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Business> Legal-Ease
UPDATED: February 11, 2007 NO.7 FEB.15, 2007
Customizing Your China Wholly Foreign-Owned Enterprises
This is the first article in a series on this topic
By Chris Devonshire-Ellis

Wholly foreign-owned enterprises (WFOEs) have long been the preferred investment vehicle for international investors looking to China for lower production costs or for market access. Yet recently, a slapdash, "cookie-cutter" approach to structuring such entities has become increasingly prevalent, and more than ever before, we are having to bail out increasing numbers of foreign investors by revising documents or even completely restructuring the investment.

While this on one hand is good news, the reality is that no professional firm likes to see such problems, and it is expensive and unnecessary for the investor to have to go through this pain, when all that was needed was more attention to detail. We prefer to see happy and successful international investors with profitable businesses. There is no reason why the current spate of shoddily-invested businesses should have begun to appear over the past couple of years. After all, WFOEs have been around since April 1986, and the first regulations to manage them appeared over 20 years ago.

However, in the rush to get into the China market, many consultants, investors and other so-called "experts" have been advising, or have been advised, in a poor and simplistic manner. The quality of some recent work from some of the new-to-China international lawyers, professional services firms and other consultants has left rather a lot to be desired. Equally, international businesspeople themselves have shown themselves to be incredibly naive on occasion when it comes to dealing with business operations in China.

Rule 1-Don't throw the rulebook away. Whatever made you a successful business overseas, don't abandon it just because "this is China." Be diligent and smart.

Rule 2-Setting up a business in China requires China tax and China legal knowledge. Not one or the other-both. You need to have professional advice in both these disciplines to get the most out of your business before you start to invest.

Rule 3-Cheap advice is dangerous. Everyone is an expert on China these days. Two years, or even just two months is all --it seems to take these days to be an "expert."

Cheap advice is just that. Do your research. Professional firms are there for a reason--they have in-depth knowledge and understanding of Chinese business and operational quirks and idiosyncrasies. Your investment needs customizing to get the most out of it.

Consulting WFOEs

Under certain and specialized sectors, however, WFOEs, rather than foreign-invested enterprises (FIEs), can be used as service entities, although this is rare. The Chinese Government revised their catalogue of foreign investment in 2002 and permitted, for international consulting firms with a good track record, WFOEs in the consulting field to be registered, as long as they focused on consultation of international economy, technology and environmental protection. In 2003 travel agencies and in late 2004 transportation and advertising were added. However, applications for these licenses are still heavily monitored and not easy to come by, requiring detailed and exhaustive registration procedures.

Consulting WFOEs aside, the general principle of WFOE and FIE means industry applications can now be divided up into two distinct investment models, supported by their own specific set of implementing rules and regulations:

Manufacturing, processing and assembly-WFOEs

Services trading, import and export, retailing, wholesaling, franchising and distribution-FIEs

This has made the legal administrative aspect of investing in the service industry far easier and clarified many of the issues concerning foreign investment in China. There are two additional factors that distinguish the two models:

Tax Holidays


WFOEs are eligible for tax holidays (profits tax), generally as follows:

Initial two years of profitability: 100 percent profits tax holiday

Next three years of profitability: 50 percent profits tax holiday

This is a long established China investment incentive. In some areas, it can be even more, especially in underdeveloped regions, or in industries the government specifically wishes to encourage. However, such holidays only apply to WFOEs and not to consulting WFOEs and FIEs. Manufacturing here then has advantages over services.

Trading via WFOEs

If you are a manufacturing business, you may still import and distribute products "not manufactured in China" under a WFOE license, provided the amount does not "in general" exceed 30 percent of the total revenue (according to state regulations), although on occasion local tax bureaus may accept 50 percent levels. This means that WFOEs can still trade and retain the tax holidays as mentioned above, as long as the trading portion remains the minority part of the business. This is worth considering as a structure if your business model requires both, for example if your clients may occasionally require additional spare parts (import and trading services) or other maintenance issues. Note that approval needs to be obtained for this, including tax bureau permission. Your books also need to be accurate, well-organized and will be subject to scrutiny by the tax bureau to ensure you are in compliance. Remember you have a tax holiday to protect and they want to ensure it is not being abused.

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