A Wholly Foreign-Owned Enterprise (‘WFOE’) is one of the most common business models for international enterprises doing business in China. However, in many cases, using a PEO solution will be more cost-effective, and reduce your risk. Here we set out the steps for shutting down a WFOE, and replacing it with a PEO.
What is a Wholly Foreign-Owned Enterprise (WFOE)?
A Wholly Foreign-Owned Enterprise is a form of organization that you can set up in China, where you, the foreign investor, retain full ownership. The WFOE is a completely autonomous legal entity, with a range of obligations under the law.
It can be contrasted with other business models for operating in China, including the Joint Venture (JV), Representative Office and Sales Office via Labor Dispatch (i.e., the model which uses a PEO). We will discuss the latter alternative below.
The WFOE is a model created under Chinese law to allow international enterprises to establish operations in China without the need to share ownership with a China-based partner. Benefits of a WFOE include:
- Equal treatment. The WFOE is treated the same under the law as a regular China-based company;
- Flexibility. There is no need to consider the preferences of an owner based in China (such as in a JV). Profits made in RMB can be remitted internationally in US dollars;
- Protection of Intellectual Property (‘IP’). As there is no joint venture, the result of your work is entirely your own.
As incorporating a company of this form is a complex exercise, we recommend engaging a professional service to support you with this process.
WFOEs can be a useful business model for operating in China in some cases, as they give you complete control of an entirely independent entity.
What Are the Disadvantages of a WFOE?
While there are benefits, there are also costs or disadvantages of operating via a WFOE:
- Administrative complexity
Establishing a WFOE can be a complex process. It requires endorsement and recognition from multiple regulatory authorities;
A significant, upfront, capital investment in the WFOE is required within the first three months of operation;
- Not available for all business types
Only some businesses can operate via a WFOE;
This is perhaps the biggest burden and potential risk for businesses that establish a WFOE. You are responsible for all taxes and filing obligations and, as the Employer of Record, you have all the compliance obligations towards employees. You must be on top of the complex labyrinth of laws that apply to running a business in China.
WFOEs also come with disadvantages. They can be costly and involve significant compliance liability for the enterprise.
The Advantages of Setting up a PEO
Given that it has disadvantages, which other models for opening a business in China might you consider? One important possibility is to set up a ‘Sales Office’ (‘SO’) via labor dispatch, and contract with a Professional Employer Organization (‘PEO’).
This is, perhaps, the most straightforward and cost-effective method of doing business in China.
In short, the SO via labor dispatch, means outsourcing your administrative and compliance obligations to a PEO located in China. When you enter into a contract with a PEO, they essentially act as a standalone set of HR, payroll, and compliance departments to manage those affairs in China.
A PEO is fully licensed and certified to provide:
- Recruitment services
Seeking out the right talent for your business in China;
- Visa facilitation services
Ensuring that you can get the visas needed for any staff being flown in from your headquarters;
- Management of worker’s insurance and compensation;
- Tax compliance
The PEO becomes the ‘Employer of Record’ for tax purposes;
- Payroll outsourcing processing and distribution of benefits.
The benefits of a PEO over a WFOE could be summarized as:
A PEO solution can be established much more quickly than setting up a WFOE;
- Reduced liability
The PEO, as the ‘Employer of Record’, takes on the core compliance obligations;
It leaves you to focus on your core business, while a partner that specializes in employment and compliance services provides a high-quality ‘back-office’ service;
With savings on initial set up, ongoing compliance and operations on the ground, a PEO is usually a much cheaper option than a WFOE.
The transition to a PEO business model may also make sense after a merger or acquisition, where an enterprise’s operations in China are being significantly restructured.
SO via labor dispatch, utilizing the services of a PEO, provides a business model which is cheaper, faster, and high quality, while reducing the compliance burden on your enterprise.
Preparing to Close a WFOE
In order to move from a WFOE to a PEO business model, first you will need to close down your WFOE. How should you proceed?
It is not a good idea (and it may be impossible), to simply close up shop and abandon the WFOE. If you were to do this, your business licence would be revoked and you would be blacklisted (which will substantially impact on your ability to ever do business in China again). In some cases, you may even become vulnerable to prosecution under criminal laws.
A formal liquidation and deregistration process must be followed.
First, to follow the required process, you must carry out a range of pre-liquidation steps:
- Endsettle all labor contracts
China strongly protects employee rights, and this may be significantly more difficult than what you are used to in your base country;
- End disputes
Any disputes need to be settled.
- Prepare your documentation
It is likely that, on liquidation, your financial records will be audited, so it is important that you have prepared all necessary documentation;
If you decide to close down an WFOE, you must follow the required process and the initial pre-liquidation steps.
Liquidation of a WFOE
The next step is to liquidate the WFOE’s assets. This requires:
- Shareholder resolution
A shareholder resolution to liquidate must be filed with the authorities;
- Establishment of a ‘liquidation committee’
This committee manages the liquidation process on behalf of the company, and provides notification to all known and unknown creditors. It must be registered with the authorities, and an announcement made via media. It must be set up within 15 days of the start of the liquidation;
- Sale of remaining assets
After selling the leftover assets, the proceeds will be used to pay liquidation expenses, employee wages and labor insurances, outstanding tax liabilities and any other debts, in order of priority;
- Distribution of proceeds/file bankruptcy
If there is anything leftover after paying off debts, this can be distributed to shareholders. If there were insufficient assets to pay all remaining debts, a bankruptcy declaration must be filed in court and a separate bankruptcy process begins;
- Approval by enterprise examination and approval departments. The authorities must approve the liquidation after it has been confirmed by the liquidation committee. Formal liquidation reports must be submitted, and it can be a time-consuming process.
In order to liquidate a company, you must confirm a resolution of shareholders, form a liquidation committee, notify required parties, sell assets, distribute proceeds, and submit documentation to authorities. If all debts cannot be paid, bankruptcy must be filed in the people’s court.
Post-liquidation Processes for Ending a WFOE
Once the liquidation is approved. The following steps should be followed:
- Cancellation of Licences
Any licenses held must be canceled;
- Submission of Financial Records
Accounting vouches, accounting books, financial statements, and other relevant data must be submitted to authorities;
After licenses are canceled, the business can be formally de-registered with the authorities;
- Close bank accounts;
- Disposal of the company chops
The company chops, the official seal of the enterprise, must then be disposed of, so that no one else can carry out actions in the name of the WFOE.
Once these steps are complete, you are in a position to set up a SO via labor dispatch, and into a contract for service with a PEO. This is an extremely straightforward, and fast, process.
After liquidation is complete, the job is not finished. You must also follow several other steps in order to finally de-register, close your WFOE, set up an SO, and contract with a PEO.
In many cases, closing down a WFOE and establishing a relationship with a PEO, will provide you with the most cost-effective and least risky business operation model. However, carrying out this process is not straightforward. A range of steps must be followed to ensure that you do not jeopardize your business prospects in China, or attract civil or criminal liability.
At New Horizons, we specialize in PEO solutions. We can support you in the process of closing down a WFOE, and putting a global PEO solution in place for you. By using a trusted and experienced partner on Chinese soil, we can ensure that the process is carried out as efficiently as possible, while still ensuring full compliance.