CHINA INCORPORATIONS LIMITED (CIL)

• Business Scope of Representative Office

ROs will have the authority to engage in economic activities and sign economic contracts which are necessary to maintain its existence and functions, and it should also carry out its activities within the business scope as set forth on Registration Certificate.

• Legal Status of Representative Office

Chinese laws do not expressly provide that Rep Offices should bear liabilities independently with their own assets (i.e. limited liability). ROs may be deemed to be part of the foreign parent enterprise. As a part of the foreign enterprise, the foreign enterprises should bear liabilities of the Representative Office (RO) with all its assets.

• A uthority of Chief Representative

Chinese laws do not clearly specify the limitation of the authorities of a chief representative or a representative. Therefore, foreign enterprises should clearly set forth the authorities of the chief representative and representatives of a Representative Office (RO) in order to avoid, to the greatest extent possible, situations in which the acts of a chief representative or a representative have binding force upon the parent foreign enterprise.

In defining the activities that an RO may perform, the State Administration of Taxation (SAT), the State Administration of Industry and Commerce (SAIC), and the Ministry of Foreign Trade and Economic Cooperation (the MOFTEC) have different provisions. The SAT prescribes what constitutes a taxable activity while the SAIC stipulates that the Representative Office (RO) should be engaged in non-direct business activities, subject to provisions in the international agreement. The MOFTC also provides that the RO's may only be engaged in non-direct business activities in respect of business liaison, product introduction, market research, and technical exchange on behalf of their heading office.

To determine whether certain activities are taxable, one has to consider the income tax rules rather than the functional role a Representative Office (RO) is to play within the organization as stated in the scope of its business. If the Representative Office (RO) performs those non-direct activities for the client of its non-resident head office or other non-resident foreign companies on a fee basis, then the income derived from those activities is taxable under the PRC income tax rules.

The representative offices that do not carry on business activities or the RO's that carry on non-taxable activities can submit applications to the tax authority for the granting of a tax exemption certificate. However, the exemption does not apply to the income earned by the staff of the Representative Office (RO) including the chief representative. Their PRC-source income is taxable whether or not they are paid by the representative offices.

The RO also has the legal obligation to deduct from its payroll income taxes and pay them to the local tax offices. In addition, the RO and all the staff have to bear certain social security contribution respectively including pension fund, hospitalization, unemployment, injury at work, and birth planning insurances. According to the Tentative Provisions issued by the State Council, the RO has to appoint a designated Foreign Enterprises Service Company to do the payroll and social security administration.

Foreign investors wishing to establish a presence in the PRC in a relatively short time with minimal investment can consider setting up a Representative Office (RO). Such investors are not required to make any commitment to bring in capital either in cash or in kind. Furthermore, the fact that an RO's approval certificate can be valid for a one-year period provides an exit option for foreign investors to test the water.

According to the PRC Income Tax Law for Foreign Investment Enterprise and Foreign Enterprise, its Implementation Regulations, the PRC Business Tax Tentative Regulations, ministerial regulations and rules issued by the State Administration of Taxation, an Representative Office (RO) that carries on business activities within the PRC is subject to tax on income derived from sources in the PRC irrespective of whether they are paid by any sources inside the PRC. The Representative Office (RO) has a legal obligation to file the business tax return on a monthly basis, and the income tax return quarterly.

There are three methods to determine the taxable income of a Representative Office (RO): the actual income method, the deemed income method, and the cost-plus method. In the absence of complete and accurate information relating to the RO's PRC-source income, the PRC tax authority normally adopts the cost plus method to ascertain the taxable income for practical reasons.

The major category of tax includes business tax and income tax. Business tax is imposed at a rate of 5 percent on the total gross amount of monthly overheads incurred by the Representative Office (RO). The business tax is filed at monthly intervals. Corporate income tax is imposed at a rate of 33 percent on the deemed profit. The deemed profit is assessed at a rate of 10 percent on the total gross amount of overheads incurred by the Representative Office (RO) during the relevant period. The Representative Office (RO) must file income tax at quarterly intervals. For example, if the monthly overhead is RMB80,000, the business tax and income tax will be calculated as follows:

Gross amount = RMB80,000 / (1-10%-5%) = RMB94,118

Business tax = RMB94,118 x 5%

Income tax = RMB 94,118 x 10% (deemed profit) x 33%

• Taxable Business Activities

The income tax rate of 33 percent including 3 percent local income tax will be reduced to 15 percent if the Representative Office (RO) is located within the special economic zones or other designated areas.

The State Administration of Taxation (SAT) lists the following types of taxable activities that a representative office may perform:

Acting as a merchandise trade agent;

Consulting services relating to business, legal, tax and accounting matters;

Services performed for fellow subsidiaries of the same non-resident holding company;

Acting as advertising agents;

Providing services relating to visa handling, fee collecting, ticketing, tour operator, and liaison for non-resident tourist companies;

Consulting services given on behalf of non-resident financial institutions;

Providing services within the business scope of a transport company;

Other taxable activities the Representative Office (RO) performs for the clients.

The following activities are not subject to income tax and business tax:

Resident representative offices performing services of market research, providing business information, liaison, consulting for the non-resident head offices on a free of charge basis;

Resident representative offices taking instructions from resident companies to act for them as an agent, and the agency activities are mainly performed outside the PRC.

The business scope of a Representative Office (RO) should be clearly stated in the application document prepared by the foreign enterprise. After approval by the relevant authority and registration with the AIC, the business scope will be stated in the Registration Certificate. A Representative Office (RO) can only engage in business activities which are within the business scope as set forth in the Registration Certificate.

Normally, ROs can only engage in non-operational activities in China, such as liaison, product promotion, market research and technology exchange. However, if a bilateral treaty between China and the home country of the foreign enterprise provides that the Representative Offices (RO) established by enterprises of both countries should have the authority to engage in direct operational activities, such provisions should prevail.

ROs will have the authority to engage in economic activities and sign economic contracts which are necessary to maintain the existence and function of the Representative Offices (RO). For example, a Representative Office (RO) entered into a purchase contract with a computer company, whereby the Representative Office (RO) will purchase a computer for office use. This computer purchase contract should be valid because the purpose of this contract is to satisfy the basic needs of its operation.

The right to engage in activities to maintain its operations is an intrinsic right of a RO. Such activities are not business activities. Examples include engaging the services of Chinese personnel, renting permanent office space, displaying the name of the office outside its premises, using a company stamp, importing personal and office goods, obtaining telephone lines, opening a bank account in the name of the office, obtaining resident visas and other permits for expatriate employees and referring to itself as having an "office" in China.

Representative Offices (ROs) are Chinese legal entities because they are registered under the Chinese laws. However, Chinese laws do not expressly state that ROs should bear liabilities independently with their own assets (i.e. limited liability). That's why ROs may be deemed to be part of the foreign enterprise. As such the foreign enterprises should bear liabilities of the RO with all its assets. If the assets of the RO are not sufficient to satisfy its liabilities, the foreign parent enterprise should be responsible for the liabilities of the RO, though it is not clear to what extent the liabilities are to be borne by the foreign enterprise if a RO exercises its authority exceeding its business scope.

Moreover, according to Chinese laws, if a foreign enterprise establishes a RO in China, the Chinese court in the location where the RO is situated has jurisdiction over the foreign enterprise in respect of disputes arising from contracts or other property rights. This is a significant issue which a foreign enterprise should consider before it decides to set up a RO in China.

Foreign companies may also want to set up a shelf company in a country that has a bilateral judicial assistance treaty with China. However, local approval authorities have their specific requirements for the qualification of foreign enterprises that apply for establishment of ROs in respect of the amount of capital and how long the foreign enterprises have been in existence. The shelf company must meet these requirements before the application for registration will be approved.

Representative Offices (ROs), also known as Permanent Resident Offices, are established by foreign companies to engage in business liaison, product promotion, market research, exchange of technology and other permitted activities in China.

ROs are not allowed to directly engage in operational activities. The Administration of Industry and Commerce (AIC) usually specifies in the Business Scope, which is shown on the Business License of ROs that it should not engage in any direct operational activities. Therefore, RO is not considered a form of direct foreign investment in China.

It should be noted that up to now only Representative Offices (RO) of foreign airlines are exempted from that restriction under bilateral treaties.

Representative Offices (RO) are important as foreign companies may conduct business liaisons and coordination or engage in pre-operational market research. In this respect, foreign companies refer to all companies that are incorporated outside China as well as those in Hong Kong, Macau and Taiwan.