What Are the WFOE Capital Requirements in China?
WFOE capital requirements are sometimes a source of confusion for those looking to start up in China. Changes to WFOE registration procedures in recent years have made these much less of a concern than they used to be, but there are still some key things to understand.
This article will clear up the confusion and explain the current situation for the capital required:
- No defined minimum capital requirement any more
- In practice, capital is still needed but it is now much more flexible for a company to set its own level
- Timescales to deposit capital can be set in line with WFOE plans
- Despite regulation changes, it remains important to set capital levels correctly at the start – it can be costly not to do so!
Simplifying China WFOE registration – no minimum capital
For many years, the Chinese government has been committed to simplifying the process of WFOE registration. One of a number of ways they have done this is with the removal of formal capital levels. Chinese Company Law was amended in 2014 to specify no fixed minimum capital for a WFOE to be established. Prior to this, it was common to see local authorities requiring a minimum of 500k to 1 million RMB capital for consulting and trading WFOEs (and more for manufacturing WFOEs).
In some specific industries, there are still minimum levels required, but these are in specialised areas usually with financial obligations. For example, a financing or leasing company would still need a minimum of US$10 million.
Capital is still required, however!
In practice though, despite no legal defined minimum, capital is still required. It is not possible to set up a company in China with zero capital! Capital levels proposed will be reviewed by MOFCOM (Ministry of Commerce) and AIC (Administration for Industry and Commerce) as part of the company application, but just as importantly there are financial benefits for a WFOE in having a certain level of registered capital.
Government minimum in practice
Although the formal requirement has been removed, the AIC will still approve applications, and capitalization set too low can result in rejection. Instead of basing this decision on prescribed minimums, the level should be established in line with the future planned operations of the WFOE. As a guideline, AICs will look at the expected operating costs of the company over the first two years post incorporation and ensure that capital is adequate for this.
Setting a practical level
Even if it was permitted to open a WFOE with no capital, this would not help the WFOE much! There are major tax advantages to using the capital for company operating costs in the early period of operation. Any additional financing that must be injected, and cannot be taken from approved capital, will be taxed as income – not very advantageous!
This restriction and the fact that it is difficult to change agreed capital levels later, make it important to set an appropriate level at the time of initial setup.
What is registered capital?
Before planning their level of capital, a WFOE should make sure they are fully aware of what counts as capital and the rules regarding the injection of capital.
It is possible to contribute capital as cash, or in kind. In-kind contributions can be either equipment or intellectual property and can contribute up to 20% of total registered capital. It should be noted though that there are strict compliance procedures for any company wanting to use in-kind capital as opposed to cash. With less need these days to reach a minimum capital level, companies are more likely to rely on cash contribution.
As regards cash injection, this must be made from an overseas account into a registered capital account for the WFOE. This cannot happen before the business license is issued, and transactions require approval from SAFE (State Administration of Foreign Exchange). WFOEs should take care here as any funds transmitted differently, for example in advance of the setup of the WFOE structure, or via a Chinese RMB account or Chinese partner company, will not count as a valid capital contribution.
Depositing capital – a more relaxed timescale
Prior to the changes in 2014, there was a strict timeline for capital injection. 20% of the capital had to be deposited within 90 days and the remainder within 2 years. This requirement has been relaxed and WFOEs are free to define their own capital injection timeframe. The main requirement now is only that all capital is paid within 30 years of incorporation.
WFOEs are therefore free to define an injection timetable that is in line with their planned operation and/or expansion in China. This can be very advantageous as there is no need to have costly capital tied up in a capital account for long periods of time.
Companies should keep in mind however that before a WFOE can be closed down, when and if this is required, all capital must be fully paid up. This is a good reason not to set the level too high at the outset!
There is a requirement too for a WFOE to keep a reserve fund based on their level of capital. Whilst the intention of the capital injected is to be spent on company expenses rather than held as a reserve, there is a stipulation in Company Law for the gradual build-up of a reserve account. In particular, 10% of annual after-tax profits need to be directed to a capital reserve fund, capped at 50% of the total registered capital of the WFOE.
Changing capital levels – a tough process
Companies should also be aware from the outset of the difficulties of changing capital levels at a later date. Whilst this is possible, it is a complex and time-consuming process.
This involves the following steps:
- Application to MOFCOM for approval to increase registered capital. The reasons for the increase must also be given
- Application to the local AIC to change the registered capital level (once approval from MOFCOM is granted)
- Applying to SAFE for approval to transfer funds to China
- Making a bank transfer to the company’s Chinese bank from overseas
- Once funds have been received in China, the AIC will then need to re-issue the WFOE business license
Such applications and approvals are never quick in China, and this process could take up to two months. Given that a common reason for needing additional capital is an immediate shortage of funds for China operations, it may not be possible to rely on this. Note also, that a fee must be paid for making the change (0.04%-0.08% depending on total increase).
So, what is the minimum capital requirement?
Taking into account all these changes and practical considerations, what is the minimum capital for WFOE setup in China?
Today much more than in the past, this is a practical consideration based on the plans and financial projections for the WFOE. The AIC will look at this, and it makes sense for the WFOE to plan capital levels with reference to this as well. In the absence of any over-riding circumstances, it is common to base this on the planned expenses for the first two years.
Taking this as a starting point, companies should also look at expected income or shareholder payments, as well as any planned expansion. Companies new to the China market would be well advised to use an accountant with experience in China for this. There are many differences in planning costs in China, such as an increased need for advance payment for the rental, stock, and even some salary costs.
Remember is it important to set the capital level right at the start. If it is set too low, then any additional funding required will be taxed when injected (the level could be raised but this is difficult). And if it is set too high then it is likely that at some point money will be left idle in the capital account, instead of being put to use.
The information contained in this article is valid on July 25th, 2018. For updated information, please contact us via email at email@example.com.