[ By Chris Devonshire-Ellis, Senior Partner, Dezan Shira & Associates ]
Wholly Foreign Owned Enterprises (WFOE) have long been the preferred investment vehicle for international investors looking to China for lower production costs or for market access.
Yet recently, a slap-dash, “cookie-cutter” approach to structuring such entities has become increasingly prevalent, and more than ever before, we are having to bail out increasing numbers of foreign investors by revising documents or even completely restructuring the investment.
While this on one hand is good news – we make money out of handling client difficulties – the reality is no professional firm likes to see such problems, and it is expensive and unnecessary for the investor to have to go through this pain, when all that was needed was more attention to detail. We prefer to see happy and successful international investors with profitable businesses. There is no reason why the current spate of shoddily-invested businesses should have begun to appear over the past couple of years. After all, WFOEs have been around since April 1986, and the first regulations to manage them appeared over 20 years ago.
However, in the rush to get into the China market, many consultants, investors and other so-called “experts” have been advising, or have been advised, in a poor and simplistic manner. The quality of some recent work from some of the new-to-China international lawyers, professional services firms and other consultants has left rather a lot to be desired. Equally, international businessmen themselves have still shown themselves to be incredibly naïve on occasion when it comes to dealing with business operations in China.
- Rule #1 - don’t throw the rulebook away. Whatever made you a successful business overseas, don’t abandon it just because ‘this is China”. Be diligent, and be smart.
- Rule #2 - setting up a business in China requires China tax and China legal knowledge. Not one or the other - both. You need to have professional advice in both these disciplines to get the most out of your business – before you start to invest.
- Rule #3 - cheap advice is dangerous. Everyone is an expert on China these days. Two years, or even just two months…. is all it seems to take these days to be “expert”.
Cheap advice is just that. Do your research…professional firms are there for a reason – depth of knowledge and understanding of China business and operational quirks and idiosyncrasies. As we shall demonstrate, investing in China requires a great deal of attention to detail. In this article, we shall provide tips as how to make your investment work for you – save more money, make more money, and get the most out of your investment dollars. Your investment needs customizing to get the most out of it.
A BRIEF HISTORY OF WFOE STRUCTURES
There are three types of structure for WFOEs, and within those, numerous additional matters that need to be taken into consideration. Back in April 1986, when the initial WFOE regulations were published, China’s initial, somewhat nervous, steps to allow foreign investment were based purely on the premise that all investors would be manufacturing. Accordingly, the WFOE law and subsequent implementing rules – with much of the basic drafts still intact today after 20 years – were geared solely towards manufacturing entities. So, for much of the past two decades until recently, the term “wholly foreign owned enterprise” was synonymous with an international investor manufacturing in China.
However, from about seven years ago, that began to change. Local governments, seeing investment opportunities from the international services industry, began to interpret the “manufacturing” aspect of the WFOE law in increasingly ambitious ways, permitting the regulations to include executive search firms, maintenance businesses, architects and so on.
There were problems with this. Firstly, the implementing rules didn’t actually support such applications. Customs, the tax bureau, and various other government departments were at a loss with how to treat a services firm under a manufacturing regulation. The central government, caught between giving local government’s foreign investment targets to meet, yet not really recognizing the services industry, ended up with many anomalies and absurdities.
There were problems with foreign investors too, and increasingly, amongst the bona fide manufacturers. Limited to sales in China of their own manufactured product, they found they were barred from importing and distributing spare parts from overseas, as that was considered a service. Products broke down. Getting spare parts through customs was a nightmare. Invested manufacturers started to grumble. End users found themselves with unserviceable machinery. Meanwhile, architects and headhunters amongst other service industries ignored the rules and poured in, under the dubious guise of “building contractors” and even “human resource advancement producers”.
This mess continued for some time – an unholy pot-pourri of trying to get service business scopes into manufacturing recognition, and a stand off between local governments wanting to approve service licenses and the central government not having the supporting legal infrastructure, let alone the political problems with allowing foreign investment into the domestic services industry.
But in summer 2004, China finally unveiled its long–awaited regulations for the provision of “Foreign Invested Commercial Enterprises” (FICE), which took the heat off the somewhat abused WFOE law and catered, in full, for international investment in the service sector.
