Archives: rep office

Just updated our research regarding China Representative Office rules relating to employees and note the following.

Q.  How many foreigners can work for the Rep Office? What is the proper term for referring to these employees?

A.  A Rep Office may hire no more than four foreign persons, each of whom is called a representative. These people are hired directly by the Rep Office and are treated as normal employees under China’s employment law system. That is, they are to be hired pursuant to a written contract and their taxes and social benefits must be paid.

 

Q.  If four foreigners work for the rep office, can the rep office directly or indirectly hire any Chinese employees?  If yes, how many?

A.  A Rep Office cannot directly hire any Chinese nationals. It instead must hire Chinese nationals indirectly through a Chinese dispatch company such as FESCO. There is no limit to the number of Chinese nationals who can be hired indirectly.

 

Q.  Can the foreigners work directly for the American home office?

A.  All foreign employees of the Rep Office resident in China must be hired by the Rep Office. They cannot work directly for the American home office.

The Rep Office must appoint a Chief Representative. The Chief Representative is not required to be an employee of the Rep Office and is also not required to reside in China. However, if the Chief Representative is not an employee of the Rep Office it must be an employee of the parent company. It is therefor possible to have a situation where four foreigners work in the Rep Office in China as representatives while a fifth foreigner who works for the parent company is designated as the Chief Representative. That is, the Rep Office has four resident representatives and a fifth, non-resident Chief Representative.

 

Q.  Can the Chinese work directly for the American home office?  Or do they have to work for a third party agency, like FESCO?

A.  No Chinese individual can work directly for a foreign Representative Office. The Chinese nationals must work for a dispatch company under a contract between the dispatch company and the Rep Office.

 

Q.  If the Chinese are the Representatives (let’s say there are only 3 Chinese workers and no foreigners), can they work directly for the US home office? Or do they have to work for a third party agency, like FESCO.

A.  As noted above, all Chinese nationals must be indirectly employed under a dispatch agreement with a Chinese dispatch company such as FESCO. They cannot work directly for the foreign parent of the Rep Office. In addition, the dispatch agreement must be between the Rep Office and the dispatch company.

 

It is important to note that the Rep Office needs a good contract with Chinese dispatch company and also must make sure that the Chinese dispatch company has an agreement with the Chinese workers that protects the foreign company.  Just by way of example, if the foreign company wishes to protect its trade secrets, it should make sure that the employment agreement between the Chinese workers and the Chinese dispatch company mandates that the employees not reveal trade secrets of the foreign company.

The New York Times has an excellent article on doing business in China. The article is entitled, “New Path for Trade: Selling in China,” and it is replete with good advice.  Except mine.

Let me explain.

The article is on selling goods in or into China and it talks of the great opportunities there and of how to do it well.  It presents the following good advice:

  • Bilingual is not bicultural.  Lou Hoffman of The Hoffman Agency notes something I am always saying: do not mistake language for culture.  Someone can speak your language and still have no clue about how you want to conduct your business.
  • Let others open the door.  Ric Cabot of Cabot Hosiery Mills/Darn Tough Socks tells of how his company “edged into the Chinese market” by testing it with a Chinese distributor.  “But if it gets to the point where we see we’re leaving too much money on the table, we might consider doing something different.”
  • Don’t get knocked off.  Earl Kluft, owner of E.S. Kluft & Company talks of the knock-off problems his company had in its first foray into China and of how things are going better this time due to a better a better China-based partner. Kluft found its new partner “through a friend” and with that partner it has “cautiously re-established a sales channel with minimal upfront investment.” The Chinese partner pays royalties and is able to buy Kluft’s mattresses at “a special discount.” I then chime in, advocating finding “reliable partners on the ground…. through people you know, and then pay for whatever due diligence is necessary to make sure that you have made the right choice.” And to do all of that “before you start doing business with them.”
  • Look locally before leaping.  The article talks of how some states have government-run international trade programs that offer counsel. Samar Ali, Tennessee’s assistant commissioner of international affairs then discusses the sorts of issues his group raises with those seeking to do business with China.  “We’ll help them see if there’s a need for their product in China and to think it through: Do they need to set up a WFOE? Do they need to have a presence or not? Should they go the e-commerce route? And tell them how much they should budget going forward.” This assistance includes help with business-to-business matchmaking through already vetted Chinese companies.
And then there is the one I do not like so much and it’s mine.
  • Set up shop as a WFOE.  The article notes that “it is possible to scout opportunities with a so-called rep office and to do business in China by selling through distributors or by licensing products to a Chinese company, most American businesses that are serious about selling in China invest the time and money to establish themselves as a wholly foreign-owned enterprise, or what is known as a WFOE (pronounced WOOF-ee).” It then adds this: “We do probably 100 WFOEs for every rep office,” said Dan Harris, a lawyer with the Seattle firm Harris & Moure who writes a blog about Chinese law and business.

What I do not like about this is that I am concerned that it will be read as my saying that setting up as a WFOE is virtually always the best way to sell to China and I did not say that because I do not believe it. I was asked about what it takes to set up a company in China and what sort of entity usually makes sense.  To that, I unequivocally answered with “WFOE.”  But what I was not asked was whether one can or should consider selling to China without any entity at all and had I been asked that, I would have unequivocally answered, “yes, that is often the best way so long as it is possible.

We are actually big believers in getting product into China via distributorship or licensing arrangements:

What is so funny about the NYTimes article coming out when it did is because we received some criticism of our last blog post, Getting Your WFOE Approved In China. What It Really Takes, in which we had this to say about forming a WFOE in China:
No wonder I use words like “slog” and “excruciating” and “unending” to describe to our clients what it is going to be like as we secure their WFOE registration in China.
The New York Times article rightly discusses the difficulties in registering a WFOE in China:
And think months, not weeks, to get all of the paperwork approved. “In China, you can’t do anything last minute,” said Savio S. Chan, president and chief executive of U.S. China Partners, which is based in Great Neck, N.Y., and which helped Vision Quest move its light fixtures out of regulatory limbo. “It can easily take up to six months to set up a WFOE.”
Mr. Chan has it right, which is one of the many reasons why anyone looking to sell their product to China needs to consider all options, not just a WFOE.
WFOEs, distributorships, licensing deals and yes, sometimes even a Rep Office can all make sense, depending on the specific situation.  When it comes to China (and just about anything else), there is no one size fits all.  I just hope that nobody thought I was saying otherwise.
What do you think?

Richard Brubaker over at All Roads Lead to China just did an interesting post on the return of China Joint Ventures. The post is entitled “Who is up for another round of Joint Ventures,” and its thesis is that China is getting tougher on foreigners so foreigners are reconsidering the value of a Joint Venture in which they can take advantage of their joint venture partner’s local connections.  Yes, but….

Richard starts his post by relating a recent conversation he had with a friend in a large multinational about the “barriers that foreign (industrial) firms have been facing recently in realizing the ROI they had planned on for their investments in China.”  The conversation then went to the question of how companies would react to these barriers:

Which opened up what I felt was the most interesting questions… Would firms roll the clock back and start all over again? Would they open up their IP for access to the market? Or… would firms begin to exit?

Questions that have no answers, but unlike 3-4 years ago when China was the only market that was providing positive growth figures for many firms, there are now questions about China’s short/ medium term trajectory and other countries that are seeing positive growth in markets like Brazil.

Which is to say that China, even for all its promise, is  perhaps not as compelling as it once was depending on the industry, timing of the cycle, and whether or not the firms felt like they had heard that song before.

JV 2.0?  Is it right for all firms?

Things that make you go hmmm.

First off, Joint Ventures are not right for all firms. In fact, they are wrong for most firms.

But Richard definitely makes some good points. China is getting tougher on foreign businesses, both in the way government is treating them and in terms of competition.  But in determining how to go into China, there is absolutely no “one size fits all” solution and for most companies, there are a whole host of options short of jumping into bed with someone you do not know well.

For those who are not familiar with the inherent risks of China joint ventures, I urge you to read at least some of the following:

To grossly summarize all of the above posts/articles on China Joint Ventures, they are risky because you are not on an even playing field with your joint venture partner who may end up having a lot of incentive to kick you out of the joint venture just when the joint venture starts taking off.

Fortunately, there are all sorts of ways to dip one’s toe into China, without doing a Joint Venture.

Opening a Rep Office is one of those ways.  In the old days (say 5-7 years ago), Rep Offices were the traditional way to test the China market.  Forming a Rep Office was considerably cheaper and easier than forming a Wholly Owned Foreign Entity (WOFE) or a Joint Venture and yet by doing so, the foreign company could enter China on its own. The problem today with Rep Offices, however, is that the Chinese government has so limited their range of activities, that they now make sense for only a tiny subset of companies seeking to do business in  China.  For more on what it takes to set up a Representative Office in China and the pros and cons of doing so, check out the following:

But here’s the thing.  For many companies seeking to do business with China, neither a WFOE nor a Joint Venture, nor even a Rep Office makes sense.  For many companies seeking to do business with China, avoiding going into China at all can be the best option.  In fact, these days, in most instances when a company calls us wanting “to go into China,” our default position is to try to figure out how that company can achieve its China goals without going into China at all.  I am always saying that running a company in the United States is very difficult and time consuming and anyone planning to go into China must first realize that running a company is much more difficult and time consuming there, ignoring even the language and cultural difficulties.  Oh, and it is expensive as well.  Of course.
So if “going into China” via a WFOE, a Joint Venture, or a Rep Office does not make sense, what else is there?  Many companies have no real desire to go into China at all. Rather, their real desire is to make money from China by selling their product or service or technology to China. Looking at it that way, there are three common additional options:
  1. Selling your product into China via a distributer or distributers based in China.
  2. Selling your product into China simply by exporting it from your own country.
  3. Licensing or selling your brand name or your technology to a company in China.
Earlier this year, we did a post, entitled, Selling Your Product To China Through A Distributor. Just The Basics.  That post started out talking about how distributorships are a viable option for getting one’s product into China, without having to form any sort of China entity to do so:

I often get calls from companies that want to get their product into China or increase sales there. Many times, they are under the false impression that they have two choices: go it alone or form a joint venture with a Chinese company. Entering into a distributorship relationship with a Chinese company (or companies) is another option. From a strictly legal perspective, distribution relationships between foreign and Chinese companies are actually fairly straightforward and are far easier and generally less risky than joint venture deals and typically far less costly and time consuming than going it alone.

From a business perspective, taking most products into China (be they industrial or consumer), marketing it, selling it, and then delivering it, is a massive task for any foreign company. I hate to trot out a cliche, but China is a big and diverse country and it should be viewed as many markets, not just one. Yet with China’s wealth rapidly increasing, it is the rare company that is not at least desirous of adding China to its list of markets. China is becoming a consumer/buyer nation.

For more on China distributorship relationships, check out the following:

Licensing or Technology Transfer arrangements are other options for monetizing a product, name or technology in China and we have seen a number of companies succeed with those. In a licensing or technology transfer deal, the foreign company can sell rights to a Chinese company for a limited geographic area (maybe just China) and/or for a limited time.  Alternatively, the foreign company can just sell the rights to the Chinese company.  This sale of rights too can be limited geographically or even by product.  For instance, XYZ foreign company may make 20 different products but license or sell rights to use its name and product technology and product IP (such as patents) for only one product and limit that even further by limiting the geographical use to just China.  For more on China licensing agreements, check out the following:
Lastly, and certainly not least, is the option of simply export sell your product into China from your own country. We have clients who have done this particularly successfully with things like industrial equipment, where there is a real and perceived benefit to having the product made in the United States and selling from the US and shipping from the US works just fine because the price is so high (typically $100,000 and up) for the product that shipping costs are not that big a factor.  For more on this straight selling and exporting method, check out the following.

So what is the best way to do business with China?  It depends….

What do you think?

One of the most common calls my law firm receives is the one from someone saying that they want to “start a business in China.” The first thing we do with that sort of caller is to seek to ascertain whether a China business is actually necessary.  Forming and then operating a business entity in China is not fast, is not easy, and is not cheap. I usually convey this by asking the caller if they find it easy running a business in the United States (or Europe), what with having to figure out and pay taxes, rent, wages, vendors, etc.  I then point out that having a business in China means they will have to do the same thing over there. So whenever possible, we seek to determine whether there is some way the caller can conduct business with China, achieve its goals with respect to what it is seeking to do with China, while not having a business in China at all.  For potential alternatives to forming a China business, check out the following:

But if forming a China business does make sense, the next issue is what kind of business makes sense. On this, you typically have three choices: a Wholly Foreign Owned Entity (WFOE), a Joint Venture (JV), or a Representative Office.  These days, the overwhelming majority of foreign companies seeking to do business in China go in as a WFOE, but there are definitely still instances when a Joint Venture or a Representative Office makes sense.  For more on the differences between these three sorts of entities and on what it takes to form each of them, check out the following:

If you are going to have a China business entity, you are going to have employees (indirectly in the case of a Rep Office). That means you are going to need written employee contracts (it virtually always makes sense to have these in both Chinese and in English) and a written employee manual/employee handbook (again, in English and in Chinese).  You probably will want your employee agreements to speak to issues like trade secrets and non-competes (which are limited in China) and overtime.  For more on employee contracts and employee handbooks, check out the following:

The last thing you need to focus on if you are going to be doing business with China, particularly if you are going to be doing business in China, is protecting your intellectual property. In nine out of ten cases, this means registering your trade name and your other important trademarks in China. On some occasions, this also means registering your patents or copyrights in China as well. For more on registering your trademarks in China and protecting your IP there, check out the following:

The above are the four main issues confronting foreign companies seeking to do business in China. 1) Determine if a China company is necessary.  2) If a China entity is necessary, form the right one. 3) If you are going to have a Chinese company, you should have the proper employment contracts and employee manual.  4) If you are going to be doing business in China, you are going to need to take certain steps to protect your IP.

That was easy, wasn’t it?

ABC News is pushing (I received two different emails from ABC on it) a Diane Sawyer/ABC News clip entitled, “‘Made in America’ Products Selling in China.” Though it is the proverbial 3.28 minute puff piece, it is right on the big picture. There are huge opportunities to sell American product and American products are viewed very highly in China.

It starts out noting how “the Chinese spent $104 billion in U.S. exports in the last year — up 542 percent from 10 years ago.”  For more on how China has been greatly increasing its purchases of American goods, check out Selling Into China: The New Wave.  The clip then highlights a number of large and small U.S. businesses that are either trying to sell into China or have succeeded in doing so. Everyone is happy, everyone is at least a little bit jingoistic, and everything looks as easy as simply putting your product on the net and waiting for the hordes of Chinese consumers to come to you. Of course, real life (as opposed to the media’s portrayal of it) is quite different.

The clip completely fails even to touch upon the following extreme basics:

  • Logistics
  • Customs/Duties/Regulations
  • Organizational structures
  • Intellectual property
  • Getting paid

So we will.

Logistics.  We are lawyers, not logistics people, but we know enough to know that if you are going to sell product into China, you need to figure out the best way to get it there and the cost of doing so and whether the costs are prohibitive or not.

Customs/Duties/Regulations. Just yesterday, I received an email from someone asking me why it was having to pay 18% at China customs for its food product, while one of its competitors was paying 7%.  The e-mailer wrote the letter as though we would have an answer right off the top of our heads, but our response was essentially that we had no clue.  We then talked of how it may be because of a difference in processing of the product, it may because of a difference in sizing of the product, it may be because of a difference in from where the product originates or was processed, or it may even be because one of the numbers was wrong.  We would need to know a whole lot more even to guess.  A few weeks earlier, someone had called me because China customs had just refused entry of their product into China because it did not meet China’s safety standards. The caller kept saying how it had “never even occurred” to him that China might have tougher safety standards than the United States.  Well, it should have. The U.S. Government has a very helpful website dealing with China customs.  Check it out before you ship.

Organizational Structures.  How exactly are you going to sell your product into China?  Are you going to do it exclusively from the United States? If so, you will not be able to take RMB unless you use some sort of intermediary.  Are you going to use a distributor in China to get your product sold? If so, will this be an exclusive or non-exclusive arrangement? Who will pay for marketing?  Who will repair the product when something goes wrong? How will you make sure that the distributor does not do something to tarnish your reputation? Or will you set up an entity in China (a Wholly Foreign Owned Entity (WFOE), a Joint Venture (JV) or a Representative Office) to handle your China sales?  Do you have even a basic understanding of how China retail works?

Intellectual Property.  If you want to prevent others from using your brand name or your logo in China, you absolutely must register those as a trademark in China and you should do so before you sell any product there.  For more on registering trademarks in China, check out WHEN To Register Your China Trademark. You face similar issues regarding copyrights and patents as well.

Getting Paid. Presumably, you are seeking to do business with China so as to increase your profits. Unfortunately, selling product internationally has a much higher risk of non-payment than does selling product domestically. We discussed this in The Basics Of Getting Paid When Selling To China:

If you are going to sell product into China (or anywhere else internationally), you should consider employing the following to increase your chances of not getting stiffed:

  1. Secure all of the payment in advance. Sophisticated buyers typically will not accept this unless you put up a performance bond or open a standby letter of credit so that it can get its advance payment back. Note, however, that it can sometimes be difficult for Chinese companies to obtain government approval to make full payment in advance.
  2. Conduct due diligence on your buyer.
  3. Secure some of the payment in advance. This obviously will not guarantee you full payment, but it is better to lose some as opposed to all from a sale.
  4. Secure a Documentary Letter of Credit. With this, you will be paid when there is documentary evidence you have shipped the product according to the terms and conditions of the letter of credit. Smart buyers typically require an inspection certificate to ensure the product complies with the specifications in the contract or the purchase order. This sort of letter of credit mitigates your risk because your buyer’s bank has irrevocably guaranteed to pay upon presentation of the required documents.

We generally recommend our clients secure this letter of credit from a major (not a tiny) Chinese bank, such as Bank of China, China Construction Bank, Industrial and Commercial Bank of China, China Development Bank, and Bank of Communications, or a  branch of a known American, Asian or European bank. WARNING:  We have seen more than our share of fake letters of credit.

To encourage exporting, many countries, including the United States, make it fairly easy and cheap to purchase insurance to cover an improper non payment on the letter of credit.

There are all sorts of variations on the above, but these are the basics.

So yes, Ms. Sawyer, selling into China is rife with great opportunities and we would be the last people to say “don’t do it.” But it is not nearly as simple as you portrayed it, at least if you don’t want to lose your shirt.

What do you think?

 

I know I keep reading how China’s economy is just fine, but my firm just keeps getting more inquiries and more work relating to shutting down offices and companies in China. 

Of those, the most heartbreaking are coming from Chief Representatives of China Representative Offices who are concerned about their own liabilities when their China Rep Office closes.

Typically, the Chief Representative tells the Rep Office employees that the Rep Office is going to be shutting down. Naturally enough, the employees ask about their getting paid. The Chief Representative usually tells them not to worry, which causes them to worry more and go to their local government. A local government official then comes by and informs the Chief Representative that he or she is PERSONALLY responsible for paying the Rep Office’s employee salaries AND all outstanding taxes. 

The Chief Representative then contacts my firm and we tell him or her that he or she does indeed run a very real risk of being on the hook for any and all Representative Office debts and so they had better make sure their home office pays. What can happen to a Chief Representative if the home office refuses to pay? We’ve heard of all sorts of things, ranging from the Chief Representative being held at a hotel for weeks until all debts are paid, to Chief Representatives sneaking out of town and then out of China, under fear of being put on a list that will prevent them from ever returning.

But what happens when the head office/owner of the China Representative Office files for bankruptcy in the United States?

In those situations, we recommend that the Chief Representative hire a US-based bankruptcy lawyer to file a claim against the bankruptcy estate on his or her own behalf.  The Chief Representative could claim that the US company owes him or her the amount owed to the Chinese employees and the Chinese tax authorities because the Chief Representative assumed that debt on the home office’s behalf.  Will this work?  We don’t know. Yet. 

Will the bankruptcy court hold that the Chief Representative is owed anything by the home office in bankruptcy? And even if the bankruptcy court does hold that the bankruptcy estate owes the Chief Representatve the amount the Chief Representative (and the estate) owes in China, is there any basis for the Chief Representative to claim entitlement to any higher percentage on his debt than any of the other unsecured creditors? In other words, will the Chief Representative get anything more than the usual pennies on the dollar creditors usually get? I rather doubt either the employees or the tax authorities in China will cut the Chief Representative much slack simply because his or her home office has filed for bankruptcy in the United States.

Quite the ugly situation. Bankruptcy lawyers (and others), what do you know?

We should have written on this years ago, but since it has never presented a real problem for my firm’s clients, it just never really rose to a level that it occurred to me. My mistake. The it to which I am referring is the send out a bill scam to whomever has just registered a company or IP just about anywhere in the world.

But before I explain the scam in full, I will quote from the comment that finally spurred me to write this post:

Shortly after registering my WFOE, I got an early morning phone call from (a Beijing land line) someone who identified herself as being with the Tax Bureau in Beijing.  I’m a night owl who frequently works on US time so I missed most of the details due to still being asleep and her ignoring all of my “I’m asleep, please don’t talk to me now” comments.

It wasn’t until the next phone call (a Jiangxi cell phone number) identifying themselves as being in Hainan that I caught the gist of them saying they had a published copy of the tax code that all new enterprises were being required to purchase for 2000 rmb and change, that they would be mailing it to me whether I wanted it or not, that the bank details would be in the mailing, and if I didn’t pay I’d be in big trouble.

All comments along the lines of “don’t want,” “don’t need,” and “can’t use” were ignored and a couple days later the books arrive by courier.

My first hint that something was wrong was the package label.  It wasn’t addressed to my company.  It wasn’t addressed to the 22 letter English name that causes me all sorts of headaches with every single official bureau that must use the name on my ID.  It was addressed to my Chinese name.  Not only that, but they got the family name wrong.

Inside the box I find some very official looking books (on very flimsy paper) with a (still ridiculously huge) price tag that doesn’t match the number they gave me on the phone.

I also find a fake fapiao.

The local police got involved and, at one point, were trying to set up a sting to get the scammers to come and meet me if they wanted to get paid but although they agreed a couple times, they’d never show up.

I continued to get early morning phone calls off and on for the next month.  In one phone call, the people on the other end threatened to have my visa revoked if I didn’t pay up immediately.  In another, I got death threats.

A few months later, a company I’m involved with (but which isn’t in my name) did a change of address.  The Chinese person whose name is on the documentation is the listed contact person but the number is mine.  When I got a phone call asking to speak to him so they could tell him about the important tax materials they would be mailing, I just hung up the phone.

Yup. This happens just about all the time, though usually not quite so aggressively (this is the first I have heard of death threats).

Here’s the deal.

Just about every time my firm registers a trademark or a copyright or a corporate entity anywhere in the world — be it a WFOE, a Rep Office, or a Joint Venture in China, or an LLC or a Corporation in the United States — our client gets a fake invoice. The invoice purports to be from the trademark or copyright or company registration office of whatever country it is in which we just did the registration and it is usually for anywhere from USD$250 to $750. This happens so frequently that it is our firm’s policy to warn our clients in advance of these.

The tax one of which the commenter wrote has become the scam du jour in China, which makes me think it is working. The fact that at least ten percent of our clients contact us about such invoices even though we have warned them about them in advance and assured them that we will cover ALL government filing fees and costs also indicates that these fake invoices do work, at least sometimes.

It is actually a pretty good scam in that it is not even clear to me that the scammer is violating the law. I say this because the invoices I have seen for this particular scam involving China WFOE formations usually say that they are offering a copy of the tax code along with tax consulting advice. So though the fees they are charging for this are absurd, they are at least offering something for the money. Where the illegality comes in though is that they are really just offering what you can get for free from the Chinese government and they are making it seem as though your registration is going to be held in limbo if you do not pay, which is, of course, completely untrue.

My law firm has overseen hundreds of company and IP registrations in China and not once have we or our clients ever been hit up for additional and unwarranted fees by the Chinese government. Not one time. Also (and unlike in some other countries), we have never been told to pay an extra fee for “expedited” service. So if something like this happens to you, the odds are overwhleming that it is not the government and it is not legitimate.

In any event, you have now been warned.

Have any of the above happened to you? What do you think?

Got an unusual phone call from a client yesterday.

The client is an American company that conducts business with China, not in China. This means that there is absolutely no legal requirement that it have a Chinese entity such as a WFOE or a Joint Venture or a Rep Office. What it does with China is 100% legal and above board. None of this can or has been disputed.

One of China’s largest newspapers had written a very positive article on our client but before they could run it, they needed to see our client’s China company registration. Because our client is not registered in China (and again, this is wholly proper), it could not produce such a registration and so the story did not run.

This is the first I have ever heard of such a thing. Is this new or has it always been the case? Is it yet another example of China’s strong intent to crack down on illegal foreign businesses?

Last week I did a quick post on the leasing requirements for forming a WFOE. That post generated some excellent comments/questions, hence, this Part II.

A couple people asked about the legality of “virtual offices.” 

Virtual offices were once common in China though as far as I know, they have always been 100% improper for a WFOE. WFOEs must have a separate and unique address in a space that is zoned for the business that the WFOE will be do. If it is an office, then a small office will do, but it must have a separate and unique address and a sublease will not work. However, if the WFOE needs more, like a workshop or a warehouse, then that is what must be leased. In Beijing, Shanghai and Guangzhou, for instance, the authorities actually come out and inspect the space and if it is not in compliance with the requirements for a WFOE they will reject the application for the WFOE.

I have received calls from people who have had their WFOE rejected for this very reason and, as I have written previously, once you have your WFOE application rejected (no matter for what reason), it becomes much more difficult ever to get it accepted.

In the old days, companies oftentimes wanted a virtual office in a favorable tax district (e.g., Pudong) and then had their real office in some other district or city.  However, under China’s new tax code this tax reason is no more.

Note also that for the WFOE to be approved, the lease is supposed to be registered and if you are going to get the tax deduction for your lease payments, you need a registered lease and a receipt (a fa piao) from your landlord. I do not see how this can be done if you are using illegal and unregistered space. 

If you are not going to get the right space for a WFOE, you are probably better off not getting a WFOE at all. Registering a WFOE and then not complying with ALL of the requirements for having a legally operating WFOE is a classic example of trying to operate quasi-legally in China. For why this is a bad idea, check out “Quasi-Legal In China. Not The Place You Want To Be” and “Forming A Company in China. Do It Right Or Do It ALL Wrong, But Don’t Do A Rep Office.

This post is essentially a re-running of a post we did at the end of last year. We are re-running it because as China’s economy starts to waver, the Chinese government seems to have stepped up both its tax collection and its closing of illegal foreign businesses another notch. I received two calls just last week from companies who were told that their “Rep Offices” were illegal and that they needed to form a WFOE right away or simply leave China.

Now is really not the time to be operating in quasi-legal mode in China. It just isn’t. 

Every couple of weeks my firm gets an email or a phone call from a small business that is seeking to justify forming a Rep Office in China instead of a Wholly Foreign Owned Enterprise (WFOE). These small businesses typically go into advocacy mode explaining why their business can and should be a Rep Office in China. They then go on to explain that they simply cannot afford to form a WFOE in China due to the minimum capital requirements, the legal fees, and the taxes. 

They then want me to condone their Rep Office plans but I never do.

In fact, the increasing number of these requests has caused me to get even blunter than usual, and my most recent response exemplifies this: 

What you are describing doing as part of an RO [Rep Office] is definitely not proper for an RO. Not even close. 

In terms of minimum capital required, because it is Dongguan, it is likely to be pretty high. Sorry. 

You pretty much have two choices. You can operate completely off the grid and risk getting shut down, or you form a WFOE. Probably the worst thing you could do would be to form an RO that operates illegally because they you are just drawing attention to yourself.  

I get the sense that the people contacting us on these things are hoping that they somehow have found THE loophole that nobody else has found and that if only they can get the blessings of an attorney for what they are doing, that their operating illegally will somehow not be illegal. I wish I had some magic oil I could sell (for a helluva lot of money) that I could sprinkle on illegal China businesses to make them legal, but I have no such thing.

Those who think they are going “sorta” legal by forming what is clearly an illegal Rep Office in China are very similar to those who think they are “sorta” protecting themselves legally by doing a “sorta” joint venture with their girlfriend. I wrote about those people in a post, entitled, “Operating Illegally In China. Half-Assing It Does Not Help.” In that post, I described the following email I had recently received from my co-blogger, Steve Dickinson:

We had one of these the other day and it precipitated an email from my co-blogger, Steve Dickinson, to me, which went as follows:

If these people are going to go illegal in China, they should go 100% illegal. That is, enforcement either through really strong family connections (your father knows her father) or enforcement through gangsters and the like. I know people who have succeeded this way but I don’t know anyone who has succeeded with an illegal contract. This is not because contracts don’t work in China, because you and I have won enough China contract cases to know that they do.

It is because the Chinese judges are totally on to these sorts of arrangements and they know they violate or seek to evade Chinese law. They therefore have and will continue to deem such contracts void. Why do people live in this fantasy world thinking that somehow they are so different or that they have discovered the solution? Why do they think a Chinese court would enforce a contract designed to evade the law?

Take an alternative example. Remember John Smith’s [yes, it is an alias] company we formed in Beijing a few years ago? Not sure if you remember this, but that investment was with his Chinese wife. However, we did that as a very formally organized WFOE and left the wife and her family with the irregular side of the deal. His US company is the only shareholder and he runs the board. His company has had no trouble and he has had no trouble because he is legal and secure. His US LLC [and with it, the China WFOE] were just purchased by _______ [a pretty big name U.S. company]. The reason the purchase was successful is that the whole company was “clean” and therefore it could be purchased by a foreign public company.

I then concluded that post with the following:

As lawyers we are never going to tell our client to go full illegal, but in my role as a blogger, I have to think going full illegal would probably make better sense than paying a lawyer to draft a void contract. I think people know this, but their rightful discomfort at operating illegally makes them want to clutch on to something that will allow them to justify (however falsely) their actions.

The same holds true with respect to forming a Rep Office when a WFOE is required. Forming the Rep Office in that situation will just serve to let the Chinese government know where you are and what you are doing and will make it easy for them to realize that what you are doing requires a WFOE. On top of that, as I am always saying, you should not form a Rep Office with plans to form a WFOE in a year or so “if everything works out.” You should not do this because you will end up paying THREE times as you will pay for forming the Rep Office, pay for shutting down the Rep Office (and this is not cheap), and then pay for forming the WFOE.

What really drives me crazy about all this though is that on at least three occasions, companies for whom we have refused to form Rep Offices have written me to tell me that “so and so” company formation company is willing to form the Rep Office for them, as though this mere fact means that my firm was wrong in declining to take money to do something we know will eventually not work.

And though I take no happiness from this, I will note that one of the three companies that went ahead and formed a Rep Office against our advice did contact us about a year later to tell us that the Chinese government was now making them form a WFOE.

For more on what is involved in forming a company in China, check out the following:

Doing business in China? Don’t do it half right because you are only increasing your risk. 

Get legal now.