Sept. 9 – It normally takes four to six months to complete the application for setting up a foreign-invested enterprise (FIE) application and organize the opening of a bank account for the new company. However, there are start-up costs in the interim phase, which some foreign investors meet by sending the start-up funds to their local agent or the personal account of an employee to cover the initial costs.
The problem with this approach is that, although these funds are paid for the purpose of setting up the FIE, they will not be recognized as part of capital injection once the business license is issued. In order to be recognized as capital injection, funds must be transferred by the foreign investor from their overseas account to the nominated capital account directly, not via any third party.
Over the years, we have seen foreign investors deal with this problem in various ways. However, there is no perfect solution so far due to the rules and regulations relating to foreign currency control and incorporation. Every option has its level of feasibility, as well as carries its own limitations. We discuss these options – their feasibility, as well as potential risks and limitations – below.
Open a temporary special foreign exchange expense account
According to the State Administration of Foreign Exchange (SAFE), if foreign investors planning to establish enterprises with foreign investment in China need to conduct market research, planning, and preparatory work for establishment of institutions in China at the initial stage, they can open an expense account (upon obtaining the notification for advance examination and approval of the company name from the administrations of industry and commerce). The foreign investor can then deposit foreign exchange funds into this account to settle payments.
Based on our experience, the application procedure for opening this expense account might take two to three months. In addition, complex verification procedures are necessary to complete settlements and transfers of funds, and the account is also subject to routine supervision from SAFE.
Paid by foreign investors on behalf of FIE and charged back
Normally, foreign investors would consider the easiest and most efficient way of managing these expenses is to have setup costs paid firstly by the headquarters on behalf of the FIE. After the bank account is set up and capital injected, the FIE then repays the headquarters. Although this arrangement seems practical and easy, unfortunately it cannot be carried out smoothly in China due to foreign currency control and tax regulations. Companies frequently encounter trouble in remitting funds overseas, heavy tax burdens and long-term unsettled payables.
Paid by foreign investors on behalf of FIE without charging back
In this case, foreign investors pay the setup costs directly to the vendors (both local and international vendors) and do not charge the costs back to the FIE. In this case there are no issues relating to foreign currency payment, no risk of fund repatriation tax, and no effect on the FIE’s cash flow. This is the easiest way to handle the setup costs.
Paid by foreign investors to individual’s bank account in China
The payment for setup costs could initially be paid to a personal bank account belonging to the general manager or another employee in China. When the RMB account is ready, the GM could claim the expenses from the FIE as a staff reimbursement so that the start-up cost will show on the FIE’s local book for CIT deduction. This could be an easier solution for low start-up cost amounts.
Paid by related party who has establishment in China
If the foreign investors have other establishments in China (they could be in the form of a representative office or another FIE) which has sufficient cash, the start-up costs can be funded by this related party and arranged for settlement later when the RMB account is ready. However, if the payment is made by an RO, this might attract a challenge by the tax authority as ROs are not supposed to pay any expenses on behalf of other entities. Such expenses could potentially be considered as a cost of the RO itself and subject to taxation.
As mentioned above, there is no ideal solution for this issue. One important thing to keep in mind is that, for all expenses which will be eventually charged back to the FIE, official tax invoices with the title consisting of the full FIE Chinese name should be collected from vendors in order for the expenses to be deducted for taxable income calculation.
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, Hong Kong, Vietnam and India. For a more detailed analysis on the most efficient and cost-effective ways to set up an FIE in China, please email firstname.lastname@example.org, visit www.dezshira.com, or download the firm’s brochure here.
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