How’s Your China WFOE? Please Check

Not sure why (China government arrest quotas?), but at the end of every year, my law firm always gets a slew of emails and phone calls from foreigners in big trouble in China. In past years the trouble has mostly involved unpaid taxes, usually with the following sort of scenario:

Foreigner (disproportionately Northern European) calls to say that they are in their home country for the holidays and they have learned that the “tax man” has come by and is extremely unhappy about the company not having reported all of its China earnings. The person wants to know whether it is safe for him (it has 100% of the time been a male) to return to China. Three more minutes of talking reveals that this company has not even come close to paying its China taxes and the person on the other end of the line “justifies” this by saying his Chinese accountant told him that “nobody pays these taxes.” I very dispassionately tell this person that I don’t know what percentage of foreign companies pay their China taxes, but that the China attorneys at my firm advice all our clients to pay all their taxes and that is in large part because China LOVES going after foreign companies that don’t pay all their taxes AND has gotten really good at catching those that don’t. I then tell him that he absolutely should not go back to China unless and until his company has cleared up all back taxes, with interest and with penalties. I got only one such phone call (so far) this year.

No, this seems to be the year of the busted (pun intended) China WFOE, as we have received one email on this, one Facebook communication (on our China Law Blog Facebook Page), and one phone call. Vaguely summarized, these are two people who were . arrested and put in jail for about ten days and then released and told not to leave their city and one person who was visited by the police and told not to leave his city. All are being “questioned” about doing business in China without a WFOE. Doing Business in China Without a WFOE: Will the Defendant Please Rise. Hard to tell exactly what is going on with any of the three. One vehemently claimed he had paid someone to form a WFOE for him and that person had said he had in fact formed the WFOE, and yet the police said he had no WFOE. So it appears he was scammed. The other weakly claimed he “thought” he had formed a WFOE but my sense is that he never did and now the chickens were coming home to roost for him.

The third one was the most interesting, because he insisted that he had formed a WFOE with a “legitimate” entity formation company but it appeared that company had formed the WFOE as a consulting WFOE and this company (with 18 employees) clearly should not have been a consulting WFOE. I do not know if the entity formation company duped this person by forming the company as a consulting WFOE (this is not uncommon because these are typically the easiest and fastest WFOE to form), knowing it did not really qualify under that scope, or if the foreign company had started out as consulting WFOE and then morphed into something else and then failed to alert the Chinese government, as required. This was the person who was never imprisoned. See Forming a China WFOE: Scope is Key.

All three of these broken/non-existent WFOEs were in second tier (at best) Chinese cities and in all three cases I recommended that the person in extremis secure a really good and local criminal lawyer.

Bottom Line: Check your WFOE. Now. And if you are going to form a WFOE, make sure you do it right. Please. Oh, and one more important thing: many times foreign companies would be better off not forming a WFOE at all and not having any of their own people on the ground in China at all. For more on this, check out Forming a China WFOE: Needed or Not.

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.