Considerations for Entrepreneurs Setting Up a WFOE

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For those who may not know, the Wholly Foreign-Owned Enterprise (WFOE) is a limited liability company (LLC) owned and controlled by foreign investors without any native Chinese investors or business partnerships required. They are completely foreign-owned compared to other investment vehicles like joint ventures, which involve at least one domestic (mainland Chinese) partner.

WFOEs are a common investment vehicle for mainland China-based businesses, because entrepreneurs can incorporate a foreign-owned limited liability company. The most unique feature of a WFOE is that it does not include the involvement of a mainland Chinese investor.

The original idea for WFOEs in China was to encourage manufacturing activities that were either export orientated or that introduced advanced technology to the Chinese industry. However, China’s entry into the World Trade Organization (WTO) changed these notions. As a result, WFOE businesses in China have shifted to consulting services, software development and trading. Additionally, the strict restrictions that WFOEs were originally subjected, like the capital requirements that were set at levels for which only large multinational and medium-sized companies had the resources have changed, as well. The effects of Foreign Direct Investments in China, which have been positive, have prompted the government to ease the requirements on WFOEs, encouraging more foreign capital. For example, the capital requirement for companies starting a consulting business, which was 140,000 USD, has been reduced to 100,000 RMB (or approximately 15,000 USD). In addition, entrepreneurs can obtain an Import/Export License, a privilege they were ineligible for previously.

There are several advantages of setting up a WFOE in China. The biggest one is the ability for the company to operate independently. Since the involvement of a domestic Chinese investor is not required, the WFOE allows the company to operate aligned with the interests of the parent organization without the lengthy negotiation processes that takes place in a joint venture.

Also, a WFOE can exist in China as an autonomous entity with the operational functions of a registered company. It has the flexibility to implement sales and marketing plans, recruit staff, issue invoices, receive revenues in RMB and apply for trading licenses. As a recognized legal entity, a WFOE has greater protection of intellectual property since its rights are supported by the national jurisdiction of China. Furthermore, a WFOE is eligible for tax exemptions if it operates within a Free-Trade Zone, an Export-Processing Zone or a province designated for foreign-investment enterprises.

Despite all of the advantages, there are a few disadvantages of a WFOE. Establishing a WFOE can be a long and tedious process, especially since language barriers can complicate the complex licensing procedures. Foreign companies that lack the knowledge and expertise of China’s business customs may find it difficult to establish relationships with clients and suppliers, which could negatively impact a WFOE’s long-term success, particularly if it is unable to create a supply-chain that is more cost-effective and efficient than its competition.

Additionally, setting up a WFOE can take months, depending on the nature of its operations and the license-requirements, and the process can be expensive. A minimum of 20% of the registered capital must be put into a corporate bank account within the first three months and the remaining 80% within two years. While the sum of capital has to be invested into the company’s operations in China, the return must contribute to China’s economy.

In terms of growth, a WFOE can expand its operations, but its business scope is limited. A detailed scope of the company and its operations are required when registering. This business scope is subject to approval from the authorities, limiting its capacity.

As a result, it is very important for entrepreneurs setting up a WFOE to consider their business scope. Will the company distribute media, advertising or content via youku and toutiao? Will it be involved in publishing content, like movies, music and books? Will it distribute video games using Tencent, Yodo1 or 360? Will it provide online education using VIPKid, yoli and NetEase? Will it be manufacturing and contracting with Foxconn or Huawei? If so, the business must be a Registered Chinese Enterprise.

Another important consideration is whether or not the business scope involves selling directly to Chinese consumers on WeChat, the dominant platform in Chinese social media. The way WeChat is integrated into almost every aspect of China’s daily life has significant implications for foreign companies doing business in China. It is no longer just for sending messages and sharing news, pictures and video. It provides online shopping, mobile payments for groceries, cash gifts and services. More than 300,000 retail stores have integrated WeChat payment into their point-of-sale systems. To sell directly to Chinese end users on WeChat, a WFOE is needed to issue local invoices. Additionally, a fapiao, an official invoice issued by the Chinese Tax Bureau and provided by the seller is needed for any goods or services sold in the country. The Chinese government uses these invoices to track tax payments.

If the business scope involves cross-border transactions, the process for creating a WeChat account may vary, depending on countries and industries. It is important for these companies to contact a specialized agent to set up cross-border payment and an official overseas WeChat account. Additionally, if storefronts, restaurants, warehouses, factories or branches are part of the business plan, a WFOE may be needed for each.

Refer to the Decision Tree chart below as a basic guide for those entrepreneurs considering whether or not to set up a WFOE in China to conduct business. It may not be needed. There are many valid reasons why companies enter the Chinese market without forming a WFOE. However, if selling directly to Chinese consumers, controlling the company’s message and using WeChat matters, the more important it will be to have a WFOE to take advantage of all this social network has to offer.

Photo credit: James LaLonde

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