Even though China’s government and its Economic Development Zones have made it easier to register and setup a Wholly Foreign Owned Enterprise (WFOE), it is still a relatively complex and time consuming process. On an average, a WFOE registration requires about 600 signatures and 300 stamps. Below are three mistakes that should be avoided when setting up your WFOE in China.
Mistake nr 1: Not bringing in enough registered capital
Registered Capital (“RC”) and Registered Total Investment are the initial declared investment to your Wholly Owned Foreign Enterprise (WFOE) so that it can operate until it becomes profitable and represents the equity that an investor has in a WFOE. These capital declarations are required during the application procedure when your enterprise establishes a WFOE in China.
Even though China has liberated its minimum capital requirements, it is crucial to look beyond the minimum guideline amounts and make a realistic estimate of how much money your business needs to operate in China before you start making profits.
Otherwise, you might find yourself in a situation where your enterprise is undercapitalized and unable to pay its bills. You can salvage this by bringing in more money to your WFOE, but this is a time-consuming bureaucratic hassle, (not to mention that this money is taxed as profits); meanwhile your daily operations might suffer if you are out of funds and you could go out of business!
WFOE registration in China is not an overnight affair.
Mistake 2: Being careless with the company chops
Where the Western world uses signatures, the Chinese uses company seals, or “chops” to legalize and ratify documents. Thus, the holder of the company chop can exercise power and sign for the company.
There are different types of chop that grants different authorities; the most important chop is the Executive director Chop and the Company Chop which needs to be strictly controlled.
Many executive directors are not continuously present in China and hence, the company chop is a practical way to delegate authority to a trustee. However, this practice can also backfire if the trustee decides to misuse the power granted by controlling the company chop. In fact, using a company chop, someone could for instance change the stock structure of your enterprise and have the control over your company signed over to another group or individual! Not realizing what role the company chops play can thus be a fatal mistake for your enterprise; they need to be kept under close scruitiny!
Whoever controls the chops controls the company.
Mistake 3: Not defining an adequate business scope in the Articles of Association
When registering your WFOE in China, your company’s operations are defined by its business scope – which in effect is a one sentence description of the industry it is authorized to operate in. Unlike other countries, the business scope in China is more detailed and has more implications than in the west. An enterprise can only engage in operations within its business scope as approved in its registration with the Chinese authorities; thus this business scope needs to be carefully defined.
The articles of association are the operating rules of your company and is in effect as long as the business is operating in China (which could be decades ahead). If your company scope is too wide or too narrow, it could create problems with the tax bureau and customs if you are applying for breaks and incentives as well. Manipulating the scope of the business to get certain tax breaks if your actual business activities don’t warrant it is not to be recommended, avoid all advise to the contrary from local officials or other consultancies.
If you misalign the business scope with your actual business activities, you can either be fined, or in serious cases, have your license withdrawn.