By Dezan Shira & Associates
Editor: Steven Elsinga
As China’s urbanization continues at a rapid pace, flocks of foreign architects have found their way to the Middle Kingdom. With the Western world still recovering from a crash in real estate prices, construction has obviously slowed down. For many foreign architects, China has therefore proven to be a welcome opportunity.
These opportunities lie mostly in the high-end of the commercial real estate sector. The low to mid-end of the market, along with most of the residential property, is dominated by local architects. While many of the foreign-designed landmarks in cities like Beijing and Shanghai make the newspaper headlines, most opportunities these days are in fact found in the fast-growing lower-tier and inland cities. Many of these cities like to distinguish themselves by erecting extravagant, eye-catching edifices. The international allure of a foreign architect adds even more prestige to the project.
In recent years, this has led to a proliferation of sometimes odd-looking, foreign-designed creations shooting up all over China – apparently much to the scorn of the Chinese central government. Xi Jinping has therefore personally called for a moratorium on the construction of ‘weird buildings’. Rather than a matter of taste, these comments should be viewed in light of the corruption crackdown launched under Xi Jinping. Many of the more outlandish creations are merely prestige projects for city officials, and are financed with taxpayer money. Combined with the popular unrest over ordinary citizens being kicked out of their homes to make room for property development, some aspects of China’s construction frenzy have become politically sensitive.
Despite this recent trend dampening some of the interest in foreign architecture, a ready market remains. Foreign architects are reputed for quality, creativity and – importantly – the use of green technology. As China continues to struggle with pollution, the government is frantically exploring ways to move toward a more environmentally sustainable growth model.
Entering the China market
Dezan Shira & Associates has helped numerous foreign architecture firms get a foothold in China, and as such, has come to understand which approaches tend to work or fail. We will now compare three different models and explain why, in our experience, the third model has the best chance of being successful. The three models are: providing architecture services from abroad, setting up an architecture firm in China, or setting up an ‘architecture consultancy’.
Servicing clients from abroad
Foreign architects do not necessarily have to be in China to do their work; all the drawings and designs can be done from an office in their home country. Apart from finding clients, there is no reason that compels an architect to physically be in the country. The foreign firm could simply open a Representative Office, liaise with clients that way, and receive payment in its home country.
While possible in principle, architects will often find that Chinese clients are reluctant to pay foreign companies directly in foreign currency. There are two reasons for this. Firstly, due to the foreign currency controls that the Chinese government has put in place, paying foreign currency abroad is often either prohibited, or involves a lot of hassle, paperwork and uncertainty for the Chinese party.
The second hurdle has to do with the Chinese tax system. In order to offset VAT and deduct expenses, Chinese companies need to show a special VAT invoice, also called a fapiao. These fapiao need to be printed on a special type of paper that can only be purchased from the Chinese tax office. To purchase these invoices, one needs to have a limited liability company in China. Entities incorporated abroad therefore cannot obtain a fapiao, nor can their Representative Offices in China. If a Chinese company is unable to get a fapiao for its expenses, it is left with a significant and unnecessary tax burden. For this reason, Chinese clients will very likely insist on foreign companies setting up an entity in China. With such an entity, the Chinese client can pay in RMB as well.
One may find that some clients are capable and willing to pay in foreign currency to an account outside China, in which case setting up a Representative Office for practical reasons would suffice. However, such clients are likely to be the only exception.
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Setting up an Architecture WFOE in China
China’s corporate laws are relatively rigid in that they require a company to define what activities it intends to engage in, and demands the company to stay within that scope. When the company is first created, it needs to describe what the business scope is, and apply for a new business license if the business scope is to be changed. Companies in China cannot issue fapiao for activities that lie outside their stated business scope. A company simply incorporated to ‘receive payments’ is unlikely to be approved. Chinese corporate law also requires entities to have a physical office, independently accessible with its own door and desk. Creating a letterbox company solely for the purpose of receiving payments is therefore not an option.
If a company in China wants to bill for architectural services, it needs to have architecture in its business scope. In other words, an architecture firm would need to be set up in China. In our experience, however, the licensing requirements for foreign-invested architecture firms are so prohibitively stringent that most firms are unable or unwilling to meet the standards.
One of the major obstacles is the staff requirement. One fourth of the staff in a foreign-invested architecture firms needs to consist of foreign architects or engineers that have both foreign and Chinese certifications. This means that the company would need to have a large part of its staff take the Chinese architecture or engineering exams. In addition, one fourth of the firm’s “core technical staff” should consist of foreigners with relevant technical design experience. The regulation does not clarify what this specifically means.
If the foreign invested firm is a JV with a Chinese equity partner, these requirements both drop to one eighth. Furthermore, the regulation requires that these foreign architects, engineers and core technical staff remain in China each year for over six months.
The foreign company or individuals (including Chinese partners, if any) need to already be engaged in architecture, and provide two examples of their work. Of these, one project needs to have been completed in the applicant’s home country.
Apart from the license to set up an architecture firm, the company needs to acquire additional licenses depending on the type of projects it seeks to engage in. These are divided into three categories: Comprehensive Qualification, Sector Qualification and Specialized Qualification. The Comprehensive and Sector Qualifications are subdivided into different applications with grades. As a result, there are several dozen different licenses for different projects, each with their own requirements. These requirements range from prior experience, staff types and count and registered capital – often running into several million RMB.
For this reason, most foreign architects resort to the third alternative.
Setting up an Architecture ‘Consulting’ WFOE in China
The work-around for this problem is to set up a WFOE that provides architecture consultancy services, i.e. advising Chinese architects. Its business scope would typically cover matters like architecture consulting, real estate information advisory, market research, landscaping advisory, indoor architecture consulting and project management consulting. Which exact services such a company is allowed to perform is at times ambiguous. What is clear is that a Consulting WFOE may review third-party drawings and do conceptual design. However, such a company may not explicitly bid for or sign contracts for architectural design or project management.
In practice, the foreign architecture consulting firm often does most of the work, but goes through a licensed Chinese architect that places its signature on the final product. This way, the foreign architecture firm can still provide its services, without having to meet the stringent licensing requirements under Chinese law. Over the years, Dezan Shira & Associates has helped numerous foreign architecture firms set up such arrangements, and ensured that these firms remained in compliance with Chinese regulations.
As clients pay their fees to the WFOE in China, a common issue is how to take this money out of China in a tax-efficient way. Companies in China are subject to 25 percent corporate income tax. When the profits are subsequently repatriated by issuing dividends, another 10 percent dividend withholding tax is levied. This leaves the company with a significant tax burden, especially considering that most of the work may in fact be done overseas.
One way to bring taxable income down is to hire foreign architects through the WFOE and have them work in China. The firm can also send its architects to China on short-term projects of several months, and then have the head office abroad charge the WFOE. This arrangement of having the WFOE pay the parent company is a form of transfer pricing; a means to both reduce its taxable income in China and take money out of the country without paying dividend tax. The overseas head office can charge the WFOE for other services as well, such as use of royalties and back-office services. To be considered legal, these transactions would have to be at market prices. Inflating the prices to get more money out and save more on taxes is strictly forbidden, and the Chinese tax authorities heavily scrutinize these practices.
Such an approach would require including a stipulation in the WFOE’s articles of association, as well as a framework of contracts covering the arrangement.
This article is an excerpt from the August issue of China Briefing Magazine, titled “China Investment Roadmap: the Commercial Real Estate Sector” In this issue of China Briefing, we explore the latest trends in commercial real estate in China, and discuss how foreign companies can benefit from China’s massive construction boom. We provide a guide to how firms can sell construction materials in China, and finally detail how foreign architects can most effectively enter and take advantage of China’s rapid urbanization.
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