Manufacturing Export Goods in China

May 08, 2008 | BY

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China is not a free economy. Every business activity is regulated. According to current PRC laws and regulations, any established presence of a foreign company shall be approved and lodged with relevant government authorities. Unregistered business activities may be caught and deemed illegal by Chinese government authorities.

The established presence of a foreign company in China normally takes one of two forms that being either a Wholly Foreign Owned Enterprise (WFOE) or a representative office (Rep Office). A WFOE has a far wider scope of operation than a representative office, which by its very nature is restricted as to what it can do. For example, a WFOE can enter into product purchase agreements with other companies, import and export products without the help of other trading companies, and employ its local employees. A rep office, by contrast, is limited to liaison activities and cannot directly enter into contracts or provide services; a rep office may only employ local Chinese employees through local service companies.

In relation to investment requirements as an independent legal entity, a WFOE is required to have certain amount of investment from the parent company which can support its business operation. According to the PRC Company Law(中华人民共和国公司法), the minimum registered capital of a WFOE is RMB100,000. By contrast, there is no minimum requirement for the registered capital of a rep office as long as the operating expenses paid by the parent company are sufficient for its daily operations.

For approval and registration procedures the establishment of a WFOE must be approved by a local approval authority and registered at the relevant Administration for Industry and Commerce (AIC). Again by contrast, establishing a rep office requires only the latter, registration in the AIC and there is no requirement of governmental approval. Consequently, and in general, the legal paperwork for the establishment of a rep office will be simpler than that for WFOE incorporation. As an example, a rep office can undertake Quality Control (QC) and act as liaison with factories and other suppliers. A rep office can sign contracts on behalf of the parent company, but not on its own behalf, therefore the office cannot by itself enter into binding contracts or complete deals alone without authority from its parent company.

A rep office is not permitted to sell, make, trade, or export goods, nor to invest itself in China but it can act as a liaison centre and can carry out quality inspection as well as liaise with the factory, and undertake business promotions. Upon registration with the Chinese authorities, a rep office may enter into long-term office leases and obtain longterm multiple-entry visas for expatriate staff. A large amount of set-up capital need not be paid. The office can also open local bank accounts, hire Chinese employees and display trade name and signs identifying the company's presence in China. But the rep office must line up a licensed export company to export the goods, which will usually charge at a commission. Moreover, although a rep office usually does not generate revenue, it is still required to pay business tax based on its expenses (presumed profit from expenses). The formula for computing business taxes on an expense basis is very complicated, but roughly speaking, it will amount to about 15% of the total expenses (rent, salaries, everything recorded on the books of the rep office as its expenses), subject to local regulations of the city where the rep office is located and industryspecific regulations.

If a foreign company intends to expand its business in China be it manufacturing, trading, investment etc it would be best off setting up a foreign company in China to deal with the factory, other vendors, and interact with the authorities. Setting up a foreign company in China takes almost three months, as there are various procedures. Alternatively, a foreign company can also establish a Hong Kong limited company as a wholly owned subsidiary and then, with the Hong Kong subsidiary as the parent, apply to set up the representative office in China. Under the Closer Economic Partnership Arrangement (CEPA) between mainland China and Hong Kong, Hong Kong companies enjoy favourable treatment in setting up representative offices in China.

All documents of the parent company to be submitted in support of its application to set up a representative office must be notarized by a Chinese notary, which is not cheap. If the parent company is a Hong Kong company, Hong Kong counsel is used. If the parent company is a US company, then its corporate documents will have to go through a more complicated notarization process - they will have to be first notarized by a notary public, then certified by the Clerk of Court and finally processed for diplomatic authentication in the US Chinese Consulate.

Many foreign companies (FIEs) in China will first set up a rep office before investing into a joint venture (JV) or WFOE; the rep office can then be closed after the JV or WFOE is established. There is of course the maintenance cost of the rep office such as rent, salaries, tax, and the need to supervise it. The export company will do the usual export documentation and a service commission will be payable.

These are not the only options for manufacturing in China and exporting to the USA. A foreign company may use a trading company, and pay the usual commission. The trading company can only prepare the export documentation, and can not be relied on to perform QC. The foreign company must either have its own QC team in China, or engage an independent firm to do the QC. The foreign company would also have to engage a licensed export company to export the goods. Under present regulations, foreign investment in a trading company is not allowed.

Another option is to have the China factory with whom the foreign company does business get an export license (unless it already has one), so the factory could itself export the goods; export must be done through a licensed export company. The factory would have to apply to the Chinese authorities to alter its business scope to include export trading. The success of the application will depend on the proportion of the factory's production for export and its registered capital; the higher its export volume and registered capital, the more likely the application will be granted.

If the factory directly exports the goods to the foreign company, it will be receiving hard currency. Consequently, whether the factory is willing to apply for the export license may well depend on whether it has need to use foreign currency, eg, whether raw materials have to be imported from other countries; and whether the factory is willing to hire additional people to prepare the export documentation and so on. It is also likely that the foreign company would have to pay the factory the usual export service commission, and still have to hire its own QC team, either through a rep office, engaging an independent firm, or sending its own QC team to China to inspect every shipment (obviously highly unpractical).

Every situation in China is unique, and no business should make its decisions without careful consideration of the various alternatives available, including (and perhaps especially) the legal ramifications and costs and benefits of each.

*About the author Richard Sybert is a partner in the Southern California offices of Gordon & Rees LLP. He served as General Counsel for nearly a decade to a Hong Kong-based global trading company, and is admitted as a solicitor of the High Court of Hong Kong. He counsels numerous U.S. companies on doing business in China and on protection of intellectual property.

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