Many foreign investors assume that opening and managing a wholly foreign-owned enterprise (WFOE) in China is as simple as getting the new business registered. But its not always that easy.

Foreign investors often rely on home-country consultants to advise them on Chinas business and tax regulations, as well as on how to structure the business. It is also common for investors to use the services of inexpensive local Chinese consulting firms for WFOE registration, many of which do not provide an international standard of service. Such firms often only provide the most general information about Chinese law and regulations for business and tax planning purposes. This approach can result in a host of problems once business operations are underway

Plan ahead for funding

One common problem stems from a lack of understanding and subsequent planning for funding a WFOE. Foreign investors often only focus on the minimum registered capital requirement (usually around $150,000) and ignore the total investment specification. By default they set the total investment equal to the registered capital, limiting options if the WFOE uses up the registered capital before becoming self-sufficient. In this case, the only way to provide additional funding to the WFOE is go through a costly and time-consuming registered capital increase application and approvals process.

However, if during the advance planning stages, the ratio between total investment and registered capital is set up properly, the investor may also have the option of providing interest-free or interest-bearing loans to the WFOE. Unlike the registered capital, such funding is not locked in China and can often prevent a WFOE start-up from faltering.

Parent company management fees

A second common error occurs when the parent company of a WFOE charges management fees to the WFOE for services rendered, such as IT and accounting support. Management fees are allowed but they incur a 10% withholding tax that must be withheld by the WFOE at the time of paying an invoice. Furthermore, these fees are not allowed as expense deductions when the WFOE files corporate income tax. In short, management fees are taxed twice. However, if such cross-border services are set up and managed correctly using properly drafted service agreements, the double-taxation situation disappears.

Careful planning is the answer

The areas highlighted above only scratch the surface of the problems that foreign investors may face. Others include taxation, transfer pricing, and compliance with business regulations; the inadvertent creation of permanent establishments; and the challenge of setting up and maintaining proper accounting records.

The majority of these problems can be avoided by comprehensive planning during the initial stages of forming a WFOE. Such planning is best conducted with trained professionals who can provide an international standard of service and who truly understand the complexity of Chinas business and taxation laws. The benefits of this will far outweigh the initial costs, and sound planning will always improve the odds of business success.

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