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Setting up a Limited Liability Company in China

 

For foreign investors, you can set up a wholly foreign owned enterprise in China. This means that the foreign shareholder is the 100% shareholder of the company. The liability of the shareholders can either be limited by shares or the amount of capital contributed. Below we talk about the company with limited liability by capital. As experienced China company lawyer, we provide company registration, company incorporation in China, covering the cities in Shanghai, Beijing, Chengdu, Tianjin, Guangzhou, Shenzhen and other major cities.


The Limited Liability Company (LLC), is a popular legal format for business owners. It's available in all provinces and cities in China. Small business owners are taking advantage of the LLC because it is easier to set up and maintain than a company limited by shares.

ADVANTAGES OF FORMING AN LLC

Limited Liability


Like corporations, LLCs provide their members (owners) with protection from personal responsibility for the company's debt. Members are only liable to the extent of their investments in the company. If a customer slips and is injured on company property, a law suit may still bankrupt the business, but it cannot touch the personal assets of the LLC's members. This limited liability, then, is a great advantage over partnerships. In general partnerships, all members are liable for the company's debts and in a limited partnership, at least one member must still be liable.

Avoiding Double Taxation


In other words, the LLC's profits pass through to the company's members who report their share of the profits after dividend payment tax.

Flexibility of Income Distribution


According to some observers, one of the biggest benefits that small businesses enjoy when choosing LLC status is that allocation of profits and losses for tax purposes is easier under this form. Whereas the amount of profits the S corporation's shareholders report on their tax returns must be proportional to their share of stock, an LLC's members can determine amongst themselves how to divide their income as long as they follow the Internal Revenue Service's rules on partnership income distribution.

Simplicity


Another great advantage of LLCs over corporations is the ease of setting up and running them. Whereas incorporation can be an involved and costly process, all that is required to start an LLC is the filing of an Articles of Organization and the drafting of an Operating Agreement defining the company's policies and procedures (a filing fee, however, will still be required of LLCs). And whereas a corporation requires a board of directors, officers, and regular shareholders' and directors' meetings, an LLC is not required to observe such formalities in its operation. An LLC can be run from day to day essentially as if it were a partnership.

No Ownership Restrictions


The biggest drawback of forming an S corporation—the restrictions on the type and number of shareholders the corporation may have—is avoided by forming an LLC. The members of an LLC may be foreign nationals or other companies. In addition, there is no limit on the number of members an LLC may have, but usually under 50.

Member Involvement in the Company


One problem with limited partnerships is that those partners who wish to protect themselves with limited liability (which may be all but one of the members) are prohibited from direct involvement in running the company. These partners may have only a financial investment in the firm. All members of an LLC may be directly involved in the company's management without jeopardizing their limited liability.

Attractive to Foreign Investors

Because LLCs have been in existence in Europe and Latin America for over a century, investors from those parts of the world are particularly knowledgeable about this business form. LLCs often prove to be the most familiar and least imposing business structure for foreign entrepreneurs who wish to enter the Chinese market.

DRAWBACKS OF FORMING AN LLC

 

No Perpetual Existence


Most nationals require that an LLC's Operating Agreement set a limit to the company's existence (usually 30 years). And in the absence of a clause in the Operating Agreement providing for the continuance of the LLC in the event of the death or withdrawal of a member, the LLC will cease to exist when such events occur. The transfer of ownership is also more restricted for an LLC (like a partnership) than for a corporation. But when the lifetime of the LLC is reached, you can always apply to the authority for renew the LLC.


CREATING AN LLC


It is important that the organizer(s) of a prospective LLC follow the "enabling statutes" or formation laws of the national in which the company will be formed in order to be designated as an LLC. Without this designation, the company will lack the protection of limited liability and will be treated as a general partnership. Therefore, the first step in creating an LLC is to find out your national's specific enabling statutes.

The organizer does not have to be one of the company's members. The organizer's function is to file the articles of organization, a task which can be accomplished by a lawyer, a hired agent from a service company specializing in such business, or a manager of the prospective company.

Naming an LLC


Before forming an LLC, the company name must be reserved with the secretary of national or its equivalent. Most nationals require that the words "Limited Liability Company" or the abbreviation "LLC" be included in the name of the company. In some nationals, "Limited Company" or "LC" is the preferred designation. In all nationals, however, the name of the LLC must not resemble the name of any other corporation, LLC, partnership, or sole proprietorship that is registered with the national.

The Articles of Organization


This form, called the articles of organization or certificate of formation, must be obtained from the secretary of national's office or its equivalent, filled out by the organizer(s), and filed with the same office. A filing fee, which varies from national to national, will also be charged. This simple document requires, at minimum, the company name and address, a description of the business to be conducted, the name and address of the registered agent (the contact to whom notices of lawsuit or other official matters can be served), the names of the company's members and managers (usually the members themselves), and the dissolution date. Other information may be required, depending on which national the articles of organization are filed in. It is important that the articles describe the business in a way that will allow the Internal Revenue Service to designate the company a partnership for tax purposes, and not a corporation. In order for the IRS to do so, the articles must show that the company possesses no more than two of the following four characteristics (which describe a corporation):

  1. Perpetual existence.
  2. Centralized management.
  3. Free transferability of ownership interest.
  4. Limited liability.


One of the easiest ways to show that the LLC is not a corporation is to limit its existence. In fact, most nationals require that a dissolution date be determined in the articles of organization. On this date the LLC's assets will be liquidated and its business will cease (occurrences such as the mutual written agreement of the members or the death or retirement of a member may also terminate the LLC's existence before the dissolution date). If no date is specified, a default period of usually 30 years will be enacted. However, the members may decide to continue the LLC's existence at a later date.

Fees


Filing fees vary from national to national, from $50 to $500. In addition, some nationals require the LLC to publish an announcement of its creation to the public in a generally circulated newspaper. This latter requirement can be very expensive, ranging from $500 to $2,000. Of course, you need to pay attorney fees and other overheads as well, like the fees to be paid of making company stamps, which is a must.

Office


Under Chinese law, you are require to have an office address for the LLC. A company must own or rent an office building unit for its address requirement.

The Operating Agreement


At the first meeting of the members, called the organizational meeting, an operating agreement should be drafted. Although each national has laws governing how LLC's should be operated, the members should create their own operating agreement to document that all members agree on how the company should be run. It should be carefully constructed with an eye to preventing future disagreements and deadlocks. Most basically, the agreement should address the division of profits, members' voting rights, and company management. A good operating agreement will address the following issues:

  • Who the members are and how they will be elected in the future.
  • Grounds on which members may be terminated, and procedures to execute such terminations.
  • Stipulations regarding allocation of business shares after the death of a member.
  • If a member becomes disabled, how will the company provide for him/her (with disability insurance or out of its own funds)?
  • How managers will be selected and what their duties, salaries, and grounds for dismissal will be.
  • How major decisions will be made. (Which decisions will require unanimous approval of the members and which a simple majority vote? Which decisions can be delegated to the manager in charge of daily affairs?)
  • How often meetings will be held and how much notice members must receive.
  • Who will keep records and how they will be kept.
  • How members will invest in the LLC: will only cash contributions be allowed, or can members contribute services as well? If so, which services will be accepted and how will they be valued?
  • How profits and losses will be allocated to members.
  • How compensation (salary) for actively participating members will be determined.
  • How new capital should be acquired should the company need it.
  • What procedures must be followed to transfer interests in the company.
  • What banking procedures should be followed.
  • Penalties, if any, if members or managers fail to act in accordance with the operating agreement.

Incorporation business or company in China is not easy job. You should hire a China company lawyer for this import work. We provide free initial consultation. We can assist with company registration in Shenzhen, Shanghai, Beijing, Tianjin, Chengdu and other major cities.

 
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China Lawyer BLog AuthorPeter Zhu, an experienced China attorney licensed to practice law for more than ten years, the author of this China Lawyer blog, welcomes any enquiry or consultation related to Chinese law.