Just sent an email to an American company setting out the basics of what it should be looking for in the initial stages of determining whether it wants to invest in another American company that has a WFOE in China. The list included that the American company make sure that the China WFOE is properly registered and structured. But in that same paragraph, I added the following, which I probably would not have done even six months ago:
You should determine whether its [the WFOE’s] employees are all signed to proper contracts and whether the WFOE has paid ALL employer/employee taxes to the government and that it is not at risk for a large number of employee lawsuits. We have in the last few months been contacted by a slew of foreign companies that are trying to decide whether to stay in China after having learned that they owe large amounts in employer taxes or large amounts to their employees that they “didn’t realize” they had failed to pay.
In one instance, the American company said that its WFOE manager never told the home office that the WFOE had not been paying employer taxes for the last few years and now the Chinese tax authorities were demanding that [very large] payment. In another instance, the American company doing business in China via its wholly owned WFOE had just learned that one of its employees had been badly injured and had sued the WFOE and won and now the WFOE owed this employee a lot of money and it did not help that it did not have written contracts with any of its employees and now it was having to deal with that as well. Both of these were in the last week!
One of our China lawyers also got an email from another American company who was being “confronted” by its lead employee because it was doing business in China with “employees” but without ever having registered an entity that would allow it to do so legally. My response to that company was as follows:
You may be in the worst situation possible. You are operating completely illegally in China at a time when the Chinese government has stepped up its searching for companies just like yours and shutting them down and issuing massive fines and worse. So on the one hand, you have absolutely no choice but to get legal fast or you might find your entire China program shut down and nobody from the US able to go there again.
But on the other hand, you have a Chinese “employee” who on one level “completely owns” you because if you do something that he doesn’t like he and all of your other “employees” can sue you for back wages/back taxes because you had no written contract and because you failed to pay their benefits and because your relationship with them was/is illegal. And if you do all of a sudden choose to go legal, your overall employee costs will increase by about 60%. Right now, you are, let’s say, paying an employee $1000. If you go legal, you will need to pay around 40% in employer taxes, which will get you to $1400. But even that won’t work. Because if you go legal, your employees are going to have to start paying their own income taxes of about 25% and that will mean that they will almost certainly demand a raise to cover that. So you give them a raise to $1300 and then your 40% will be on that amount, which will then raise the monthly salary+benefits to around $1820 a month. And this completely ignores the corporate taxes and other fees and costs that your China entity will need to pay.
So essentially you either pay a lot of money to get legal or you should just start acting as though your China operations are almost certainly going to get shut down within the next 1-12 months. One thing you do not want to do in this situation is to go to China or to send anyone from your company to China to “try to work things out.” For why this is the case, check out The Single Best Way To Avoid Being Taken Hostage In China.
Your best course of action might just be to start all over in Vietnam.
Bottom Line: There has never been a better time than now to make sure that you know what is going on with your China WFOE and that your China operations are fully legal.