Background

Starting from the beginning of this year, the Administration of Industry and Commerce (AIC) in many localities reportedly has suspended the practice of accepting new and renewal applications for liaison offices. By way of background, it was a common practice for many foreign-invested enterprises (FIEs) to be registered officially in free trade zones (FTZs), yet to have their principal place of business located outside the zone. Although the Company Law was silent regarding the permissibility of this practice, it was supported by a regulation issued by the State Administration for Industry and Commerce (SAIC), which allowed domestic companies (both FIEs and purely domestically invested)to register an office with limited liaison functions at another locality different from its registered principal business address. Technically, such functions should have been limited to indirect market research and support functions.

Also at the start of this year, a new Company Law came into effect that emphasized and strengthened the regulation of companies' use of branches. However, when the SAIC amended its regulations to reflect the changed Company Law, the provision regarding use of liaison offices was deleted. Thus, the practice of domestic companies' establishing liaison offices was no longer supported by either law or regulation. Subsequently, many local AICs stopped issuing new licenses or renewing the expiring licenses – all without official explanation. In the absence of official explanation, many contradictory opinions have emerged regarding the legal status of liaison offices, the potential impact on foreign companies' representative offices and the use of branches by domestic companies. Some argue that only branches of a company will be allowed, that use of liaison offices is prohibited and that such offices must be converted to branches. One school of thought even holds that representative offices of a foreign company (rep offices) also will be suspended due to the change in the Company Law.

FIE Branches and Liaison Offices

An FIE is a domestic company although the investment for it comes from overseas; as such, it is subject to special laws governing foreign investment as well as the Company Law. As is true for all other domestic companies, FIEs were allowed to have branches and liaison offices in different localities. The difference between branches and liaison offices of a domestic company was that branches were allowed to engage in business activities, but liaison offices were not. Naturally, as a result of engaging in business operations, branches needed to pay local taxes but, not surprisingly, liaison offices did not. In addition, use of branches was and is permitted by the Company Law, but liaison offices were permitted only by a regulation of the SAIC.

The revision of the Company Law does indeed change the rules for establishment of branches of domestic companies. Under the prior version, formation of a branch of a domestic company required no special procedures. The revised Company Law, however, requires each branch of a company to register with the local AIC and apply for a business license, which may grant local officials the authority to collect taxes from the branch.

As discussed above, liaison offices have been a form of business unsupported by statute although arguably permitted by regulation. In former practice, a liaison office was required to register at its local AIC but was not subject to local taxes, because technically it could not engage in any business activities. However, implementation of the revised Company Law has led to a change in attitude toward the establishment of liaison offices among AICs in many localities. Squire Sanders has confirmed that AICs in Beijing and Shanghai have refused to accept applications to establish liaison offices. In addition, our inquiries have also revealed that conversion of liaison offices into branches has not, as of this date, been ordered. Government officials have given contradictory opinions on the future of liaison offices, but no official opinion or rule has been published to date.

Foreign Company Rep Offices and Branches

Use of a rep office is one of the two forms of presence of a foreign company permitted to exist in China. Under current law and regulation, a foreign company may establish either rep offices or branches in China, and neither constitutes a separate legal person. A foreign company is a company formed under the law of a foreign country and has its principal business place in foreign country. (Please note, an FIE is not a foreign company, but rather a domestically-formed company, and the discussion of rep offices and branches in this section has no applicability to the treatment of FIEs.) The distinctions between rep offices and branches of a foreign company are similar to the distinctions stated above for liaison offices and branches of a domestic company. Rep offices are not allowed to engage in business activities unless authorized by special regulations, but branches are permitted to engage in business activities. The use of a rep office by a foreign company is explicitly authorized by a regulation promulgated by the State Council. A foreign company's use of branches is permitted by the Company Law.

Because the rep office of a foreign company is regulated by a special regulation but not governed by the Company Law, the Company Law's revision does not affect the legal status or procedures for formation of rep offices. On the other hand, branches of a foreign company are governed by the Company Law and the revision may affect their legal status and procedure of formation. (Please note, the branches of a domestic company including FIEs and the branches of a foreign company are governed separately by two different provisions of the Company Law.) However, a comparison of the old and new versions of the provision governing branches of a foreign company reveals no difference in wording. In other words, the revision of the Company Law did not in fact change the rules and requirements regarding use of branches by a foreign company. Thus, the revision of the Company Law alone has no effect on either the use of rep offices or branches by foreign companies. Whether subsequent change may be effected by promulgation of implementing regulations remains to be seen.

Conclusion

The revision of the Company Law has not affected the legal status or the formation procedures of the rep offices and branches of a foreign company, but it has changed the rules governing the use of branches of domestic companies including FIEs. With the existence of liaison offices by domestic companies now unregulated and unsupported, whether this concept will be abolished and, if it is, how the AIC will deal with existing liaison offices, are not yet clear.

According to our sources, the SAIC and Ministry of Commerce have been discussing the issue and may promulgate a new regulation or circular to address it. Until then, new liaison office applications by domestic companies will be rejected, but existing offices should not be affected.