For every 100 Wholly Foreign Owned Entities (WFOEs) and Joint Ventures (combined) my law firm sets up in China, it sets up one Representative Office. Why so few, when Rep Offices are the easiest entity for foreigners to form in China? Because their inherent limitations mean they seldom are the best way for foreign companies to go into China.
Representative Offices are aptly named — they are the China representative of the foreign company. A Rep Office is not considered a separate legal entity under Chinese law and it is limited to performing only “liaison” activities. It cannot sign contracts nor can it bill customers. It cannot supply parts nor perform after-sales services for a fee. It cannot earn any money in China nor take any payments from a Chinese person or business for any reason.
Representative Offices are pretty much limited to engaging in the following:
- Conducting research
- Promoting their foreign company owner
- Coordinating their foreign company owner’s activities in China
- Other activities that do not and are not intended to generate a profit in China
Because forming a Rep Office in China is faster, cheaper, and easier than forming a WFOE (see Forming a China WFOE: How Long Will That Be Going On?) companies often consider forming a Rep Office in China to “test the waters” there, with the intention of switching over to a WFOE once it becomes clear China will be viable for them.
My law firm’s foreign direct investment lawyers generally discourage this approach because “switching” from a Rep Office to a WFOE is not really a switch at all. It involves two truly distinct and really expensive and time-consuming steps: (1) shutting down the Rep Office and (2) forming a WFOE from scratch. Because the cost of forming a Rep Office, shutting down the Rep Office, and then forming a WFOE will be at least three times the cost of just forming a WFOE in the first place, forming a Rep Office with the later intention of forming a WFOE seldom makes sense. Companies will almost always be better off just biting the bullet and forming the WFOE straight away.
Companies sometimes contact our China lawyers believing they need a Rep Office because they need a Chinese entity to sell their product or service into China. Not necessarily. In most situations, companies can sell their product or service into China without having any in-country China footprint.
But sometimes a Rep Office does make sense. My law firm once set up a Rep Office for an American company selling American-made equipment with an average transaction value of $2 million. This company had no plans to manufacture its equipment in China and it already had a contractual arrangement with a Chinese company to repair its equipment in China. All it wanted was an on-the-ground China presence to improve its sales and to let its customers and potential customers know it was serious enough about China to commit to having an office there.
There are three basic requirements for forming a China Rep Office:
- There must be a lease on an approved space for a period of at least one year beyond the approval date of the Rep Office. Since many jurisdictions accept leases only from a small group of approved office buildings, care is required. Shanghai, for example, is one such jurisdiction. The lease must be registered, which also can cause problems in some jurisdictions.
- There must be a designated Chief Representative to manage Rep Office affairs.
- There must a foreign entity (typically a limited liability company or a corporation) for the China Rep Office to represent. Private individuals and partnerships cannot establish a Rep Office in China. In addition, most jurisdictions in China do not allow newly formed entities to form a Rep Office.
The local approval authorities usually issue their decisions on Rep Office approval in about thirty days, at which point the Rep Office must do many of the other things typically required of businesses in China. However, in some cities, the decision can take much longer, depending on the whims of the local officials.
The following three things make Rep Offices unattractive:
- Even though Rep Offices are not permitted to earn income in China, they are subject to taxation. There is at least a 10% tax on the gross expenses of the Rep Office. If the Rep Office is large and has a number of employees, this tax can be quite high.
- A Rep Office is not permitted to hire Chinese nationals directly; such hiring must be done indirectly through contracting with a Chinese third party employment agency such as FESCO. Such contracts are generally unattractive for foreign companies.
- A Rep Office is limited to four foreigners , each of whom is called a representative. The Rep Office hires these people directly and they are treated as normal employees under China’s employment law system. That is, they are to be hired pursuant to a written contract and their taxes and social benefits must be paid.
Bottom Line: Look before you leap into a China Representative Office and do not get seduced by their relative ease of formation.