When contemplating setting up a business in China, one needs to consider what structure to use. But before deciding on the structure, it is important to lay out a strategy. Strategy must lead structure.
Structuring your WFOE Business scope
You need to ensure your business scope is accurate and genuine. The requisite administrative government offices will quickly pass your proposed business scope, but that does not mean you are finished. Your proposal will then make its way to the state and local tax bureaus, and they will also thoroughly check your application. Any attempts to fool the tax bureau into thinking you are producing one thing when you are actually producing another will inevitably fail.
WFOEs (wholly foreign-owned enterprises) can only operate within the business scope approved by the authorities. The scope of business article within your articles of association will define exactly what your company is going to do. If you are going to be selling your product domestically, be sure to mention China's required compliance with the WTO treaty. This will allow easier access to the domestic marketplace. Also, your business focus must be clearly indicated or problems with the tax bureau and customs will arise when seeking due tax refunds. This does not mean your WFOE must be one-dimensional, but that you must be honest and prescient when planning your operation. Beyond being a complicated approval process, it is also a lengthy one due to the requisite translations and multiple bureaucratic departments.
Registered capital requirements
Registered capital requirements are dependent on location and industry and are used as an entry barrier to ensure foreign-invested enterprises are of sufficient quality and financial strength.
Minimum capital requirement
The legal minimum capital requirement for a domestic commercial, manufacturing or service enterprise is 30, 000 yuan ($4,389) but immediately jumps to 100, 000 yuan ($14,631) for entities with only one shareholder present. In reality, however, the minimum capital requirements vary drastically by location and industry. For instance, a manufacturing WFOE in Beijing may face different capital requirements than a manufacturing WFOE in Tianjin, a service WFOE in Shanghai, or a foreign-invested commerce enterprise in Guangzhou. Shop around and compare regional differences. But beware, people are often duped into attractive but untenable minimum capital requirements proffered by local magistrates trying to meet their quotas. This will lead to complications with the central and local tax bureaus, both of which will be intimately involved in your business life. It might be helpful to note that your registered capital is also your limited liability and this is also reflected in this amount. This could become a deal-breaker if a potential client wants to do business but cannot determine whether or not you are sufficiently capitalized.
Registered capital and total investment figures are both required during the application procedure. The total investment is the amount necessary to realize the company's operations, while the registered capital is the equity pledged to the local authorities. The difference between registered capital and total investment represents the debt of the investment and can be made up by loans from the investor or foreign banks. Pay attention to the relationship between registered capital and total investment in case you need to obtain further debt or other financing from your holding company or other financial institution. Keeping this window open will cost you nothing, but closing yourself off from further financing by equating registered capital and total investment may leave you handcuffed. The payment schedule of the WFOE registered capital also needs to be specified in the articles of association. The investor may choose to pay it as a lump sum or in installments.
It is crucial for the investor to understand the importance of minimum registered capital, total investment, and working capital; but beyond that, basic investment criteria remains the same. The government will look at the general viability of the project and a reasonable cash requirement for a particular type of investment. Injections of cash and plant equipment take place after the WFOE license is approved, making it a no-risk investment in terms of money up front.
The amount of working capital required until a business is self-sufficient is often underestimated. When the time comes, do not simply put in the minimum registered capital requirement during initial capitalization as you may later find the business is under-capitalized, unable to pay its bills and out of funds. Injecting capital is costly in terms of time and money. Any money sent to make up an operational shortfall that does not follow the government's business cash injection protocol can be subject to the 25 percent of corporate income tax. Err on the side of over-funding. It is an operational cash flow issue, not a regulatory licensing matter. Bear in mind that newly established foreign businesses in China must still make a tax deposit to customs for VAT and remit duty on initial imports, usually for a period of about six months. Many new businesses do not cater for this as initial working capital (as part of their registered capital requirements), leaving them short of cash later on. Again, factor in your working capital requirements as your registered capital amount as opposed to any "minimum" suggestions.
(The third and final part of this article will appear in Issue 47)
The author is Senior Legal Associate of Dezan Shira & Associates Beijing Office (www.dezshira.com)