China Cracks Down on Foreign Representative Offices

By Wang Biqiang, Ouyang Xiaohong
Published: 2009-08-17

News, cover
Issue 431, August 10, 2009
Translated by Tang Xiangyang
Original article:

The State Administration for Industry and Commerce (SAIC) is planning to strengthen supervision of the resident representative offices of foreign enterprises in China, according to a source within the department's Bureau for Registration of Foreign-Invested Enterprises.

Under instructions from the State Council, SAIC has produced draft regulations entitled Registration and Administration of Resident Representatives Office of Foreign Enterprises. The draft regulations are currently being revised and are expected to be approved by the State Council some time in the near future.

"According to recent reports from local bureaus for industry and commerce, the current organization of representative offices of foreign enterprises is rather chaotic," the source quoted above observed.

The EO has learned that some local bureaus have already begun inspecting local representative offices.

Bad Behaviour: How Foreign Representative Offices Break the Rules

According to the source quoted above, many resident representative offices of foreign enterprises (referred to below as simply representative offices) are infringing Chinese regulations and are also breaking Chinese law.

Examples of disregard for the rules include cases of investment fraud, unauthorized changes of office address and failure to extend registration certificates after they have expired.

However, according to investigations conducted by SAIC, the most common crime committed by these representative offices is to engage in business activities, which contravenes regulations introduced in 1983 that restrict representative offices of foreign enterprises to non-business activities.

An executive working at a representative office who is currently under investigation, revealed that although they're prohibited from doing business, almost every representative office of a foreign company is engaged in some sort of business activity.

"The fact that we're restricted from doing business means we have a huge advantage, not only do we avoid having to pay taxes, but we can also avoid a whole lot of other troubles. If we changed into a regular company, then we'd have to pay a lot of taxes," said another executive at a foreign firm, succinctly explaining the main reason why representative offices of foreign enterprises choose to illegally engage in business activities.

According to current tax law, representative institutions without operating revenue or income are not required to pay any sales or business tax.

It's difficult to know exactly how much direct and indirect economic loss is inflicted on China each year at the hands of the illegal business dealings of these representative offices, but according to our source at SAIC, every year there are quite a lot of reports related to the illegal acts of foreign representative offices. In most of these cases, the problems identified are the same.

Our source at SAIC refused to give specific numbers in relation to the number of representative offices engaged in illegal behaviour, but he did reveal that representative offices are similar to an office in that they're mainly responsible for the internal dealings of a company. As they are not a corporation nor a judicial person, these offices do not accept much in the way of legal liability.

Because of this, for any company that suffers economic loss or any other form of harm in their dealings with these representative offices, the likelihood that they will receive any compensation or other form of payment is much less than it would be if the action involved a regular company. In addition to this, as it's a foreign organization, it's difficult to pursue the case.

The Ministry of Public Security published an article in 2008, warning companies to be on the alert for criminals presenting themselves as employees of resident representative offices of foreign enterprises engaging in financial fraud.

In April 2008, the Beijing Public Security Bureau investigated and punished 16 representative offices of foreign enterprises which were engaged in financing fraud, in all they defrauded over 600 medium and small-sized Chinese corporations of tens of millions of yuan.

Maintaining an Open Investment Environment

Local SAIC representatives and offices have already begun to conduct investigations into the dealings of various resident representative offices of foreign enterprises. At the same time, there have been rumors that some foreign corporations are considering closing down their representative offices in some Chinese cities. This has led some foreign investment institutions to speculate that China maybe reducing its openness to foreign investment.

However, according to our source, the local bureaus are simply engaged in routine supervisory work in anticipation of the new regulations coming into effect. "This is legal and ought to be done." SAIC's next step will be to strengthen supervision. "I'm not sure whether these moves will cause foreign enterprises to pull out, but the crackdown on representative offices is part of an ongoing trend, it has nothing to do with the larger investment environment," he said.

He went on to argue that SAIC was a fair arbiter and that it treated foreign and Chinese companies the same way, there are no special favors or unjust punishments, all decisions are made according to the relevant laws and regulations.

The foreign company executive currently under investigation that we quoted above believes that  local bureaus of industry and commerce would use three methods to inspect all the representative offices in China: examining their annual accounts, auditing their books and by receiving reports of misconduct.

"As too many representative offices don't pay tax, the government has noticed they are involved in business," according to another executive at a representative office.

He added that foreign enterprises had anticipated the Chinese government's crackdown on representative offices.

According to an executive at one representative office, foreign corporations have already figured out a few ways to get around the government's inspection. In order to avoid admitting they were illegally engaged in business, they'll instead shift their business activities to legitimate areas that include business support, market research, customer relations etc.

Another approach is to have their parent company sign contracts on behalf of the representative office, thus enabling them to keep their books clean and clear of any unlawful transactions.

As the current regulations were introduced in 1983, some of the content is not so well suited to present conditions. SAIC released the draft of the new, expanded regulations titled  Registration and Administration of Resident Representatives Office of Foreign Enterprises in August last year.

One of the main problems with the current legislation is that the fines for breaching the rules have become inadequate. For example, according to the current  regulations, the most a representative office of a foreign enterprise can be fined for unlawful behavior is only 20,000 yuan. The new regulations have raised the maximum fine to 500,000 yuan.

The under-investigation executive quoted above believes that it's the fall in central government fiscal revenue that has motivated government agencies to strengthen their supervision of representative offices.

In the first half of this year, the fiscal revenue of the central government has fallen by 2.4% year-on-year. This means fiscal revenue will have to increase by 20% in the second half year if the government is to meet its target of raising revenue by 8% on last year's figure.

However, our source at SAIC claims, "this has nothing to do with the economic situation or fiscal revenue," local bureaus of industry and commerce began inspecting representative offices last year and they were motivated by the numerous problems that has accumulated over many years.

"Some local bureaus began investigating and were later encouraged by SAIC, because, according to Chinese law, representative offices are supposed to be supervised by local bureaus."

As for those foreign enterprises who are planning to remove their Chinese representative offices or reduce their business in China, he said, it might be due to the fact that they don't need a Chinese representative office any more.

Before investing in China, many foreign enterprises would first set up a representative office as a base to observe the investment environment and familiarize themselves with the Chinese market.

"After they've founded a subsidiary in China, many foreign companies no longer need a representative office, so they remove them. It's quite natural," he said.