Changes in Regulations

-       Does a Representative Office Still Make Sense for Your Business?

As new regulations have been issued by the State Council to strengthen the administration of Representative offices (ROs), it is time to reassess the organizational structure of your China operations.

Registration of business scope is of the utmost importance when establishing in China as this determines the range of business(es) a company can operate within. A RO can predominantly be used as a base for preparatory and liaison work as it cannot engage in profit making business activities; hence it has a very limited business scope.

ROs

The limitations in a ROs business scope was not clearly defined pre 2010, however, with the implementation of the new regulations these have been further specified. This means that the administrative burden of running a RO has increased and so has the associated costs. Below you will find some of the most noticeable changes in the new regulations:

-        A restricted number of visas for representatives (expatriates); this has been limited to four.

-        Tighter control of annual reporting; an annual report should be submitted between March 1 and June 30 every year.

-        Shorter operational term; the business license must now be renewed every year and not every third year.

-        A general increase of tax burden; although this will vary from RO to RO, the general tax burden based on expenses has increased from 8.82% to 10.94%.

-        Tax exemption has basically been cancelled for all ROs.

-        Harsher penalties; various fees for non-compliance have been introduced and/or increased.

Although the increased control significantly impacts ROs already in existence as well as those foreign investors who are considering opening ROs, the new regulations have made ROs administrative obligations more clear. Thus, for ROs setup with the purpose of conducting liaison and other non-profit activities the implementation of the new regulations is certainly an improvement. Also, it is still possible for the overseas parent company of the RO to invoice business partners and clients in China.

WFOEs

Meanwhile, the application process for establishing a wholly foreign owned enterprise (WFOE) has been made simpler and in turn caused an increase in popularity among foreign investors. This change in trend is also affected by the above mentioned limitations on ROs. The application process is relatively simple if the WFOE is engaged in trade (import/export) or consultancy; however, if the WFOE is engaged in industries such as banking, education, insurance and tobacco the application process is more complicated due to a strong governmental interest in these sectors.

Although procedures for establishment have been made simpler this does not mean that ‘changing’ a RO to a WFOE can be done swiftly.

The process can be divided into two parts, which can be carried out simultaneously: 1) establishing the WFOE and 2) closing down the RO. Part two is heavily influenced by the history of the specific RO and can take from two months to two years depending on the time the RO has been operating and former administrative compliance. During this period relevant documentation must be submitted to authorities for examination.

It should be noted that once the WFOE has been setup and approved by authorities it is ready to perform business regardless the status of the RO.

Minimum capital requirements are imposed to ensure that newly established WFOEs have sufficient capital for the establishment and implementation of the business plan indicated in the business license issued. Although capital requirements have been lowered, a WFOE should have a well-documented budget since it is time consuming to increase the registered capital amount. Below we have listed some of the most important issues to consider when changing from a RO to a WFOE:

-        Change of tax implication.

-        Transfer of personnel and other assets.

-        Holding structure of the WFOE.

-        Capital commitments.

-        Possibility of branch offices.

-        Revenue stream of the WFOE.

-        Repatriation.

Conclusion/Question

As the ongoing implementation of new laws and regulations set their marks on daily business activities, a foreign invested RO must do a continuous analysis balancing the increased costs of administration and compliance against the inability to engage in any profit-making activity. Every RO should ask: does it make sense to keep operations going with the current organizational structure and can we further develop under this? The RO as base of China operations is under increased scrutiny from the Chinese authorities and strict compliance with regulations is advised in order to avoid penalties.

The new regulations will come into effect on March 1 and impact the operations of all ROs in China.

It is advised to seek professional help when establishing a RO/WFOE, or making structural and organizational changes in an existing enterprise, due to the complexity of the processes involved.

If you have questions regarding how to restructure your China operations please contact:

Victor Kok

Manager of Incorporation Services

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