This article will explain you how to set-up a WFOE (WOFE) in China, including: types, advantages & limitations, procedures, taxation, common mistakes to avoid and factors to consider before setting up one.
The Wholly Foreign-Owned Enterprise (WFOE) is a limited liability company (LLC) wholly owned and controlled by the foreign investor(s) with no native Chinese investors or business partnerships required. The Western culture has turned its abbreviation into real word so you may see WFOE referred to as a “WOFE” which is more easily made into a pronounceable word.
Wholly Foreign-Owned Enterprises (WFOE) in China
In China, the original concept for WFOEs was to encourage manufacturing activities that were either export orientated or introduced advanced technology to Chinese industry. However, with China’s entry into the World Trade Organization (WTO), these conditions were gradually changed. WFOE business entities in China are increasingly shifting more to consulting and management services, software development, and trading.
Types of WFOE Structures
As you can see in the graphic, WFOE isn’t your only option to start doing business in China. WFOE corporate structures also have several options. In Mainland China, there are four types of organizational structure for foreign investors: WFOE(65%), Representative Office(20%), Partnership Enterprise (FIPE) (10%), and Joint Venture(5%).
The definition of a WFOE is neither clean nor pristine. The Ministry of Commerce makes the rules, but each province and tier 1, tier 2 and tier 3 city can interpret those rules to their benefit. Thus, not only must you know the national law, but you must also be ready to adapt to the local interpretations of those laws. In any case, there are three basic variations:
- Consultancy of Services WFOE which means you have intellectual properties and services but no physical ones.
- Manufacturing WFOE which is self-explanatory
- Trading WFOE which is essentially a commercial enterprise that sells but does not manufacture goods. Typical activities in this group include brand franchising, retail, and wholesale distribution. You may run into another term used for this type of WFOE. It’s also called a Foreign Invested Commerical Enterprise (FICE).
Within these three basic options, there are next level breakdowns as you get into the particular type of operations within each category. They can be identified by the conditions and requirements for setting up the business. The steps to set it up are the same. It’s the paperwork and foreign investment fund required to get approval for the business to operate.
The Advantages of a WFOE
The benefits of establishing a WFOE include, but are not limited to:
- No Chinese partner must be considered in the business strategy of the WFOE. The WFOE is independent and free to chart its course within the specifications of Chinese business law.
- WOFE’s have the ability to carry out business formally. They can issue invoices to customers in the China required foreign investment fund (RMB) and receive revenues in the same manner.
- WOFE’s have the capability of converting profits from the RMB to US dollars and send it outside of China to the parent company.
- WOFE’s have protection under Chinese law for intellectual knowledge and technological assets.
- WOFE’s have sole control over human resources so long as they comply with Chinese law.
- When it comes to innovation and business efficiency, WOFE’s can improve operations, management, and future development so long as they stay within the scope of business operations described in the paperwork that was filed to get approval to operate.
- This is a new advantage created when the Ministry of Commerce changed some of the WOFE requirements on March 1, 2014. Now, an investor’s parent company does not have to be in existence for more than two years to be able to establish a corporation in China. This is a case of abductive logic at work. China wants exposure to cutting edge technology. Much of the new technology is owned by startup corporations that have been in existence for a very short time. The Chinese observe and adapt in leaving room for alternate solutions.
- WOFE’s are exempt from having to obtain an import/export license for the products they manufacture.
- WOFE’s can buy real estate in China.
The Limitations of a WFOE
- High Establishment Difficulty – The application process is very involved, and each step may have a profound impact on the future development of the company including in the areas of business scope, financing, tax rates, director board management, etc. The process is long, involves many authorities, and it is easy to make mistakes (from 6 to 18 months).
- Capital Requirements – There is a minimum capital requirement to set up a WFOE. It varies among industries, but typically 15% of the total investment should be injected within one month after obtaining the business license starting from 50,000 USD.
- Restrictions – A WFOE faces limited access to government support and a potentially steep learning curve.
Subject to All Applicable Chinese Taxes
Taxation on WFOE
- Corporate tax: 15% to 25% (depending on the WOFE’s location and industry)
- Income tax: rates up to 35% of business profits
- Consumption tax:1% to 56% of sales revenue of goods. Export are exempt.
- Stamp duty tax: 1%
- Land appreciation tax: 30% to 60% of gains on transfer
- Resources tax: 1% to 20% depending on material
- VAT:17% / 13% for certain food, goods, books and utilities.
- Dividend tax: 20%
- Interest tax: 20%
- Royalties tax: 20%
- Deed tax: 3% to 5%
- Social Security tax: 37%
- Real Estate tax: 12% on rental value
Steps to Set Up a Chinese WFOE
How to Set Up a WFOE ?
One can break this down into a thousand steps, but fundamentally, three things need to be done.
- The minimum registered RMB capital for Consulting WFOE, Service WFOE, IT WFOE that must be established is RMB 100,000 ~~ 300,000 which is approximately USD$ 50,000 or Euro€ 35,000, (20% as initial funding within three months and the balance of 80% should be added within two years).
- Trading or Manufacturing WFOE registration should have its RMB fund at a registered minimum of USD $80,000 or €58,000 euros, (20% as initial funding before the three-month point, and the balance of 80% should be added within two years)
- The minimum registered capital for a Food & Beverage WFOE registration would be RMB 300,000 – 500,000 (paid-up capital could be added within 30 years).
2. Provide the required documentation
- Two copies of your company Certificate of Incorporations, Articles of Formation or Equivalent document certified by Chinese Embassy or Chinese Consulate overseas or for the individual investor, two copies of the passport of Investors certified by Chinese embassy or consulate.
- Two copies of the investor’s bank reference letter that declares the investor to be in good standing with the bank.
- Copies of the passports of the parent company’s director, the PRC legal representative that will submit the paperwork and the Chinese company’s supervisor.
- Six copies of the China corporation’s supervisors resume.
- Proof of registered capital, Business scope document, eight proposed Chinese names for the China company.
- Office address in China plus two copies of the leasing contract, two copies of proof of real estate ownership, and two copies of a letter that identifies the landlord of the property being leased.
- Four copies of the Letter of Authorization that gives the China company supervisor authority to sign documents on behalf of the parent company, lease office space and deal with any administrative requirements required to establish the China company.
- If you’re setting up a Trading WFOE, you need the most recent CPA certified annual audit report of the parent company and identification of the Customs HS Codes for the proposed import/export products in China.
That will take care of the documentation needed to register a Trading, Service or Consulting WFOE. Additional documentation will be necessary for a Manufacturing WFOE:
- Statement of Purpose and estimated investment
- Organizational structure and number of employees
- Copy of the permission for land use and an environmental impact evaluation
- A report of products to be produced, size of the production capacity, a detailed list of manufacturing equipment and a business plan
- Environmental protection measures being installed
- Requirements for service utilities (power, water)
3. Follow the proper registration procedures:
The first point of order is that you must engage a licensed PRC entity (legal firm) to submit all of the documentation to incorporate a WFOE to the relevant Chinese authorities. This legal PRC entity will become your sponsor and will present the documents in this order to obtain all permissions, licenses and perform legal transactions in making sure all issues are in order:
- Name, registration with State Administration of Industry and Commerce (SAIC)
- Certificate of Approval by Ministry of Commerce or Foreign Economical Cooperation Bureau
- Application for Business License with SAIC
- Reviews made by Public Security Bureau (PSB)
- Organization Code License by Technical Supervision Bureau (TSB)
- Tax Certificate by Taxation Bureau
- Registration and approval with State Administration of Foreign Exchange (SAFE)
- Open foreign currency and RMB bank account
- Transfer capital from investor’s overseas bank account
- Capital Verification Report by a Certified Public Accountant (CPA)
- Apply for Permanent Business License with SAIC
- Financial certificate registration
- Statistics license registration
- Import/Export license applicable for a Trading & Manufacturing WFOE
Common Mistakes to Avoid When Setting up a China WFOE
- Miscalculation of the time required to set up the WFOE. Time is your enemy in this process. Every day spent chasing down all the details and weathering the delays in approval costs money. Take care with estimating your capital requirements for WFOE start-up. Use a well thought out, conservative estimate to make sure you don’t run short.
- Your Business Scope documents and Articles of Association (AoA) require very precise and well-considered language. Do not use vague language as it will probably hurt you in the long run when it comes time to update your documentation to expand your activities.
- Many companies underestimate the complicated and laborious process of setting up a WFOE. The more you know before getting to China, the better off you’ll be.
- Location, location, location … do it right the first time as changes to this factor in your business plan is the largest cause of delays in getting WFOE approval.
- Failure to register your trademark and intellectual property declarations in China well before you start the process to set up a WFOE. The fact that those trademarks and intellectual property issues have been declared in another country means nothing to the Chinese.
Factors to Consider Before Setting Up a Chinese WFOE
The idea of wanting to create a presence in China is a businessman’s dream. The domestic consumer market has unlimited potential as wages rise and Chinese consumers have more disposable income to buy consumer products such as a smartphone, computer, automobile, and other desirable goods. The cost of labor is relatively cheap although that has changed significantly over the past fifteen years as it has tripled by some conservative estimates across the economic spectrum and has increased much more in the highly competitive high-tech labor force.
However, once you’re over the initial euphoria, business is still business, and you have to perform some due diligence to decide if establishing a business in China is right for your company. At the highest level, consider these three important factors. If you pass through these gates on a positive note, then digging deeper is warranted although a difficult path to follow.
1. Chinese Law and Business Regulation
International trade integration into Chinese culture is still a maturing environment. The Chinese seek to protect native Chinese companies while still encouraging foreign businesses to set up shop in China with the idea of getting Chinese-owned business exposure to Western technology and business practices. The People’s Republic of China (PRC) is also a political entity that wants to have positive control over everything that happens within their borders. Thus, business regulations are dynamic and pervasive. This occurs because the Chinese use abductive reasoning as the basis for what they do while Western cultures use deductive reasoning in most of their business pursuits.
The differences are subtle but powerful and explain why Chinese law changes so often. According to Wikipedia, “Abductive reasoning (also called abduction, abductive inference or retroduction) is a form of logical inference which goes from observation to a theory which accounts for the observation, ideally seeking to find the simplest and most likely explanation. In abductive reasoning, unlike in deductive reasoning, the premises do not guarantee the conclusion.” Thus, as they observe International and Western business in action, they continually adjust their business regulations to exercise greater control over the process.
So, as a foreign-owned business wanting to enter the Chinese market, you must observe and understand the current Chinese business law, learn from it in an abductive reasoning sense, and anticipate what the next iteration of those laws will be in the near and far term. Will these rules of law remain conducive for the survival and growth of your company? It’s not an easy task and is counter to deductive logic nature of Western cultures.
From the wholly foreign-owned point of view, you may not be required to join with Chinese investors and business partnerships, but you will have to integrate with the Chinese culture which will need some native Chinese business consulting relationships.
2. Business Consolidation in China
The financial strength and consumer trust enjoyed by domestic Chinese companies make it a very challenging competitive market. Does your product offer enough of a unique and differentiated product from other competitors in the market? The battlefield of Chinese competition is littered with International corporations that have come and gone from China.
The difficulty of doing business in China and the resulting increase in investment required has led a reversal of American companies setting up shop in China. According to Siva Yam of the Chicago-based U.S.-China Chamber of Commerce, “We have seen a lot of U.S companies struggling [with] their China” operations, said Siva Yam, president of the Chicago-based U.S.-China Chamber of Commerce on December 8, 2016. “The market is much more mature. We have seen a significant drop of U.S. companies going to China. … On the contrary, they are coming back here.”
The lesson learned is to do a robust and thorough sanity check on the viability of being competitive in the Chinese market before you jump into the fray.
3. Chinese Enforcement
This is where things get fascinating and absorbing. It’s a marketing issue and an examination on how to reach the Chinese masses if domestic integration and selling of services and products are the reason you’re setting up a WFOE. You must use the Chinese equivalents of services like Google, Facebook, and other Internet resources to reach the Chinese market because these services are blocked in China. VPN alternatives exist but are spotty and routinely tracked down and blocked by the Chinese government. Additionally, the Chinese masses don’t use VPN. You must integrate through services like Baidu, Alipay, and WeChat which the Chinese government has significant influence over.
The only thing that will get you through the creation of a WFOE in China with your sanity intact is to prepare for the exercise thoroughly, be patient and respectful with Chinese authorities both national and local and most of all, follow the rule of law in China. Your Chinese legal sponsor can be your best friend if you respect his value and knowledge and put your best guanxi foot forward in developing a lasting relationship to help you over the WFOE speed bumps.