A strategy sometimes followed in China is to first open a smaller, simpler Representative Office (RO or Rep Office) company with the intention to later convert it to a more complete WFOE. Whilst this may make sense in some cases, companies need to be aware of the challenges. This article will explain to you how to transform a Representative Office to a WFOE and in the specific:
- That there is no simple “upgrade” option to convert a RO to a WFOE.
- The process is long and costly, and basically involves the creation and financing of two companies.
- It may still make sense for some companies, it just depends on their situation and China plans.
Representative Offices and WFOEs
Representative Offices (Rep Office or RO) and WFOEs are the most prevalent structures for foreign companies in China, both allowing independent foreign control of the company. They are however quite different, with Representative Offices being much more restricted in the business they can conduct, and not able to derive a profit in China.
Many companies are attracted by the simpler setup, cost and ongoing maintenance of a Representative Office, and indeed that will suit some companies either initially or for the long term, depending on their planned business and growth. For many however, there comes a time when they look to switch to a WFOE.
Why transform a Representative Office to WFOE ?
We see several reasons why companies with a Representative Office later choose to move to a WFOE structure. These include:
- They planned the RO just to conduct initial market research or administrative activities and now want to start profit-making business in China.
- The business has expanded and the RO structure is now too limiting.
- There is a growing need to issue invoice / Fapiao in local RMB currency.
- RO operations have grown and the tax liability is now too high – a WFOE would lower it.
No simple conversion
Unfortunately, there is no simple prescribed procedure to convert a foreign-owned RO into a WFOE. Despite the fact that this is a situation company often find themselves in, the strict company registration and management procedures in place in China do not make allowances for any form of transfer.
Essentially, the RO needs to be fully closed down and an entirely new WFOE structure registered and licensed. Both of these can be long and complex processes. As such, we would not recommend closing the RO before setting up the WFOE. Indeed, the best way is to start the RO closing procedure only after the WFOE setup procedure is well underway.
If this is not done, the RO may find themselves stuck in a lengthy period where they are not able to continue any of their business activities, and could have issues maintaining employee contracts and salary payments.
The Process – close the Representative and open a WFOE
As discussed, in general, the best process to follow is to first start the WFOE registration process and then close the RO. This allows for better business and employment continuation, but of course, brings with it an enhanced burden of extra cost and administration to deal with two company structures.
There may be situations where a different process is better, we would always advise discussing your situation with a professional. For example, a simple RO that has little or no contracted staff and very simple operations may not be harmed by first closing than starting the WFOE registration.
STEP 1 – Register the new WFOE
Start the procedure to register the new WFOE. The first step of this is to apply for approval for the new company through MOFCOM. Once this is obtained, the application can be made for the main business license and other licenses/permits through the local Administration for Industry and Commerce (AIC).
Various sets of documentation will need to be prepared for this application, much of it new or different to existing RO details. In particular, note the following:
- A detailed Articles of Association document is required, with specific content and formatting.
- A capital injection schedule should be decided on and documented (and will be difficult to change later).
- A defined Business Scope needs to be set that will affect what activities the new WFOE can conduct. This will differ from the RO so needs to be thought through.
- An Actual Controlling Person needs to be identified for the WFOE. This can be an organization or an actual person (within limits). The responsibilities differ from the RO chief representative.
For full details of the WFOE setup procedure, documents required and other advice, see our WFOE guide.
STEP 2 – Transfer employees to WFOE
Once the WFOE is registered and has a business license issued, employee contracts can be transferred over. Chinese employees working for the RO will have been hired through a Chinese Dispatching Agency and these contracts will have to be terminated. Doing this at this stage of WFOE setup means that a new contract can then be signed almost immediately with the WFOE.
Of course, there are various negotiations and preparations that will have to take place before this. Such as deciding which (if not all) staff to transfer across to the WFOE, agreeing to new contract terms with the staff, and agreeing termination time and conditions with the Employment Agency.
STEP 3 – Close the Representative Office
The process of closing the Representative Office is known as de-registration (unlike WFOE closure which is referred to as liquidation due to its legal status).
Overall, this process typically takes 4 to 6 months but can take much longer if there are delays or challenges from the tax bureau or other authorities along the way. The process should be maintained and followed to a conclusion, but if done correctly should have minimal impact on the WFOE getting started to conduct business.
The following is an outline of the de-registration tasks required:
- Conduct final tax audit (with Chinese licensed accountancy) for all taxes paid and owing, and settle any outstanding payments or penalties with tax bureau.
Some tips for conversion
- Make sure you understand and prepare for the tax, administration and audit requirements for the WFOE. A WFOE has much more substantial administration, audit and compliance requirements than a RO. This, as well as a different taxation scheme (based on profits rather than expenditure), means potentially higher costs and time required to manage from the outset.
- Consider when to transfer staff from the RO to the WFOE.
Plan carefully when employees will transfer and ensure everyone is aware. Issues here could cause delays in company operation or cause staff to be lost. As suggested previously, the most appropriate time to make the employment contract transfers is whilst the RO still exists and after the WFOE is licensed. Additionally, though the company should ensure that bank accounts are set up in time, and capital injection to make salary payments is either completed or planned soon. Otherwise, funds may not be available to make first salary payments.
- The closing down procedure for a Rep Office needs to be completed fully and correctly.
This is important as if the RO stays registered but unmaintained, fines and penalties will be issued. The Chief Representative can also be blacklisted and prevented from future company ownership in China.
Is it worth opening a Representative Office first?
Given the challenges in converting from a Representative Office to a WFOE, is it then worth it at all to take this route?
Well, like most business operations it depends on the company circumstances. Whilst first having a Representative Office then moving to WFOE means two company set up processes (and corresponding cost and time effort), it can still make sense for some companies. Some examples include:
- If the planned operating time of the Representative Office is long enough to justify the lower costs of operating over this period.
- A company may prefer to manage their risk and embark on the less costly, less involved Rep Office first – particularly if they are not sure about future operations in China.
So, it can make sense – it just needs to be thought through and justified beforehand!