A Comparison of China Company Structures
When foreign investors are considering establishing a company in China, deciding on the right market entry vehicle or in other words deciding on the company structure to start operations in China is crucial to understand. The appropriate mode of entry when setting up a legal presence in China depends on multiple parameters, with the intended business activities and industry in China in which a foreign investors wishes to operate being the most important considerations.
According to Chinese legislation, we can identify three main company structures through which foreign investors can establish a presence in China. These company structures include 1) a Wholly Foreign-Owned Enterprise (WFOE or WOFE), a Joint-Venture (JV) and a Representative Office (RO). Although some less utilized investment vehicles exist, they are excluded from this article due to their limited application in practice. In this article we will further examine the different legal company structures in China available to foreign investors and will enumerate on their differing requirements as well as the advantages and disadvantages associated with these investment vehicles.
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Regulating Foreign Investment into China
Before explaining the different company structures available to foreign investors considering to establish a company in China it is important to understand the essentials on how foreign investment into China is regulated. Following the implementation of the new Foreign Investment Law (FIL) as of January 1st, 2020, foreign investment into China is based on the principle of National Treatment, which implies that except for specific requirements pursuant the Negative List for Foreign Investment into China, the Chinese authorities should treat foreign investors equal to domestic investors.
Here the so-called Negative List for Foreign Investment into China governs and provides guidance to business sectors and industries where possible restrictions and prohibitions can exist. The company structure which a foreign investor can choose to enter the Chinese market depends on whether a particular industry is stipulated within the Negative List, where the Foreign Investment Negative List (FINL) specifically denominates sectors where foreign investment is restricted or prohibited. For example, if a particular industry is included in the Negative List it may only be feasible to enter this sector through a Joint Venture rather than a WFOE.
Different Company Structures in China
As mentioned in the introduction of this article, the main company structures available for foreign investors to set up a presence in China are the WFOE, Joint Venture and Representative Office and in the section below we will discuss these investment vehicles in-depth.
Wholly Foreign-Owned Entity (WFOE)
A Wholly Foreign-Owned Enterprise or WFOE is the most common and generally preferred investment vehicle for foreign investors. A WFOE is a Limited Liability Company (LLC) which is established exclusively through a foreign investor’s capital (hence the denomination “wholly foreign-owned”) and therefore is the China company structure for foreign investors to retain the greatest level of control and independence in matters of the company’s operations, strategy and human resources.
The following are some of the important features of a WFOE:
- A Wholly Foreign-Owned Entity is a separate legal entity and as a Limited Liability Company the liability for the foreign investor is limited to the amount of registered capital contributed by its shareholders.
- The shareholders of a WFOE must contribute an amount of registered capital to the company, however, the law does not stipulate a required minimum and the registered capital can be contributed over a 30-year period.
- In general, a WFOE can engage in any commercial activities such as services, trading and manufacturing provided that these business activities are not part of the Negative List.
- The WFOE can hire both foreigners and local Chinese employees directly without limitations on the hiring process.
It should be further noted that we can broadly distinguish between three types of WFOE, namely:
- The Consulting WFOE: licensed to operate as a consulting business within the service industry.
- A Trading WFOE: which in addition to providing services is licensed to conduct trading, wholesale, retail and franchising activities in China. This type of WFOE can additionally also apply for a customs license to independently import/export goods in/from China.
- Manufacturing WFOE: in addition to consulting and trading activities, the manufacturing WFOE can legally also engage in manufacturing and assembling processes. Although the process of registering this type of WFOE is similar to the aforementioned WFOE types, an additional environmental impact assessment must be performed.
Because the WFOE structure provides foreign investors control over the company’s operations and full claim to a the profits of the Chinese entity, the WFOE is the preferred option for foreign investors to establish a presence in China provided that the industry in which the company operates and consequently the business activities it performs is not limited by Chinese regulations.
To learn more about the establishment of a WFOE in China, please request a free copy of our WFOE in China White Paper.
Joint Venture (JV)
Similar to a WFOE, a Joint Venture is a Limited Liability Company (LLC), however, it is established through a partnership between a foreign investor and a Chinese company or individual (hence it is referred to as a “Sino-Foreign Joint Venture”).
The important features of operating a Joint Venture in China are the following:
- As the management of a Joint Venture is more complex due to the involvement of several shareholders with diverging interests, the shareholder agreement plays a crucial role in defining the rights and responsibilities of the parties involved in the partnership. This constitutional document must be additionally prepared during the incorporation phase as compared to the establishment of a WFOE.
- Same to a WFOE, a Joint Venture the investors are limited in their liability to the amount of registered capital they contributed respectively.
- Joint Ventures can engage in any commercial activities in China and may provide the opportunity to access industries or perform activities which would be limited to WFOEs as per the Negative List.
- A Joint Venture can also hire both foreign and Chinese employees without direct limitations in the hiring process.
The Joint Venture structure is frequently utilized to access areas of business in China which are (either directly or indirectly) restricted or prohibited by Chinese regulations or are intended to leverage the local knowledge and network of the Chinese counterparty. Nevertheless, Joint Ventures tend to be more complex to manage due to potentially diverging interests of the shareholders as well as the methods in which shareholders can exercise control over the operations of a Joint Venture.
As such, foreign investors should carefully consider the establishment of a Joint Venture and clearly define the rights and responsibilities of the parties in the partnership and the structural details of the company during its establishment phase. Please request a free copy of our Joint Venture White Paper to learn more about establishing of a Joint Venture in China.
Representative Office (RO)
Whereas the aforementioned company structures are considered separate legal entities it is important to note that a Representative Office is considered an extension of its headquarter, and therefore is generally considered as a type of “liaison office”.
A Representative Office is defined and limited by the following important features:
- A Representative Office is only allowed to conduct marketing and research activities for its headquarters and to act as a liaison to coordinate with business contacts on behalf of its parent company. This means that the Representative Office cannot engage in any commercial activities, including the issuing of invoices to customers, signing of contracts and collection of revenue.
- Although a foreign investor does not have to contribute any capital to a Representative Office, the headquarter bears full responsibility for the conduct and full liability for the Representative Office.
- The Representative Office can directly employ up to 4 foreigners (“representatives”, including one Chief Representative and up to three General Representatives). However, a Representative Office cannot directly employ Chinese staff and instead must rely on a third-party service provider to hire Chinese staff on its behalf.
Due to its limitations the Representative Office structure is not always considered the most optimal mode of entry into the Chinese market. Because it is legally not feasible to change a Representative Office structure into either a WFOE or Joint Venture it is essential for foreign investors to consider the range of business activities they wish their Chinese entity to perform at the moment of market entry as well as the range of activities it may need to perform in the future before the establishment of a Representative Office.
Summary of Different China Investment Vehicles
The below table provides a summary of the comparison of the important features of the three main company structures available to foreign investors to enter the Chinese market:
Compliance and Taxation of China Company Structures
Once a foreign investors has established a Chinese subsidiary, it is required to complete several administrative and compliance requirements on a monthly, quarterly and annual basis. In this section we provide a brief enumeration of the compliance and taxation requirements facing the legal company structures as discussed in this article.
All companies in China must maintain a reliable record of accounts in line with the Chinese Accounting Standards (CAS), also referred to as PRC GAAP and submit on a monthly basis their Balance Sheet and Income Statements to the Chinese tax authority when completing monthly tax filings. Whereas the Chinese Accounting Standards stipulate that “accounting should be based on the accrual basis” for for-profit enterprises (incl. WFOE and JV), it is important to note that Representative Office have to follow cash-based accounting (our full article on accrual- vs cash-based accounting contains further information).
Furthermore, all foreign-invested enterprises in China, including WFOEs, Sino-Foreign joint Ventures and Representative Offices, must complete the following annual statutory requirements (please refer to our full article on annual audit and compliance in China for more information):
- A year-end statutory audit (by a qualified CPA);
- An annual Corporate Income Tax Filing;
- Publishing of the annual publication report.
Lastly, most companies in China must complete several taxation requirements, including the filing and payment of Corporate Income Tax (CIT), Value Added Tax (VAT) and Surtaxes, as well as those for Individual Income Tax (IIT) and social security contributions (for a complete overview, please refer to our article on monthly, quarterly and annual compliance). It should be noted however that because representative offices cannot engage in commercial activities, their taxable income is calculated based on the company’s actual expenses, over which enterprise income tax and value added tax is calculated.
As discussed in this article, there are several company structures available to foreign investors wishing to enter the Chinese market, including the Wholly Foreign-Owned Enterprise (WFOE), Sino-Foreign Joint Venture (JV) and the Representative Office.
When foreign investors are considering establishing a company in China, deciding on the right company structure to start operations in China is crucial and will depend on several factors such as the intended business activities and industry in which the investor wishes to operate. Furthermore, foreign investors should carefully consider the legal limitations as well as the advantages and disadvantages of the various company structures before establishing a presence in China.
We have advised numerous companies on their China market entry strategy and the legal structure of their investment, which has enabled our clients to be well equipped for doing business in China. If you are considering to set up a company in China and require any advice or support regarding the different investment vehicles available to start operations in China, please do not hesitate to contact us at firstname.lastname@example.org.
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