On January 4, 2010, the State Administration of Industry and Commerce (“SAIC”) and Ministry of Public Security (“MPS”) of the People’s Republic of China (“PRC”) jointly issued a notice (“2010 Notice”) establishing new rules governing the administration of foreign representative offices (“ROs”).¹  The 2010 Notice, effective on January 15, 2010, significantly impacts ROs already in existence, as well as those foreign companies who are considering opening ROs in the near future.

Brief Overview of Representative Offices
Representative offices are established in China as a vehicle to explore China’s market. As opposed to other investment vehicles allowed in China, ROs are not legal entities under PRC laws, and they cannot engage in profit-making activities such as trading or manufacturing. Allowed to engage in other than direct profit-making activities, an RO can function as a liaison office for its home office, conduct market research, provide market support, establish contacts, and negotiate contracts on behalf of its home office. An RO cannot issue invoices nor sign contracts on behalf of its foreign parent company.

PRC legislation first allowed establishment of ROs in the early 1980s. Early legislation was primarily designed to allow large multinational foreign companies to explore China’s market in advance of establishing a wholly foreign-owned entity (“WFOE”). PRC policies also favored large foreign companies that manufactured goods for export, and PRC tax incentives were given to these export-driven companies that established a WFOE. However, since early PRC laws required a minimum capitalization of RMB 500,000²  to establish a WFOE and a WFOE had no trading rights, ROs were often considered attractive alternatives. Establishing an RO took less time for approval than a WFOE and set-up costs were inexpensive. As a result, many ROs were established but often exceeded the authority granted them under their scope of business.

In 2005, PRC laws changed to allow open market access as required by its membership in the World Trade Organization. Changes in the laws made establishment of WFOEs more attractive than ROs. New laws provided WFOEs trading rights so that they could retail, wholesale, and distribute their products domestically. In 2005, the minimum capitalization required to establish a WFOE was reduced from RMB 500,000 (at least US $60,000 or possibly higher) to RMB 30,000 (under US $ 4,000). These changes resulted in WFOEs becoming the preferred foreign investment vehicle in China. Operating an RO with no right to engage in profit-making activity (or operating an RO beyond its legally permissible scope) made less sense when a foreign business could more easily establish a WFOE.

As a result of the changes in the law, many ROs were abandoned by their foreign parent companies, but failed to deregister. There were many ROs which up until this time had been improperly engaged in profit-making activity. Some ROs operated at more locations than they had been allowed as designated places of registration or had merely moved without registering the change of address. Some ROs employed a large number of foreign expatriates, raising questions as to whether they were actually conducting business within their allowed scope of business. Other ROs neglected to renew their registration beyond the authorized three-year term. The lack of accountability has made it difficult for PRC authorities to regulate ROs.

New Regulations under the 2010 Notice
The 2010 Notice now imposes tighter controls to handle these concerns.

Number of RO Representatives Limited to Four
An RO can no longer employ more than four representatives, including the chief representative. Moreover, all foreign RO staff must be registered as representatives; thus, an RO can engage at most four expatriates. An RO cannot increase the number of allowed representatives. If a representative leaves employment, no new representative is allowed.

Operational Term
In order to standardize and control administration over ROs, local SAICs may no longer issue three-year certificates. Going forward, registration certificates shall be for one year only, and must be renewed annually. Where current registration certificates are valid for more than one year, upon the expiration of the current term, such certificates will be replaced with one-year registration certificates.

Strict Administration over Registration Documentation
All relevant documents related to the establishment of an RO or changes in its name or authority, including the incorporation certificate and bank letter, must now be notarized, legalized, and authenticated in the PRC Embassy or Consulate in the foreign company’s country of incorporation. The new requirement may be costly and more time-consuming, but it ensures the validity of the foreign parent company. (In the past, forged documents had been submitted to authorities.)

Foreign Parent Company- At Least Two Years in Existence
When establishing or changing the name of an RO, incorporation documents must be submitted demonstrating that the foreign parent company has been in existence for at least two years. This new requirement is aimed at ensuring the parent company’s legitimacy.

Enforcement Powers to Supervise and Conduct On-Site Inspections
The 2010 Notice requires the authorities to conduct on-site inspections within three months of the establishment of an RO. It also provides authority to the local SAIC and the Public Security Bureau to jointly conduct investigations where violations in registration are found.

Conclusion
The 2010 Notice affects how foreign investors operate their existing RO or how they structure their planned investment vehicle when entering China’s market. ROs continuing to operate in China must be careful to comply with the new regulations under the 2010 Notice. Unless an RO is truly established to perform limited liaison activity, foreign investors with already established ROs may want to consider converting the RO to a WFOE with trading rights. Foreign investors contemplating opening an RO should perform a careful analysis, balancing the increased costs of administration and compliance against the inability to directly engage in profit-making activity. Establishing a WFOE may be a better choice.

For More Information
For more information on the new regulations and how they might impact your current or future planned investments in China, please contact Russell Leu at leu@taftlaw.com or your primary Taft attorney.

¹ The 2010 Notice is silent on its applicability to special forms of ROs, including ROs of foreign law firms which are subject to different rules promulgated by different governmental and judicial authorities.

² The minimum amount was merely a threshold amount; depending upon the nature of the business activity or the location of establishment, local authorities have set higher amounts. For example, in the early 2000s the minimum capitalization amount in Shanghai for a manufacturing WFOE was RMB 1,000,000 (about US $140,000).