We have written a number of times recently of how China is cracking down on Representative Offices and how they seldom make sense anymore. This past week, I encountered yet another potential pitfall. First though, a bit of general background on China Representative Offices.
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.
There are three basic requirements for forming a Rep Office:
- 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.
- There must be a designated Chief Representative who will manage the affairs of the Rep Office.
- 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.
There are two major issues that make operating a Rep Office in China unattractive:
- Even though Rep Offices are not permitted to earn income in China, they are nevertheless subject to taxation.
- 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.
So this past week, our China business lawyers were talking with a new client from Spain that is interested in getting into China. The company is a service business that spun off from a much larger company about a year ago. I cannot reveal its business, but I can say that it is already representing a number of Chinese companies going overseas and its plan was to open a Rep Office in China to push more China business to its Spain and Mexico offices. After we initially told them that Rep Offices seldom make sense in China any more, we were starting to see reasons why it might make sense for this company. As we were talking through their situation with them, we all of a sudden realized that China now pretty much requires the Rep Office’s parent company to have been in existence for at least two years.
We alerted our client to this and we then talked a bit about possibly buying an older shell company to own the China Rep office. Eventually (and fortunately), we all decided a WFOE made better sense in any event.