We have frequently been writing of late on how China has like never before been tracking down foreign companies (especially U.S. companies) that are operating in China without having a business entity (a WFOE or a Joint Venture) that allows them to legally do so. See Donald Trump and Your China Business: Double Down, Ditch It or Die and Donald Trump and Your China Business: Double Down, Ditch It or Die, Part 2. In China’s defense (not that its decision to rigorously enforce its own laws needs any defense), the new WFOE formation rules enacted last year do actually make it somewhat faster, cheaper and easier to form a WFOE.
Anyway, since we started hitting this issue hard here on the blog, we have gotten an even greater stream of emails from people who have been “caught” by the Chinese government and from people who want to know what exactly they need to do to get legal. But the most interesting emails come from those who either fully or partially refuse to believe what has been happening in China and how at risk they are. About half of the emails sent to our China lawyers evidence at least some aspect of this and about half of those mention forming a company in Hong Kong as an option for solving all problems.
So let me say right here and right now that forming a company in Hong Kong will not do a thing to make you legal in Mainland China. Nor will forming a company in Macau or Taiwan or Singapore. If you are doing business in the PRC/Mainland China, you need a PRC legal entity, such as a WFOE or a Joint Venture. See Having A Hong Kong Business Does NOT Make You Legal in Mainland China. See also A Hong Kong Company Is NOT a Mainland China Company and a Hong Kong Trademark is NOT a Mainland China Trademark. If it were otherwise, virtually nobody would go through the agony and the costs of forming a WFOE; they would instead pay some accountant in Hong Kong about USD$1,000 and have an HK company in less than a week. Please, please, please do not fool yourself into believing otherwise!
The below email is an amalgamation of two emails I received just this morning, both involving people with United States and Taiwan passports.
I came across your law blog and would like to ask a question. I’m in a slightly strange situation, professionally and nationality wise, and I I wonder if you might be able to offer me guidance.
I am a US/Taiwan dual national living and working as a freelancer in Shanghai, which is my base. I work in the _________ business on a contract-to-contract basis. Though my Taiwanese friends are always telling me not to worry about things like taxes, the more established and successful I become, the more I think I should be figuring out how to get legal in China and make myself legitimate, business-wise.
I am a ________________ and I do other related things. For example, I’ve just been asked to __________ on a relatively large project. Sometimes I am paid in RMB and other times I am wired foreign currency to accounts I hold overseas. Sometimes because I am not a legal business the companies I work for negotiate discount rates from me because my not having a China company precludes them from getting a tax deduction for their payments to me.
As I progress professionally, the amounts I charge and get paid keep increasing and I worry about what all of this means for the long term.
A friend has suggested I go to Hong Kong to set up a WFOE. However, I know some of the rules are different for Taiwanese nationals who wish to set up businesses in China.
It is not my ambition to have a big company or service but I also know that this gray area situation may not be sustainable forever. I also want to know if any of this might affect me as a U.S. citizen. At the moment, I just file federal taxes online.
Please let me know if you have encountered cases such as my own, and if you might be able to point me to resources that would enable me to best formalize my situation.
Our response is always something like the following:
Setting up a company in Hong Kong will not help you one bit in terms of getting legal in China. You need to re-think what you are doing because as you get bigger you become a bigger target. I do not know how China treats Taiwan citizens, but if you are an ethnic Chinese there on a US passport, you are probably at the top of the list. My advice is that you start doing something and fast. You should consider either leaving China or setting up a WFOE in China that employs you. If you leave China you can do some business in China without triggering the need to have a WFOE in China, but because you provide services there, you will still be required to pay income tax there. So long as you are paying your United States taxes, the U.S. very likely does not care what you are doing or where you are doing it; your big concern should be the PRC, especially since you live there. The bigger you get, the more likely it is that someone will rat you out or that you will be noticed by the Chinese government. Productive legitimate businesses do not operate with this sort of hammer poised to hit them on the head. What you should do is weigh the various costs and benefits of your various alternatives and decide on one.
What are you hearing out there?
We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.