Establishment & Operation of WFOEs in Free Trade Zones

Actual Business Operations

Originally, the central government's intent for permitting the establishment of such WFOE trading companies in FTZs was to encourage export and entrepot trade. However, in recent years this aim has been re-worked by local authorities in their efforts to attract foreign investment. In practice, it is feasible for a WFOE trading company to engage in a form of domestic trade, i.e., purchasing goods from local suppliers not related to their affiliated companies, and then reselling such goods to local purchasers. Although local government authorities and trading companies in an FTZ are aware that WFOE trading companies' engaging in domestic trade are not entirely in compliance with central government laws, it has become a prevalent practice of WFOE trading companies to engage in this form of domestic trade activity. Legally speaking, in this regard, some risk does exist. However, with this practice so prevalent and the direction and momentum of Chinese trade laws being towards liberalization, most foreign investors consider this risk to be minimal.

In practice, almost all WFOE trading companies in Waigaoqiao or Shenzhen Futian FTZ that wish to sell goods in other parts of China may do so by joining the Bonded Commodities Exchange Markets, which are set up within the FTZ. Such commodities exchange markets are developed to help a WFOE trading company by providing value-added tax (VAT) invoices to document the WFOE's sales. These markets essentially clear goods through customs and then stamp the relevant VAT invoices for a fee. Normally, the cost of these fees shall include a Rmb3,000 annual membership fee and a 0.1% handling fee based on each specific trading amount. Such VAT invoices make it possible for a WFOE trading company to receive renminbi from domestic PRC enterprises outside the zones and to properly document the transaction. Furthermore, renminbi received by the WFOE trading company can be easily converted into foreign currency and remitted out of China as legitimate dividends. Also, the commodities exchange markets may refund 25% of the VAT value back to the WFOE trading company.

Capital Requirements

The minimum registered capital of a WFOE trading company in Waigaoqiao is US$200,000, payable within six months after the issuance date of the business licence. The minimum registered capital of a WFOE trading company in Shenzhen FTZ is HK$2 million or the equivalent in US dollars, likewise payable within six months after the issuance of the business licence.

Procedures for Establishing a WFOE Trading Company

For the purpose of establishing a WFOE trading company in the FTZ, the foreign investor needs to appoint an agent to submit the application documents on behalf of the investor. Usually, the incorporation procedures for establishing a WFOE in all the Free Trade Zones take about one month to complete.

Enterprise Income Tax

The enterprise income tax on WFOE trading companies in the FTZ shall be levied at the rate of 15%. However, a WFOE trading company with an operation period of over 10 years shall be exempted from enterprise income tax for one year (starting from the first profit-making year), and shall then be allowed a 50% reduction in enterprise income tax during the second and third years (i.e., taxation at a rate of 7.5%).

Setting up Offices Outside of the FTZ

A WFOE trading company in an FTZ may establish offices outside of the FTZ. These offices can conduct liaison work for businesses included in the business scope of the WFOE trading company. The tax preference for WFOE trading companies in the FTZ does not extend to these offices. A WFOE trading company in an FTZ may not establish any other business branches outside the FTZ.

Bank Accounts and Foreign Currency

A WFOE trading company in the FTZ can open both renminbi and foreign currency accounts with banks located in the FTZ. Trades conducted between the WFOE trading company and customers outside the FTZ must be settled in foreign currency, while trades conducted in the FTZ can be settled in either renminbi or foreign currency. It should be noted that foreign currency accounts may not be opened outside of the FTZ for the offices of WFOE trading companies in the FTZ. No income may appear in the renminbi accounts of the office other than sums allocated by the WFOE trading companies. Sums of money that may be allocated by the WFOE trading companies are limited to reasonable operating expenses.

By Wang Dao Fu, Zhong Lun Law Firm, Shanghai