Several structures are available to a foreign investor who invests directly in China. One commonly-used legal entity is the WFOE, which is a limited liability company that is wholly owned by its foreign investor(s); a Wholly Foreign Owned Enterprise. However, setting up a limited liability company does not mean that it can engage in every business activity, as the scope of business needs to be determined upon establishment. In case the limited liability company wants to expand to other kinds of business activities at a later date, it is subject to the approval of the government authorities. For this reason, it is extremely important to properly define the business scope of the company.
For those businesses that want to import and export, purchase and sell (including wholesale and retail) in China without a Chinese partner, a trading WFOE (sometimes called a Foreign-Invested Commercial Enterprise or FICE) should be established. A trading WFOE allows for a more direct relationship with Chinese suppliers and customers, and also opens to the possibility of warehousing in China. Moreover, it provides the opportunity to buy Chinese goods and sell them directly to Chinese customers, even under a foreign brand name. The WFOE is also allowed to engage in franchise activities and to take part in transactions on the basis of commissions.
Although the trading WFOE has some clear advantages, including the ability to sell to local Chinese customers and purchasing from Chinese suppliers in Chinese Yuan and to issue fapiaos, there are also some disadvantages as one needs to invest capital in order to establish the trading WFOE and the establishment procedure is complex and can take around half a year. Also one needs permission of several government authorities.
The minimum capital requirement for a (trading) WFOE is RMB 30,000 for a company with a single shareholder and RMB 100,000 for multiple shareholders. One can easily see that this amount of registered capital is rarely enough in practice to cover the start up costs. As the Chinese government has notable discretion when approving the establishment of a company, it usually demands higher amounts (usually RMB 500,000 to 1,000,000). In order to determine this amount, the government often takes into account the business scope of the company.
The trading WFOE – just like most companies in China – will be subject to corporate income tax, at a rate of 25 per cent. The basic principle for this tax is that income derived from China should be taxed in China. Besides corporate income tax, trading WFOEs are subject to value-added tax (VAT). All companies and individuals that engage in the sale, processing, distribution and/or importation of goods need to pay this tax. Companies with a revenue of more than RMB 5 million per year will be required to register as general VAT taxpayers; these companies are able to deduct input VAT and usually pay a tax rate of 6 percent, 11 percent or 17 percent, depending on the type of products. Smaller companies (revenue of less than RMB 5 million per year) can use a reduced VAT rate of 3 per cent. For trading WFOEs it is usually important to register as a general VAT taxpayer as it enables these companies to deduct input VAT from output VAT, thus reducing their tax burden.
Besides wholesale, trading WFOEs with the correct business scope can also open retail outlets to sell products to individual customers.
Online selling (or ‘e-tail’) has grown explosively with the development of the Internet in China. According to data of the EU SME Centre and Ministry of Industry and Information Technology (MIIT), the number of internet users has tripled between 2006 and 2010, and China is expected to have 800 million Internet users by 2015. According to a report by McKinsey&Company of March 2013, China has become the world’s second-largest online selling market “almost overnight” with revenue estimates of USD 210 billion for 2012. They state that e-tailing is not merely a substitute for offline consumption, but also complements it, thereby enlarging Chinese consumption even further.
Although these online selling developments sound promising and the law has been developed with the booming of this sector, these issues remain unclear with respect to the regulatory framework, as it still can be inconsistent and uncertain. The main authorities related to e-tail business are the Ministry of Commerce (MOFCOM) and the MIIT.
Choosing the Right Structure for Online Selling
Foreign companies that want to set up an online business need to consider the structure of this business. They can for example use a trading WFOE or can choose for a contractual relationship with a Chinese company to set up a website in China. For foreign companies that already have established a trading WFOE in retail it is more logical to use this WFOE. After the establishment of the trading WFOE, the foreign company must create a website through which the same range of products will be sold. An Internet Content Provider (ICP) license filing will be required, though a WFOE is not allowed to engage in delivery and online payment activities. For the delivery of the products a separate WFOE could be established which has a transportation license. As this is a complicated procedure, most online shops outsource the delivery (for example to TNT, China Post etc.). With respect to the payment, online payment platforms such as AliPay and PayPal are already widely accepted.
One can also consider engaging in online selling via a third party platform in China, like Taobao Tmall; as Chinese consumers are already familiar with these websites, it can be a good alternative. These websites usually require the payment of an annual fee.
Another option is to start up an e-tail business via a website outside China which is translated into Chinese or via a third party platform outside China. Companies that have no operations in China yet can consider this option, but due to the distance consumers might have to bear high delivery costs and the delivery speed may be low. But more importantly, the Chinese firewall causes problems for Chinese customers to visit websites outside China, which makes online shopping via these websites difficult. Moreover, the products will be treated as imports, and so imports may trigger duties and result in more complicated procedures.