As a foreign enterprise, there are multiple ways to enter the Chinese market. Some of the most common solutions include establishing Sales Offices, Joint Ventures, WFOEs (Wholly Owned-Foreign Enterprises), or Representative Offices. Since each and every company has its own objectives, interests, and needs, it is imperative to determine which form of establishment best suits them. WFOEs and ROs are two solutions that are quite different from each other. In order to utilize the solution that will maximize the chances of a foreign business to flourish in China, one must know the different characteristics, advantages, and limitations of each solution. Through this article, the differences between WFOEs and ROs will be discussed.
As the name already indicates, a WFOE/WOFE (Wholly Owned Foreign Enterprise) is a company setup in China that is 100% owned by a foreign investor/company. A WFOE is a completely independent, economic entity, bearing legal liability independently. The structure of a WFOE is gaining more and more popularity and is probably one of the most well-known structures out there. In most cases, the WFOE is preferred by companies with a relatively high amount of employees (10 or more). Generally, many companies prefer this legal form as it allows them to act independently and there is no need to collaborate with a Chinese partner (i.e. Joint Venture). One of the most common forms to establish a WFOE is the creation of a Limited Liability Company (LLC). In general, there are three types of WFOE’s;
- Manufacturing WFOE
- Consultancy WFOE
- Trading WFOE (Foreign Invested Capital Commercial Enterprise)
Manufacturing WFOEs are dedicated to businesses, consultancy WFOEs are allowed to provide a service, and trading WFOEs denotes the WFOE is for “trading” the wholesale, retail, and franchise operations in China. Companies can simply work in the business area that is laid down in the business license. Furthermore, investments carried out exclusively with foreign assets are restricted with special laws and additional restrictions.
Despite the fact that the WFOE structure is a common way to enter the Chinese market, one must keep in mind that WFOEs also have some unique restrictions and limitations that requires a lot of commitment and patience.
What are the Advantages of a WFOE?
- No need for a Chinese partner. Thus an independent management is possible, which contributes efficiency in daily business.
- The long-term licensing (15-30 years).
- A WFOE is able to invoice directly and the payment can be in RMB.
- The ability to create filial companies in other cities.
What are the Disadvantages of a WFOE?
- The establishing process is long, difficult, and complex (6-18months).
- The high capital requirements of the enterprise ($50,000/month* depends on industry).
- Subject to all applicable Chinese taxes.
The Representative Office in China (also known as a Liaison Office) is a separate legal entity that represents a foreign company in China. This solution is considered an inexpensive and easy method to create a legal entity. However, despite the low number of prerequisites, the RO structure is often not recommended due to the fact that there are many operational limitations. Usually, this form of implementation is utilized when foreign companies perform marketing and research activities in order to see if China is a viable option.
Another factor that can be difficult is that when a firm wants to change its establishment to a WFOE from a Representative Office. The firm cannot simply submit its request to the Chinese government and pay the conversion fee. Rather, the firm must first go through the hassle of shutting down the RO and go through the whole process of forming a WFOE from scratch, which can take up to 6-18 months. So one must keep in mind that once deciding to establish themselves as a RO, switching to other structures require time and patience.
What are the Advantages of a RO?
- Easy and simple to create (duration usually takes less than 1 month).
- Ability to study the market in another territory while promoting the foreign company.
- Create a local contact network, gather information and develop advertisement.
- Rent commercial and residential premises.
What are the Disadvantages of a RO?
- Cannot sign contracts nor bill customers.
- Due to the limited operational range, the average duration is usually 2 years.
- Subjected to a number of different taxes depending on business plan, location, etc. (Effective tax rate is 11% of the company’s spending).
- Enterprise must be at least two years-old and the RO certificate will last for as long as the foreign parent company exists.
In conclusion, there is no definite better or worse solution. It all depends on the current objectives of the foreign enterprise such as the number of employees, amount of capital, future objectives, etc.
Overall, a RO is recommended for companies that are still not 100% sure that the Chinese market is a viable option for them or companies that are in a hurry to establish themselves in China. Companies like these, ought to first establish themselves in China through a RO, conduct market research and then, start to build a local network. If this process is successful, then the company can change its form of establishment to other alternatives. Whereas, a WFOE is more suitable for relatively larger companies that already know and are confident about embarking their long-term mission of establishing presence in the Chinese market.