Establishing A Representative Office In China

Among foreign investors, the most popular form of business establishment in China is the Representative Office. Its main attraction is that it is simpler and cheaper to establish than either a Joint Venture of a Wholly Foreign Owned Enterprise ? since no Registered Capital is required, startup costs are roughly 10% of the cost of establishing either of these. Representative Offices are also open to almost all industry sectors, including some sectors that are off-limits to Joint Ventures and Wholly Foreign Owned Enterprises. Furthermore, the Chief Representative need not reside in China. However, Representative Offices are very limited in the activities that they may carry out.

Why do foreign companies establish Representative Offices in China?

1. To conduct preliminary research before deciding whether or not to make a direct investment in China.

2. To provide data and promotional materials to potential partners and/or clients.

3. To coordinate the activities of its parent company in China.

4. To make travel arrangements for representatives of its parent company or Chinese clients or potential clients.

5. A foreign company might already be doing business with China from overseas but lack the market penetration to justify a full-blown investment (some of these Representative Offices later upgrade to Wholly Foreign Owned Enterprises, Cooperative Joint Ventures, and Equity Joint Ventures. Note that in certain industries such as insurance and finance there are sectors that require foreign investors to operate a Representative Office for at least 2 years before making a direct investment.

6. To hire local employees to help them find suppliers.

7. As a cheap and simple way of doing business in China by exceeding its legal scope of business. This is not a good idea because it is likely to get the company in trouble with the authorities.

8. To establish a presence in a business sector currently forbidden to direct foreign investment with a view to getting to know the market in anticipation that China will liberalize its regulations in the future in line with its WTO commitments.

Representative Offices are generally allowed to:

* lease office space and arrange for utilities * purchase office supplies * coordinate the issuance of work permits and visas for foreign employees * open and maintain bank accounts in local currency and foreign exchange * display office signs and distribute promotional materials * hire local staff though labor service organizations (this requirement might be partially lifted if the draft Labor Contract Law goes into effect.

Taxation of Representative Offices

Although a Representative Office may not engage in profit-making activities and cannot receive income, it is still somehow subject to taxation under certain circumstances (usually on a deemed profit basis)

Two types of taxes are generally applicable to Representative Offices are Enterprise Income Tax and Business Tax. It may be subject to taxation, for example, when it acts as business liaison for a transaction that generates commissions. The Enterprise Income Tax rate applicable to Representative Offices is 33% (inclusive of a 3% local surcharge). Fortunately, however, the business activities of a Representative Office can be exempted under certain circumstances, although these exemptions vary from industry to industry.

Representative Offices are required to pay value added tax (VAT), consumption tax, and customs duties on any domestic purchases and/or imported equipment, as well as stamp duties (usually a negligible sum). The Representative Office need not pay property-related taxes for leased office space, so don?t let your landlord convince you otherwise.

Legal Status of a Representative Office

A Representative Office is not considered an independent legal entity but rather an extension of its parent company. Accordingly, the parent company must bear all of the Representative Office?s legal liabilities and debts. The foreign company should carefully safeguard the Representative Office?s financial and corporate seals to ensure that they are not misused.

The authority of the Chief Representative is governed not by Chinese foreign investment law, but rather by the foreign parent company?s jurisdiction of incorporation. However, the parent company is still subject to the jurisdiction of the local Chinese courts with respect to all contractual issues, including property rights.

Establishment Procedures

Only one Representative Office may be established in each Chinese city. Set-up is accomplished in 4 steps:

1. Pre-approval Procedure - The foreign parent company must first locate a Chinese sponsor to help it obtain the required approval and registration. This can usually be done with the help of the local Ministry of Commerce (MOFCOM) office, which will introduce the foreign parent company to a designated agent (a Foreign Enterprise Service Company, a/k/a FESCO) that is licensed by MOFCOM to handle foreign Representative Office applications. The sponsor will charge a fee of approximately US$800 - $1,000 for notifying the foreign company of upcoming deadlines and any problems with the application materials. The foreign company will also be required to enter into a lease for ?Grade A? office space prior to approval, because a signed lease agreement is one of the prerequisites for approval of the Representative Office.

2. Application ? The Representative Office application and supporting documents should be submitted to the appropriate examination and approval authority. The examination and approval authority for a Representative Office will normally be MOFCOM, but foreign companies in certain industries such as banking, insurance, law, accounting and media will need to apply to the authority with jurisdiction over the foreign company?s particular industry. If the application is approved, a Certificate of Approval will be issued by the examination and approval authority, usually for an extendable initial term of 3 years.

3. Registration ? Registration must be completed within 30 days after the certificate of approval is issued. An application (together with supporting documents; see this site?s section on ?Documentation? under ?Rep Offices? for details) is submitted to the local branch of the State Administration of Industry & Commerce (SAIC). This process normally takes 1-2 months and concludes with the issuance of a Certificate of Registration (similar to a business license), which must be renewed annually. Any subsequent change must be registered with the local SAIC.

4. Post-Registration Procedures ? The new Representative Office is expected to register its location with the local Public Security Bureau (the police), make financial and corporate seals, open a foreign exchange bank account, register with the local and national tax bureaus, complete customs registration (in order to import office equipment and daily necessities for its staff), and register with a FESCO to recruit Chinese staff. The Chief Representative should apply for and receive a Residence Permit from the Public Security Bureau with jurisdiction over his/her residence (see this site?s section on ?Foreign Staff? under ?Labor? for further detail)..

Only after completing the foregoing procedures may a Representative Office begin operations. Registration must precede even preliminary activities such as distributing business cards, establishing direct telecommunications lines, and obtaining a multiple entry visa or an apartment for the Chief Representative (the latter requires the Chief Representative?s Residence Permit).

Closing Down a Representative Office ? This can be a lengthy process if it is not handled correctly. This is especially so if the office was not originally established entirely in accordance with Chinese foreign investment law but rather through back-door connections (a common occurrence among China?s more experienced foreign investors). China?s legal system is becoming more and more transparent and administrative bodies are increasingly actually enforcing the law, so it?s a good idea to do things the right way the first time. There are several steps required to close down an office ? don?t just walk away, especially if you have (or think you might have) long-term plans in the China market.

First, various documents need to be prepared and provided to the relevant authorities. A cancellation form needs to be submitted to the Industrial & Commercial Bureau, and a detailed explanation needs to be provided as to why the office is closing. Application must also be made to the local Commission of Foreign Trade & Economic Cooperation (COFTEC). Both the Representative Office manager and the general manage of the parent company must sign the form. A separate application also needs to be made on parent company letterhead and stamped with its company seal. There must also be a board resolution that agrees to the closure of the office (a statement indicating that the office is to be closed signed by the chairman of the board of the parent company is sometimes accepted).

Further, the bank must provide a notice that confirms cancellation of the Representative Office?s bank account. Tax payment certificates and receipts from national and local tax bureaus must also be furnished to the Representative Office?s original examination and approval authority along with a brief statement about the settlement of debits and credits. The tax bureau will require the closure audit report to be approved by a certified public accounting firm. The corporate seal, financial seal, and the business license must be surrendered to the Industrial & Commercial Bureau. If all the necessary documents are provided and taxes have been paid, the closure procedure should take roughly 2 weeks.

David Carnes is licensed to practice law in California. He speaks and reads Mandarin Chinese and has several years experience working with Chinese law firms and Sino-American joint ventures. Check out his website, China Legal Bulletin, at http://www.lunaticwisdom.com/blog1.