For every 100 Wholly Foreign Owned Entities (WFOEs) and Joint Ventures (combined) my firm helps set up in China, it only sets up one Representative Office. Why so few, when Rep Offices are the easiest entity for foreigners to form in China? Because their inherent limitations mean they seldom make sense.
Representative Offices are aptly named — they are the China representative of the foreign company. A Rep Office is not considered a separate legal entity in China, and it is limited by law to performing “liaison” activities. It cannot sign contracts or bill customers. It cannot supply parts or perform after-sales services for a fee. It cannot earn any money in China or take any payments from a Chinese person or business for any reason.
Rep Offices are pretty much limited to engaging in the following…
- Conducting research
- Promoting their foreign company owner
- Coordinating their foreign company owner’s activities in China
- Other activities that do not and are not intended to generate a profit in China
Because forming a Rep Office in China is faster, cheaper, and easier than forming a WFOE (see The Agony And The Ecstasy Of Forming A China Subsidiary Company — WFOE), companies oftentimes consider forming a Rep Office in China to test the waters there, with the intention of switching over to a WFOE once it becomes clear China will be viable for them. We generally discourage this because “switching” from a Rep Office to a WFOE is not really a switch at all. It involves two steps: (1) shutting down the Rep Office and (2) forming a WFOE from scratch. Because the cost of forming a Rep Office, shutting down the Rep Office, and then forming a WFOE will be considerably higher than just forming a WFOE, forming a Rep Office with the later intention of forming a WFOE seldom makes sense. Companies will almost always be better off just biting the bullet and forming the WFOE straight away.
Companies sometimes contact my firm believing they need a Rep Office because they need a Chinese entity to sell their product into China. Not necessarily. In many situations, companies can sell their product into China without having any in-country footprint.
Sometimes a Rep Office does make sense. My firm once set up a Rep Office for an American company selling American-made equipment with an average transaction value of $2 million. This company had no plans to manufacture its equipment in China, and already had an arrangement with a Chinese company to repair its equipment in China. All it wanted was an on-the-ground China presence to improve its sales and to let its customers and potential customers know it was serious enough about China to commit to having an office there.
There are three basic requirements for forming a China 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 company or a corporation) that the local office represents; private individuals and partnerships cannot establish a Rep Office in China. In addition, most jurisdictions in China do not allow newly formed entities to form a Rep Office.
The local approval authorities usually issue their decisions on Rep Office approval within around thirty days, at which point the Rep Office must do many of the other things typically required of businesses in China. However, in some cities, the decision can take much longer, depending on the whims of the local officials.
There are three major issues that make working with Rep Offices unattractive:
- Even though Rep Offices are not permitted to earn income in China, they are nevertheless subject to taxation. There is at least a 10% tax on the GROSS EXPENSES of the Rep Office. If the Rep Office is large and has a number of employees, this tax can be quite high.
- 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. Such contracts are generally unattractive for foreign companies.
- A Rep Office may hire no more than four foreign persons, each of whom is called a representative. The Rep Office hires these people directly and they 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.
The bottom line on Rep Offices is to look before you leap and not get seduced by their relative ease of formation.
Dan Harris is a founding member of Harris Moure, an international law firm with lawyers in Seattle, Chicago, Beijing, and Qingdao. He is also a co-editor of the China Law Blog. You can reach him by email at firstname.lastname@example.org.