Dude, Just Form a China WFOE

Think of this cake as your China WFOE and be enticed.

Don’t fall apart on me tonight
I just don’t think that I could handle it
* * * *
I wish I’d have been a doctor
Maybe I’d have saved some life that had been lost
Maybe I’d have done some good in the world
’Stead of burning every bridge I crossed

Bob Dylan, from Don’t Fall Apart on Me Tonight

About a year and half ago, I did a blog post entitled, How To Manufacture In AND Sell In China Without A WFOE, in which I talked about how our China lawyers have been drafting agreements to allow clients that manufacture in China without a China WFOE to sell their products in China via the following workarounds:

1. The foreign company and the Chinese manufacturer enter into a manufacturing agreement that protects the foreign company’s intellectual property and deals with all other related manufacturing issues.

2. The foreign company enters into a separate license agreement with the manufacturer. This agreement provides that the manufacturer will sell the product within China to entities (distributors) selected by the foreign company. The sale to the distributor is made at an agreed price that includes profit to the manufacturer and a payment to the foreign company. We have characterized the payment to the foreign entity in various ways. In some cases, we characterized it as a license royalty, in other cases we characterized it as a sales agency fee. The characterization can also influence whether the agreement must be filed with the Chinese government, and where.

My friend and China consultant extraordinaire, Michael Zakkour, immediately called me to complain about this post. Michael has been intensely involved with China business for fifteen years as a China consultant and I respect him immensely. By way of a quick aside, he is also the author of a terrific book on China, China’s Super Consumers, which if you haven’t read, you absolutely should.

Anyway, Micheal did not like my post because he thought it could lead companies that need a WFOE to justify not having a WFOE. My response to Micheal was a bit flippant and consisted of my (probably) saying something like the following:

I trust our readers and I am sure they will get help in figuring out when it is appropriate for them to have a WFOE and when they can get along without one. Our job as blogger is to give our readers their options and if they (rightly or wrongly) think they can without professional help figure out which of the options makes the most sense for them, that’s their prerogative.

Not going to concede Michael was right but I am going to say we have in the last few months been getting a ton of companies coming to us with multiple wounds (any of which standing alone will likely eventually be fatal) asking our China lawyers for one or two or more “band-aids,” believing that is all they need.

The below is a composite of what our China lawyers have been getting of late:

  • Company comes to us that has been having its products made in China and then shipped back to the U.S. and then shipped back to China when sold to WFOEs in China owned by U.S. or European companies. These U.S. and European WFOEs are now telling the U.S. company they are no longer willing to buy from the U.S. company in dollars; they now will only buy from China and pay in RMB. This is happening for two reasons. One, the U.S. and European WFOEs want to pay less and they do not want to pay to have product shipped to the U.S. and back to China. And two, these U.S. and European WFOEs are having enough trouble getting money out of China (See Getting Money Out of China: What The Heck is Happening?) and they want to eliminate outgoing payments from their China WFOEs whenever possible. I tell these companies their best long term solution is to form a China WFOE that will allow them to get paid in RMB in China and sell its products from China to companies in China. This is potentially fatal wound number one. The companies often want us to fix their problem so their planned sale FOR NEXT WEEK can go through.
  • In addition to the above selling issue, the companies coming to us also tell us about one or more people they are using as “independent contractors” to help them in China and they want to know our “thoughts” on this. I immediately direct them to this article I wrote for Forbes, China’s Tax Authorities Want You:

Chinese law limits hiring China-based employees to only Chinese legal entities. This means that if you are an American software company, you cannot hire someone in China to do your coding or to provide your support services. This means that if you are a Canadian company selling widgets, you cannot hire someone in China to sell widgets for you.

Any person (as opposed to a registered business entity) performing employment-like services for you in China is your employee because China essentially does not recognize independent contractors — and you need to pay employer taxes and benefits on that employee. These employer taxes and benefits vary from city to city, but they usually total around 40 percent of an employee’s salary. Many foreign companies do not realize they have employees and they fail to pay required employer taxes and benefits.

I then explain how if they do not quickly do something about this “independent contractor,” situation they are in real danger of  being hit with a massive China tax bill, plus interest, plus penalties, plus other even worse possible sanctions. This is potentially fatal wound number two. Once we explain the dire situation in which the company has put itself in China, they usually want us to fix this problem in a week or so as well. I usually explain various expensive and not terribly good short term remedies and then how their best long-term solution is to form a China WFOE and hire these independent contractors as employees.

  • As if the above were not enough, these companies often come to us with some unusual and potentially potentially fatal wound number three. I do not want to go into any specifics on this one for fear of anyone seeing themselves too in this post, but what this wound usually involves is the company doing something in China the Chinese government would likely view as constituting doing business in China, such that these companies doing these things without their having a Chinese corporate entity violates Chinese law. I tell the company it is at major risk of being taxed for all past business it has conducted in China, plus interest, plus penalties, plus other worse sanctions, and their only solution to stop doing these things (and hope they never get caught for what they did previously) or to form a WFOE to be able to do these things above board. This is potentially fatal wound number three and again, the company usually wants us to come up with something to staunch the bleeding while they figure out what to do and do it.

Dude, don’t wait, just get a WFOE….

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