Wholly Foreign Owned Enterprise and Representative Office Compared
Wholly Foreign Owned Company (WFOE)
1. Status
Such a company is independent legal entity registered with only foreign capital in China and under Chinese law. The managing director (if only one director is appointed) or Board of directors and legal representative are appointed by the foreign parent company. The WFOE abides by the Chinese company law and regulations like any other Chinese company.
2. Legal liability
The WFOE is liable to its assets like a limited liability company in Western legal practice. The minimum capital to be registered is usually around USD120,000. In some cities and for some industries, however, the minimum capital required could be as low as USD12,000.
3. Commercial Activity
Chinese corporate law restricts companies to their business scope, i.e. the range of business activities it can perform. A WFOE is also restricted in such a way. The business scope of a WFOE is usually restricted to a manufacturing or processing or general service activity. Certain special economic zones allow WFOEs to have a purely distribution activity for products of the mother company’s group. Pure trading as a business scope (with restrictions to only a single category of products) is now allowed with much the same requirements in terms of capital requirements.
Within its business scope, the WFOE can have normal commercial activities of buying materials, transforming them and reselling its products, locally or abroad. If it approved to do so, it can just buy, store and distribute and act as its mother company’s Chinese agent.
The WFOE can declare customs, import and export according to its business scope.
Local currency can be exchanged against hard ones provided it is for legal buying activities in respect with the business scope.
Profits can be repatriated, in foreign currency.
4. Personnel
Local staff is hired directly under the Chinese labor law. All its dispositions must be respected. They do not make it difficult to hire and fire people. Trade unions are encouraged but not obligatory. In any case, they have proved to be no hindrance to the management.
Foreign managers and employees can be appointed and receive work and residence permits as well as the appropriate visas.
5. Premises
The WFOE must be located in those premises reserved for commercial activities, i.e., commercial buildings or commercial-cum-residential buildings.
6. Taxes
WFOE pays income tax (and business tax if applicable) as Chinese companies (usually 33% of the net profit).
Tax breaks can be obtained for encouraged industries or export-oriented industries and in some cities. generally speaking, WFOE is only liable to income tax at a reduced rate at 15%.
In addition WFOE normally obtain the right to import all of their production equipment free of VAT and customs tax.
Personal income tax of the WFOE must be deducted from the employee’s monthly salaries and paid by the employer.
7. Requirements for Registration
The WFOE must be approved to be registered. This approval will include checking:
a) The proposed name of the WFOE
b) The articles of associations of the company (they must abide by the Chinese WFOE law) and its feasibility study. The business scope is a key element of the approval. An environmental protection study must also be made and approved.
c) The premises rental or purchase contract
d) The resumes and passports of the board members and their proper appointment by the mother company’s legal representatives
e) The parent company’s financial situation, as for the RO Final registration is granted after the registered capital is paid in.
Representative Office (RO)
1. Status
It is an office of a foreign company in China. As such it is not a Chinese company. It can be compared to the embassy or consulate of a company in China. It has no registered capital.
2. Legal Liability
The RO is not a separate legal entity and therefore it does not assume liability on its own. Instead, the foreign parent company assumes the liability of the RO. This liability thus extends to the registered capital and assets of the mother company.
3. Commercial Activity
a) As the RO is not a Chinese company it does not enter into business transactions as a Chinese company, but as a foreign company.
b) Consequently, the RO does not have a capital, it does not buy or sell in its own name.
c) It has a bank account that is used only to receive money from the mother company and pay for its local expenses. (It does not have the right to pay for goods that the parent company would buy, for example.)
d) The RO cannot declare customs, import or export goods, as the mother company does not have such a right in China. It can however receive mail, parcels of samples and send out such samples. It can also import equipment and goods for its own use. (Computer systems, other office equipment’s.
e) The RO can act as a liaison between its parent company and the parent company’s business partners in China. It can conduct purchase or sales negotiations, quote prices or receive quotes from suppliers, effect market research, market and promote its parent company products, hold seminars, take part in exhibitions. In general, it can conduct any legal activity that the mother company representative could conduct in China if they would come on a business trip.
4. Personnel
a) As a foreign company office in China, the RO does not fall under the labor law for Chinese companies. As well it is not entitled to enter into own arrangements with local staff as it cannot register for and provide social welfare.
b) Local staff can be hired with the approval of specialized Chinese human resources companies to which fees must be paid in addition to the staff’s salary. These fees provide the necessary and legal social welfare cover to the local staff. The formal labor contract is signed with the Chinese HR company. It is standard and does not allow for any important modifications. Besides, an agreement with the hired staff fixes the staff’s salary.
This agreement may be copied to the HR company or remain strictly between the local staff and the RO.
c) Foreign representatives approved by the relevant authorities receive a work and residence permit as well as the corresponding work visa.
A local staff can be appointed as Chief Representative.
5. Premises
As a foreign company in China, the RO is restricted to use specifically approved premises for its offices, be they bought or rented. However, a RO could be located in those same buildings as allowed for a WFOE.
6. Taxes
a) The RO is liable to pay taxes in China, though it is not a Chinese company. These taxes can be calculated in 2 ways, subject to the approval by the Chinese Government:
– according to a percentage of the profits generated by the RO for the foreign company
– as a percentage of the expenses of the RO.
Tax authorities have no proper way to evaluate profit generated by the RO for the Mother company. As a result, they require at least that tax be no less than the percentage on expenses. This is usually the way foreign company choose to be taxed.
b) Staff (local and foreign) and liable to pay income tax according to Chinese law. This tax is paid by the employee or the foreign company as per agreement with the staff.
7. Requirements for Registration
The RO must be approved before it can be established. The approval includes checking of:
a) The financial situation of the parent company (usually in the form of a bankers’ reference letter issued by the banker of the parent company).
b) Latest audited financial statements must also be supplied (this requirement only applicable to RO in restricted industry).
c) The personal situation of the appointed Chief Representative, including his resume and passport.
d) The location of the RO (lease agreement for the office premise must be produced).
Permanent Representative Office or Wholly Foreign Owned Enterprise
1. The RO is usually a first step for a presence in China. It is a completely sufficient and suitable structure for any buying activities. It also suits sales activities when no production, assembly or after-sales services must be provided by the foreign parent company.
It is not really satisfactory for distribution activities as it forces the parent company to rely legally (for ownership of the products and collection of the money) on a third party as distributor and import agent. (Often, these 2 functions must be spread to 2 different companies.) In general, it is complicated, risky from the point of view of obtaining payment and not very satisfactory from the point of view of the services provided to the customers.
As there was previously no possibility to register WFOE distribution companies, many foreign companies have used their RO as a virtual distribution company, formally going through local importers and distribution agents. Problems stories are numerous and I would not recommend this approach. The requirement for establishing a WFOE for the purpose of distribution has been lowered substantially, we now normally recommend the trading WFOE at the first place.
2. A WFOE is almost always recommendable for any production, processing or distribution activity.
The alternative could be a JV. However, in general a JV partner active in the particular field of activity of the JV brings no real advantages and often additional problems.
Successful JVs must be analyzed on a case by case basis to discover the reasons for their success.
Until recently, WFOE could not be registered with a distribution business scope. Besides, rampant smuggling via Hong-Kong made it uncompetitive for a WFOE to import legally and necessary to go via an import “agent” in South-China.
With the new lower customs tariffs and the drive against corruption becoming effective, and with the substantially lowered capital investment requirement, a distribution WFOE makes sense now and it is expect that a trading WFOE to become more and more the solution and preferred choice for foreign investors making a presence in China.