With the reopening of China’s borders, domestic markets reeling from the pandemic and a supply chain back on track, overseas companies are re-examining their options to establish a presence in one of the largest markets but with a certain caution.
Why set up a physical presence in a digital era?
In a constantly changing environment, remote managing the development of a brand and sale of products & services may prove quite costly and inefficient in the long run; instead, the dedication of on-the-ground resources may enable a company to timely fine-tune its offer and reach the right customer (or supplier) base.
These efforts may mean properly hiring a team to assist with logistics, marketing, TP liaison, brand building, sales events, and handling customer queries and complaints. Although there are other (temporary) solutions like (EoR) to employ a team, establishing an entity in China may pave the way to a successful long-term business.
Numerous activities may require setting up a company in China, even cross-border e-commerce, sourcing, service support and other light activities (in contrast with manufacturing, full trading, food & beverage).
How to invest in China?
When market entry and legal research converge towards the need to open an entity in China, investors may choose a lighter form of a service-based limited liability entity (formally known as WFOE) instead of a representative office (except for NGOs).
This article focuses on the financial and tax appreciation of a WFOE in China. Read our dedicated guide for an exhaustive tour of the considerations and steps towards opening a wholly foreign-owned enterprise (WFOE).
This lighter form of WFOE is structurally and legally the same as a full-service WFOE; however, it often acts as the support office of its foreign mother company and therefore invoices its costs periodically to its direct shareholding entity with a markup. This financial operating mode is due to the difficulty of the WFOE to clearly assess its profit, which in a way is very similar to most representative offices. From the taxation perspective, this model is known as a cost-plus where cost signifies the recharge of its costs and plus is the markup; cost-plus is a widely known and recognised transfer price (TP) mechanism. This form of structuring could be called a “Cost+” WFOE.
How does a China “Cost+” WFOE work?
Example of a “Cost+” WFOE with the following (non-exhaustive) costs and expenses:
1. Amount to invoice to HQ
|Annual budget in CNY
VAT rates (small tax payer): 3% (this rate will go up to 6% when the total cost exceeds CNY 4.25 million)
Local surcharge taxes (12%): 0.4%
Amount invoiced to HQ: 1,819,136
*The markup rate must be defined along with the rule of TP mechanism and be at arm’s length.
The rates observed are usually 10-15% in China, however, the rate determination must be carefully reviewed.
2. Result & taxes to pay
|Amount in CNY
|Profit before tax**
|Total taxes to pay (VAT/LT & CIT)
Corporate income tax rates:
- Less than CNY 3,000,000: 5% (reduced rate for small companies for FY 2024)
- More than CNY 3,000,000: 25%
Corporate income tax to pay: 10,957 (0.7%)
VAT and local tax to pay: 53,730 (3.4%)
Total: 64,717 (4.0%)
In comparison, most representative offices are taxed at an effective rate of 8.4-12.3% of the expenses; which in this case would be equal to:
Amount of VAT/local tax & corporate income tax to pay under a representative setup: CNY 133,835 to 197,082
**Assuming that all cost and expenses are tax deductible
For more information about the reduced rate of 5% available to small-profit companies, please read our latest newsletter: Preferential income tax policies for micro and small enterprises with thin profit.
The above example indicates that in many cases, a “Cost+” WFOE will be more advantageous than a representative office. Beyond a significantly lower cost, the WFOE will also enable its investor to hire employees directly and invoice local customers, which is not permitted under a representative office set up.
To find out more about the adequate setup for your operations in China and how to establish an office for your business needs, please send your enquiries to:
Contact our teams for expert support and further information about entering the market and setting up a legal entity in China.