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This article is authored by Flora Luo (Executive Director, Nexia TS Shanghai) and Dr. Scott Heidecke (Senior Consultant, Nexia TS Shanghai).
During the double-digit GDP growth years leading up to China’s modernised Enterprise Income Tax (EIT) law in 2008, most foreign companies conducted business in China in one of two ways. Many took advantage of tax breaks and inexpensive operating costs by establishing joint venture or Wholly Foreign-Owned Enterprise (WFOE) manufacturing companies, which produced goods for export and consumption outside China. Others chose to source goods in the country and establish Representative Offices (ROs) to assist with the process.
Considerable change has taken place since 2008, not only because of more moderate GDP growth and the evolving taxation system, but also as a result of the increasing number of foreign-invested entities directly selling goods and services into an expanding Chinese market.
A RO is established without any capital investment, and allows the foreign parent company to conduct necessary business dealings in China without the RO performing any of the direct profit- Global Insight April 2018 | 12 making activities. The structure is ideal for those that source goods in China and simply want local personnel in place to assist with purchasing negotiations and quality monitoring.
Meanwhile, a capital-invested WFOE is a fully operational business entity, legally separate from its parent company, and capable of conducting all manner of business, just as domestic Chinese companies do. Before 2008, ROs were commonly exempted from EIT. This is no longer the case, and since RO taxation can now exceed that for WFOEs, many foreign companies are re-evaluating their RO business structures.
Where a foreign company requires a presence in China and is deciding between a RO and a WFOE, it must evaluate its long-term goals. If it is only sourcing goods with no intention to ever sell goods or services in China, an RO is likely to be the best option. They are easier to set up and to exit, and if planned appropriately, taxation can be on a par with a WFOE.
However, if the ongoing sale of services in China is expected, a properly planned WFOE is usually preferable. For the sale of goods, a WFOE is usually only necessary where both sourcing and sales occur within China.
As China’s economy continues to mature, the country offers a vast market for both goods and services supplied by foreign entities. This trend has inspired the conversion of many ROs into WFOEs. At the same time, the elimination of tax exemptions for ROs has led to an increase in RO closures and a decrease in new RO registrations.
Many companies now prefer to conduct business in China entirely cross-border. The choice of most suitable method is subject to numerous considerations. It is therefore essential that businesses engage a knowledgeable adviser to help make the right decision.
For more information, please contact:
Director of Global Expansion & Tax Advisory,
Nexia TS Shanghai
Dr Scott Heidecke
Senior Consultant, Nexia TS Shanghai