Faulty Licence Applications & Tax Structuring Problems
The scenarios and problems below apply to all the above categories of foreign investment but for sake of convenience we have used the “Foreign Invested Enterprise” (FIE) term to cater for all.
Sending Start-up Funds to Somebody Else before FIE is ready
It takes normally three to four months to complete the FIE application, however, some foreign investors can’t wait that long and try to send the start-up funds to their local agent or local staff to cover the cost for the initial office fit-out, overhead or even equipment purchases. The problem is that these funds, as paid for the FIE setup can not be recognized as part of your capital injection once the business license is issued, as the capital injection has to be transferred by the foreign investor from their overseas account to the nominated Capital Account directly, and not via any third party.
We have previously had clients remitting up to USD200,000 to their local supplier to ask them pay for rental and purchase equipment prior to the licence being issued, with them subsequently finding it very difficult for them to pursue the balance and show such purchases as part of their capital injection. Rather, it is better to arrange this as an internal loan between the parent and the FIE and book it as a roll over amount instead of including it as part of the FIE’s registered capital budget.
Registered Capital Issues - Undercapitalization
One of the most common – and serious- problems with FIE applications, especially for small businesses, is the issue over registered capital. This is a much misunderstood area. Confusion exists, and many ill-advised investments are made in China due to misinterpretation of the local governments term “minimum registered capital”. And is not supposed to be a ruling on how much you need to invest. Actually, the amount of registered capital needed in the business depends on a number of different factors :
- Location. Some regions in China apply different levels of capital requirements than others to reflect their lower or higher regional operational costs
- Scope of Business. For certain industries or services, the applicable registered capital amount can be quite high. This is sometimes used as a protectionist tool to discourage foreign investment, and is sometimes used to ensure only the right standard of international business can enter the market to ensure quality of applicant. Please note that if some existing businesses wish to expand their current scope of business, it may be a requirement to increase the amount of registered capital.
- Cashflow. This is critical and often overlooked. Registered capital is also required to fund the business operations until it is in a position to fund itself. Generally speaking this should be catered for in the ‘feasibility report’ – which is a business plan type document that is submitted to the authorities as part of the application process. However, in the rush to attract new investments, and as a result of a lack of even basic economics, many government agents do not pay much attention to detail to this report. Often the happy foreign investor will naively assume he’s gotten a great deal due to ‘minimum amounts’ being identified as all that is required. However, the business can come to a shuddering halt if the registered capital amount is insufficient to support the operations cash flow. It is not just a simple matter of wiring additional funds to China. Procedures have to be followed :
- Application to increase the registered capital with the original licencing authority
- Re-issuing of business licence reflecting this – important as the registered capital amount is also the limited liability status of the business
- Application to the State Administration of Foreign Exchange to transfer funds into China
- Bank to bank fund transfer
