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Next March, new rules will come into effect, requiring even higher standards for foreign enterprise representative offices in China. These rules may have far-reaching implications for both new foreign investors and foreign investors who already have representative offices.
Two government departments have long been seeking to restrict the use of representative offices, namely:
- the Administration of Industry and Commerce (the AIC), which suspects that representative offices are used to hide profit-making businesses; and
- the police, who want to close what they view as a visa loophole for foreign workers entering China.
The build up to these regulations goes back to January 2010. We issued an alert at the time to highlight the way China is cracking down on representative offices of foreign companies with unprecedented changes.
The changes we emphasised back in the alert included the stricter compliance regime and the new requirement that a representative office can only have four representatives. There was no existing legal basis for this, and since the early 1980s there has been no limit on the number of representatives allowed.
Ten months later, on 19 November 2010, the PRC State Council issued the Administrative Regulations on Registration of Foreign Representative Offices of Foreign Enterprises (the “RO Regulations”), which will take effect on 1 March 2011.
The legal basis for the existing regime, the Administrative Measures on Registration Representative Offices by Foreign Enterprises, issued by the State Administration Industry and Commerce (“SAIC”) on 5 March 1983, will then be repealed.
The RO Regulations heighten scrutiny in the establishment and operation of representative offices by foreign companies (“ROs”) by introducing more stringent compliance requirements and tougher penalties.
Applicability
ROs established by non-profit organisations are not governed by the RO Regulations. Similarly, law firms, insurance firms and accounting firms, which are separately regulated, will not be covered.
If an RO engages in profit-making activities, the government has the right to confiscate all proceeds and business-related tools, raw materials, equipments, tools and products, as well as a fine of RMB50,000 to RMB500,000. If the circumstances are serious, the RO’s registration certificate could be revoked.
Scope of RO Activities
The RO Regulations specifically allow ROs to carry out the following activities, provided that relevant prior government approval (if any) has been duly obtained:
- market survey, exhibition and publicity activities related to the products and services of foreign parent companies; and
- liaison activities in connection with sales of products, provision of services and domestic procurements and onshore investments of foreign parent companies.
ROs engaged in activities beyond the aforesaid scope have to make rectification within a prescribed timeframe. Failure to do so will incur a fine of RMB10,000 to RMB100,000. If the circumstances are serious, the RO’s registration certificate can be revoked.
Establishment of accounting books
The RO Regulations require ROs to establish and maintain accounting books, accurately recording the appropriation of funds by foreign parent companies and the RO’s payments and receipts. This indicates an increasing focus of the Chinese government on tax compliance of ROs. According to the current tax rules, any RO that is not able to keep proper accounting records to ascertain its revenue and costs would have to report its corporate income tax at a deemed profit rate of no less than 15 %.
Incorporation requirements
The RO Regulations reaffirm two incorporation requirements provided in the Circular on Strengthening Administration of Registration of Representative Office by Foreign Enterprises issued by SAIC on 4 January 2010:
- the foreign parent company should have been in existence for at least 2 years; and
- an RO should have no more than 4 representatives (chief representative included).
Qualifications of representatives
The candidate to an RO’s chief representative or representative should be disqualified if he/she has been:
- criminally prosecuted for a crime that jeopardises China’s national security or public interests;
- served as the chief representative or representative of an RO that has been cancelled or had its registration certificate revoked or has been mandatorily closed down, and it has been less than five years since such cancellation, revocation or close-down; or
- any other circumstances as may be stipulated by SAIC.
Annual reporting obligation
The RO Regulations impose an annual reporting obligation on ROs. Every year from 1 March to 30 June, ROs are required to submit an annual report to the registration authorities, setting out the current status of their foreign parent companies, conduct of activities by the ROs and an audited statement of the RO’s payments and receipts. Failure to submit an annual report will incur a fine of RMB10,000 to RMB30,000. If such a failure is not cured within the prescribed period, the registration certificate of the RO can be revoked.
Residence term of ROs
The RO Regulations provide that the residence term of an RO should not exceed the term of its foreign parent company. Within 60 days upon expiry of the term of an RO, its foreign parent company should effectuate a change of registration with the registration authority. However, the RO Regulations are silent on the validity term of an RO’s registration certificate. The existing practice is that a registration certificate is valid for one year and can be renewed on a year-to-year basis.
Information sharing mechanism
The RO Regulations contemplate that SAIC and its local counterparts establish an information sharing mechanism with relevant government agencies (e.g. the entry and exit administration department of public security bureaus) , to exchange RO-related information and coordinate the in-department cooperation in countering the irregularities of ROs.
Suggestions to foreign investors
For foreign investors considering an initial entry vehicle into the Chinese market, it is advisable to weigh the pros and cons of the RO option in terms of compliance obligations and costs. For foreign investors who already have an RO presence, it is imperative to revisit the compliance status of their ROs and get fully prepared to comply with the new regulatory requirements.
On balance, we think that it is better to start straight off with a corporate entity, unless there is no intention of ever going beyond mere liaison and market research.
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