This article is a complete guide to starting a company in China. Here’s an index of the subjects we will cover:
Are you sure you need a company in China?
In this article you’ll discover that starting a company in China is not at all simple. The first question you need to ask yourself is if in order to realize your objectives, is it absolutely necessary to have a legal entity in China or if, instead, it’s enough to use an “umbrella” company, an off-shore company (such as a company in Hong Kong, which is certainly easier and cheaper to run), a distribution agreement or a representative office.
To be brief, if you intend to hire a large number of workers in China (let’s say more than five), receive payments in China without paying commission to an intermediate company, open a factory (or even a firm that requires specific structures), then opening a company in China is absolutely necessary. In almost all other cases there are easier solutions (described in the next three sections).
What is an umbrella company?
An umbrella company is a company that hosts your employee or team in China (usually your sales/marketing/import-export manager or any kind of consultant). It also works for any kind of freelancing job as long as it is a service.
Thus, if you’re interested on having (an) employee(s) based locally, an umbrella company can help:
- Recruit (an) employee(s) for you if necessary;
- Pay salaries, taxes related to the employee’s salary, insurance, contributions and or maternity to your employees;
- Receive payments from your Chinese clients directly in China (to then pass it on to your company’s foreign account);
- Pay, in your place, your suppliers;
- Rent you an office for your employees or a warehouse for your products.
In pratice, if for you it’s important to do business in China in a simple and inexpensive way, using an umbrella company is surely the best option, at least to begin with.
Once your business gets on its feet, you can certainly open your own independent company (so as not to have to pay an umbrella company for the services described in the list above).
Note that, obviously, this option makes sense only for certain types of businesses, such as consultants for example. If instead you intend to open a factory or operate in an industrial sector that requires a Joint-Venture (see the following sections of this article to learn more on prohibited industrial sectors or those restricted to foreigners), then this option is not for you.
What is a distribution agreement?
If you intend to make your products in China to then resell them to Chinese clients, the easiest way to do so is to come to an agreement with your manufacturer so that it itself will handle the distribution of the merchandise with your brand. Click here to learn more about this option.
A distribution agreement with a Chinese company can be the right solution even if you intend to resell in China your merchandise produced abroad.
What is a representative office?
A representative office is certainly easier to open than a company; the problem is that this option carries with it a series of limitations, such as not being able to receive payment from your Chinese clients. It is therefore useful only in the event that you need a support office (such as a marketing or sourcing office).
Since a representative office cannot receive money from your clients, the only way to pay the expenses is to send money from abroad. Note moreover that, even if you don’t have any profit, the Chinese government requires the payment of taxes, usually calculated as a percentage of the expenses.
Starting a company in China: WFOE (Wholly Foreign Owned Entity)
Every company that is controlled by a quota equal or superior to 25% by foreigners is considered a FIE (Foreign Invested Enterprise).
The most common FIE is the WFOE (Wholly Foreign Owned Entity), that is, as the name suggests, a legal entity completely owned by foreigners.
The type of WFOE used in the great majority of cases is the LLC (Limited Liability Company), where the responsibility (or “liability”) of each partner is limited to the capital they themselves invested in the company (as in the US or in Europe).
Ever since China entered into the WTO it is also possible to form a WFOE that exclusively handles acquisitions and sales in China (or a so-called “trading company” or “retail store”). Such companies still fall under the category of the WFOE and are called Foreign Invested Commercial Enterprises (FICE).
Note that, depending on the nature of the activity (manufacturing, consulting, language school, services, commerce, etc) and the province where you register your company, a different registered capital (or the initial capital that you need to deposit in the company’s bank account after obtaining a commercial license but before the company begins to operate) is required.
Even if these days, the minimum registered capital can be very low, it is still recommended to make an estimate of the company’s expenses until it’s able to be self-sufficient – thanks to the profits it generates – and choose a registered capital that doesn’t stray too far from the estimated sums.
The reason is, if the expenses should come close to the amount in the company bank account before the company begins to generate a profit, to avoid bankruptcy you’ll be forced to send an injection of money from abroad. That requires a new procedure to register the registered capital (which will take up to 8 weeks and the approval of the local government) or the payment of profit taxes on the amount paid so as to avoid the imminent bankruptcy. Both problems can be avoided, in fact, by setting a registered capital sufficient enough to support the expenses until the point the company will be capable of sustaining itself.
If in the future you think to sell your Chinese company, then it is possible that it would be to your benefit to own a foreign “controlling” company, or a company outside of China that controls, in your place, the shares of your Chinese company. In this case, at the time of sale you can simply cede the foreign controlling company without having to deal with the long procedure necessary to transfer the property of a company in China.
To conclude, even if a WFOE can pay dividends to shareholders, there is a restriction: the dividends of a given year, such as 2016, can be paid only if the company is profitable (ie. earnings are bigger than expenses) for that year. Another way to “withdraw” the gains of a Chinese company is to pay consultancy fees to a foreign company of whom you’re a shareholder.
Starting a company in China: Joint-Venture
After the WFOE, the FIE (Foreign Invested Enterprise) most common is the Joint-Venture, or a company controlled by both foreign and Chinese partners.
Note that a Joint-Venture usually implies a transfer of technology. Given the well-known problems associated with intellectual property that plagues China, foreign companies who intend to make or sell high value products (such as a patented product or software), often prefer to opt for a WFOE.
In the event that you wish to operate in a “restricted” industrial sector (such as SaaS, Software as a Service), a Joint-Venture is your only option. To learn more about restricted industrial sectors, read point 2 of the next section.
As for the rest, WFOE and Joint-Venture are rather similar.
The complete procedure to start a company in China
Note that the procedure we’ll be describing deals with the “Services WFOE”, or a company completely owned by foreigners that deals with services. As far as “Manufacturing WFOE” and Joint-Venture, the procedure is similar (even if some details can differ depending on the specific case).
1. Choose an agency or legal firm that will help and counsel you during the formation process and the running of the company
If you think that you can do it on your own, you’re wrong. Reading this section you’ll see that to open and run a company in China it is necessary to trust a professional that not only speaks Chinese fluently, but is also competent in legal and fiscal matters.
2. Choose the business scope in which you intend to operate and determine if it is encouraged, restricted or prohibited to foreigners
In China there are a industrial sectors in which the government encourages foreign investment (usually by means of fiscal incentives), sectors restricted to foreigners (or in which a foreign partner can only operate by means of a Joint-Venture with a Chinese counterpart, of which you can usually own no more than 49%) and industrial sectors that are completely prohibited, and therefore inaccessible for foreigners.
This information can be consulted online, in the Catalogue for the Guidance of Foreign Investment Industries.
This catalogue is updated periodically. In general, the sectors that are encouraged are those that promote innovations in areas such as environmental protection, export or the development of the poorest regions of the country. Just as an example, in 2015 the elderly care industry became an encouraged sector, probably due to the fact that in China there’s a growing need for that type of service. An example of a restricted sector would be one of the industries that have a negative impact of the environment. Forbidden sectors include those considered politically sensitive, or that can be damaging to the country.
Bear in mind that if your industry is not mentioned in the catalogue, that simply means that it is not encouraged, restricted, or prohibited. In this case, the industry is simply defined as “permitted”.
The choice of business scope (or industrial sector) is extremely important.
If you choose a business scope that is too “vast”, the risk that the permit to open the company will be denied increases because the sector in which you wish to operate falls under one of the restricted or prohibited sectors increases proportionately.
If, on the contrary, you choose a business scope that is too “limited” (or too “specific”), your application will probably be approved but, later, you run the risk that the government will force you to close the company because you’re operating outside the scope that you declared at the time of starting the company.
Complicated? I’ll explain with an example. The business scope in which it is easiest to operate is “consulting”: obtaining the permits is easier and the cost and time needed to form the company is without a doubt less.
This is why many agencies specializing in helping foreigners open their own company will suggest that you open a consulting firm even if, in reality, you want to do something completely different (such as manufacturing and/or selling products in China).
The problem is that, as I already said, as soon as the local government realizes that you’re operating outside of your scope (“consulting”, in this case), they’ll force you to close shop. And believe me when I tell you that lately, uncovering foreign companies that operate outside the scope of their business is one of the favorite pastimes of Chinese government officials.
Therefore, to quote the China Law Blog, “It’s the business scope, stupid!”
3. Make sure that all foreign investors have the approval to own shares in a Chinese company
As already mentioned, often foreign investors choose to own the Chinese company through a foreign company. In this case, you have to make sure that the foreign company is approved by the Chinese government. For the majority of foreign companies this point is a formality, however it is still important to make sure there aren’t any problems and to provide all necessary documents such as a foreign company business license, a letter of recommendation from the bank in which the foreign company opened an account, and others.
4. Prepare all necessary documents to obtain governmental approval to be able to legally operate in China
To gain permission to start your company and operate in China you must submit the following list of documents (the majority of which must be drafted in Mandarin – another reason why using a professional before proceeding is imperative):
- The name of the company, in Chinese, that you plan on using. Bear in mind that, in order to avoid that the name you’ve chosen for your company is already in use or, for some reason, is unusable, you must ask for the name’s pre-approval with the right authorities, that is the AIC (Administration of Industry and Commerce) in the city in which you intend to open the company. This pre-approval may require between 2 to 15 days, depending on where you apply;
- The list of controlling partners (or companies) who, as was discussed in the previous section, must also be pre-approved;
- The managerial structure, or the names of the board directors, general manager, supervisor and legal representative, which often coincides with one of the directors, and color copies of the passports of all those involved;
- The legal address of the company (including the name, email and phone number of the owner of the land or building). Note that the address of the company should be “exclusive” (it’s not possible to share an office with other companies or have a virtual office in order to reduce costs) and “appropriate” to the business scope of your company (for example, if your company deals with manufacturing you can’t register it in an office in the city center, you’ll need suitable space for the type of production you wish to carry out). In addition, note that it is absolutely necessary to present a regular rental contract (or of acquisition).
- The Articles of Association (AOA), which contain vital information about the description of the business scope in which you intend to operate (whose importance has already been thoroughly discussed in this article), the managerial structure, the method of returning profits and more;
- The number, citizenship, salary and benefits for employees (in case you still don’t know who you’re going to hire, you must then specify the positions for which you intend to hire);
- The registered capital (that we already discussed in one of the previous sections of the article) and the total investment (which includes both the registered capital and eventual future “loans” on the part of the company’s investors or third parties, such as a bank);
- A feasibility study: a business plan and investment budget (following the standard format provided by the authorities) so as to convince the authorities to approve the opening of the company by the feasibility of your business plan. In the event of the contrary, the project will not be approved. It goes without saying that the registered capital and business scope play a fundamental role in the approval process. If for example you intend to start a cell phones factory, you certainly can’t propose a registered capital of 20,000 USD, which will obviously be insufficient to finance a project of that type. On the contrary, for a consulting company much less will be necessary since that type of business doesn’t require a significant initial investment;
- Any other document requested: the list of documents to submit can vary depending on the scope of your business, the city and province of the company (which will depend on the legal address you intend to submit) and the sudden changes to which Chinese law is subject.
As you’ve figured out from this last point, even if the list that I just presented is a great starting point, it is not to be considered an exhaustive list. Again, my advice is to use an agency or legal firm to guide you as to what steps to take according to your situation (business scope, address, etc).
If you don’t have all your documents in order, your application will almost certainly be denied, and after the first denial, getting the necessary permits becomes even more difficult.
5. Apply for approval with the responsible authorities
To get an approval certificate and business license, you’ll have to deal with two different government entities: the Ministry of Commerce (MOFCOM) and the State Administration of Industry and Commerce (SAIC) or most likely, in the event of a “modest” investment, with their local branches.
The local branches of the MOFCOM are often called COFTEC (Commission of Foreign Trade and Economic Cooperation) or BOFCOM (Bureau of Foreign Trade and Economic Cooperation). As far as SAIC goes, the local branches are often distinguished by the name of the city in which they’re found, such as Shanghai AIC or Hangzhou AIC.
Note that, depending on the city or province, the forms and/or documents to submit can vary quite a bit.
As has been already said, one of the crucial points in the approval procedure concerns the approval of the company’s business scope. If in fact, the responsible authorities decide that your scope falls under a “restricted” or “prohibited” industrial sector (trust the Catalogue for the Guidance of Foreign Investment Industries), the scope will be modified or, in the most extreme cases, your request will be denied.
Note that, to get approval for an “encouraged” industrial sector, which as has been mentioned implies fiscal advantages, you must also obtain approval from the National Development and Reform Commission (NDRC) or, for not-too-big investments, from a provincial branch of the NDRC, or Provincial Development and Reform Commission.
Regarding the timetable, the responsible authorities should let you know if you’ve been approved or not – and give you your approval certificate, – within 90 days from when you submitted your application. However, keep in mind that, in the event of “special” circumstances (which as usual are not clearly defined by Chinese law), that period could be prolonged to allow for “further verification”.
6. Get a business license
Once you get your approval certificate, you’ll have 30 days to register with the AIC and apply for your business license.
Here is a list of necessary documents to apply for your business license:
- An application form;
- The Articles of Association;
- The newly-acquired approval certificate;
- The name of the company in Chinese, pre-approved by the AIC;
- A copy of the business licenses of the company investors (these too pre-approved);
- A letter of recommendation on the part of the banks in which the company has an account;
- The list of the names of directors, general manager, supervisor and legal representative;
- Any other document requested by the AIC you apply to (again, this will depend on the city where you intend to start your company).
The founding date of the company will correspond with the day you are issued the business license.
7. Opening a bank account and depositing the registered capital
Once you get your business license, in order for the company to become active you’ll have to pay a corresponding amount to the registered capital in the company’s bank account, which you’ll have to open with the Bank of China or another bank designated by the SAFE, or the State Administration of Foreign Exchange (here’s a list of the main Chinese banks).
The difference between the total investment and registered capital can be paid in the future, and as has been already covered, can be a loan from company investors or a loan from a third party, such as a bank.
To conclude, note that there’s a close correlation between the total investment and the registered capital. For a WFOE the works in the manufacturing field and has declared a total investment less than 3 million USD, for example, the minimum registered capital must correspond to 7/10 of the total investment.
8. Other possible procedures to perform after getting your business license
Besides opening a bank account and depositing the registered capital, here is a list that is not at all exhaustive, of the approvals (or registrations) that you need to get (or carry out) after getting your business license:
- Approval from the PSB (Public Security Bureau) of the company chops, that in China are extremely important since often, a signature is not enough, you’ll also need a stamp;
- Registration with the Tax Bureau;
- Registration with the Customs Office;
- Registration with SAFE (State Administration of Foreign Exchange);
- Hire an accountant (the accounting books are mandatory in China);
- Any other request or necessary approval, which can vary according to the type of WFOE and/or the city where you opened the company.
In which city or province should you open your company?
Before choosing the city and province in which you want to have your legal address, that is the city in which you’ll operate, you should keep in mind the following factors:
- The presence of managers, employees and qualified workers: if it’s true that in the first tier cities like Beijing or Shanghai you’ll have a greater choice, and it’s also true that you’ll have much more competition and you’ll have to offer higher salaries;
- Proximity to infrastructure, suppliers and clients: it doesn’t make any sense to open an electronic factory in Beijing if all material and component suppliers are in Shenzhen; just as it doesn’t make any sense to open a factory in Sichuan if the savings due to a lesser salary cost is offset by the increase of the cost of transporting your merchandise because there is no international port in the area;
- The legal system: even if things are changing, in the first tier cities like Beijing and Shanghai the laws are notoriously more transparent. That said, as long as it doesn’t involve significant investments, the local governments of second or third-tier cities are “hungrier” for foreign investments; therefore it’s more likely that they’ll help you get the necessary permits to start your business;
- Incentives for foreign firms such as tax reductions on profits or import/export duties: these incentives are easier to get in the so-called special zones such as the Special Economic Zones (SEZ), the Economic and Technological Development Zones (ETDZ), the High-tech Industrial Development Zones (HIDZ), the Free Trade Zones (FTZ) or the Export Processing Zones (EPZ). The local government could also offer you advantageous incentives, even outside of those special zones, depending on how interested they are in your investment.
Corporate taxes in China
Here’s a list of taxes to consider for a WFOE or Joint-Venture:
- Corporate Income Tax: This is a tax on profits (or the gross income less the company expenses) of 25%. There exist however various ways to get a tax reduction on profits (for example if the your industrial sector is “encouraged”, you’ll only pay 15%);
- Turnover Tax (or Transaction Tax): This is a tax on sales that can vary between 3% and 5% depending on the type of business (the exception is “entertainment” firms, for which this tax vary bewteen 5% and 20%);
- Custom Duties: These are custom duties on goods imported or exported from China (even in this case there are various ways to get a reduction or exemption from duties, such as if your firm is found in a Free Trade Zone);
- VAT: The VAT in China is usually 17%. As in Europe, this is a tax on consumption so companies can “unload” it;
- Individual Income Tax: This is a tax imposed on dividends levied by the company partners and the tax on workers’ salaries.
How to avoid the most common errors when starting a company in China
- If you can avoid it, avoid starting a company in China. As you’ve already read in this article, there are other options, such as for example the use of an umbrella company or a distribution agreement;
- If, after having attentively evaluated the situation, you decide that you need a company in China, hire a professional in the field. Be on guard of agencies that give you a budget that’s “too good to be true”, of those that agree to help you open a company before having evaluated if it’s truly necessary and, as was already said, of those who recommend that you open a consulting firm even if, in reality, your business scope is completely different;
- Don’t think that you’ll be able to start a company in China and get it operative in a month. The timetable, as mentioned, is at least four months (if you’re fortunate);
- China is a continent: weigh carefully which city is best suited for opening your company;
- Carefully consider the scope of your business so as to avoid restricted sectors, understand if you’re eligible for incentives, and not preclude future expansion;
- Independently of the minimum registered capital required, figure out what type of initial investment you’ll need (so that your company can sustain itself before spending all your initial capital);
- Give the proper importance to the Articles of Association; this is not a formality;
- If your company owns an intellectual property such as a patent or trademark, make sure that that legal protection extends to China;
- Don’t underestimate the costs you will incur, such as distribution problems, high workforce turnover, legal consulting and other problems that are common when you do business in China.
- China Law Blog – A great blog dedicated to the practical aspects of Chinese laws and how these influence your business;
- China Briefing – Another excellent blog dedicated to the Chinese legal system, with particular attention to the fiscal and operational aspects of those who conduct business in China;
- Setting Up Wholly Foreign Owned Enterprises in China – An extremely practical book on how to start and run a WFOE in China, written by the authors of the China Briefing site;
- Doing Business in China for Dummies – A book that, like the majority of books in the “for dummies” chain, offers a practical introduction on what there is to know about how to run your business in China.
[Cover Photo’s Copyright: Depositphotos.com]