Russian Entity Formation: Wholly Foreign Owned Entity (WFOE) Versus Representative Office

POSTED MAY 5TH, 2011

In this article, Olga Zvereva and Oksana Demina explain the differences between a Russian WFOE, a Russian Representative Office, and a Russian Joint Venture, and then explain why a WFOE is usually the best entity for foreign companies doing business in Russia.

By: Olga Zvereva and Oksana Demina

One of the most common requests we get regarding Russia comes from non-Russian companies seeking assistance in setting up a Russian joint venture or a representative office. When we tell them that only rarely does it make sense to go into Russia with a joint venture or a representative office, they commonly respond either with surprise that there are other alternatives or by telling us how this is, how their very well run competitor had entered the Russian market. When we explain that Russia now allows Wholly Foreign Owned Entities (WFOE), they quickly realize the benefits of not getting enmeshed with a Russian joint venture partner. The benefits of a WFOE over a Representative Office are more difficult to explain.

The purpose of this article and its accompanying chart is to briefly compare the advantages and disadvantages of establishing a business in Russia as a representative office or as a limited liability company (OOO) wholly-owned by a foreign entity. At the outset, however, it must be made clear that if your intention is to buy or sell goods in Russia, you cannot legally go in as a representative office. A representative office is limited to representing or marketing for a foreign owned entity. It is not allowed to conduct real business within Russia. In the past, many foreign companies would go into Russia as a representative office and then conduct business within Russia, but only because they had no other real choice. Companies have that choice now.

Items	Representative office	Limited Liability Company (OOO)
Legal Status	Not an independent legal entity. All property would be owned by the foreign (non-Russian) entity. Not allowed to conduct commercial activity so it doesn't technically generate profits. Limited to negotiating contracts, marketing or conducting other supporting activities for the foreign entity.	Can act only through a manager authorized to act for and on behalf of the foreign entity pursuant to power of attorney. All the rights of a Russian company. Managing Director elected by the foreign company can act on behalf of OOO without a power of attorney within the framework provided by Russian legislation, OOO corporate documents and agreements concluded between OOO and the director.
Charter Capital	None	Approximately $330 minimum charter capital required.
Fees and costs	$10,000 -$18,000	$3,500 -$6,500
Foreign employee issue	Foreign employees must obtain personal work permit	In order to employ foreign employees, a company must obtain an employment permit. Afterwards, every foreign employee must obtain a personal work permit.
Taxation	Subject to payroll, retirement, road, and social security taxes.	Subject to same taxes at same rates as representative office, but also subject to income tax, VAT (e.g. equipment shipped for sale to Russia is subject to VAT); property taxes, and transportation taxes (if OOO owns vehicles. The foreign entity dividends received from OOO may be subject to either U.S. or Russian taxation according to the Treaty signed between USA and Russia regarding double taxation.

In deciding whether to establish a representative office or a WFOE, the investor must balance the convenience of a representative office with the ability to conduct business in Russia through a WFOE. A representative office in Russia can be opened and closed with relatively little formality. Since the office is not a Russian legal person, it is not subject to many of the burdensome regulations that apply to legally established Russian companies. Since a representative office cannot conduct business within Russia, the office is not subject to burdensome tax and reporting requirements. However, the business activities of a representative office are severely restricted to the point that it usually can do little more than act as a company's marketing arm in Russia. On the other hand, a WFOE entity in Russia is considered to be a legal person, and as such, it enjoys both the rights and obligations of any other Russian company. Thus the scope of business operations for a WFOE in Russia is nearly always equivalent to that of any other Russian company. But a WFOE in Russia is also subject to the same taxation, reporting and company regulation requirements of any Russian company. The burden of these obligations for a WFOE must be balanced against the freedom to conduct real business in Russia in each individual instance where a company wishes to conduct business in Russia.

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a joint venture – совместное предприятие

a representative office – представительство

to enmesh - запутывать

pursuant to power of attorney - в соответствии с доверенностью

charter capital – уставный капитал

a payroll – платежная ведомость на зарплату

VAT - value added tax – налог на добавленную стоимость

ROLE-PLAY. Role-play the following situation:

Student A: You are a lawyer and you are to give advice to a foreigner regarding establishing a business in Russia. Ask about the purpose of your client's business. Speak about a representative office and a WFOE, their advantages and disadvantages. Recommend the best form of business.

Student B. You are a foreign businessman and you'd like to start a trading business in Russia. Ask a lawyer about the best form of company for your business.

( Источники: Collins internet-linked dictionary of Law by W.J. Stewart

International Legal English by Krois-Linder Amy. Cambridge University Press, 2006.

http://en.wikipedia.org

http://www.lawyerintl.com/law-articles)

Task 12. Study the text below, making sure you fully comprehend it.

Franchising

Franchising is the practice of using another firm's successful business model. Franchise is a contractual arrangement in which the owner of a trade name, copyright, patent, trademark, or some form of businesss operation, services (franchisor) offers others (franchisees) to use that property, operation, process or services. The franchisor usually prescribes the conditions and procedures for conducting business by the franchisee. The franchisor also may advertise, advise, lend capital or otherwise assist the franchisees.

The franchise is a kind of relationship where the parties (franchisor and franchasees) are business entities whose business structure may be in the form of sole proprietorships, partnerships, or corporations. Some examples of today's popular franchises are McDonald's, Subway, Domino's Pizza, and the UPS Store.

Franchise Agreement

The franchise agreement, usually prepared by the franchisor, is a very complicated document covering many aspects of the prospective relationships between the franchisor and the franchisee. The most important provisions of such an agreement are the following:

1. The initial payment of the franchisee to the franchisor as well as the continuing payments (royalties) throughout the term of the franchise. This fee is usually paid monthly or quarterly and is typically calculated as a percentage of gross sales, not the profits; so a franchisee will still owe the franchisor money if his business is unprofitable.

2. The franchisor is usually entitled to control such aspects as

a) the franchisee’s business site, territory and premises

b) the franchisee’s qualifications, financing, working standards, purchases

c) the franchisee’s status as independent contractor

The agreement stipulates arbitration and venue in the event of a dispute and covenants that the franchisee not compete against the franchisor or its franchises after his franchise is terminated.

3. The duration of the franchise, any renewal periods, and the franchisor’s grounds for termination.

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Franchising – франчайзинг — система, при которой один экономический объект (напр., фирма или даже государство) предоставляет другому экономическому объекту право действовать на рынке от его имени и часто под его именем (напр., выпуск фирмой, вступающей в рынок, своей продукции под маркой старой и более известной компании).

covenant - соглашение, договор

venue - место проведения ч.-л.

up-front fee – разовая комиссия, уплачиваемая вперед

Task 13. Find equivalents of the following words and word combinations in the text above:

коммерческое предприятие индивидуальное предпринимательство предписывать условия охватывать многие аспекты ведение бизнеса помогать франчайзи потенциальные отношения первоначальный платеж текущие платежи в течении срока франшизы вознаграждение выплачивается ежемесячно или ежеквартально процент от общих продаж

франчайзи будет выплачивать франчайзеру деньги, если бизнес не приносить прибыль иметь право контролировать место расположения бизнеса, помещения закупки предусматривать место рассмотрения экономических споров не конкурировать с франчайзера продолжительность франшизы периоды возобновления основания для прекращения франшизы

Task 14. Find the appropriate definitions of the terms listed in the left column of the table using the word combinations from the right column:

(1) Patent	(a) the exclusive and assignable legal right, given to the originator for a fixed number of years, to print, publish, perform, film, or record literary, artistic, or musical material
(2) Business entity	(b) a government authority or licence conferring a right or title for a set period, especially the sole right to exclude others from making, using, or selling an invention
(3) Copyright	(c) a symbol, word, or words legally registered or established by use as representing a company or product.
(4) Trademark	(d) is a commercial, corporate and/or other institution that is formed and administered as per commercial law in order to engage in business activities, usually the sale of a product or a service.
(5) Venue	(e) the party in a franchising agreement that is purchasing the right to use a business's trademarks, associated brands and other proprietary knowledge in order to open a branch.
(6) Covenant	(f) a party in a franchising enterprise that ultimately owns the rights, trademarks and proprietary knowledge of the specific business entity.
(7) Franchisee	(g) a contract in its entirety or a promise within a contract for the performance or nonperformance of a particular act
(8) Franchisor	(h) the place where something happens, especially an organized event such as a concert, conference, or sports competition: