By Maarten Roos & Chen Yun, R&P China Lawyers
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 means to have an office and pay expenses directly in China. Particularly among international companies that source from China, the representative office 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 (in the Strengthening Administration of Registration of Representative Office by Foreign Enterprises), and revolutionizing the way that there activities are to be taxed (through the 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 "Representative Office Regulations"), effective as of 1 March 2011, further tightens the belt. Applicable to all representative offices of foreign companies except those of non-profit organizations and law firms, insurers and accounting firms, the Representative Office Regulations further clarify some of the establishment restrictions and operational limitations of representative offices. We summarize the most important issues.
Representative offices 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.
A representative office 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 representative office's business license will be revoked. Moreover, if a representative office engages in profit-making activities, its proceeds and business-related tools, raw materials, equipments, and products could be confiscated, and the representative office can be fined at between CNY 50,000 and CNY 500,000.
Incorporation & Representatives
A new rule is that a foreign company can only establish a representative office if it has been incorporated for at least two years. Also, the office can have no more than four (foreign) representatives, including one chief representative.
Annual Reporting Obligations
Representative offices 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 office as engaged in, and an audited statement of its accounts. The penalty for failing to submit an annual report is CNY 10,000 to CNY 30,000, and can even lead to a revoking of the representative office's business license.
Information Sharing Mechanism
The Representative Office Regulations contemplate that China's company registration bureau, the State Administration for Industry and Commerce, together with its local counterparts establish a system to share information with other government departments, such as the Entry- and Exit Bureau of the Public Security Bureau and the tax departments, 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. In other words, it can become easier for authorities to detect, investigate and penalize foreign employees of a representative office that fails to pay due taxes on his income.
The Representative Office Regulations increase the cost of operating such a representative office 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 a representative office 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 representative office may still be the way to go. But for many other business activities, including sales in the Chinese market, the representative office has already lost much of its relevance.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.