minimum capital requirements

A quasi-fascinating email just crossed my desk regarding the minimum capital requirements required for WFOE formation in China. I was cc’ed on this email from one of my firm’s lawyers to another, musing about the minimum capital required for a company that would be profitable from day one, based on payments from its parent company:

Way back in 2005 and 2006, we worked on several consulting WFOES and I interpreted the rules just as you have. Since payments to the WFOE were going to be guaranteed by the parent company [the company that would own the WFOE] for work done by the WFOE for the parent company, we took the position that the WFOE’s registered capital should be limited to its hard start up costs: rent, equipment, utility prepayments, etc. For many of the service companies, this would mean a very low initial capital need of say $40,000 or so. Our idea was to capitalize the WFOE with $40,000 and then start billing the parent immediately. In those days, there was no real tax issue, so the billing was planned for the actual cost of the service. The fact that this did not accord at all with the requirement that the WFOE earn back its initial capital within 3–5 years was something we just ignored.

We took this idea to the Shanghai government and to a few other cities as well, and said, “Okay, our registered capital required is $40,000. This is substantially more than the statutory minimum of RMB 100,000 (around 12,000 back then), so let’s get going.”

The response was, “No. We require a minimum registered capital for all WFOEs in the amount of $US150,000.” We replied, “But, we don’t need this capital. We have no use for it. It is a waste. The response was, just use the capital for your operating costs until you run out. You can then start billing your parent company for the service income after the capital has been used up.”

This was all done before China adopted its new income tax law and started imposing transfer pricing rules and related. So after these things came to pass, we went back to the government in Shanghai and said,”if we follow what you have demanded in the past, this will actually reduce the amount of taxes you collect.” The officials said, “We do not care. Just do it the way we have always required because we want to determine in advance that the parent company has the financial wherewithal to fund the operations of the WFOE. Taxation is not our concern.” So in this environment, the tax advisors said, “Well, under this approach, it is best to make your registered capital as high as possible so that you can avoid taking taxable payments from the corporate parent as long as possible.” So this is what we did.

As you have identified, this approach is not consistent with Chinese tax law. On the other hand, this approach is quite consistent with the real goal of the Chinese regulators. They are very concerned that a WFOE that is 100% dependent on payments from its parent company will in fact never get funded. They therefore want to see as much initial capital as possible up front as a pre-payment of expenses. The small amount of tax foregone is not really the issue on which they are focusing. All of this is explicitly commercially unreasonable. Please tell me something new about China.

Having said the above, things have changed a lot in China over the past three years on the tax front, so it is time we look again into this issue.

For more on WFOE formation and minimum capital requirements, check out the following:

Very helpful post over at the always helpful International Business Law Advisor Blog.  The post is appropriately entitled, The 5 Key Factors You Must Consider When Establishing a Foreign Corporation [link no longer exists] and it lists out the following:

Decide on Corporate Form:  The post talks of determining the right corporate form for the country in which you will be establishing your company. For China, this might mean Joint Venture, Representative Office, Wholly Foreign Owned Entity (WFOE), etc.  For more on forming a company in China, check out the following:

Identify Your Business Purpose:  The post notes how “unlike in the U.S., the business purpose of an entity in a great number of foreign jurisdictions require that the business purpose of the entity to be described in detail.”  This too is true of China, where what you list as the scope of the business can end up limiting what it can do. For more on this, check out the following:

Choose the Corporate Name:  The post notes how a “great majority of foreign countries have specific requirements regarding corporate names” and this is true of China as well.

Determine the Officer and Director, if any:  The post notes how some countries do not recognize the U.S. concept of “director and officer”  and of how residency requirements may also apply. China definitely has a different leadership structure than is familiar to Americans and this oftentimes results in problems.

Quantify Capital Requirements: The post notes how minimum capital requirements “necessary to form an entity varies by country.”  This is actually true within China where some cities have fairly low minimum capital requirements and others have much higher such requirements.  For more on China’s minimum capital requirements, check out the following:

Okay, so what is the missing, most important consideration of all?  Whether it even makes sense to form a company overseas.  This is by far the most important and also most complicated in forming an overseas entity.

Is forming a company overseas really the best way to accomplish what you are seeking to accomplish?  Might you be able to sell your product or services pretty much as well via a licensing, franchising, or distributorship relationship?  Do you really need a company in a foreign country to have your products made there or your research conducted there, or might you be better off just outsourcing?

Most importantly, is going overseas really right for your company.  Running a single domestic company is tough enough.  Now consider running two or more companies at the same time, with one or more of them being in a foreign country.  Or as my friend Ben Shobert would say, Are You China Ready?

Forming a company in China. It makes my blood boil because, quite frankly, there are a number of consultants out there who are essentially lying to their clients about what it takes to form a company in China. They make it sound easy and cheap and so when one of my law firm’s China lawyers tell them it is difficult and expensive, they often think that we trying to put one over on them.

Part of the problem is that in many countries it is easy and cheap to form a company. But in China it is not easy and if it is cheap, something is wrong and something will go wrong.

One large part of the problem is minimum registered capital. Chinese law says it must be at least 100,000 RMB, which equals roughly $13,000. So fly by night company formation consultants use this to make it seem that the minimum capital requirement is always $13,000 and so when we tell prospective clients we expect their minimum capital requirement to be around $240,000, some of them are thinking we just must not be very connected.

Here’s the real deal with registered capital. That $13,000 figure is a guideline. It was originally in place to ensure that new WFOEs had enough capital to sustain their business.

More importantly even if the Chinese government lets you get away with the absolute minimum in registered capital you very well might 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.

If you inject less than you need in registered capital to sustain your WFOE until it can generate sufficient revenues to sustain itself, your WFOE will need a cash injection from somewhere. If you transfer money to your WFOE from overseas but do not go through the correct process of re-registering your registered capital (which typically takes at least six weeks and involves your having to get a new business license issued) any funds that you (or anyone else) injects into your WFOE will count as income to your WFOE and be taxed accordingly.

The 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.

Earlier this year, 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. We noted that China’s minimum registered capital requirement was the biggest source of confusion for these companies after they had talked 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.

Are we clear?

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.

Oh, and remember what your mamma told you: you get what you pay for.

Around 25% of my law firm’s China legal work is done with US or European attorneys, and a good chunk of that work is helping them help their own clients form a Wholly Foreign Owned Entity (WFOE) in China. The law firms that retain us do not have their own lawyers in China but because the China work they are doing for their clients is just one part of their work for that client, quite logically, they want to coordinate that work with whichever China lawyers they retain.

We recently took on three new WFOE formation matters for US lawyers. Two of these matters are for lawyers working on behalf of their clients and one is for a lawyer who owns the (non-law related) business. All three of these lawyers told me they had spoken with company formation firms and had grown frustrated with the information they were being given.  They relayed that these firms were not giving clear answers to many of their questions, but were instead responding by saying China WFOE laws were “vague” and/or “ever changing.”

What these company formation firms are saying is just not correct.

Chinese law on WFOE formations is actually quite clear and I suspect these company formation firms were claiming otherwise only because the laws are vague to them. Near as I can tell, these company formation firms typically consist of a foreign voice or two (oftentimes in Hong Kong) who takes in the work and then farms it out to a Chinese law firm in a low cost city to do the work. The people on the phone or at the other end of the e-mail at these firms have never read China’s laws on WFOE formation and so, not unexpectedly, those laws are vague to them.

As for “ever changing,” on January 1, 2006, there was a sea change in China company formation laws for foreign companies, but they have remained static since then.

By far the biggest source of confusion/frustration for these US and European attorneys seeking information on forming a China WFOE is the minimum registered capital requirement.

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.

Are we clear?

Great post over at DiligenceChina, entitled, “China Business Entry: Business Registration is a Group Project,” [link no longer exists]on how to get your business into China. I love the post because it is written from the perspective of a highly educated and knowledgeable businessperson (NYU MBA with substantial China business experience), rather than by a China lawyer.

I apologize for citing so directly from the post, but I fear that if I do not, I will imbue it with the legalese it so blissfully lacks. So here goes, with my own (sparing) comments, within brackets:

I managed to wrangle a lawyer and a real estate consultant into a single room for a meeting yesterday. The lawyer is China attorney Steve Dickinson, of Harris Moure, an international law firm based in Seattle with a number of lawyers in China and the real estate expert is Dan Turgel of WAT Property & Investment and I asked them to explain the company set-up process in China. Both are experts at Chinese business, fluent in Mandarin and have plenty of successful deals under their belts, so it was a very valuable session.

The results were complex and will be unique for each situation, but here are the important points:

  • WOFE (or WFOE) is rapidly becoming your only real option. That’s Wholly Owned Foreign Enterprise [or Wholly Foreign Owned Enterprise/Entity]. Representative offices are cheap and easy to set up, but you are not allowed to handle money or sign contracts. Seriously. A real drawback, and they are starting to enforce the rule. Joint Ventures with unfamiliar local partners should not even be a serious consideration until you know the terrain and the players well.
  • Get your lease taken care of early. You can’t wait until the business is already formed to start worrying about real estate issues. A 1-year lease is part of the application process. That’s one year from the date of the APPROVAL, which can take 4 months or so from the start of the application. The lease has to be certified, verified and authenticated. Chinese bureaucrats LIVE for this kind of detail, and you aren’t moving forward without one.
  • Your China accountant, China law firm and China real estate people need to be involved in the process from the very beginning, hopefully in the same room at the same time. You want your China business formation to be a single, unified process ‘ not a series of fits and starts. When you find out you are missing a signature, chop, or form – you cannot tell the Chinese authorities the dog ate your homework.
  •  It’s not quick, cheap or painless, but it is possible and manageable. Every situation is unique and every location has its own variation of The Rules, so there are no hard and fast rules. But the business formation should run you in the neighborhood of US $10,000 to $15,000 and take between 6 months and 1 year (from the start of the process, not the application!).
  • You will need to show a business plan, a manpower projection, pro-forma financials for the China project, and all sorts of verification about the existence of the US company. This will include an authentication by both the Secretary of State’s office (state level) and the Chinese Consulate in your jurisdiction back home. Start planning early.
  • You also have to deal with minimum required capital rules, which vary for every business situation. Plan on something in the neighborhood of US$140,000 – $240,000, but every situation will be unique.
  • Is there any way to cut corners and save money? Sure thing. Some methods make sense, like setting up in new industrial zones that are eager for overseas investment or lesser-known cities that encourage specific types of business development. Other methods are simply bad ideas, like using local consultants with special connections that involve forged documents, back-door approvals and other illegal methods. Steve warns investors that you’ll find that these informal methods may be effective for getting your investment funds INTO China, but will make it virtually impossible to get your money OUT when the time comes to exit.
  • The rules are a bit complex and seem daunting at first, but Steve and Dan had no trouble laying the process out quite clearly, even to a simple MBA like myself. Within 45 minutes, I had a much clearer sense of what was involved in forming a new company in China. Understanding the specific rules is a lot less important than finding international consultants who are knowledgeable and reliable.

My only addition would be to note that minimum capital requirements in many second tier cities are often more like $15,000 and that even the higher numbers set forth above should not be daunting because minimum capital sent into China is available for funding business operations pretty much from day one.

By: Steve Dickinson

Yesterday, in a post called Chinese Company Formation — Forming a Wholly Foreign Owned Entity (WFOE) in China, I discussed the basic requirements for forming a wholly foreign owned entity (WFOE) in China.  One of the questions I am asked most frequently about forming a WFOE in China is how much the Chinese government requires in minimum capital.  This post follows up on yesterday’s post by addressing the minimum capital requirements issue.

Every company in China must 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. Where the registered capital is small, the entire amount must be contributed immediately upon formation of the company. A certified public accountant must be engaged to provide certification of the contribution of registered capital. 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. 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 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. 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.

We are frequently asked about the legal minimum capital requirement for a WFOE. The answer to this question is clear as a matter of law, but this answer is essentially meaningless in actual practice. Under the new Chinese Company Law, the minimum capital requirement for multiple shareholder companies has been reduced to 30,000 RMB (less than $4,000 US). For single shareholder companies, the amount is 100,000 RMB (a bit over $12,000 US). However, these numbers have no real meaning for the formation of a WFOE in China.

The real question is what the Chinese authorities will consider as adequate capitalization for the specific project. Of course, that answer varies 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 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 and 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 of the circumstances. Once the investor has a clear idea of the outlines of a project, it is usually a good idea to engage an attorney to contact the local regulator to see what the regulator’s 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.

In determining what constitutes adequate capital, one needs to consider the peculiar situation in China that rents are typically paid in advance, that payment for products for sale are typically paid in advance, and that a reasonable advance reserve for salaries is also required. Thus, the initial start up cost is much higher than in a location like the United States, where credit and time payments are more common. In addition, the foreign investor should account for 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.