Start a Business in China – Wholly Foreign Owned Entity (WFOE)
A WFOE (Wholly Foreign Owned Enterprise) is the most common structure used by foreign companies in China, and with good reason! In this guide to WFOEs, we look at what this is and whether it is right for your setup in China.
In particular, we will discuss:
- What is a WFOE?
- Why open a WFOE in China?
- The advantages of the WFOE structure and the limitations to be aware of
- An overview of WFOE registration and management
- Our advice on areas to be aware of
What is a WFOE?
Let’s start at the beginning – A WFOE (Wholly Foreign Owned Enterprise) is one of several company structures available to foreign companies in China. The wider term of FIE (Foreign Invested Enterprise) refers to any company with some form of foreign ownership (greater than 25%). Other common structures include Representative Office (RO) and Joint Ventures (JV), but these are more limited in scope than WFOEs.
The WFOE structure arose with the opening up of China and later accession to the World Trade Organisation. Permitted activities and industries open to foreign companies have steadily grown, and continue to do so. WFOEs have become the most popular structure among foreign investors. They offer the most freedom in business operations, as well as full independence as there is no need to operate with a Chinese partner.
Originally, WFOEs were most often used for manufacturing activities, with foreign companies able to set up operations without partnering in China. As the nature of business in China has changed, and restrictions on foreign companies have lessened, the number of WFOEs operating in other areas, such as trading, consulting and high tech development has grown.
WFOEs can be registered as one of three main types – manufacturing WFOE, trading WFOE and consulting WFOE. The main difference these days is in the Business Scope of each. WFOEs are restricted in their permitted activities by a succinct Business Scope definition. All WFOEs are full legal entities in China, and are governed by Chinese Company Law.
Why open a WFOE?
A WFOE is popular for good reason. It has many advantages over the other common options of a Representative Office or a Joint Venture. These advantages include:
- Can be formed without a Chinese partner
A WFOE is independent, able to manage its own operations, funding and business development. Unlike a partnership operation or Joint Venture, a WFOE does not need to share management responsibilities, profits or Intellectual Property with a Chinese company partner.
- Can make profits in China
A WFOE can fully conduct business in China, in line with its agreed business scope. It can issue local currency invoices to customers and make profits from its activities. Note that the alternative setup of a Representative Office is not permitted to do this.
- Able to hire staff directly
A WFOE can manage its own human resources (without using a Chinese agency), and hire staff both locally and from overseas.
- Able to send funds overseas
Any operating profit made in China can be converted to foreign currency for repatriation to an overseas parent company.
- The best option to protect IPR in China
There is no need to share business information with a partner, and the WFOE structure provides some level of IP protection under Chinese law.
Limitations of a WFOE
Within its defined Business Scope, a WFOE has as much freedom as is possible for a foreign company in China to operate. Nothing is perfect though, and there are a few important limitations to be aware of when considering a WFOE or starting WFOE registration:
- Permitted activities limited to defined Business Scope
A short single line “Business Scope” is defined as part of the setup process and approved by the government. Once set this will limit the activities that a WFOE can perform. Of course, this should be defined carefully as being either too vague or too focussed will affect business that can be carried out, and the willingness of Chinese companies to engage.
- Limited capital for setup
As part of the WFOE registration process, a fixed amount of capital, along with a timetable for capital injection, is agreed. This can be used for company setup, capital purchases, etc. throughout the first years of operation. Increasing the registered capital level later is possible but complex, and any funding injected above the registered capital will be taxed as income.
- Complex and lengthy setup process
Despite simplifications in recent years, the China WFOE registration process remains complex and multi-stepped. Doing things right will take time, resources and investment. A WFOE remains the best option for maximum ability to do business in China, but this restriction should be considered for any company that needs to operate quickly, or just make initial market exploration. An alternative Representative Office structure, or simply hiring outsourced employees, might be preferable.
China WFOE registration – an improving process
The Chinese government remains supportive of foreign companies opening in China, particularly in key desired industries and sectors. As such, they have in recent years made a number of changes to simplify the process for foreign company registration in China. This includes:
- Moving a large part of the application process online.
The introduction of a single application for a “5 in 1” license (as opposed to lengthier individual applications for each required previously).
Relaxation of WFOE capital requirements. Formal specified minimum capital levels have been removed and WFOEs are able to define capital levels and injection schedule that match their business plans.
Nevertheless, it remains a bureaucratic process, involving interaction with several government departments, and requiring plenty of paperwork still! Things are easier and faster than in past years though, and improvements continue to be made.
For full details of WFOE registration and setup, see our guide to China WFOE registration. In summary, this involves the following steps:
Apply for name approval and registration. Names must be appropriate for the company and branding but also meet specified requirements.
Rent office space as necessary. Before an application for WFOE incorporation, it is necessary to have a minimum 1-year lease for company space in the city of registration.
- Online registration via MOFCOM. This provides the approval required to set up and license the WFOE.
Apply for a “5 in 1” business license from the local Administration of Industry and Commerce (AIC). One single application is made for licenses covering the main business license, tax registration certificate, organization code certificate, social security registration certificate, and statistical registration certificate.
Carving chops for the new company. Chops, or seal, form the official representation and authentication of the new company.
Opening bank accounts. A WFOE will need at least two accounts – a local currency account and a capital contribution account – normally with the same institution.
Further registrations with local authorities. WFOEs must be registered for VAT payments with the local tax bureau. Also, a trading WFOE will need to carry out customs and import-exit registration.
Issue contracts and complete the necessary registration for employees. As a WFOE can directly hire staff, contracts will need to be issued for new employees, or transferred across from agencies if hired under a previous agreement or Representative Office structure.
Ongoing management of a WFOE
Anyone opening a WFOE should be aware beforehand of the ongoing requirements to operate. WFOEs are, like any company, subject to various taxes and must also undergo comprehensive financial and tax audits and reporting each year.
The main taxes that need to be considered include:
Tax on company income /profits. The main tax is Corporate Income Tax (CIT), levied on profits at a rate of 25%. There are some discounts in place and CIT changes are a common way for local authorities to offer business incentives
Withholding tax paid on payments to non-resident enterprises, including dividends, royalties, interest, and rent. The current rate is 10%.
- Consumption / indirect taxes including VAT levied on different products and services at rates of 16%, 10% or 6%.
- Consumption Tax of between 1% and 56% for various manufactured or imported consumables and luxury goods.
- Stamp Duty levied on various contracts, licenses and accounting books, at a rate between 0.005% and 0.1%.
And the various annual requirements placed on WFOEs include:
An annual audit conducted by a Chinese Certified Public Accounting (CPA) firm. This looks at the previous year’s financials and cash flow and needs to be completed by the end of April each year.
An annual tax return, to be completed by the end of May. This involves a full reconciliation of CIT paid for the previous year, as well as consideration of Transfer Pricing between related parties.
- An annual report to be submitted to the local AIC by the end of June, containing detailed company and financial information.
For more details on tax rates and annual compliance requirements for WFOEs see our separate articles discussing these.
Our hints – things to be careful of during WFOE setup
As with any complex business process, it is best to go into China WFOE registration well prepared! At FDI China, we have worked with many companies to successfully open a WFOE. There are a number of things we have seen along the way that can help a new company.
Don’t underestimate the time and resources needed. China WFOE registration can be a long and involved process. Without the right preparation and commitment internally though, this can be made worse! It is important to allocate proper time and resource from all required areas as early as possible.
Beware of regional differences. Although WFOEs are governed at a national level by Chinese Company Law, there are many regional differences. A degree of local government control is very common in China, and this certainly affects WFOEs. They will usually set requirements such as WFOE capital requirements, specific application procedures, and Free Trade Zone benefits and concessions.
Choose the right location and set an appropriate Business Scope from the outset. These are vital parts of WFOE registration that very much define what business the new company can engage in. Changing these later can be very difficult (it effectively requires re-registration), so spending the time to choose these properly is time well spent!
Remember it is easy to make mistakes in the registration process. Especially for those companies new to China, there are many parts of the setup process to be careful with. Interaction with several government bodies is needed, and there are many requests for very specific details and information – for example, company plans and financials, and company ownership/control structure. WFOE documents (such as the Articles of Association) must be completed accurately, using the right terminology. Any mistakes in these areas can unnecessarily lengthen the setup process.
Apply for Intellectual Property (IP) rights registration as early as possible. There have been many issues in the past with IP protection in China. The situation is improving, but it is still important for foreign companies to register for patents, trademarks or copyright as early as practical – this is possible in most cases through agencies prior to registration.
The information contained in this article is valid on September 20th, 2018. For updated information, please contact us via email at email@example.com.