short-term investments is the CJV. The CJV is the favored entity for build-operate-transfer investments in China. In a typical CJV the foreign partner will provide funding, technology and know-how while the Chinese partner provides land, labor, natural resources and domestic know-how such as contacts, connections and government approvals. The CJV is not obliged to register but if it does so it is treated similar to the EJV ("hybrid" CJV) otherwise it is treated similar to a partnership ("true" CJV) with no limitations on personal liability.

The RO

This entity allows a foreign investor a local Chinese presence to manage services, co-ordinate sourcing activities, or conduct marketing to "get a feel" for the Chinese market without the commitment or overhead of a WFO or EJV. Therefore, ROs are established to engage in permitted activities such as technology exchange, market research, business promotion, and business liaison but are not allowed to engage in any profit making activities such as sales and invoicing.

It is important to note that a RO is not a separate legal entity of the foreign investor, but rather just an extension of the parent company and therefore does not have the limited liability a separate entity would possess. RO are also subject to government taxes and fees based on their expenses so it is important to register such an entity in China so as to not run afoul of any of the local regulations.

General Business Issues

In recent years, over 50% of foreign investment in China has been through WFOs due to the absence of a minimum investment requirement and local ownership. However, this entity is not possible for all types of investments, so EJVs and CJVs are also used when appropriate.

In China, the national and/or provincial governments regulate all economic activities and also approve all foreign investment in the country. Foreign investments are cataloged in the following way by the government.

1. Encouraged – Provincial Authorization Required
2. Permitted – National and Provincial Authorization Required
3. Restricted – National and Provincial Authorization Required
4. Prohibited – No Approval Granted

Taxation in China

Taxation in China occurs at the national, provincial and municipal levels. Resident companies and individuals are taxed on a worldwide income approach, with the majority of Chinese Income Tax Treaties (including the U.S./China Income Tax Treaty) providing for the foreign tax credit method to avoid double taxation. Before 2008, the Chinese corporate income tax code provided for a federal tax rate of 30% and an additional local income tax at a rate of 3% with a plethora of preferential tax rates and special deductions for foreign enterprises in targeted business and geographic areas.

In 2007, the National People's Congress passed a new Corporate Income Tax Law ("CIT") that eliminated many of the tax incentives that had typically been available to foreign companies while it reduced the current corporate income tax rate from 33% to 25%. Foreign investors should be aware that the new law, which is set to take effect on January 1, 2008, demonstrates a more selective attitude towards foreign investment and consolidates the two separate tax regimes for domestic-invested companies and foreign-invested companies, thus placing domestic-invested companies on tax parity with foreign companies investing in China.

It should also be noted, while the new tax law grandfathers existing foreign company tax holidays, for foreign entities whose tax holidays have not yet begun (tax holidays begin in a company's first year of profitability), their tax holidays shall be deemed to commence from 2008 and run for 5 years. This may result in a partial or complete loss of the incentive depending on when profitability is actually reached and should be reviewed closely by a foreign company's tax advisors.

Finally, besides corporate income tax, taxes such as value added tax (VAT), consumption tax, business tax, vehicle and vessel license tax, stamp tax, native farming and forestry produce tax, animal slaughter tax, customs, city real estate tax and land value added tax should also be taken into account before any investment in China is made.

Doing Business in India

In contrast to China, India – thanks to its history as a (former) British colony and a founding member of the Commonwealth of Nations has its roots in the British system and especially its company law shows this heritage. For this reason, the entities available are ones that are similar and comparable to any in the U.S. or U.K. India allows for foreign investment in the following entities. 1) A Liaison/Representative Office ("L/RO"), 2) a Branch Office ("Branch"), 3) a wholly or partly owned subsidiary company, 4) a Project Office. Please note that whichever entity is chosen government registration will be required and that this process is complex and time consuming. Therefore, it is highly recommended that these tasks be performed by a local professional services firm to avoid needless delays and false starts. Even with local professional help the process can still take months to complete.

The L/RO

This entity allows a foreign investor a local Indian presence to manage services, co-ordinate sourcing activities, or conduct marketing to "get a feel" for the Indian market without the commitment or overhead of a branch or company. Prior approval of the Reserve Bank of India ("RBI") is required for opening of a L/RO. The activities of a L/RO are restricted to representing in India the parent company, promoting export and import from/into India, promoting technical/financial collaboration between the foreign parent and Indian companies and communications between foreign and Indian companies. A L/RO is not allowed to undertake any business activity in India and therefore, does not earn any profits or income in India.

It is important to note that a L/RO is not a separate legal entity of the foreign investor, but rather just an extension of the parent company and therefore does not have the limited liability a separate entity would possess. L/RO are not subject to any income tax in India since they cannot have any profits.

The Branch

A foreign company is permitted to open a Branch Office in India subject to prior approval from RBI. The permission is specific and the Branch Office cannot undertake any activity other than the activity expressly permitted by RBI. The RBI's permission is restrictive in nature and for undertaking of any new activity the Branch is required to obtain specific prior approval from RBI. A Branch is taxed on income received or deemed to be received in India and income, which accrues or is deemed to accrue in India.

The Subsidiary Company

A separate legal entity company can be incorporated in India either as a Private Limited Company ("LTD") or a Public Limited Company ("PLC"). As in the U.S. and U.K., PLCs are subject to more stringent requirements as compared to private companies and hence it is more usual to see a LTD used as an entry entity by foreign investors. These structures are fairly flexible with proper approvals and if operations so demand, a LTD can be converted at a later date into a public company. These entities are subject to tax as separate entities in India not unlike the treatment of similar entities in the U.S. and U.K.

Once a foreign company has decided to use a LTD it has two options for ownership. It can either form a wholly owned subsidiary ("WOS") where all the share are held by the foreign investor, or it can form a Joint Venture company ("JV") in collaboration with an Indian partner where both, the foreign investor and the Indian partner contribute towards the capital of the company in an agreed ratio.

It should also be noted at this time that such companies have minimum capital requirements and shareholder and director limitations so it is important to have local professional help to navigate these issues. Both, public and private companies are formed by registering the memorandum and articles of association with the Registrar of Companies in the state where the headquarters or main office is to be located. If the documents are in order, the Registrar grants a certificate of incorporation. Changing either document (particularly the memorandum) can be complicated.

The Project Office

Generally the Project Office ("PO") is only used when a foreign entity has secured from an Indian company a contract to execute a project in India. A person opening such an office is not allowed to undertake or carry on any activity other than the one relating to and incidental to the execution of the project. The Project Office must also be terminated and closed upon completion of the specific project. Profits from the project can be remitted, net of taxes outside of India after complying with all required regulations. For tax treaty purposes a PO is considered a Permanent Establishment ("PE") if it lasts more than ninety days and then any resulting profits are subject to tax in India.

Taxation

Corporate tax rates have been lowered in recent years in keeping with the government's aim to broaden the tax base and ensure greater compliance. In addition to direct corporate income tax, companies in India are subject to a minimum alternative tax, wealth tax, capital gains tax, fringe benefits tax, and indirect taxes such as value-added tax (VAT), service tax, excise duties and various levies of individual states and municipalities. Tax incentives focus mainly on the setting up of new industries, encouraging investments in infrastructure and promoting exports. Export and other foreign-exchange earnings were previously favored with income tax incentives but these have generally been phased out except for predominantly export-oriented units. The Special Economic Zones Act 2005 grants fiscal concessions for both developers and units in the Zones and a legislative framework for setting up offshore banking units and international financial service centers.

Resident companies are subject to tax on worldwide income at a tax rate of 30% with a surcharge of 10% and a 2% education surcharge on all taxes including indirect and service taxes. The effective tax rate for resident companies is hence (at least) 33.66%. For foreign companies a different income tax regime exists with a higher tax rate. Foreign companies are liable to tax at 40%, with a 2.5% surcharge and 2% education surcharge, therefore being liable an effective tax rate of 41.82%. But India has entered into Income Tax Treaties with more than 65 countries (including the U.S.), and in doing so, India usually follows the principles of the UN model convention and therefore, reduces the taxes of companies located in treaty countries.

China and India in comparison

China and India are currently becoming major players in world economy. Obviously neither country can be ignored, but each has strengths and weaknesses that should evaluated before making an investment decision.

The starting point for a comparison of China and India are their fundamental differences in the political system and social structure. India calls itself the largest democracy in the world. With a multiparty parliament and a population that is estimated to be over one billion, India certainly has the right to make that claim. This is contrasted by China with its one-party system and communist based economic system, which exerts central control of its economy with certain market reforms in many areas of the economy. With these reforms, China is attempting to disprove the assumption that economic growth, social welfare and a free market economy are always linked to democracy and political freedom and participation.

Another major comparative advantage of India over China is undoubtedly its sizeable English speaking population. As a former British colony and present member of the Commonwealth of Nations, English is one of the official languages in India and it is widely used. Despite the fact that the Chinese government has decreed that all students must study English after the age of five, it is thought that this Indian advantage will last for at least the next generation.

Infrastructure always plays a vital role in economic change and economic rise. China's growth prospects are boosted by its relative abundance of infrastructure and China is keener on developing infrastructure and on spending on modern infrastructure than India is. For example in 2002 China spent USD $128 billion on power and transport infrastructure compared to only USD $18 billion for India. China's highway network amounts to 1.4 million kilometers compared to "only" 200.000 kilometers for India. Finally due to insufficient port capacity, the lead-time for Indian exports to the U.S. is roughly three to four times greater than for Chinese exports. And this also applies to imports into India. According to a commentary in Asia Times, a cargo that takes six days to travel from Singapore to Mumbai (Bombay) could sit in the port for 30 days before it is unloaded. The Indian ports are poorly prepared for contemporary container based shipping. And unfortunately, it is getting even worse in India, as the rest of the world upgrades to the next generation of larger container ships the port facilities in India have not been upgraded. Thus, while India is standing on the sidelines, China already handles one fifth of the world's shipping containers and is developing massive new ports in Shenzhen and Shanghai to handle the new generation. China also benefits from the reintegration of Hong Kong and can also use its port to move goods out of China.

A major factor in the business decision is usually the supply of labor and the labor laws. The findings show remarkable differences between India with its legacy of a socialist past and the still communist country China. One would expect the Chinese labor law as being very strict and protective to the workers and the Indian laws much more liberal. But in reality it is the opposite. Although India has announced considerable deregulation, there remain many laws designed to protect workers but actually having the effect of discouraging new employment. For example companies with more than 100 employees require government permission to dismiss workers, as a result, factories are reluctant to take on new workers unless they are confident that demand for their output will be steady. On the contrary, China has labor laws that are not always (or hardly ever) enforced. For example, labor is restricted to 43 hours per week but in practice Chinese factory workers tend to work 12 or even more hours a day. This practice of "keeping workers busy" may have contributed to China's great advantage (when trade restrictions were lifted) in the apparel and textile industries. On the other hand, one should notice that with a more and more emerging consumer awareness of labor conditions under which goods have been produced and the increasing importance of keywords such as "corporate social responsibility" these hard-fact-advantages of production costs can quickly turn into soft-fact-disadvantages when it comes to branding, corporate image and consumer acceptance.

The survey shows that both China and India have a lot in common (size, population, emerging markets, corporate structure) but also have huge differences that should be noted. China and India are countries standing on the threshold of becoming global superpowers. Entering either of the countries economies and markets will obviously be a great challenge but probably also be critical to economic survival of U.S. based companies in the future.