Foreign investment into the People’s Republic of China (hereafter “China”) can be made via one of several types of investment vehicles. Choosing the appropriate investment structure for your business depends on a number of factors, including its planned activities, industry, and investment size.
In this part, we discuss:
- Representative office (RO);
- Wholly foreign-owned enterprise (WFOE); • Joint venture (JV); and
- Other options.
We will also discuss the impact of the Foreign Investment Law (FIL) on choosing the investment structure.
Representative office (RO)
An RO is an attractive way for foreign investors to get a feel for the Chinese market as it is the easiest type of foreign investment structure to set up. Unlike more robust vehicles, such as the WFOE, an RO is an extension of the foreign company without independent legal personality. That is to say, it does not possess the capacity for civil rights and cannot independently assume civil liability. When an RO signs a contract, it is the foreign company that is bound by the agreement.
Besides, there are only a limited number of activities an RO is permitted to be engaged in. ROs are generally forbidden from engaging in any profit-seeking activities and may only be used to facilitate the activities of the foreign company in China. These are:
- Market research, display, and publicity activities that relate to company products or services; and • Liaison activities that relate to product sales or services and domestic procurement and investment.
ROs acting in violation of their allowed activities will be fined, and their illegitimate income will be confiscated.
In addition, as an RO is not a capitalized legal entity in China, it is limited in its hiring ability. An RO cannot directly hire Chinese employees. Instead, it is required to employ local staff through a qualified labor dispatch agency. The agency acts as the employer for legal purposes, and sends employees to work at the RO for a fee. An RO may directly hire up to four foreign nationals as the representatives, and these do not need to go through the agency.
Even though an RO does not earn revenue, it is still subject to Chinese tax. ROs are taxed as a permanent establishment in China, which usually amounts to a liability of approximately eight percent of the total expenses of the RO.
“ Choosing an investment structure depends largely on your goals in China.For companies looking to target the Chinese consumer, the foreign- invested commercial enterprise (FICE) has become the gold standard investment model.”
RO is generally a good solution for companies that are procuring from China and want to keep staff on the ground for quality control, or for maintaining short communication lines with China-based suppliers, agents, and distributors.
Wholly foreign-owned enterprise (WFOE)
A WFOE is a limited liability company wholly owned by one or more foreign investor(s), which offers a very straightforward management structure.
Unlike an RO, a WFOE can make profits and issue local invoices in RMB to its suppliers. A WFOE can employ local staff directly, without any obligations to employ the services of an employment agency. A WFOE can also expand to create subsidiaries in China.
And compared to a JV, a WFOE has better autonomy and flexibility to execute the company policies intended by the investors without considering the Chinese partner. It is also believed to be better at protecting the company’s intellectual property and technology.
However, the set-up procedure of a WFOE is more complicated. And WFOE is not feasible if the targeted sector is listed as “restrictive” in the Special Administrative Measures on Access to Foreign Investment (“National Negative List”) or the Free Trade Zone Special Administrative Measures on Access to Foreign Investment (“2020 FTZ Negative list”), where foreign investors need to have a Chinese equity partner to form the business. In other words, incorporating a WFOE to engage in these sectors would not be permitted. Investors that try to do so will see their application denied. WFOEs that engage in these activities illegally after being incorporated face fines or even the cancellation of their business license.
There are three distinct WFOE setups available:
- Service (or consulting) WFOE;
- Trading WFOE (or foreign invested commercial enterprise [FICE]); and • Manufacturing WFOE.
While all three structures share the same legal identity, they differ significantly in terms of their setup procedures, costs, and the range of commercial activities in which they are allowed to engage. Trading WFOEs and manufacturing WFOEs must derive the majority of their revenue from their namesake business, but can also provide associated services. Service WFOEs are additionally permitted to conduct trading activities related to their services.
Joint venture (JV)
A JV is formed by one or more foreign investor(s), along with one or more Chinese party(-ties). Previously, Chinese individuals are explicitly excluded to be the shareholders in a JV with few exceptions. However, under the new FIL, which took effect from January 1, 2020, this limitation was no longer existed. Chinese individuals could jointly invest with foreign investors, which offers more flexibility in choosing business partners.
There are mainly two reasons for foreign investors to choose a JV structure:
- The foreign investor wants to invest in a restricted industry sector, where the law permits foreign investment only via a JV with a Chinese partner; and
- The foreign investor wants to make use of the sales channels and network of a Chinese partner who has local market knowledge and established contacts.
Before the FIL enacted, there were two types of JVs in China, and they differ primarily in terms of how profits and losses are distributed:
Equity Joint Venture (EJV):
- Profits and losses are distributed between parties in proportion to their respective equity interests in the EJV;
- Generally, the foreign partner should hold at least 25 percent equity interest in the registered capital of the EJV; and • An EJV should be a limited liability company.
Cooperative Joint Venture (CJV):
- Profits and losses are distributed between parties in accordance with the specific provisions of the CJV contract; and
- A CJV can be operated either as a limited liability company or as a non-legal person.
With the new FIL coming into force, the newly established JVs will be subject to the provisions of the Company Law, which implies changes in many aspects, such as governing structure and operating rules. However, JVs established before January 1, 2020 following the old EJV Law or CJV Law will have a five-year transitional period to arrange relevant transitions to be compliant with the new requirements.