WFOE Pre-establishment Considerations
Opening a WFOE is the first step to doing business in the exciting, challenging, but hopefully profitable China market. There are many things for a company to consider as they embark on this process, and in this article, we look at a selection of the ones we consider most important:
- Choosing the correct WFOE structure
- Understanding and planning for registered capital in China
- Deciding on the most appropriate business scope and registration location
- Looking early at WFOE tax and VAT requirements
- Making sure time and resources are appropriately allocated from the outset
Opening a WFOE in China – 5 key considerations
How to setup a company in China is an immediate concern for any business looking to open or expand into the country. The setup process is not always easy, and it can be long, resource intensive and often expensive. With the right preparation however it can be made much simpler – a key issue or delay in the process is often poor preparation.
Before starting the task of China WFOE registration, it is important to familiarise yourself with the full requirements, process and documentation needed. But even before that, there are some key areas to consider – the earlier the better. This will save time, money and frustration further down the line!
Decide on planned WFOE structure
A WFOE will need an ownership structure defined from the start. This is not always as straightforward as simply using the foreign parent – many companies prefer to make use of a separate holding company structure, or to open a specific holding company in a tax efficient location (Hong Kong or the British Virgin Islands for example). The decision as to what is best here requires consideration of various issues including company scale and future plans, taxation, desired anonymity and legal situation.
In recent years the situation has become more complex, with the introduction of “Actual Controlling Person” regulations. This involves the identification of the ultimate owners of the company. It is required to identity all investors in a WFOE, down to the individual or public company level (no private companies are permitted). Holding structures can still be used to facilitate complex ownership, but not to hide the identity of the owner or owners, and this needs to be considered from the outset.
Understand WFOE Capital requirements
In the not too distant past (pre-2016) there were fixed minimum registered capital levels in China defined by the government. For some business these could be over requirements and a costly part of doing business in China. It is good for WFOEs in China that these minimums have now been removed, but it still remains important to consider required capital as early as possible.
The reasons for this are less to meet government requirements, but more to aid business operations. As a guide, sufficient funding is needed to cover the WFOE’s financial obligations before the company is self-supporting (often set as 1 year), but this will vary for different company types and business plans. There is also now much more flexibility than in the past regarding the time period over which capital should be injected, and WFOEs can set this to match their planned operations.
Getting this right at the outset can be challenging, but it is important. Capital injection remains an efficient way of funding business setup and early operating costs. Any amount needed for permitted activities in excess of capital levels will be taxed as income. If the level is set too high though, funds will locked into a capital account that could be better used elsewhere.
Capital levels can be changed later but this is a complex and time consuming process that many companies choose to avoid.
Know your scope of business and business location
One of the unusual aspects of opening a WFOE in China is that the business it can perform is guided by its defined “Business Scope.” This is a short description of the business that the company will engage in, provided as part of the initial WFOE registration.
Needless to say, it is important to define this right, and this can take some effort. Thought must be made about both initial and future planned business, but approval is unlikely to be given by MOFCOM for anything too wide. It will also effect doing business with Chinese companies, as they will only engage with (and receive invoices from) appropriately defined businesses. Changing the business scope after incorporation is possible, but it can be a long and complicated process.
Along similar lines, thought should be put into the location (city / province) where the company is registered. It will affect future potential business and clients, both due to specific location and also due to associations with location and brand (a finance company registered in Shanghai for example presents a different image than one registered in Chengdu). There can of course also be other considerations such as differences with taxes or incentives, availability of appropriate staff or business space and costs.
Of course, tax will be a major considerations and administrative task post WFOE setup, but there are also some issues that need to be thought about before registration.
Firstly, there are some specifics related to the way China taxes WFOE’s during the “pre-operation” phase (the period between issue of the business license and first issue of invoices or generation of revenue). Many of the costs incurred during this period are eligible for income tax deduction. These include wages, printing fees, training fees, registration fees, transport fees, and purchases of non-fixed assets.
Secondly, tax and costs should be considered early as part of defining the capital levels. There are many areas, both during setup and later, where cost can be settled out of registered capital.
And thirdly, various tax registrations will be required during WFOE setup, including VAT. The VAT system in China has been simplified in recent years, but still remains quite complex! In particular companies should look early at the implications of registering as a “general” rather than “small scale” VAT taxpayer regardless of size, as this effects the rate paid and the ability to deduct from VAT.
Consider availability of time and resources for the setup process
Before embarking on the WFOE registration process, many companies believe that the delays and complexities of registration are mainly related to the Chinese government and obtaining approvals etc. Whilst there is some truth in this, and there is often an element of back and forwards discussion prior to various approvals being received, one of the main factors in delays is planning and preparation required by the company.
Setting up a WFOE in China is not a straightforward task, and there are many important issues that need to be looked at before or early on in the process. Some, but not all, of these have been highlighted in this article. Committing the right time and resources to make appropriate and correct decisions early on will save a lot of time and effort later!
In addition, there is often a lot of information and documentation required from various parts of the company or related parties. Having the right people, advisors and agents involved and committed from the outset is vital here.