The economic growth of the People’s Republic of China has significantly slowed down compared to the past few years. Whatsoever, it is still showing positive growth figures and is still on the right way to become the world’s largest economy. The establishment of a WFOE (Wholly Foreign-Owned Enterprise) has been the preferred model of foreign companies when entering the Chinese market. This market entry method allows to operate as a fully legal entity, trade, manufacture, export, and hire local and foreign staff, however, it also requires higher management demands and a broad knowledge of China’s legal framework. In this article, we will uncover a series of crucial tips to setup a WFOE in China.
Pre-Considerations / Tips to Setup a WFOE in China
► Is a WFOE Really Needed?
Do you really need a business entity in China? In a lot of occasions investors are obsessed with establishing a WFOE but most of the time it isn’t really needed in order to satisfy the business activities planned. There are other ways to sell your product in China (labor dispatch) without going to the expense and effort of creating a WFOE. Entering the market via the labor dispatch model allows a company to develop its business and perform profit-making activities. The foreign company would still be in control of their product and distribution strategy but, via some contractual vehicles with a Chinese firm for licensing, manufacturing and distributing.
► Understand How the Registered Capital Works
Firstly, it is important to mention that there isn’t a law that stipulates a minimum registered capital to open a WFOE in China; However, this doesn’t mean that a registered capital doesn’t need to be injected. The registered capital will be the funds used by the company to satisfy all the initial expenses for a year or until the company becomes self-sufficient. Investors may decide the period of capital contribution, which is settled on a schedule of contributions defined in the Articles of Association. Finally, the need of providing 30% of capital in cash doesn’t apply anymore.
Another challenge that foreign investors must face is to calculate a properly registered capital. The amount varies according to many variables such as the industry, type of WFOE, number of employees, etc… An average amount could go from RMB 200,000 to 500,000, excluding manufacturing WFOEs.
If the initial registered capital is not enough, it is possible to add more capital by performing an extra injection which is tax-free but very time-consuming.
► Careful When Defining the Business Scope
The business scope is a one-sentence-description that briefly explains the core business of the WFOE in China. It is highly important to wisely brief the description, as the company’s future activities will be limited to what it states. It can be self-limiting the scope is too narrow or self-defeating if the scope is too broad. Besides of increasing the possibilities of having the application rejected. Remember, if the application is denied, the clock goes back to zero, and it will be required to start all over again.
Furthermore, the description should address matters such as: How many employees will be employed? Which nationality? What kind of tasks will they be in charge of? What are the demographic targets? etc…
► Human Resources Requirements
As mentioned above, a main advantage of setting up a WFOE in China is that it enables foreign companies to hire foreign and local employees, although this also means a higher demand of time and commitment.
In China, especially, it is very important to have a well-informed HR department that can not only take care of the basic HR requirements such as: recruiting local employees, salary payrolls, tax and social security contributions, business expenses, etc… But also know how the Chinese Labor Law applies to other HR components such as: severance pay, notice period, holidays, leave days, probation period, non-competitive agreements, etc…
This human resources requirements may become a heavy charge when someone is new to the Chinese labor system and the main priority is to focus on the development of the company. Thus, it has become very common among foreign enterprises to outsource the HR tasks to local organizations, enabling foreign companies to have the HR work done efficiently and by local experts who are familiar with the job.
A simple example is foreign companies trying to find and recruit the right local Chinese talents. Obviously, when foreign companies are new to the labor market, they tend to lack the knowledge on how the recruitment is locally performed, which tools are used, how to approach candidates, or simply how to negotiate the offer or contract. Being the reason why foreign firms tend to outsource their recruitment needs. INS offers a China-specialized headhunting service that over 50 foreign companies across all industries have already benefited from.
► Choose the Right Location
When it comes to choosing the WFOE location, it is worth taking your time; Making the right choice may save you time in the future. This decision is one of the first cause responsible for delaying WFOE setups. When deciding it, you should take into account factors such as: which type of Chinese Tier city best suits your business activity? Which location is more convenient for your employees and shareholders to develop your business? What are the cost differences between one area or the other? The cost of labor? Need to build an infrastructure? What are the tax contributions according to areas? etc…
► Make Sure the WFOE Will Run in a Compliant Manner
Unfortunately, simply setting up a WFOE in China is not enough. There are extra requirements one may face even after completing the complex establishing process. It is crucial to know that China takes accounting very seriously, and is constantly vigilant for fraud. Even though one may not be intending to do something wrong, just one small accounting error could have your business under the spotlight of the Chinese government for all of the wrong reasons. Thus, in order to avoid trouble, creating a plan to tackle Chinese accounting, taxes, and annual auditing is essential from the beginning.
For example, a common difficulty found by newcomers into China is having to manage the social security contributions for its Chinese employees. As the tributary system differs, so does the contributive calculation according to the different tax rates at each specific time and location, and salary.
INS offers a payroll and tax compliance service for foreign companies in China to mitigate the juridical and administrative errors. We provide tailor-made solutions for each business in order to comply with the Chinese labor law.
► Difficulty of Setting up a WFOE
Setting up a WFOE can become a very long and complex process if one underestimates the Chinese bureaucracy. Departing from the fact that the majority of the paperwork must be done in Chinese, it is also recommended to know beforehand which documents will be required at each step so one can provide them on time and avoid disapprovals from Chinese authorities.
Perhaps the biggest issue foreign companies face is the language barrier. It is needless to say that one will definitely have to deal with a lot of Mandarin Chinese when doing business in China. Unless the foreign company has Chinese employees, it may be wise to get professional help from a local agency that knows the procedure and will get the company started as soon as possible without administrative hurdles.
►What Is Your IP Situation in the Mainland?
Intellectual property (IP) is a big concern for all foreign companies running a WFOE in China. First, before you even consider a WFOE, is your IP house in your native country in order? What IP do you expose to the Chinese market? Do you know how to protect your IP under Chinese law? It’s not the same as your home country. Have you registered your IP in China? The list of questions goes on and on. These questions must be answered because, in time, you will have to draft contracts in China with all the right provisions to protect your IP in the eyes of the Chinese court and legal system.
Moreover, these are some crucial pre-considerations that foreign investors must think about before making any move towards their business plans in China. Get in touch with us if you have any questions regarding the expansion or development of your company in the Mainland. INS is a consulting company offering HR and company solutions with over 10 years of experience in this market.