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When to Upgrade Your China RO to a China WFOE

When to Upgrade Your China RO to a China WFOE


As we approach the end of 2010, annual audits loom for all foreign invested enterprises in China. The State Administration of Taxation employs a fiscal year to denote reporting requirements, and this then makes it an excellent time to consider the future of your business if still using a representative office in China.

China's State Council recently issued new regulations to "strengthen" the administration of resident representative offices (ROs) of foreign enterprises in China. The new regulations require ROs of foreign enterprises to provide audited accounting information on a regular basis, prohibit them from conducting profit activities, and specify the relative penalties for foreign enterprises that violate the rules. As we previously advised in March, tax structuring of ROs has also changed, with ROs now being liable for deemed profit rates of 15 percent. These regulations affect foreign investors setting up representative offices in China, as well as ROs already established on the mainland as they touch on the establishment, management, permitted activities and staffing of ROs.

The main changes as affect existing representative offices are as follows:


Management

Representative offices cannot employ in excess of four foreign staff, including the chief representative.

Taxes

From this year onwards, representative offices will not be permitted to apply for tax exemption as has occasionally been the case in the past. Additionally, the SAT increased the "deemed profit tax rate" from a fixed 10 percent to a variable 15 percent to 30 percent. This has increased the amount of tax liabilities ROs usually have to pay on the sum of their costs from an average of 8.7 percent to a new minimum rate of 11 percent, depending on the specific case. Additionally, this new variable rate is determinable by the tax bureau and not by the RO, meaning that ROs are potentially at risk of the tax authorities increasing their deemed profit tax rate without prior notice. Although this is dependent upon a number of variant factors on a case by case basis, it is very likely that under the new conditions, an RO with more than 8 to 10 employees involved in quality control and/or market research is now paying more taxes then a service WFOE or a FICE involved in the same activities.

RO operations

It should be remembered that representative offices may also not engage in any profitable activities. This has been rather loosely monitored by the government in the past, however over the course of this year, ROs are being increasingly monitored for trading activities. If you are using your RO illegally for trading purposes, you will get caught. Punishment, which includes the serious category of tax evasion, can be severe. The China tax bureau has the power to fine up to five times any amount due, plus additional penalties for non-compliance. Foreign chief representatives should be aware that amounts due in excess of RMB10,000 in China can be classified as a criminal offense, and be subject to jail time if sufficiently serious or should fines be unpaid. The current regulatory climate in China towards foreign investors also dictates that this is not a time to be playing with the prospect of being hit with fines or jail time. It is the time to be considering getting out of such possibilities by getting into compliance.


The new guidelines for what ROs can actually do come into effect on March 1, 2011. The "Regulations on the Administration of Registration of Resident Representative Offices of Foreign Enterprises" were issued this year on November 19, and state:

"The RO cannot engage in any profit activities except for those activities which China has agreed on in international agreements or treaties. The activities ROs can be involved in include market research, display and publicity activities that relate to company products or services, contact activities that relate to company product or service sales, domestic procurement and investment. ROs will have to pay an RMB50,000 to RMB200,000 penalty for profit activity involvement, and RMB10,000 to RMB100,000 for exceeding the activity scope mentioned above."

The new regulations reveal special concern over the degree of business undertaken by ROs as well as their valid financial records. They call for the availability of RO accounting books and forbid ROs from using the accounts of other enterprises, organizations or individuals.

If you require your China operations to directly buy and sell, have its own import/export license, and legitimately trade in China you will need to change your current RO structure to that of a foreign invested commercial enterprise (FICE) or wholly foreign owned enterprise (WFOE) in order not to fall foul of these new regulations concerning the use of an RO.
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