TABLE OF CONTENTS
Introduction
Regulatory Famework
Legal Status and Capital Requirements
Feasibility Study Report
Business Scope
Setting Up of a WFOE
The Maintenance of WFOE
Taxation of WFOE
Tax Deductions
The dissolution of WFOE
The Procedure of Dissolution
Time Required
Audit Required
Introduction
A Wholly Foreign Owned Enterprise (WFOE) is a limited liability company owned and managed by a foreign investor or combination of foreign investors in China.
This type of investment vehicle did not become legal until China joined the WTO in 2001, and since then has become the most popular structure for foreign enterprises in China.
WFOEs were originally used to attract foreign capitals and foreign productions of high technology (Article 1, PRC Wholly foreign-owned enterprises Law: “In order to expand foreign economic cooperation and technological exchange, and promote the development of the Chinese economy…”).
In other words, they were the first investment vehicle tailored for all those activities classified as “encouraged” and for which the Chinese partner was not required by the law.
The Chinese government enticed these types of companies to invest in China with tax and tariff incentives, as well as subsidies and administrative convenience (Article 3, PRC Wholly foreign-owned enterprises law: “Wholly foreign-owned enterprises must benefit the development of the Chinese economy. The state shall encourage the establishment of wholly foreign-owned enterprises that export commodities or that are technologically advanced.”).
After several reforms relating to foreign investments in China that have taken place over the years, the economic activities that can be carried out through a WFOE have been considerably expanded.
On the basis of their business scopes, currently it is possible to set up the following types of WFOEs: 1) Manufacturing WFOE; 2) Service or Consulting WFOE; 3) Foreign-Invested Commercial Enterprise (FICE) which is a WFOE allowed to do trading, wholesale, retail and franchising.
The WFOE is nowadays the most used business form by foreign investors due to the high level of independence and autonomy in its management.
In fact, a WFOE can: a) implement all its strategies and policies without having to consider the involvement of a Chinese partner; b) formally carry out or engage in business activities; c) trade freely in/outside China; d) bill, invoice and transact in RMB with customers; e) convert RMB profits to U.S. dollars or other foreign currencies for remittance to its parent company based abroad; f) full control of its human resources.
Regulatory framework
The legal bases for the establishment of a WFOE are the PRC “Wholly Foreign-Owned Enterprise Law” (中华人民共和国外资企业法), revised by the Standing Committee of the National People's Congress on 31 October 2000, and the PRC “Detailed Rules for The Implementation of The Law on Wholly Foreign-Owned Enterprises”(中华人民共和国外资企业法实施细则), revised according to the Decision of the State Council on revising the Rules for the Implementation of the Law of the PRC on Wholly Foreign-Owned Enterprises on 12 April 2001.
Other important applicable laws and principles are: The Foreign Investment Industrial Guidance Catalogue 2015 (外商投资产业指导目录); The PRC Enterprise Income Tax 2007 (中华人民共和国企业所得税法); The PRC Company Law 2013 (中华人民共和国公司法); Notice of the State Council on Printing and Distributing the Reform Plan for the Registered Capital Registration System (the“Registered Capital Reform Notice”); State Council Opinions on Further Improving the Utilization of Foreign Investment 2010 (国务院关于进一步做好利用外资工作的若干意见); Regulation of the People's Republic of China on the Administration of Company Registration 2014 (中华人民共和国公司登记管理条例); Regulation of the People's Republic of China on the Administration of the Registration of Enterprise Legal Persons 2014 (中华人民共和国企业法人登记管理条例); Detailed Rules for the Implementation of the Administrative Regulation of the People's Republic of China on the Registration of Legal Person Enterprises 2014 (中华人民共和国企业法人登记管理条例施行细则).
In addition, there are numerous regulations and implementation notices relating to specific businesses, subjects and products. Foreign investors should check out these specific regulations, which may vary from city to city, province to province.
Legal status and capital requirements
As in the western legal systems, a WFOE acquires the status of legal person with its liability distinct from that of its investors, with the liability of investors limited to the contributions made to the registered capital of the WFOE.
A minimum of one shareholder, either a corporation or a natural person, who must not be Chinese national, is required.
According to the article 18 of PRC implementing rules of WFOE, upon approval and as specified in the laws and regulations of China, a WFOE may also have other forms of liability.
It is important to notice that the PRC Wholly Foreign-owned Enterprises law and its related implementing rules do not mention the cases of loss of the limited liability as well as the consequences for some subjects (manager, legal representative, director or board of directors). This matter is fragmentary regulated by different laws (e.g. company law) and interpretations of courts on specific cases. The result is an unclear and incomplete regulation.
Thus, the registered capital remains the only real guarantee for creditors (and Chinese government) of a WFOE. This is the main reason for which central and local authorities continue to ask the payment of the capital and its registration according to the old criteria and rules, without considering the recent amendments.
More clearly, on December 28, 2013, the Standing Committee of the National People's Congress approved some amendments to the PRC Company Law, effective from March 1, 2014. These amendments “shall” apply to registered capital requirements for domestic and foreign invested enterprises in China.
The new regime will not apply to the following types of companies:
Banking financial institutions
Securities companies
Futures companies
Fund management companies
Insurance companies, professional insurance intermediary institutions and insurance brokers
Direct sales enterprises
Foreign labour cooperation enterprises
Financing guarantee companies
Joint stock companies that are established by means of share offer
Labour dispatch enterprises
Pawn shops
Insurance asset management companies
Micro-financing companies.
According to the changes in the registered capital system of foreign-invested enterprises:
Minimum registered capital for establishing an enterprise in China is no longer required “unless” laws, administrative regulations, or the decisions of the State Council provide otherwise. The amendments removed the minimum registered capital requirements, which were, RMB 30,000 for most limited liability companies, RMB 100,000 for one-member limited liability company, and RMB 5,000,000 for joint stock limited companies.
The foreign investor has now the discretion in determining the amount of registered capital for its operation in China based on business needs, rather than the approving authority based on “the match of the amount of registered capital and the company's operational scale”.
The 15% initial capital contribution (or 20% for the other FIEs) has been eliminated, and the 30% minimum cash contribution is no longer required. In addition, the amendments eliminated the 20% cap for in-kind capital contribution with industrial property rights and proprietary technology.
“Capital Subscription System” has replaced the “Capital Paid-In System”. The capital paid-in system requires companies to file details of both their registered capital and paid-in capital with the State Administration for Industry and Commerce or its relevant branch. The amendments greatly simplify the capital contribution process establishing that an investor has the sole discretion in determining, as provided in the Articles of Association, the amount, form, and contribution schedule of the company's registered capital.
The annual inspection system has been replaced by an annual reporting system, where companies are required to submit annual reports including information on the company’s paid-in capital. The SAIC or its local branches will conduct random review of the contents of a company’s public reports and will impose administrative penalties on those companies that are found to have concealed information or provided false information in their annual reports. Further, companies that fail to publicize their annual reports could be listed in the “List of Enterprises with Abnormal Business Operations” or the “black list” on the Public System.
Unfortunately, local authorities by virtue of their discretion, are not applying the above amendments, and the “zero registered capital rule” is currently available only in some cities and for domestic companies.
For foreign investors, local authorities will approve the investment project on a case-by-case basis, and the registered capital amount, its requirements and payment can be negotiated. Thus, according to the settled practice-old regulations:
Capital must be of private nature, public offering of capital is not allowed
A certain ratio between the total amount of investment and the registered capital (higher the amount of investment, lower is the percentage of the registered capital asked by authorities e.g. USD 1 million total amount of investment – registered capital 70%, USD 5 million total amount of investment – registered capital 50%, etc.)
Minimum Registered Capital (RMB 30,000 – but it is almost impossible that authorities will accept this minimum amount). The true is that the local authority will decide/suggest the minimum registered capital (requirements) and their suggestions vary drastically by industry and location
When the capital is contributed in installments, the first installment must be not less than 15% of the registered capital or the minimum capital requirement and it must be paid within 90 days and the rest within two years from the date the business license is issued
At least 30% of the registered capital should be in cash and in-kind capital (IP asset, machinery, technology) should not exceed the 20% of the registered capital of WFOE
foreign investors’ capital contributions to a WFOE may be in the form of foreign currency
Companies should disclose the amount, form, and contribution schedule as well as the paid-in capital amount via a public disclosure system. The State Administration of Industry and Commence has set up the National Enterprises Credit Information Publication System, through which anyone can check the shareholding and capital contribution information of all companies incorporated in China.
Feasibility Study Report
The feasibility study report (可行性研究) plays a key role for the establishment of a WFOE. It is, with the Articles of Association, the most import document to be submitted for the purpose of application of a WFOE.
By the feasibility study report, it depend the approval of the investment plan/establishment of WFOE and “eventually” the application of the amendments relating to registered capital and its payment.
In this report, the entire WFOE project must be described, explaining each business activity that it will conduct in China, demonstrating that all activities follow Chinese regulations and that the entire project is feasible both technically and financially.
Business scope
A WFOE can only legally conduct business within the business scope that appears on its business licence.
The business scopes are strictly interpreted for all businesses by Chinese authorities hence, a foreign investor must be sure that in his business licence are listed all the activities necessary for the development and success of his investment (e.g. design, develop and manufacture of X product/s and related parts and components; technical consulting, technical development and technology transfer; etc.). Any amendment to the business scope requires further application and approval.
Currently it is possible to set up in China the following types of WFOEs:
Manufacturing WFOE. Manufacturing WFOEs in China usually refer to companies engaged in industries such as machine manufacturing and electronics, building materials and construction, medical equipment and transportation. Foreign manufacturing companies, especially high-tech enterprises, have always been encouraged by the Chinese government with advantages of tax incentives, low labor costs and efficient infrastructures and transportation. The procedure for establishing a manufacturing WFOE is the most complex.
Service or Consulting WFOE. A consulting WFOE is a company that provides professional consulting services on matters as legal, accounting, insurance, tourism, education and management consultation. A service WFOEs is a company that provides technical services or consulting services to third parties on matters as technology, technology transfer and technology development.
Foreign-Invested Commercial Enterprise (FICE). A FICE is defined as a foreign-invested enterprise that engages in the following areas: a) agency with commission: selling other owned goods and providing related services by sales agency of goods, broker, or auctioneer or other wholesaler on the basis of contractual relationship; b) wholesale business: selling goods and providing related services to retailers, industrial users, commercial users, organizational users and other wholesalers; c) retail business: selling goods and providing related services to individual or collective consumers in fixed locations or by means of television, telephone, internet and automat; d) franchise business: licensing of trademark, trade name and business mode by entering into a contract with others for the purpose of returns and licence fee. The possibilities of FICEs have been further expanded by the new Measures for Foreign Investment in Commerce promulgated by China’s Ministry of Commerce (April, 2014). According to the measures, foreign-invested commercial enterprises can distribute imported and locally manufactured products through their own wholesale, retail and franchise systems and provide a host of related services, including storage, warehousing and garage services, inventory management, repairs, maintenance, training and delivery. Wholesaling and agency operations with commission are also permitted.
Setting up of a WFOE
The procedure for establishing a WFOE may vary from city to city and because of the business scope. Under the existing system, the procedures for setting up a WFOE consist of an examination and approval of the foreign business project by the local Ministry of Commerce (MOFCOM) and the registration of the WFOE with the local Administration of Industry and Commerce (AIC). The normal time frame for setting up a WFOE is 60/90 workdays. The application can be summarized in three main steps:
Name Registration. The proposed name of WFOE must be approved by the local Administrative Bureau for Industry and Commerce. According to the “Regulations on the Management of name of Enterprises”, (企業名稱登記管理規定), the proposed name should contain the following info: enterprise name, industry, location and liability form (e.g. ABC Consulting Shenzhen, ltd).
Application for the approval of the proposed investment. After the approval of the proposed name, foreign investor should submit some documents to the local MOFCOM. The examination and approval authority shall reply within 30 days on receipt of the feasibility study report and articles of association. After the feasibility study report and articles of association have been approved, the applicant shall apply to the examination and approval authority, which shall issue the Approval Certificate within 3 days after receiving the application. The approval certificate will be issued by the local office of the MOFCOM.
Registration with the Administration Bureaus for Industry and Commerce. Upon issuance of the Registration Certificate, there is a 30-day limit for registering the company with the AIC, which then issues the temporary business license. Following the issuance of the temporary business licence, the applicant has to complete post-establishment registration procedures.
The Maintenance of WFOE:
a) Audit and accounting. Accounting records are required to be kept in Chinese or in another language with Chinese translation. Annual audit by a local auditor is required.
b) Annual Examination. Annual examination is a system that is peculiar to corporations in China. In particular, the examination will be concentrated on the areas of registered capital, operations, registration details and financial details. The examination is in the form of a report completed by the enterprise concerned annually (together with the payment of an annual fee). The annual examination will be conducted from March to June every year. Those enterprises unable to fulfill the requirements of the annual examination may have their business licence revoked.
c) Registered Address and Business Address. Registered address is the official and legal address of a WOFE.
d) Legal Representative. Legal representative is the only representative of the company and it must be appointed by the board of directors (in case there is no board of directors it must be appointed by manager, CEO, shareholder, etc.). Usually, if the legal representative does not intend to stay and work in China for over 90 days (within a year), no employment visa is needed. In case that the legal representative is a foreigner and intends to stay in China for over 90 days in a year, employment visa is needed.
e) Directors. A board of directors is not always required. For a small-scale company, the general manager or legal representative is the CEO of the company and shall be treated as having the power of the directors of the company. There is no residential requirement for the directors.
f) Social Security. Effective 15 October 2011, all foreign individuals who legally work in China with either a work permit, resident permit, or permanent residency certificates are required to participate in the PRC Social Security System. If a company hires a foreign employee, the company shall register this employee with the local social security authority within 30 days of the employee receiving their work permit. The mandatory PRC Social Security contributions for foreign individuals include basic pension, basic medical insurance, work-related injury insurance, unemployment insurance, and maternity insurance schemes. Employers are required to contribute to all the five schemes. Employees, however, may only be required to contribute to some of these schemes according to local social security rules (e.g. basic pension, basic medical insurance and unemployment insurance in Beijing).
Taxation of WFOE
On 1 January 2008, the new income tax system went into effect, applying to all foreign investment enterprises within China and all domestic Chinese enterprises as well. This new tax system has simplified tax procedures and it applies to both domestic and foreign-invested enterprises and, subject to transitional rules, enterprises that have enjoyed preferential treatment. Currently WOFEs are liable to the following types of taxes:
Income Taxes: Enterprise Income Tax, Individual Income Tax
Transaction Taxes: Value added tax (VAT), Consumption tax, Business tax (abolished by the VAT Reform)
Miscellaneous Taxes: Custom duties, Vehicle and vessel licensing tax, Stamp duty, Land appreciation tax, Real Estate Tax, Deed tax, Natural resource tax.
The new Enterprise Income Tax Law contains a general anti-avoidance rule that allows the tax authorities to make adjustments when an enterprise has entered into an arrangement with limited commercial purposes or no effects other than reducing taxes. Tax credit is allowed for income taxes paid to other countries on certain incomes.
There are two systems of tax authorities in China, namely, National Tax Bureau and the Local Tax Bureau.
In general, the National Tax Bureau is responsible for assessing and collecting taxes for enterprises and corporations, while the Local Tax Bureau is responsible for individual income taxes and property taxes.
Tax Deductions
All documented costs that are related to generating taxable income are deductible unless the law specifically provides otherwise. Non-deductible expenses include:
costs to purchase or construct fixed assets (such items must be capitalized)
costs incurred to acquire and/or develop intangible assets
interest costs that must be capitalized
distributions with respect to equity interests paid to investors
royalties from a branch office paid to a head office.
The Dissolution of WFOE
A Wholly Foreign-owned Enterprise may be dissolved upon the expiration of the term or, when the WOFE suffers heavy losses due to mismanagement, force majeure, or, when the WOFE becomes bankrupt or is lawfully closed because of a violation of Chinese laws or regulations, with the result that public interest has been harmed, or for any reasons specified in the WOFE’s constitution.
There is no limitation under PRC law as how long such a term must be, although WOFE’s typically have a term of 15 to 25 years. Requests for an extension of the term of operation must be submitted to this authority 180 days prior to expiry.
In case if the WOFE does not dissolve properly, it can result in the following outcomes: the information of dissolved WOFE’s legal representatives and shareholders will be recorded by the Industrial and Commercial Administration Bureau. They will be disqualified and will not be allowed to become directors, supervisors or managers in other WOFE(s); the unfavorable credit reports of the dissolved WOFE’s legal representatives would be kept in government departments for at least seven years. The said legal representatives would also be punished and would be ordered to pay compensation to the relevant governmental departments.
The Procedures of Dissolution
Dissolving a WOFE in China would typically involve the following eight steps:
1) Setup Liquidation Committee. The WOFE is required to setup a liquidation committee for preparing liquidation application and reports. This consists of balance sheet, inventory records and financial evaluation report. The creditors must be informed in written form within ten days after the committee is setup.
2) Publish a public announcement of the dissolved WOFE. The WOFE is required to publish an announcement of dissolution to the public in one national newspaper and also in another local (provincial or municipal level) newspaper.
3) Submit liquidation reports to the authorities. The committee is required to submit liquidation application and reports which consist of a WOFE dissolution application form, foreign investment enterprise authorized certificates and business licence to relevant authorities (such as the Industrial and Commercial Administration Bureau or the Municipal Commission for Foreign Economic Relations and Trade) for their permission to dissolve the WOFE.
4) Dissolution registration in Tax Bureau. After obtaining the permission-in-principle from the authorities, the pre-dissolved WOFE is required to apply for de-registration in the local Taxation Bureau and State Administration of Taxation Bureau. All tax payments are required to be settled before the dissolution registration.
5) Dissolution registration in Customs. The pre-dissolved WOFE is required to submit the dissolution application, customs registration certificates and business licence to the local Customs.
6) Dissolution registration at the Industrial and Commercial Administration Bureau. The committee is required to submit liquidation reports together with dissolution registration permissions from the Tax Bureau and Customs, to the Industrial and Commercial Administration Bureau.
7) Bank account cancellation. The dissolved WOFE is required to cancel its bank account in China. A dissolution application, along with the dissolution permission from Industrial and Commercial Administration Bureau and other relevant documents must be submitted.
8) Other actions for dissolution. The dissolved WOFE is required to inform other relevant government departments for the dissolution e.g. State Administration of Foreign Control, Quality and Technical Supervision Bureau, Census and Statistic Bureau, Finance Bureau and Public Security Bureau etc.
Time Required
The length of time for dissolving a WOFE mainly depends on the position and condition of the WOFE, for example its financial position and tax payment conditions. It usually takes 4 to 6 months in general to complete the whole dissolution process.
Audit Required
Audit is required before and during process of dissolution. Unlike the usual audit performed by a Certified Public Accountant, the dissolution audit would be handled by the Tax Bureau, which requires the WOFE to provide relevant taxation documents and to cooperate with them closely.
For setting up a WFOE in China, please visit our China Company Formation page