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Joint ventures (JVs) are a commonly adopted investment structure for foreign entities seeking to enter the Taiwan market and expand their business presence with local partners. Setting up a JV in Taiwan enables foreign and local investors to combine their capital, resources, expertise and market knowledge, as well as share risks and costs, while developing new technologies and markets jointly. Given that the establishment and operation of JVs could be subject to various local laws and regulations, foreign investors should be aware of the relevant rules to benefit from the competitive advantages.

Corporate forms

There are four types of companies in Taiwan:

1. 1. Unlimited liability company;
   2. Limited liability company;
   3. Unlimited company with limited liability shareholders; and
   4. Company limited by shares. For foreign investors, a company limited by shares is the most favourable form as it can be established by two or more shareholders, and the liability of each shareholder is limited to the amount of capital they have injected.

A JV partner may subscribe to preferred shares and enjoy dividend rights, voting power, veto rights, a specific number of board seats and/or a preferential conversion ratio. To strengthen the JV structure, a closely held company (which is also limited by shares but comprises no more than 50 shareholders) can stipulate share transfer restrictions in its articles of incorporation (AOI) to restrict any transfer of shares not in line with the agreement between the JV partners ab initio (from the beginning). Considering the prevalence of use of a company limited by shares, this article focuses on the major features of this particular corporate form.

Foreign investment approval

All inbound investments by foreign investors and investors from China (excluding Macau and Hong Kong) are subject to prior investment approval by the Department of Investment Review (DIR) of the Ministry of Economic Affairs (MOEA). In general, a foreign investor can freely invest in a JV company unless the JV company engages in any of the prohibited or restricted businesses on the “negative list” published by the government. A PRC investor may only invest in the permitted businesses on the “positive list” published by the government and is subject to review by the DIR.

When considering whether to approve foreign investment in the joint venture, the DIR will review the investor’s shareholding structure and the proposed business plan. The investment review department may request additional information, consult with relevant governmental bodies and/or conduct ad hoc reviews on a case-by-case basis to gain a comprehensive understanding of the investment and its impact. Depending on the size and complexity of the investment, the review process by the department typically takes one to two months for foreign investments.

Corporate governance

Under the Company Act, the board is entrusted with a wide range of power and authority over the daily business operation of the JV company, while shareholders retain the power to decide on certain matters prescribed under the Company Act.

Such matters include, for example, amendments to the AOI, capital reduction, liquidation and dissolution, and approval of a merger, sale of all or substantially all of the assets or spin-off. Except for the matters requiring shareholder approval under the Company Act, the operations of a company are, by and large, determined by the board.

Directors, while acting in the interest of the shareholders, owe fiduciary duties to the company. The board of a company limited by shares with two or more JV partners must comprise at least three directors, unless its AOI permits one or two directors acting in lieu of a board.

Each partner, as a corporate shareholder, may itself be elected as the director of the JV company and designate a representative to serve as its director representative and may replace such representative at any time. Alternatively, a partner may appoint a representative to be elected as a director of the company and serve in the representative’s personal capacity.

While a partner may appoint multiple representatives to be elected as directors or supervisors, its representatives cannot serve as a director and supervisor concurrently. If the partner’s representative has already been elected as a director, the supervisor appointed by the partner should be elected in his/her personal capacity to ensure the checks and balances.

Reserved matters

The Company Act prescribes a list of matters requiring a majority (majority vote from at least half of a quorum) or supermajority (majority vote from at least two-thirds of a quorum) approval at a shareholders’ or board meeting (reserved matters). In the past, JV partners could freely stipulate a higher quorum and voting threshold for a customised list of reserved matters under their AOI.

However, in 2019, the MOEA adopted a more conservative view that a company may stipulate higher quorum and voting requirements in its articles only for those reserved matters that are explicitly permitted under the Company Act. Hence, when formulating the reserved matters to be incorporated in the articles, JV partners should pay special attention and ensure compliance with the act.

Albeit with the abovementioned, JV partners can still agree on the reserved matters in the JV agreements without reflecting them in the AOI. While the Company Act permits shareholders to enter into a voting agreement or establish a shareholder voting trust, in the event of a dispute, the court will examine whether the arrangement adheres to the corporate governance principles and the applicable laws and determine validity.

Deadlock

There are no specific statutory provisions addressing a deadlock between JV partners, which leaves the parties with wide discretion to resolve the dispute. In practice, deadlock resolution mechanisms are usually incorporated into the JV agreements, which typically include a cooling-off period, negotiations between executive officers of the partners, and buyout provisions.

If a consensus cannot be reached, the partners may choose to dissolve the JV company or exercise the call or put option as a last resort. However, without the adoption of preferred shares or closely held company, if a partner transfers shares to a third party in breach of the agreement in the event of a deadlock, such a transfer might still be valid due to the limitation of specific performance, and the non-breaching partner may only claim for damages and other remedies available under the agreement.

Dividend distribution

Under Taiwan law, a JV company may distribute dividends to its foreign JV partners either quarterly or annually, as stipulated under its AOI. Before paying dividends, the company should first make up any losses, pay taxes and set aside a legal reserve. In addition, dividends or bonuses cannot be paid if there are no surplus earnings.

In terms of tax, dividends distributed to foreign partners are subject to a 21% withholding income tax, or a lower rate if provided under an applicable tax treaty. Furthermore, profits of a company for the current year that are not distributed by the end of the following year will be subject to a 5% retained earnings tax. The amount paid as retained earnings tax cannot be offset against the income tax payable on the distribution of those retained earnings to the partners.

Exit of JV partners

Common exit strategies for a JV include a share buyback by the JV partner, a sale of shares to a third party or an initial public offering. If a foreign partner wishes to exit by selling its shares in the JV company, it should first obtain prior DIR approval for the transfer of shares. On closing of the share sale, where physical share certificates are issued, a securities transaction tax of 0.3% of the transfer price will be levied against the seller to be deducted and payable by the buyer.

Conclusion

Forming a JV could be a strategic and beneficial move for foreign investors to expand into a new geographical market such as Taiwan. Foreign investors should carefully assess, through due diligence, the potential financial, cultural, legal and regulatory challenges and risks involved in forming and operating a JV company.

This article serves as an introduction to the JV structure and regulations in Taiwan, while in-depth consultation with experts in the relevant fields would be advisable for foreign investors to make informed decisions.

LEE & LI
8F, No.555, Sec. 4, Zhongxiao E. Rd.,
Taipei 11072, Taiwan, R.O.C.
Tel: +886 2 2763 8000
Email: attorneys@leeandli.com