One of the frustrating issues about advising corporate clients in China is how many of them, prior to seeing our firm, are so often badly advised on the China establishment procedures. Far too often, assumptions are taken that setting up a wholly foreign-owned enterprise (WFOE), for example, is a standard application procedure. We’ve even seen "cookie-cutter" models used both by lower end firms and even China government investment departments keen on making it as easy as possible (for them) to secure your consulting fees and investment dollars.

The truth is that setting up a WFOE properly is not an easy, standard procedure at all. The legal administration aspects of the process are relatively straightforward, however the real trick with WFOEs, and one that requires actual on-the-ground China experience in both law and tax, is getting the financing right and the tax planning in place. In this regard, all WFOEs are different, and all require specific attention to detail to get right. Otherwise, serious post-incorporation problems can arise that can affect the very credibility of the business operations and, at the very least, cost you considerably in wasted monies and additional financing. In short, structuring a WFOE in China is less of a legal issue and far more of a tax and finance issue. In this article we provide details of some of the common mistakes that are made when adopting a "standard cookie cutter" approach to a WFOE application.

Pre-incorporation for foreign-invested enterprises: Faulty license applications and tax structuring problems

The scenarios and problems below apply to wholly foreign-owned enterprises, foreign-invested commercial enterprises and joint ventures, but for sake of convenience we have used the term foreign-invested enterprise (FIE) to cater for all.

Sending start-up funds to somebody else before FIE is ready

It takes normally four to six months to complete the FIE application, however, some foreign investors can’t wait that long and try to send the start-up funds to their local agent or local staff to cover the cost for the initial office fit-out, overhead or even equipment purchases. The problem is that these funds, as paid for the FIE setup, cannot be recognized as part of your capital injection once the business license is issued, as the capital injection has to be transferred by the foreign investor from their overseas account to the nominated capital account directly, and not via any third party.

We have previously had clients remitting up to US$200,000 to their local supplier asking them to pay for rental and purchase equipment prior to the license being issued, with them subsequently finding it very difficult for them to pursue the balance and show such purchases as part of their capital injection. Rather, it is better to open a temporary capital account right after the name registration is completed. Here’s the deal if you don’t handle this properly – the Chinese tax department will assume it is earned income and it will be subject to income tax of 25 percent. That is a very expensive way to fund a business.