Post Registration Matters as a Structural Concern

One of the most common, and most serious, problems with WFOE 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?. This is meant as a guideline only, and is not supposed to be a ruling on how much you need to invest.

Additionally, there is often conflict here between the local government ? keen on securing another foreign investor in order to meet its targets ? and other government departments, responsible for monitoring and managing China business issues, especially the tax bureau and customs.

It is important to note that tax collection is administered centrally, while the approvals process is at a local level. This means conflicts can and do arise between what the local government says in order to attract your investment, and what the tax bureau then says in dealing with any lack of compliance. And by then it?s too late ? you?re already committed ? and you have no choice other than to go through additional pain and hassle to get things put right, usually involving more investment capital.

In fact, some local government officials are downright reckless when using ?minimum registered capital requirements? as a sales pitch. The amounts they may state may not be in compliance with the actual needs of your business or other government department requirements ? the classic obfuscation that so often blurs the thinking and otherwise competent planning by international investors. There are also many, many consultants out there who are also either blissfully unaware and ignorant of the real importance of registered capital and how to cater for it properly, or downright calculating, knowing that under-capitalisation can drive additional business their way from the unfortunate investor if they play the scenario correctly.

Registered capital is a key issue when structuring your investment and planning its financing ? you need to get this right or face serious problems ? either immediately, or later on. They can be avoided.

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, or 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?, the business plan 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 economic intelligence, many government agents do not pay much attention to detail to this report. Often the happy foreign investor will naively assume he?s got a great deal due to ?minimum amounts? being identified. 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

The above steps take between six to eight weeks. If you have already run out of operational money, you by now have not paid staff for two months, your suppliers, and possibly your utilities. In effect, your business has been throttled before it even had a chance to breathe. It is vital you properly capitalize your business in China, in accordance not just with government guidelines over ?minimum registered capital? but also pure economic and operational realities.

Businesses can and do go broke in China because of this issue. Unscrupulous consultants may not always advise on the matter as they seek to gain more fees from you in terms of sorting the problems out when they arrive, or because they are just in the business to make a quick cheap buck out of handling your registration processes without putting any thought into the business aspects of your operations.

Important Registered Capital and Tax Issues That Are Commonly Misjudged
VAT Treatment
There is still one common misconception on ?VAT Exemption on Exports?. If the refund rate is lower than the levied rate, the company must bear the additional VAT cost on exportation. The VAT cost is calculated as follows :

Manufacturing Company :
VAT Cost = (Export ? Imported Raw Materials excluding customs duty)×(Levy Rate ? Refund Rate)

Trading Company :
VAT Cost = (The cost of Local purchased Raw Material)×(Levy Rate ? Refund Rate)
Generally speaking, the levied rate is 17%, the refunded rate is 13%.

You need to ensure, if you fall into this scenario, that you have sufficient registered capital to hand to fund this cashflow gap.

Customs Deposit on Imported Raw Materials To Be Subsequently Exported
We often hear the misconceived statement, ?there is no VAT and Custom Duty levied on imported raw materials used for manufacturing goods locally if these are then finally exported 100%?. It is incorrect. Actually, newly established Foreign Invested Enterprises must still make a tax deposit to Customs for VAT (at around 17%) and remit duty on the initial importation, generally for six months. Many new businesses do not budget for this as initial working capital to be contributed as part of registered capital, leaving them short of cash later. You must factor this amount based upon your participated imports into your registered capital requirements when working out your required capital injection and cashflow forecasts. It is a common mistake and can have very serious implications if it is not catered for at your financial planning stage.

Other Government Departments That Require Attention
Factories, health and safety and the fire department will all require checks and be responsible for issuing their own licenses, for which you will have to pay. These are usually minimal amounts, but can add up for sizable businesses. Environmental protection can however be expensive ? if your business is potentially polluting, you need to be aware beforehand how this matter needs to be dealt with and the likely costs for dealing with it. All this needs to be catered for ? yes, as your working capital, as reflected in your registered capital injection for operating costs.

To know more, the whole issue is available (after a free subscription) on China Briefing website with others archives
For more information on China’s legal and tax issues or to ask for professional advices in related matters, please write to info@dezshira.com

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