New Partnership Regulation

On November 25, 2009, the Measures for the Administration of the Establishment of Partnership Enterprises by Foreign Enterprises or Individuals (the "Foreign Partnership Measures") were promulgated and will come into effect on March 1, 2010. The formal promulgation of the Foreign Partnership Measures, which had been in the drafting stage for several years, came about more quickly than most observers had expected, and has given rise to a general sense that the PRC government is aiming to encourage more foreign investment by providing foreign investors with an additional investment option. Foreign investors, both companies and individuals, will be permitted to set up a formal partnership with domestic or foreign companies or individuals. 

Subject, as always, to the exercise of discretion on the part of the interpreting and implementing authorities, primarily the Ministry of Commerce (MofCOM), the benefits of the Foreign Partnership Measures to foreign investors, which includes all commercial art enterprises, could be significant. The language of the Foreign Partnership Measures does not contain any express affirmative requirement for the approval by MofCOM or its counterparts at the provincial levels for the establishment of a foreign partnership enterprise in certain industries. In addition, a spokesperson for the Legal Division of the State Council said during an interview in November 2009 that the establishment of foreign partnership enterprises will not require MofCOM approval other than in cases where the partnership will be investing in restricted or prohibited industries.

The availability of the partnership option may lower the timing and cost of setting up an enterprise in China. A significant potential benefit to foreign investors is the possibility of lower taxation. Under current PRC law, a partnership is not taxed as an “enterprise,” and as such is not subject to enterprise income tax (EIT). PRC tax laws currently treat partnership enterprises as individuals, but subject to somewhat different tax rates than those applicable to natural individuals. Whereas an individual person is subject to taxation at progressive rates ranging from 5% to 45%, the investors of a partnership enterprise are subject to the progressive rates ranging from 5% to 35%. By contrast, all enterprises incorporated in PRC (including domestic companies, JVs and WFOEs) as well as enterprises incorporated overseas but whose actual business management is in the PRC (such as BVI and Cayman Island entities making return investments in China), are characterized as “resident enterprises” and are subject to EIT at a rate of 25% on income earned both within the PRC and abroad.

As the concept of foreign partnership enterprises is still new to the PRC tax authorities, it is likely that tax regulations specifically applicable to foreign partnership enterprises will be promulgated in the future. We expect that we will have a clearer picture of the tax treatment as well as other aspects of the Foreign Partnership Measures after more detailed provisions come out in the next few months.