China Representative Offices
Is your company considering setting up a Representative Office in China? You will likely find that the process is not as easy as it used to be. In many cases, plans for a Chinese Rep Office result in creating a Wholly Foreign-Owned Enterprise (WFOE), which is one significant step beyond a Rep Office.
A company may establish a Rep Office only to conduct marketing and other non-transactional operations in China to “test the market.” These offices are not separate legal entities. They merely serve as the organization’s representative within China.
Why Companies Attempt to Set up a Representative Office in China
The Rep Office format appeals to companies because they view it as a faster, cheaper, and easier alternative to establishing a WFOE in China. They consider the Rep Office a viable solution for testing the waters when attempting to enter the Chinese market. Many of these businesses intend to transition to a WFOE once they gain a foothold in the country.
In some situations, companies view the Rep Office as a vehicle for marketing their products and services in China without leaving a large footprint or dealing directly with regulators. However, despite a company’s intentions when considering a Rep Office in China, it often doesn’t turn out to be the best option.
Many businesses run into issues with Rep Offices because they do not understand the limited scope of a Rep Office. Others understood the limited scope and intended to establish a WFOE once they determined that the China market would respond well to their product or service. And still others never intended to fully comply with the Rep Office restrictions.
What Are the Guidelines for China Representative Offices?
Companies wishing to set up a Rep Office in China must fulfill these requirements:
- Establish a physical location: Foreign companies must enter into a minimum one-year lease for office space beyond the Rep Office’s approval date. There are some limitations on the availability of approved sites, depending on the scope of business.
- Designate a legal representative: Companies must appoint a legal representative responsible for managing the Rep Office’s affairs.
- Get your business license: Even Rep Offices need to be licensed and establish an official company chop or seal.
- Establish other corporate accounts: These include a tax registration number, a bank account, and social insurance and housing fund accounts for Rep Offices with Chinese personnel.
The approval process can take 30 days or longer.
What Are the Limitations of Setting up a Representative Office in China?
Besides the often daunting challenges of establishing a Rep Office and meeting the stringent requirements, the entity has numerous limitations. These offices generally cannot engage in direct selling or profit-generating activities. They typically can only perform what the Chinese classify as liaison activities. They cannot issue invoices, sign contracts, or supply parts or post-sale services for a fee.
In general, a Rep Office can only conduct the following tasks:
- Performing tasks that don’t involve generating a profit
- Promoting their business
- Coordinating their activities within Chinese borders
- Executing research activities
Why Do the Chinese Discourage Representative Offices?
China discourages the practice of establishing Representative Offices for several reasons. Money is the primary driver. While setting up these entities in the past resulted in significant tax savings for foreign companies, this has not been true for years. To ramp up revenue collection, China increased its tax rate on countries that implement Rep Offices over a decade ago, eliminating the financial incentive.
During this time, China also cracked down on its Rep Office enforcement practices. It limited what it considers acceptable liaison activities, making it more challenging for companies to operate freely. The government instituted additional provisions to make these offices less favorable and more costly, including closer review of key personnel and M&A-style activities.
Additionally, China’s State Administration for Industry and Commerce implemented updated regulations for these offices in Shanghai, the country’s thriving commercial center with a population of over 24 million. The new standards included limiting Rep Office head counts and shortening the registration validity period. These standards, coupled with nominally reducing the disparity in treatment between Chinese-owned companies and WFOEs, were intended to push foreign companies to establish WFOEs instead of Rep Offices.
When Does a Representative Office in China Make Sense?
At Harris Bricken, we generally discourage setting up a Representative Office in China due to these restrictions and limitations. Virtually no for-profit business in the US wants to only engage in the limited Rep Office activities available. Our law firm has discovered that the WFOE format offers more flexibility. We also discourage establishing a Rep Office with the intent to move to a WFOE because switching is often not the best solution. The process can also be time-consuming and cost-prohibitive. It typically requires shutting down the existing Rep Office and creating a brand-new business entity.
However, establishing a Rep Office can make sense in some situations. For example, our firm recently set one up for an American company that sells its equipment for approximately $2 million per unit. Because the company had no plans to manufacture its products in China and it already had an arrangement to repair the equipment it sold there, establishing a WFOE was unnecessary. The Rep Office served the purpose of establishing an in-country presence for business development purposes. The US parent company would then negotiate and contract from the US with a US-style contract.
In summary, think twice before setting up a Representative Office in China. While the ease of formation can be attractive in theory, the numerous limitations and restrictions can deter your company’s long-term success.
Do you have questions about the viability of a Rep Office in China? Contact our firm to learn more.