More than 50 percent of all foreign entities registered in China are Representative Offices (ROs). The rules for ROs were initially set in 1983. ROs became popular because they were a cheaper, less paper-intensive gateway vehicle into China.
Although limited, ROs did not require a joint venture or some of the more onerous requirements, necessary to set up a company in China.
However, that is all going to change in March. China is intent on closing the loopholes in its business operations laws. The days of using an RO as a shadow trading business which avoided scrutiny and taxes are numbered.
Note: this is one of many signals the central government is sending that it is going to get tough on those foreign operations that have been playing fast and loose in China. Licensing, registration and tax considerations are in part driving this, but the other part is that as China’s economy matures, the central government is less concerned about attracting investment and more concerned with leveling the playing field for its domestic markets.
It is probable that this trend will be an ongoing one, so careful attention needs to be paid if you see a future for your product or service in China’s markets.
Important changes include:
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Yearly (between March 1 and June 30th) filing of audited account information, transactions and legal status.
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Increased fines for those who file late 10 to 30 thousand RMB ($1,500 to $4,500 US).
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Increased fines for filing false information including fines from 20,000 to 200,000 RMB ($3,000 to $30,000 US).
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Increased fines for violating permissible activities of between 50,000 to 200,000 RMB ($7,500 $30,000 US).
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Increased fines for violating the scope of registered activities of 10,000 to 100,000 ($1,500 to $15,000 US).
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Requirement that all new ROs notify the appropriate government entities and publish their scope of activities, including products and services in the appropriate designated channels.
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In addition, along with the fines, you face the possible revocation of your license(s) and expulsion of your staff, especially if their visa’s were based on their activities with the RO.
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ROs are no longer exempt from corporate income, VAT or sales tax (taxable income will be imputed to be at minimum 15%, up from 10%, of any revenues generated regardless of losses or deductions effective January 1, 2010).
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ROs will also be subject to arms-length transfer pricing rules if there are licensing agreements in place with the parent or other entities.
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The salaries of foreign employees of an RO will also be closely scrutinized and adjusted upward for tax purposes, if the foreigner is deemed to be receiving dual compensation in and outside China.
What can an RO do? Very little, ROs are limited to market research, activities related to displaying or showing products or services and/or contacting companies to make them aware of products and services. They cannot sell products or services or engage in any for profit activities. In actuality how ROs are supposed to operate has not actually changed in terms of the 1983 laws but it is clear that the added penalties and regulations are a noose waiting to catch those unwary enough to change direction.
What does this mean to you? If you have an RO, first find a good accountant who is familiar with the changes and can advise you and second start looking at alternative vehicles for your business dealings in China. ROs will effectively have few benefits and many liabilities after March 1.
Alternatives to consider
In most cases you need to consider either a FICE or a WFOE, depending on the type of business you wish to pursue.
A FICE is a Foreign Invested Commercial Enterprise. These are mostly used for import/export, distribution, retail outlets, wholesales, brokerage transactions and franchises.
WFOEs are Wholly Foreign Owned Enterprises, which are used most often for manufacturing, consulting and professional services. Remember, there are a number of areas that are either prohibited or require special licenses.
Keep in mind that minimum capital requirements and licensing are just the beginning and that you need to look carefully at China’s changing tax and regulatory structures and system. As indicated in past articles, where you locate can potentially have a huge impact on your business future. There are incentives and different requirements for capital, licensing and taxes depending on the area.
For those of you who have a Chinese RO, get busy and good luck, you have a lot of work to do and little time to do it in.
