My wildly unscientific observations tell me that about nine out of ten companies that go into China legally end up succeeding. My wildly unscientific observations also tell me that about eight out of ten companies that go into China illegally end up failing within a couple of years. Of the other two companies that went into China illegally, one usually becomes legal within a few years and ends up suceeding and the other one ends up failing a few years later.
I have no idea on the accuracy of my statistics, but I truly do make an effort to keep up with every company that contacts my law firm. I do this by every six months or so sending an email asking them how things are going in China. These emails go to those companies that chose not to retain my law firm, but instead to do things illegally in China, and to those that did. No science here, but a bit more than a feeling….
I thought of all that today when I read in the highly respected Economic Observer of how China is cracking down big time on China Rep Offices. Let me start out by saying that I am generally (not always) not a big fan of Rep Offices and that for every WFOE my law firm registers for our clients, we probably do around one Rep Office. The biggest problem with Rep Offices is that their utility is limited. Rep Offices are not to make money in China. Rep Offices are mostly to be used to market the home office. The Rep Office is not to engage in sales within China. The last Rep Office we did was for a US company that makes multi-million dollar equipment in the United States. The point of the Rep Office was to market that equipment within China, with the contracts for the sale of that equipment to be with the US company and the payments for that equipment to go to the US company and the manufacturing of that equipment to occur in the US, and the shipment of that equipment to come from the US to China. So far, near as I know, all of the sales have been from our US client to US and other foreign businesses doing business in China. These businesses pay our client in US dollars, all outside China, no problem. That is a legitimate Rep Office.
The problem is that Rep Offices are easier and cheaper to form and register in China than Wholly Foreign Owned Entities (WFOEs). This sometimes leads cash-strapped companies to want to start in China as a Rep Office and then later convert to a WFOE. This is usually a bad idea. It is a bad idea because if your China based business operations in China do not legally entitle you to operate there as a Rep Office, you are operating there illegally. Some may believe that operating in China as a Rep Office is better than operating in China without having registered as anything at all, but I am not so sure. I have absolutely no evidence to back this up, but my sense is that if you are going to operate illegally anywhere, you are probably going to be better off being entirely off the gird, than half on it.
Starting as a Rep Office with plans to convert to a WFOE at some later date is also usually a bad idea because the conversion is not likely to be smooth. It is not as though one can start as a Rep Office and then smoothly file one piece of paper with some governmental office saying “I want to convert to a WFOE now, so here is my 10,0000 RMB conversion fee.” No, not at all. The way one “converts” to a WFOE from a Rep Office is more like having to go through all of the rigmarole of shutting down the Rep Office in China (no small task) AND having to go through the whole rigmarole of forming a WFOE from scratch.
I mention all this because I have just learned from the Economic Observer (a highly regarded Chinese publication) that China has stepped up its crackdown on illegally operating foreign Representative Offices. The article is entitled, “China Cracks Down on Foreign Representative Offices,” and it makes a whole lotta sense. To grossly summarize, it says that the Chinese government is sick and tired of full fledged businesses operating in China as Rep Offices and it is going after those businesses that are doing so. It is increasing the fines to 500,000 RMB (around USD$75,000) and stepping up enforcement. The article talks about how the government is looking at a shortfall in 2009 tax collection and going after illegally operating Rep Offices is one of the measures it will be taking to increase collections.
No surprise to me….

  • HuanYi

    Wow, what a shocker…. The Chinese government is going after ROs that are illegally run and operating out of their scope. Tax shortfall for the CCP and going after illegal businesses?? So is the US with UBS clients…. What’s the big deal? This should have been done a long time ago. The truly legit businesses operating within their scope have nothing to worry about.

  • The Slow Death Of The China Rep Office.

    I have written a number of times recently of how China is cracking down on Representative Offices and of how they seldom make sense anymore. This past week, I encountered yet another potential pitfall. First though, a bit of general background on China…