This is a complimentary recording: We are pleased to have Kristina Koehler-Coluccia join us from Koehler Group—recently acquired by CSC®—to share her expertise in establishing a legal presence in China. Establishing a legal presence in China is not as straightforward as incorporating an entity in the United States. There are several aspects that require due consideration, including:
- The general business scope and activity of the entity, which needs to be clearly defined from the start of the incorporation
- The physical office requirement for the entity as its registered place of business
- The structure and budget for the investment that need to be carefully thought through
- The opening, operation, and maintenance of three sets of bank accounts in China for continuous operations
To view the next webinar in this series, please click here to watch, “Expansion into China - Corporate compliance in China: Secure your investment.”
*This is a direct transcription and may contain inaudible portions
Anu: Welcome to our webinar "Establishing a Legal Presence in China." My name is Anu Shah, and I will be your moderator.
Joining us today is Kristina Koehler-Coluccia. Kristina is one of the leading experts in entity incorporation in China. Since 2003, she has advised and represented Western clients with their business interests in China. She has worked on numerous complex transactions including foreign direct investments, corporate restructuring, company liquidations, and M&A deals. She frequently advises on and represent foreign clients in tax, accounting, and trade-related matters.
With that, let's welcome Kristina.
Kristina: Anu, thank you very much. I'd just like to wish everybody here today a happy New Year, and thank you for joining me in presenting the topic of establishing a legal presence in China.
Before we begin, I'd just like to introduce my firm, Koehler Group. Koehler Group has been acquired by the CSC in October 2015. Our main focus is on inward investment into the Asia-Pacific region. We assist U.S. investors with their market entry into three jurisdictions: Hong Kong, Singapore, and China.
Our firm was established in 1979, and since then we have grown to having just over 120 professionals located throughout our 10 offices in the three jurisdictions. Our main objective is to help foreign investors not only with their market entry, but also to develop aftersales solutions for their accounting tax needs.
One of our unique advantages is that we speak not only of the local dialects in the three jurisdictions that we operate in, but we also have Western account managers that speak a variety of European languages.
Without further ado I'd like to begin today's presentation, which is "Establishing a Legal Presence in China."
The key point to remember when establishing an entity in China is that there are tremendous resources and information available through the Internet and through the web. The key point here to remember is that what you read on the Internet is not actually what occurs in the Chinese market. It's truly advisable to any company that's looking to investment in China to consult ether with a legal law firm or an advisory firm that's located there.
Before we begin on the topic of the types of entities that exist in China, I just want to do a poll to see the sectors that the attendees are in, and also follow up on what you're interested in doing in the Chinese market.
Anu: Thank you to everyone who's participating in the poll question. This is a freeform answer that will ask you to submit your sectors in. Give you all a moment to type in your answer.
Thank you to all that participated. We're going to go ahead and put another poll question up for you. This one's a multiple choice question and you can make more than one selection. What are you looking to do in the Chinese market? We'll give you all a moment to make your selection.
Thank you, again, for participating. We'll turn it over to Kristina.
Kristina: Thanks, Anu. What's come out of these two polls is the fact that everybody seems to be in completely different sectors and industries, everything from legal, M&A, investment advisory, all the way to energy sector, high tech, clean tech, NGOs, etc. It doesn't really help me to focus the presentation since there's such a variety of sectors, but I will advise on certain aspects that you need to know in certain industries.
On the second poll, what's interesting to note is that actually a third of you would like to set up consulting or advisory, a third of you are interested in trade, which involves sales and distribution, and a third of you are interested in manufacturing in China.
In all industries or sectors that you're looking to go into, what's important is to understand the types of entities that exist in China. On the slide in front of you, you'll see two types. One is wholly foreign owned enterprise, and the other is foreign invested commercial enterprise.
If you've already done some research online, you'll find that these two terms come up quite frequently. If it were up to me, these terms would be completely deleted, because when you're establishing an entity in China, you are actually establishing a limited liability company. For the presentation, I'll be using the term LLC quite frequently, which also relates to establishing an LTD.
Let me explain the two different terms that you're seeing here on the screen so that you can relate it potentially to the research that you've done. A wholly foreign owned enterprise simply means that you're establishing an LLC that is owned by a foreign investor.
For the purpose of this webinar, let's say it's a U.S. investor. They are 100% owning the shares of the wholly foreign owned enterprise. Similarly, with the foreign invested commercial enterprise, it's 100% owned by a foreign investor, in this case a U.S. investor, but the entity in itself is an LLC or LTD.
Under each category, you'll see a variety of types of sectors and industries. Ultimately, this is referring to the business scope of the company. I will highlight business scopes on another slide further along in the presentation, but this is really important to remember. What you're seeing on the slides here today is my interpretation of the regulations in China. For me, under a wholly foreign owned enterprise, this would mean a management consulting company, information tech, recruitment, architecture, design, and logistics. As you can see, it's anything that's related to service.
If you're looking at a foreign invested commercial enterprise, this is a relatively new term in the history of China's legal system, because it was only established in 2008 when the Chinese government permitted foreign investors to handle important export functions and activities themselves. Under that category, I've listed wholesale trading, retail trading, ecommerce and manufacturing.
Just to add a note here, the regulations and laws in China are not black and white as they would be in the U.S. or in Europe. There is lot of room for interpretation, and in a lot of instances, one would assume it's very grey. Again, the interpretation that you're seeing here on screen is mine and mine alone. This is how I would define the types of entities that are existing in China.
Let's reiterate. You have the wholly foreign owned enterprise and the foreign invested commercial enterprise. They are 100% owned by a U.S. investor, but ultimately, they're a limited liability company.
There are obviously other entities that exist in China, and the key is knowing what they are. I've listed them here. I'm going to explain a little bit how they relate to U.S. or foreign investors.
The next one you have is domestically invested enterprise, which means that be shareholder is 100% owned by a mainland Chinese individual or a group of individuals.
You may be wondering why I have actually listed that here. Most companies that approach me for incorporating their entities in China wish they had incorporated yesterday, which means they're in a rush. in order to establish an entity in China, you need at least a period of six to eight months to have all the legal activities completed.
Most people can't wait that long. They have contracts in place, they have bids that they want to win, they have projects that need to be processed, or they have secondees that they want to send to China. They need a legal entity ASAP.
What a lot of them do is they'll interview for either general managers in China or sales managers. Although they've only known these people for a very short period of time, they will rely on them to establish a domestically invested enterprise, where the U.S. investor has no right or no say, but is silently investing capital, in order to be able to have a presence in China to process all the deals that are going through.
Is it a method that I would recommend? Absolutely not. I've seen too many of these instances where things have gone wrong, but naturally the investor is always right and they'll generally do what they think is best. Honestly, you really need to think that plan through. You need to do a due diligence on the individuals that are there, and really make sure if that's an investment way or strategy for the long term.
The next is a joint venture. In China, a joint venture is known as having two shareholders, one being a foreign investor, so let's say the U.S. investor, and the other being a mainland Chinese investor.
The most frequently asked questions I get on joint ventures is, "Do they still exist? Are they still common? Is it a method that I would recommend?" Joint ventures are not as common anymore as they used to be. People are much more careful in taking that route.
My recommendation for doing a joint venture would be, one, that you are an industry or sector that's still restricted in China, and you're required to having mainland Chinese joint venture partner to delve into that sector. The second would be that you're late in the market. You have a lot of competitors that are already in China, and you need a partner on the ground that has already done the research, has already got contacts, maybe is already selling, distributing, or producing in the market, and you see the viability and the advantage of forming a relationship with that mainland Chinese investor in order to be able to grow the business. Really, only in those two scenarios would I recommend companies to take the joint venture route.
Foreign invested partnerships are something similar to a joint venture structure, but you would have maybe only foreign invested individuals or entities coming together. It's not as common and not really used a lot, but it is a form that can be used.
Last but not least is representative offices, which historically were really the main form of entity that was utilized to enter the Chinese market. A representative office is a liaison office of the shareholding company. As it says, liaison office means it cannot do very much. In China, it actually really only means you have the ability to hire mainland Chinese staff legally by having this type of entity. Otherwise, you can't negotiate contracts. You can only act as a liaison with suppliers and with customers as a relationship manager basically. Any other type of operational activities would not be permitted.
Whenever you're establishing an LLC or an LTD in China, the key component is the Articles of Association. The first step is really obtaining from the Administration for Industry and Commerce, or the AIC, which is the government body in China that approves all applications for China entities whether they're domestically owned entities or foreign invested entities, draft documentation that needs to be filled out and completed in order to be able to then submit those documents and register your company.
One of the key documents is the Articles of Association, which basically is your company's by-laws, and the regulations you want to instill in your company throughout the term of your Chinese subsidiary's operation.
The draft documentation that's provided by the Administration of Industry and Commerce is extremely superficial in terms of all the chapters and all of the clauses. It's highly advisable to go to a law firm or to go to a business advisory firm to get a better understanding of what needs to be added into those draft articles to make sure that the by-laws are bulletproof in all types of scenarios.
On this slide, I've listed areas that, for me, are most critical when creating an Articles of Association for a company establishment. There are two main parts that a lot of people don't even think about.
One is an exit strategy. If the Chinese market is not useful for me, or I have been cheated on, or I have been sued, how can I exit the market? You certainly want clauses in the Articles of Association that give you the ability to exit the market easily.
The other is, again, a long-term plan. It's if you want to sell the shares of your company and you want to do a share transfer. All these long-term goals and objectives, or scenarios, should really be thought about when drafting the Articles of Association.
The next critical point is the business scope. I have actually touched on it when looking through the types of entities that exist in China. As I mentioned, you're creating a limited liability company in China. Whether you want to call it a wholly foreign owned enterprise or a foreign invested commercial enterprise, ultimately you are establishing an LLC.
The critical point is understanding what activities and functions you want this entity to be. For me, I can compare it to Hong Kong. In Hong Kong, when you establish a company, you can be extremely vague in your business scope. You can write general trade, and you can do services. You don't have any additional licenses that would need to be applied for.
In China, it's a completely different issue. The key point to remember is that, at the end of the year, you are required to do a financial audit. The auditor, by going through the various trade transaction service agreements, will double-check whether what you are doing is included in your business scope.
On the slide in front of you, I've actually added two samples, one for a management consulting company and one for a wholesale trading company.
A management consulting company, you'll see I've added investment consulting, enterprise planning, trade information consulting, environmental consulting, and scientific and technical consulting. Most certainly you might not be doing all of these functions, but it is recommended to keep everything inside for a long-term forecast in case at some eventual point you want to do one of these services.
I'll give you an example of Koehler Group. We're a management consulting company in China. We have all of these items inside. I certainly don't do scientific consulting, but I do have additional items in my business scope relating to bookkeeping, payroll, and tax. As such, I've had to apply for additional licenses in order to be able to add those three items into my business scope.
Whatever you want to do, you should really list out all the activities and see what requires additional licenses, what can be approved, or more importantly, if you are restricted in some of those activities.
In terms of trade or even manufacturing, one of the key points here is you need to list the products that you're going to be trading in, that you're going to be selling, or that you're going to be manufacturing.
One of the documents that needs to be provided is a list of HS codes, which are custom codes that are assigned to the products you want to import, export, sell, distribute, or manufacture. It's important to know, again, what are you looking to sell, produce, or buy in the short and in the long term?
I've added here, also, representative offices. You'll hear throughout my presentation that I'm quite negative on representative offices. I actually personally wish the Chinese government would remove them as an option for foreign investors, primarily because if you've already made a decision to go into the Chinese market, then you're already committing to the market, you're investing in the market, and you're taking a risk.
A representative office, quite frankly, besides being able to employ mainland Chinese people, is useless, because all you can do is market research. You can have a showroom, you can go to tradeshows with that company name of the rep office, you can find suppliers, find customers, but you can do no negotiation. You can't sign any agreement. You actually have to stay away from being considered operational.
Many of you may then ask, "How can the Chinese government really find out if an operational or not?" Surprise, surprise, they can make government visits without letting you know. If they feel that you have a size of an office which is operational, they may confiscate computers and look at an emails to see how operational you've actually been. It is a key point when establishing your rep office whether it really fits what you're doing or not.
Throughout my 13 years of working in the Chinese market, I obviously have a lot of frequently asked questions that are provided to me. I thought it would be good, during this presentation, to highlight some of those.
The first is, "Can I change, update, add, or remove items from my business scope?" The simple answer is yes. As we all know, China is not simple. It's quite bureaucratic. Whenever you want to do any type of change, you have to keep in mind the timeframe required to make that change. As a rule of thumb, any change you want to do, business scope, for example, takes approximately eight to 12 weeks to obtain the approval from the Administration of Industry and Commerce.
To make things even more complicated, a lot of people change their strategies over time. If today you're planning on setting up a consulting company, what about tomorrow when now you want to do trade, you want to buy and sell, you want to import and export, you want to start manufacturing locally, or you want to have a retail shop, whether a live one or an ecommerce one? What can you do about your business scope? This one makes it a little bit complicated because there are certain stipulations that the Administration of Industry and Commerce says.
When you are a consulting company, and you want to go and add trade to your business scope, usually there are no issues. You're already in a commercial office building. You're potentially not going to move offices unless you want warehouse space. The issue comes when you want to do manufacturing and you want to be in a manufacturing facility, which means you have to change your registered office address.
If you want to add retail, you have to show to the Administration of Industry and Commerce a Retail Lease Agreement. If you want to do ecommerce, you have to apply for an Internet Content Providing license. There are all these additional items you need to consider whenever you want to make changes, as well.
The key point for many companies today that have initially established representative offices is "What happens if I want to go from a rep office to an LLC, whatever that LLC might be, such as consulting, trade, manufacture?" The key point is you can't convert. If you actually want to establish a rep office today, and in five years, you now want to manufacture, it's a brand new application procedure. That's what makes a lot of difficulties and adds cost to your long-term strategy in the Chinese market.
Investment capital requirements is a key component for me, primarily because prior to March 2014, in many different sectors and types of entities, there were different minimum requirements for investment capital. Just as a note, in China, investment capital is known as registered capital. There's a different terminology associated with it.
Due to these minimum qualified amounts that were indicated by the Chinese government, many investors, whatever size you can think of, became quite lazy to create business plans, P&L forecasts, and cash analyses, so they just said, "We'll invest what we have to invest, we'll set it up, and we won't think of." I used to get so frustrated because I knew that, six months later, they were going to get into cash difficulties.
It is so important for any company that is going into China to make sure they create a business plan, they calculate how much their startup capital they need in order to run their business, they really do a cash flow analysis, and they really do a P&L forecast.
As of March 1, 2014, the PRC Company Law was updated, and it abolished the minimum investment requirements. They did that, to my pleasure and to my relief, in order to push companies to do real business plans when entering the Chinese market.
A lot of companies, when they come to China, always have a very negative point of view on China. I don't, obviously, having lived there for such a long time and dealing with business there. I am so impressed by the developments that have occurred in the Chinese market. One of the changes that occurred now almost two years ago, I'm thrilled by, and it has really changed the perspectives of many investors that have gone into the market.
Just to look briefly at some of the questions that I get from investors entering the Chinese market: Are you able to increase the registered capital? Yes, you are, but you don't want to increase it too much because, at the end of the day, that's also your liability. It's also your working capital. You really need to create a balance in terms of what your registered capital should be against your working capital needs, and also what your liability should be for the entity.
Are there differences from city to city based on this new regulation? Yes, there are differences, which obviously doesn't make things easy for anybody, especially if you are in sectors that are restricted or in sectors that require additional licensing. You definitely need to see whether that additional licensing will require specific minimum registered capital amounts. Although the general law is that there is no minimum, there are city-to-city requirements, there are sector-to-sector requirements, and you really should research that prior to entering the market.
Are you able to decrease the registered capital? In the Articles of Association, there is a clause which states that you're not permitted to decrease it. The reasoning behind it is that the Chinese government is saying, "You've made a business plan. You're entering the market. If you say you need this capital, you should really be investing this capital."
However, it could very well be that you win a deal and you just don't need the capital or cash anymore for the investment. You're able to sustain yourself throughout the term of your startup. The answer to the question is actually, in the Articles of Association, no, you cannot decrease, but there are special applications you can make in order for you not to have to transfer the remainder of the registered capital that hasn't been transferred yet.
Are you able to use the capital as working capital? You must. You must use that capital as working capital.
Does a representative office have registered capital? It does not. A representative office, as I said, is just a liaison office. What happens month-to-month is that the office in China will say to the head office in the U.S., "I need cash," and they will then be remitting it. That's usually a very simple process.
Once you know how much capital you want to invest, the next step is understanding bank accounts in China. For me, the critical point about bank accounts in China is not only what type of accounts you need to open, but it's also who's going to operate those accounts. Who is physically going to go to the bank counter to get cash? Are you going to have petty cash? These are all questions you need to consider in terms of the operations, particularly when you're a startup.
There are three types of account that you must open when opening an account in China. The first is a capital account, which basically means that all investment capital, registered capital, and loans that you might apply for would go into that account. At some point, that account will be at zero. Just keep that in mind.
The registered capital, because it's working capital, will then be transferred into the settlement account. The settlement accounts basically are made up of a renminbi basic account and multicurrency accounts. You're using those accounts for all types of trade transactions, paying expenses, etc.
Then, every month, there are tax declarations that need to be made, and tax liabilities that will be incurred, and you will need to transfer from the settlement account money into the tax account. As such, the tax account needs to be opened up so that the tax bureaus have the ability to deduct the tax amount directly, without you actually having to pay it as a TT transfer.
Here are most frequently asked questions. Should you use a foreign bank or a local Chinese bank, and what are the differences? I certainly hope there are no banks online, because, for me, I would honestly say out of efficiency purposes, choose the closest bank branch that is near your office in China. Open up with them, because you will realize how old-fashioned the systems are in China and how often you or whoever is operating the account will actually need to go to the bank in order to do certain transfers.
Whether you use a foreign bank or a Chinese bank, there really are no differences. They all have online banking capabilities. Most people speak English, which is usually a big concern for my clients. They also have telephone banking opportunities.
For me, actually, the key point is that most foreign banks don't always have all the capabilities as the Chinese banks do, primarily because the foreign banks have to go through approval processes with the People's Bank of China whereas the local Chinese banks are state-owned and they can pretty much do everything that they're permitted to do in the Chinese market.
When you're opening the account in China, the legal representative has to show their passport. They do not physically have to be in China. What a lot of our clients do is they send their original passport by registered mail just so they can avoid the trip of going to China.
Having said that, though, you should definitely research which bank you want to operate with, and definitely go to China, visit the bank, and get a feel for who you want to work with and who you feel the most comfortable with.
The next points are really related to the operation and understanding who's going to be the contact person for the bank. Who is going to operate the account? Who's going to do the transfers? Online banking exists, but one key point that people forget is that, when you write the name of the beneficial owner for the transfer, it has to be written in Chinese characters. You definitely do need somebody there who can write that.
Koehler Group, as well as many other service providers in China, offers solutions and outsourcing services to aid clients in that respect. Particularly if you're a startup in China, you've hired someone, and you definitely don't trust them yet with access to the bank account, you may want to outsource that function initially until you feel more comfortable with the staff that are on the ground.
Corporate credit cards are a very Westernized concept, and doesn't really exist in the China market. Some banks do operate, others don't. Again, it's important to meet with the banks, understand their capabilities, and understand what your needs are in the Chinese market.
As I mentioned, most people are very negative about the Chinese market, about setting up a legal presence in the Chinese market, and about the bureaucracy that's involved. I've even heard comments saying, "The Chinese government doesn't want foreign investors. If they had a choice, they'd kick everybody out. It's just simply not the truth.
I think the next slides really highlight how the Chinese government is improving the application process and the investment opportunities that exists in China.
As of October 1, 2015, so just three months ago, the Chinese government came out with a new system whereby they have one code that is associated with three government bureaus. They have now what is called the USCC system. What this basically means, and I'll portray this by showing the actual application procedure for establishing a company, is that they've eliminated the step of the enterprise code certificate and the tax certificate. Everything is now combined when you do the business license application. What this means is that rather than the application procedure taking six months, it can now take approximately five months.
Many of you will say, "One month out of six months, what does that actually mean?" This is a huge drive for China to improve things and make things better, and to eliminate certain procedures in the application phase.
For me, again, not only is the elimination of the minimum requirements of investment gone, but now you have better and more improved application procedures, as well. It's just phenomenal how the processes are going.
Although I'm not really touching on accounting and tax today, the strives of the tax authorities to improve accounting and tax regulations has just been phenomenal in a very short period of time.
Again, be optimistic about China. The opportunities are there for U.S. investors. Don't be scared or have this fear that, because China is so far away, things are bureaucratic and complicated. They're not. Things are definitely improving over a period of time.
Corporate structure is a very important aspect for me when I'm advising my clients on incorporating in China, primarily because a lot of investors are scared about being in the corporate structure for a Chinese entity. They say, "I don't want to be there. I will be the first person put in jail if something goes wrong." That's a very negative point of view because really, ultimately, what could go wrong?
Corruption in China has been reduced tremendously that nobody is going to be sent to jail. You might get a slap on the hand if you've done something wrong, just like you might get a slap on the hand in the U.S. if you've done something wrong, but it doesn't mean you can't be part of one of these corporate structures.
What I've seen with a lot of clients is they'll just try to find anyone who wants to take that role, including individuals that know nothing about the China business, they're not part of the China team, and hence, because of that, they're willing to take on that role because they have no clue what's going on. That's really not the right way to take this. If you're going to have a board of directors, an executive director, a GM, a legal rep, or a supervisor, you really need to choose the right people that fit those roles, and that can aid the company in developing and in growing.
For me, I think that's really one of the most critical decision making processes, to find the right people. Part of Koehler Group's services is obviously to aid you in understanding what those roles are, what they entail, what each of these decisions mean, in order to be able to guide you in finding the right people within your organization to take on those responsibilities.
For representative offices, which is a little bit different than LLC, you just have to appoint a chief representative. For representative offices, this is slightly different because, in the end of the day, the chief representative of a rep office is liable to pay personal income tax in China. For all the positions of an LLC, they don't have this liability. For a chief representative, even if you don't reside in China, you have to pay income tax. Again, that's a huge negative for me in terms of establishing a representative office in China.
Anu: Thank you, Kristina. Folks, we'd like to ask you another poll question. On the screen we'd like to know which city in China are you looking to establish? There are three different tiers as your options, and also an option to select, "Undecided." We'll give you all a moment to make your selection.
Thank you to everyone that participated.
Kristina: The outcome really is that the majority of you are either undecided, or you're inclined to go into one of the Tier 1 cities of Shanghai, Beijing, Guangzhou, Shenzhen, Chongqing, or Tianjin. Why is this so important? Why am I placing such a focus on where do you want to be?
The key point is the following quote: One office address means one legally registered company, which obviously is very different in the U.S. where you can establish as many companies as you like in one registered office location. In China, the Chinese government is trying to have companies invest in operational entities, meaning that, when you go to the Chinese market, you are going to employ people through that entity, you're going to be active through that entity, and you're going to be operational through that entity. They have the saying "One office address is for one legally registered company."
For a lot of startups, what we recommend to them is, particularly if they're planning on remaining a smaller size, usually my threshold or rule of thumb is, if you have four employees or less, go into a business center. At that point, you don't have to invest in the renovation of an office, you don't have to buy furniture, and really business centers offer you the flexibility to expand or downsize as you're developing in the market, particularly during the startup phase.
Registering your office address is relatively complex in China, and you may think, "Why?" Let me give you the following tidbits. The first is changing your office address, which sounds like a relatively simple procedure, but in China, if you are located in Shanghai, there are approximately 12 to 15 districts in China. If you want to move from one district to another district, you need to do a tax closure audit in your original district, and reopen in the new district that you want to establish yourself in. Sounds bureaucratic, sounds crazy, but it is what it is. You have no choice around it. It's very important, when you've already decided on a location, to decide what district you're going into in that location.
My recommendation again is to review the districts. Visit the various districts. You may start off in a very small office, but you need to see whether that district can actually help you to expand and grow if you need to so that you don't have to do disclosure audits.
The other key point is, if you want to or if you have established your business in Shanghai, and after a year and a half or two years, and trust me, this is a true case study, you have decided that actually Shanghai was completely the wrong place to establish your business and that you should have gone to Beijing or Shenzhen, what can you do? Unfortunately, in China, you cannot simply move your company from one municipality to another, or from one city to another. You have to set up a brand new entity in that city, and you have to take in the timeframe. If you want to establish a brand new entity, it does take approximately five months.
You need to keep in mind the research that you have to do when going into the market. Choose the right location. In that location, choose the right district.
A lot of companies expand over time. For example, Koehler Group, we've expanded tremendously. We have not only our head office in Shanghai, but we also have a branch office in Beijing, a branch office in Shenzhen, and a branch office in Guangzhou. The key point here is understanding what those branch offices should do. Should they be operational? Should they be non-operational? Basically, the difference revolves around the accounting principles and tax principles, and whether you want those branch offices to invoice or not.
Just know that at some point you may want to expand in China from just one location to several locations, and it is feasible, but it does require applications for branch offices.
Changes to your legal entity. Whether you're in the U.S., Europe, or anywhere in the world, any time there's a change to your structure, you do need to update it with the Administration of Industry and Commerce. If you want to change your business scope, your registered capital, the corporate structure, or the office address, you have to make sure that you do that timely, primarily because, again, at the end of the year, the auditor is going to review all these items and they're going to check whether you've updated the company appropriately and on time. If you haven't, you will get a slap on the hand and penalties may also arise. You certainly want to do those things on time.
I'm going to focus a little bit now on representative offices. My focus is primarily on the fact of the business scope, what you're permitted to do, and what you're not permitted to do.
Primarily, as I mentioned earlier, it's a liaison office. All you are permitted to do are liaison functions. As such, anything that revolves around being operational could result in penalties, and in worst case scenarios could result in the suspension or revocation of your registration certificate and ultimately could result in the chief representative being blacklisted by the Administration of Industry and Commerce, meaning that that individual would not be permitted to be in any other corporate structure in China.
There are a lot of surprise visits that are done by the Chinese government. Usually, the rep office name will be picked out of a hat and will then be investigated. In addition to that, if you have employees on staff that you're planning on firing, or the relationship has gone sour, you can pretty much be assured that that employee will go to the Chinese government and denounce you if you are doing things outside of your business scope.
That all leads me into really why an LLC is better off for you versus a representative office. I've listed five various reasons here. Primarily, most companies will look at cost. What is my annual budget going to be to manage and run an LLC versus a representative office?
Obviously, if you have an LLC, costs are going to be higher because, quite frankly, you're going to be legally operational, and you should be doing certain invoicing and certain accounting functions that a representative office is not permitted to do because it's purely a cost center.
When you're looking at annual budgets, obviously LLCs will be automatically more expensive than representative offices, but not by much. If you look at representative offices and what they have to do, from a corporate compliance standpoint, it's very different from an LLC.
On an annual basis, a representative office has to actually notarize, by the Chinese embassy in the U.S., the shareholder's company kit, all the documents associated with the company kit, like memorandums of understanding, all the business licenses, etc., which can be a nuisance. I certainly do know that the Chinese embassy and the consulate here charge a pretty penny for those notarizations to occur. Keep that in mind in terms of corporate compliance requirements and accounting and tax requirements.
I am going to end the presentation on maybe a sad note in terms of looking at liquidation and RO closures. Obviously, whenever somebody is planning on investing in the Chinese market, they're not planning at some point to liquidate it, but it's important to know what the procedures are. When you're liquidating a company in China, the entire process takes about 18 to 24 months. You do need to make a business plan and understand whether a LLC is important for you or not. A closure of a rep office usually only takes nine to 12 months, which is, again, not a short period of time, but it is much less than the liquidation.
The reason for the length of time is primarily because the tax bureau is investigating the last three to five years of operation, and making sure that there are no outstanding tax liabilities for the entity. Obviously, for an LLC, that investigation is a much lengthier process than it would be for a representative office that's purely a cost center. It is something to think about.
On a high note, let me end the presentation with my top 10 tips for establishing a legal presence in China. The first is do your market research on what the right structure is for you, but do your market research also on whether there are true opportunities for your company in China.
The second is establish the right culture from Day 1. I can't emphasize this more. When you are investing in the Chinese market, you are a guest in the Chinese market. You are going to China because you see the opportunities there, and you're planning to make a profit out of your investment in China. Don't expect that the mainland Chinese will become Americanized, or will adapt to the American culture. I can tell you now they won't. You will need to adapt yourself to that market. You will need to change certain things within your organization to be able to adapt that new subsidiary into your own culture.
You really need to be aware of the cultural differences. Mind you, it doesn't mean that the mainland Chinese are not curious about the Americans or want to understand how the processes are done. It's just that it has to be done very carefully.
Avoid a lack of attention and communication with your partners and the teams in the local market in China, which is much easier to say than to do, particularly with the 13-hour time zone difference. It doesn't mean you can't travel there. The amount of companies I've seen where the management doesn't go and see what is happening or occurring is too many. With the time zone issue as a problem, you really need to go often enough. It doesn't have to be one individual. It can be a variety of individuals from a variety of departments that go.
Ethical situations, for me, is always a big issue because investors come and they say, "This is China. It's permissible." No, it's really not. As common sense would say, what you wouldn't do in the U.S., you don't do in China. Absolutely not. Don't think that just because it's China you can get away with it. In a majority of cases today, you can't get away with it. Stick to your ethics. Make sure you don't do things under the table.
Dealing with inexperienced foreign and local staff. Again, this is really for budgeting reasons that a lot of people hire new graduates to go into China to run and manage a business, or they hire local staff that are not even familiar with their sector. I would always say, as the investment goes, really try to find the right people from Day 1, and build around that. You really want to have the right philosophy and the right mentality. You want experienced people who know your product and know your service line in order to be able to be successful in the market. You don't want those people to come in at a later stage. You want them there really from Day 1.
I should've put Point 6 as Point 1. Register your intellectual property. If you have not invested in China yet, but you have done business in China, you've been at trade shows in China, or you've passed out your name cards in China, please make sure you register your trademarks in China. If you haven't done that, do that today. It's extremely simple. It's inexpensive, and it's a very simple process to get done.
With additional licenses, understand, based on activities that you want to do, whether there are restrictions or any additional licenses that you need to apply for, because that will really cater then to the application procedures that are involved.
Be aware for government interaction. I didn't see too many people polling for wanting to be in the Tier 3 or Tier 4 cities, where primarily most governments in those areas are trying to attract foreign investment in order to bring up their standard of life and look good amongst all the other cities in China that they have foreign investors located there and they'll make a lot of promises. They'll say, "You get five years' rent-free land," or they will say, "You get 0% profits tax on your first three years of profitability." Don't believe any of the promises unless they're written down on paper, signed by the government official, and more importantly chopped by the government office. If that's not done, don't believe in the promises, and certainly don't make budget surrounding those promises.
The appointments of the directors and senior management personnel all relates to the corporate structure that you're trying to develop in the Chinese market. Make sure you select the appropriate people.
Point 10, again, for many it may sound silly, but for me, I think it's really vital: Obtain advice and pay for it. Make sure you don't just rely on new employees that say that they can do what they promised they'd do, like, "I know a government official that can set up the company in two days." Really, they can't. In two days, you know the company is unestablished, but you have a team of suddenly five employees that are not properly employed.
Go to a variety of lawyers. Similar as when you would find out you're sick and you want to have second and third opinions, do the same in China. Meet with a variety of lawyers. Meet with a variety of advisors. Meet with headhunters. Meet with a variety of corporate service providers that can assist you and aid you in the establishment of your business in China, particularly during the startup phase where it's critical to have all of the processes and internal control systems implemented.
Anu: Great. Thank you, Kristina. That was great.
We will now open up the Q&A session, and we're also going to put up one more poll question on the screen for you. Would you like to be contacted by a Global Subsidiary Management specialist? Please click one of the options on your screen if you're interested in learning more about this service.
Also, just as a reminder, you can download a copy of today's materials from the Handouts box. If you'd like to see what other webinars CSC offers, click on the free education webinars link in the "Join Us For More" box.
Let's take some questions from the audience. Ann is asking, "Am I able to convert my representative office to a limited liability company?"
Kristina: No. Actually, a representative office cannot be converted to a limited liability company. If you would want to set up an LLC, that would be a brand new establishment that would need to occur. You would then ultimately have to close down the representative office once that LLC is established.
The key point around that, though, and where it gets then a little bit complex, is that most likely you have negotiated a long-term agreement for your lease, and you would want that LLC to be registered in that representative office location. As I mentioned earlier, one company, one registered office address. You'd probably have to move the rep office to a new location and put the LLC then in that office where you're operational.
Anu: Great. Thank you. London is asking, "Do you provide consulting services for NGOs interested in moving into China or Hong Kong?"
Kristina: Yes, we do. NGOs is a very particularly sector in China, as well as in Hong Kong, but we do offer advisory on that.
Anu: Amy is asking, "Have there been any advancements in being able to protect intellectual property?
Kristina: Yes. The trademark law has been updated, and I believe there are going to be further updates that will occur in 2016. One of the key changes that has occurred, or improvements that, from my perspective, have occurred, is that previously it took about 18 months to register a trademark in China, and now that's just been reduced to nine months. That's, again, another phenomenal update in terms of the speed that things are progressing.
Anu: Chanel is asking, "Can a WFOE also handle import and export functions, or can that only be done through FICE?"
Krisina: Again, I really hate the terminology WFOE and FICE. An LLC can do import and export. You just need to make sure you add that into your business scope. From my interpretation, a FICE is handling import and export functions whereas the WFOE is doing more service-oriented functions.
Anu: Thank you. Dan is asking, "Do we have to have a location? Can we manage client location remotely and use local companies when assistance is required?"
Kristina: I think that requires a little bit more information from my side, so we'll follow up on that.
Anu: We'll follow up offline. Thank you. Cindy is asking, "Has international investments slowed in China given the economic slowdown in China?"
Kristina: No, it hasn't. I was on a panel of experts just six weeks ago, and this question also came up. There's still 7% growth in China. That's still phenomenal. Where else in the world do you see 7% growth? Yes, previously the growth in China was double digits, which, again, is outstanding and phenomenal, but the fact that it has slowed down, it's still 7%.
When people constantly ask me, you know, "Have you seen a slowdown? Are people not investing anymore?" people are still investing. People are still going into China. It's new opportunities for foreign investors, particularly in areas where China really needs help. If you look at the clean technology sector, high technology, urbanization, architecture, all of the areas that China is not yet mature on, all the foreign investors are diving into that area in order to win those opportunities and win those bids for those projects.
Anu: Excellent. Again, thank you, Kristina. That is all the time we have today. If we didn't get your question, we will contact you with a response after the webinar. Thank you to everyone who joined us today. We hope to see you next time.