Rules Further Tighten Regulation of Foreign Representative Offices

Foreign companies must adapt to a stricter regulatory environment when planning to expand in China through representative offices.

By David Livdahl, Jenny Sheng, and Huiyuan Li

Representative (rep) offices are one of the most popular and cost-efficient vehicles for foreign investors to use in China without committing significant resources (see Representative Office Characteristics). Recent PRC rules, however, have made setting up and operating a rep office more difficult. As a result of stringent new requirements on the documents needed to apply for a rep office and procedures necessary to comply with PRC law, maintaining a rep office is now a more resource-intensive operation. Foreign companies interested in establishing operations in China should thus carefully research whether the rep office is the optimal structure for their business needs. To successfully navigate the process of selecting an investment vehicle, companies must understand the regulatory and legal regime that governs rep offices.

New rules and obligations

The PRC State Council on November 19, 2010 issued rules that increase scrutiny over foreign rep offices, enhance supervision of rep office activities, and impose more stringent compliance requirements. The Administrative Rules on Registration of Representative Offices of Foreign Enterprises (the new rules) took effect March 1, 2011. The new rules replaced the 1983 Administrative Measures on Registration of Representative Offices of Foreign Enterprises (the 1983 measures), issued by the PRC State Administration for Industry and Commerce (SAIC). The new rules further enhance the PRC government’s supervision and regulations on foreign company rep offices and implement many of the proposals outlined in the Notice on Further Strengthening the Administration of Foreign Enterprise Permanent Representative Office Registration (the notice), jointly released by SAIC and the PRC Ministry of Public Security (MPS) in January 2010 (see the CBR, September-October 2010, China Tightens Restrictions on Foreign Representative Offices). The new rules and the notice apply to rep offices of all foreign profit-making enterprises.

Supervision and scrutiny requirements

Stricter requirements for registration

The new rules require foreign companies to submit memoranda of agreements for incorporation and articles of association, in addition to the firm’s incorporation certificate and a letter issued by the company’s bank that certifies its credit. Companies must also submit an appointment letter, and detailed resumes and copies of the chief representative and other representatives’ passports to a local administration for industry and commerce (AIC) office where the rep office will be established. In contrast, the 1983 measures did not require submission of memoranda and articles of association.

The new rules also stipulate that the foreign parent company of the proposed rep office must have existed for at least two years before the rep office’s establishment. This requirement will make it more difficult to set up an offshore company (for example, in Hong Kong) specifically to sponsor the rep office. Alternatively, some foreign companies may wish to purchase an existing shell company in the British Virgin Islands, the Cayman Islands, or Hong Kong to serve as the PRC rep office’s parent company. But local AIC offices may have different policies on whether to accept an application for establishment of a rep office by a foreign shell company immediately after such an acquisition (assuming the shell company would be renamed after the acquisition).

Limited number of representatives

Both the notice and the new rules limit rep offices to four representatives (including the chief representative)–a shift from the 1983 measures, which did not restrict the number of representatives. After the rep office registers with the local AIC office, the office will issue certificates to the representatives, who may use the certificates to apply for residence permits with the applicable exit-entry administration under MPS.

In addition, the new rules list categories of individuals who may not serve as representatives:

• Individuals who have been prosecuted criminally for harming China’s national security or public interest;
• Individuals who have served as a representative of a rep office that was closed down or the license of which was revoked or canceled for harming China’s national security or public interest or other unlawful activities; and
• Other individuals as provided by SAIC regulations.

Vague terms for rep offices

According to the new rules, a rep office’s term of duration must not exceed that of its foreign parent company–a change from the previous policy, which did not specify limits on terms of duration. The new rules, however, do not explicitly stipulate the maximum number of years a rep office may operate.

Additional compliance requirements

The new rules provide additional compliance requirements that cover accounting, annual inspection, auditing, and other issues to which foreign companies and their rep offices should pay close attention.

• Information sharing  The new rules reaffirm the commitment in the 2010 notice that SAIC and its local counterparts will establish an information-sharing mechanism with relevant government agencies (such as entry-exit, foreign exchange, and tax authorities) to exchange information related to rep offices and to coordinate on enforcing rep office rules.

• Accounting and auditing  The new rules for the first time require rep offices to set up accounting books that follow accounting-related regulations and policies (which are not specified), and accurately record the funds provided by foreign parent companies and rep office expenses and income. Rep offices must open their own bank accounts; they may not use the bank accounts of other enterprises, organizations, and persons in China, including those of their parent companies.

• Public announcement  A rep office must also publicly announce its establishment in a media outlet designated by the relevant AIC branch. Rep offices that fail to do so may be fined ¥10,000-¥30,000 ($1,532-$4,596) or have their registration certificates revoked.

• Annual inspection  The rep office must undergo an annual inspection from March 1 to June 30 by submitting to the local AIC branch a set of annual reports, including information on the rep office’s business operations, proof of the legal existence of its foreign parent company, and an audit report issued by an accounting firm addressing the rep office’s income and financial status during the previous year. Rep offices that fail to submit these reports on time will incur a ¥10,000-¥30,000 ($1,540-$4,620) fine or have their registration certificates revoked. If a rep office submits annual reports that contain false information or withhold required information, it must revise the reports and pay a ¥20,000-¥200,000 ($15,321-$30,642) fine. The rep office’s registration certificate will be revoked if the circumstances are considered “serious,” though “serious” is not defined.

• Foreign parent company information filing  A rep office’s foreign parent company must file with the AIC any change in its authorized signatories, organizational structure, registered capital, and scope of business within 60 days after such a change occurs.

Suggestions for foreign investors

Foreign investors that wish to establish a new entry vehicle into the China market should weigh the pros and cons of a rep office versus other foreign investment vehicles (such as a wholly foreign-owned enterprise [WFOE] or joint venture) in terms of compliance obligations and costs (see the CBR, September-October 2010, Choosing a China Investment Vehicle). Foreign investors that already have established rep offices in China should revisit the status of their rep offices to ensure compliance with the new rules. Companies should

• Arrange for their rep offices to complete annual inspections.  Under the 1983 measures, rep offices were not required to undertake annual inspections, which are an annual routine for WFOEs in China. Rep office staff should keep in mind that, under the new rules, they need to arrange to complete these examinations.

• Stay updated on new developments.  The regulatory regime governing rep offices may continue to change. Rep offices should communicate frequently with their legal counsel and the local AIC branch to ensure compliance with new regulations.

New developments and future prospects

Since early 2011, SAIC and other government agencies have begun taking steps to implement the new regulations. SAIC in February 2011 issued the Circular on Implementing the Administrative Rules on Registration of Representative Offices of Foreign Enterprises, which requires rep offices established before 2011 to apply for new registration certificates by the end of August. Rep offices must complete annual inspections before they may apply for these certificates. Rep offices established this year should also apply for new certificates, though they do not need to undergo the 2011 annual inspections.

Compared with the previous SAIC and MPS measures and notices, the new rules were issued by a higher legislative organization–the State Council–and introduce more stringent compliance requirements and tougher penalties. Foreign investors and their rep offices should adapt to the scrutiny of the new compliance environment and be prepared to face new rules in the future.

Representative Office Characteristics

Representative (rep) offices have several unique advantages. They have no mandatory initial capital requirements and have less stringent compliance guidelines compared to wholly foreign-owned enterprises. They are not independent legal entities, so all liabilities or obligations incurred are done so in the name of the foreign parent company.

But rep offices also have disadvantages and limitations. They may engage only in non-profit-generating activities related to the foreign parent company. Such activities include market investigation, exhibition, and promotion of the parent company’s products and services, and liaison activities for the parent company. Most rep offices must also re-register and renew residence and work permits for foreign representatives every year and file tax quarterly with tax authorities.

Applicability of New Rules

The Administrative Rules on Registration of Representative Offices of Foreign Enterprises only apply to rep offices established by profit-making organizations incorporated in foreign jurisdictions; rep offices established by foreign nonprofit organizations are not subject to the new rules. Like the earlier measures and notice, the new rules govern rep offices established by entities from Hong Kong, Macao, and Taiwan. The new rules do not cover rep offices of accounting firms, insurance companies, and law firms, which are regulated separately.

David Livdahl ([email protected]) is a partner, Jenny Sheng ([email protected]) is an associate, and Huiyuan Li ([email protected]) is a China advisor with Paul, Hastings, Janofsky & Walker in Beijing.