Establishing a WFOE (Wholly Foreign-Owned Enterprise) in China: Main Issues

company-chopA WFOE is a Chinese limited liability company, wholly owned by one or more foreign investors. This is an investment vehicle often favored by foreign investors because it is (or is supposed to be) under their full control as there is no local partner. Furthermore, its preparation and establishment procedure does not involve all the lengthy negotiations that a sino-foreign joint venture usually takes.

Procedure

The procedure for the setting up of a WFOE involves principally:

  • reserving a company name with the relevant local Administration of Industry and Commerce (AIC); note that only the Chinese company name is subject to approval by the AIC. The name reservation is valid for six months. The investor needs to apply for an extension of the name reservation if the application for the WFOE’s business licence (i.e. certificate of incorporation) is not submitted within six months;
  • obtaining approval from the Ministry of Commerce or its relevant local branch;
  • obtaining a business licence from the relevant AIC. With the issue of the business licence, the WFOE acquires legal personality; and
  • completing various post-business license matters such as registration with various authorities (including the tax authority, local administration of foreign exchange, statistics authorities and finance authorities) as well as obtaining the corporate chops and opening the company bank accounts.

The timing for the completion of all the establishment formalities varies according to the project location and the level of the authorities involved. Generally, the issue of the company business licence takes two to three months from the submission of all the documents. The completion of the post-business licence registration usually requires one to two months. At this point, the investor can contribute the registered capital. After the capital verification of the relevant contributions, the WFOE can convert the capital contributions into RMB and start using these funds for its operations.

Pre-establishment issues

There are a number of preliminary issues that must be addressed:

  • business scope;
  • registered capital and total investment;
  • feasibility study;
  • articles of association;
  • office (or factory) lease.

Business scope

The business scope of a company sets out the activities that the company may engage in. The business scope is usually drafted following a standard wording adopted by the local authorities. For example, the standard business scope of a commercial WFOE is:

  • “import, export, wholesale, commission sale (excluding auction), of [name of the products]; provision of the relevant ancillary services”. 

The business scope of the WFOE will be set out in the feasibility study and the articles of association.

Registered Capital and Total Investment

The registered capital (注册资本) refers to the total amount of capital injected by the investor and roughly represents the investor’s equity in the WFOE.  Registered capital must generally be sufficient to fund the planned business operations of the WFOE.

The statutory minimum registered capital required to establish a Chinese company is RMB 30.000 (RMB 100.000 if the company has a sole investor). In practice, the authorities require substantially higher registered capital for a WFOE.

The total investment is the registered capital plus the amount that the WFOE is allowed to borrow from its investors/shareholders or financial institutions (so called borrowing gap). Regulations set the proportion between the total investment and the registered capital. For instance, if the total investment is up to and including USD 3.000.000, the registered capital must be at least 70% of the total investment.

Feasibility Study

A feasibility study must be prepared for submission to the approval authorities. The feasibility study is essentially an analysis demonstrating the commercial viability of the intended investment and serves the purpose of “selling” the project to the approval authorities. The feasibility study must include an introduction to the investor, and the purpose, intended activities, business scope and planned operations of the proposed WFOE. It must also include a financial analysis, covering total investment, registered capital, expected costs and anticipated profits. The financial projections have to cover a five-year period from the establishment of the WFOE.

Articles of Association

The articles of association is the constitutional document of the WFOE. The articles of association set out, among other things, the business scope, registered capital, the powers of the investor(s) and the rules concerning the board of directors or the executive director, the supervisory board or the supervisor(s) of the WFOE.

The articles of association also govern the internal organization of the WFOE and the roles and responsibilities of the legal representative, general manager and other senior management officers. Further, the articles of association govern the WFOE’s accounting system, the management of the WFOE’s employees, the term of the WFOE and the procedures for the dissolution and liquidation of the WFOE.

Office (or Factory) Lease

Among the documents that the investor has to submit for the WFOE’s establishment, there is also a lease agreement for the registered address of the WFOE. The parties to the lease agreement are the foreign investor and the landlord. The lease agreement should provide for the automatic assignment of the investor’s rights and obligations under the agreement to the WFOE as soon as the WFOE is established. For WFOE’s registration purposes, the lease agreement needs to meet the following requirements:

  • the lease term has to be of at least one year;
  • provision of a rental payment is usually required;
  • the usage of the premises, as shown in the relevant real estate property certificate, must be “office” (办公) or “commercial usage” (商业 or 商铺) for a consulting WFOE or a commercial WFOE, whereas it has to be “industrial usage” (工业) for a manufacturing WFOE;
  • the landlord must be the owner of the premises as shown in the real estate property certificate or a person or entity authorized by the owner (in writing) to lease the premises to third parties.

Corporate changes

Changes to the WFOE’s registered capital, business scope, registered address or corporate governance rules are possible but the investor needs to obtain approval from the original approval and registration authorities. In particular, changes to the WFOE’s business scope or registered address may be problematic. The changes to the business scope may encounter regulatory constraints or prompt the authorities to require an increase of the registered capital to be commensurate to the new proposed activities. A change of the WFOE’s registered address may also be problematic if it entails moving from the jurisdiction of one tax authority to another. It is advisable, therefore, for an investor to try to foresee the needs of the WFOE’s operations for at least a three to five year period to avoid embarking on time-consuming corporate changes from a very early stage.


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