As a foreign enterprise, you can use multiple business structures 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 with a number of considerable differences. In order to utilize the solution that will maximize the chances of a foreign business to flourish in your target market, one must know the different characteristics, advantages, and limitations of each solution. This article will discuss the differences between the two Chinese company types and help you to determine which is best for your future business decisions.
WOFEs in China
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 alone.
Whether jointly owned or as a sole proprietorship, the structure of a WFOE is gaining more and more popularity and is probably one of the most well-known member managed structures out there. In most cases, many companies prefer a WFOE for a relatively high amount of employees (10 or more).
Generally, many companies prefer this legal form as it allows them to act alone 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). Forming an LLC in China can be complex.
There aren’t the same rules about personal liability that those abroad may be familiar with. In general, there are three types of WFOE’s:
- Manufacturing WFOE
- Consultancy WFOE
- Trading WFOE (Foreign Invested Capital Commercial Enterprise)
Manufacturing WFOEs perform production operations. Consultancy WFOEs provide advisory services to potential customers. Trading WFOEs provide wholesale, retail, and franchise operations in China. Companies can transact business as specified in their business license.
Furthermore, investments carried out exclusively with foreign assets are restricted with special laws and additional restrictions for the holding company.
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?
- WFOEs don’t require a Chinese partner, so fully independent management is possible. This contributes to efficiency in daily business.
- WFOEs allow for 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.
Representative Offices in China
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 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 (RO).
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. Then, forming a WFOE from scratch can take up to 6-18 months.
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 Representative Office?
- 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 Representative Office?
- Cannot sign contracts nor bill customers.
- Due to the limited range of operations, 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, number of employees, amount of capital, future objectives, etc.
Overall, a RO is a cost effective entity type for small businesses that still aren’t 100% sure about the Chinese market. This is also a viable option for companies in a hurry to establish themselves. Companies like these can 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. A WFOE is more suitable for relatively larger companies that are confident about embarking their long-term mission in the Chinese market.
Companies wanting to avoid the complications that come with either structure, can use a PEO to operate immediately in China without a local entity.