By Leon Lee
As the Chinese economy continues to grow and evolve, there are plenty of business opportunities for both local and foreign companies. One way for foreign companies to enter the Chinese market is through setting up a wholly foreign-owned enterprise (WFOE).
First established in 1986, a WFOE is a limited liability company that can earn profits and issue local invoices in renminbi which is useful as invoices are used to obtain tax deductions in China. Compared to a joint venture, a WFOE has more freedom, can better protect its intellectual properties and can even hire local staff directly rather than through employment agencies.
While there are certainly advantages to setting up a WFOE, the process can be quite complicated for those unfamiliar with the Chinese business environment. biz.hk spoke to Karen Cheung, a senior business manager at Orangefield with more than nine years of experience in corporate services targeting China market entry, on the process and challenges that might come along the way.
biz.hk: What are some of the first things people should know about setting up a WFOE?
Cheung: The process of setting one up is quite time-consuming. And unlike setting up companies in other places around the world, when you set up a Chinese entity, you need to put a registered capital. That means a deposit into a bank account in China. So, if you say you need to have 100 dollars, you need to come up with that cash and actually put it into China.
The time frame and bureaucracy [need to be considered] because setting up in China is still quite bureaucratic in terms of the documentation and the paperwork that you need to submit. At some certain bureau level you still need to submit them physically so someone needs to run there and bring the paper, versus where in Hong Kong you can submit electronically.
biz.hk: About the registered capital, is it true that locally-obtained renminbi cannot be used?
Cheung: So let’s say I am McDonald’s USA and then I go into China to set up McDonald’s China. The registered capital I bring into China must be foreign. Meaning, I can bring in renminbi, but it needs special approval. Usually, McDonald’s USA must bring in foreign currency because of course, I am an American company. They will ask questions if I bring in renminbi, such as, “Where did you get renminbi in America?”
Another thing is as McDonald’s USA, I can’t possibly raise funds in China and then use that as a registered capital and put it into a Chinese company because usually for the registered capital, it must be from the mother company. So if I am a Finnish company set up in China, then I need to bring in funds from Finland.
So if you talk about locally-obtained renminbi, if you raise funds and put into registered capital, what I understood from practice is that it’s not allowed as the company is supposed to be foreign invested. But let’s say the renminbi is actually earned profit from China, let’s say McDonald’s China earned and then paid its due tax, then you are free to use that money to open more McDonald’s as you wish.
biz.hk: What about the zero registered capital rule? How does that affect the setup of a WFOE?
Cheung: As of March 1, 2014, the Chinese company law has changed. Before, when you set up a company, every type of company has a range of registered capital required. But after the company law change, you can start a company up in China with as little as one renminbi. What the Chinese government is trying to do is they want to encourage more people to start a business and make China a more innovative environment.
What it is officially called is that the minimum registered capital rule has been abolished. Before the Chinese government said that if you want to set up a factory, you need to have a hundred thousand US dollars for registered capital but now there is no minimum.
But there is one point you have to be very careful about. Even though they say that you don’t need to have any registered capital, in practice you cannot set up a factory with one renminbi. So, from the application process the industrial commercial bureau may not approve your application.
biz.hk: Another thing that needs special attention to when setting up a WFOE is the business scope. Can you please elaborate more on that?
Cheung: For the business scope, what we do is that we need to put it as wide as possible. Let’s say I am McDonald’s USA, of course I am going to do restaurant business, right? In my business scope I need to put everything that is relevant to restaurant services so I will put catering food, provision of food and etc.
Because what happens if I only put that McDonald’s would sell French fries but not make ice cream and then five years later I want to make ice cream? We won’t be able to make ice cream because it was not included in the business scope. So, it’s never one sentence. You have to pick and choose very closely and carefully what you want to include.
Usually when you plan your business scope, you need to plan what you are going to do for the next five years. It needs to be as wide as possible but still relevant to the business you are doing. So you can’t say in McDonald’s China, I am going to make ice cream, provide food service and manufacture t-shirts in there. It will be rejected.
You can change and increase the business scope but actually it is a lot of paperwork. When you amend the business scope, you have to update all the licenses of the Chinese company, it’s a lot of work and a lot of time.
biz.hk: Are there any differences in procedures or regulations in setting up a WFOE in different parts of China?
Cheung: So basically the national regulation and procedure in setting up a WFOE in China are more or less the same. They are dictated by the administrative regulation that sets out certain rules and what you need to do.
However if you go to a smaller city, or like maybe a village area, in practice, they might be a little different. Maybe in, let’s say, Shanxi, they will ask you to do an extra step and to run to the tax bureau two times instead of once. But on the overall scheme of things, they are more or less the same.
biz.hk: Is it possible for a company to set up a WFOE themselves without help from a service provider?
Cheung: You can do it if you actually understand Chinese law, you can read Chinese, and you know which bureau in China to run around because it is a very lengthy process. Each time you set up a company, you have to run to maybe six different departments. Also, each city and bureau requires different documents and different types of writing. So it’s not really impossible, it’s very possible if you have the time, resource and knowledge.
But there are a lot of misconceptions with service providers. Usually a lot of service providers say that they can set up a WFOE, but in reality they stop when the business license is ready.
When you have your business license ready in China, it only gives you a legal entity. But a lot of service providers who actually do not have China offices, they don’t do anything after they get the business license. After the business license, you [still] need to open the bank account, register for the tax account and get the customs license. Without doing those, what we call post-business license registration, their company is useless.
biz.hk: Closing a WFOE isn’t any much easier, right?
Cheung: Yes, that’s very true, because closing up a WFOE will require a complete tax clearance. When you liquidate a company in China, let it be a wholly foreign owned enterprise or domestic company, the Chinese government are very strict in that sense, because they want to make sure that however long you have existed in China, you have all the tax cleared up very well and nicely and they try to get every bit of that before you get out of China. The process is actually quite lengthy and they actually will check everything. It’s quite complicated and difficult.