Setting up a WFOE just got easier

While China allows foreign investors to set up wholly owned subsidiaries (commonly known as wholly foreign-owned enterprises or WFOEs) in most industry sectors within the mainland, incorporating and operating a WFOE in China is a complicated endeavour. The process is subject to stringent regulatory requirements imposed on each stage of a WFOE's life, including, for instance, a rigid capitalisation threshold during the establishment process and mandatory annual inspection exercises after establishment.

This approval-based regulatory framework had remained substantially unchanged since the enactment of the PRC Wholly Foreign-owned Enterprise Law (中华人民共和国外资企业法) (WFOE Law) in 1986 until early 2014 when a series of new regulations were issued. These include the State Council's Plan for Reforming the Registered Capital Registration System (国务院注册资本登记制度改革方案) (Plan), promulgated on February 7 2014; the State Council's Decision on the Repeal and Revision of Certain Administrative Regulations (国务院关于废止和修改部分行政法规的决定) (Decision), promulgated on February 19 2014 and effective March 1 2014; and the State Administration of Foreign Exchange's Circular on Further Improving and Revising the Policy for Control of Foreign Exchange on the Capital Account (国家外汇管理局关于进一步改进和调整资本项目外汇管理政策的通知) (Circular), promulgated on January 10 2014 and effective February 10 2014. In addition, the PRC Company Law (中华人民共和国公司法) was further amended on December 28 2013 (Company Law Amendments) which had an effect on WFOEs. As part of the legislative programme to transform China's business regulatory framework from an approval-based system to a registration-based system, these three new regulations and the Company Law Amendments have introduced systematic changes to the process of incorporating and operating WFOEs.

Relaxed establishment requirements

Previously, capitalising a WFOE was subject to mandatory requirements on the minimum amount of registered capital, the time limit for making capital contributions, and limitations on using in-kind (non-cash) capital contributions. These requirements have been cancelled under the new regulations.

Two previous statutory requirements have been abolished, namely that a WFOE's registered capital should be Rmb100,000 (US$16,000) or more, and that the amount of a WFOE's registered capital should be commensurate with its operational scale. The abolishment of the latter requirement, codified previously in Article 22(2) of the PRC Wholly Foreign-owned Enterprise Law Implementing Rules (中华人民共和国外资企业法实施细则) (WFOE Law Implementing Rules), has profound practical implications for processing the application for WFOE establishment. This requirement gave the PRC approval authorities, especially local governments, considerable discretion in determining whether a proposed amount of registered capital was sufficient, resulting in uncertainty and inconsistency in the approval process. Its elimination (except for WFOEs engaged in businesses listed in the Plan, which remain subject to the minimum registered capital requirements) will improve the predictability of this process by removing the approval authorities' discretionary power.

A foreign investor setting up a WFOE was required to comply with a number of statutory requirements regarding the investment schedule: (a) the entire amount of the registered capital had to be contributed within three years of the WFOE's establishment; (b) the capital contribution could be made in instalments, but the first instalment had to be made within 90 days of establishment of the WFOE, and its amount had to be at least 15% of the registered capital; and (c) each contribution had to be verified by a certified PRC public accountant, who issued a Capital Verification Report, which had to be filed with the approval of company registration authorities. Failure to meet any of these requirements would subject a WFOE to administrative penalties including revocation of its business licence. The Decision has eliminated these statutory requirements, freeing foreign investors from these administrative burdens and associated costs. An investor in a WFOE is still required to establish a capital contribution schedule in the application documents and the articles of association of the entity, but this schedule no longer needs to comply with these eliminated statutory requirements.

The Decision (in Article 5(3)) repealed Article 27(2) of the WFOE Law Implementing Rules, which provides that (a) an in-kind capital contribution in the form of intellectual property and know-how should be appraised in accordance with customary international valuation principles and (b) the contributed value may not exceed 20% of a WFOE's registered capital (at least 80% of the registered capital must be contributed in cash). In-kind capital contributions are therefore no longer subject to the 20% limitation. Since the Company Law Amendments have abolished the 30% cash capitalisation rule applicable to all types of companies, a WFOE can in theory be fully capitalised with in-kind contributions. This change has a significant impact on foreign investors intending to use technology and other intangible assets to capitalise their WFOEs in China. They are now legally permitted to capitalise a WFOE with all intangible assets. However, the assets must be properly appraised in accordance with the applicable law and regulations, and all documentation supporting the appraised value must be submitted to the approval authority when applying for WFOE establishment.

Less scrutiny of operations

The newly established regulatory regime has also lessened restrictions on matters relating to daily operations, notably in annual inspections, extending of outbound loans, and dividend distributions.

WFOEs and all other entities are no longer required to undertake annual inspections with a wide array of authorities, which would usually take several weeks to complete each spring. Instead, they are now required to make a public disclosure by filing (normally in electronic form) an annual report with the company registration authority, with the report being accessible to any entity or individual. Currently, due to the lack of implementing rules, how a WFOE should procedurally comply with this self-reporting obligation remains unclear, but the company registration authorities are expected to publish the relevant procedures soon. Once implemented, this change will relieve WFOEs and their shareholders of burdensome and time-consuming inspection exercises.

Previously, a domestic entity including WFOEs could only extend loans to an offshore company with which it had a direct equity relationship, namely its parent company or a subsidiary approved by the local branch of the State Administration of Foreign Exchange (SAFE). The Circular provides that a WFOE will be able to extend loans to any of its offshore affiliates, such as an entity that is under common control but does not have any direct equity relationship with the WFOE. Additionally, the quota granted to each WFOE by the SAFE branch for outbound loans is no longer subject to the once applied two-year validity restrictions. A WFOE can apply for the extension of the validity period at any time in accordance with its operational needs.

Article 5(2) of the Circular has also abolished the rule stating that the amount of distributable dividends in a foreign-invested enterprise (including WFOEs) may not exceed the aggregate of dividends payable and undistributed profits distributable to the foreign shareholder(s) as set forth in the latest audited financial statements. In addition, the process for a WFOE's remittance of dividends out of China is considerably simplified with the elimination or partial waiver of numerous documentation requirements.

Rolling out the welcome mat

Altogether, these changes represent probably the most significant overhaul of the legal framework governing the incorporation and operation of WFOEs since the 1986 WFOE Law. With the systematic reform of China's business regulatory structure and foreign direct investment regime introduced at the end of 2013, additional changes to further relax the regulatory environment for WFOEs are likely to take place in the near future.


Thomas Man and Jing Bu, Morrison & Foerster, Beijing


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