What is the protocol when your WFOE comes to the end of its life cycle? Rupert Gerald, commercial director and head of the APAC Sales Desk, Donald Tsang, executive director and head of Corporate Services Greater China, and Jack Yan, general manager, Shanghai, explain how to follow the correct procedures.
A wholly foreign-owned enterprise (WFOE) is the most common way for foreign investors to set up and operate businesses in China.
The Chinese government has introduced measures to encourage foreign investment and to bring accounting closer to internationally recognized standards. Nevertheless, China remains a cautiously controlled economy and the RMB is subject to strict foreign currency regulations.
This is why investors, in consultation with their professional advisors, need to be clear on the policies and procedures around profit repatriation during their WFOE’s operating phase, and to understand the process and audit requirements before closing down a WFOE at the end of its life cycle.
Repatriating funds from a WFOE in China
In China, there are two bodies in charge of overseeing and administrating foreign exchange: the State Administration of Foreign Exchange (SAFE) and the People’s Bank of China, China’s central bank.
We’re often asked when a WFOE can pay profit back to the overseas shareholder. Broadly speaking, there are three conditions that need to be satisfied:
- When you have retained earnings in the business
- When you have completed the annual statutory audit
- When you have satisfied all tax compliance in China—including filing an annual corporate income tax return at 25% and a dividend tax return at an additional 10%
It’s recommended to seek professional advice with regard to the profit repatriation of your WFOE so you are fully compliant with all applicable laws. Once you have met these conditions in accordance with the company’s policies and procedures, you can formalize the profit repatriation from a WFOE in China by making an application to your bank with supporting documents. Typically, this might be done once a year, although you can do it as frequently as you wish.
Your bank may require additional documents or ask supplementary questions to approve the transaction, and it will review and approve the payment on behalf of SAFE.
How to close down your WFOE operations: Exit strategies in China
At the end of the life cycle of a WFOE, it’s important to close it down properly to avoid fines, censure, and any personal liability. When it comes to the final stage of exiting your WFOE, there are two options—sale or liquidation.
Sale of a WFOE: If you’re planning to sell your WFOE, you’ll need to file a corporate income tax for share transfer, change the name of the shareholder on the business license renewal documents, and change the name on the bank account.
Shareholder name changes can be quick (around seven days) if there’s a Hong Kong shareholder involved. If there’s a mainland Chinese shareholder, the same process can take up to two months.
Liquidation of a WFOE: To qualify for final liquidation of your WFOE in China, you must clear your final tax payments. All business licenses granted to the company must be reversed, and there will be a three-year “re-audit” covering its activities, requested by the tax authorities. The tax audit must be completed before managers can expect to get clearance from the tax authorities to shut down the company.
You also need to ensure that the WFOE has terminated any employment relationships and settled any debts. If you fail to follow the right procedures, the shareholders and managers can face penalties and directors may be held personally responsible for costs and damages. Therefore, it’s recommended to take professional advice for the sale or liquidation of your WFOE so you protect your interests during the winding-down process.
What are the benefits of using a Hong Kong holding company for your WFOE?
Setting up a holding company in Hong Kong provides a number of strong benefits for investors. It can speed up the incorporation process at the beginning of the WFOE’s life and is particularly efficient when you are winding down your WFOE investment.
The benefits of a Hong Kong holding company for a WFOE include:
- A 50% reduction in tax on dividends. In terms of taxation of a WFOE, dividend tax is levied at 10% on any profit repatriation. However, under a double tax treaty agreement between Hong Kong and China, this will be reduced to a 5% dividend levy, if the conditions are met.
- On the sale of your WFOE, the transfer of shareholder name is quicker if the new shareholder is based in Hong Kong.
- Within the initial incorporation process of a WFOE, the notarization process takes less time if it’s done via a Hong Kong holding company, making it more straightforward and cost-effective for an investor.
- There’s an established infrastructure of professional tax advisers in Hong Kong familiar with the intricacies of FDI in China.
- Hong Kong has a robust and well-established banking system and legal network, and its advisers offer bilingual services.
- Hong Kong remains a common law jurisdiction, offering many similarities with other major business jurisdictions around the world.
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This document is provided by CSC for information purposes only and does not constitute an offer, invitation, or inducement to contract. The information herein does not constitute legal, tax, regulatory, accounting, or other professional advice and therefore, one should seek appropriate professional advice before considering a transaction as described in this document. No liability is accepted whatsoever for any direct or consequential loss arising from the use of this document.
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