Currently all Foreign Invested Enterprises (FIEs), in particular Small and Medium-sized Enterprises (SMEs) are going through challenging times to manage their domestic and international operations. With the global financial crisis on everyone's mind, SME's are revisiting the idea of China in order to survive the downturn. At the moment they are taking a wait-and-see attitude through the Chinese New Year and may relocate many of their operations to China in order to incur lower-costs.
The easiest and most economic way for these SME's to have a legal presence in China is to establish a Representative Office (RO). The purpose is for the liaison with businesses and customers from China / Asia to the rest of the world on behalf of its parent company. A RO is not considered to be a separate legal entity (i.e. it is tied to its parent company) and it cannot carry out direct revenue earning business activities (i.e. it cannot enter into purchase/sales contracts and cannot receive payment for products or services, issue invoices or repatriate monies overseas). A RO is restricted to conduct only "indirect operational activities", such as:
Requirements for a RO
There are no capital contribution requirements for a RO. Establishing a RO is therefore largely a matter of complying with the prescribed application procedures. The time frame of the application procedure is two months. A series of documents must be submitted and the timeframe for preparation is dependent upon the parent company.
There is no longer a requirement that the parent company be established for one year; however a bank reference letter must still be issued stating the current standing with the bank. Additionally the parent company's business license must be notarized by the Chinese embassy in the home country.
A RO must either be situated in an office whereby the landlord has a right to rent his office space to RO's or in a Grade "A" office building. A list of rental certificates and contracts are required and must be submitted to the government authorities for approval. If the landlord cannot provide such rental certificates, it is recommended to discuss with the government authorities whether the RO can be located there. It is highly suggested that no leasing contract be signed until it is certain that the RO can be registered in that location.
In many cities, such as Shanghai, Shenzhen and Guangzhou, a real estate certificate must be provided to the government authorities as well - the landlord should handle this procedure.
A Chief Representative must be appointed by the parent company. This person will be responsible for the activities of the RO and is considered the "legal face" allowing him to sign all related government forms and any documents that are required by the government offices. That said this person can also have automatic authorization on bank accounts and can create any type of Powers of Attorney.
It is advisable to companies to choose somebody who is familiar with the China business, will be travelling to China and knows the staff and the people that are or will be in the RO. The reason for this is that when it comes down to the end-of-year audit and closure of the RO (if it would ever occur), generally the tax official will ask to see whether the individual has paid all necessary personal income tax.
It is a requirement that the Chief Representative be automatically liable to pay personal income taxes in China, even if they are not residing in China. If the person is not residing in China, then they must pay personal income tax on their worldwide salary based on the number of days they are in China for that specific month. Should the person be based in China, then tax will be paid on a monthly basis based on the China Salary income.
Accounting and Tax Filing, Tax Exemption Applications and Annual Audit Requirements
A RO, although indirectly operational, is liable for filing and paying Business Tax, Enterprise Income Tax, and Individual Income Tax for the employees and Stamp Tax. This may sound strange to many FIEs, especially as a RO is a non-profit-making center, however the Chinese government does require that tax be paid as they consider that by having such an office in China, profit is being made in the parent company at least.
It is therefore recommended to keep a series of bookkeeping accounts based on all the expenses of the RO and all original receipts should be kept in the office for a minimum of five years according to the PRC Law. On a monthly and/or quarterly basis, the RO will then pay approximately 10% tax on its total expenses for that period.
If the parent company is a manufacturing entity, the RO can apply for tax exemption status, meaning they would no longer be liable to file and pay Business Tax and Foreign Enterprise Income Tax.
Additionally annual Audits and Annual Inspections are necessary for RO's and must be completed before May each year.
Additional Requirements for Representative Offices
If there are any changes associated with the RO, such as change of office address, change of Chief Representative, change in business scope, these must be approved by the original approving authority and all certificates associated with the RO must be changed.
Every year (depending on location) the RO will be required to be renewed by the original approving authority and new company documents must be issued.
Employment of Mainland Chinese and Foreigners
A RO is not permitted to hire their mainland Chinese staff directly. Employment organizations are required to hire the local employees on behalf of the foreign companies. According to Chinese officials, as RO's are not legal entities, the foreign labor service market needs to be regulated and standardized in order to guarantee that welfare and social benefits are provided to the employees by the RO's.
Foreign employees can be employed directly by the RO. Once the Registration Certificate of the RO is obtained and once arriving in China, the foreign expatriate must receive a Health Check performed by a specific government hospital before being able to apply for the work permit and residence visa.
It is important to note that employment permits and residence visas are subject to annual inspections and renewals by the local labor authorities. It is the employer's responsibility to present these documents to the issuing certificate office. Failure to observe and follow the regulations in general can lead to penalties.
Recommendations for Ease of Operation
Have control and communicate
Many foreign companies feel they only need to send a company representative from overseas to China once or twice a year. It is important to conduct visits regularly, supervise the running of the office and to try and keep complete control with the parent company. Emails and/or phone calls should be made on a daily basis to check on the office. Simultaneously it is important to recognize the RO as a party of the company group and maintain personal contact. At the same time, sales reports, supplier visits, expense sheets should be provided in English for making it possible for the foreign investor to understand and know what is being done in China.
Do not turn a blind eye
Many companies before deciding to establish a RO will hire local staff to take care of the establishment process for them. Many companies end up realizing after three or four years that in fact their RO had never been established legally in the first place and they had been hiring local employees illegally as well as not declaring or paying any type of tax. It is important for foreign companies to make an investigation as to what the Chinese legal requirements are and how to implement some form of corporate governance into their RO so as to prevent this type of action.
Many foreign companies feel that it is appropriate to promote business activities that they themselves would never conduct in their home country, but because it is China they believe they can get away with it. This is a wrong perception of China. It is important that foreign investors employ local staff legally. RO's must declare their staff to the employment organizations, under which by law they need to be employed. Not doing so, may save costs but if at any point the investor dismisses a staff member or a staff member resigns, the local employee (more often then not) will report the investor to the authorities and ask for more compensation than is required by law. The costs will be more than if the investor had followed the law from the beginning.
Experienced Foreign Staff
It is very common in China to find young foreign professionals, who speak fluent Mandarin who have the motivation and energy to start up the business. Due to their lower salary compensation wishes compared to the more experienced managers, who complain that China is a hardship living experience, this could be a good and reliable way for foreign investors to enter the market.
Outsourcing Administration Functions
Many companies look to outsource their administrative functions, such as accounting, tax filing, payroll and other corporate governance functions to external consultants. This benefits the investor in two ways:
This can be an asset for investors who want to only focus on the company's day-to-day activities and alleviate any financial and business risks.
Protection of the Parent Company by having a Holding Entity
Many foreign companies feel it is a risk to establish an entity in China. The establishment may not require a high capital investment but there can be a risk factor. Due to these aspects, more and more investors are establishing offshore companies to act as a holding entity for their China investment and thereby creating a buffer layer to take over the full liability for the Chinese operation from the parent company. The establishment of many of these offshore companies is an easy process and due to an uncomplicated tax system and accounting requirements, simple to operate. Double taxation agreements have been drafted and implemented between China and many of these offshore jurisdictions, which adds an additional benefit.
There is no reason for foreign investors to be nervous or hesitant about establishing a China operation, particularly in relation to opening a RO. The key for many investors is to make sure they do not become excessively complacent and to avoid any fraud or non-compliance issues. It is advisable to obtain advice and assistance through a consulting company or law firm in relation to the requirements, regulations and related activities.
Should a foreign investor with an existing RO have concerns, then it is recommendable to conduct an internal audit review to make sure that the office is in compliance. Common indicators for non-compliance can be abnormal expenses, high turnover of staff (in some cases no turnover at all), fluctuating bookkeeping records and no use of company bank accounts.
It is wrong to expect everything in China to operate as in the home country. However, it is equally wrong to place blind trust in the system and accept any problem which arises and saying "That's China". Supervising and paying attention to one's RO can prevent many problems from arising and can alleviate any worries and fears.
All information in this report is verified to the best of our ability and is assumed to be correct at time of release; however, Klako Group does not accept responsibility for any losses arising from reliance on the information provided within.
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