A New Question for VIE Structures: Can We Do It Without a WFOE?

At Torres & Zheng at Law, P.C., we specialize in U.S. transactional law, including mergers and acquisitions, as well as business structural design. This blog post provides a general discussion of a newly proposed Variable Interest Entity (“VIE”) structure. It is based on publicly available information and insight from PRC counsel and does not constitute legal advice. For matters relating to PRC law, readers should consult PRC-qualified counsel directly.

The Traditional VIE – WFOE Model

In China, certain industries are subject to foreign investment restrictions, which means that foreign investors cannot directly hold equity in the operating company. To overcome this barrier and still achieve offshore financing, the VIE structure has become a widely used arrangement. Traditionally, the Wholly Foreign-Owned Enterprise (“WFOE”) plays a central role in this setup.

In the classic model, the VIE agreements are typically signed among three parties:

1. the WFOE (established and controlled by the offshore holding company),
2. the VIE company (the onshore operating entity), and
3. the VIE shareholders (PRC nationals).

Through these agreements, the WFOE functions as a “bridge” inside China, while exercising contractual control over the VIE’s operations and profits.

New Question: Can We Skip the WFOE?

Recently, we received an interesting inquiry:

Is it feasible to dispense with the WFOE and have the offshore company enter directly into VIE agreements with the PRC operating company and its shareholders?

This raises a fundamental question about whether the WFOE is strictly necessary for the structure to work. Insights from PRC counsel indicate that, while the current law does not appear to expressly prohibit this type of structure, there are still practical challenges when it comes to implementation. Some of the key issues are outlined below.

Funding the VIE and Its Shareholders

In traditional VIE structures, funding often flows through a WFOE, which can provide loans to support the VIE’s operations. By contrast, in a direct structure, the offshore company may need to provide funding directly to the VIE or its shareholders. This raises several issues:

• When shareholders are individuals: PRC individual residents are not permitted to obtain external borrowings, making it difficult for offshore companies to lend to them directly.
• When shareholders are domestic enterprises: Longer-term loans require registration, which can be challenging for new entities without an operating history.
• Cross-border guarantees: If a domestic shareholder pledges its equity, the arrangement may qualify as a “domestic guarantee for foreign loan”, which requires registration. In practice, such registrations are often difficult to complete.

Service Fee Arrangements

Generally, service fees are a common mechanism for transferring profits from the VIE to the offshore structure. In conventional VIE structures, service fees are paid to the WFOE under an Exclusive Business Cooperation Agreement, typically treated as “current account” transactions.

Without a WFOE, however, payments made directly offshore may be reclassified as “capital account” transactions. This creates a mismatch between the contractual description and the actual fund flow, which can result in regulatory scrutiny, penalties, or delays in processing.

Tax Considerations

• VAT deductions: In the traditional VIE model, the WFOE can claim VAT deductions as a PRC taxpayer. In contrast, a direct structure without a WFOE offers no such mechanism, which may result in a higher overall tax burden.
• Related-party scrutiny: Cross-border service fee arrangements that shift revenue offshore may be reviewed more closely by tax authorities than domestic related-party transactions, potentially leading to adjustments or additional taxes.

Final Thought

While it suggests that no current law explicitly prohibits a direct offshore VIE contractual structure, it remains highly uncertain in practice. Obstacles around funding, foreign exchange, and tax treatment make the model difficult to implement compared with the more established WFOE-based VIE.

Companies exploring alternative structures should weigh these practical risks. For U.S. law compliance and regulatory matters, our team provides practical guidance grounded in hands-on experience. For PRC law considerations, we recommend seeking advice from PRC-qualified counsel before proceeding.

Authors: Nick L. Torres, Esq. and Jean Huang

Contact Person: Nick L. Torres, Esq. and Zhiqi Zheng, Esq.