A presentation on the challenges for investors into China

1. CHALLENGES FOR INVESTORS
IN 2010
Richard Kimber
Managing Partner of RHK Legal
13 June 2010
in Shanghai
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2. 
◆ China- An Overview
◆ Challenges and Risks for Investors in 2010
PRC Tax Regulatory Environment
IP Protection
Corporate Governance – Trade Secrets
Emerging Chinese Protectionism
Summary
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3. The Overview
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4. The Overview
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5. The Overview
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6. The Overview
Growth of Consumer Spending 2004-2007
[ US$ B ]
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8. Challenges and Opportunities for Investors in 2010
a. China evolving from a Production Economy to a Consumer
Economy
b. Beijing priority now is to both encourage SME development and
upgrade efficiency of tax revenue system
WHY
（ i) 2009-2010 drop in FDI- alarm bells
(ii) 2009-2010 Infrastructure Stimulus will end
(iii) Continued weakness in US and Europe
(iv) SME development encourages consumer spending ie consumption
(v) SMEs operate in the goods and services sector e.g. retail, food and beverage,
franchise, education, health and fitness, fast food
(vi) SMEs create 85% of all new jobs
C. Social Pressures- Industrial Wage Claims ( Honda and Foxconn)
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9. Challenges
PRC Tax Compliance
China is trying to streamline its tax assessment and tax collection
 An uphill battle largely of its own making – SAT not computerized. A bonus in an export oriented economy, a
liability in a consumption based economy.
 GFC inspired tax reform-– FDI dropped 22% in 2009 – Europe and US was main culprit for fall in PRC tax
revenues.
Representative Offices are discouraged now as an investment vehicle. New Circular in February 2010 will
operate to apply a deemed tax rate on ROs who do not keep adequate accounting records. SAT realizes a lot of
untaxed business activity was going on involving ROs.
The deemed profit rate for Ros raised to 15% from 10%- to increase tax revenues and also discourage use of
ROs.
WALKING A TIGHT-ROPE
Conflict between local tax bureaus and development zones giving unofficial and official tax incentives to attract
FDI and SAT stepping up assessment and collection of tax revenue
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10. PRC Tax Compliance
Late 2009-2010- SAT has issued a raft of new circulars
Circular 18- aimed at Representative Office
deemed tax rate raised to 15% from 10%
tax can be assessed on actual income if records not kept by RO
Circular 601
Foreign investor can only rely on DTA with China if it satisfies “ substantial business” test
NEED TO SHOW:
Board meetings held offshore
Local Director
Registration as a Taxpayer
Independent Company Image
Office Lease
Third Party Contracts
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11. Circular 698 -- December 2009
- retrospective from 1 January 2008 and set alarm bells ringing
- Seeks to impose PRC capital gains tax on disposal by an offshore holding company of its shares in a
PRC subsidiary (direct transfer) or disposal of shares of the intermediate holding company (indirect transfer)
- requires disclosure to SAT of “offshore indirect transfers” of equity in a domestic enterprise.
- investors use offshore companies, e.g. BVI, Hong Kong, Seychelles, Caymans to avoid PRC tax
on capital gains by disposal of shares in the offshore holding companies.
- SAT will look at the “indirect transfers”
where the offshore holding company disposing its shares is located in a country with an offshore tax rate less of
than
12.5% or is not taxed on offshore income.
- obligation within 30 days of the execution of the equity transfer contract, for the foreign investor to submit
relevant
documents to local tax bureau where domestic subsidiary is located.
Note: If SAT decides the equity transfer has “no reasonable business purpose”, it may impose additional tax at
domestic level or deem the local PRC subsidiary not to be foreign owned.
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12. Therefore SAT now applies Substance Over Form “Principle”:
With more and more tax information exchange agreements being signed
between China and BVI, HK etc it is clear full tax compliance is going to
be
on the agenda for foreign investors and SMEs in the PRC in 2010.
Solution:
(a)look carefully at how to structure investment into China.
(b) Which DTA provides most benefit
(c)Show “substantial business” of offshore investor.
BE AWARE THAT FOCUS IN 2010 IS ON TAX AVOIDANCE
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13. IP Registration---- Patent/ Trademarks and Copyright
More importance being attached to IP protection by both local and foreign enterprises.
— China now creating its own local IP and technology transfer from China due to increased offshore investment.
— Ever increasing need for clients to register copyright, patents and trademarks to operate in China.
— Too often clients don’t take action to protect brands and IP until after establishing China operations.
Now State Trademark Office has undertaken to shorten TM registration process from 26—32 months to 10 months.
Case Studies:
(a) Acted for Australian Olive Oil Manufacturer to advise on JVC for distribution. Negotiated Sales Agreement and TM
License.
Client discovered JV partner had registered Client’s trademarks during negotiations. Increase costs for Client in obtaining
re-transfer of IP right.
(b) Hong Kong based nightclub subject to copycat trademark registration in China
MANTRA: REGISTRATION BEFORE NEGOTIATION
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14. Trade Secrets- pre and post RioTinto
Pre- Rio Tinto
PRC Anti- Unfair Competition Law ( effective 1 December 1993) defines a trade secret as follows:
(1)It is not known to the public
(2)It is practically usefully and may bring profit to its owner
(3)Owner has taken measures to keep it confidential
PRC Courts have upheld trade secrets in the “ YSJ Co. Ltd” case. – proprietary customer management database.
Post- Rio Tinto
NOW: Interim Regulations for the Protection of Secrets in Centrally Administered Companies (SOES). – 26 April 2010
Now defines that …”any technological information or business information that falls within the realm of state secrets
must be treated as such according to PRC state secret laws.
Note: Any foreign investor negotiating with an SOE should ensure they sign mutual non-disclosure and
confidentiality agreements where there is an exchange of corporate information.
- Obtain written undertaking from SOE that information provided does not breach the April 2010 Regulations
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15. Corporate Governance – post Rio Tinto
● Ensure that anti-bribery and anti-corruption undertakings are signed and accepted by all local employees and those
written
undertakings filed with HR.
● Obtain third party supplier undertakings whenever possible including an obligation to report employee misconduct.
● Not just a domestic issue, looks like ASIC in Australia will adopt stringent anti-bribery compliance regulations which
will no doubt extend to PRC operating subsidiaries.
Whistleblower phenomenon —ex-employees are now reporting tax and corporate compliance breaches for
reward
to local SAIC and tax bureaus and SMES are being increasingly subject to tax and labor audits with little or no
warning.
MANTRA: IN CHINA EVERYTHING IS NEGOTIABLE
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16. Internal Corporate Governance Trade Secrets (Intangibles, business
processes, client databases, product specifications, price details etc. )
1. employees execute a separate detailed “Copyright and Trade Secret Assignment Agreement” and
“Non-Disclosure and Confidentiality Agreement”.
HOWEVER not enough to have handbooks and staff manuals.
(recent PRC court decisions place onus on employer to prove specific written notice to employees and have employees
sign
undertakings)
2. Prepare a Handover Checklist of items which must be delivered up by an
employee on finishing employment eg,
Hard drives
Communication Devices
Databases in all formats
Catalogues and Product Specifications
Technical Materials
3. Ensure both the employer and employee sign this Handover Checklist preferably when joining and also on ceasing
employment. Keep copies with human resources.
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17. Chinese Protectionism
a. PRC Indigenous Innovation Policy- Government
procurement to be of locally developed products for following sectors:
(i): Computer Software
(ii): Telecommunication Product
(iii): Energy Conservation Product
has caused US great concern
b. Working Guidelines for Recognition of High and New Technology Enterprises- January
2008
-Tax preference only available to HNTE where the IP is owned by the FIE or Dom Co.
CONTRAST:
Circular No. 166- 31 December 2009
Income from a qualified environmental protection and energy and water saving projects
-Eligible for 3 year EIT exemption
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18. SME Perspective
1. Expect increase in random tax or labor audits and requests by SAT for self
assessments of tax liabilities.
2. Increased tax incentives for SME set up, lowered capital requirements
and streamline application process.
3. Corporate Governance now a priority and review internal office procedures,
third party agreements and labor agreements.
4. SME financing should become easier – local PRC banks are establishing
SME loan departments and aggressively seeking FIE borrowers.
5. Be aware of the broad definition of “commercial and state secrets” when dealing with
SOEs and PRC private companies. Make your confidentiality and non- disclosure agreements
mutually binding.
6. Obtain written undertakings and indemnities
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19. SME Opportunities
1. Chinese Fast Food
2. Western Fast Food
3. Retail
4. Beverages
5. Gym, Fitness and Leisure
6. Auto After-Market
7. Luxury Retail
8. Education + Training
9. Furniture + Household Products
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20. NATURE OF THE INVESTMENT
Foreign Investment Catalog
Status of industry/ Description Examples
activity
Encouraged Special incentives possible Manufacture of wind power
Usually high tech or agriculture industries turbines
Agribusiness
Permitted All activities not mentioned in catalog are All sectors not mentioned in catalog
permitted
But may be difficult to get approval for
uncommon activities
Restricted Special approval required- usually JV Production of cigarettes
partner necessary Operation of oil refineries
Usually are protected sectors Media production/ Publishing/ TV
and Film
Prohibited Activities are disallowed Arms manufacturing
Harms national interests or environmentally Operation of gaming industry
damaging
When considering setting up in China, first step is to check the catalog
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21. Capital Requirements
Injection Methods
Total Investment Registered Capital Capital Contribution
Less than 3 million No less than 70% of total investment Complete injection within 6
months
Between 3 and 10 No less than 50% of total investment Or
million with a minimum of 2.1 million if total
investment is below 4.2 million Capital contributed in
installments: 20% within first 3
Between 10 and 30 No less than 40% of total investment months with the remaining
million with a minimum of 5 million if total injected within 2 years
investment is below 12.5 million
Currency: US Dollars
Between 30 and 36 No less than 1/3 of total investment
million with a minimum of 12 million
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22. Doing Business in China
Opportunities in China do exist- country has been opening up, growth rates are
impressive, population is getting wealthier, FDI has been pouring in …
However, competition is fierce; China market should be approached gradually, un-
emotionally and with realistic expectations
Long-term vision is a must, quick profits are unlikely- time, money and effort are
necessary
There is no such a thing as one China market, rather several regional/ provincial/ local
markets
Gaining local knowledge is crucial- adapt your business practices to the local
environment
Conducting proper due diligence, developing a sound strategy, and legal framework
are key success factors
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23. Golden Rules for Success in China
Research your market
Spend time on partner selection
Seek the less travelled road- 2nd tier cities
Use agent and representative where appropriate
Ask for it all up front
BUT- always have personal involvement
Manage Risk- Political/ Economic/ Disaster/ Individual
Register IP and Copyright
Develop a strategy to protect your IP
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24. Thank You for you attention !
RHK Legal
Shanghai Office
Suite 507, Jingan China Tower
No. 1701, Beijing West Road,
Jingan District, Shanghai, 200040 China
Tel: +86 21 6288 8821
Fax: +86 21 6288 8823
Hong Kong Office
Room 2406, 24/F., Hopewell Centre,
183 Queen's Road East,
Wanchai, Hong Kong
Email: info@rhklegal.cn
Website: www.rhklegal.cn
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