China Procurement Centers Going WOFE Because It Makes Sense

Because Chinese goods are so cheap, a huge number of foreign businesses have set up procurement centers in China to oversee their China purchasing.  For many years, these China procurement centers were formed as Representative Offices because Chinese law did not allow such businesses to be Wholly Foreign Owned Entities (WFOE). 

That law recently changed and my firm has been inundated with converting these representative offices into WFOEs.  These procurement centers are taking advantage of Chinese law now allowing trading companies to form as WFOEs.  The typical procedure is to form a new China WFOE trading company and then "sell" the assets of the representative office to the new WFOE. The new WFOE is a Chinese entity and is subject to taxation in the same manner as are all foreign owned companies (WFOEs) in China.

Since Representative Offices in China are not permitted to conduct business in China, they are not subject to China's business income tax.  They are, however, subject to a 10% tax on their gross expenses.  This tax is not considered to be an income tax because under Chinese law, Representative Offices cannot earn income.  Procurement Center Representative Offices in China are converting to WFOE trading companies to take advantage of the following: 

1. Employment in China:  A Representative Office is not permitted to hire Chinese employees directly.  A WFOE can hire Chinese employees directly. 
2. Location of Operations in China:  A Representative Office is permitted to operate only in the city in which it is formed.  Any office in a different city requires forming a completely separate representative office.  Now that procurement centers are permitted to form as WFOEs, the Chinese authorities are beginning to crack down on those companies operating unregistered satellite offices. One government official told us "they" were no longer willing to look the other way on these violations.  The typical penalty so far has been to close down the offending office or offices and impose any previously unpaid taxes.  We are not aware of other civil or criminal penalties being imposed (even though available), but we expect to see those imposed on those companies that lag behind in getting legal.  Things are much more flexible for a WFOE.  The WFOE is formed in one city, but then, by using a simple notice procedure, can open up branch offices in other cities throughout China.
3. Taxation:  A WFOE trading company operating as a procurement center normally pays less in taxes than the equivalent Representative Office. This is because a Representative Office pays taxes on its gross expenses, not on its income.  If properly structured, a WFOE procurement center will earn little to no income in China because its revenues will be balanced out by its expenses. Since there is little to no income, there is little to no tax.  Because these WFOE procurement centers will normally pay little to no taxes on income, they typically need not worry about locating in a tax free zone and can focus on operational reasons in determining their China location.  This lack of income also means that even if China raises its tax rate on foreign companies to bring it into line with its tax rate on domestic companies, procurement center WFOEs will feel little to no impact.

Though converting from a Representative Office to a WFOE is initially fairly complicated, its long run costs savings makes it worth it for most foreign procurement centers in China currently operating as a Representative Office.