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WFOEs, JVs and ROs: A summary of China’s legal entity options for expanding businesses

As the world’s second largest economy and most populous country, China is a magnet for foreign investors. Despite its appeal, however, China poses considerable and unique challenges for multinational companies looking to expand. The first step to overcoming these challenges is understanding China’s legal entity options, which allow multinationals to perform business activities in the country.

Expanding companies must choose the optimal legal entity based on the benefits, limitations and costs of each and the company’s own situation and goals. This article provides an overview of China’s legal entity options for foreign investors. Entities are often referred to locally as foreign invested enterprises, or FIEs.

Wholly foreign-owned enterprise (WFOE)

Description and benefits

A wholly foreign-owned enterprise is entirely owned by foreign investors and is the most popular foreign investment vehicle in China. A WFOE — pronounced “WUH-fee” — is a limited liability company. The term is used interchangeably with the term “enterprise with sole foreign investment” in China’s official English-language documents. There are three commonly used WFOE types: services, trading and manufacturing, each with its own permitted activities and registration requirements.

A WFOE’s capital is provided solely by the foreign investor, who must open a renminbi (RMB) basic account and capital bank account with a domestic bank or other state-approved foreign bank. The investor must also go through foreign direct investment (FDI) registration with the State Administration of Foreign Exchange (SAFE).

A WFOE can employ local workers, make profits and issue local invoices in RMB. It may also remit profits outside China as an exception to exchange control rules.

A WFOE provides more independence, flexibility and control for foreign investors relative to other entity types, along with providing intellectual property rights. Multinationals entering China should register to protect their IP with the Copyright Protection Centre of China, or CPCC.

Drawbacks

Establishing a WFOE (or a joint venture, described below) may take a longer time relative to other legal entity types, and may in the short term be relatively expensive. However, in recent years China has taken steps to widen the WFOE’s potential investment scope, as well as streamlining establishment and licensing procedures. The approval process — after the required documents are submitted — can take about three months, depending on the nature of the business activities.

While a WFOE provides flexibility, its business activities require prior approval, and any deviation will require further consent from local authorities. Operating periods must also be extended with official approval. In addition, because a WFOE is solely owned by foreign investors, it does not offer some of the advantages gained from partnering with a local company, which may include potential immediate access to local facilities and networks, employees and an established customer-base.

Joint venture (JV)

Description and benefits

A joint venture in China is a limited liability company comprised of a foreign joint venture party and a Chinese joint venture party. To obtain a JV business licence, the parties must submit a locally compliant shareholders’ agreement and articles of association to Chinese authorities.

The foreign-held stake in a JV is typically at least 25 percent of the total registered capital. The Chinese joint venture party’s stake may include the use of local facilities. Other assets such as intellectual property rights may also contribute to registered capital if approved by authorities.

There are multiple JV types. Under an equity joint venture (EJV) arrangement, profits are distributed in proportion to each party’s registered capital. Under a cooperative joint venture (CJV) arrangement, certain proportions may be negotiated, such as those related to control, profit and risk.

A foreign joint venture party may remit its portion of profits outside China. In addition, the law positively encourages JVs to market their products internationally, and if necessary establish branches outside the country. A JV must open a bank account that is approved by Chinese authorities.

Drawbacks

As mentioned, JVs must be approved by local authorities, and the entity structure is subject to standards and limitations. Foreign investors should also consider China’s negative list, which relates to industries and sectors where foreign investment is precluded. Ideally from the outset, a foreign venture party should consider both its immediate and future business activities, to avoid the need for troublesome amendments to the JV business license at a future stage. 

As with any partnership in any jurisdiction, an investor should enter a JV only after conducting thorough due diligence on the proposed partner. This process should include gaining a firm understanding of the partner’s financial health, brand reputation, corporate and cultural compatibility, and other factors.

Depending on the foreign joint venture party’s home country, cultural differences may present unforeseen future problems — including legal disputes — after an agreement is reached. In extreme cases, there may be disputes over intellectual property. If a JV’s board cannot resolve a dispute, under JV laws the partners should pursue a settlement through either mutual agreement or arbitration.

Representative office (RO)

Description and benefits

A representative office is more formally known as a resident representative office of a foreign enterprise. Compared to a WFOE or JV, an RO offers a relatively quick and inexpensive way to establish and maintain a China presence. No registered capital is required to establish an RO.

A foreign enterprise may appoint one to four representatives to an RO. By law, an RO may not conduct profit-making activities, but may engage in: market study and promotion of products or services; and liaison activities related to product marketing, service delivery, and domestic procurement and investment. An RO may be suitable for multinationals who seek an entry point to explore China’s market. The entity can provide a platform for feasibility studies before transitioning to either a WFOE or JV structure in the longer term. 

Drawbacks

As mentioned, ROs are strictly limited in their activities and may not turn a profit or issue invoices. If an RO is found to have engaged in profit-making activities, local authorities are authorised to exact fines and confiscate any illegally made income. 

The law states that an RO does not have the status of a legal person, or entity. In other words, an RO is in effect an extension of the foreign enterprise. It therefore does not provide a layer of legal protection for the enterprise should a dispute arise. This also limits the ability of an RO to directly employ local employees. In such cases, an RO must make use of employer-of-record services (described below).

Another option: Employer of record (EOR)

In certain limited situations, a multinational may employ local employees in China using employer-of record services. An EOR — sometimes referred to as a professional employer organisation (PEO) — is a third party that has an established legal entity in China and acts as the local employer on behalf of the client, in this case the foreign enterprise. The EOR hires local employees for the client, provides payroll and HR services, remits income taxes, and manages local social security benefits.

It needs to be stressed that in China, EOR engagements are not intended to be permanent solutions, nor should they be seen as a long-term alternative to establishing a legal entity. EORs are a legislative grey area and should be used for very limited employee counts and short durations.

Multinationals looking to successfully invest in China — whether they establish a legal entity or use EOR services — should seek expert advice at an early stage so they can understand their market-entry options, including the risks and benefits of each.

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