Establishing a Sourcing Entity in China

China is in a constant state of flux, and the legal environment is certainly not immune to this reality. As a foreigner your behavior is often scrutinized more than a local so you need to constantly be aware of the legal bounds under which you and your business operate. This article attempts to provide an overview of typical legal set-up options for a sourcing company in China, including RO (Representative Office), WFOE (Wholly Foreign Owned Enterprise) and FICE (Foreign Invested Commercial Enterprise).

Choosing the proper set-up

The overall objectives of your operation are the most significant aspect to consider when establishing an entity in China. What are your short and long term goals? What types of products do you want to source? Do you want to distribute, assemble, or manufacture products domestically? Do you plan on employing local staff? The answers to these and other questions will help define your objectives so that you can formulate a legal strategy that best serves them.

It is important to note, that no one legal solution exists to accommodate all of your unique conditions. Therefore, the more detailed your understanding of your objectives, the better equipped you are to make good decisions. Further supplementing your understanding with proper due diligence is always important when making decisions of such lasting consequence. Let us now take a look at typical legal set-ups for trading companies.

Representative Office (RO)

This formation is popular because (1) the registration process is shorter in duration and usually easier to complete, and (2) there is no minimum level of capital investment required. An RO will be suitable if its planned functions are simply liaison, market promotion or research. For sourcing companies, it will mean you have to give up a significant amount of control over your operations. All transactions must originate from abroad, and you are required by Chinese laws to heavily rely on 3rd party services providers, such as an Import/Export agent, Logistics provider, and HR outsourcing agent.

International Trading Wholly Foreign-Owned Enterprise (WFOE)

With official minimum registered capital of RMB 100,000 for a single shareholder company (but closer to USD 60,000 to 70,000 in practice), an International Trading WFOE allows added control over your business operations. However, the enterprise must be located in a Free Trade Zone (FTZ) and it is usually limited to export activities. Those that wish to distribute within China must either use a 3rd party distributor or apply for a separate import/export license (which essentially qualifies them as a FICE in a FTZ).

Foreign-Invested Commercial Enterprise (FICE)

Unlike the Trading WFOE, a FICE has the ability to import and locally distribute on top of export activities and may also qualify for retail activities. Both have the same level of required minimum investment, but in practice the FICE necessitates substantially higher levels (about USD140,000). The registration process is also more complex compared to that of a trading WFOE. A major issue to consider when evaluating the advantages of a FICE is location. Specifically, operating inside or outside of a Free Trade Zone significantly alters the investors options.

FICE inside a Free Trade Zone

A FICE operating inside a FTZ enjoys freedom in its business scope, but at a price. The FICE is unlimited in terms of what can be traded so long as it does not belong to a prohibited trade category according to the Chinese laws. A major drawback from operating inside the FTZ is that VAT invoices can only be issued through the relevant governing authority, creating a fair bit of logistical hassle. Additionally, you will undoubtedly pay a premium to exist in the FTZ - costs of services, talent, office space, etc tend to be higher. Finally, it will be more difficult to establish branch offices in other locations.

FICE outside a Free Trade Zone

Outside a FTZ, a FICE’s trade activities are limited to those relevant to its stated business scope. But it also enjoys some advantages. Unlike operating in a FTZ, the FICE is able to issue its own VAT invoices, operational costs may be significantly less, and branch offices can be set up more flexibly.

Manufacturing + FICE

Enterprises looking to incorporate manufacturing activities with its trading business can explore setting up a Manufacturing entity with an extended FICE status. However, such entities must maintain an above-50% revenue stream through its manufacturing activities. Historically, this requirement acts as a measure to prevent enterprises from abusing such entity status to access preferential tax policies granted to manufacturing enterprises. Even though the new corporate tax law has scrapped most of such preferential treatment, the authorities may still scrutinize enterprises enjoying tax incentives due to their encouraged status (eg. High and New Tech Enterprises).

Business registration is a complex process that involves navigating China’s far-reaching bureaucracy. While it is not compulsory, using a specialist service that understands not only the legal environment, but also the objectives of your business is highly recommended. Selecting the optimal legal entity from the beginning is crucial to your success in China. Don’t proceed without a thorough understanding of the legal implications of your actions.

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For more information on establishing a sourcing entity in China, please contact:
Ms Lynn Ng
Manager, The JLJ Group
Email: lynn.ng@jljgroup.com
Tel: +86 21 5211 0068 ext 821

This article is contributed by The JLJ Group – a one-stop service provider assisting foreign companies to enter and grow in China. Over the past ten years, JLJ has assisted more than 400 international clients with their China entry and growth projects. Their client base includes Multinational Companies, Small & Medium Enterprises, Government Organizations as well as individual investors from more than 30 countries in Americas, Europe and Asia-Pacific.