A crucial, and often overlooked, aspect of establishing a WFOE in China
Jul. 18 – Many foreign investors nowadays seem to regard wholly foreign-owned enterprise (WFOE) applications as just that – an administrative procedure that can be left to local managers or development zone advisers to handle. Seduced by the “fast service, one stop shop” approach and the desire to keep friendly relations with the government, many foreign investors seem quite content to spend a minimum amount of time looking at the articles. This is a mistake. When establishing a company with a likely 20-30 year lifespan, you’d better know what it is you’re agreeing to. Articles are the operating rules of the company and it is vital they are properly structured. If not, you can create problems later on, and even lose out on benefits almost from day one. You must devote serious management time to these. Here we highlight some of the articles, what they mean, and what should be included.
Scope of Business Article
As mentioned earlier, this needs to be detailed, as well as honest. If it is too wide or not clear enough it can cause post-licensing problems with the tax bureau if you are applying for tax breaks as well incentives, and additionally with customs. It is extremely unwise to try and manipulate a scope of business to try and get tax breaks into your business if your actual activities do not warrant this, and avoid consultants or even development zone officials who try to persuade you otherwise. It should be straight forward, clear, and open, while leaving scope for the future expansion of your operations by including as much as you can – within reason.
Production Scale Article
This can be useful in terms of expressing an exit strategy. If you link production and profitability scales to what you would consider unacceptable levels of business thus requiring liquidation, it makes it far easier to obtain approval for closure if this eventuality occurs. You should also link production and profitability scales to the Liquidation Articles later in the document.
Total Investment Article
As discussed above, there is a relationship between your registered capital and your total investment capital, and this needs to be worked out as it can affect debt financing and the ability to obtain parent company loans.
Board of Directors Article
Keep it small (indeed the regulations also allow for only one executive director board structure as well!) and allow for board meetings to be held externally from China or even by telephone conference. Emergency board meetings, being just that – an emergency – should be called at 24 hours, and not one month’s, notice!
General Manager Article
This is a legally responsible position so put it in the hands of someone you trust – ideally your expat manager in charge of production. Limit the term of office to an annual period to give you some leeway. GMs can be notoriously difficult to fire if under the long terms identified in the standard articles.
Trade Union Article
Your staff has the right to form a trade union if there are more than 25 personnel – including expatriates (who may also join the union); if members are less than 25, a basic-level trade union committee may be established. Make sure you work out how to control the budget and influence its expenditure.
If a union is formed, then the elected representative has the right to attend company management meetings, and the company must also fund the union, with 2 percent of all employees’ salaries, each month (staff must also make a small contribution). It is not uncommon for these funds to be misused, and for the union representative to become a bit of a nuisance as well. Funds should be used for workers’ education, welfare and entertainment, and many of the factory basketball courts you see in China have been funded in this manner. Funds may also be used to provide legal support to employees with grievances against the company.
Management interference can be minimized by restricting the union representative access only to the portion of meetings during which staff and workers’ rights are to be discussed, while budgets for the use of union funds can also be agreed upon and implemented.
Profits Repatriation Article
Can’t find it in the basic draft? That’s because it’s not there. This needs to be built in – essentially giving your parent company the right to bill the WFOE for services for management expertise, royalties, licensing agreements, interest on loans, R&D cost allocations, sales and marketing cost allocations and so on. If you don’t have these drafted in it becomes difficult to overlay the service contracts into the articles and obtain approval for this mechanism. It could save you a significant amount on your profits tax bill.
Merger and Acquisition
Again, not in basic drafts. So if you want to sell the business how can you value it? It’s easier to identify a set of rules beforehand. Identify asset valuers, accountants and industry professionals who can value the business. Make their decision final and binding with a time limit for offers to be accepted or bettered, and a mechanism for payment and share transfer itself. You never know what will happen down the road and who can tell what China or your business will be like in five years?
As mentioned earlier, try and link this to the production and profitability scales. Typically they are rather woolly meaning interpretation can creep in – and the local government, whose approval is required – may have different ideas as to what is and what is not a liquidation scenario. Tie this to unacceptable, defined production and profitability levels and it’s easier to exit if you need to.
Maintaining currency consistencies in the articles and business license
When applying for your business license, it is important to pay attention to detail when completing the business license application and cross-referencing this against the articles. For example, as does occur, sometimes the capital amount to be registered on their business license is shown in RMB, however, the Articles identifies this amount in Euros or U.S. dollars.
Consequently, if the exchange rate fluctuates, the injection verified by the local CPA firm, required to prove the registered capital transfer was made, may no longer match the figures on the business license. The registered capital converted into RMB may be less than the promised capital amount. So, you, the investor, have to transfer more funds. You also have to complete another capital verification, which you need to arrange with a local CPA firm and pay for, all of which is an annoyance and wastes your money and time.
Portions of this article were taken from Asia Briefing’s recently revised and updated “Setting Up Wholly Foreign Owned Enterprises in China” guide which includes a 10-page Articles of Association sample draft. This technical guide is essential reading for anyone looking at setting up a WOFE in China. To purchase the full version, priced at US$40 for immediate PDF download, please access Asia Briefing Bookstore.
Dezan Shira & Associates is a boutique professional services firm providing foreign direct investment business advisory, tax, accounting, payroll and due diligence services for multinational clients in China. The firm specializes in assisting foreign enterprises establish legal entities, such as China WFOEs. For advice, please email email@example.com or download the firm’s brochure here.
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