This post focuses on the registered capital needed to form a China WFOE. This is the fifth 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). Part 4 was on the steps required to form a China WFOE. Our next post will be on why it is so important you get the business scope right on your WFOE application.
China has liberalized its minimum capital requirements for a WFOE and the amounts required have been reduced in most Chinese cities/districts. But even if the Chinese government is going to let you deposit only very small amount of registered capital, you almost certainly will want to put in more.
In determining how much you should contribute in registered capital for your China WFOE, you should start out by considering how much money you will need to sustain your China WFOE until it can generate enough China revenues to sustain itself. If you inject less than needed to sustain your WFOE until it generates enough in revenues to sustain itself, your WFOE will need a cash injection from somewhere else at some point. 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 secure government approval ) the funds that you (or anyone else) send to your WFOE will count as income to your WFOE and will be taxed accordingly by China’s tax authorities.
Way back in 2007, we did a post entitled, China Company Formation Law Is Clear — WFOEs Are Easy, in which we discussed three companies my firm was 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 required does vary, depending mostly on the nature and size of the company to be formed and on the city (sometimes even the district within 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 may be immediately used in operating your WFOE. 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.
Today, just as back in 2007, 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 far more expensive to operate most businesses in Shanghai than in rural 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.
China’s 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 after providing a clear explanation of the project.
In our experience, China’s local regulators virtually never consider the statutory minimum determining adequacy of capital. They instead make their determination on what they believe will be 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 a China lawyer 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. Most of the time, the regulators will work with you in determining the amount of capital and listen to your explanation as to why it should be different than what they initially suggest.
My firm’s China attorneys always go to the local regulators before we get very far along in the application process to get a feel for the capital that will be required. Once we explain the nature of our client’s business to the regulator, the regulator’s minimum capital decisions is virtually always a very workable one for our clients. You do not want to just file your application for a WFOE and sit back and wait to see what the regulator says about your minimum capital requirements because there will be a good chance you will not like at all what he or she says and there will also be a good chance that you will not be able to change it either.
In determining what will constitute adequate capital for your new China WOFE, you should 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.