How to start a business in China as a foreigner
One of the questions I’ve been asked frequently over the past few months is the issue of incorporation for entrepreneurs doing business in China. Your ties to China boil down to a couple different options depending on the nature of your unique business. Essentially, Chinese expat entrepreneurs have a few options when it comes to a legal entity, these are the options in my opinion:
- WFOE (wholly foreign-owned enterprise)
- Hong Kong Limited Company
- Singapore Private Limited Company
- Offshore (any offshore company)
- USA Company (Wyoming LLC)
This is an attempt to make complicated international law and taxation implications understandable to a broad audience who just want the answer to this question; I’m looking for doing business in China – where should I form a company? (and why Hong Kong might not be the answer you were looking for…)
They each have upsides and downsides, I’ll do my best to highlight what the advantages and compliance burdens of each might look like.
Assets and human capital within China
A wholly owned foreign enterprise (Hereinafter referred to as WFOE – and oftentimes pronounced “Woofie”) would be the best option to start a business in China as a foreigner and operate and control any physical assets or human capital within China.
This is not to say that an e-commerce type business (very common in China) would need a WFOE, but rather that someone who has an office, staff, and needs to make payroll on the books in China would benefit from a WFOE.
The service fee will vary depending on which company you use. I found lawyers charging between 1000 and 10,000 USD. I’m sure there are some charging more, and some charging less.
|WFOE Company Type||SERVICE FEE (USD)*||Approx. GOV FEE|
|Consulting company||1-10,000||1,000 USD|
|Service WFOE, Software company||” “||1,000 USD|
|Trading Company with Import/Export license||” “||1,000 USD|
|Freight Forwarding company||” “||2,000 USD|
|Food & Beverage WFOE||” “||2,500 USD|
|Manufacturing WFOE||” “||4,000 USD|
NB: Be aware that certain industries and areas may have a significantly higher cost. Things which require additional licensing (for instance alcohol trading, education, etc) would certainly be more expensive and time-consuming.
WFOE High Cost
The difficulty comes with the compliance and set up this entity. It also requires a large initial capitalization. Since China still maintains foreign currency control policy, many firms advise to choose a registered capital within RMB 100,000 ~ RMB 500,000. Additional government fees would apply (0.8‰ of its registered capital) for registered capital more than USD 140,000.
Most of the Chinese expats I know agree that there is some benefit to having payroll and being able to pay social security. You can attract higher level talent and you are generally perceived as more legitimate.
However, let’s not kid ourselves, this is China – and money talks. Most employees would be more than happy to receive funds from a Hong Kong company (or another offshore entity). Probably, for the right employees – you could pay them less in US dollars or even a cryptocurrency such as bitcoin.
The legality of this would be murkier than setting up a WFOE, but – you might save yourself a ton of time and effort without the government ever actually noticing what was going one.
- Location Businesses (factories, etc.)
- Visa Benefits
- High Capitalization
- High Compliance
- High Tax
- High Set up Cost: ~$5000 (excluding ~$50,000 capitalization.)
Hong Kong Company
Hong Kong is a reasonable choice of a jurisdiction to establish a legal entity and start a business in China as a foreigner, and probably the first thing people consider if there is anything for doing business in China – because it is relatively easy to set up the company.
The Legal Framework
The Legal and regulatory framework is sound, and common law (I just wish it was in English and not Cantonese!)
One of the great benefits to Hong Kong is that if the Hong Kong limited company does not trade or do business in Hong Kong, it does not need to pay any taxes in Hong Kong – making it an offshore entity.
However, it will need to be audited on a yearly basis, and there is some cost involved with that. Worse, this cost is impossible to accurately predict beforehand, as the audit and accounting cost will vary dependent on the total number of financial transactions involved with the company.
Companies in Hong Kong that elect for 0% taxation by the Hong Kong Inland Revenue Board must face yearly audits from a certified firm in Hong Kong. These can vary in price dramatically. There is an upside to facing yearly audits. If a potential acquirer or buyer of your business comes in, then your finances are likely in order due to the yearly audits you’ve been facing.
- Tax Treaty with China
- Merchant Accounts
- Bank Account Opening
Bank account openings are getting very stringent! In recent years, the environment has changed completely and the bankers want to see a substantial amount of deposited funds, and reasonable justification for why you want to set up in Hong Kong, along with every piece of paperwork under the sun. If you want to get a bank account set up quickly, and without hassle… look elsewhere.
Merchant accounts in Hong Kong are also a pain in the ass. I’m not sure why they need to be so complex, opaque and bad at doing business, but they are. There are better merchant services available elsewhere.
This isn’t to say that bank accounts or merchant accounts cannot be established. They can – it’s just a matter of proving that your business is legitimate and will make the bank money. As always with offshore banking, an introduction can be very useful.
US With-holding Tax
Another issue with Hong Kong, in particular, is that it does NOT play well with the US. That is, any payments sent to a Hong Kong company from a US company will be subject to a 30% withholding tax.
Planning to sell on Amazon or eBay and thinking that money will get to you tax-free? Think again. You will be slapped with 30% withholding tax my friend when you file form W-8BEN-E.
So if you are thinking about selling into the US (or you are American yourself) then a Wyoming LLC might be a much better option.
Singapore is a notable option for those doing business in China or Asia in general. I’ve written at length about Singapore companies and how to immigrate to Singapore to start a business on entrepass.
For the relevance of China – as of November 2014, the RMB is now fully convertible with the Singapore dollar (SGD). The Red dot and the Red Dragon have always had good relations.
Great Logistics, Banking, Infrastructure
Singapore is the busiest port in the world, with an excellent banking and legal structure established by the British. If you feel insecure about your intellectual property in China, you should never feel this way about Singapore. The banking system just works. Fellow entrepreneurs sometimes complain there are a lot of forms required to do something like changing a signatory on an account.
This is a good thing, because the banks understand and help facilitate proper corporate governance. Singapore is a place where people are held accountable, and you can expect to go to court or jail if you do something corrupt or illegal.
English (and more)
Unlike Hong Kong – almost everyone in Singapore speaks English. Or at least they speak “Singlish” which is English with a heavy Singaporean accent- Ok lah!
Most Chinese Singaporeans are also fluent in Mandarin Chinese, although, will always tell you that “mainlanders” instantly distinguish their accent. There are also 2 other official languages in Singapore, Tamil, and Bahasa Malay. Singapore is a very diverse and welcoming place for foreigners to do business.
There is a lot of venture capital in Singapore. More than Hong Kong at the current time, and the venture capitalists here are cognizant that with Singapore being a relatively small market of 5 M, that companies will need to branch into new markets using SG as an HQ. There was over 1B invested in Singapore startups in 2014.
- No Yearly Audits (Unless your Pte. Ltd. company has a corporate shareholder, you will most likely not need to be audited on a yearly basis.)
- Tax on profits less than 150,000 are not taxable for the first 3 years of company operations.
- Local Director
One is required to keep a local Singaporean (or permanent resident) as a director of the Private Limited Company. The first question I always get is: Will the director of my Singapore company have any real power? Yes- they will be a director. However, a director is a temporary position in a company, who is elected by the shareholders and can be replaced at any time by holding an EGM (extraordinary general meeting) or on a yearly basis by holding an AGM (Annual General Meeting).
Something else to note: In terms of Residency and the 2nd Flag of Flag Theory – Singapore and Hong Kong are some of the best jurisdictions in the world to have clarity, and a solid foundation in your personal income tax at a very low rate. Both jurisdictions are infamous for millionaire and billionaire migration because of the reasonable tax code.
This option refers to using an offshore entity and flying ‘under the radar’. This would most likely not be suitable for full-time residents in China (see word on CFC’s below) but nonetheless is a very viable option. In this section, I mean offshore companies like Nevis or Belize
While Hong Kong and Singapore have very reasonable top income tax rates for corporations in the high teens (HK 17% and Singaporee 16.5), if you want a zero percent rate – you should look offshore, or get more creative with a jurisdiction which might allow for tax exemptions. For instance, you could do business in Malaysia, or set up a company in Thailand approved by the Board of Investment where you can get an 8 year tax break.)
If you don’t want to deal with audits, or even accounting, you might want to think about an offshore company. China is a large country and they don’t have complete control over the 1.6 Billion people who live there, let alone the expats who go in and out of their borders as permanent travelers.
An offshore company is a cheap, low compliance alternative to the above solutions. You’ll have a more difficult time getting merchant processing, but it is possible. If you are dealing in large transactions or bank wires, then for sure an offshore company would accomplish that.
This would not help with your visa status, but it would be a private way for you to do business without attracting the attention of any authorities.
CFC’s on China
This is a vastly more detailed account of the actual legality and taxation of offshore companies in China. This will not be interesting unless you have this specific problem. I’ll try to distill the information from several sources in a cogent manner, but probably more research is needed using these guides as a starting point:
- www2.deloitte.com/content/…/dttl-tax-guide-to-cfc-regimes-210214.pdf – see China section.
According to China Corporate Income Tax Law, a foreign controlled corporation (commonly referred to as a “CFC”) is any business enterprise or legal entity established outside China by a tax resident enterprise in China.
The legal framework of China’s CFC rules
Article 45 of the CITL states:
“For an enterprise controlled by resident enterprises and/or individual residents of China and established in a country (region) where the effective tax rate is significantly lower than the tax rates set forth in Paragraph 1 of Article 4 (namely 25 percent) hereof, and which either does not distribute profits or distributes profits lesser than it should, not because of reasonable operational needs, the portion of the above-mentioned profits attributed to the resident enterprises shall be included when computing the taxable income of the resident enterprise in the current period.”
Source: Deloitte Touche Tohmatsu CPA Ltd., Enterprise Income Tax Law and Implementation Rules of the People’s Republic of China: Chapter 6, Special Tax Adjustments, 2008, at 20.
Article 45 of the CITL does not provide implementation details, however, Article 116 of the Implementation Rules of the Corporate Income Tax Law (IR) states:
“Individual residents of China as cited in Article 45 of the CITL refer to individuals, who have an Individual Income Tax obligation for their domestic and overseas income, in accordance with the relevant provisions of the “Individual Income Tax Law of the People’s Republic of China”.”
Article 117 of the IR explains “controlled” in Article 45 of the CITL:
3. a resident enterprise or an individual resident of China directly or indirectly holding 10 percent or more of total voting shares, and such resident enterprise(s)/individual resident(s) jointly holding more than 50 percent of total shares of the foreign enterprise;
4. the shareholding percentage of resident enterprise(s) and individual resident(s) of China does not meet the percentage standard as stipulated in (1), but substantial control is formed over the foreign enterprise in respect of shareholding, financing, business, purchase and sales, etc.
5. A CFC is defined as a foreign enterprise that is “controlled” by Chinese resident enterprises, or collectively by Chinese resident enterprises and Chinese individual residents, and is established in a country (or region) where the actual tax burden is “obviously lower” than the tax rate prescribed in article 4(1) of the EIT Law (i.e. 25%). The Implementation Rules define the term “obviously lower” to mean an effective tax rate (ETR) in the foreign jurisdiction that is lower than 50% of the tax rate in China (i.e. a rate of less than 12.5%).
6. The meaning of “control” is defined in Article 77 of Circular 2: substantial control in terms of shares, capital, operation, purchase and sales. Futher, “control in the shares” means that a Chinese resident shareholder directly or indirectly holds no less than 10 percent of the voting shares of a foreign enterprise in any single day of a taxable year, and jointly holds no less than 50 percent of the total shares of the foreign enterprise.
Shares indirectly held by Chinese resident shareholders are accumulated by multiplying each proportion of the shares held by each level together. However, if the proportion exceeds 50 percent, then 100 percent should be used for the calculation.
Every G20 country has some laws regarding CFC’s and controlled foreign corporations. If you own an offshore company, you should take the time and energy to learn the laws of your country, and how they might affect your tax situation, and potentially get advice from a lawyer.
TL;DR – You might owe tax in China by controlling a foreign company (either as a shareholder, or if your company is a shareholder) – so there is a tax risk there.
- Low compliance
- Low Tax
- May not fit neatly into compliance, tax and regulatory burdens.
Set up for a USA company is extremely quick. First, the individual will form the legal entity, and obtain an EIN (employee identification number. If a foreigner is setting up the company, they can first obtain an ITIN, or you can use form S-4 to designate a US person. If this sounds complicated, it’s not – the US government just loves to use abbreviations. Basically, either you need a tax number, or someone needs a tax number in order to get the company tax number. Then, you take the company formation documents and the EIN to a bank – and once you open an account you are in business.
The banking system in the US is still one of the best in the world (despite SWIFT being almost antique, it’s still widely accepted) – and the silicon valley startups everyone has come to rely upon for ease of starting a new business: Ebay, Stripe, Paypal, Braintree, Amazon, etc. make it super easy to get up and going for relatively low cost. For less than a few thousand bucks, you can be up and running.
You’ll need to file yearly tax returns to the IRS, and state franchise fee and registered agent fee. However, yearly compliance will be less than $1000 – which is far less than the other options listed here.
It’s also possible that as a non-resident American, you might not have a tax event, if no business is being done with America, or by Americans. (this is highly contingent upon your business plan and model, but it is possible to have an “offshore company” within the United States. Just make sure that you talk to an accountant or tax attorney first for advice on your specific situation.
This might not normally be the first option that springs to mind when thinking about doing business in or with china. However, since Americans have a worldwide tax obligation and incredibly complex CFC rules and regulations, it may make it much easier for the taxpayer to use a simple US entity for their worldwide operations.
Americans may get the benefit of simplicity by using a US entity because Americans who are owners of a foreign corporation must file a lot of forms to the IRS, potentially form 5471, 8938 – and others for instance for 90-22.1 to the Treasury department.
- Quick and Easy to set up
- Works with Amazon, Ebay, Stripe, Paypal
- Yearly filings to IRS
- Potential withholding tax to foreign entities/individuals
The conclusion here is that there isn’t one legal entity that makes the most sense in China for every circumstance. It’s contingent upon your own goals, process and thoughts. However, what you can do is model yourself after other corporations have done to who have successfully navigated the legal framework.
If you want to learn more about how to start a business in China as a foreigner, you may consider joining our Flag Theory Intel Community, a Do-It-Yourself Information center that may empower you to take an action. If you need personalized advice to find the best solution according to your specific circumstances, you can check how we can help you or email us at [email protected]. You can also check our free tools to compare jurisdictions and incorporate a company, get a second passport or establish a residency or open an offshore bank account at: incorporations.io / passports.io / bankaccounts.io.