Archives: China WFOE

China has liberalized its minimum capital requirements for a WFOE and the amounts required have been reduced in many Chinese cities/districts. But even if the Chinese government is going to let you get away with a very small amount of registered capital, you may want to pay more.

You should think about the registered capital you should be paying by considering how much money you will need to sustain your China WFOE until it can generate enough revenues from its own cash flow in China to sustain itself. If you inject less than you need in registered capital to sustain your WFOE until it generates enough in revenues to sustain itself, your WFOE will need a cash injection from somewhere. If you transfer money to your WFOE from overseas but you do not go through the correct process of re-registering your registered capital (which typically takes at least six weeks and involves having to get a new business license issued) the funds that you (or anyone else) send to your WFOE will count as income to your WFOE and will be taxed accordingly.

We often get calls from fairly new WFOEs seeking our help in figuring out how they can problem here is that quick-buck China lawyers and China consultants are interested in securing their fees to stay in business, not in your long term well-being. Getting you a WFOE as fast and as cheaply as possible in the short term is their goal because by the time you get hit with the tax bill they have already moved on to their next victim.

A while back, we did a similar post, entitled, China Company Formation Law Is Clear — WFOEs Are Easy, in which we discussed three companies my law firm’s China lawyers were in the midst of forming and noted how China’s minimum registered capital requirement was the biggest source of confusion for all three of these companies. All three companies contacted us after having become confused about registered capital after talking with various company formation consultants. We blamed the consultants for the confusion, insisting that the law itself is clear:

The law on minimum registered capital is clear, but the amount of capital that will be required does vary, depending mostly on the nature of the business of the company to be formed and on the city in which it is going to be registered.

Every company in China must have a stated registered capital. The registered capital includes all of the components of the initial investment in the company, including its start up cash, contributed property, and transferred intellectual property.

Where the registered capital is small, the entire amount must be contributed immediately upon formation of the company. If the amount is large, it may be contributed in installments. There are a number of schedules for the percentage and timing of large amounts of registered capital.

It is a crime to state a registered capital amount and then fail to contribute. It is also a crime to withdraw registered capital after it has been contributed.

The purpose of registered capital is to provide some notice to creditors of the capital adequacy of the company. Because of this, Chinese regulators take very seriously the rules regarding registered capital.

Registered capital is an initial investment that is intended to be immediately used in the operation of the company. It is not a deposit that must just sit in a bank and never be touched. It can be used to pay salaries and rent, to purchase product, or for any other normal start up operating expense. Registered capital may include contributed real and personal property used in operating the business. Many foreign investors think registered capital is some sort of security deposit that they can never utilize. This is not true.

On the other hand, some foreign enterprises believe they can simply withdraw their registered capital to their home country after the Chinese company begins normal business operations. This also is not true. The only way to get funds from the Chinese company out of China is by repatriating profits or by liquidating the Chinese company. Both of these methods will work, but they both require paying Chinese taxes and meeting other requirements under Chinese law.

Investors should also note that the RMB is not a freely convertible currency. For companies that will earn RMB income, the issue of conversion to U.S. dollars or other foreign currency should be carefully considered.

Chinese law is quite clear regarding minimum capital requirements for a WFOE but the statute’s prescriptions on this are essentially meaningless in actual practice. Under Chinese Company Law, the minimum capital requirement is either 30,000 RMB (less than $4,000 US) or 100,000 RMB (a bit over $12,000 US) depending on whether it is a multiple or single shareholder company. However, these numbers have no real meaning for forming a WFOE in China.

The real question is what the Chinese authorities will consider as adequate capitalization for the specific project and that always depends on the type of business and its location. For example, it is very expensive to operate a business in Shanghai. On the other hand, it can be very inexpensive to operate the same business in a rural part of China. It is expensive to operate a capital intensive business like manufacturing, but relatively inexpensive to operate a knowledge based consulting business. Finally, some Chinese cities just seem to want WFOEs more than others.

The Chinese regulators usually consider all of these issues. To complicate matters, each local regulator has its own basic standards on what constitutes adequate capital for certain types of business activities. These numbers are not published, but when asked they will almost always be provided. They can only be determined through direct contact with the regulator but only after providing a clear explanation of the project.

The local regulator virtually never considers the statutory minimum in making a determination regarding adequacy of capital. Rather, the local regulator will determine what it believes is an adequate amount of capital based on all the circumstances. Once the investor has a clear idea of the outlines of a project, it is usually a good idea to engage a China attorney to contact the local regulator to see what their response will be to the proposed amount of investment. This initial screening can save a lot of time if the investor’s idea of the proper amount of capitalization is dramatically different from that of the local regulator.

My firm’s China attorneys always go to the local regulators to get this amount before we get very far along in the application process. Almost without exception, our experience has been that after we explain the nature of our client’s business to the regulator, the regulator’s decision on the minimum capital required has been a very workable one for our clients.

In determining what constitutes adequate capital, one needs to consider the peculiar situation in China that all rents are paid in advance, that payment for products for sale are usually paid in advance, and that a reasonable advance reserve for salaries is also required. Thus, the initial start up cost is going to be higher than for a comparable company in the United States, where credit and time payments are much more common. Chinese regulators will not approve a project that looks risky or under-funded.

For more on forming WFOEs in China and the minimum capital required to do so, check out Chinese Company Formation, Part II — WFOE Minimum Capital Requirements and Chinese Company Formation — Forming a Wholly Foreign Owned Entity (WFOE) in China.

Our China lawyers often review leases for companies early in the WFOE registration process. Our work in this area has been growing exponentially as word has gotten around regarding WFOE registrations increasingly going awry and landlord problems stemming from WFOE leases.

The pendency of a WFOE formation is a complicated time for a commercial lease because of issues surrounding who the tenant on the lease should be. Should it be the foreign company that will be owning the WFOE or should it be the not yet formed WFOE?

Most of the time when we are called in to review these leases, the line on the lease where the tenant’s name should go has been left blank. The company that retains us has no idea what company to list as the tenant and so they hire us to help. Choosing the tenant is a significant issue and — as is typical for so much else in China — different cities require different procedures.

The following two approaches are typically followed in China for the tenant of a WFOE to be:

  • Specify the U.S. (or other foreign country) parent company as the tenant on the lease. If this is done, it is important that the tenant be the company that will be the parent company of the WFOE (and not some other entity). The lease should also specifically provide that when the WFOE is actually formed, the landlord will allow the lease to be assigned to the WFOE at no cost. Some landlords will require a time limit, some do not care. Failing to put this into the lease upfront can lead to the landlord charging an exorbitant amount to allow the assignment, which assignment you will need to get your WFOE registered.
  • Specify the WFOE as the tenant. You cannot use this method unless a name for the WFOE has already been approved. Under this approach, the landlord normally will require a time limit for the formation of the WFOE. Various remedies are proposed for dealing with the situation where the WFOE is never formed. This is a very awkward method, since a non-existent entity is being specified as the tenant. However, recently the Shanghai government has begun insisting that this method be used. Again, it is critical that your method complies with local requirements.

Determining how to proceed regarding the named tenant requires input from the local government authorities who will approve the WFOE. If your lease does not handle the lessee issue properly, the government generally will not approve your WFOE and/or you will end up having to incur all sorts of additional landlord and contracting costs.

If the U.S. (or other foreign country) company is listed as the tenant, the U.S. company will be required to pay the rent and the security deposit and other fees. Since the U.S. company is not a Chinese company, it will be required to pay these fees in U.S. dollars and that creates the following issues, among others:

  • The landlord must be willing to accept payment of initial rent and deposit in U.S. dollars.
  • The management company must be willing to accept payment of its management fees in U.S. dollars.
  • The utility companies must be willing to accept payment of their fees in U.S. dollars.

All of this can be quite complex and in many Chinese cities, the utility companies simply will not accept dollar payments. Many landlords will also refuse to accept U.S. dollar payments.

It is also important that the lease for a potential WFOE address the issues arising from WFOE formation. Our China lawyers typically draft a lease addendum that addresses the following:

  • The landlord acknowledges that the lease will be used for legal address for a WFOE.
  •  The landlord warrants that the leased premises is legally suited for use as a WFOE address.
  • The landlord agrees to cooperate with all documentation and procedures required for use of the lease in the WFOE formation process.
  • The landlord agrees to register the lease as required and to provide tax receipts for all rental payments. If there is a problem with the premises in terms of zoning or payment of fees, the government will refuse to register.
  • The landlord agrees to provide proof of ownership of the premises before execution of the lease.
  • The landlord agrees that if the lease is rejected by the government in connection with the WFOE formation process, the lease will terminate and the landlord will refund all payments made up to the date of termination.

Many landlords — particularly smaller landlords and landlords in cities with little foreign direct investment — will refuse to execute such an addendum. When that is the case, our job as lawyers is to discuss the costs and benefits of increased due diligence and the various risks involved in moving forward, or not.

 

In the bad old days (last year), every company in China was required to have a stated registered capital. This amount is provided in the Articles of Association of the company and is also noted on the company register. The registered capital includes all of the components of the initial investment in the company, including its start up cash, contributed property, and transferred intellectual property. The purpose of registered capital was to provide some notice to creditors of the capital adequacy of the company. Because of this, Chinese regulators took very seriously the rules regarding registered capital.

Registered capital is an initial investment intended to be immediately used in operating the China-based WFOE. It need not just sit in a bank and never be touched. It can be used to pay salaries and rent, to purchase product, or for any other normal start up operating expense. Registered capital may include contributed real and personal property used in operating the business. Many foreign investors think registered capital is some sort of security deposit that they can never utilize. This is not true. On the other hand, some foreign enterprises believe they can simply withdraw their registered capital after the Chinese company begins normal business operations. This also is not true. Once the capital is contributed to the Chinese company, it can never be withdrawn for anything other than paying company expenses.

The only way to get funds from the Chinese company out of China is by repatriating profits or by liquidating the Chinese company. Both of these methods will work, but they both require paying Chinese taxes and meeting other requirements under Chinese law. Investors should also note that the RMB is not a freely convertible currency. For companies that will earn RMB income, the issue of conversion to U.S. dollars or other foreign currency should be carefully considered and failing to abide by Chinese law all the way along the process will likely lead to an inability to get money out of China at some point down the road.

Under Chinese Company Law, the minimum capital requirement for multiple shareholder companies was around USD $5,000 and for single shareholder companies around USD $13,000. However, these numbers never really had meaning for forming a WFOE in China.

The real question was what the Chinese authorities would consider adequate capitalization for the specific project and that varied by type of business and location. For example, it is very expensive to operate a business in Shanghai. On the other hand, it can be very inexpensive to operate the same business in a rural area of China. It is expensive to operate a capital intensive business like manufacturing, but relatively inexpensive to operate a knowledge based consulting business.

The Chinese regulators usually considered all of these issues. To complicate matters, each local regulator had its own basic standards on what constitutes adequate capital for certain types of business activities. These numbers are not published, but when asked they will almost always be provided. They can only be determined through direct contact with the regulator and only after providing a clear explanation of the project. The local regulator virtually never considered the statutory minimum in making a determination regarding adequacy of capital. Rather, the local regulator would determine what it believed to be an adequate amount of capital based on all the circumstances.

In determining what constituted adequate capital, one needed to consider the peculiar situation in China that building rents are virtually always paid in advance, that payment for products for sale are virtually always paid in advance, and that a reasonable advance reserve for salaries is also required. Thus, the initial start up costs are much higher than in a location like the United States, where credit and time payments are more common. In addition, the foreign investor needed to take into account the risk aversion of the Chinese regulator. The Chinese regulator will not approve a project that looks risky or under-funded. The regulator has no incentive to do this, especially for a 100% foreign owned entity.

We frequently would saw three big mistakes made by foreign investors regarding required minimum capital. Foreign investors hear that assets can be used as a contribution towards the minimum capital requirement, so they go ahead and ship certain assets over to China, expecting to use those assets towards minimum capital. The problem with this approach is that unless the proper authorities have been notified and granted their approval in advance of the shipping, the assets you just shipped to China will not be applied towards minimum capital, and you will have a huge problem on your hands.

Another common mistake is the foreign investor putting a value on its assets (including its intellectual property) and assuming the Chinese regulators will put the same value on those assets in determining the contribution towards minimum capital. The Chinese regulators will require their own appraisal (at your expense) l of anything other than monetary contributions towards the minimum capital requirement, and those appraisals tend to come in low, particularly for IP.

The third common mistake was believing that the lower registered capital the better, when in fact that is rarely the case. If your WFOE starts out with too little in registered capital and then needs more to fund salaries or to pay rent or any other expenses, it typically needs to get that money from its foreign parent company and those funds are taxed to the WFOE as income. It is possible to secure government approval to increase the registered capital, but that can be time consuming and when wages are due, there is usually little time to waste.

But earlier this year, China eliminated any minimum registered capital requirement for WFOEs and my firm’s China lawyers have received a number of emails from companies asking about the impact of that change. Our answer has mostly been that we do not expect the change to have much impact for most companies. We say that for the following three reasons:

  • We are not convinced that all localities will be doing away with minimum capital requirements.
  • The law change does not change the tax considerations discussed above.
  • This last one comes from one of our readers, who rightly states that “having a substantial registered capital amount provides a sense of trust in the company. Some companies will not work with suppliers with a registered capital amount below a certain level. Will a WFOE with zero registered capital be trusted? Looking at the registered capital amount may be an old way of thinking but sometimes habits are hard to break.

“What are you seeing out there with WFOE minimum capital requirements?

For more on China WFOE formation, please check out the following:

Despite the increasing restrictions on using employee dispatch companies for hiring of “your” China employees, our China lawyers have seen very little by way of a slowdown in smaller companies choosing to go that route, especially if doing so will allow them to delay having to form a China WFOE that much longer.

The legal issues for foreign companies that use employee dispatch companies are not terribly complicated, with one exception.

The way the whole system works is that you as the foreign company sign a contract with the employee dispatch company for it to hire as its own employee an individual or individuals you would like doing work for your company. The better dispatch companies generally have pretty good contracts for this and so our role as attorneys for our foreign clients is mostly to point out the provisions at which our clients have some negotiating power.

The complication arises in the contract between the employee dispatch company and its/your employee and it is here where we see the most mistakes being made. The employee dispatch company drafts its employment contract with its/your employee to protect and benefit itself, without any real regard for you.  In most respects, your interests are fairly well lined up with the employee dispatch company and so for the most part it is a good thing that most of these companies draft good China employee contracts.

But when it comes to your intellectual property, you need to account for the fact that your employee dispatch company does not care at all. And when I say, “at all,” I mean at all. Your employee dispatch company does not care if its contract with its/your employee protects your IP and your employee dispatch company does not care if its contract fails to protect your IP.

For this reason, you have to care and you have to be the one to make sure that the employee contract reflects this. If you want to be sure that the employee does not end up owning your intellectual property, you need to make sure that the employee contract is clear on this. If you want to be sure that your employee signs a contract that reduces the likelihood of he or she running off with your trade secrets, you need to make sure that the employee contract has provisions for that.

Cause if you do not make sure that your China attorneys do this, nobody else will.

This post is by Grace Yang, one of our China lawyers resident in Beijing. Grace has her B.A. from Beijing University and her J.D. (law degree) from the University of Washington. Grace is licensed to practice law in Washington and New York States and she will be sitting for the China bar exam this fall. The below post stems from a recent project/memo Grace did for one of our American clients doing business in China.

 

We are often asked whether it is legal to pay a non-Chinese employee from both the China WFOE and from a company outside China (usually the US parent company).  The answer to that question is an easy yes, but the tax issues that arise from that are where things get difficult.

It is perfectly legal for an American company to pay its American employees from both China and the United States. However if your American employees are resident in China for more than 183 days in any calendar year, you must pay taxes in China on the combined U.S.-China salary of your employees. This obligation to report and pay taxes is stipulated in the Circular of the State Administration of Taxation on Income Tax Paid by the Enterprises with Foreign Investment and Foreign Enterprises for Their Employees on Behalf of Their Enterprises Abroad (Guoshuifa [1999] No. 241).

The Circular on Questions Concerning Tax Payments for Wage and Salary Income Gained by Individuals without Residence within the Territory of China (Guoshuifa [1994] No. 148), mandates that if your employee works in China for less than 183 days in a calendar year, he or she is obligated to pay taxes only on that portion of salary received from the China WFOE when he or she was in China.

But if your employee works in China for more than 183 days but less than 365 days and so long as your employee did not live in China for a full year prior to this year, your employee must pay China taxes on the salary paid by the China WFOE and on the salary paid by your US entity during the period he or she is in China. In other words, your employee must pay taxes on whatever salary was earned in China, no matter who pays it.

If your employee works in China for over one year, but less than five years, your employee must pay China income taxes on the salary received from the China WFOE as well as on the salary received from your US entity during the time your employee is in China.

Don’t let the above throw you off, it is actually quite simple: if your employee works in China for 183 or more days in any calendar year, both you and your employee must pay tax on the combined U.S.-Chinese salary. There is no way around this obligation. We advise our clients to take this seriously, because failure to comply with this rule can result in penalties for both the WFOE and for the employee.

The problem is that foreign companies have customarily ignored this rule and while Chinese tax authorities have recently become much more aggressive in enforcing it. The issue normally arises when the employee applies to renew his or her visa. If the employee has resided in China for more than 183 days, the local tax authority will request a copy of the employee’s US tax return. If the employee fails to provide the US return, that employee’s visa gets denied. If the employee does provide the U.S. tax return, the tax authorities assess the tax, along with interest and penalties.

Our China attorneys are aware of several cases where foreign employees were denied entry into China after 183 days of residence for failing to report their combined salaries. We also are aware of multiple cases where the Chinese tax authorities took very aggressive penalty actions against WFOEs for failing to report and pay taxes on the combined salary of their high level China company managers. The risk of noncompliance is therefore significant.

So what should your WFOE do? Report the combined salary and pay the full tax, or ensure your employee resides in China no more than 182 days in any calendar year. In part II (coming tomorrow), we explain why you really do have no choice in this.

The other day we did a post on how to shut down a China WFOE, entitled, How To Shut Down Your China Operations. In that post, we mentioned the possibility of selling your China WFOE to an employee or employees or selling it to another foreign company looking to go into China.

We got the following comment/question to that post:

Is there really a market for existing WOFEs? We have been operating for five years now and we are certainly fully aware of how hard it is, but I do not intend to quit, but certainly there will come a time when we need to exit China. One option is sale, but I really doubt that is possible. Does anyone know of examples? Also partial sale to key staff, for a peppercorn perhaps, seems to be a good idea from a business point of view. Does anyone know if this is possible?

I responded to that comment with the following comment of my own:

Not much of a market at all. The problem is that to buy a WFOE requires that the buyer essentially want to do exactly what the seller has been approved to do. So for example, if I want to do a consulting business in Qingdao, I must buy a consulting business in Qingdao. And then I also have to make sure that the costs of my doing due diligence on the WFOE and the risks of buying into the liabilities and problems of the WFOE, do not outweigh the advantages of taking over a WFOE, as opposed to forming a new one.

I am going to expound on my comment a bit here.

It is possible to sell a WFOE and our China Lawyers have been involved with a couple such sales and they are not particularly difficult from a legal perspective, but they are very difficult to justify from a business perspective and, in fact, none of the deals on which we have worked have actually closed.

You can sell your WFOE to a Chinese company (and this would include to an employee) and then it converts to a domestic company. Again, this is not terribly difficult legally, but such sales are rare because usually the employee knows exactly why the WFOE is closing down and usually the employee can choose to essentially take over the WFOE after the foreign company has left, and do so “informally” and without any payment.

You can sell your WFOE to a foreign company looking to do business in China, but that too has all sorts of difficulties, many of which we detailed in a previous post, entitled, Buying And Selling China WFOE Shell Companies. Not In My Lifetime?

In that post, we talked of how our China attorneys are always getting emails and calls from someone asking us if any of our clients might be interested in buying a China WFOE and of how our usual answer is “no.”

The people trying to sell their WFOE usually tout it as being completely liability free and therefore ready to go much faster and at a much lower price than if someone were to have to form their own China WFOE. For what it takes to form a WFOE in China, check out the following:

If you read any of the above posts, you will no doubt conclude that forming a WFOE in China is a convoluted and time consuming process, and it is. Therefore, buying an off the shelf WFOE must be much easier, right?

Wrong.

To quote from our previous post on selling a WFOE:

The thing about off the shelf WFOEs is exactly that: they are off the shelf and not customized. And that is where all of the problems arise. Let’s take as an example a WFOE that someone tried to interest me in many months ago. That company was in the IT outsourcing business in a second tier city. So right there, its only real potential buyer is someone who is interested in doing IT outsourcing in that second tier city.  Because if the buyer of that WFOE is interested in doing anything other than IT outsourcing, it will need to petition the government to expand or change its business scope. Similarly, if the buyer is interested in doing IT outsourcing in some other city, it will need to petition the government to move its WFOE or it will need to set up a branch in that other city, and thereby have to maintain two offices. When you throw in the fact that anyone buying a WFOE will need to conduct due diligence on it to make sure that it truly does have no liabilities of any kind (including, tax, employee, environmental, tort, etc.) and you can quickly see why forming a WFOE is going to be safer and probably equally as fast and cheap. The biggest benefit in buying a shell WFOE would be speed, but it is going to be the rare instance where saving a few months will warrant the extra risk.

In the post, “How To Form a China WFOE. Scope Really Really Matters,” we discussed the importance of a WFOE having a proper scope:

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.

The odds of a shell WFOE’s city and scope lining up perfectly with that of a potential WFOE buyer are low and we are not aware of any website that tries to match up WFOE sellers with potential WFOE buyers. We also are not aware of a single deal where someone has purchased a shell WFOE.

So yes, buying a WFOE is possible, but difficult. But we do find the idea of selling a WFOE to an employee appealing as it can make for a smooth transition all around. But the real question (again) is not the legalities, its the practicalities and the desires, and for that we will need to wait and see.

What are you seeing?

Our China lawyers have been seeing a massive increase in inquiries from American companies looking to close down their operations in China. On top of that, I shared an early morning taxi today from my airport hotel to O’Hare with a guy who was heading to China to aid in shutting down his company’s China WFOE.

I do not necessarily see this increase in company closures as all that indicative of the economic situation in China. Rather, I see it as a combination of timing and the increasing difficulties for foreign companies doing business in China. By timing, it just seems that many of the companies looking to shut down their China operations have been there for 5-7 years and that just seems to be about the time that companies decide one way or the other whether to go forward. Because so many American companies went into China from 2006 to 2008, now just seems to be the right time for so many American companies to leave.

Anyway, the big issue for companies looking to leave China is how to do that.  The below is an email (slightly revised) that I recently wrote to one company asking about its closure options:

If you are going to talk with people in China about the possibility of shutting down your China operations and leaving China for good, you do NOT want to go to China to have this discussion. See, for example, this blog post as to why: The Single Best Way To Avoid Being Taken Hostage In China

If you are going to leave China, there are essentially four ways for you to do so — at least from the facts you have given us to date. One, you close up shop there by doing everything by the book. This is very expensive, very difficult, and very time consuming. This makes sense if your company or some of its key people may be going back to China at some point in the future or you have valuable assets in China that you do not wish to relinquish. Two, you just suddenly walk out “in the middle of the night” and leave it to the local government and to your employees to pick up the pieces. Ignoring the moral issues involved with this (which I will leave up to you), this makes sense only if both you and your company plan never to return to China. Three, you do some sort of middle ground departure. This might consist of your paying your employees some severance (not because you have to do so but because you want to do so) or in some form or another turning the company over to the manager. Four, you sell the company to the manager for little or nothing but by doing so, you leave China completely legally and that means that both your company and its people can return there someday. This would almost certainly be the best solution, by far, assuming it is possible.

You might also be able to sell your company and its assets to another foreign company. This might work as it is now taking about six months to form a WFOE and a foreign company interested in getting into China to engage in the business for which your WFOE is licensed might find your company and your facility intriguing.

Let’s talk more next week so we can work on figuring out which option is best for you.

What are you seeing out there?

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.

 

One of the most frustrating things about doing business in China is the paper work.

The seemingly endless paper work….

I was cc’ed on an email the other day from one of our China lawyers to one of our clients.  The client had signed the documents required for a WFOE using the wrong ink.  The ink the client used looked like the required ink, but it wasn’t.  We told the client that the local Administration for Industry and Commerce (the “AIC” is where the WFOE filings go) would likely reject the application due to the wrong ink, but the client chose to go ahead anyway so as to potentially avoid having to go through the signing process again.  This email (with all identifiers, including city) hidden, is to let our client know that the AIC did in fact refuse their application and setting out all that our client now needs to do to ensure acceptance the next time around.

To form a WFOE in China, you typically need around 25 documents, 33 originals, 594 signatures (18 times the 33 originals) and 297 seals (9 times the 33 originals).  Fun stuff, let me tell you.   I was quoted the other day in a New York Newsday article on China, in which a China consultant talked about how forming a China WFOE takes 6-12 months.  The Wall Street Journal’s China Real Time Report, in a piece entitled, American Firms Find China Hard Work, noted the following from the recently released AmCham survey:

Investment approvals are particularly vexatious, with complaints ranging from apparently arbitrary decisions to excessive paperwork. The proportion of U.S. firms who think foreign and local companies compete on a level playing field with regard to approvals has fallen to 14% from 29% in 2011, according to the chamber’s survey.

The below email should give you a bit of flavor as to why forming a company in China can be so “vexatious.”
In line with our expectations, the _______ AIC  rejected your WFOE application documents for having been signed with the wrong type of pen. Accordingly, please have the attached documents re-executed.

The instructions for signing follow:

1.    AOA-Chinese: We need 5 Originals, all signed by ____________ and bearing the seal of ___________.

2.    AOA-English: For reference only. No need to sign or return to me.

3.    Application form-Chinese: We need 2 Originals, both signed by both _________ and _________ and bearing the seal of ___________.

4.    Application form-English: For reference only. No need to sign or return to me.

5.    Application Letter for Economic promotion bureau-Chinese: We need 2 Originals, both signed by __________ and bearing the seal of ___________.

6.    Application letter for Economic promotion bureau-English: For reference only. No need to sign or return to me.

7.    Application letter for stamp carving-Chinese: We need 1 Original, signed by ____________.

8.    Application letter for stamp carving-English: For reference only. No need to sign or return to me.

9.    Appointment letter (executive director and supervisor)-Chinese: We need 3 Originals, all signed by __________ and bearing the seal of ____________.

10. Appointment letter (executive director and supervisor)-English: For reference only. No need to sign or return to me.

11. Appointment letter (General manager)-Chinese: We need 3 Originals, signed by all of the board members (i.e., _________, _______________, and ______________).

12. Appointment letter (General manager)-English: For reference only. No need to sign or return to me.

13. Foreign exchange registration application form-Chinese: We need 1 Original, signed by ____________.

14. Foreign exchange registration application form-English: For reference only. No need to sign or return to me.

15. FSR-Chinese: We need 3 Originals, all signed by _____________ and bearing the seal of __________.

16. FSR-English: For reference only. No need to sign or return to me.

17. Letter of authorization by legal person-Chinese: We need 2 Originals, both signed by ___________.

18. Letter of authorization by legal person-English: For reference only. No need to sign or return to me.

19. Letter of authorization for delivery of legal documents-Chinese: We need 3 Originals, all signed by ___________ and __________ and bearing the seal of ____________.

20. Letter of authorization for delivery of legal documents-English: For reference only. No need to sign or return to me.

21. Letter of undertaking to work safety-Chinese: We need 2 Originals, both signed by ___________ and bearing the seal of __________.

22. Letter of undertaking to work safety-English: For reference only. No need to sign or return to me.

23. The list of board members-Chinese: We need 3 Originals, all signed by _________ and bearing the seal of ___________.

24. The list of board members-English: For reference only. No need to sign or return to me.

25. Power of attorney: We need 3 Originals, all signed by _________ and bearing the seal of __________

 

IMPORTANT NOTES REGARDING SIGNATURES: 

(1) The execution documents listed above have yellow “stickies” in the document indicating where to sign, and whose signature is required. When you print out these documents, make sure you do not print out these notes as well.

(2) Make sure to use A4 paper to print the documents and that your printer is set to A4. Note the number of pages and formatting of the documents to ensure that the formatting is consistent. If you have problems printing the documents, we can mail them to you. If you do not use A4 paper and the proper formatting, the documents will be rejected.

(3) All signatures must be made with a fine point rollerball pen using water-based ink, such as a Uniball, or a fountain pen. Do not use a thick ballpoint pen or a pen with oil-based ink. Sign in BLACK INK ONLY. All signatures must match the signature in the respective person’s passport.

(4) On those documents where the company seal (of __________) is requested, the seal should be affixed over the signature.

Once all of the above documents have been signed, please scan and email a copy to me, and send the physical documents directly to our China company formation agent.

Got all that everyone?

Twice in the last couple of months while working on registering WFOEs for clients, clients have come to us and asked our thoughts about switching their WFOE formation cities.  In both cases, their basis for questioning came from having heard that some nearby city was easier for a China WFOE formation and had better labor laws.  Our response in both cases was essentially as follows:

City A (the city for which we have already undertaken company formation work) is not known for being one of the easiest places in China to register a WFOE, but it it also is not known for being one of the toughest either.  We have registered a number of WFOEs there without any major problems.  Might it take a few weeks or even a month longer to register your company in City A than in City B (the newly proposed city)?  Yes, it might.  Then again, it very well might not.
I am not aware of the labor law being any tougher in City A than in City B, though City A does have a higher minimum wage and I believe that its various employer taxes are a bit higher as well. But unless you are planning to hire a number of employees at the minimum wage (which you are not) then this probably isn’t much of a factor for you.

This person telling you that you can set the company up in City B and have operations in City A is correct, but it will not be nearly as easy as he is making it out to be in that to do this you will almost certainly need to set up a branch office in City A to do so.  Also, if your operations are in City A and your employees are in City A, you will be bound by City A’s labor laws in any event.  You will always be better off forming your China company in the city where you will be conducting your proposed operations. What is being proposed  is a type of “virtual office” arrangement, which is almost never a good idea for China. Even in the unlikely event you save some time in company formation, the problems that would follow later would far outweigh any time benefit in the formation process.

If you would like we would be happy to do a comparison between City A and City B in terms of their labor laws and their employer taxes, but those will still be only one of many factors that you should consider in terms of where to locate.  Or do you have other reasons to favor City B over City A?
As you have probably guessed by now, the point of this post is that rarely should one choose their WFOE location based on legal considerations.  There is though one glaring exception to this “rule”: trading companies, as not all cities/provinces allow those.