China: Types of Company
Wholly Foreign-Owned Enterprise
Nature of a Wholly Foreign-Owned Enterprise (WFOE)
Although at one time it was normal for foreigners wishing to do business in China to use either a Representative Office or to form a Joint Venture, these forms have their disadvantages, and it has now become common practice to form a limited company under the Law of the People's Republic of China on Enterprises Operated Exclusively with Foreign Capital, 1986.
Originally, WFOEs were intended for export or high-technology manufacturing, but China's entry into the WTO has led to a gradual broadening of the use of WFOEs into service and trading sectors. When a WFOE is set up for trading purposes within China itself, it is more normally known as a 'Foreign-Invested Commercial Enterprise' (FICE), and is governed by the 2004 Measures for Foreign Investment in Commerce. See here for a description of the formation and operation of a FICE.
Detailed Rules For Implementing The Law Of The People's Republic Of China On Enterprises Operated Exclusively With Foreign Capital were enacted in 1990.
While the legislation lays down highly prescriptive rules for the formation and operation of a company owned by foreigners, the actual limited liability company itself must be formed under The Company Law of the People’s Republic of China, adopted October 27, 2005, effective January 1, 2006. This was an entirely new piece of legislation which brought Chinese company law significantly closer to Western practice.
As with a Representative Office, the formation of a WFOE is conducted under local rules, and central government becomes involved only if the business falls within certain nominated sectors such as financial services, telecommunications and the media.
Formation of a WFOE is not a purely bureaucratic process; the local authority will want to ensure that the proposed business will be adequately capitalized and does not present environmental risks. Their behaviour is normally said to be reasonable and quite business-minded, although there can be regional differences.
The legal minimum capital under the law is RMB100,000 (USD15,000) for a company with multiple shareholders, or RMB30,000 for a single-shareholder company, but the registered capital must reflect the needs of the business and is likely to be far higher than the minimum for most businesses. Capital requirements need to make allowance for the fact that many types of payment may have to be made in advance; business credit is unusual in China.
The capital required by the business and set down in the approved business plan will actually have to be provided, in cash or in kind, according to the timetable proposed, and once provided cannot be taken back. Profits can be repatriated by all means, although the renminbi (yuan) is still not fully convertible, and transfers will have to be approved and conducted through an authorised bank.
WFOE's are formed to operate within a defined business sector, known as business 'scope', and any extension of the business scope into another sector is likely to require an additional registration process, although all activities that are ancillary to the primary purpose are permitted.
WFOEs can employ both foreign and domestic workers, following appropriate procedures.
As with a Representative Office, a WFOE must have procured suitable premises in order to be registered in the first place. Such premises are likely to be within government-designated office, warehousing or manufacturing buildings.
Formation of a Wholly Foreign-Owned Enterprise (WFOE)
Except in certain business sectors where central government permissions are required (eg banking and financial services) the formation of a WFOE is a regional affair. Central government ceased to be involved in 2004. Sectors in which registration can be carried out regionally include manufacturing, trading, freight, consulting, contracting and advertising.
A company name must be in both English and Chinese, though, for practical purposes, only the Chinese name is important. It cannot be identical or similar to a previously registered company name. The name can be pre-reserved for a period of up to six months, which will expire if not used for establishment purposes during this time.
A WFOE must have a name in the form: Parent Company - Business activity - City - Ltd, eg Clinton Consulting (Beijing) Ltd. The chosen name (and proposed alternatives) can be 'pre-registered' for a period of six months, allowing time for the registration process itself.
Premises must also be found before the registration process begins. It is required to have physical premises in a building designated for such a purpose by the government. Accommodation addresses are not available for this purpose.
If factory or warehouse premises are also to be leased or acquired, their legal status must be such as to permit occupation or ownership by a WFOE; in many cases, especially where premises appear to be cheap, this may not be the case. Needless to say, expert advice is required on this and indeed on many aspects of commencing a business in China.
The entire formation and registration process will take up to six months, depending to some extent on the region or city of registration, and evidently also upon the complexity of the business plan. The initial registration of a WFOE must be renewed annually. Registration is carried out by the local Administration of Industry and Commerce (AIC) without the involvement of the Ministry of Commerce (MOFCOM).
The registration process is conducted by and through a 'sponsor', being a local company which is appropriately authorised, and can itself be foreign-owned. The sponsor submits the required paperwork to the AIC, and this includes:
- an application letter and standard application form;
- the articles of association of the WFOE;
- commercial feasibility study including the capital requirement;
- an environmental protection study if appropriate;
- the certificate of incorporation of the parent company;
- relevant extracts from the statutes of the parent company;
- a credit reference from the parent company bankers;
- a document appointing the director(s);
- a brief description of each directors and copies of their passports or other ID;
- evidence of the lease or purchase of office space;
- power of attorney in favour of the sponsor.
The AIC issues a Foreign Investment Approval Certificate once the business plan has been approved. Once the registration has been approved, certain other formalities must be completed within various specified periods:
- Issuance of a Temporary Business License by the AIC;
- Purchase of a 'chop' (carved stamp used to authenticate documents) from an approved maker;
- Provision of capital, or first tranche of 20% at least, and audit of this by a local accounting firm;
- Issuance of Permanent Business License by the AIC;
- Issue of an Enterprise Code Certificate by the Bureau of Quality and Technology Supervision, which is required when registering with the tax authority, the customs and in order to open a bank account;
- Registration with the local and central tax authorities;
- Registration with the customs authority (if it is intended to import office equipment, automobiles or personal effects);
- Registration with the local Statistics Bureau.
Some of the salient characteristics of a WFOE are as follows:
- There may be between one and fifty shareholders, who may be corporate;
- The articles restrict the right to transfer shares;
- Public offerings of shares are prohibited;
- Equity shares are based on capital contribution and not on numbers of shares;
- Shareholders must all be foreign;
- There must be one or more directors, but they cannot be corporate;
- One company official must be designated as its legal representative, who may bind the company without the use of a chop;
- There must be a General Manager;
- The various officers of the company need not be resident in China.
Ongoing Formalities for a Wholly Foreign-Owned Enterprise
Books of account must be set up within 15 days of approval of registration, and must be kept in the Chinese language. Audited accounts must be prepared by a domestic accounting firm on an annual basis which must be submitted to the tax authority. These are not publicly available.
The WFOE's Business License and Enterprise Code Certificate must be renewed annually. Renewal applications must be submitted one month before the date of expiry.
Remittances overseas will almost certainly be subject to foreign exchange controls, and specific permission will probably have to be obtained on every occasion, although this process can very often be administered by local banks. Many types of overseas remittance incur withholding tax.
If a WFOE ceases operations in China it must apply for de-registration and return its tax certificate to the tax authorities.
Employing Staff for a Wholly Foreign-Owned Enterprise
Under Chinese law a WFOE may employ both Chinese and foreign workers. Individual labour contracts are required and must be submitted for approval to the local labour bureau.
The contract, which needless to say must be in Chinese, must include at least a minimum seven clauses as prescribed by Article 19 of the Labour Act, and must follow a format prescribed by the local labour administration.
PRC labour law permits the termination of a direct employment on 30 days' notice, but if there is no demonstrable cause, there is a definite possibility of legal action. For this reason it may be better in some circumstances to recruit Chinese workers through an official 'labour service' office since there is no direct legal relationship with the employees. For Representative Offices it is obligatory to hire staff in this way, but for WFOEs it is optional.
Taxation of a Wholly Foreign-Owned Enterprise
There is a great variety of different taxes in China, and a WFOE may have to file various different types of tax return, monthly, quarterly or annually, covering Enterprise Income Tax, Value Added Tax, Business Tax, Consumption Tax, Stamp Duty, Land Appreciation Tax, Withholding Tax (on foreign remittances), and, if there are employees, Income Tax and social security contributions, which are withheld from pay on a 'PAYE' basis.
The headline rate of taxation for a WFOE on its profits is 25%, the same as for Chinese-owned companies since 2008. Some companies may be able to take advantage of a 15% tax rate if they have successfully 'grandfathered' their previous status; and there are regional and national incentive schemes in particular sectors which allow for lower rates.