This article was written by Pavel Khizhnyak, founder and CEO of Trade Exact Consulting. Pavel is a forex industry professional with 10+ of experience in China, Russia and the US.
I have been doing business in China for over 10 years and personally ran several Representative Offices (RO) and consulting firms in Beijing and Shanghai. I see a lot of customers making the same mistakes when coming into China and would like to share some tips on how to avoid them.
Despite the recent economic slowdown, China remains a top destination for financial firms aiming to expand their global presence. Over the past 5 years it’s become common practice among foreign entrants to choose Wholly Foreign Owned Enterprise (WFOE) instead of a traditional RO as an incorporation format in China. In this article we will review the main misconceptions about establishing your business presence in China and will share some little known insights on how to save tens of thousands of dollars along the way.
Misconception # 1. An RO is the best way for incorporation in China.
Traditionally, most companies contact us to inquire about the office setup in China, and they initially gravitate towards an RO. If 10 years ago it was a commonplace practice and was the fastest and easiest way to get in, over the years it was replaced by the WFOE alternative. And there are at least 12 reasons why you too should stay away from an RO and establish a WFOE instead.
So in which cases does it actually make sense to establish an RO given all its limitations as described above?
Nowadays, ROs remain a rare choice for those multi-national companies that are simply looking to establish a foothold in China without hiring any more than 1-2 staff and without conducting any type of business activities.
What type of WFOE do most financial companies choose?
Until recently, the vast majority of the WFOEs were registered as Investment Consulting Companies (投资有限公司). However, in January 2016, the infamous P2P company named E-Zubao vanished with over $7.6 billion of customer funds and became the largest financial fraud case in China in modern history. It also happened to operate under a WFOE Investment Consulting License out of Shanghai. As a result, the Chinese government has placed a hold on all WFOE Investment Consulting registrations until further notice. That’s why going forward we recommend choosing the Management Consulting format (商务咨询有限公司).
Misconception # 2. I need to have a physical office before I submit for WFOE registration.
Unfortunately, most newcomers to the market fall into this trap and end up spending tens of thousands of dollars on an expensive office somewhere in downtown Shanghai. The matter becomes even more complicated because often local office building landlords refuse to rent without a local license, which forces business owners to turn to even more expensive service-offices. In turn, services offices do not always allow the use of their address for registration purposes and if they do, you should be ready to pay a hefty price for it.
So it all turns into a vicious circle – you need to have an office in order to apply for a license, but you need to have a license to be able to lease a moderately priced permanent office.
In reality these expenses and headaches can be avoided if you choose the right partner to help you with the registration process. Several city districts in major cities permit obtaining a virtual office address for registration purposes. It costs a fraction of a full office rent and gives you the flexibility to choose just the right size of the office to get your local business on the way while waiting for the license application to be approved.
Misconception # 3. I need to receive full paperwork for a WFOE before I can start hiring staff.
Although of course you do need a valid Chinese business license in order to be able to start hiring your local team, there are ways for you to expedite this process without waiting for your paperwork. The key here is the fact that it can be any license – e.g. of a local out-staffing agency that has the right to hire local staff and sign agreements with your offshore entity at the same time.
Misconception # 4. I need to put up a large chunk of money – hundreds of thousands of dollars – as charter capital.
This is another example of past legacies that have firmly embedded themselves into the minds of business practitioners in China. Not long ago, the Chinese government amended the requirements for charter capital utilization, which lifted the deadlines for mandatory capital infusions. So although it is advised that you list at least $140,000 of charter capital (which may vary depending on your company origin, business plan and corporate structure), there is no obligatory timeframe during which you need to deposit the stated funds. The good news is that you can use charter capital for OPEX. Therefore, you can simply inject the optimal amount of funds required to have your operations running smoothly.
Misconception # 5. I need to have in-house HR and an accountant specialist to service the WFOE.
Lastly, another managerial mistake that we often see among the newly registered companies is hiring full-time HR and accounting staff, while the company itself has no more than 20 staff. According to regulations, any local company in China must submit monthly reports to the local tax authorities, and process payroll and social benefits on behalf of the local staff.
The truth is, there is no need to hire an in-house specialist for that. There are plenty of part-time accountants and staffing agencies who can do this work at much better rates.
I hope these simple tips help you take the right first step when expanding your operations into China.
RO has no independent legal personality – inextricably linked to their parent company. RO is restricted to non-profit making activities (marketing, quality control, market research, liaison).
WFOE can be funded directly from the parent company without any limitations. Repatriation of registered capital is possible upon dissolution of the WFOE. Registered capital can be used to cover all the operating expenses. Under the new rules, WFOEs are required to inject an amount to cover sufficient costs of operations that then pre-determined minimums as the previous rules mandated.
RO cannot hire people directly and has to go through an outside third party agency such as FESCO or CIIC, etc., which often requires a minimum two-year contract for each local employee. The RO will pay an additional monthly fee per employee.
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According to the Chinese laws and regulations, the calculation of taxation of a RO shall be based on the costs and expenses incurred. That means, the more costs and expenses for a RO, the more taxation shall be paid. Instead, the calculation of taxation of a WFOE shall be based on the revenue and profit they get in China, moreover, the expenses and cost of the WFOE could be deducted from the revenue which can further reduce the profit tax burden of the WFOE.
RO is not considered a legal entity in China and therefore is not able to sign contracts or conduct any business activities.
RO can have a maximum of 4 foreign staff members. WFOE does not have such restrictions.
Since WFOE status in China is a limited liability company and separate legal entity, it can be protective for the parent company. In case of severe legal problems in China, WFOE will be sued and has to pay the burden locally. This will not affect the parent company. However, since RO is not considered to be a separate legal entity, any problems arising from its operation in China may translate directly to its parent company.
WFOE does not have any banking limitation within its license scope and has a full range of banking activities, while RO is limited to receiving funds from parent company and pay its own expenses.
One year, multiple entry for foreign staff.
WFOE has more autonomy on decision-making than RO.
Both options allow for 100% direct foreign control.
Average actual adjusted tax burden for RO is 11,69% and only 6,72% for WFOE. WFOE pays income tax and turnover tax, while RO pays on expenses incurred and personal income taxes.
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