China Restricts Use of Representative Offices for Foreign Direct Investment

Foreign investors can no longer rely on the representative office as a quick and inexpensive means to enter the China market.

This year the Chinese government imposed strict new regulatory and tax requirements to limit the use of representative offices by foreign investors. The State Administration of Industry and Commerce, together with the Ministry of Public Security, issued the "Notice on Further Strengthening the Administration of Foreign Enterprise Representative Office Registration" (Notice No. 4). The purpose of Notice No. 4 is to increase scrutiny of representative offices in order to prevent foreign investors from abusing this corporate form. Representative offices in China are not permitted to engage in any profit-generating activities; however, many foreign investors have used them as operational business platforms. Notice No. 4 comes as a response to this trend and imposes the following requirements:

• Foreign home offices of representative offices must have been in existence for at least two years (discouraging the use of newly formed holding companies);
• Representative offices must have a physical premises in order to be registered (no "virtual" or shared offices are permitted);
• Representative office registration certificates will only be valid for a period of one year and must be renewed annually; and
• Only four foreign employees may be employed by a representative office at any given time.

The State Administration of Taxation has also created restrictions on representative offices by issuing the "Measures for the Administration of Taxation on Representative Offices of Foreign Enterprises" (Tax Measures). The Tax Measures:

• Eliminate tax exemptions on activities such as market research and information gathering;
• Require quarterly tax reporting;
• Impose stiff fines and penalties on representative offices which fail to comply with the Tax Measures or Notice No. 4; and
• Authorize officials to shut down representative offices in egregious circumstances.

The goal of both Notice No. 4 and the Tax Measures is to reduce the attractiveness of representative offices for foreign investment. As a result, registering and maintaining representative offices now requires additional costs and administrative attention. Given these new requirements, foreign investors may want to re-evaluate the use of representative offices and consider restructuring their China operations.