Frequently Asked Questions

Update:2018

1.What are the differences between a trading enterprise, a manufacturing enterprise and a service enterprise?

2.Pros and cons of setting up a RO

3.An investment project that requires land?

4.What are the tax obligations of an offshore consultancy firm?

5.Why do people choose RO and FIPE?

6.How to apply for a Z-visa and a residence permit?

7.How long on earth does it take to form a RO?

What are the differences between a trading enterprise, a manufacturing enterprise and a service enterprise?

OPERATIONS

Manufacturing enterprises:
They process or assemble tangible products. Procuring and processing raw materials characterize manufacturing enterprises. R&D companies may be deemed as manufacturing enterprises if their operations involve processing raw materials.

Trading enterprises:
Their chief feature is that they buy and sell commodities for profits.

Service enterprises:
They provide intangible services such as consultancy, technology transfer and patents. Generally there is no trading of tangible goods.

TAXES

Manufacturing enterprises:
They need to pay Value Added Tax (VAT) (VAT output tax payable minus VAT input tax payable). Both VAT output tax and VAT input tax are 17%. (A preferential VAT tax rate of 11% or 6% is applied to certain industries, e.g., agriculture,services.)（From May 1, 2018, 17% has been reduced to 16% and 11% has been reduced to 10%）
Instead of VAT special invoices, small-scaled taxpayers can issue VAT general invoices with a tax rate of 3% on pre-tax sales. The corporate income tax is 25% on net profits(Small and micro enterprises with profit below RMB 500,000, according to 10%).

Trading enterprises:
They need to pay VAT, where the VAT tax rate is 17%(now it's 16%). The rate of VAT tax refund for exports is between 5% and 17%(now it's between 5% and 16%), applicable to companies engaged in international trade. The corporate income tax is 25%(or 10% for small and micro enterprises with profit below RMB 500,000).

Service enterprises:
They generally issue VAT general invoices, subject to a tax rate of 3% on pre-tax sales. (Certain types of service enterprises such as advertising firms are subject to different tax rates.) The corporate tax rate is 25% (or 10% for small and micro enterprises with profit below RMB 500,000).

COMPANY REGISTRATION
In accordance with the Company Law, the minimum requirement for registered capital is 1 RMB for a multi-shareholder limited liability company(from March 1, 2014). Single-person limited liability companies, sole proprietorships, partnerships, and certain regulated industries are subject to different rules. In light of local regulations and operational environment, objectives of business operation and convenience for registration, we recommend the following:

Manufacturing enterprises:
The recommended minimum registered capital is 500,000 US dollars(Subscribed capital contribution). The company shall have at least 1 executive director and 1 supervisor if it does not have a board of directors or a board of supervisors. The executive director is the legal representative and may hold a concurrent post of general manager. The registration requires the enterprise to provide the lease contract of plant premises, the evaluation report of environmental impacts and the report of measures against fire etc.

Trading enterprises:
The recommended minimum registered capital is 150, 000 US dollars(Subscribed capital contribution). The company shall have at least 1 executive director and 1 supervisor if it does not have a board of directors or a board of supervisors. The executive director is the legal representative and may hold a concurrent post of general manager. The registration requires the enterprise to provide an office lease contract.

Service enterprises:
The recommended minimum registered capital is 50,000 US dollars(Subscribed capital contribution). The company shall have at least 1 executive director and 1 supervisor if it does not have a board of directors or a board of supervisors. The executive director is the legal representative and may hold a concurrent post of general manager. The registration requires the enterprise to provide an office lease contract.

Pros and cons of setting up a RO

I've seen anecdotal evidence of the trend in which small foreign firms and quite often, foreign individuals opt for RO instead of WFOE. For some of them, the biggest advantage for setting up a RO is the exemption of the so-called “registered capital”. For others, a RO looks much less risky than a WFOE.

However, RO does pose a variety of disadvantages.

1.You cannot conduct business or trading (with exceptions). Just picture yourself as an ambassador from your parent company. You’re not supposed to work as a businessman/businesswoman AND an ambassador. Despite the legal restriction, it’s not rare to witness that ROs circumvent (or just ignore) the red tape and operate just like WFOEs, especially in service industries such as consulting, travel agency and software sales.

2. Unlike a WFOE, a RO cannot apply to the tax bureau for VAT invoices “Fa Piao” nor buy them from it. The unavailability of “Fa Piao” essentially hinders your RO from selling goods/services in China. If your Chinese customers wish to purchase goods/services from you, they usually request for “Fa Piao”. Unless you engage exclusively in exporting business and only procure goods from China, you may probably find yourself in awkward situations in which you’re forced to cut the price so as to content your customers.

Wait! Are ROs supposed NOT to engage in trading activities? You’re right! ROs are meant for doing market research, data collection and business liaison alike only, not for any business transactions (with exceptions). One-person ROs appear to me to be more vulnerable to the temptation to operate like WFOEs. Of course, it’s not perfectly legal (diplomatically speaking…). Unfortunately, the Chinese authorities do not appear to have sufficient capacity and human resources to enforce all the regulations.

3. Though a RO is not a corporation and does not record profits/losses, it still has to pay two categories of taxes in China: business tax and RO income tax. In most Chinese cities, you pay approximately 6% of your total expenses for business tax and about 3% of your total expenses for RO income tax (provided that you opt for the expense method for determining tax obligations.)

They provide intangible services such as consultancy, technology transfer and patents. Generally there is no trading of tangible goods.

4. You may have to accept double taxation in the sense that you have to pay for your local employees’ salaries that are subject to their income taxes, and their social security contributions. The payroll that is tax-deductible for a WFOE becomes an expense and thus taxable for your RO.

5. You cannot even directly employ locals in the name of your RO. Local employees have to be “dispatched’ to work for you by services companies or through other arrangements. A WFOE can directly employ local talents.

They need to pay Value Added Tax (VAT) (VAT output tax payable minus VAT input tax payable). Both VAT output tax and VAT input tax are 17%. (A preferential VAT tax rate of 11% is applied to certain industries, e.g., agriculture.)
Instead of VAT special invoices, small-scaled taxpayers can issue VAT general invoices with a tax rate of 3% on pre-tax sales. The corporate income tax is 25% on net profits.

Trading enterprises:
They need to pay VAT, where the VAT tax rate is 17%. The rate of VAT tax refund for exports is between 5% and 17%, applicable to companies engaged in international trade. The corporate income tax is 25%.

6. You cannot apply for the permit to import your car from your home country in the name of your RO. A WFOE can apply for such a permit. Besides, purchasing a car in the name of a RO adds your tax obligations whilst buying a car in the name of a WFOE is tax-deductible.

They generally issue VAT general invoices, subject to a tax rate of 3% on pre-tax sales. (Certain types of service enterprises such as advertising firms are subject to different tax rates.) The corporate tax rate is 25%.

7.To set up a RO requires two-year continuous operation of the foreign company in its home country or jurisdiction of registration. However, to incorporate a company (WFOE) does not impose such a requirement. Suppose a company has been incorporated in Hong Kong since one year ago or the foreign investor has bought a company that has been operating for one year in Hong Kong. Now the investor plans to move to Mainland China.If s/he intends to set up a RO, s/he has to wait for one year. If a WFOE is to be formed, the investor can start the formation process immediately.

An investment project that requires land?

Land is state-owned in China. To apply to the authorities for the right to “use” land concerns a lot of paperwork and a time-consuming procedure. Different investment projects are subject to three categories of documentation requirements.

For those who need governmental sponsorship or subsidies, three major documents must be prepared: Project Proposal, Feasibility Analysis Report and Commencement Report of Construction Work. The authorities shall “scrutinize before approval” this category of investments. For projects that do not avail themselves of government funds, but are big enough or fall into the restricted category of investment by the Chinese government, a report of project application must be filed. The authorities shall “review before approval” this type of projects. For small and medium-sized projects that neither seek governmental funds nor fall into the restricted category, they shall submit a feasibility analysis report to the authorities for records.

The criteria for big projects and restricted investment vary from province to province, and from city to city. For example, real estate development is submitted for governmental records only in Changde, Hunan Province whilst it has to go through the review process in Hangzhou, Zhejiang Province. Accordingly, different documentation requirements apply.

However, we shouldn’t think applying for right to land use as simple as preparing the above documents. A variety of other documents have to be filed, too, for each category of projects.

It can take up to 2 or 3 years before an approval is secured from the authorities. Any short-cuts? For some industries, you may find it saves time to rent premises so as to jump off the time-consuming application process for land use. However, if you are GM and intend to manufacture cars in Hangzhou, you have to apply for land. For foreign investments, the rules are partially revised to offer certain incentives.

Have you ever engaged in applying for land for your investment project? What have you experienced?

What are the tax obligations of an offshore consultancy firm?

I've seen an increase in that both foreigners in China and Chinese nationals choose to incorporate consultancy companies in Hong Kong.

Just consider a case in which a foreign professional based in China or a Chinese professional is the sole shareholder and the sole director of his/her offshore company registered in Hong Kong. There are no other employees in his company.

I

A Chinese professional X has incorporated a limited liability company ABC in Hong Kong.

SCENARIO 1

X lives in China nearly all the time but does not register a company or a representative office of ABC at the Administration for Industry and Commerce. He works at home and offers his services intermittently in China: for example, 1 month for Project A, no business at all for two months, 2 months for Project B, 3.5 months for Project C and then again no business for the rest of the year. Assume all the projects bring about profits of 500,000 HKD (remitted to ABC corporate account). Based on my understanding of the Reply of the State Administration of Taxation on How to Determine the Permanent Establishment of Foreign Enterprises That Providing Labor Services within China and on Whom the Profits Attribute to (No. 694 [2006] of the State Administration of Taxation 19 July 2006), ABC can be deemed as a “non-permanent establishment” provided that ABC signed an assignment contract specifying the project with X each time when ABC dispatched X to work on the project. If the arrangement is so made, ABC will not be subject to income tax in China for X’s services for the projects.

For the case, ABC is not subject to profits tax in Hong Kong, for the profits are not arising in or derived from Hong Kong. As the director of a HK company your full income derived from the company is subject to salaries tax in HK. As the company does not have any territorial income arising in or derived from Hong Kong, you pay zero salaries tax. In China, as long as you do not receive any remuneration from ABC’s corporate account, you pay zero personal income tax in China.

SCENARIO 2

However, if X works on a single project, that is, 1 month for Project A, no business at all for two months, 2 months for Project A, 3.5 months for Project A and then again no business for the rest of the year. ABC will be deemed by China’s tax authorities as a “permanent establishment” and subject to 25% corporate income tax on the profits earned. Again, as the income is arising in Mainland, not in Hong Kong, ABC pays zero profits tax in Hong Kong.

In reality, it’s difficult to convince the Chinese tax authorities that X works in China without being paid by the HK company. If ABC pays X any amount, X is liable to China’s personal income tax. The issue is further complicated by that, as the director of ABC, X receives income from ABC and thus is subject to salaries tax in HK. Fortunately, X can avail himself of the Agreement for Avoidance of Double Taxation between HK and Mainland. After X properly files for the tax relief, his tax obligation will be deducted in HK.

SCENARIO 3

X feels it’s too cumbersome to handle the issues incurred in Scenario 2. He manages to persuade ABC’s clients to remit the payment to his personal bank account in China. He thinks he would achieve the same result as Scenario 1: no taxes to China or HK; and he controls the total profits.

However, we call this TAX EVASION. It’s ILLEGAL! Even if X receives no pay from ABC and thus is not liable for personal income tax in China and salaries tax in HK, ABC is still obliged to pay corporate income tax to China as it has been recognised as a permanent establishment. X evades his taxes in two senses: first, corporate income tax to China; second, director’s salaries tax to HK. The remittance of the profits to his personal account constitutes income for the director, even though X does not reside in HK.

Stress again: Scenario 1 concerns tax mitigation whilst Scenario 3 is tax evasion.

II

Now image a foreign professional Y, say, an American consultant lives in Guangzhou for more than 6 months but less than 1 year. He has incorporated a limited liability company DEF in Hong Kong. He is the sole shareholder and the sole director of DEF. DEF services both Chinese clients in Mainland and American clients in the US.

SCENARIO 1

DEF is not subject to profits tax in Hong Kong.

DEF is not subject to corporate income tax in China.

Y is not subject to salaries tax in Hong Kong.

Y is not subject to personal income tax in China.

SCENARIO 2

DEF is not subject to profits tax in Hong Kong.

DEF is subject to corporate income tax in China.

Y is subject to salaries tax in Hong Kong (if Y is paid by DEF for the project in China)

Y’s income for the project in China is subject to personal income tax in China (if Y is paid by DEF for the project in China). His income arising in the directorship of DEF for projects in the US is not subject to personal income tax in China. (However, this could change if Y lives in China for a longer period time.)

Unfortunately, the US and HK haven’t signed any double-taxation treaty yet. Consequently, Y’s income from the directorship of DEF is subject to the US tax regime. Nevertheless, Y could claim a tax relief for the part he paid to China’s tax authorities, for the US-China double taxation treaty is in force.

SCENARIO 3

If Y does not report the money derived from his project in China in his personal account to the US tax authorities, he will be deemed as evading taxes to China, HK and the US.

Have you ever formed an offshore company in HK or somewhere else? How do you handle your personal taxes and the taxes of your offshore company when you are in China? Have you adopted any tax mitigation measures? Have you observed any practices of tax evasion in China or in our home country?

Why do people choose RO and FIPE??

I often get enquiries about procedures of setting up a WFOE/RO/JV/FIPE. However, sometimes the prospective investor did not even mention (or decline to discuss?) his/her business line and investment scale, which makes it hard to offer recommendation catering to his/her circumstances and needs. The prospective investor probably wanted to figure out which business form would suit him/her best. However, without revealing basic background information, it unlikely produces case-based advice.

I have noticed that some foreigners seek to apply for Z-visas or renew their residence permits by setting up ROs. They wish to live in China legally for a longer time, which is a splendored thing to me. An investor chooses RO presumably because it is relatively easy and inexpensive to set up, for it does not require paid-in capital (or the so-called ‘registered capital’). She might even think that a RO does not have to pay much or any tax, as compared to a WFOE. (This point is arguable!) She might perceive the management of a RO is less demanding than that of a WFOE.

Quite often, the foreign firm concerned is a sole-shareholder and sole-managing director limited liability company. The investor might not wish to reveal to me that her company is actually one-person entity. She just designates herself or one of her family member as chief representative. So she or her family member can legally move to and work in China. Undeniably, more than a few foreigner incorporate such one-person LLCs in Hong Kong and then set up their ROs in Mainland China, for it’s easy and inexpensive to incorporate a company in Hong Kong.

Constrained by capital but motivated by bona-fide needs for running business, some clients would like to choose FIPE. They are often single-handed, too. Nevertheless, they probably want to operate as a business entity, not doing business illegally under the cover of ROs.

I would appreciate clients’ candidness to discuss their concerns and needs.

What are your motivations for setting up a RO or a FIPE?

How to apply for a Z-visa and a residence permit?

I was recently requested for visa information. I summarise the relevant information for reference to any one who may be concerned, though my job responsibility is focused on feasibility analysis and investment consultancy rather than visa issues.

SCENARIO I

You are a foreign national and have not entered China

It is usually your employer in China who applies for an employment licence on behalf of you.

Your employer in China secures the employment licence for you and sends it to you with a letter of invitation and an employment contract.

You need have a physical examination and obtain a health report in your home country or your country of residence. (This requirement may be exempted by some Chinese diplomatic missions.)

With the presentation of the employment license and the letter of invitation (occasionally called letter of “visa notification”) as well as the health report (if required), you apply to the Chinese embassy in your home country or your country of residence for a Z-visa.

After you enter China, you need apply for an employment permit

Take a physical examination again in China.

You apply for a residence permit, with your employment contract, tenancy contract and your employment permit.

The Z-visa serves a short-term, one-entry visa, valid for 3 months. You are supposed to apply for a residence permit within 30 days after your entry into China.

If you intend to welcome your spouse to China for family reunion, your spouse can apply to the local Chinese embassy or consulate for a Z-visa, too, as long as you are legally employed in China or work as an entrepreneur in China.

SCENARIO II

You are a foreign national and have entered China with a visa other than Z-type.

Your employer applies for an employment licence on behalf of you.

You have to exit Mainland China and apply for a Z-visa. The easiest way is to travel to Hong Kong or Macau. Apply for a Z-visa there and enter China again.

With the assistance of your employer, you apply for an employment permit.

You apply for a residence permit, which also entitles you to legally work in China.

Q & A

Q: I will be working at a Chinese company for a couple of years in Shanghai. How could I get my spouse to China from [Country X]?

A: Prepare photocopies of your employment permit, residence permit and the employment contract, write a letter of invitation and send them to your spouse. You spouse also need present the marriage certificate or a notarised copy of it (if required). File an application directly to the Chinese embassy or consulate in Country X for a Z-visa.

How long on earth does it take to form a RO?

It’s not unusual that various timelines are given to clients by different agencies. Foreign agencies typically draw longer timelines than Chinese agencies.

There’s a difference between registration time and formation time. The registration time refers to time required by governmental bodies for legally approve and register a RO, provided that the client has already had all necessary documents (e.g. bank reference, statement from the parent company) at hand. The formation time concerns the processing time from A to Z, including time for coordination, paper preparation and consularization, etc. Accordingly, the formation time is inevitably longer than the registration time.

The longest formation, to my knowledge, took six months. The parent company abroad apparently trusted a law firm in HK to set up a RO in Hangzhou. If I may speculate, the law firm probably delegated an agency in Shanghai or Hangzhou to run the errands. If a Shanghai agency is delegated, it can either directly send staff to Hangzhou or again delegate an agency in Hangzhou to handle the registration. The latter scenario is of greater probability. No wonder that extra time must have been spent on coordination in the big chain. Why not directly pick up an agency in Hangzhou? In this case, credibility and reliability overweigh speed and efficiency.

Why do foreign agencies always claim longer timelines than Chinese agencies?

There could be several reasons.

1.Foreign agencies, in most cases, tend to abide by SOPs, particularly documentation control. Chinese agencies are usually result-oriented.

2.Foreign agencies do not often make their staff work overtime whilst Chinese agencies often push their employees to work overtime in order to get cases closed quickly.

3.Foreign agencies might not be motivated to speed up. They have the incentive to signal their clients that the assignments are complicated and require more work hours so as to justify higher retainers they demanded, as compared to Chinese agencies.

So how long on earth it takes to register a RO or form a RO?

Our firm has standard processing time of 30 working days to register a RO, provided that the client concerned has got the necessary documents ready from her side.

I’ve seen an agency in Guangzhou offers even shorter time: 20-25 working days. However, I’m reluctant to “squeeze” my standard processing time shorter.

Depending on in which country the client’ parent company is located, the processing time differ somehow for document notarization and consularization. The internal documentation time in different companies can differ significantly.

If the client pushes for internal expedition of documentation requests and external notarization, the fastest formation may take 60 working days (including 30 working days for registration).

If you don’t intend to have a tight schedule, you can allow 60 working days for document preparation and postal delivery, and additionally 30 working days for registration.

So I’d be quite comfortable to state that 60 working days (about 2.5 months) are the minimum threshold for RO formation, and 90 working days (about 4 months) the normal. If any timeline goes beyond 90 working days, there must be special circumstances that call for justification.