Forming a China WFOE Under China’s New Rules: The First Pass Questions

I was carbon copied on the below email the other day between one of our China lawyers and a client for whom we just started working on forming their WFOE. I am posting the below email because it nicely sets out the basic first pass of information we seek from our clients when forming a WFOE under China’s new WFOE rules, which came out on October 1, 2016. Please note that even this first pass email has been tailored a fair amount to suit the particular circumstances of our client and the city in which it will be doing business. Once we know the district, we will tailor the questions even more.

1. We will need to determine what business the WFOE will conduct in China. From your previous emails, it appears you have the following two alternatives:

a. Business consulting WFOE that will engage in providing basic support services to the U.S. parent of the WFOE.

b. Trading company WFOE that would engage in __________________ in China.

If you are uncertain about which of these options to choose, we will need to work with you to examine the 1.b. option. Please advise and we will work with you on that issue.

2. With respect to registered capital, China no longer has a strict registered capital requirement. What is required is that you provide enough capital to the WFOE to cover its expenses up until such time as the WFOE is fully up and operating and is able to earn enough income to cover its expenses without capital infusions from the parent. So the question on capital is: how much capital do you need?

To determine how much capital is required, you will need to generate:

a. Estimated costs for the first two years of operations.

b. An income statement for the first five years of operations.

You can prepare this financial statements in-house or in consultation with the accountant who will be providing your accounting services in China.

Of course, the financial statements for the WFOE will depend on the type of business you end up choosing for China. Financials for a service WFOE are normally quite simple. Financials for a trading company WFOE are considerably more complex.

3. In connection with 2 above, you will need to identify the sources of income for the WFOE. For a service company WFOE, it is normal for the WFOE to bill the parent for services in accordance with a standard service contract. Capitalization comes first, and then later payments from the parent are treated as service payments which are income to the WFOE. For a trading company WFOE, the income stream depends on the structure of the trading system.

4. It is normal to provide for the shareholder of the WFOE to be the U.S. corporate parent. For you that would be ________. Please therefore provide me with the following information:

a. Registered complete company name.

b. State of formation.

c. Registered address and business address (if different).

d. Copy of most recent information statement submitted to the state of formation (if any).

e. List of directors and officers of the corporation.

f. We are required to report the name of the individual who is the “actually controlling person” of the shareholder corporation. If the chairman of the board is also a shareholder, that person will be the actually controlling person. If not, we will need to designate someone who fits that role.

4. Before we can determine the precise rules for company formation, we need to know the district in which the WFOE will be formed. It is not sufficient to provide [name of China city]. We will need to specify the specific district within __________.

5. You will need to enter into a lease for the WFOE office. The precise lease rules depend on the specific district of formation. In general, however, you can expect the basic rules will require the following:

a. Two year lease.

b. Executed before the WFOE application begins. We will need to provide a formal address for the WFOE as part of the application process.

c. Some districts require the initial tenant to be the U.S. shareholder and some require the tenant be in the name of the WFOE.

d. Premises authorized to be used as an office for a WFOE and that is of sufficient size to accommodate the number of proposed employees.

6. Please state the number of employees for the WFOE for the first three years of operations. Please state the number that will be Chinese citizens and the number that will be foreign nationals. Please also provide job titles and basic salary ranges.

With respect to employees, it is my understanding that some or all of the WFOE employees are individuals who have worked for you in an independent capacity in the past. Do you want to treat their employment as a carry over from past work done, or do you want to start fresh with these persons? By carry over I mean do you want to carry over their past work history for seniority purposes? Since much of Chinese employment law is based on the number of years of employment this is an important issue and we may want to bring on our lead China employment lawyer to discuss all this with you.

7. You will need to determine a Chinese language name for the WFOE. WFOE names are complex because they have 4 components: ABCD. “A” is the location. “B” is the company name. “C” is the type of WFOE, which in your case will be either consulting or trading. D is the type of corporation: Company Limited in this case. What we need you to select at this time is “B”: the descriptive part of the name. You may wish to consult with your Chinese staff on the name. We can assist if required.

Please advise on the above. If you need more information to respond, please let me know.

After I hear back from you on the above, I will provide you with questions that will take us to the next layer of issues relating to the WFOE formation process.

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.