You have set your sights on the vast Chinese market. It is vital to plan and execute your entry into China meticulously, for a mismatch between your business strategy and your choice of company structure can quickly spiral into a costly blunder.
Setting up a wholly foreign-owned subsidiary in the form of Limited Liability Company is very often top of mind for many. However, you may not prefer this type of fully fledged entity structure.
Regarded as the “lightest” company structure, a representative office (“RO”) can offer newcomers – who are not ready to take the plunge into uncharted waters with a hefty investment – a relatively easy and quick way to establish a foothold in China. This pared-down mode of presence in China has its merits as well as drawbacks, and you are well-advised to take them into careful consideration when deciding which structure best fits your business’ individual needs.
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What is a Representative Office?
In a nutshell, a Representative Office (“RO”) is a type of entity structure that enables a foreign company to enter the Chinese market without a substantial initial outlay and to have an on-the-ground presence through engaging in research, marketing, publicity, liaison and networking activities. An RO is, however, prohibited from conducting business activities that directly generate revenue, such as entering into commercial contracts, concluding sales and issuing invoices.
From the outset, it is important to emphasise that an RO cannot stand on its own as an independent legal entity. Without a separate legal personality, it operates as an extension of the foreign parent company.
In what situations setting up a Representative Office is good enough?
Setting up an RO allows you to establish a local presence without needing a full-blown subsidiary. Here are several pointers to help you decide whether setting up an RO in China is the way forward for your business:
Do you consider yourself an early-stage entrant into the Chinese market?
If you’re an early-stage entrant into the Chinese market, an RO can provide a softer landing and help you to get a feel for the business environment. This is especially important if you have limited resources and are working with a tight budget.
Are you procuring from China and want on-the-ground staff to carry out quality assurance activities and liaise with suppliers and distributors?
If you’re procuring from China, an RO can be useful in carrying out quality assurance activities, liaising with suppliers and distributors, and managing local relationships. This can help to ensure that your supply chain is robust and that you are able to meet the needs of your customers effectively.
Is your aim to conduct on-the-ground market research to help fine-tune your offering before taking the full plunge?
An RO can be useful for conducting on-the-ground market research and fine-tuning your offerings before taking the full plunge into the Chinese market. By having a local presence, you can better understand the needs and preferences of your target market and tailor your marketing activities accordingly.
Advantages of setting up a Representative Office in China
Easiest and quickest to set up
A clear and overriding benefit of establishing an RO is the ease as well as the time and cost involved. It is by far the easiest and quickest (around one to two months) to set up and cheapest to maintain compared to the other entity structures.
No capital input required
In addition, opening an RO does not require any capital injection. Although there are no minimum registered capital requirements for setting up a WFOE, capital injection is necessary.
In sum, an RO provides a cost-effective means of entry into the Chinese market, and when leveraged well, it can serve as a solid liaison base from which to make business contacts for its head office services and products.
Disadvantages of setting up a Representative Office in China
No direct business activities
The main drawback is the inability to engage in any direct profit-generating activities. As outlined above, the operational scope of an RO is limited to auxiliary activities that are incidental to profit-making activities, for example, market research or networking endeavours related to the foreign parent enterprise’s products or services. Given the narrow operational scope of an RO and the various limitations imposed on the breadth of its activities, it is understandable that fewer foreign companies are opting for this type of company structure.
No legal separation between the representative office and the parent company
Another key drawback is tied to an RO’s lack of a separate legal personality. Since it is not a standalone, fully-fledged legal entity, liability incurred on the part of the representative office would trickle through to the foreign parent enterprise if things were to go awry. As an RO cannot assume civil liability on its own, it cannot be liable in its own right for its acts and omissions. In addition, personnel working for the representative office are prohibited from signing contracts on behalf of the foreign parent company.
Limited recruiting capacity
A representative is forbidden from hiring China-based staff directly. Instead, it must employ local personnel via an approved specialist employment agency, who acts as the employer from a legal perspective and receives a fee for despatching personnel to undertake employment at the representative office. The agency will also be responsible for ensuring the timely payment of social security and housing fund contributions. There is no limit to the number of local personnel that an RO can hire.
While the foreign parent company can directly appoint its staff based in its home country and second them to China to act as representatives, the number of foreign representatives is limited to four (three representatives and one chief representative).
In the past decades, many foreign companies chose to set up ROs in China, taking advantage of its simplicity and low capital requirement. However, authorities in China have observed that there’s been an increasing number of ROs operating outside of their authorized scope of activities. As such, since 2011, China has tightened the supervision of ROs by clarifying the tax collection system of ROs and developing stringent legislations and procedures for the registration, renewal and deregistration of ROs.
Prerequisites for setting up a Representative Office in China
In order to set up an RO in China, the foreign parent company, normally a corporation or a limited liability company, must have been in operation for at least two years. This means that newly formed foreign companies, private individuals and partnerships are barred from this option.
In addition, it is a requirement to produce an appropriate lease agreement for office premises as part of the registration process, which must be located in a commercial property and the city of registration, and the lease shall be of no less than 12 months’ duration.
During the search for appropriate office space, it cannot be stressed enough how important it is to conduct verification checks to ensure that the office premises have been duly approved to be used for commercial purposes and to accommodate representative offices. To ascertain this, you should ask the landlord for the following documents:
- Business licence affixed with company seal
- Property ownership certificate affixed with company seal
- Filing record in respect of the property issued by the local authority
- In the case of a sublessor leasing commercial property from a landlord, a legally valid sublease agreement
Documents required to set up a Representative Office in China
If you are applying to establish an RO in China, the registration authorities will require the following documents:
- Application form
- Proof of address of the foreign company and proof of legitimate business operation for at least two years
- Articles of association or memorandum of association of the foreign company
- Power of attorney executed by the foreign company for appointment of the chief representative and the representative(s)
- Identity document and curriculum vitae of the chief representative and the representative(s)
- Certificate of creditworthiness of funds issued by the foreign company’s bank
- Certificate of the legitimate use of the premises of the Representative Office.
Filing obligations of a Representative Office
ROs are required to report to the local State Administration for Market Regulation any amendments in respect of the foreign parent company’s name, registered address, business scope, legal structure registered address, business scope and authorised representative, as well as any changes to the representative office’s registered address and representatives.
In addition, ROs are stipulated by law to file an annual audit report containing information on, for example, business activities, expenses paid by and funds from the foreign parent company, expatriate individual income tax matters, as well as accounts audited by a certified accounting and audit professional.
Fines will be issued in the event of late filing and the submission of false information.
Taxation considerations of a Representative Office
It is indeed true that an RO serves as a cost centre and does not engage in any profit-generating activities; therefore, it follows that an RO itself does not make any profit, strictly speaking.
The tax bureaus in China, however, take into account the revenue generated by the foreign parent company by virtue of the marketing, publicity and other related activities undertaken by the representative office, which relate to the sale of products and provision of services by its foreign parent company. Again, the legal treatment of representative offices as extensions of their foreign head offices is foregrounded here. Hence, representative offices are usually taxed on their gross expenses with a deemed profit rate of no less than 15%, depending on the specific region and the industry.
Enterprise Income Tax = Deemed Revenue × Deemed Profit Rate × Corporate Income Tax Rate, whereas
- Deemed Profit Rate = no less than 15%
- Deemed Revenue = Expenses for the Period / (1 – Deemed Profit Rate)
- Corporate Income Tax Rate = 25%
What can CW do for you?
With Chinese authorities’ increasing control over the activities of ROs, we recommend that foreign investors conduct a comprehensive assessment of the costs and benefits of operating an RO in China.
At CW, we understand that you want to hit the ground running when you enter the Chinese market. Therefore, setting the right market entry strategy from the very outset is paramount. We know that businesses come in all shapes and sizes, each with its own particularities. Providing you with a tailored and total solution, we can help you assess which entity structure is best suited to your individual needs.
To start your China business with us, get in touch today.