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

Setting Up a Representative Office in China (I): 10 Steps and Some Practical Tips

Considering setting up a Representative Office (R.O.) in China? Barbara Cisneros from INAEL Electrical Systems SA takes us through the steps she followed and gives us some tips based on her experience setting up in Shanghai in 2008.

1. – Obtaining the License.
Tip: Get somebody to guide you through the licensing and legal process.
Experience: There is a huge load of paperwork and you will not be able to do it on your own. In our case, we hired a Spanish law firm with an office here, as we also needed to legalize/authenticate paperwork for Spain. Once you have all the paperwork ready the process may take 2 to 3 months (at least in our case!)

2. – Designation of a Chief Representative.
In order to be able to start operating you MUST designate a Chief Representative for the R.O. This person will hold legal authority and will be legally liable. The Chief Representative will also pay taxes in China.

3. – Registering with the Tax Bureau.
As R.O.s don’t make profits, the Government has devised another way to get some money out of us. We are charged a percentage of the expenses our office incurs, including wages, rental, etc… I believe this percentage may vary depending on which city you live in, jurisdiction, municipality, district… In our case we pay 10% of our expenses.
Tip: I go back here to my first tip “get somebody to guide you”.
Experience:
The law firm that navigated us through the licensing process also took care of this.

4. – Accounting.  Somebody in your Team or Outsourcing?
As soon as you get your license you must start paying taxes. You pay the income tax monthly and the office taxes every three months.
Tip: (This tip is for very small R.O.s like ours (just me and a local employee.)) Unless you have hired somebody with an accounting background who additionally, and this is very important, has good contacts at the tax bureau, then I would recommend outsourcing it to an accounting firm.
Experience: In our case I decided to hire somebody with a bit of an engineering background so that she could help with my work beyond just picking up the phone. I outsourced the accounting tasks to an accounting firm.
There are plenty of companies, both multinational and local, that can do this for you. … When you are a very small company you don’t have the budgets a big multinational may be expecting from a client… so I contacted a local firm for which I had got very good references. It is working really well for us and my contact there speaks perfect English.
Extra Tip: It will save you some money if you include the cost of the annual audit in the accounting fee.
Experience: During the first three months of each year, the R.O. is audited for the previous year activity. This is done by special companies licensed to provide this service. I was aware it would have an extra cost so I negotiated the inclusion of this cost in our accounting fee.
The auditors are very thorough. I was surprise that they devoted four hours to such a small office as ours.

5. – Recruitment.
Tip:
You may choose whom you hire but you cannot complete the recruitment process directly.
Experience
: One of the limitations a representative office has is its inability to recruit directly. Instead you need to use an employment agency that has a license to provide this service. When I set up the office I was told the only available option was FESCO (Foreign Enterprise Human Resource Service Co). I’ve been told that there are a few more options now.
In my case, my boss already knew a good person for the job, so I interviewed her and passed the information to FESCO so that we could complete the recruitment process through them.

6. – Opening a Bank Account.
Experience: My Chinese staff and I visited several banks. We were taken through all the relevant information, account types, processes and fees, and with all that info in hand I made my decision.

7. – Looking for an Office.
You cannot just set up a Representative Office anywhere you want. The location/building needs to have a certain type of classification. A Chinese company can set up in locations we are not allowed to.
Tip: Study carefully all services that should be included in the office tenancy agreement (building management fees, official invoice…) as they may represent an unexpected extra cost afterwards.
Experience:
We were very lucky. There were offices available in the same building where our law firm was. We benchmarked with offices in some other locations in Shanghai and we realized the deal was good.

8. – Office Renovation … the office may need a bit of renovation before you move in….
Tip: Get somebody to manage it for you. Get a recommendation for somebody trustworthy! It may have an extra cost but it is the most efficient way to do it and it will pay back!
Experience: I had to travel and just couldn’t be on top of every step of the process (plumbing, wiring…). The Chamber of Commerce recommended somebody who “tailor-made” a project for me. I chose some office furniture, I even told him how I wanted the wiring, where the internet and the electricity sockets should go … and he managed everything for me.

9. – Becoming Operational_Office Services.
In our case we had to get telephone and internet installed. Usually other services like electricity and water are already provided by the office management.
Experience: The exact same internet service had different quotes depending on the source…You always feel there is something better out there, but you just need to focus on making a choice with the best information available so that you can become operational a.s.a.p.

10. – Becoming Operational_Office Supplies.
You obviously need office supplies, including computers.
Tip: Outsource anything which may distract your attention from your key tasks, especially those jobs for which specialized service is available, like information technology.
Experience: I got a contact for somebody who was doing computer maintenance/ IT support for another office.  I briefed him on what type of computer we needed, the quotes I had already got, and where I had checked them out… I requested him to take care of everything, from buying to set up. This person now provides us with IT support on demand and makes sure everything runs properly.

Have you set up a Rep. Office in China? Would you like to share your experience?