There are many articles about setting up a foreign company in China, often also called WFOE (wholly foreign-owned enterprise) or FIE (foreign-invested enterprise), but we want to focus on the three key factors that should drive the decision making process. Many investors get side-tracked by free trade zones and tax benefits, that often promise more than they can keep and simply don’t usually apply to most investors. Remember, there is no free lunch.
So let’s start with the most important question: What does the FIE want to do in China?
1. Business activities
FIEs have to register a business scope when they first start their business in China and this business scope will govern the kind of invoices the FIE will be allowed to issue to its clients. The tax bureau will determine the invoice categories based on the business scope during an initial check-in when the company is first set up. Therefore the business scope should focus on the business activities a company wants to invoice to its clients.
Naturally investors want the business scope to be expansive to cover as many activities as possible, but that may be challenged by the authorities. The key is be both unrestrictive and specific at the same time. This might be easier for some industries than others. The guiding principle is really the revenue source in China, i.e. the client, because they may only accept certain invoice categories, so check with them and also understand what potential future clients may require.
There are several business activities that FIEs are not allowed to engage in or face ownership restrictions. Many of them are in the area of media, education, internet technology and several others. It is therefore very important for investors to understand what exactly they want to do in China, who their customers are and will be in the near future and how they can serve that customer with an FIE in China.
It’s possible to amend the business scope of course, but it does take a few months as company documents need to be updated and filed with the authorities.
With the understanding of what the FIE wants and is allowed to do in China, it should consider financing:
FIEs have to commit to invest a certain amount as capital into the company within a timeline that can be set by the investor, but needs to be filed with the administrative authorities. The amount of capital will depend on
- Legal requirements that may exist for certain business activities (see above)
- Legal requirement that may exist for certain locations (see below)
- Operational requirements, so that the company has enough capital to generate positive cashflow through its business activities
Due to China’s tight regulations around foreign exchange, it’s important to note that currently registered capital will have to be contributed through a designated foreign currency bank account. Also, the process for increasing registered capital can take a few months as company documents have to be amended and filed with the authorities, so conservative cash-flow planning and knowing you’ll run out of money 3-6 months ahead of time pays off. FIEs running out of cash in China is not uncommon.
Debt financing for FIEs in China depends on the size and business activities in China, as Chinese banks tend not to lend to FIEs with few assets they can use as collateral and short operational term. Therefore FIEs may have to rely on their relationships with banks from their home countries. Such potentially cross-border financing may require filing with or approval from authorities, so documentation is crucial. Cross-border payments of any kind are scrutinised.
FIEs may choose to generate financing from services they invoice to their headquarters or other related parties. This will require a valid contract specifying the kind of services that are provided and it will also incur taxes based on such service transactions. Transfer pricing regulations in China and the jurisdiction of the related parties should be considered.
Knowing now what the FIE’s business activities are and how to finance them, the investors can start considering locations:
There are at least two dimensions to this:
Physical registration address
Until now, foreign companies are still required to have a physical address to register an FIE. There are some exceptions that depend on the administrative authority which varies between locations in China for specific industries, i.e. for leasing companies in parts of Tianjin, or authorities choosing not to enforce existing rules in some cities.
The physical registration address is covered by the jurisdiction of an administration authority, that is responsible for issuing the business license and from where other government authorities, e.g. tax bureau derive their jurisdiction. Different authorities have different levels of experience handling foreign investors and may even have specific policies that can encourage and discourage investment in different industries.
For example, in Beijing the Chaoyang District probably has most of the FIEs registered in Beijing, which means that authorities are likely quite familiar with the necessary laws and regulations, but it also means that processes can take a while, because there are many companies that need to be processed.
A few years ago, a foreign investor wanted to register a company in a district that was on the outskirts of Beijing and although they probably didn’t have a lot of experience with registration of FIEs, they issued the business license within only a few days, which was much faster than the standard processing time. This is not a general rule, but goes to show how jurisdictions can differ and the situation at one jurisdiction shouldn’t necessarily inform about another jurisdiction. Getting good information can take a few days and some cross-checking by experienced professionals.
The location of the business should be chosen based on access to employees, customer, suppliers, regulators, logistics and potentially other factors depending on the business of the company.
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