Key Aspects of Business Establishment for FIEs in China

April 15, 2014 Posted by China Briefing Reading Time: 5 minutes

In this China Briefing exclusive interview, Jenny Liao of Dezan Shira & Associates discusses the key aspects of business establishment in China for foreign invested enterprises, including capital requirements, the importance of internal controls and dividend repatriation strategies.

What are the key considerations for company establishment in China?

A key factor for companies just getting established in China is the ability to accurately evaluate their capital requirements. As a rule of thumb, the capital for a wholly foreign-owned enterprise (WFOE) should cover its pre-operation expenses for one year, until the WFOE is able to generate sufficient profit to run its own operations.

If a foreign-invested enterprise (FIE) injects an insufficient amount of capital to cover its initial operations, the company may encounter problems retrieving additional capital, on account of China’s stringent foreign exchange regulations on capital transfers. For FIEs to inject money beyond the capital amount, it is necessary to communicate with various governmental departments and undergo tedious procedures, such as obtaining a capital verification report. Needless to say, delays in obtaining additional capital would negatively impact company operations.

With the promulgation of the Company Law at the end of 2013, the requirement for registered capital to establish a company has been removed. At this stage, however, the Company Law amendment has greater impact for domestic companies than for FIEs, as the former can specify any amount of capital as long as it is approved by the AIC. Meanwhile, for FIEs, since foreign exchange rules have not yet been modified, they still need to obtain verification and approval to increase capital.

What are the important internal control issues for foreign invested enterprises operating in China?

Many foreign-invested SMEs require support from their internal management. Frequently, when setting up a company in China, they will dispatch only one foreign employee from their head office to China, i.e., the GM. Finance departments in China usually consist of two basic roles – a cashier and an accountant. Since the CFO remains overseas with the parent company, supervision and control tends to be weak and problematic methodologies may be used. They therefore need to hire professional firms to help with regular accounting and tax filing, as well as provide advice regarding their internal financial management and internal control in order to prevent potential losses.

For example, inventory management is calculated based on the quantity of items sold, but inventory record keeping may use the inventory’s monetary values instead. Because of this, when an external firm conducts a year-end audit, they may find a mismatch between figures, by which time much effort is required to remedy the situation. This is a problem faced by many trading companies.

They can prevent this scenario by setting up a good inventory system initially, including appropriate software and a strong internal management system.

The government requires FIEs to undergo annual statutory audits. However, we suggest that internal control/review should ideally take place on a monthly or quarterly basis. After the first year, this can be reduced to twice a year, depending on the results of these reviews. A monthly/quarterly review, which usually takes three to five days, is a detailed process involving overall assessment from financial, business and administrative perspectives, thus is more in-depth and takes more time than a statutory audit. This type of review is mostly conducted on-site, as companies are required to provide numerous forms of documentation. For bigger companies, a review may take as long as two weeks.

What should foreign invested enterprises consider when repatriating dividends back to their home countries?

Companies repatriating dividends need to be aware of whether or not there is a double taxation avoidance agreement (DTAs) in place between China and their home country, which can reduce the 10 percent withholding tax on dividends to 8-5 percent.

When repatriating dividends, some companies opt to conduct profit repatriation by themselves in order to avoid fees charged by professional firms for doing the same. However, they are frequently unaware of tax reductions available under DTAs between their home country and China – something that tax authorities will not proactively remind them of.

The process of applying for DTA benefits is quite tedious – a preferential tax treatment form needs to be submitted and the parent company must obtain certain forms of documentation from the government of the DTA country/region in question. This is because many offshore share companies are set up in locations that have DTAs with China in place, but the actual investor may be, say, in the U.S. Since there is no reduced withholding tax rate under the U.S. and China DTA, setting up in HK allows them to benefit from the reduced rate of 5 percent dividends withholding rate under the HK-China DTA. To ensure that the HK presence is not merely a shell company, tax authorities need to know whether the company has actual operations and is paying taxes since DTA benefits only apply if it is a real company.

Dividends can be repatriated after annual filing has been completed – the tax authorities will confirm how much a company can repatriate based on the net profit percentage. If the company chooses to postpone repatriation to the following year because of cash flow concerns, banks will additionally require a special audit report.

Jenny Liao is a Senior Manager with Dezan Shira & Associates and oversees the corporate accounting services department of the Shanghai and Yangtze River Delta offices. She specializes in Chinese accounting, reporting and taxation systems. She holds a master’s degree in accounting from Shanghai Jiaotong University.

Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam in addition to alliances in Indonesia, Malaysia, Philippines and Thailand as well as liaison offices in Italy and the United States.

For further details or to contact the firm, please email china@dezshira.com, visit www.dezshira.com, or download our brochure.

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