Setting Up a Representative Office in China (II): New Regulations further Restrictions

Considering setting up a Representative Office (R.O.) in China? There are a few things you should know.

R.O.s are getting a lot of attention this year, as China’s State Administration for Industry and Commerce (SAIC) issued in January new regulations that further restrict their activity[1]. These regulations are already being implemented in Shanghai and are said to be on the way for the rest of China.

I must admit that every time I read about R.O.s, commentators highlight their limitations and the hassle involved in switching to another form of legal entity, if needed later on. So consultants tend nowadays to favour the establishment of WFOEs (Wholly Foreign Owned Enterprises) as a better long term option if you are committed to a project in China.

I read about these new regulations right after I had finished interviewing Barbara Cisneros from INAEL Electrical Systems SA  on the topic of how to set up a Representative Office (R.O.) and I must admit I feared I was about to produce an “obsolete” blog post even before posting it on line. But then, I decided to go ahead with that post and further explore the new situation with Ana Inchausti, from Inventta, a consulting company specialized in internationalization projects in Asia.

Before I jump into her feedback, I will recap the main changes that these new rules mean for R.O.s:

  • The foreign company must prove that they have existed for at least two years (ouch! for newly created companies that would like to operate here…)
  • Registration Certificate will be valid for only one year (in the past it could extend up to three years)
  • Foreign employees, who will all hold the position of “representative”, will be limited to a total of four only. This includes the Chief Representative of the office.

And I will also summarize the main advantages and limitations traditionally attributed to R.O.s:
Advantages:

  • It is the fastest option to set up locally, it just takes between 2 and 3 months, once all the paperwork is ready
  • It is cheaper than creating a WFOE, as you need NO capital to establish.
  • It allows you a presence in China and hence better perform a series of non-profit making activities (like market intelligence, business relationships, better access to suppliers, “introducing products” (not directly selling them or invoicing) or being able to give technical support/coaching on those products).

Limitations:

  • You cannot place orders or produce invoices, in a nutshell, you cannot do anything that may represent a profit making activity (all that needs to be done from headquarters)
  • You cannot employ staff directly (you have to go through the government employment agency)

Interview to Ana Inchausti, from Inventta (by e-mail).

  1. Do you still consider R.O.s a practical option to establish here?
    R.O.s have been traditionally the most common investment vehicles in China since foreign companies were allowed to set up legal entities in the country. During some years it’s been the best choice to enter in the market in a quick and cost-efficient way. Keeping in mind that no capital investment is required, many investors have been strongly attracted by this legal form to set up their business here.
    After the new regulation came into force in 2010, the general context has changed and to some business, R.O.s might not be the most interesting way to go; to others, it’s simply not possible to set up R.O.s because they no longer qualify to pass the approval and examination of the authorities …… The obligation to the foreign company to prove that it has existed  for more than 2 years in their countries of origin and the limitation to hire more than a certain number of foreign employees are making R.O.s a non available option to many investors, even if it was their choice in the first place.
    However, at Inventta, we analyze our clients’ investment and business plans on a case by case base; and we are still advising this kind of structure in some specific cases where all the new regulations are not having great impact . We consider all the aspects involved in a business, not only the registration or the start up periods to which many of the changes introduced apply, but we also bear in mind the future life and needs of the business.
    To the question if we still consider R.O.s a practical approach to establish businesses in China, we would say yes, R.O.s are still an interesting approach but maybe to a more reduced group of projects than in the past.
    …… We would not advice to choose a R.O.s as an investment structure to companies that may need to hire more than 4 foreign employees (which it is not allowed any more), to companies that will have great expenses (for example: rental, salaries, business trips…etc) because the tax is paid taking the monthly expenses as the tax base, and, obviously, to companies that need to issue “fa piao” (invoices) to their clients.

  2. Which type of company do you recommend this approach to?
    We would advice our clients to set up a R.O when they are going to keep a small medium structure with low costs and just a few employees and overall if, after doing the math, to pay tax based on their expenses is still more interesting and competitive than to pay a profit based tax, as its compulsory to the WOFEs.

  3. Do new regulations change the way you will be advising your clients?
    The new regulation came into force in January 2010 and, as in many occasions, without too much pre advice, so we all had to adapt our advising and strategy methods to make sure we are covering our clients’ needs. On the other hand, all investors had to changed their business plans to adapt their projects to the new legal frame affecting foreign corporate establishment in China.

So, now my question goes to the blog readers. Are the new regulations going to affect your activity as a Representative Office?


[1] Link to the State Administration for Industry & Commerce of the People’s Republic of China
Notice of changes in Registration of Foreign Representative Offices – English reference translations:
http://202.108.90.68/nd/100108143617-0.htm

Other English sources for this information:
http://www.picozzimorigi.cn/main/reports.php?id=30

http://www.martindale.com/government/article_Sheppard-Mullin-Richter-Hampton-LLP_916678.htm

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