When the volume of goods sourced in China is large, the buyer may start to ask the following questions:
Should I set up my own operation in China?
What are my options?
How much would it cost?
Over the years in China, I have had ownership or a director level position in 8 WFOE’s and 2 JV’s. I don’t claim to be a business formation guru as I still take advice from the experts when it comes to legal and accounting issues. But in this article, I’d just like to share some of the key lessons I have learned from my particular experience.
First off, for those readers who are not yet familiar with the term, “WFOE” stands for “Wholly Foreign Owned Entity”. There are many variations to the WFOE, such as “trading WFOE” or “manufacturing WFOE”. But what makes the WFOE special is that this type of business structure does not require any Chinese partners, yet the business is on a level playing field with Chinese owned businesses (at least in theory, from a legal perspective).
For those that want their own team on-the-ground in China, let’s take a look at the question “what are my options?” I arrange the options below in order of the upfront capital investment needed to launch the business.
Outsource the sourcing to China-based service provider
Rent a serviced virtual office
In separate articles I will cover the pros and cons of using options 3, 4, 5 & 6. But in this article, I would like to focus on the WFOE.
The common reason large buyers shift from simply buying China direct to having their own WFOE are as follows:
- Distributors and wholesalers may desire to move up the supply chain and become a manufacturer
- A manufacturer back home may move to China to reduce costs and/or be closer to key customers in Asia
- An entity on the ground in China with dedicated staff allows for closer control of the supply chain. It’s a lot easy to jump in a car and visit a factory than fly half way around the world!
- It takes people to manage the supply chain. Having them based in China vs. EU/N. America saves costs
The main advantage of having a WFOE is that you are in control of your own destiny. It’s your people on the ground.
Setting up a WFOE in China is a lengthy process. For example, even after you have a company set up, it can take additional time to get the “normal tax payer status” and then you can apply for the right to process your own VAT. In my experience the full process can take from 8 to 18 months.
If you engage an agent to help set up your WFOE, be clear about what you wish to accomplish with your WFOE, and make sure they can give a quote for the whole process. Too often the client goes with a low cost agent only to find out the cost was low because they agent is handling some but not all of the critical steps.
A WFOE requires a significant upfront investment. Two big investments are Registered Capital and Physical Space.
The PRC government uses the registered capital requirements to achieve two goals.
First, by having a large capital requirement they are raising the bar and preventing smaller and underfinanced companies from setting up in China. China’s economic development was based on attracting large companies with experience and deep pockets.
Second, having a high registered capital threshold ensures the investment dollars are spent in China. This money can’t easily be pulled out of China while your WFOE is being formed. So it can sit there for months or years if you really screw up the application!
It’s a bit of a catch 22, but one counter intuitive aspect of the WOFE process is that you can’t get approved to do business unless you have a formal contract for rent or land purchase. But you can’t start doing business until your WFOE is approved.
So if you make the investment in land and buildings, you want to make sure that your application process is running in parallel with your building schedule. If not, you could end up having a beautiful factory that sits there idle while you wait for your paperwork.
Even if you are renting a space in China, you will need to sign a lease with the landlord first and start paying rents upfront while you wait for your WFOE paperwork to together. Landlords know how the system works and it is very rare that they will let you sign a lease now, but start paying rent later.
You can make the most of this downtime by re-decorating, setting up the production line/ office and recruiting initial staff. But technically you can’t hire people until the WFOE is done, so it’s very much a gray area, be careful.
Some in-process WFOE’s go so far as to cross the line between testing to trial production. If you go that route, don’t expect to actual ship any of the goods out of the country until your WOFE paper work is fully completed. And realize that if an audit takes place, the local official will have the right to fine you or reject your WOFE application is you are perceived to be running production rather that conducting training and setting up your shop. To add insult to injury, it will be next to impossible to apply for a VAT rebate on items that were produced in your shop in advance of the completion of the WFOE.
There are fundamentally three routes to take when applying for a WFOE. But in my opinion, setting up a WOFE is very technical and the most important thing you can do is get a good registration agent to advise you on the process.
I have been in China almost 15 years, speak the language, have plenty of intelligent local friends to lean on BUT I would never try to set up a WFOE on my own without the help of a registration agent. This isn’t like setting up a company in Delaware where you can register the business online overnight. Overlooking the tiniest of details can have catastrophic impact on the ability of the WFOE to perform as planned. Legally, yes a foreigner has the right to apply for a WFOE on their own. We also have the right to jump head first off the Great Wall of China. That’s doesn’t mean it is a good idea.
Let your Landlord or Local Government do it for you
In order to get you to buy land or rent factory space in a certain area, the landlord or local government may entice you by offering to handle the WFOE formation for fee or at low cost. This can be very dangerous. It may sound good at first, but your incentives are not aligned. They have the goal of rushing the paper work to get your investment. You should have the goal of structuring a WFOE that protects your long term interests.
It’s very naive to think they will put your interest ahead of their. Maybe I am jaded after living here so long but when I hear “let’s do a win-win deal”, it usually means the local partner plans to win twice! I once had a bilingual contract handed to me where the Chinese language said what they wanted and the English language said what I wanted. But this is China, so of course the Chinese language is the binding language in event the English and Chinese differ.
Additionally, be extremely careful if the landlord introduces a registration agent and/or if the landlord is the local government. It’s very hard to negotiate with the municipality and almost impossible to sue them if they mess up your WFOE. Keep in mind the judge on the case will be a government employee. Good luck with that!
Engage a Registration Agent
I make no attempt to hide the fact that using a registration agent is the best option. For me, the real issue is not to use or not to use an agent, but rather, which agent should be engaged. There are basically three choices.
Generally speaking, the large multinational consultants and accounting firms (you know who they are from the adverts on CNN) will do a fine job. But the fees they charge can be as big as their billboards at the airport. Just because you use those firms back home for your accounting, doesn’t mean they are the right choice for your WOFE set up in China. Explore all your options and make an educated decision.
Next we have the “local-western hybrid” registration agents. These firms are often owned and managed by Westerners, but focused exclusively on China business. I like using these kinds of agents because they have the local knowledge, but also have the western mind set for customer service. Unfortunately, their pricing can be all over the place, so make sure you ask around and deal only with a reputable firm.
To be fair, I should also point out that there is no shortage of Chinese registration agents in China. Once again, there is significant variation in price and professionalism within this group. But as a general rule of thumb, you can expect the services of the local firms to be priced lower than the other two options above. But you often get what you pay for.
Regardless of who you choose make sure you ask four essential questions:
What is and isn’t covered in their fee structure?
Can the service fees be linked to the key project gates?
Do they have their own staff on the ground and/or experience in the district where you wish to set up the WFOE? Notice I said “district” and not “city” or “province”! Local knowledge is critical for a smooth WFOE set up.
Can you get a few references from their clients who have used their services to set up a WFOE?
All in costs for a WFOE
Here is an overview of fees to set up in South China:
- Registration Agent: Depends on the agent and size of the WOFE. But even for a small trading WFOE (no manufacturing) I don’t know of any professional agents that charge less than 16,000 USD for the full service Trading WFOE set up. Manufacturing WFOE’s are more complex and I have seen billing range from 50,000 to 500,000 USD.
- Registered Capital for Manufacturing WFOE in Guangdong is hundreds of 1000’s USD (luckily not Millions!) in most cases.
- Government costs/fees + Tax fees + Application fees depend on the location and exact details of the WFOE but can range from 4,000 USD to 10,000 USD for the simple WFOE.
The physical set-up costs depend on location, buy vs. rent, size of factory, equipment and decorations.
The on-going costs of the WFOE depend on # of employees, salary, taxes, BOM, utilities, rents and such.
8 Critical Items for WFOE set up
For your reference, here are some of the items that some business people often overlook when thinking about setting up a WFOE.
- Trading WFOE vs. Manufacturing WFOE. Which one is best for your needs?
- Scope of Business. If your WOFE is set up to export shoes and later you wish to do electronics, you may have significant roadblocks to deal with.
- Additional Licensing (domestic sales? Import/export? VAT?)
- Are there location or industry incentives offered by China government to the WFOE?
- China Tax Planning. In China the WFOE has to report monthly and annually, so not only do you need good tax planning, but you also need to budget for the man power to process all the paperwork.
- Global Tax Planning. The tax rates in HK, PRC and your home country are not the same. Structure your business in China to avoid unnecessary tax exposure while not breaking any laws in any of the jurisdictions where you operate.
- Plan for Profit Repatriation. Making money in China is nice. Spending it is even nicer. Make sure you have a plan for how to get your earners overseas into your pocket back home.
- Budget. Get a firm handle on the true costs to set up and run your business. It is not uncommon for the investor to sink money into a WFOE only to lose that investment because they were underfinanced and never got the point where the doors were open and revenue could be realized.
Having your own WFOE can be a wonderful thing- more control over the supply chain, reduced costs in the long run and improved protection of IP. But a mistake in any of the 8 areas above can be devastating to the business causing great loss of money and time. So plan accordingly and do your homework.
About the author
Mike Bellamy is an Advisory Board Member & Featured Blogger at the not-for-profit China Sourcing Information Center (www.ChinaSourcingInfo.org). He is also the author of, “The Essential Reference Guide to China Sourcing” (chinasourcinginfo.org/book) and founder of PassageMaker Sourcing Solutions (www.PSSchina.com).
Related Topics, Resources and References
How to choose the China business’ structure? (Part 2) (there are 5 articles written by a Chinese lawyer in the series)
Experienced or Not. Setting Up in China. (article introduces a series of 5 video interviews with a registration agent. The videos are also posted at CSIC)
Readers may contact the author of this article (Mike Bellamy) via the Contact Us page at CSIC if you would like to be introduced to his endorsed service providers for business formation, accounting, tax advice and legal support.