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One of the most intimidating questions faced by foreign companies that are interested in investing in China is to choose an appropriate status for their company. The choices lie between establishing an RO i.e., Representative Office, or WFOE i.e. Wholly Foreign-Owned Enterprise, or using the services of a PEO.
These options are basically different commercial organizational structures that are formed by foreign-invested commercial enterprises all across China, except for a few cities like Taiwan, Hong Kong, and Macao.
In line with this topic, this article shares:
- Comparison of RO (Representative Office) vs WFOE (Wholly Foreign-Owned Enterprise)
- Legal requirements and paperwork required to establish these organizations.
- The difference in tax requirements for RO and WFOE.
- What a PEO is and the benefits of using it in China
How to register a company in China – RO vs WFOE
The differences in both these organizational structures lie in their function that corresponds to their relevant roles and liabilities. Let’s take a look at each of these organizational structures.
What is a Representative Office?
RO serves the basic purpose of market promotion and liaison for the foreign-invested commercial enterprises in China. The specific functions of RO include technology exchange, target market research and product promotion, offering assistance to the overseas parent companies for operating in Mainland China, and the operational nature of business liaisons. As an individual and independent entity, RO holds no legal rights of its own and doesn’t possess complete economic functions to conduct commercial activities. The expenditure of an RO is conducted through the remittances of the overseas parent companies.
The limitations for a representative office include the inability to sign contracts with customers or suppliers using its name, to hire staff independently, to open an LC account in a bank, to request the qualification of a general taxpayer, and to apply for an independent import/export license. However, the representative office registration process is simpler than that of WFOE.
Circumstances for establishing a Representative Office
ROs are normally established under the following circumstances:
To enter the Chinese market
The establishment of a Representative Office is generally preferred when a foreign company initially decides to invest in China and lacks complete knowledge of the market. In this scenario, developing an RO with few employees (not more than 10) is helpful in gaining market insights. It further helps the foreign company in developing its company’s image – all the while finding new commercial contacts and opportunities during the process.
For supervision and daily monitoring:
A Representative office is generally preferable for the daily liaison and tracking of operations in a scenario where the initial contract has already been established with domestic companies, but the domestic suppliers can contact the overseas parent companies for different purposes like goods delivery or signing of contracts.
What is a Wholly Foreign-Owned Enterprise (WFOE / WOFE)?
Wholly Foreign-Owned Enterprise, in contrast to RO, is a foreign-invested limited liability entity that is legally entitled to carry out all the operations similar to that of a normal company. A WFOE is more beneficial than RO due to its more proper structure, expandability, and flexibility. A WFOE is allowed to issue invoices, open bank accounts, apply for import and export licenses, engage in fundings, hiring employees, etc.
Governmental treatment for RO and WFOE
As far as the government is concerned, it treats both the organizational structures differently. The supervision and entry-related permits like taxation agreement, establishment approval and industrial entry permits, etc., for RO, are a bit relaxed while they are strict for WFOE.
If we look into the background of the establishment of ROs and WFOEs, we find that the Government of China had never allowed the establishment of foreign invested commercial enterprises until the 1980s. Before this period, the establishment of RO was permitted to some extent however these restrictions were relieved considerably after China joined the WTO. The establishment of WFOE initiated after the proclamation of Order 8 in 2004, by China’s Ministry of Commerce. Even today, the formation of WFOE in some industries like petroleum and advertisements faces substantial restrictions, while it is much easier to establish an RO for all the industries except for banking.
Differences in Tax Policies
The differences in tax policies for RO and WFOE are listed below:
Taxes for RO
There are 3 types of representative offices:
1- ROs that are established in China by foreign law firms, financial companies, auditors and consulting companies.
These ROs serve as an extension of their overseas parent companies and hence the business activities in which such ROs are engaged is not so much different from WFOEs. Such as are allowed limited business operations like invoice purchasing and are also subject to the taxes based on the normal rate of taxation.
2- ROs developed by foreign-invested commercial enterprises in industries like trade, agent businesses, and trade.
These ROs are foreign yet permanently based companies and they as a bridge between the customers of their overseas parent companies to provide the services like agent business of introduction of services or the permanent RO that cannot provide proper documents to prove where they handle their customer’s products or even their own products. They also serve their parent companies and related subsidiaries with the services, which cannot supply the agreements and contracts to declare the income correctly.
Such ROs solely focus on corporate liaison and market promotion and are not allowed to collect funds or sign contracts. The approximate tax rate for the ROs in this category is around 10 percent of the expenditures.
3- Representative offices of non-profit international organizations or foreign government offices in China.
The ROs in this category are allowed to apply for tax exemption, once their verification is conducted by the tax authorities.
Taxation for WFOE
The taxes applied on WFOEs are similar to that of the normal companies. WFOEs normally pay a 5 percent operation tax of incremental income amount, 25 percent income tax, and a 17 percent VAT. Several other taxes also apply to this type of organizational structure.
1- Difference in the handling of bank accounts
WFOEs are allowed to open bank accounts of various types and they can also enjoy extensive financing services through different financial institutes.
On the contrary, ROs are not allowed to open L/C accounts. Neither are they allowed to use the financing services. Although RO can open a bank account and even accept payments in foreign currency, these funds cannot be utilized for day to day operations.
2- Difference in criteria for hiring staff
WFOE organizations are authorized to employ their staff and pay their salaries, while ROs cannot directly hire their staff and need to go through a third party agency to employ staff for them.
3- Requirements related to the capital amount
WFOEs need to submit the registered capital amount to confirm the investment scale while no capital is required for the establishment of RO. With regards to the WFOE capital requirements, the minimum amount for a retailer company is Shenzhen is RMB 300,000, while its RMB 500,000 to establish a wholesale organization.
The overseas parent companies of WFOEs need to meet strict requirements regarding market positions and qualification proofs, while the requirements for ROs are quite lenient.…
Formal processes for establishing ROs and WFOEs
China’s WFOE registration requires the scrutiny and approval of the Foreign Economic Commission before the process of a business license could start. On the other hand, the Representative office registration application form can be submitted online before the start of the formal processes at the Administration of Industry and Commerce.
The requirement of certificates
Both RO and WFOE are granted with the allowable years of operations, which are normally 3 years for RO and 20 years for WFOE. WFOEs need to acquire certain additional certificates that are not needed by ROs for example, a certificate of financial registration.
The approval of WFOE generally takes around 2 months, as the process is more formal. This time frame is increased by 1 month if it applies to the qualifications of an importer or taxpayer. On the contrary, the approval process of RO is just one month long. Besides, there is a possibility in the case of transforming the Representative Office (RO or Rep Office) into WFOE.
What is a PEO and what are the benefits of using it in ChinaA professional employer organization (PEO) is a third-party human resources provider that hires the employees on behalf of a company and takes over the co-liability of the employees of its clients. There is a co-employment arrangement when a partnership is developed between a business and a PEO. This implies that PEO service provide becomes the co-employer of the employees of an organization. In such a scenario, the PEO service provider manages the legal employment responsibilities of the employees, while the client still manages and handles the day-day activities of employees. A PEO can mostly help companies to free up time and resources which helps them to focus on the other business developing activities.
Benefits of using a PEO
- All the legal liabilities and employer responsibilities are completely transferred from a company to the PEO.
- It enables quick and easy expansion in the Chinese market.
- It provides the companies to explore new markets in a cost-efficient manner without the need to establish a company.
- Engaging the PEO provides the benefit for companies to have more time to focus on profit-generating activities.
- It can help support companies after any mergers or acquisitions.
- Engaging a PEO service provider helps minimize the cost and risk related to the hiring of employees and also provides a quick setup for companies to start a business.
- PEOs help to provide affordable benefits and insurance coverage. PEOs can use their number to obtain group insurance cost at a lower rate within a large pool of employers.
Risks of using a PEO
- There is very little control left for a company over how to influence things as all the details of Human Resources are directly taken care of by the PEO. Therefore, the addition of a PEO can cause the addition of extra steps in the communication of basic messages as some PEOs have the requirement of having all the communication pass through them, although these could be handled by the company itself.
- PEOs can also become expensive rather than forming an internal HR team, depending upon the size of the organization. Furthermore, it could also be really expensive to terminate the service with the PEO as there will be a different number of services performed by the PEO that could ultimately come over as a responsibility to your company.
- PEOs fully control the benefits and insurance. There is no flexibility outside the plan available with the PEO. The coverage may sometimes be inferior although the rates would be quite reasonable.
- The co-employment relationship can also result in loss of controls as PEO assumes all of the responsibility and liability for Human Resource. This could result in loss of control of benefits plans, risks and also lead to loss of the company’s culture as well.