China Tightens Restrictions on Foreign Representative Offices

New PRC rules for representative offices may lead companies to rethink their investment approach.by Carl Erik Heiberg and Vivian Zheng.China has recently taken measures to dispel some foreign-investor perceptions that it is discouraging foreign investment. For example, earlier this year the PRC State Council raised the Catalogue Guiding Foreign Investment in Industry’s total investment threshold for “encouraged” and “permitted” foreign-invested projects that require central-level approval from $100 million to $300 million. The change increased the approval authority of provincial governments and may allow more foreign-invested projects to be approved.

China has tightened restrictions on foreign representative (rep) offices, however. On January 4, 2010, the PRC State Administration for Industry and Commerce (SAIC) and the Ministry of Public Security jointly issued the Notice on Further Strengthening the Administration of Foreign Enterprises’ Representative Office Registration. The notice stipulates higher government scrutiny of rep offices’ business operations, outlines additional requirements for foreign companies to establish rep offices or renew their registration in China, and limits the number of representatives that foreign companies can appoint. The notice has implications for new and existing rep offices in China and may cause foreign companies to rethink some of their China strategies.

The benefits—and limits—of rep offices

Depending on the industry, foreign investors may conduct their China operations in a number of ways: by establishing a wholly foreign-owned enterprise (WFOE), an equity or cooperative joint venture (JV) with a Chinese partner, a foreign-invested company limited by shares, or the more recently permitted foreign-invested partnership (see Choosing a China Investment Vehicle). All of these investment vehicles require a capital commitment and are subject to various industry-related restrictions and PRC government approvals. An inexpensive alternative entry strategy may be to register a rep office.

Rep offices are not separate legal entities; they are, as the name suggests, the China representatives of foreign companies. Most rep offices do not require PRC government approval and can register with a local SAIC branch directly, though China has issued specific regulations for certain industries that require foreign companies to obtain approval from the relevant industry regulator before registering with SAIC (see Table). A rep office takes far less time to set up locally than other investment structures. Once a foreign company submits all required documentation, registration with SAIC generally takes one month to complete, and follow-up registrations with other bureaus often take another month. The foreign company appoints a Chinese or foreign chief representative and can appoint additional representatives, all of whom must register with the local SAIC branch. Though rep offices must obtain leases for physical offices in approved office buildings and pay other operational expenses, they are comparatively inexpensive to set up because they do not require capital contributions.

Rep offices’ permitted activities are generally limited in scope. This structure allows foreign companies to establish a permanent presence in China to conduct non-revenue-generating activities—such as acquiring market intelligence, building business relationships, gaining better access to suppliers, and marketing new products—on behalf of their overseas headquarters. Rep offices, however, are generally prohibited from conducting direct profit-making activities, including placing orders, signing business contracts, collecting payments, issuing invoices, and providing fee-based after-sales services. All such activities must be done by the overseas headquarters. In addition, a rep office cannot employ Chinese personnel directly, but must hire them through a contract with an authorized foreign services company.
The ins and outs of rep office registration

With the exception of law firms, all foreign companies must submit rep office registration materials to the local SAIC branch through an approved government agent. (Law firms only need to apply for approval from the PRC Ministry of Justice.) The required materials differ slightly depending on the city but generally include a government application form, an appointment letter for the chief representative and other representatives, a copy of the local office lease, an apostilled (certified by the applicable PRC consulate to be authentically notarized) certificate of incorporation, an apostilled letter of good standing from the bank with which the foreign company normally does business, and other supporting documents.

Of these documents, the bank letter of good standing and the certificate of incorporation often take the most time to prepare. Though the letter of good standing requires only a general reference from a bank, some foreign companies occasionally have difficulties obtaining the letter if they register the rep office using a special purpose vehicle (SPV) that has not yet established a relationship with a bank. (An SPV is a new legal person entity incorporated in a jurisdiction outside the People’s Republic for the specific purpose of being the parent company for a rep office in China.) The process to obtain an apostilled certificate of incorporation varies somewhat from location to location but generally requires that

• The certificate be simultaneously issued by the relevant company registry and notarized;
• The notarization be certified by the relevant government authority; and
• The certificate be apostilled by the relevant PRC embassy or consulate that has jurisdiction over the parent company’s location of incorporation.

After registering with the local SAIC branch, the rep office must register with several other local PRC government bureaus and agencies, each of which requires different registration documents. These authorities include the local branches of the

• Public Security Bureau (PSB) to obtain a PSB Registration Certificate, which is used to apply for visas for foreign representatives, and a Notice of Chop Carving, which allows the office to obtain its official company chop or seal from a registered chop-carving office;
• Bureau of Quality and Technical Supervision to obtain an Enterprise Organizational Code Certificate and an Integrated Circuit Card;
• Statistics Bureau to obtain a Statistics Registration Certificate;
• State Administration on Foreign Exchange to receive formal permission to open a foreign currency bank account;
• State and local tax bureaus to obtain state and local tax certificates; and
• Customs to obtain a Customs Registration Certificate if the rep office or its employees will import personal belongings, office equipment, or sample goods that must pass through PRC Customs.

The rep office must also apply for work permits and visas for any foreign representatives and must apply to a local bank to open foreign currency or renminbi accounts.

A foreign company must register any changes that would affect its rep office’s registration materials with SAIC within 30 days of the relevant change. For example, a rep office must register a new lease if it moves to a new office or registers a new apostilled certificate of incorporation to change its name if its foreign parent company’s name changes. Prior to the January 2010 notice, foreign rep offices were also required to renew their registration certificates every one to three years, depending on local requirements.

The new restrictions

The January 2010 notice states that some rep offices have been operating outside of the restrictions—specifically, changing registration items without authorization, submitting false supporting registration documents, and conducting business operations illegally. The notice thus sets out several provisions to strengthen the administration of rep offices.

Registrations, renewals, and changes

A new provision in the notice states that foreign companies applying to establish a rep office in China must have been in existence for at least two years, as evidenced by an apostilled certificate of incorporation. This means that foreign companies must use established vehicles, rather than incorporate new SPVs, to handle their rep office operations. The notice also requires foreign companies to obtain and provide new apostilled certificates of incorporation each time they apply to renew their rep offices’ registration certificates—a potentially onerous process—and requires rep offices to renew their registration certificates every year.

Number of representatives

In addition to stricter registration and renewal requirements, the notice creates new bureaucratic hurdles for rep offices’ operations. Specifically, it limits the number of representatives that a company may appoint to four individuals, including the office’s chief representative. (Previously, there were no explicit limits on the number of representatives that a foreign company could appoint.) Existing rep offices that have more than four representatives may not appoint additional representatives, though the notice does not specify whether such offices must reduce this number to comply with the new rules. One local SAIC official in Beijing indicated that reduction would likely be unnecessary unless a rep office applies to SAIC to make changes to its registered representatives. (In addition to SAIC’s registration requirements, the PRC government has found practical ways to enforce the rule, such as refusing to issue visas or work permits to foreign employees of rep offices that have more than four registered representatives.) The notice also does not specify whether the restrictions would apply to rep offices of companies in industries that require regulatory approval. Local SAIC officials have provided different answers to this question, likely because of the limited number of registration applications that have been received since the notice was issued.

Spot checks

The notice states that local SAIC branches will perform spot checks on rep offices within three months after the registration certificates are issued. Rep offices found engaging in direct operations may be subject to administrative fines, and those discovered to have moved without updating their registered addresses or operating without valid registration certificates may be subject to increased scrutiny by the authorities.

Is a rep office still worth it?

Though rep offices have no capitalization requirements, some foreign investors have long debated whether opening a rep office was worth the time and effort due to the limited scope of its permitted business activities. Given the recent tighter restrictions on rep offices, more companies may begin their China operations with a WFOE, which can conduct revenue-generating activities directly. Furthermore, increased localization of approval procedures and decreased capital requirements have made establishing a WFOE less onerous.

Setting up a rep office may thus be the best choice for a foreign company that is mainly interested in promoting its overseas products and services and establishing networking relationships between Chinese businesses and their overseas operations. In addition, for some entities—such as foreign law firms and certain nonprofit organizations—a rep office may be the only option for conducting their China operations.

Many foreign companies are finding that the question is not simply whether they should set up a WFOE or a rep office, but rather how they can best take advantage of the vehicles available for foreign investment through a multifaceted approach. Because various investment vehicles and industries are subject to different regulations and authorities, a foreign company may find it advantageous to set up multiple rep offices, WFOEs, and Sino-foreign JVs. The different permitted business scopes of these various investment structures may allow companies to conduct more business in China. The correct approach for investing in China largely depends on the particular industry and the specific goals of the company.

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Recent Updates to Representative Office Tax Law

The PRC government earlier this year issued new measures that promise significant changes to how foreign representative (rep) offices calculate and file taxes in China. The changes bring China’s law on rep office taxes in line with the 2007 PRC Enterprise Income Tax (EIT) Law and may subject rep offices to new tax requirements and potentially higher tax burdens.

According to the Provisional Measures for Foreign-Enterprise Representative Office Tax Administration, which were released by the PRC State Administration of Taxation in February 2010 and took effect retroactively from January 1, 2010, foreign rep offices must now declare and pay income, business, and value-added taxes on income attributable to the rep office. Previously, rep offices could negotiate EIT exemptions with local tax bureaus on the basis that their rep office activities did not generate revenue. Under the new measures, local tax bureaus can no longer accept new rep office applications for EIT exemptions and must re-evaluate the applications of rep offices that enjoy existing exemptions. Only rep offices that have protection under a relevant double tax agreement may be considered for EIT exemptions.

The measures also clarified tax registration procedures for rep office staff and offered three formulas to calculate tax liability, depending on how complete the rep office’s financial records are:

• Actual amount method  Used when the rep office has kept complete records of its expenditures and revenue, this method is comparable to the tax calculation standard laid out in the EIT Law. (Though rep offices typically do not engage in traditional profit-making activities, income has been assessed—and tax levied—based on the services they provide.)
• Actual-revenue-deemed-profit method  The tax authority will use this method when the rep office has kept complete records of its revenue but not its expenditures. The reported revenue is multiplied by the tax rate and a “deemed profit rate,” which can be no less than 15 percent.
• Cost-plus method  This method is used when the rep office has kept complete records of its expenditures but not its revenue. In this case, the tax authority will generate a figure to indicate revenue: Revenue = expenditures / [1 – deemed profit rate – tax rate].

This figure will then be multiplied by the determined profit rate and tax rate to calculate tax liability.

The cost-plus and actual revenue-deemed-profit methods empower local bureaus to determine the formula that rep offices must use to calculate their income tax liabilities, using the all-important deemed profit rate. The new measures increased the minimum rate from the previous 10 percent to 15 percent. Because 15 percent is a base rate, however, local tax bureaus may have the discretion to apply a deemed profit rate that is even higher. The new rules thus create a strong incentive for rep offices to keep accurate records of their revenue and expenditures to avoid using the deemed-amount method to calculate tax liabilities.

—Nina Palmer and Julia Zhao
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[author] Carl Erik Heiberg ([email protected]) is an associate and Vivian Zheng ([email protected]) is a senior legal consultant at O’Melveny & Myers LLP’s Shanghai office. Legal consultant Ying Ying Tao and intern Diana Duan assisted with this article. [/author]