This being Thanksgiving weekend and all, I thought I would reprise (and update) some of our “more important” posts, including the one below on how to form a WFOE in China. The below post is “important” because so companies looking to form WFOEs in China refer to it when they first communicate with our China lawyers regarding their China plans and because so often companies come to us after having stalled midway in their China WFOE formation efforts.
Forming a China WFOE. It’s complicated.
The below is a typical initial email we send to clients that retain us for China WFOE formation. More than anything, this email highlights why forming a WFOE and why it tends to be so complicated and time consuming, and how different it is from forming a company in the United States.
Thank you for engaging us to assist with the formation of your China WFOE. I have set forth below the preliminary information and documents we will need. Depending on the exact nature of your planned China operations and local government requirements (which change frequently and can even vary depending on the nature of the business), we almost certainly will need additional information at a later date, but this should be a good start.
2.Some of our clients elect to form a Hong Kong company as an intermediary company, so that the sole shareholder of the WFOE is the HK company, and the sole shareholder of the HK company is the US company. At one time forming a HK company made it significantly easier to move through the initial stages of the WFOE formation process, but these days it’s pretty much a wash. Forming a HK company is relatively cheap and but it will create yet another corporate entity and it will require ongoing maintenance, which will include annual reports, taxes, renewals, and so forth. Forming a HK company also requires opening a Hong Kong bank account, which usually requires a director of the HK company go to Hong Kong in person.
The main reason to form a Hong Kong company is for tax reasons, particularly if you anticipate your China WFOE will become a profit center and remit substantial sums back to its parent company. We will need to work together to determine whether your tax situation warrants our forming a Hong Kong company to own your China WFOE.
3. Have you determined a location for the WFOE? If you have already have a proposed office address, please provide it, along with the landlord’s name and contact information. If you haven’t yet determined the exact address, then provide the city and district (e.g., Huzhou, Wuxing District).
4. If you have a lease or proposed lease for the office space, please provide us with that. Note that the lease should be valid for at least one year beyond the eventual approval date for the WFOE. As the WFOE may not be approved until several months hence, it is best for the initial term of the lease to be at least a year and a half, with 2 years being even better. The lease should also be in a proper format, and typically will need to be registered with the local real estate authority. We will work with you on this. An appropriate lease is required for WFOE approval.
5. We will also need proof that the landlord owns the property you plan to lease and that it has the authority to enter into the lease. This is usually proved via a land rights certificate and documentary proof of existence from the landlord (i.e., a national ID for an individual, and a business license for a company).
6.We will also want to make sure that your proposed use is acceptable for the premises and that the premises are suitable for use by a foreign-owned entity. It used to be possible to check this with the local SAIC, but this information is no longer publicly available so we will need to make sure the lease includes provisions protecting your interests in this regard. We typically like to see the landlord guarantee its premises are suitable both for a WFOE and for your proposed use. We also will want lease provisions that require your landlord cooperate with our requests for documents, receipts, or certifications. All of this must be in Chinese, of course.
7. As part of the WFOE formation process, we will review the lease to make sure it is suitable for use by a WFOE, contains adequate protections for you during the formation process, and is properly executed. You should also have us conduct a substantive review of the entire lease and if you wish, we can also negotiate with the landlord on behalf of your company. If you want to know more about the linkage between a WFOE’s lease and its formation approval, I suggest you this: China WFOE Lease Reviews.
8. Please provide four proposed company names in Chinese, in order of preference. The shorter the better; if possible, use no more than four characters. For now, we only need the basic name (e.g, “Nike,” not “Nike, Inc.”) We will then work with the local authorities to determine what should be the full legal name, which will likely include the scope of business and the location. Note that the Chinese authorities are going to be concerned with your WFOE’s Chinese name. The WFOE’s English name will be unofficial and is, for the most part, up to you.
9. Please prepare a one-page summary of your WFOE’s activities that includes the following:
(i) A general description of the business your WFOE will conduct (i.e., the services and/or products it will provide). Once we get this, we will work with you to make this scope of business work for China, because this can actually be determinative of whether your WFOE is approved or not and it also will influence various other WFOE related matters for you going forward. For you wish to know more on China WFOE scope, I suggest you read How To Form a China WFOE. Scope Really Really Matters, Part II and the initial post in that series.
(ii) How the WFOE’s services and/or products will change over the 5-year period following formation;
(iii) How you will staff your WFOE (e.g., the number of employees upon formation, how that number will change over the next 5 years, and the citizenship of each employee);
(iv) Job descriptions for each employee and an explanation of how the employees will be managed;
(v) A general description of the customer base;
(vi) The cashflow model for the WFOE. From which entities will the WFOE’s income come from? How will this income be generated? Will the WFOE’s income stay in China or be paid to an entity in another country? To which entities will the WFOE’s expenses be paid? For what purpose will these expenses be paid? What are the estimated amounts of such inflows and outflows? In what currency will payments to/from the WFOE be made?
(vii) A detailed first-year cost projection for your WFOE.
(viii) A one-year and five-year pro forma income statement and balance sheet.
(ix) A statement of the amount of “total investment” and the amount of “registered capital,” if not contained in one of the above financial statements. Registered capital is money the parent company must contribute to the WFOE after formation. By contrast, total investment is the amount of registered capital plus the amount of (optional) debt financing the WFOE can take on. There is no requirement that the WFOE raise funds through debt financing; however, having a total investment amount higher than the amount of registered capital will give your WFOE flexibility with debt financing that, from a regulatory standpoint, it would not ordinarily have. Such debt financing is simply a loan from the parent company. Note that if a WFOE needs an influx of cash from its parent company, a loan is usually preferable to a payment, as the Chinese tax authorities treat the latter as income to the WFOE and will tax it accordingly. The relevant Chinese regulations state that for lower-capitalized WFOEs (i.e., those with total investments of less than US $3 million) the amount of registered capital must be at least 70% of the amount of the total investment.
10. Describe the WFOE’s management structure. Will it have (1) a board of directors or (2) a single director (called the managing director or executive director)? Once you decide that, we will need to know the identities of the following for your WFOE:
(i) Managing/Executive Director (or all the Directors, if you have a board): This person is in charge of overall management of the company, but not day-to-day management.
(ii) General Manager: This person is in charge of day-to-day management of the company—making bank deposits and withdrawals, paying taxes, arranging utilities, hiring and firing, and so forth. As a matter of law, the general manager and the managing director can be the same person and do not need to reside in China. As a practical matter, for any company actively operating in China, the general manager should be resident in China.
(iii) Supervisor: This person has nothing to do with the WFOE day-to-day operations. The supervisor merely represents the interests of the shareholders, and oversees the actions of the managing director (or board of directors, if you have a board). In a one-shareholder WFOE, the supervisor does almost nothing, but Chinese law still requires you appoint one.
(iv) Legal Representative: This person has overall responsibility for managing a China WFOe, and this person has the authority to act in the name of the company. The “legal representative” is a position unique to China companies; the closest analog in American corporate structure is the chairman of the board. By definition, the legal representative has authority to sign contracts on behalf of the company. The legal representative is not a standalone position; he or she virtually always is either the chairman of the board (for a three-person board) or the managing/executive director (for a one-person board).
11. Note that though the same person can simultaneously serve as the managing director, legal representative, and general manager, that person cannot be the supervisor. The supervisor must be a separate person.
12. Please provide color copies of the passports of the above people and a current resume of the WFOE’s legal representative.
The first step in WFOE formation is to apply for registration of the WFOE company name. But before we can do that, we must first finalize both your company’s scope of business and the exact location of the office, because the address of the office determines where we must submit the WFOE application. Additionally, the specific procedures for WFOE formation vary depending on the city and district in which your office will be located, and on the scope of business. In other words, the first step itself requires a considerable amount of preparation.