Introduction to Wholly Foreign Owned Enterprises in China

We have heard earlier from Gabriel Yong from NUS@Shanghai on doing business in China. Continuing on the business in China series, Kenneth Wong, president of SHEN, introduces us to the concept of wholly foreign owned enterprises in China, and offers the guidelines and rules for a foreign entrepreneur to set up their business in China.

Wholly Foreign Owned Enterprises (WFOEs) have become the investment vehicle of choice for the international investor wishing to manufacture, process, or assemble in China. It negates the need for a Chinese partner and does not require large amounts of registered capital to fund. Although WFOEs are in essence to be used for facilities involving production lines, they have under certain conditions also proved suitable for service industries albeit with some restrictions over location. Manufacturing WFOE’s, with an eye on total export of their China manufactured product, may also enjoy significant tax and other incentives if based in Free Trade or Export Processing Zones.

Legal Status & Limited Liability Definition
WFOE’s are limited liability companies established under Chinese Company Law. The shareholders are 100% foreign, usually an international business who would own the company 100%. Limited Liability is recognized by the amount of registered capital injected into the business. Although this may in fact be a combination of two assets, cash injection and equipment, the total value of these also represents the extent of the WFOE’s liability. This affects situations involving insolvency as the assets may depreciate and the cash is legally allowed to be used as operational capital. Under these quite normal circumstances then it is wise just to bear in mind that in the event of bankruptcy the parent would be expected to make up, via injection, the difference between the registered capital amount and the actual value of cash and equipment in order to satisfy creditors.

Reduced Capital requirements
The lure of huge market potential coupled with the promise of tax holidays, tax incentives and financial rebates has helped China attract foreign direct investment (FDI) and to become the biggest recipient and utilizer of FRI in the world. A significant factor contributing to that is the reduced minimum paid-up registered capital requirement for the formation of WFOEs.

Previous Requirements

• Consulting/IT/Design/Manufacturing WFOE – USD 140,000
• Retailing WFOE – Not Permitted
• Trading WFOE- USD 200,000 permitted to be incorporated only in the Waigaoqiao Free Trade Zone (WGQ FTZ) and not eligible for Import/Export (I/X) License.

In the past, only large multinationals and medium-sized corporations were able to afford the above-mentioned registered capital requirements and were willing to take greater risks when venturing into China. However, their subsequent success then created a ‘ripple’ effect on their supplier/service providers outside of China, including the smaller companies. This then initiated the next phase necessary to sustain the influx of FDI into China.

Following the amendment of the Company Law and the Administrative regulations for the Registration of companies, it is now possible to incorporate WFOEs with the following paid-up registered capital

• Consulting/IT/Design WFOE – RMB 100,000
• Retailing WFOE – RMB 300,000
• Trading WFOE inside WGQ FTZ- RMB 500,000 for “small-scale tax payer” and RMB 1 million if 17% Value-Added tax (VAT) status is required. Import/Export License can now be issued

Domestic Trading (i.e. buying and selling of goods within China) can now be added into the business scope of a trading WFOE. To differentiate this newly-approved structure, the term Foreign-Invested Commercial Enterprise (FICE) has been introduced. Minimum paid up registered capital is RMB 500,000 for “small-scale taxpayers” and RMB 5 million if 17% VAT status is required but certain districts may allow application with RMB 3 million paid-up registered capital.

• Manufacturing WFOE – RMB 500,000 and not subjected to additional paid-up registered capital in order to apply for 17% VAT status.

As an added incentive, the regulations for the administration of the registration of companies’ paid-up registered capital were amended to allow a longer period of capitalization as follows:

• First 3 months- 20% of paid-up capital subject to a minimum of RMB 30,000
• Within 24 months – remaining 80% of paid-up capital.

As part of this significant reduction in the paid-up registered capital requirement for WFOEs, there are now several far-reaching implications for changes in regulations.

1. The Representative Office (RO) has become more or less a redundant structure due to its inherent weakness, which includes the following: