WFOE set-up in the Shanghai Pilot Free Trade Zone

Wholly Foreign-Owned Enterprise (WFOE) is, by far, the favorite entity for foreign investors looking to set up a company in China. Representative Offices may offer cheap and easy way to feel Chinese trends, Joint-Ventures may give you a privileged access to the market, but WFOE are the only way for a foreign investor to have full control on its operations in China. And where else than in Shanghai would you set up a WFOE? Since the launch of the Shanghai Pilot Free Trade Zone (SHPFTZ) last September, new opportunities for foreign investors are arising in the city. The Zone will see the liberalization of its economy through successive reforms that will be, if successful, implemented in the rest of the country. Incorporating in the Zone has therefore the double advantage of letting you benefit from major reforms and sense China’s future. No wonder why entrepreneurs are currently rushing into the city.

However, Shanghai is still a part of China and business is still not as easy as in Hong-Kong or Singapore. Paperwork remains a heavy burden, legislations can prove obscure and information is difficult to gather. After a full year of reforms, though, the administrative, fiscal and legal systems have greatly improved in comparison with the rest of the country. Therefore, it was time to provide an overview of WFOE set-up in the Shanghai Free Trade Zone.

The key benefits of the SHPFTZ are listed below and further discussed in this publication.

Company Registration Paperwork

WFOE registration is often described as a long and painful journey, which explains why so many entrepreneurs seek an on-the-ground assistance. Even though it is still a rather long process in Shanghai, the paperwork has been sensitively reduced – by about 40% – thus leading to halve the registration duration – about 2-3 months in the SHPFTZ against 5-6 in the rest of China.

An overlook on the main steps to register the WFOE in the SHPFTZ are summarized below. Durations may vary from a business to another, especially when it comes to restricted industries. Note that certain industries, even among authorized ones, will ask for further approvals and paperwork.

As said before, fillings and procedures have been reduced in the zone. Among important documents that are unnecessary to submit in the SHPFTZ are the Bank Reference Letter, the Annual Auditing Report of Investor and the Feasibility Study Report. Note that if your business scope does not aim at restricted industries, you can start your business before obtaining all the documents, as long as you are in the registration process.

For more advices about how to set up a company in China, see here.

Business Scope

The Chinese Business Scope is much more detailed than in other countries. Usually taking the form of a short sentence, it has to summarize all the possible future activities of the company.  Note that the Business Scope will appear on the Business License delivered by the State Administration of Industry and Commerce (SAIC). Even though modifications are possible, they require further approvals and are therefore slow to become effective.

Even though the Zone tries to open more than the rest of China, some businesses are still forbidden to foreign investments. So as to enable investors to know where they can send their money and where they cannot, the Shanghai Government released the Negative List, explicitly listing the forbidden industries. In the rest of China, the process in which a business scope involving borderline industries is accepted or not is still rather obscure. The Negative List is therefore a positive step towards more transparency. The Negative List is to be updated every year. Last version was released in July 2014authorizing Foreign Direct Investments (FDI) in 51 new industries, reducing to 139 the number of forbidden industries. Among the newly opened industries are the Healthcare Industry and some activities related to the Internet.

Some industries, on the other hand, are encouraged. Companies working with the proper activities can receive subsidies and incentives from the state. Most of these activities involve high-end products manufacturing and designing, innovative processes or research and development efforts, following the government’s will to see its industries move upmarket.

Financing the WFOE

Two sources of money can be used to fund your company: Registered Capital (RC) and loans.

Registered Capital is the money wired into the company from direct investors. It is used to buy assets and start operations. Following a recent reform of China Company Law, there is no more minimal registered capital requested to set up a company. Furthermore, investors can decide themselves when and how the money will be injected in the company capital account. The manner the investment will be processed has to be specified in the Articles of Association submitted to the Minister of Commerce.

Loans are the second source of cash at the disposal of a WFOE. However, the Chinese lending industry is still underdeveloped, with very high difficulties for non-state-backed industries to contract loans with Chinese banks. Of course, alternative solutions are available. The only fully legal and less risky one, though, is to borrow from a foreign bank.

The ratio between registered capital and debt is governed by a thin capitalization rule. It varies depending on the total amount of Registered Capital subscribed. The following table sums it up:

Money borrowed from foreign banks and coming from foreign investment are rarely libeled in RMB, which is needed to pay your local suppliers. Or, these conversions from foreign currency into RMB are tightly controlled by the State Administration of Foreign Exchange (SAFE) in most of China. However, a recent reform implemented in April 2014, enables companies to convert at will their registered capital from a foreign currency into RMB through a specific account that banks will monitor, reducing the paper filling that was needed in the past. Note that the area of this reform application has been broadened to 16 other pilot zone.

The following figure sums up the financing process of a WFOE:

Tax in Shanghai Free Trade Zone

The Shanghai Free Trade Zone has several key advantages from a fiscal point of view. If tax rates are sensitively similar to other parts of China (see beside), the Zone still benefits from innovative structures and regulations. Key measures are the following:

  • Value-Added Tax replaces Business Tax:Shanghai, along with the whole country, is pursuing the aim to replace the old tax system using Business Taxes by Value-Added Taxes, which is internationally recognized as more business-friendly. The process started in January 2012 and is still going on, with new industries included every year. Currently, the VAT tax varies between 3 and 17%.
  • Easing on imports: the Zone does its best to simplify traders’ businesses. Since last May, the custom checks have been postponed from before to after entering in the Shanghai Free Trade Zone (registration within 14 days). Companies can use their own vehicles to move their imports from one part of the Zone to another, rather than relying on those supervised by the customs. Globally, the administration has simplified and alleviated the paperwork for imports.
  • Better Tax Services: Recent releases from the State Administration of Taxation (SAT) have shown the Shanghai Government commitment to ease tax payers’ lives. It has moved most of its taxation services online, simplifying form fillings and reducing paperwork. It has also cancelled the need of approvals to get Tax Registration Numbers, moving to a supervision-based policy and thus easing company’s ways of doing business.

Generally speaking, the shanghai government has set different kinds of tax incentives aiming at specific industries so as to attract foreign businesses in the zone.

Legal system in the Zone

The recent split from the China International Economic and Trade Arbitration Commission (CIETAC) by its Shanghai Branch, leading to the creation of the Shanghai International Arbitration Commission (SHIAC), has enabled the legal system in the Shanghai Free Trade Zone to reform itself more deeply and rapidly than in the rest of China. It has recently released a new set of arbitration rules, aiming at aligning the SHIAC standards with the internationally used ones in the domain of Alternative Dispute Resolutions (ADR). These reforms should further structure and clarify dispute resolution processes.

See also: WFOE China  

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