How To Form A Representative Office In China.
For every roughly 100 China WFOEs and Joint Ventures (total) my firm helps set up in China, it does one Representative Office. Why so few Rep Offices, when it is generally agreed they are the easiest entity for foreigners to form in China? Because the inherent limitations on China Rep Offices mean they seldom make sense.
Rep Offices "represent" in China the foreign company back home. Rep Offices are not a separate legal entity; they are the China representative of the foreign company. Most importantly, they are not allowed to engage in profit making activities. Chinese law limits them to performing "liaison" activities.They cannot sign contracts or bill customers. They cannot supply parts and after-sales services for a fee. They simply cannot earn any money in China or take any payments from a Chinese person or business for any reason.
NOTE: This post does not discuss branch offices for banks, insurance companies, accounting firms or law firms, all of which are permitted to engage in profit-making activities in China.
Rep Offices are pretty much limited to engaging in the following:
-- Conducting research.
-- Promoting their foreign company.
-- Coordinating their foreign company's activities in China.
-- Other activities that do not and are not intended to generate a profit.
Because forming a Rep Office in China is faster, cheaper and easier than forming a Wholly Foreign Owned Entity (WFOE), companies oftentimes consider forming a Rep Office in China to test the waters there, with the intention of switching over to a WFOE once it becomes clear China will be viable for them. We generally discourage this because "switching" from a Rep Office to a WFOE is not really a switch at all. It involves both shutting down the Rep Office and forming a WFOE pretty much from scratch. Because the cost of forming a Rep Office, shutting down the Rep Office, and then forming a WFOE, will be considerably higher than just forming a WFOE, forming a Rep Office with the later intention of forming a WFOE seldom makes sense. Companies will usually be better off just biting the bullet and forming the WFOE straight away.
Other times, companies have come to my firm believing they need a China Rep office because they need a Chinese entity to sell their product into China. Oftentimes though, these companies can sell their product into China without having to create any in-china footprint at all.
There are definitely times where a Rep Office makes sense. By way of one example, my firm set up a Rep Office for a US company that sells US made equipment for around $2 million each. This company has no plans to start manufacturing its equipment in China so there would be no need to form a WFOE for that. It already had an arrangement with a Chinese company to repair its equipment sold into China, so no need to establish a WFOE for that purpose either. This company merely wanted an on the ground China presence to improve its sales and to let its customers and potential customers know it is serious enough about China to commit to having an office there.
There are three basic requirements for forming a Rep Office:
1. The most important requirement is that there must be a lease on an approved space for a period of at least one year beyond the approval date of the Rep Office. Care should be taken with this requirement, since many jurisdictions accept leases only from a small group of approved office buildings. Shanghai, for example, is one such jurisdiction. The lease must be registered, which can also cause problems in some jurisdictions.
2. There must be a designated Chief Representative who will manage the affairs of the Rep Office.
3. There must a foreign entity (typically a limited liability or a corporation) that the local office represents; private individuals and partnerships cannot establish a Rep Office in China. In addition, some jurisdictions in China do not allow newly formed entities to form a Rep Office.
The local approval authorities usually issue their decisions on Rep Office approval within around thirty days, at which point the Rep Office must do many of the other things typically required of businesses in China. However, in some areas, the decision can take much longer, depending on the whims of the local officials.
There are two major issues that make working with Rep Offices unattractive:
1. Even though Rep Offices are not permitted to earn income in China, they are nevertheless subject to taxation.There is a 10% tax on the GROSS EXPENSES of the Rep Office. If the Rep Office is large and has a number of employees, this tax can be quite high.
2. A Rep Office is not permitted to directly hire Chinese nationals. All hiring of Chinese nationals must be done indirectly through contracting with a Chinese employment agency such as FESCO. Recent changes in the Chinese labor contract law have made such contracts extremely unattractive. Rep Offices can directly hire foreign nationals.
The bottom line on Rep Offices is to think before you leap and not get seduced by their relative ease of formation. Every once in a while my firm will get called by someone who formed a Rep Office (usually through a formation company) within the last year or so who tells us they are now ready to "switch over" to a WFOE so they "can start making money" in China. These people believe this "switch" will involve little more than a one page notice of change and are shocked to learn that it will actually involve a shutdown and a new formation. Do not let yourself become one of "these people."
Comments (26)
Read through and enter the discussion by using the form at the endChris - January 11, 2010 8:16 PM
All the caveats on what Rep Offices can and cannot do noted and appreciated. We have run a number of Rep Offices in China for many years. Despite the limitations, they have been very useful in promoting overseas products and services and enabling Chinese b-to-b clients to establish quite profitable arrangements with our overseas operations.
Another advantage of Rep Offices is the low cost of on-going operation. Compared to a WFOE, accounting and corporate services are quite simple and low cost.
Where an overseas business is clear about the limits on the scope of activities a Rep Office can undertake, and it matches short and medium term business objectives, a Rep Office is a valuable and useful structure.
Dan is quite correct that a Rep Office is not a 'market entry' strategy where the business objective is to bill clients in China at a later date. Closing a Rep Office down is a major exercise and will invite close scrutiny by tax authorities who will look to extract every possible cent during the shut down exercise. Where the objective is to build a China business, a WFOE is a much more flexible structure.
Where the business objective is to build sales, brand and presence of operations overseas, and a direct arrangement between Chinese partners and overseas operations will be enhanced by a PRC presence, Rep Offices have their place.
Jing - January 11, 2010 9:58 PM
Thanks for the great post Dan, the information is really helpful.
Does this mean that there are no capital requirements to forming a representative office?
I own an LLC with just myself in it, (I just freelance and work over the internet). Since most of my family is in China, and I'm a U.S. citizen, do you think this is a viable option?
Thanks so much for your time!
Jing
Dan - January 12, 2010 6:35 AM
Chris,
You are 100% right. There are times where a Rep Office is absolutely the way to go and you have done a great job setting out when those times arise and why it makes sense.
Dan - January 12, 2010 6:38 AM
Jing,
I have no idea. I would need to know so much more to be able to give you good counsel on this. Heck, it is even quite possible that what you are doing does not require a China company at all. I find that to be true fairly often of companies that contact me regarding forming a China Rep Office. In the end, our determination is that they do not need a China office of any sort, at least in the short term.
Santas Little Helper - January 12, 2010 7:41 PM
Jing, there are in fact no capital requirements to set up a Representative Office. Obviously you do need to budget for the overheads, rent, staff, fit out and then the operating costs, but no, there are no capitalisation requirements unlike a WFOE, FICE or JV, which does make RO a cheap option if you need one.
Matthew - January 12, 2010 9:47 PM
Good post Dan. This a very common problem area. Primarily I think its a hangover from when many RO's received tax free status.
I do agree that there is a time and a place for an RO. However, I do think that this is becoming less and less. One of the prime reasons for this is tax. Depending on how the SAT's approach to permanent establishments develops, I think there is a significant potential for an RO structure to leave a company in a MUCH worse tax position in the future.
Chris - January 13, 2010 6:31 PM
Matthew, please elaborate on what the potential tax implications are for Rep Offices being treated as "permanent establishments" for the purposes of taxing the revenue their liaison work delivers to overseas operations. I have seen almost nothing on the SAT's approach to this issue.
Surely the point of a Rep Office is that, if fully compliant in paying expense based tax, its likely contribution and value to the overseas operation has been taxed at an appropriate level already.
Maybe work on a joint post with Dan on this issue.
The issue does not solely affect Rep Offices, but also WFOE's with related party transaction Agreements with HQ.
Matthew - January 13, 2010 9:35 PM
Chris,
I was intending to do a post over at China Tax Insights on my predicitions for tax developments in 2010 and will raise this issue then.
This is more a feeling that I have based on the trends of the past 18 months and a few comments by the SAT. I believe circulars 601 and 698 are just the tip of the iceberg and more can be expected.
The difference with a WFOE is that they are a separate corporate entity and hence are taxable under the Enterprise Income Tax Law in their own right. This means that the transfer pricing and the anti-avoidance rules are a more appropriate, direct mechanism in respect of such entities rather relying on a PE argument.
I will elaborate more on this point in my post which is coming soon.
Ron - January 14, 2010 4:10 AM
Great post. Could you elaborate on how the recent labor law changes have made hiring Chinese nationals through FESCO less desirable?
I used to work for a consulting company that had an RO in Beijing working for American clients; payments occurred in the US, but all the activities that actually generated the profits occurred in China. Was my company looking for trouble?
Elizabeth L. Thomson - March 14, 2010 12:45 PM
Interesting comments but our clients certainly have found the Rep Office to be useful . For one client the RO was the perfect solution to doing quality control and sourcing in China .
They did go on to have some WFOE's but the RO remained in place.
All of our clients use Hong Kong companies as the gateway to China so that the RO is a subsidiary of the Hong Kong company.
This provides more flexibility ( and security ) than merely using an RO as a direct subsidiary of the foreign ie US / Canadian company.
Shun - March 22, 2010 9:17 AM
Hi Dan,
Thanks for the excellent post. I have a company (internet business) in USA and want to set up a local office in China. The primary purpose of the local office is to do development and research for my US company.So, there will be no profit but only cost/expense. Can you please tell me which entity is the best? If I set up WFOE, how can I deduct my expense in China from my USA tax?
Thanks.
Adam - June 13, 2010 10:04 PM
Hi !
The new rules says: Those company is incorporated more 2 years can establish RO in china. If i used shelf co. from hong kong to set up RO in China. Is that possible... without any annual return and new bank account..
Thanks
Agatha - August 16, 2010 9:05 PM
Hi,
I have a question concerning foreign private school (Higher Education). The rep office will engage the following :
-Conducting research
- Promoting the school
- creating alumni network
- Coordinating partership with chinese universities
- Recruiting students (tuition fees paid oversee)
I heard we couldn't register as a school as the education scope is very difficult to get. We have no plan to open a school in China, so do you think we should open a rep office as a private compagny, or considering opening a WFOE if the situation is getting more difficult for rep office?
Thank you,
Best regards
clive - September 3, 2010 2:49 AM
I have an office in China, (not registered)
1)how long can I take to register an RO befor I am illegal,
2)My parent company is In Hong Kong, but only recently created. (2 months) can I register an RO to this new company
3) can i register two (2) RO`s in one office (I have two companies in HK)
Clive
Olivia - October 29, 2010 6:54 PM
Hi Clive,
To question1) if everything goes smoothly, it takes around 15 working days,
2)can not establish a RO till parent company has been legally set-up for 2 years
Olivia
vlad - November 29, 2010 7:15 AM
Hi Dan,
I opened a RO In hangzhou. The foreign customers can accept my european fa piao?
Sara - January 14, 2011 9:36 AM
My company wishes to open a RO in Hangzhou. Because of previous travel, we already know who we would like to hire. I do not believe we will ever have the need to open an WFOE because all the responsibilities of that office will pertain only to Quality Control and Sourcing. Is there anyway to get around hiring through FESCO? Or can we control who FESCO chooses if the Chinese Nationals we wish to hire are already chosen. If we cannot get around this, what is the next option instead of opening and RO?
I appreciate the help!
Ivy - January 18, 2011 9:01 AM
I wonder who can provide some help with Agatha 's question below. I have the same issue.
Thanks in advance!!
//Agatha - August 16, 2010 9:05 PM
Hi,
I have a question concerning foreign private school (Higher Education). The rep office will engage the following :
-Conducting research
- Promoting the school
- creating alumni network
- Coordinating partership with chinese universities
- Recruiting students (tuition fees paid oversee)
I heard we couldn't register as a school as the education scope is very difficult to get. We have no plan to open a school in China, so do you think we should open a rep office as a private compagny, or considering opening a WFOE if the situation is getting more difficult for rep office?
Thank you,
Best regards
//
Dan - January 18, 2011 12:20 PM
Agatha/Ivy,
I doubt anyone of any real competence will answer your questions and the reason for that is that there is no way to give a good answer without all sorts of additional facts and also additional research (including talking with government officials). The real question is whether what you are planning to do should be a rep office or a WFOE and this sort of analysis can get quite complicated. The fact that it is education related is probably (though not definitely) of far less import than what it is exactly that you will be doing. You essentially have two choices. One, you work with the government to figure all of this out and if you do open your business as a Rep Office, hope that it will be allowed to remain open with your being able to do with it what you planned or you retain legal counsel to figure all of this out for you.
I hate to tell people to retain legal counsel and this is probably the first time I have ever done so on a comment, but I feel it necessary here as you really are pushing it if you expect a serious answer to what you have set out, which really is a very complicated legal question to which a good answer isn't even possible without a lot more information.
Alex Wong - February 18, 2011 8:28 PM
How much of this, if any, has changed due to the new rules? Will you be updating?
Li Jiuan - March 10, 2011 12:36 AM
Really great advice..I am facing the exact situation..a dilemma between setting up a RO and WFOE. It would be great if there's an update on the new rules. Previously, the number of Representatives was cap at 4 and I heard from a corporate advisory that the cap has been revised to 3 as of this month.
Appreciate the help & thanks in advance!
Stephen - March 11, 2011 2:40 AM
Hi! Can a RO in China accept money from a client for service provided into their corporate a/c in HK. Can a client transfer RMB from their a/c in Mainland to HK.
dan (another dan) - May 6, 2011 12:32 PM
The choice between a ro and a wfoe depends on what you plan to do in China and a strategy on how to do it.
Don - May 23, 2011 1:23 PM
Very useful insights. Thank you.
I wish to set up a sourcing office in Shanghai. Due to lack of local knowledge(mainly dealing with government offices and their requirements), I have been contemplating opening a RO and then later on convert to a WFOE. Clearly stated on this blog, this would not be the smart way to go.
However, having hardly any local knowledge, is it a smart thing to jump in with capital and all other associated costs and expenses and set up a WFOE?
Do you foresee any legal ramifications of leaving the RO as is and set up a WFOE once I have a much better understanding of the ground situation(under another company I have ofcourse)?
Thank you & best regards,
scott - May 29, 2011 2:58 AM
Can an RO rent or buy a company car?
Brgds SJ
Rodney Arnold - June 29, 2011 5:33 AM
My company, of which I am the Chairman employs a Chinese National in China to promote our products with support from our UK head office.
We pay this person directly into her bank account. Is this legal in China?
I am advised by by MD that we should form an RO and employ her through the RO but from what has been described on your web site the RO can not employ her and she has to be employed through a special employment agency. Is this correct?
If we have to employ her through an employment agency to be legal what are the cost implications?
If we have to employ this person through an employment agency and pay any fees they charge what is the benefit in opening an RO other than showing your company has substance?
Many thanks
Rodney Arnold