Shared Service Centres in China
We have seen a lot of interest lately in companies setting up shared service centres in China. In some cases, back-office or help desk functions have been transferred from Hong Kong to mainland China. In other cases, companies seeking to streamline and rationalise their China operations have set up shared service centres. Indian outsourcing companies have also expressed an interest in combining their operational expertise with the Asian language skills available in China. This article reviews some of the key issues when considering setting up a shared service centre in China.
Scope of business: Unlike in other jurisdictions, where companies can engage in any business activity they consider will provide an economic return, Chinese companies are restricted to those activities specified in the scope of business described in their business licence. Chinese authorities are reluctant to allow companies to a wide or vague scope of business. Instead, the scope of business must be tailored to fit the business of the company.
Although the scope of business can be changed, this requires approval from Chinese regulatory authorities. Getting approval to include a new, unrelated activity in the company’s scope of business can be difficult, especially if it alters the nature of the company. For example, extending a manufacturing company’s scope of business to allow it to provide shared services for other group companies combines manufacturing with consulting and services. It is often easier to establish a new company to be the shared service centre rather than trying to convert an existing company. Converting a manufacturing enterprise into a consulting and service company may also lead to the loss of valuable tax benefits.
When setting up a new company to be the shared service centre, you should ensure that its scope of business covers the whole range of proposed services, even if you intend to start with only a few of them. It is also a good idea to review the company’s scope of business as part of the change management process when relocating further services to the shared service centre. This will help avoid the company accidentally acting outside its business scope as its business changes over time.
Chinese authorities can shut down a company’s operations with little or no warning if they discover that it is acting beyond its scope of business. This is a critical factor to consider in the context of shared service centre continuity planning.
Data privacy: Many countries have enacted data privacy legislation governing the collection, use and processing of personal data. Examples include the Privacy Act in Australia, the Privacy Ordinance in Hong Kong and the Data Protection Act in England. To date, no such similar law has been enacted in China, so the processing of personal data in China is essentially very simple. Care should be taken, however, if the shared service centre will be processing data from elsewhere, e.g. for employees in other Asia-Pacific countries. In this case, you should check the relevant local legislation to identify whether data can be transferred to China for processing and, if so, whether any special measures need to be taken to protect personal privacy.
It should also be noted that under China’s National Security Law and other Chinese laws, Chinese authorities have very wide powers, which may be exercised in order to satisfy ‘the needs of state security’. Those powers include the ability to enter premises and seize documents and data. This risk should be addressed through data back-up procedures.
Regional variations in regulations: One of the challenges when working in multiple locations in China is to address the extensive range of local regulations that sit alongside national legislation. A particularly relevant example for shared service centres is payroll processing, especially the calculation of social security benefits. In different provinces they calculate social security benefits by reference to the city average monthly salary, the previous year’s city average annual salary, the individual’s average monthly salary for the previous year or total monthly wages for all employees. Each location must be checked.
These different policies do not prevent a shared service centre from being set up, but the systems that are implemented must be sufficiently flexible to be able to handle the different calculation methodologies.
Wholly foreign owned enterprises (WFOEs): If you want to set up a stand alone vehicle to operate as a shared service centre in China, the simplest option would be to set up a wholly foreign owned consulting and management service company. Provided you incorporate it within the correct scope of business and obtain the relevant approvals, this would enable you to centralise back office and administrative functions for your operations in China. This is also the least capital-intensive vehicle available.
Chinese holding company: A Chinese holding company is an interesting option for a shared service centre because the regulations governing such a company specifically permit it to engage in services and activities that typically form the basis of a shared service centre. These include: providing human resources services, technical support and personnel training, providing after sales services; providing operating leases of equipment and machinery, providing market research services, providing transportation, warehousing and other general services, and engaging in certain import and export rights.
As with all things Chinese, setting up a holding company as a shared service centre is not without its complications. Some of the services can only be provided to subsidiaries in which the holding company has invested. Some of the activities require the unanimous consent of the board of directors of the invested subsidiary company, e.g. providing technical support, personnel training and HR. This is easy to satisfy if the subsidiary is wholly owned but can be more troublesome in a joint venture. Other activities, e.g. providing operating leases of equipment, can only be provided by a holding company that has invested at least US$30m of capital in subsidiary companies or research and development centres.
Despite these complications, Chinese holding companies are a popular vehicle for establishing a shared service centre in China.
Regional headquarters: For companies that are willing to invest US$100m in registered capital (or US$50m if they already have investments in China which are valued at RMB100bn and made a profit of RMB3bn in the previous year) there is the opportunity to set up a regional headquarters. In addition to the holding company activities, a regional headquarters can set up a finance company to provide financial services to its invested subsidiaries; provide outsourced services to companies inside and outside China; and engage in ‘other approved businesses’. If you are looking at a wider regional role for your shared service centre, this would be worth examining.
Although most shared service centres focus on accounting functions, payroll, HR, marketing and similar activities, some companies may be considering centralising procurement and distribution activities in China. This has been difficult, however, with the enactment last year of the Foreign Trade Law and the Foreign Investment in Commercial Enterprises Regulations, companies can now adopt a more co-ordinated approach in China through a Foreign Invested Commercial Enterprise (FICE).
Although Chinese holding companies and regional headquarters are permitted to engage in certain trading and distribution activities, the Foreign Trade Law and Commercial Enterprises Regulations provide more comprehensive trading rights. Consequently, if the shared service centre is to engage in centralised trading and distribution activities, you should comply with the requirements of the Commercial Enterprise Regulations and set it up as an FICE qualified WFOE, holding company or regional headquarters.