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UPDATED: April 19, 2007 NO.17 APR.26, 2007
Legal Ease: Customizing Your China Wholly Foreign-Owned Enterprises
By CHRIS DEVONSHIRE-ELLIS
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Important registered capital and tax issues that are commonly misjudged

- VAT treatment

There is still one common misconception on value-added tax (VAT) exemption on exports. If the refund rate is lower than the levied rate, the company must bear the additional VAT cost on exportation. The VAT cost is calculated as follows:

· Manufacturing company:

VAT cost = (export - imported raw materials excluding customs duty) × (levy rate - refund rate)

· Trading company:

VAT cost = (the cost of local purchased raw material) × (levy rate - refund rate)

Generally speaking, the levied rate is 17 percent and the refund rate is 13 percent.

You need to ensure, if you fall into this scenario, that you have sufficient registered capital to hand to fund this cash flow gap.

Customs deposit on imported raw materials to be subsequently exported

We often hear the misconceived statement, "There is no VAT and custom duty levied on imported raw materials used for manufacturing goods locally if these are then finally exported 100 percent." It is incorrect. Actually, newly established foreign-invested enterprises (FIEs) must still make a tax deposit to customs for VAT (at around 17 percent) and remit duty on the initial importation, generally for six months. Many new businesses do not budget for this as initial working capital to be contributed as part of registered capital, leaving them short of cash later. You must factor this amount based upon your participated imports into your registered capital requirements when working out your required capital injection and cash flow forecasts. It is a common mistake and can have very serious implications if it is not catered for at your financial planning stage.

Other government departments that require attention

Factories, health and safety and the fire department will all require checks and be responsible for issuing their own licenses, for which you will have to pay. These are usually minimal amounts, but can add up for sizable businesses. Environmental protection can however be expensive, if your business is potentially polluting, you need to be aware beforehand how this matter needs to be dealt with and the likely costs for dealing with it. All this needs to be catered for--yes, as your working capital, as reflected in your registered capital injection for operating costs.

Structuring financially efficient investment

Enhanced profit repatriation--reducing profit taxes in your business

This is a tax issue and applies to all wholly foreign-owned enterprises (WFOEs) that sell services or products in China. If no structural changes are made to your articles, you lose out on between 4 percent and 13 percent of your total profits in wasted and unnecessary profit tax payments. WFOEs, as mentioned earlier, are not just simple licensing applications, and if you treat them as such, you end up with an inefficient business.

Enhancing your China profitability by reducing your profit tax burden is essentially a matter of introducing into the business a series of allowable service contracts between the WFOE and it's parent company back home. These services can include:

 Management expertise;

 Royalties, such as for trademark and patent use;

 Interest and administration on loans made to the WFO; and

 Other services as required

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