WHOLLY FOREIGN OWNED ENTERPRISE
A wholly foreign owned enterprise (WFOE) is a limited liability company 100 per cent owned by one or more foreign investors, and today is the most common and preferred choice of entity for foreign investment in China.
There are a number of reasons for this. Firstly, a WFOE gives the foreign investor(s) total ownership and management control free from interference by Chinese partners (as may occur in joint ventures), thereby eliminating the risks associated with choosing the wrong local partners. Secondly, unlike a representative office, a WFOE can engage in profit-making activities, issue invoices, and directly hire employees without the need for engaging the services of an employment agency.
Furthermore, profits earned may be remitted back to the parent company and/or the overseas investor(s). A WFOE also has an independent legal personality separate from the parent company, meaning that it can execute contracts with other entities and with individuals, and is ultimately responsible for its own liabilities and obligations, which significantly reduces the legal risk for the parent company. Additionally, its limited liability form means that the liabilities of the foreign investor(s) are limited to the total investment (both registered and paid-up capital), and thus the investor(s) generally cannot be held liable for debts exceeding the total investment.
Despite the above advantages of the WFOE structure, however, there also exist a number of disadvantages, although these are negligible. For example, the application and registration process is more complicated than that of a representative office, and is therefore more time consuming and expensive. Furthermore, a WFOE has a registered capital requirement, which a representative office does not. This basically means that funds from the overseas investor(s) need to be contributed over the life of the company.
The permitted activities in which the WFOE can engage are also limited to its business scope specified during the application process. This makes sudden changes in business strategy and operations outside the business scope difficult, as the WFOE will need to go through the cumbersome and time-consuming process of applying to the relevant authorities to have it modified.
Furthermore, a WFOE is also restricted or prohibited from operating in certain industries, which are specified in China’s Negative Lists. Usually updated each year, there are two Negative Lists applying to foreign enterprises, with one being applicable nationally and the other in Free Trade Zones. Therefore, before proceeding to set up a WFOE, the company’s business scope will need to be determined together with the general purpose of establishing the entity. If it is in conflict with Chinese laws and regulations, the investment structure may need to take the form of a Joint Venture (JV) or a Variable Interest Entity (VIE) structure.
A final disadvantage of a WFOE, from an operational point of view, is the lack of local business knowledge, expertise and connections, and potential access to government support, that a JV with a Chinese partner may bring.
There are a number of different types of WFOEs, including, but not limited to, the following:
- Consulting / Services
- Food & Beverage
- Technology Development
While the above WFOE types all have the same legal identity, the registration procedures can differ slightly, as some WFOE types require additional documentation, approvals and licenses. A restaurant, for example, requires licenses from the food authorities and fire protection authorities, whereas a consulting company does not require these.