This interview is part of the Wood Egg project, a series of guides for entrepreneurs covering 16 different Asian countries. I contributed research for the China guide and this was one of the interviews. For the complete WoodEgg Entrepreneurs’ Guide to China 2014 version, please visit WoodEgg.com.
Today’s guest is Fabian Knopf, senior associate at Dezan Shira, a consulting and advisory firm focusing on services for foreign direct investment in Asia. Fabian is an expert in legal structuring, cross-border taxes, as well as HR laws and practices for foreign companies in China and Hong Kong. Today, we discuss how to set up a Chinese company, the different options, and the pros and cons.
Understand the different types of companies a foreigner can set up in China
Explore the advantages and disadvantages of the different company structures: Registered Office, WOFE, Joint Venture.
Briefly overview of business permits and taxes
You can connect with Fabian via LinkedIn or on Twitter @fabian_knopf
Dezan Shira publishes a great resource, China Briefing, which covers topics related to doing business in China
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Episode Transcript (provided by WoodEgg):
JP: Okay. Number one, options for business structures in China.
Fabian: Right. So, there are... You start at the bottom with the easiest form, essentially, which is a representative office which is not its own entity. It belongs to the investor outside of China. And you can employ people here. You can rent an office here. Everything is legal. The employment is through a third party and you're only allowed to do non-profit generated activities. For example, research, liaison suppliers, finding customers, market research in general. Just staying in touch, having an office, having a showroom, for example. Just being somewhat of a base in China for a company that doesn't want to make that jump.
The next step would be a wholly foreign owned entity which is a what is commonly referred to as WFE. That one is essentially a limited liability company as we know it as well, and can take the form of a limited liability company which is basically the most common one. It's all really like a pick and choose model, although, the options aren't very plentiful. And that's, as I said, essentially a limited a liability company. It has its own entity here in China. There's a registered capital or an investment connected to that. You can employ people here directly. There's basically a business scope that has to fall into a certain category, the foreign investment catalog. There's just three categories, essentially. It stays restricted. It stays encouraged and there's a [indiscernible 00:26:41] where it's not restricted, essentially. So, in everything within the restricted and with the non-restrictive category are encouraged that is feasible for the WFE to engage in. So, yeah, a really regular company as we know it everywhere else.
Then, the joint venture is essentially just the joining of two entities into one. Basically, the same for the WFE as well. The same characteristics. Other than that, maybe the foreign investment catalog might actually have a requirement for a joint venture with a certain percentage, with a certain ownership of one party toward another. That entity, that joint venture can then move into a more restricted investment category of the catalog. It's just a joint venture. Anywhere else, very similar for job placement as well.
There's a fourth one, essentially, which is a foreign invested partnership which is specifically for venture capital firms. For example, that one that invests in China. It's not an entity itself. It's more of a business structure. So, the FFE itself doesn't have an entity itself. It doesn't need to be registered. It's a bit difficult right now.
Legislation was passed in 2011 or came into effect, or 2010. Up until now, there's not that many in China. It's very difficult for authorities even in Shanghai or Beijing to grant approval of this. So, it seems to be a very, very controlled entity. There's [Collette (sp) 00:28:25] group has one with Folsom group in Shanghai. It's a $100 million fund. And there's a few other examples that have come up.
But, it's really, I guess it kind of relates to the financial development of China or the financial depth, the financial development in China of institutions, and the market in general which is not very progressive. So, that's also maybe why it's not been making much head way into the market. So, it's really the representative office, the WFE and the joint venture right now.
JP: Okay. Can you, just to give sort of perspective, most big companies when they come to China, if they're a big brand like PNG, for example, what are they using?
Fabian: They're using a WFE most of the time, exactly.
JP: I guess some of the things JV's are like Volkswagon.
Fabian: Exactly. So, the automotive industry was one of the restricted industries. That was actually redacted from last year, I want to say, so that's not a requirement anymore. For foreign, you know, they still have to be approved and it's certainly not an easy process.
Fabian: To go through that. For example, one of the requirements is not necessarily Chinese ownership or part Chinese ownership anymore.
JP: So, before, there was a requirement that the Chinese had needed to own a certain percentage if they wanted to do automotives?
Fabian: That's correct, yes.
JP: I see. And then, so that's an example of JV. So, who has representative offices, like, research firms?
Fabian: No. Research is one of those that falls into the restricted category. Research is banned.
JP: Oh, I see.
Fabian: Yeah, it's one of those things where the authorities will ask further questions and when in doubt, not approve the entity. So, the representative office would be a typical model which is a sourcing model where you essentially have the typical South China model, I would almost call it. You have a company in Hong Kong. You have a representative office here in China and one more in wherever. And, essentially, you have people in that representative office that will go to the factories and do quality control and they run around with all the samples and make sure that whatever the Hong Kong company wants is being executed here.
And then, the factory ships to the Hong Kong company. So, there's no invoicing with the RO. The invoicing is always between the factory and the Hong Kong company. So, it's kind of a helper, I guess, if you like. And it's just like a market entry. You just kind of want to see is there... You have to [indiscernible 00:31:13] for market research essentially, not for other clients but for yourself, is there a demand for my product or my services and you just kind of start off with that. Also, law firms have to be registered as a special representative office. They can't register as a limited liability company, for example.
JP: Okay. What about those consulting firms that are international? Those are...
Fabian: There are different consulting firms and so the Big Four, for example?
JP: Yeah. So, like BCG has an office in Beijing.
Fabian: Right. Well, they are management consulting. So, they would most likely be WFE. I think it's the same for us. We're a consulting company which is a WFE in that sense.
JP: There are strict sort of... Well, I don't know if that strict. There are supposed limitations on the representative offices.
JP: And has the lease, like, has the enforcement gone more strict recently? Because there are probably people running around doing things with representative offices that they weren't supposed to, right?
Fabian: Yes. And there's many, many different ways that people have gotten creative in terms of... So, the problem is if you... I'm sure it isn't just one way of how people have misused the representative office in some way. If you want to buy something in China, you usually need an invoice. And with a representative office, you can actually buy something, essentially. So, in what way that really benefits the representative office now is up to interpretation, really.
But the could, for example, just get these invoices if the invoice is by [indiscernible 00:32:55] in some way through a legal channel, obviously, and then just pay with the money they receive from their mother company for a certain kind of product. And then, I'm not sure how they would be able to get it out of the country but I'm sure it's possible. Which, again, it's not from within the scope of the representative office.
Fabian: So, yes, that has been something that's been cracked down on and actually been addressed by legislation in 2011 which basically limited the number of foreign employees that could be hired, and raised the tax rate, the effective tax rate on representative offices. And then, just make sure you are not, that you're explicitly saying, “This is not [indiscernible 00:33:34]. This is legal.”
JP: Okay. And for companies looking to enter China, is there any advantage to setting in Hong Kong first? Is there any special advantage?
Fabian: Yes, but not to every company. One big advantage is, I guess, but this requires a bit of planning, is any business that benefits from the CEPA which is their close economic partnership agreement between Hong Kong and the Chinese mainland which is essentially saying, for example, the tourism industry, again, a restricted industry in China. If you are a foreign entity that's been setup, I think, it has to be five years in Hong Kong with all the necessary licenses in Hong Kong as well, be registered as a tourism provider with all the chops and approvals. Then, when you then make an investment into China and say, “I want to do this now,” and then be able to say, “Look, this is what I've done in Hong Kong. And on this agreement, I can do this, this and this now and I'm not restricted. I can actually do these things,” then, that it beneficial to having a Hong Kong company and having a business there.
JP: So, what entity would they be once they come to China?
Fabian: They would also be a WFE. They would also be a WFE in that sense.
JP: Oh, okay. But, not everyone can just come and setup that WFE?
Fabian: Exactly. That's right. But, a lot of people come and say, “I have a China business,” and they really only have a Hong Kong office, which it doesn't really matter whether you have that office in Hong Kong or in New Jersey. There's no difference. You know, exporting is all the same. You can't issue any official Chinese invoices. You're closer geographically, yes, but that's it.
JP: I see. Okay. So, the next one. We already talked about some of the advantages and disadvantages of each kind of businesses.
Fabian: I can go a little bit more, maybe, just into a quick comparison.
Fabian: So, the representative office is fairly low cost in starting up. So, you don't have to put up a registered capital. There's no initial investment. You, essentially, just feed it money every month, every quarter. And there's a limited business scope, although, of course. You're not, no profit making activity and it's not scalable. It's not scalable because, at least not from a monetary perspective, you pay an effective tax rate on costs. So, the higher your costs go, the more people you hire, the bigger office that you have to rent, the more cost that people generate, the higher your tax bill goes. So, there's are no [indiscernible 00:36:26] scale unless your profit margin in Hong Kong or wherever you are is dramatically increasing as well and you can make that justification for you internally. But, that's usually not the case. So at some point...
JP: It's much worse to get taxed on cost and on profits.
Fabian: It's awful. It's awful. Exactly. So, we've had clients that are, you know, they'd be occupying a whole floor of a building with over 100 people. You know, they were big companies too. But, it's not an efficient model. It's not what you want to run even mid-terms. It's something that you want to have in mind, okay, I need to move to a WFE. This is the much better, more suitable option here. So, WFE, relatively is high startup costs. You have the registration process is quite long and tedious and you have to put up a registered capital.
JP: Has there been a trend of that going up recently?
Fabian: Not by the law, no. The legislation doesn't have anything like that. They have a minimum that is written in the legislation bu it is the case that it's generally higher and especially in areas where clusters like CBE...
JP: Oh, it depends on the... Okay.
Fabian: Because you always have to see, the law is written by Beijing but it's being implemented by Fujing. So, the offices have a certain quota that they have meet in terms of foreign investment attractives. So, they will set that quota and they will set the registered capital according to the quota that they will have to meet. So, they have their own interest in that as well. So, that's something to keep in mind as well. The WFE has, also, in terms of compliance cost as well, you have to put up with taxes that are a bit more complicated than just for the representative office. But, you can be a full market participant. You're, essentially, free to do whatever you do within the business scope that you have chosen, essentially, within the restrictions of the foreign investment catalog.
And, joint venture, also has high startup costs which is essentially not much different from the WFE. There's a few more things that you have to do before the regular registration. You just kind of have to figure out yourself within the two partners, what you want to do. And there could be better market access with a Chinese partner, for example, that you can be introduced into a certain market to customers, to suppliers. It might also be easier dealing with authorities, although, you don't want to step over the line of being into a legality, essentially. [indiscernible 00:39:31] is nice but it's not always 100% clear whether or not this is legal. So, there are advantages and disadvantages to that.
JP: Okay. I think that's a good summary. Don't have any other follow questions with that one. So, let's move onto the next one. Any advice on naming businesses in China? Are English names okay or should they be localized? And maybe a little bit about how localization happens. It's kind of interesting but, like, [indiscernible 00:40:43] is sort of a fenetic localization. And Pizza Hut is a very odd localization which is like, “Must win customer.”
JP: These should cover the whole... I don't know if you guys advise companies on this. How does that process manage? Is it some dude at the company who decides or is it like a localization naming company?
Fabian: No. So in terms of registering the company as a legal entity, first of all, you have to have a Chinese name.
Fabian: You can pretty much pick whatever English name you want. You don't register that name. At least, not with the registration authority. So, that's has to be a name. And there's certain restrictions of what you can say. For example, you can't just use the name China like [indiscernible 00:41:42] or others. So, they have to be somewhat correspondent to what you do as well. Although, then again, you have a lot of freedom in a way but you can't just go and do whatever you want.
English names, then... When you essentially pick that name, and then think about what makes sense. And what we do here, and I'm sure that this is mostly what companies do, you kind of make sure that it's not something stupid, that it doesn't...
JP: It doesn't mean tampons.
Fabian: Exactly. When you want to sell... Right. But, I mean, we're not a marketing... I guess, that will be kind of a PR company's job.
JP: So, I guess, do they have to operate under the same Chinese name that they registered or can they have operating as Mike Dunlaw of McDonald's?
Fabian: I'm not 100% sure but I would think so. It might just be their brand. And I'm sure they obviously have that as a brand. So, it's definitely a brand and that's really important. And it doesn't really matter, you don't really have to put your company name up on the board if you're selling burgers. You have to have your business license in the shop and that you can see in every restaurant. And there, it has to be showing your real name. But, that is not going to hurt your or your customer experience in that sense.
JP: So, legally your company has to be Chinese but it could just be something you keep on...
Fabian: Exactly. It just has to be your company registered name. You don't have to go advertising with it. It just has to be on all the necessary documents which is usually just stuff you need in accounting or just legal compliance. It's not something you go marketing with necessarily. It's really all about brain building that you can do parallel.
JP: Right. Okay. So, let's talk about the next one which is how long does it take incorporate a business structure in China? I guess, we'd have to separate between the different types of...
Fabian: Right. Generally, a representative office will take about two months, maybe three months. And what I'm using here is when the company is all setup, it has bank accounts, it has a tax registration, it can essentially operate, you know. Same with the WFE. It's about four to six months. Within two or three months, within two months, you have a business license but you can't do anything with it yet. You don't have bank accounts. You don't have any money. So, you can sign the labor contracts. You can't do anything with them because you can't actually pay your employees. So, there's that differentiation between company that legally exist and you can actually use it.
JP: What's the most time consuming part of the two months to get a WFE setup? Is it just waiting to here back on approval?
Fabian: Yeah. I mean, one of the big problems that you have is that you havestep-by-step process. And so, you do have to get approval from two authorities here. It's Off-Tech and AIC. So, Off-Tech is a bureau of foreign trade and economic commission. And then, you have AIC which is [indiscernible 00:45:25] for industry and commerce. So, those two entities have to approve. That usually takes a month and a half.
And before that, there's a couple things. You need a lot from the investor. And there's a lot of paperwork for them to go through and it needs to be prepared. It needs to be signed. Lots of passports and it has to be all the right color and whatnot. So, there's a lot of things that need to be done before that. But, yeah, it actually does take that long, essentially, a month and a half for the authorities to come through. It's not all the client's, no.
And joint ventures is, essentially the same, about four to six months. The clients or the company that wants to setup, it will take them a lot longer than with a WFE. And the foreign invested partnership, the FIP, also is on paper and what's been done before. It doesn't take very long. It's a fairly easy registration process because there's not a lot of restrictions on it at all. But, again, it's just one of those things that doesn't get approved because the FRE's don't want to. They're not 100% sure. It's been very [indiscernible 00:46:47].
JP: Okay. So, next is the cost including service fees, government fees.
Fabian: I think it's anywhere between... I mean, the good thing is we do both. We setup companies and we're accountants. So when a company has been setup, not by us, we can still see how much somebody else charged them for it. And we've seen some pretty awful figures.
JP: Do you get a range of...?
Fabian: Right. Exactly. For example, a bad example or a very high example is like an American law firm was charging their client by the hour which is, I think they were somewhere at $200,000. I think that's probably the high end but I'm sure it's not the ceiling. I'm sure it gets higher. You can probably get it as cheap as maybe $10,000 or $20,000.
JP: With all the fees and everything?
Fabian: Well, yeah, maybe not that. But, I put a range down here from $20,000 to about $200,000. It really depends on which service provider you have, whether they have something of a foreign connection, whether they are Hong Kong or whether they are Chinese, whether they are multi-national. So, there's a big range as well.
And what I mentioned earlier, what exactly does it include? Does it include getting your business certificates that shows that company exists or does it also include bringing in the capital and opening bank accounts, these kind of things because that doesn't necessarily always is included in what people cloaked. So, you do need to make sure that compare and equals which is sometimes difficult because it's process of a lot of steps.
JP: Okay. I think that's a good description of the range. What is the, not the mean, but the median, what are the most common costs around? Is it closer to 20 or closer to 200. On that end, it's closer to 20.
Fabian: Yeah, I think, reasonably you can expect something between 50 and 100 probably. But, again, I think there are definitely Chinese firms who do it for cheaper and there's definitely foreign firms who do it for more. These are all ranges that are for simply trading companies that don't need any other licenses. For example, just a regular import/export license, it's nothing special.
But if it's high alcohol distribution license or a catering license, you know, things that are not within the regular business scope that does require other licenses, that would add to the costs, obviously. But just the business structure, essentially, that would allow you to do certain things without any exceptions, without anything special. That's what we're talking about here.
JP: Okay. Well, that ties into the next question which is how can new businesses find out which permits are necessary? So can you just in broad strokes, paint maybe the categories or the different things that might require permits? And then, obviously, they probably need professional help to understand.
Fabian: Right. Just initially, how can they find out whether there is anything? The fold answer is always you have to check with the authority that you want approval from. That's the best source, that there's nothing else really. Obviously, have people that have been working with that authority for some time and they would know that as well. But, the ultimate source is really the guys that don't look at the law because that is not necessarily helpful. But, the authority that will actually approve you.
And, as I said, anything in food circulation, for example. If you want to certify, you know, the certification company. Certain products, like food circulation, like I said, seafood, raw seafood, milk, so cultural goods. So, there's a lot of things.
JP: Are they all under the same branch of government that governs it?
Fabian: No. No, unfortunately, not. There's different bureaus that are in charge of that. So, yeah, if you're lucky, there is... So, everything is extremely de-centralized in China in a way. If you think about it, that doesn't really make a whole lot of sense. But, that's kind of the Beijing consensus, that you have a lot of people in the room and all of them have to agree. So, it's kind of everybody has the same vote but the vote doesn't count if not everybody agrees. So, that's what you need to make sure.
And that's kind of one of things, also, in terms of accountability. Nobody is every accountable because there's not one party in charge. There's always at least two people that are involved in something or two organizations. So, that's what makes it difficult. And that's why it's extremely important to make sure that you plan such a process. So, if you, for example, sometimes it makes sense to get the license after you get the business registration and sometimes it makes sense to get it before. But, you need to make sure why is that and it depends on locality. It depends on the kind of license you're getting.
And some cities have setup one-stop service centers. Suzhou, for example, has it. I don't thing Shing Jing has it yet. I don't thing Juan Jong has it. There's several cities who've been forward thinking in that way and it's been very helpful, obviously.
JP: So, you just fill out one and open...
Fabian: You just go and you have the AIC right there. You have the office right there, the tax building. You have, essentially, all of the entities that you need to check in with. They have a counter and you just go there and talk to them. You can spend plenty of time there as well. But, you have them all in the same place. You don't have to drive from office to office.
So, those are the sources where you need to look. I'm sure there's plenty of online blogs that you can look at as well. We have one, ChinaBriefing. You can get a general idea but you will never, it's not legal advice in that sense. You should definitely always check with the source.
JP: So once you know which permits you need, how can a new business get it?
Fabian: Most of them, I guess, the regular channels. For some of them, the authority might not be accommodating. You might have to use an agent that has [indiscernible 00:54:15] or whatever you want to call it. And I'm using that term for a reason. And to make sure that it happens. That's a fairly, I wouldn't really say efficient, but it's a way that works. It's not efficient but it works.
JP: Tried and true.
Fabian: Right, exactly. So, those are the two ones that you can do.
JP: What is in terms of the trading company, what's the most common permit?
Fabian: Food is actually quite a bit recorded, just trading, importing, milk powders are huge.
JP: So, you need a special permit just to import milk powder?
Fabian: Yeah, that's right.
JP: Just milk powder?
JP: All dairy products.
Fabian: Right, exactly. Dairy products. And then, customs needs to approve that. It's a very tight process that a company needs to go through. Not just with registration but also in every time customs is bringing them in. And what I said before, for alcohol, raw fish.
JP: Any kind of alcohol.
Fabian: Well, they differentiate between just regular alcohol like beer or them like high spirits.
JP: Yeah, I heard getting a wine importation license in China is very tough.
Fabian: Right. And then, I mean, importation is in just circulation. And then, you know, a restaurant needs a special license. For example, hygiene and to pass that is not that easy either. So, it's hard to make generalizations really. For trading companies, or the one that helps is really into food.
JP: Okay, cool. Let's jump to the next one and make good progress.
Fabian: We're half way through, almost.
JP: Yeah. What are the current tax rates for businesses?
Fabian: We have a corporate income tax at 25% and we have a business tax that ranges between 5-20% which is mostly 5%.
JP: What's the difference between the two?
Fabian: Well, corporate income tax is a tax that's levied on business profits. And then, a business tax is just a transaction based tax, actually. And it's all services. So, just for a service transaction like a consulting agreement, that... Although, business tax is slowly being replaced by VAT as well. So, VAT is kind of trying to... I mean, they've been starting to reform from last year in January in Shanghai and it's being implemented now across the country from this month.
What it does is take all services but not yet. For example, our services would be considered VAT tax already which means that's a 6% tax now. So, the business tax is kind of going into... It's going to be replaced sooner or later. So, the range is also due to different kind of businesses. Twenty percent, for example, is for entertainment businesses. They charge 20% on a dollar and charge 20%. So, that's business tax.
And that's a very simple transactional tax. You have a certain amount, you slap 5% on top of that. That's how it works. VAT is a bit more difficult. I'm not sure, it was Canada I have VAT or the goods and services has a sales tax.
JP: Yeah, business services tax is actually visible on every receipt.
Fabian: Right, exactly.
JP: So, we add it on top of the product. But, VIT, I've only ever heard of VAT being used in customs.
Fabian: Right. It's important as well because VAT is being taken into consideration when capitalizing the customs, for example. So, VAT is similar to a goods and services tax. It's also called that in Singapore, for example. VAT in Europe is run on the VAT system as well. I know the US doesn't. They have a sales tax but it depends on the state and even within the state, it's not 100% clear.
JP: Yeah, the county.
Fabian: Right. It's a bit of a mess. It's like India. So, the VAT system in that sense is you have a VAT input, you have a VAT output. So whenever you purchase something, you have a VAT in if it's a VAT taxable service or product that you have. And then, you sell it on. And then, you have a VAT out. The difference between those VAT values is going to be your VAT payable. The fact that there is a difference is because you obviously have a profit margin. So, with your profit margin, you're controlling your VAT taxable, VAT payable. That ranges between 3-17% while 3 is actually, in most cases, you can't consolidate that one. You can't have a 3% VAT in and a 3% VAT output. That doesn't work that way.
There's a consumption tax as well which ranges greatly. It's not even possible to put a range on it. You can say from 0% to about 56 or 59%. For example, it's like a luxury tax almost.
JP: Where does that get taxed?
Fabian: Like, the different points. Usually, an import is a big point but also in manufacturing. Not often in trading, for example. So, usually, where it enters. And that differs as well. So, the highest ones are in tobacco, for example. That's around the higher 50's. You have it on oil and on cars, watches that are being imported, for example. So, it's a fairly messy tax but it's also one that's easily just applied like business tax. It doesn't, there's not discounting system like in VIT. But, it doesn't get applied very often. That's one of the good things. So, regular businesses don't usually deal with it.
JP: I see. So, say you're a French grocery store or whatever. So, everything that is sold has a business tax?
Fabian: No, that would have a VAT on it because that's a goods and services tax. Everything that's a good, that's a product, that's definitely VIT.
JP: Oh, okay.
Fabian: And so, there's still services that are taxed with business tax but there are already some services that are taxed with VIT.
JP: Oh, okay. So, business tax was supposed to apply to services but it's...
Fabian: Exactly, it's being pulled away. And the idea is just to make... Actually, there's a tax saving for service providers because they can also use the VAT that they get in and reconcile it with the business that they have. It doesn't work everywhere. Like, the south, for example, hasn't gotten the memo yet. But, in Shung Lai, that's the case.
JP: Interesting. Okay. And then, if you're the French grocer and you're importing some luxury...
Fabian: Like watches or foods...
JP: Some certain things, spirits, then that would get another consumption tax added on top of it.
Fabian: Exactly. That would only be on imports, essentially, or the import is kind of stuck with that. They've paid that much and they want to get the cost back and they pass on to consumers. At the end of the day, whether it's consumption tax or corporate income tax, the consumer makes...
JP: That's why wine is so expensive in China.
Fabian: Exactly. That's why Porsche and Lamborghini is so expensive. They're about 40% more expensive.
JP: And then, at the end of whatever financial period, you also get taxed on your profits?
Fabian: Exactly. And that's the corporate income tax, 25%. That's correct.