what we think

Establishing a Representative Office continues to be a popular approach for foreign companies to establish a presence in China. While this office cannot engage in commercial activities such as trade, services or manufacturing, it does allow for the hiring of local employees (indirectly) and expatriates (directly) who can engage in liaison and marketing, and it gives the foreign company a means to pay expenses directly in China. Particularly among international companies that source from China, the RO remains very popular.

Is this about to change? Last year China adopted new legislation that was meant to more strictly regulate such offices, re-emphasizing that they are prohibited from engaging in commercial activities (Strengthening Administration of Registration of Representative Office by Foreign Enterprises), and revolutionizing the way that there activities are to be taxed (Interim Measures For Tax Administration Of Representative Offices Of Foreign Enterprises). The promulgation on 19 November 2010 of the Administrative Regulations on the Registration of Foreign Representative Offices of Foreign Enterprises (the “RO Regulations”), effective as of 1 March 2011, further tightens the belt. Applicable to all RO’s except those of non-profit organizations and law firms, insurers and accounting firms, the RO Regulations further clarify some of the establishment restrictions and operational limitations of RO’s. We summarize the most important issues.

ROs are specifically permitted to:

• organize market surveys, exhibitions and publicity activities related to the products and services of the foreign parent company; and
• engage in liaison activities related to the sales of products, provision of services and domestic procurements and onshore investments of the foreign parent company.

An RO that conducts activities beyond this scope will first be ordered to correct their actions ; failure to comply can lead to a fine of CNY 10,000-100,000. In serious circumstances, the RO’s business license will be revoked. Moreover, if an RO engages in profit-making activities, its proceeds and business-related tools, raw materials, equipments, and products could be confiscated, and the RO can be fined at CNY 50,000-500,000.

Incorporation & Representatives

A foreign company can only establish an RO if it has been incorporated for at least two years. Also, an RO should have no more than four (foreign) representatives, including one chief representative.

Annual reporting obligations

ROs are subject to an annual reporting requirement, which shall be completed between 1 March and 30 June of each year. The annual report must include information on the current status of the foreign parent company, the activities that the RO as engaged in, and an audited statement of the RO’s accounts. The penalty for failing to submit an annual report is CNY 10,000-30,000, and can even lead to a revoking of the RO’s business license.

Information sharing mechanism

The RO Regulations contemplate that China’s company registration bureau (the State Administration for Industry and Commerce) and its local counterparts establish a system to share information with other government departments, such as the Entry- and Exit Bureau of the PSB and the Tax Bureau, to exchange relevant information and to coordinate inter-department cooperation in investigating and countering irregularities. This could have a major impact, for example, on representatives who do not pay individual income taxes in China.

Conclusions

The RO Regulations increase the cost of operating an RO in full compliance with the law, but more importantly they tackle some of the loopholes that foreign companies have taken advantage of in the past. More than ever, foreign companies should carefully consider the legal, fiscal and operational benefits as well as the drawbacks to operating an RO versus establishing an independent legal entity in consulting, trading or even manufacturing, or even deciding not to formally establish in China at all. For sourcing in particular, the RO may still be the way to go. But for many other business activities, including sales in the Chinese market, the RO has already lost much of its relevance.