Header graphic for print
China Law Blog China Law for Business

How To Form a China WFOE. Scope Really Really Matters.

Posted in China Business, Legal News

Pretty much every week my law firm gets contacted by an American or European company with big plans for China. Almost invariably (and this is a good thing), this company has spent tens of thousands of dollars in researching China for their business and in travelling back and forth to China to scope things out. Their calls to me usually begin with them telling me that they have done their research and they want to form their own China company to conduct business in China.

I then explain the various options foreign companies have for going into China — still essentially confined to going it alone as a Wholly Foreign Owned Entity (WFOE, a/k/a Wholly Owned Foreign Entity or Enterprise or WOFE), Representative Office (Rep Office) or partnering with a Chinese company in the form of a Joint Venture (JV).  

Then we start talking about what sort of entity makes sense for this particular company. Nine out of ten times, the company wants to go into China on its own as a WFOE and that is where the problem sometimes starts. The company has heard that China is very capitalistic and “wide open” and did not know that is not really the case, particularly as it relates to foreign companies. 

China has what it calls its “Catalog for the Guidance of Foreign Invested Enterprises.” This catalog divides foreign investment into “encouraged,” “restricted” and “prohibited” investments. Foreign companies cannot invest in prohibited industries and foreign investment in restricted industries typically requires the foreign company joint venture with a Chinese company. Industries that are not classified into any of the three categories are generally assumed to be permitted.

So every once in a while, I have to inform the American or European company that it simply cannot go into China at all or that it can only do so if and when it has found a Chinese company with which it can joint venture. The moral of the story is that it makes sense to find out whether your proposed company can work in China at all, and to do so before funding market and operations research or China trips.

But this research is oftentimes not so simple and that is because a lot depends on how the business is defined when the application is made. The business scope is relevant to the catalog on foreign investment because a business sometimes can fit within one or more categories of the catalog and how you describe your business scope on your WFOE application can make the difference between approval and rejection. You sometimes can massage the description of your business scope to obtain more favorable classification.

BUT — and this is why I am writing this post now — if you under or overreach on the description of your business scope, you might find yourselves in big trouble.  We are getting an increasing number of calls from American companies in trouble with the Chinese government for doing things in their business that were not mentioned in the business scope section of their initial WFOE.

In some cases, the companies have admitted to us that they were never “really comfortable” with the business scope mentioned in their applications, but that the company they had used to form their WFOE had “pushed” them into it as it would “make things much easier.” In some cases, the scope of the business changed after the application was submitted and the company had failed to secure approval in advance for the change. And in some cases, the company probably would never have been approved at all had it been upfront and honest in its application. In nearly all instances, the companies had managed to secure local approval but were now in trouble with Beijing, which constantly is auditing these applications. In one instance, the local government went back and changed its mind, probably after conducting an audit of its own.

I cannot go into any more detail on these matters, but I can give this advice: applying for a WFOE in China involves a heck of a lot more than just filling out a form and getting approval. It does matter for what you get approved and you (or whomever you are using for your WFOE application) need to know China’s foreign investment catalog inside and out before applying. You then must tailor your application to meet both the requirements of the foreign investment catalog AND the reality of what you will be doing in China. A failure to comply on both fronts will lead to, at best, a rejection of your application and, at worst, being shut down months or years later.

If you take away nothing from this post, please at least understand that your getting local government approval for your WFOE does not mean you are out of the woods. There is little to no benefit in getting approval for a non-conforming WFOE.  

  • Chris

    I’m constantly having to remind overseas HQ on the restrictions on our approved business scope. There are a range of businesses & operations and business models that would be profitable and interesting. However we do not have approval in our current business license and are very unlikely to get approval from the relevant Bureaus of Industry and Commerce as they are in the restricted/prohibited investment areas.
    HQ appears surprised by this having presumed post company formation that operations would be unrestricted.
    Despite this, there is significant flexibility within approved business scope. On the Business License, approved business scope terms are fairly generic “Business Consulting” “Training” and can cover many particular forms of activities.
    Having an active approach with the local Bureau of Industry and Commerce, explaining clearly what you do and how it falls within approved business scope is also useful. After one quite pleasant enough meeting they indicated that a couple of our business activities were “stretching” approved scope, suggested we submit an application for additional areas and promptly approved several new terms. No penalty, no lawyers and almost no cost.

  • http://www.qingdaohhh.com Another Chris

    Hehe, business scope is always fun. I get quiet a few inquiries of companies that want to trade “stuff” and then explain that they want to look around and see what they can export. That will then range from medical equipment, electronics, agricultural goods and furniture – for one company. And then they are surprised that such a business scope is not cheap in China.
    Wish more people would read your post, Dan.

  • http://www.pbl.com David W

    Dan & Steve, it IS just amazing how the way things are done in a client’s own “home jurisdiction” can color its view on how things must work, say, in a foreign jurisdiction on the other side of the planet! One can feel like a dentist in an extraction, when trying to get clients to commit to a business scope before they go and start a WFOE (not to mention the discussions on capital requirements. Oh boy!). Similarly, a common fight with clients is that before they create a WFOE or set up ANY sort of shop in China, they might want to be sure that they have some actual business flowing there. They seem to think that people will just flock to give them business because they have big noses or are a known brand in Montana or Nuneaton or something. Companies want to hop on the China bandwagon, and don’t understand that they can’t just retrofit themselves, nor just shut things down, if all doesn’t pan out after they get there. Throw in the “I MUST be in Shanghai mantra” (often coming from the mouths of people who’ve never been to Asia before, let alone to Shanghai or anywhere else in Asia, and have no idea about the serious cost/benefit factors, leasing issues, etc.), and sometimes it would appear that the MSG in their American/European-Chinese dinners perhaps has been affecting their minds.
    So in addition to the fact that creating a WFOE itself is more complicated and requires more forethought than filling out a form or two (I think that may be a quote from someone or other–not on this Blog or the Comments, of course), it really goes to a whole foundation of having a proper strategic plan in place, of the nature that should apply for all businesses, everywhere. Otherwise, it’s like a financial services company that suddenly, and arbitrarily, decides it’s going to get involved in the hospitality or fashion shoes industries, without research or the appropriate planning or resources. Opening a business in China, even for an American or European business in the “same industry,” still requires the same level of forethought and planning as moving into a new strategic realm.

  • Kate

    This is quite helpful to foreign investors.
    As an in-house lawyer of US base WOFE in China, we also experienced another problem. You need pay attention to your exact Chinese translation for your business scope. Sometime the wording on your business license actually is not what you want or understand from English version. There is always difference , which can bring your later business in trouble. For example, you need explain to China Customs that the equipment or product you import is really under the business scope.
    The problem happened due to the lanague bar of technical understanding. You need find someone in your company who really understand your business clearly both in English and Chinese, then work with China local lawyer and goverement closely to confirm the wording of your business scope before application for a new company or to change your business scope.

  • Rick Simpson

    It’s articles like these that make me recommend your blog to everyone going to China. Thanks.

  • http://www.elitelawyerproject.com/blog Kim

    Kate I sincerely appreciate the tip, and can understand how easily the incorrect use of the Chinese language could skew the understanding of the business license. I continue to enjoy this blog and it’s factual straight forward information.

  • Big Four

    I know others have already said it, but it’s true. This is the best description I have seen for how to form a WFOE in China and I think that is because it is one of the few that is not written from the angle of “hire me.” Thanks for this column and thanks for the blog.

  • http://www.kyzen.com Tom

    Thank you for the wonderful information in your blog. As a company we have been planning how we step things up in China for several years and your comments have had a major influence on our thinking. I do have a question. I have heard about a corporate structure that you never seem to mention. FICE, Foreign Investment Corporate Entity I believe does not allow for manufacturing but does allow for multiple sites, whereas WOFEs are I believe single site operations. Does it truly exist? Why is it never mentioned as an option? Appreciate the info.