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Wholly Foreign-owned Enterprises (WFOEs)
A wholly foreign-owned enterprise – commonly referred to by its acronym. WFOE- is an enterprise which is 100 per cent owned by a foreign company or companies. Increasingly, foreign businesses are opting to set up WFOEs because such an investment provides them with complete control over the business and direction of the operation. It also tends to maximise return as a second party investor is not involved. However, a WFOE is not always the most appropriate investment vehicle, especially for a first-time investor seeking to find his way in a new, and often difficult environment.
WFOEs are generally established as manufacturing or assembly operation for the purposes of export. Until recently, WFOEs were not allowed to trade (meaning that they could not sell into the domestic market) but that situation has changed (see below for further explanation).
WFOEs are often but not always, located in a special economic zone (SEZ) where they can take advantage of special tax rates, improved infrastructure and a variety of local suppliers and services which have grown in and around the zone in support of the SEZ.
WFOEs: New regulations covering trading
China has recently ratified new regulations that permit foreign companies to establish fully operational wholly foreign-owned enterprise trading companies, allowing them to buy and sell in China. Under the regulations foreign companies will be allowed to set up majority joint venture trading companies (as from 1st June 2004) and wholly owned trading companies (as from 1st December 2004).
Previously, the minimum registered capital for retail companies was Yn50m (for wholesale companies, it was Yn80m). Now, the entry requirements for retail business have been drastically lowered, to Yn300,000 for retail companies (Yn 500,000 for wholesale companies).
Note also that existing wholly foreign-owned companies in China will be permitted to extend their business licence, adding trade to the allowed business scope. Foreign companies are now be able to broaden their product range and offer their full portfolio, including finished goods manufactured outside China.
Advantages of WFOE
The advantages of establishing a WFOE include:
• Independence and freedom to implement the worldwide strategies of its parent company without having to consider the involvement of the Chinese partner;
• Ability to formally carry on business rather than just a representative office function and capable of issuing invoices to their customers in renminbi (the Chinese currency) and receive revenues in renminbi;
• Capable of converting renminbi profits into US dollars for remittance to their parent company outside China;
• Protection of intellectual know-how and technology;
• Greater efficiency in its operations, management and future development.
Disadvantages of setting up a WFOE
What are the disadvantages of setting up a WFOE?
A disadvantage for an inexperienced investor setting up a WFOE in China is that much of the knowledge, administrative processes and contacts a partner would bring has to be gained the hard way. Strong relationships are a key factor for successful business in China, whether with the local authorities where the enterprise is located or along the supply chain.
Setting Up
Factors in selecting location
• Proximity to customer base and major cities: locating close to major customers is a higher priority where transportation costs are proportionally higher.
• Local availability of service industries and quality of infrastructure. This will reduce investment costs.
• Human resource availability within the region.
• Quality of communications and living conditions: Good communications are a must. Most major cities have developed housing zones.
• Availability of development zones with financial incentives with respect to the site and buildings.
• Terms and availability of business development land, as well as incentives offered on foreign enterprise income tax, value added tax and business tax. Such incentives will differ, depending upon product, process and location.
Registering the WFOE
Having selected the location for the enterprise the next step is registration. For that a detailed business plan is needed. This is essentially the internal justification document that would have been prepared in the early days of the whole process. Amongst other points the business plan must cover:
• Reasons for investing in China (list the positives that will be obtained from investment).
• Predicted market growth (difficult, so take best and worst cases into account).
• Opportunities resulting from establishment of WFOE (highlighting the benefits to the investor and all the spin-off benefits that the investment will bring to the region: employment, new skills, additional income for housing zones, hotels, and so on).
• Costs of establishing and operating the WFOE.
• Risk analysis. This should include upside and downside, but inevitably contains some speculative predictions. For instance, some enterprise zones allow a 25 per cent refund of VAT for several years, but the decision on this is only taken during the second year of business; accordingly the business plan must be sufficiently robust to tolerate the worst condition.
• All other key factors, including cashflow, predicted levels of imports and exports, and the commercial structure of the WFOE.
Business scope
According to WFOE regulations, "Foreign investors are permitted to set up a 100 per cent foreign-invested enterprise in industries that are conducive to the development of China’s economic benefits, and not prohibited or restricted by the state." The Catalogue of Guidance to Foreign Investment categorises fields of potential investment as "prohibited," "restricted" and "encouraged". It is advisable to fully comprehend the interpretation of these categories, and also note as follows:
• To obtain the most attractive terms such as tax breaks and VAT rebates, qualifying under the "encouraged" category is essential.
• Business scope is a "one sentence description" covering all of the present and future activities of the WFOE; it is essential this encompasses every envisaged scope of future activity. The WFOE can only conduct business within its approved business scope, which ultimately appears on the business licence.
Choosing the business name
The Chinese name should be formatted as follows: first word - location/name of town; second word - company name/product; third word - activity; fourth word - company structure.
The name then has to be registered with the local office. The use of ‘China’ ‘Sino’ and ‘International’ are not permitted in the Chinese name unless very special permission is given, although they are permitted in the non-Chinese name.
Prior to any of the following applications, the investor(s) should reserve a name for its prospective WFOE with the local Administrative Bureau for Industry and Commerce (SAIC). This is called "Name Pre-registration" in China.
SAIC requires that a proposed name and two alternative names be provided.
Buildings
• Rent, buy or build? Review these options: the decision should be made for accounting reasons, not on cost alone.
• Appoint a local design bureau to ensure compliance with building regulations. Remember that regulations vary from one municipality to another.
• Commission a construction company to build the facility if ready-built premises are not available. Some British companies can undertake this on behalf of the investor.
Staff
• Establish management, production, financial, HR and sales structures.
• Appoint departmental managers.
• Employ artisans for the work force.Words of adviceBe determined with a robust business plan that will withstand scrutiny. Challenge statements that rules and regulations do not permit the establishment of your stated enterprise. Meet and lobby the mayor and every official in the municipality, so that everyone understands your plans and, more importantly, feels involved in your new and exciting enterprise. This should help to achieve the best terms and a condensed time frame for the establishment of your new enterprise.
During negotiations, the establishment of a WFOE should be made conditional upon the selected development zone assisting in obtaining all the necessary permissions, licences and approvals. Such processes are quite tedious, however, and it is essential to secure the best terms available. Although a ‘fast track’ is possible, the process will normally take around six months.Meet officials informally before your application is submitted to explain your plans and expectations. Listen to their advice. They will be helpful and may be flexible if they can understand your overall plan (sometimes not easily explained - except over a drink or few!) Convey enthusiasm to all. Ensure that officials understand the features of your enterprise and the benefits to their municipality through your investment.Application proceduresAll documentation should be issued through the offices of your professional advisors who will be working with the selected development zone where you plan to create your enterprise.Stage OneSubmit Project Proposal. (Usually takes around 30 days)
The foreign investor is required to submit a Project Proposal to the local approval authority (Approval Authority) where it intends to establish the WFOE. Generally, the Project Proposal should cover the following points:
• the purpose of the WFOE, production plan and market forecasting;
• the scope and scale of the business, the products to be produced / services to be provided (a 4-5 line description should suffice);
• financing, financial forecasts and evaluations;
• the technology and equipment to be used;
• land-use requirements (including the area), selection of sites;
• personnel and wages; and
• any requirements for public facilities (water, electricity, coal, gas or other energy source).
Stage Two
Submit feasibility study: investment details, level of employment, organisational structure, expected profitability. (Allow 60 days for approval)
Stage Three
Submit formal application
The following documents should be submitted to the local Approval Authority:
• name and address of WFOE
• a written application for the establishment of the WFOE;
• a Feasibility Study Report. Based on our experience, this is generally a 20 page document;
• the Articles of Association of the proposed WFOE;
• a list of the proposed chairperson and the members of the WFOE board of directors, and appointment letters;
• the incorporation document of the WFOE investor;
• a credit certificate of the WFOE investor issued within 3 months;
• lease agreement for the premises. Based on our experience, an actual executed lease agreement is not required and it is generally acceptable and common for the WFOE investor to merely show an intention to enter into a lease agreement by entering into a space reservation agreement with the landlord;
• plant required and technology to be imported, impact on environment, raw material requirements
• the reply of pre-registration of name approved by the relevant SAIC; and
• other documents as may be required by the Approval Authority such as importation requirements (for establishment and operating), articles of association and taxation of WFOE.
As for the timing of approval, Approval Authorities are required to make its decision within 90 days from receipt of all the documentation. However, many local Approval Authorities are able to give its decision within 5 to 15 working days upon receiving all the required documentation.
Stage Four
Registration process: submit business proposal, feasibility study, list of equipment requirements, memorandum of understanding, legal documents of parent company, proof of company credit, names of directors, letter appointing directors to the board, recommendations for general manager and deputy general manager and their identification papers, notification of approval of WFOE, name (six original copies of many of these documents had to be submitted: it did take some effort to organise and achieve a satisfactory application). (Another 30 days)
Stage Five
Application to foreign trade commission for business licence.
Within 30 days after obtaining the approval certificate, the foreign investor will need to register and apply for a business licence for the WFOE from the local SAIC. As part of this step, the foreign investor will need to submit similar documentation to the approval documentation for SAIC filing purposes. This is purely a procedural step and the local SAIC must issue the Business Licence within 30 days, but in our experience SAIC will usually issue the Business Licence within 5-10 days after receiving all the required documentation.
Once the business licence is issued, the WFOE is deemed to be a legal person duly organised and existing under PRC law and will have full operational rights to operate a business in China within the scope of its Business Licence.
Once your business licence is approved then you may proceed with applications to State Administration of Industry and Commerce. Having obtained approval from the tax and customs authorities, and commodity inspection bureau, you are now legally entitled to open foreign exchange and renminbi accounts and can start to employ staff and commence the long processes that are needed when establishing any new facility. You are now in business in China.
If all this seems unduly complicated, be assured that procedures are getting easier and more manageable all the time. If you really can't face all the bureaucracy and form filling, contact the China-Britain Business Council and we will guide you through the whole process.
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