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Major Issues for the Foreign Companies Regarding WFOE Formation in China

From raw materials to sourcing various products, Chinese and U.S. commerce have become closely aligned over the years. American companies always try to lower their manufacturing cost and Chinese manufacturers and sourcing agents fulfil their needs by providing everything they want. However, doing business in China is not as simple as it seems.

The Chinese authorities are closely monitoring foreign companies that are doing business in China without a China entity( WFOE, Joint Venture or Rep Office) and targeting them with the high-level tax crackdown. Till now, forming China entity and starting a business over here is not a clear cut concept for many U.S. business owners.

China has six recognized types of business organizations available to foreign investors who wish to register their companies:

  1. Partnership Enterprise (PE or FIPE)
  2. Wholly Foreign Owned Enterprise (WFOE)
  3. Joint Venture
  4. Representative Office
  5. Shanghai Free-Trade Zone company
  6. Hong Kong Free-Trade Zone company

What is Wholly Foreign Owned Enterprise (WFOE)?

A Wholly Foreign Owned Enterprise is a limited liability company owned solely by the foreign investor. It is under foreign control and does not have any formal Chinese ownership. A WFOE requires registered capital and its liability is limited to its equity, it can generate income, pays tax in China and its profit can be repatriated back to the investor’s home country. Any limited liability enterprise in China which is 100% owned by a foreign company, individual(s) or companies can be called as WFOE.

If any foreign company want to do business in China, they need to form a Wholly Foreign Owned Entity or WFOE. But along with WFOE, there are several issues that U.S. companies need to keep in mind. Here we are discussing all of them.

  • Primarily, forming a China WFOE is a lengthy and costly task. Apart from this, operating and owning Wholly Foreign Owned Entity is way too much expensive and time taking process. That’s why most of the China lawyers suggest their clients to avoid WFOE unless it is absolutely necessary. The very first thing that China attorneys do for their clients is to identify the true need and requirement of a China WFOE formation.
  • It is a crucial decision to identify whether to opt for a Rep Office or a Joint Venture rather than a WFOE. In many Chinese industries joint venture is allowed and acceptable instead of a WFOE.
  • Although an HK Company is not a legal entity in mainland China, many foreign companies choose to form a Hong Kong company as an SPV to invest in China. After closely considering all the specific situations, it is often profitable to form a Hong Kong Free-Trade Zone company.
  • WFOE formation generates two scopes. First, it allows easy formation of the WFOE without hamstring it in future. Second, it creates better business opportunities without facing much difficulties.
  • Chinese business lawyers help their clients give an approx amount of capital needed to form a WFOE. They will also offer a view how much Chinese government will charge. They will thoroughly explain to you what Goldilocks situation is.
  • In case of an office, business locations do not matter a lot, but for the retail establishments, location could prove to be a major concern. If your official business location is same as your initial retail location you need to face added hassle. In this sort of situation, the business owner needs to secure approvals from the Chinese bureaucracy to change their business location. There are also all sorts of issues that can arise from having a location in one place and your employees in another.
  • For all their employees, companies need to prepare Chinese-language employment document. The contents of this document are- 1. Labor Contracts 2. Company Rules and Regulation 3. Confidentiality Agreements 4. Non-compete Agreements 5. Educational Reimbursement Agreements.
  • Foreign businesses need to take every necessary steps in order to ensure their IP is protected in China. The process involves identifying what IP can and should register in China as a patent, copyright and trademark. To ensure the protection of IP, it is highly important to draft appropriate contracts with the suppliers, vendors, employees and counter-parties.
  • It is highly important to open an account in the China bank along with engaging qualified accountant and bookkeeper. They will appropriately respond to deal with any transfer pricing issues. Moreover, a good accountant is essential for solving tax and other accounting related issues.
  • Compliance is one of the major concerns for the SMEs, who typically name the parent company’s CEO as the WFOE’s legal representative, and thereby expose the CEO to criminal liability in China for employees’ misdeeds. So it is really important to keep China compliance house is in order to avoid any sort of unwanted legal issues form Chinese authorities.

Foreign businesses must seek expert advice from the professional business lawyers in China to avoid any sort of impediments posed by the authorities.

About Michael Wong

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