With a quick set-up procedure and low initial costs, many foreign
investors use the Representative Office (RO) to make their first entry
into China. However, as a company’s operations in China develop
and expand, investors often run into the constraints that the RO
structure imposes.
As we shall discuss in more detail throughout this report, a
Representative Office is quick to attract a high tax burden when its
activities in China increase.
In addition, China’s corporate laws demand strict adherence to an
entity’s business scope. By its very nature, the business scope of
the Representative Office is very narrow. Expansion plans may soon
run into legal obstacles. This is because the RO is not intended
to be an investment vehicle, but rather to provide some ancillary
functions in China for foreign companies based abroad. In this way,
the Representative Office acts merely as a cost center.
At this point many investors start looking at the option of setting up
a Wholly Foreign-owned Enterprise (WFOE).
The key difference between these entities is that a WFOE is an
independent legal entity under Chinese law, whereas an RO is seen
as an extension of a foreign company incorporated abroad.
Setting up a WFOE offers investors all the options of a a full-fledged
subsidiary. For a full transition, the investor needs to shut down the RO.
This is because certain costs associated with operating an RO cannot
be eliminated without closing it down, such as office rent and taxes.
Investors should note that one cannot simply stop paying for the
RO’s expenses and walk away. This would result in the investor being
blacklisted and barred from doing business in China. The new WFOE
would then almost certainly be shut down as well.
In this report, we outline what the procedure looks like, and what the
optimal timing would be.
INTRODUCTION
ALBERTO VETTORETTI
Managing Partner
Dezan Shira & Associates
Alberto@dezshira.com