Representative Office or WFOE, that's a question

Many foreign companies which are interested in the investment to mainland China are often faced with such a question – to set a foreign representative office or a wholly-owned foreign company? Which way is suitable for the status of the company?
Representative office (hereinafter referred to as “RO”)
Wholly Foreign Owned Enterprise (hereinafter referred to as “WFOE”)
(In this article, we focus on the discussion of the difference between a RO and a WFOE, particularly the difference between a RO and a WFOE engaging in the “wholesale” and “retail” business.)
These two kinds of establishment are both organizational structures of commercial organization established by foreign companies in China (except for those in Hong Kong, Macao and Taiwan), with the differences as follows.

Different Functions and Roles

The biggest difference of the two kinds of organizational structures lies in the functions, which lead to different liabilities and roles.
Generally speaking, RO as the spearhead of foreign enterprises in China exists for the liaison and market promotion, with main functions of operation natures of business liaison, product promotion, and market research, exchange of technology, preparation and assistance in mainland China in assisting the parent companies overseas.

RO itself has no qualification of a legal entity, with incomplete economic functions to engage in the commercial activities with common significance. RO cannot directly sign contracts with suppliers or customers in its own name and is not entitled to apply for the independent license of import/export, to apply for the qualification of a general taxpayer, to employ staff independently and to open an L/C account in banks. The expenditure of RO must be from the remittance of the parent companies overseas.

In the case of RO of the commercial companies, RO are often establishing under the following circumstances:

In the initial stage for a foreign company to invest in China, there is not much market information available. By establishing a representative office with fewer employees (generally no more than a staff of 10 employees), initial market situations can be obtained, commercial opportunities developed, company image set up and contact with cooperation partners established.
In the case that initial contact has been established with domestic enterprises, but the domestic suppliers can directly contact the foreign parent companies, including the signing of contract and delivery of goods in an industry, a representative office is more preferable for the supervision and day-to-day liaison.
WFOE is a foreign invested limited liability company, entitled to perform all duties of a common company, including signing contracts, employing staff, applying for the license of import and export, issuing various invoices, opening various accountants and engaging in financing etc. independently, on which it would be unnecessary for us to go into more details.
From the perspective of the dynamic functions of a company, a WFOE is far more advantageous than a representative office in its applicability, flexibility and expandability and the customers are expected to choose the organizational structure based on their actual situations.

Different Attitudes of Government

The entry permit and supervision of the government on the 2 organizational structures are different, generally loose for RO and strict on WFOE, which can be clearly seen from the industrial entry permit, taxation arrangement and approval of establishment etc.

At the very beginning, the Chinese Government only allowed the establishment of RO in many industries but not the establishment of foreign companies, which lasted for a considerable period of time. Since the 80s, Chinese Government began to allow the establishment of the representative offices and the restrictions on the establishment of foreign commercial companies were gradually relieved only after China entered into WTO. It can be said that only after the proclamation of Order No. 8 by the Ministry of Commerce in 2004, could the establishment of wholly foreign owned enterprises step into a period of rapid development. This year is 2006. It seems that the policies in some of the industries such as advertisement, petroleum etc. are still strict and it does not seem to be so easy to establish a wholly foreign owned investment enterprise in these industries. But it is comparatively easy to establish a RO and there does not exist much policy barrier for the establishment except for the industries such as banking.

Difference in Tax Policy

There exists a big difference between the tax policies for a RO and for a WFOE as follows:

Tax of RO:
The representative offices can be divided into 3 categories:

RO established by for foreign law firms, auditors, consulting companies, financial companies etc. in China
Owing to the fact that the services of such representative agencies in China can be regarded as service extension of their parent companies overseas, the business engaged in by the RO are not so different with those handled by WFOE. These companies belong to a special category, which are allowed to purchase invoices and pay taxes based on the normal rate of taxation.
RO established by foreign company in the fields of services, trade and agent business (belonging to the RO in common sense)
The official definition of them is as follows: The foreign permanently-based RO act as go-betweens for the customers of their parent companies in the services of introduction and agent business or provide their parent companies and subsidiaries with services, which cannot supply accurate data and vouchers such as contracts and agreements to make correct declarations on the income or permanently-based representative office which cannot supply sufficient certifying documents to prove where they handle their own products or handle products for others.
RO of this category are not entitled to sign contracts and collect payment. They mainly focus on the market promotion and commercial liaison with the tax payable calculated based on the their expenditures. The estimated rate of tax is approximately 10% of the expenditures.
RO of foreign governments or non-profitable international organizations in China. After going through the tax exemption verification by the tax authorities, such RO are entitled to apply for tax exemption.
Tax of WFOE is identical to that of the ordinary companies, to be levied based on the current tax policies of China, usually subject to an operation tax of 5% of the incremental income or a VAT of 17%, income tax of 25%, as well as other taxes.

Difference in Employment

The RO are not entitled to employ the staff directly, which must be processed through a third-party intermediate agency with relevant qualifications. The WFOE in China are allowed to employ their staff directly and pay the funds for the employees.

Difference in Financial Services

The RO may open accountants in banks and accept the payment in foreign currencies. However, the same can only be used for the day-to-day expenses. They are not allowed to open L/C accounts in banks and to accept other more extensive financial services.

However, the WFOE are entitled to open bank accounts of various types, so long as relevant requirements of the banks can be met. They can also enjoy the services of financing and financial management through various financial institutes.

Difference in Conditions for Establishment

There is no requirement on the capital for the establishment of a RO while the WFOE are required to inject the registered capitals in conformity with the investment scales. Minimum registered capital is RMB300,000 for a retailer commercial company in Shenzhen, and RMB500,000 for a wholesale company.

In the case of a RO, the requirement on the qualification and market position of their overseas parent companies are not so strict, while in the case of a WFOE, certain requirements exist for their overseas parent companies.

Difference in Process of Establishment

The difference is described briefly from the following aspects:

Time requirement
It takes one month for the approval of a RO. In the cases of a WFOE, it takes at least 2 month to complete the formalities. If it applies for the qualifications of a general taxpayer or an importer, one more month shall be added.
Register process
On-line application shall be submitted first for the establishment of a RO before handling the formalities with the Administration of Industry & Commerce.
For the establishment of a WFOE, the examination and approval of the Foreign Economic Commission shall be necessary before handling the formalities of business license etc.
Certificates obtained eventually
Some of the certificates are only for WFOE and not for the establishment of RO, such as the certificate of financial registration etc. Duration of operation approved will be 3 years for a RO and it will above 20 years for a WFOE.