China presents ample opportunities for new and existing businesses to expand, and it is no surprise that small, medium, and large companies are interested in China’s established and emerging markets. Businesses looking to do just that must choose, however, the appropriate legal structure for their presence in China. With there being advantages and disadvantages to each structure, company owners and executives should consider carefully which one will prove the best fit for their business goals and objectives. This is especially the case with Registered Offices (ROs), which are easier and cheaper to establish than other types of presence in China, but come with some major limitations that may seriously affect a company’s ability to conduct business.
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Options for Establishing a Legal Presence in China
Foreign investors have four main options when it comes to establishing a presence in China. The four options are:
- Wholly Foreign-Owned Enterprise (WFOE)
- Representative Office (RO)
- Foreign Invested Partnership Enterprise (FIPE)
- Joint Venture (JV)
Of these options, the WFOE (Wofe) is the most common. Around 83% of businesses looking to establish a presence in China end up creating WFOEs, whereas only 10% establish Representative Office, 5% FIPEs, and 2% Joint Venture.
What is a Representative office (RO)?
Interestingly, ROs are not actually allowed to conduct operational activities in China on behalf of the parent company, despite the structure’s moniker suggesting it could as the parent company’s ‘representative’. Instead, ROs serve as more of an extension of the parent company, not a separate legal entity. Lacking this critical status, Chinese law relegates the RO to activities that are non-profit making. These include:
- Conducting surveys and other forms of research in the local market on behalf of the parent company
- Relationship building and maintenance with contacts in China
- Data gathering in the local market
- Distributing informative materials to potential Chinese clients or trading partners
- Coordinating activities of the parent company in China
- Facilitating travel and other arrangements between the parent company and contacts in China
Specifically, the RO is prohibited from
- Engaging in profit-generating activities directly (some marketing is an exception to this rule)
- Completing deals and signing contracts on behalf of the parent company
- Pursuing the interests of, or representing, any company other than the parent
- Issuing invoices or receiving funds for any reason
- Investing in equipment or property
Despite these considerable restrictions, there are some benefits to establishing a RO in China.
What are the main benefits to setting up a RO in China?
With no capital requirements, China Representative Offices are an attractive option for companies looking to ‘test the waters’ in China without investing heavily or establishing extensive networks. If the parent company does have significant capital to invest in China, ROs may be well suited to companies that have intentions to be in China in the long-term and are looking for a ‘starter’ entity that they can later develop into a WFOE.
That being said, the existence of capital really is key here, as the long-term cost of ‘switching’ from a Representative Office to a WFOE is considerable. While it may make sense to take this approach if rapid market entry is desired, the ‘switch’ actually entails establishing a RO then dissolving the RO, only then to establish a WFOE. There is no legal possibility of merely adjusting the status of the RO to form a WFOE without first having to dissolve the RO.
All in all, though, ROs provide a rapid and convenient means of establishing a presence in China, and – for that reason alone – they remain a popular option for many businesses.
What are the potential drawbacks of ROs?
Widely known as the easiest of the legal structures to establish in China, ROs do, however, come with some major drawbacks, which accounts for their relatively low adoption rate compared to other structures. Of particular day-to-day or practical importance are the following limitations:
- ROs are not legal persons, therefore they cannot sign contracts under Chinese law
- ROs are not able to bill customers
- ROs are not permitted to supply goods or services, nor perform after-sales services in relation to any goods or service sold by the parent company
- ROs may not take payments from a Chinese legal person, whether an individual or a business, for any reason
Businesses looking to enter the Chinese market for the first time should consider the potential and drawbacks of establishing a RO. Despite their ease and low cost, ROs come with considerable legal limitations that may ultimately prevent the parent company from expanding successfully into the Chinese market. Other forms of business structure may, therefore, be advisable – especially for larger companies who can more readily absorb a higher initial capital investment.