Structuring your WFOE

Wholly foreign-owned enterprises (WFOEs) require some fairly complicated documentation. To many people, however, this appears to be merely an administrative issue that just needs to be catered for, filled in as quickly as possible, translated and filed. This is a grave mistake. Forget about consultants with “government connections,” cheap consultants, or local government advisors sitting in development zones who tell you applications can be processed in a week or two. That is not enough time to properly deal with all the nuances that you need to consider.

WFOE structural issues depend on a number of factors, such as what it is you want to do, how this impacts upon your tax treatment, your cash flow and the customs, and your ability to repatriate profits. We will now discuss in detail differences within specific types of business.

Operational matters as a structural concern

- Consulting WFOE and FIE applications

For services, there are many structural options. However, for entities such as these, no tax holidays are available. This means you are liable for tax on profits from the first year of operations, and that means tax planning is needed at the pre-incorporation stage to work out how to minimize this legally. Trading foreign-invested enterprises (FIEs) also need proper investment for working capital. If not, you can get into trouble very quickly if your registered capital is insufficient.

- WFOE applications-manufacturing

More options-will you be selling purely to China, purely for export, or a combination of both? What you do affects your tax position and how you handle this. Selling in China means collecting local revenues. How can you minimize tax on this? How can you get the money back home? Can you import duty-free? How can you claim back value-added tax on exports? Can you get tax holidays? How do you apply for these? What other incentives are on offer? Are you an encouraged industry that brings additional benefits?

These and many other questions start to bite when looking at manufacturing in China. Of particular consideration are the arrangements that need to be made if you are generating income that puts you firmly into the Chinese taxpayer bracket and you need to know how to deal with this to your best advantage.

- Location issues as pre-investment planning

Inappropriate site locations

Not all locations are applicable to all kinds of business-industrial, commercial, residential-and if you commit to the wrong type of location, you will be unable to proceed with your desired business license application at a later stage. Do your due diligence and make sure you know exactly the status of the building or land and its suitability for your particular type of foreign investment. If incorrect, this is an expensive mistake to make. Check what is being told to you by the local government with the land authorities.

Land use rights

There has been an increase over the past few years in the abuse, and occasionally quite deliberate misrepresentation to foreign investors, of the actual circumstances concerning land use rights. This is essentially a legal due diligence issue that is required when acquiring land, and it is vital to carry out background checks to confirm the status of the land in question. There are two types of land use rights:

Allocated rights-meaning someone else has the title, but permission to use for a specific purpose is provided for you. These take the form of an issued certificate in your name.

Granted rights-meaning you have title of the land.

For obvious reasons, granted rights are more expensive than allocated rights. Granted rights mean you can profit from any increase in the value of the land if you develop it, whereas with allocated rights this is not the case. A certificate is also issued demonstrating you have a title.

Also important to note is the scope of use appearing on the certificate that identifies exactly how the land can be used. Again for obvious reasons, this needs to be consistent with your business. Problems can occur in several ways:

Granted rights were paid for, but allocated rights provided-if you want title to the land, you must specify granted rights in all circumstances.

Invalid scope of use-agricultural land, especially in China, is at a premium, and permission to convert it to commercial use has to be obtained at the state level. Yet many local governments themselves issue fraudulent certificates, taking land from farmers for a pittance, illegally changing the rights, and then selling it for commercial usage to foreign investors. It is a common scam, and if you get caught, no matter how innocent you are, you stand to lose your investment. You must check with the local land authorities on all matters of land use, scope of use and so on to verify what you are told is correct.

Access rights-some land can have issues with access rights, and details to provide for this must be hammered out as part of any agreement. Fraudulent use of land is a common problem, and you can easily lose hundreds of thousands of dollars if your due diligence is not carried out properly.  

This is the second in a series of articles on this topic, the first of which appears in Issue No. 7.