This post focuses on the nuts and bolts of forming a Wholly Foreign Owned Entity (WFOE) in China. This is the fourth post in our series on what it takes to form a WFOE in China. Part 1 set out the questions our China lawyers typically ask our clients for whom we are forming a China WFOE. Part 2 was on the issues our China lawyers confront in determining whether a China WFOE makes sense for our clients at all. Part 3 was on whether it makes sense to have a Hong Kong entity own your China WFOE (or China Joint Venture). Future posts will discuss China’s “new” minimum capital requirements for WFOES and why WFOEs have become so important for doing business in China, especially as China’s economy slows.
The steps for forming a WFOE in China typically consist of the following:
1. Determine if the proposed WFOE will conduct a business approved for foreign investment by the Chinese government. Do This One Thing Before Doing Business In China.
2. Determine if the foreign investor is an approved investor. Generally speaking, any legally formed foreign business entity is authorized to invest in a WFOE in China. The investor must provide the documentation from its home country proving it is a duly formed and validly existing corporation, along with evidence showing the person from the investor company authorized to execute documents on behalf of the investor. The investor also usually must provide documentation demonstrating its capital adequacy in its country of incorporation.
To meet these requirements, the following documents are normally needed from the investing business entity:
a. The Articles of Incorporation or equivalent (copy)
b. The business license, both national and local (if any) (copies)
c. The Certificate of Status (Original)(U.S. and Canada) or a notarized copy of the Corporate Register for the investor or similar document (original)(Civil Law jurisdictions)
d. A Bank Letter attesting to the investor company having a sound banking relationship and to the account status of the company (original).
e. A description of the investor’s business activities, together with added materials such as an annual report, brochures, website, etc.
a-d should be translated into Chinese. e should either be translated into Chinese or summarized in Chinese.
Many investors create special purpose companies to serve as the investor in China. The Chinese regulators have become accustomed to this process. However, the Chinese regulators will usually still seek to trace the ownership of the foreign investor back to a viable, operating business enterprise. Investor secrecy is not an option in China. However, the corporate register for the Chinese company will merely state the name of the foreign, special entity investing company as the owner. In that sense, as far as public disclosure is concerned, investor privacy can be maintained. The foreign investor should also understand that this tracing process can add time and cost to the China company formation process.
3. Chinese government approval for the project. In China, unlike in most countries with which Western companies tend to be familiar, approval of the project by the relevant government authority is an integral part of the incorporation process. If the project is not approved, no incorporation is permitted. The two are inextricably linked.
The following documents usually must be prepared and provided to secure approval for incorporation/project approval:
a. Articles of Association. This document will set out all of the details of management and capitalization of the company. Nothing can be left for future determination; all basic company and project issues must be determined in advance and incorporated in the Articles. This includes directors, local management, local address, special rules on scope of authority of local managers, company address, and registered capital.
b. Feasibility Study. The project will not be approved unless the local authorities are convinced it is feasible. This usually requires a basic first year business plan and budget. We typically use the client produced business plan and budget to draft up a feasibility study (in Chinese) that will satisfy the requirements of the Chinese approval authority.
c. Leases: An agreement for all required leases must be provided. This includes office space lease and warehouse/factory space lease. It is customary in China to pay rent one year in advance and this must be taken into account in planning a budget because the governmental authorities will be expecting this.
d. Proposed personnel salary and benefit budget. If the specific people who will work for the company have not yet been identified, it will usually make sense to specify the positions and proposed salaries/benefit package. Benefits for employees in China typically range from 32% to 42% of the employee base salary, depending on the location of the business. Foreign employers are held to a strict standard in paying these employee benefits. The required initial investment usually will include an amount sufficient to pay salaries and employee benefits for a reasonable period of time during the start up phase of the Chinese company.
e. Any other documentation required for the specific business proposed. Generally, the more complex the project, the more documentation required.
All of the above documents must be prepared in Chinese.
4. It usually takes two to five months to secure for governmental approval, depending on the nature of the project, and its location size and scope. The investor must pay various incorporation fees, which fees vary depending on the location, the amount of registered capital and any special licenses required for the specific project. Typically, these fees equal a little over 1% of the initial capital.
On large and/or complex projects, the approval process often involves extensive negotiations with various regulatory authorities whose approval is required. For example, a large factory with serious land use or environmental issues is almost always going to take longer to form than a well-funded three person consulting WFOE. Thus, the time frame for approval of incorporation is never certain. It depends on the type of project and the location. Foreign investors must be prepared for this uncertainty from the outset. See Forming A China WFOE. How Long Will That Be Going On?