Op-ed Commentary: Chris Devonshire-Ellis
Jun. 5 – All foreign investors know that setting up in China requires capital. What is less well-known in the case of establishing wholly foreign-owned enterprises (WFOEs) and joint ventures (JVs) is the recognition that not all of the registered capital requirement needs to be in cash. In fact, up to 70 percent of it can be injected in the form of alternative assets such as plant and machinery, intellectual property, and so on.
Accordingly, the question concerning registered capital requirements can essentially be broken down into three portions: cash, equipment, and intellectual property.
Although certain industries do still mandate specific cash requirements in order to fulfill registered capital obligations, these have been relaxed from several years ago and are now only a large financial obligation for cash-heavy industries such as banking, finance, and certain heavy industry areas. For the majority of foreign investors wishing to manufacture or trade in China, the registered capital amount is no longer so much of a burden and can be viewed as being equivalent to sensible cash flow needs.
This is important, as the registration part of injecting registered capital into a company is both time-consuming and precise. It is not simply a matter of just wiring money to the company bank account, and if this is done, the Chinese tax bureau will regard it as taxable income. Money needs to be wired in from overseas, and registered with the State Administration of Foreign Exchange (SAFE) prior to it being transferred into the capital account. This fully identifies the cash as being “registered” capital and is not taxable. Your advisors will be able to provide assistance with this procedure.
Another issue that affects the cash portion of this – and especially the cash flow aspect – is the question of what is actually needed? This also can vary and needs to be well organized and catered for in advance. Underestimating the actual amount of registered capital requirements is both costly and administratively a burden, as new permission has to be sought to inject new capital – something that could have been avoided with detailed planning from the outset. Again, good quality proven advisors in China will be able to assist, however “hidden” capital requirements can come from a number of different sources.
The status of the business VAT registration can have a sizeable impact on bonds that may need to be lodged with customs for example, as may reclaimable duties on imported equipment. Other costs may arise depending upon the specific business in terms of meeting costs associated with additional departmental checks. These all levy fees for their licensing obligations, and can include departments such as environmental protection, health and safety, fire department and so on. Your advisors will be able to give you estimates on these – this needs to be calculated as part of the registered capital cash needs.
The rule as concerns the cash aspect of registered capital is that it needs to be the amount of cash required to get the business started, and as much again to get it operationally effective. The latter issue may take time for the business to generate sufficient cash flow to cover its own costs, and this portion can in fact be spread out over several injections. However, working out these obligations and timeframes requires attention to detail, on-the-ground knowledge, and good financial planning if this is to be executed without problems.
Generally speaking, the equipment to be used as part of the registered capital must be new, and supporting documentation needs to be provided and registered with the customs bureau to justify the amount of capital it attracts. We have been able to argue occasional cases where the required equipment was second-hand (in the case of some specific technologies, some equipment may be old), however this is difficult, although not impossible. The value of the equipment varies of course, and may also be offset by substituting a cash provision for the purchase of similar equipment that may be obtained in China. Not surprisingly, China prefers this and does offer some incentives to purchase equipment locally (as long as the cash was registered beforehand). For imported equipment, it should be noted that duty is fully payable on the valuation, which means again a registered capital cash provision needs to be made for this. However, the duty paid is reclaimable at 20 percent each year for five years. Equipment can be up to 70 percent of the total registered capital figure.
IP can also be injected as a registered capital asset, and should be especially if the technology and/or brands are to be used in China (we also strongly advise that IP registration in China goes hand in hand with this). However, there are inconsistencies within China’s own regulations as concerns the injection of IP as registered capital. According to China’s Company Law, the cash portion of registered capital may not be less than 30 percent, implying that IP as part of registered capital could be as high as 70 percent. This may be of interest to cooperative or equity joint ventures. However, within the WFOE implementing rules, it is explicitly stated that IP as part of registered capital may not exceed 20 percent. Accordingly, the amount that may be injected as part of IP valuations can differ. As a rule of thumb, unless you and your legal advisors are prepared to argue the case for JVs, the IP portion is generally considered at the 20 percent mark.
The conditions for attaching a value to IP are fairly rigorous and time-consuming, however this can be accomplished with the assistance of on-the-ground advisory support and consultants familiar with the procedures. Registered capital is an important part of the business establishment process in China, and unfortunately one that many businesses under-anticipate. Attention to detail must be paid to the cash obligations as underestimating this can lead to unnecessary and avoidable administration and operational cash-flow problems later on. Pre-incorporation and financial planning are part of this procedure, and we recommend using practices with an on-the-ground presence and experience in this aspect of corporate investment.
Chris Devonshire-Ellis is the founding partner of Dezan Shira & Associates. Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.
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