China Law Update : China Business Law Lawyers & Attorneys : Sheppard Mullin Law Firm : Direct Investment, Dispute Resolution, Intellectual Property, Antitrust, Venture Capital

By Carol Xu

Recently, MOFCOM issued the regulation permitting the use equity interest as capital contribution in FIEs (“the Provisions”).

According to PRC’s Company Law (amended in 2005), investors are only allowed to make capital contributions in cash, in kind or in such intangible property rights as intellectual property rights, land use rights or other transferable non-cash property with appraisable value. A pilot scheme permitting equity interest as capital contribution was launched in 2009 by the State Administration of Industry and Commerce (“SAIC”)[1], which stipulated that equity interest contributed as capital shall be registered with SAIC or its local counterparts. However, such measures fell short on giving a clear guidance on how equity interest can be contributed as capital in FIEs. Therefore, the issuance of the Provisions filled the gap and provided clearer guidance in this area.

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By Amin Amirkia

Last week, the Legal Affairs Office of the State Council issued for public comment a draft proposal (“Proposal”) to the implementation guidelines of the Law of the People's Republic of China on Guarding State Secrets (“State Secrets Law”).

The Proposal addresses various state secrets issues, including security classifications, the qualifications for those in posts involving the handling of state secrets, state secrets confidentiality systems, the supervision and management of state secrets, legal liability, and remedial procedures in handling the leaks of state secrets and related investigations.

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By Amin Amirkia

Earlier this month, China’s Ministry of Finance, State Administration for Industry and Commerce, Ministry of Commerce, State Administration of Foreign Exchange, and China Securities Regulatory Commission issued the Notice on Issuing the Scheme on the Localized Restructuring of Sino-Foreign Cooperative Accounting Firms (“Notice”), requiring the Big Four to “localize” their operations in China. The Notice became effective on May 10, 2012.

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By Amin Amirkia

The China International Economic and Trade Arbitration Commission (“CIETAC”) recently adopted revised arbitration rules (“Revised Rules”), to be effective on May 1, 2012. The Revised Rules replace the rules that became effective in 2005 (“2005 Rules”).

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By Yan Zhang

In late 2011, China’s National Development and Reform Commission (“NDRC”) and Ministry of Commence (“MOFCOM”) jointly announced the new Foreign Investment Guidance Catalogue (2011 Amendment) (“New Catalogue”). For years, China’s Foreign Investment Guidance Catalogue (“Catalogue”) has been among the most essential regulations and industrial policies in guiding foreign investment. The New Catalogue became effective on January 30, 2012, replacing its predecessor which became effective in December 2007.

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The Ministry of Commerce, Ministry of Finance, General Taxation Administration Bureau, State Administration for Industry and Commerce, National Bureau of Statistics and State Administration of Foreign Exchange (“SAFE”) have recently released the “Notice on Implementing the Joint Annual Inspection of Foreign-Invested Enterprises in 2012” (“Notice”). Pursuant to the Notice, the time period for the joint annual inspection of foreign-invested enterprises (“FIEs”) for 2011 is from March 1 to June 30 2012, and all FIEs established and registered in China on and before December 31, 2011 shall be subject to the annual inspection within the specified time.

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On February 23, 2012, the People’s Bank of China, Ministry of Finance, MOFCOM, State Administration of Taxation, General Administration of Customs and China Banking Regulatory Commission jointly issued the Notice on the Administration of Company Settling Export Trade in Renminbi (YinFa [2012] No. 23). According to this notice, company will be subject to “key supervision and administration” if in the last two years it (1) has committed tax evasion or export refund fraud, or issued or accepted fake VAT invoice; (2) has been subject to the investigations of tax bureau and public security bureau for tax evasion, export refund fraud, issuance or accepting fake VAT invoice; (3) has committed serious Customs violation e.g. smuggling; (4) has committed serious violations of financial regulations; (5) has committed serious violation of state foreign trade laws and regulations (6) has committed serious violation of other laws.

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By Amin Amirkia

The “Big Four”, which dominate the Chinese market, are facing regulatory changes that could mean that only accountants with Chinese qualifications can be partners in their China-based audit practices.

At the time of China’s accession to the World Trade Organization in 2001, the Big Four successfully lobbied to have an exception to China’s requirement that only Chinese certified accountants could own Chinese accounting firms. As a result, the Big Four were allowed to maintain their foreign ownership in their existing joint ventures. However, the exception only applied to the Big Four’s existing joint ventures, which have 20 year terms. As a result, the joint venture agreements signed by KPMG, Deloitte & Touche, and Ernst & Young will expire later this year, with PricewaterhouseCoopers’ to expire in 2017.

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On February 16, 2012 the Beijing office of Sheppard Mullin had a reception to celebrate the opening of new office space in China World Trade Center in the central business district. Firm Chairman Guy Halgren welcomed our 120-plus guests. Prior to the reception, Sheppard Mullin hosted a roundtable discussion on the Anti-Monopoly Law of China (“AML”). We had 18 participants, including in-house counsel for major corporations, as well as the German Chamber of Commerce. Our guest speaker, Mr. Zhang Yuqing, former director general counsel of the Chinese Ministry of Commerce (“MOFCOM”), who headed the inter-agency group which developed the AML, spoke on two topics which will probably be “hot” this year: a new regulation which will fine companies which didn’t report their transactions and went ahead with the transactions, and another regulation that deals with national security review. Gary Halling, head of Sheppard Mullin’s antitrust practice, spoke about recent enforcement trends in the U.S, specifically with respect to cartels. Michael Zhang of Sheppard Mullin’s Shanghai office also attended and gave his views on investment structures. The subsequent discussion among the participants was lively.

Sheppard Mullin hosts such roundtable discussions periodically, where we invite government officials and representatives of companies to exchange ideas and ask questions in an informal, off-the-record setting. If you are interested in participating in future roundtable discussions please contact Becky Koblitz, email address: bkoblitz@sheppardmullin.com. Below are the opening remarks of Becky Koblitz, Special Counsel, Beijing office of Sheppard Mullin Richter & Hampton LLP.

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The Ministry of Commerce and the State Administration of Foreign Exchange jointly released the Notice on Further Improving the Administrative Measures for Foreign-Funded Investment Companies (“the Notice”) on Dec 8, 2011. While amending some of the current regulations on foreign-invested investment companies, the Notice also sets some new restrictions.

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Responsive to issues faced with difficulty in obtaining financing by businesses (particularly small- to medium-size enterprises) due to the global financial crisis, State Administration of Industry and Commence officially released Administrative Measures for Corporate Debt-for-Equity Swap Registration (the “Measures”) recently, which formalizes regulation of debt-for-equity swap on the national level. The Measures will be put into implementation on January 1, 2012.

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The State Administration of Foreign Exchange of the People’s Republic of China (“SAFE”) is the principal gatekeeper for incoming and outgoing investment made in foreign currency. SAFE wields tremendous influence over capital inflows and outflows and, as such, the rules it promulgates can significantly affect inbound investments. Recently, SAFE issued Circular 19, the ‘Operating Rules for the Administration of Foreign Exchange in Financing and Round-trip Investment by Residents in China via Special-Purpose Companies’, an important addition to an existing body of rules and regulations of special importance to foreign investors.

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According to the Supreme People’s Court, when foreign investors purchase non-performing assets from Chinese firms and collect payments from the original borrower/guarantor it somehow changes the nature of the original guarantee. Consequently, on October 27, 2010, the Supreme People’s Court issued Notice on Trial of Cases Involving Issues of Validity of Guarantee Contracts Related to Use of Foreign Investment by Chinese Companies in Dealing with Nonperforming Assets (the “Notice”) in an effort to provide some guidance on such matters.

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Beginning December 1, 2010, foreign-invested enterprises, foreign enterprises, and foreign individuals are now required to pay the city maintenance and construction tax as well as the education surcharge, from which these entities and individuals were formerly exempt. Prior to this regulation, the PRC levied those taxes only on Chinese-owned and funded enterprises and Chinese citizens.

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In a new effort to bring clarity to regulations on the trial of cases involving Foreign Investment Enterprises (FIEs) in China, the Supreme People’s Court, the country’s highest court, implemented on August 16, 2010 Provisions on Issues Concerning Trial of Cases Relating to Foreign Investment Enterprises (I) (the “Provisions”). The Provisions deal mainly with cases involving such FIEs as contractual joint ventures, equity joint ventures and wholly foreign owned enterprises. The most important of the Provisions concern the following:

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78 Centrally administered State-owned enterprises ordered to withdraw from real estate development.

Soon after the NPC (the National People’s Congress) and CPPCC (the Chinese People's Political Consultative Conference) sessions, during which the top authorities expressed concerns over housing prices and possible intentions to control the property bubble, Beijing's land prices reached record highs, and the biggies shareholders of the winners in the recent three biggest land auctions were all state-owned firms.

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On February 20, 2010, the State Administration of Tax (the “SAT”) issued “Measures on the Administration of Approval and Collection of Non-resident Enterprise Income Tax” (the “Measures”). Non-resident corporations, defined in Article 3, Paragraph 2 of the Enterprise Income Tax Law of China, are governed by the Measures regarding enterprise income tax (EIT) issues. The EIT of representative offices of foreign enterprises is covered by Circular 18 [2010] issued by SAT on the same day. The Measures went into effect of the date of issuance.

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After Shanghai allowed foreign private equity and venture capital funds to incorporate in Shanghai in August 2008, Beijing recently became another pioneer in giving legal status to foreign investment funds. On December 20, 2009, Beijing Municipality released a circular entitled Interim Measures on Establishing Foreign Invested Equity Investment Fund Management Enterprises (the "Measures"). The Measures are effective as of January 1, 2010, for a trial period of three years.

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On December 7, 2009, the Ministry of Commerce and the Ministry of Science and Technology jointly announced their opinions on encouraging technology export ("opinions"). Opinions on encouraging technology export focus mainly on three areas: implementing preferential policies, closer international cooperation and improvement of the related public administration. The aim is to support enterprises in their export of well developed industrial technologies.

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By Jennifer Ding

China’s State Administration for Industry and Commerce (“SAIC”) and Ministry of Public Security issued a joint Notice on Further Administration of Registration of Foreign Companies’ Resident Representative Offices (the “Notice”) on January 4, 2010, in light of increased problems with foreign representative offices providing counterfeit registration materials and violating rules regulating their business operations in China. The Notice heightens the scrutiny over registration procedures, personnel structure, and operations of foreign representative offices, which the issuing administrations claim will enhance the enforcement of current regulations and help maintain economic and market order. There is no direct requirement in such Notice that the new restrictions established will be applied to foreign representative offices of certain professional-services firms (including law firms) and liaison offices of foreign-invested enterprises. A summary of changes outlined by the Notice is as follows:

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On November 23, 2009, China's Supreme Court launched public consultation on draft Regulations on Issues in Adjudicating Cases Involving Foreign Invested Enterprise Disputes (Part 1) (the "Guidelines"). The Guidelines provide detailed rules regarding dispute resolution for foreign investors based on the court's experience in real cases.

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The Chinese Ministry of Health (“MOH”) announced the promulgation of the Hospital Complaint Rules (for Trial Implementation) (the “Rules”) on November 26, 2009. The Rules aim to improve the management of hospital complaints and reduce medical accidents and negligence.

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On November 25, 2009, China’s State Council issued the long-awaited Administrative Measures for the Establishment of Partnership Enterprises in China by Foreign Enterprises or Individuals (the “FIP Measures”). The FIP Measures will take effect on March 1, 2010.

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Approval of the Draft Foreign-Invested Partnership ("FIP") Regulations

On August 19, 2009, China’s State Council approved, subject to further clarifying amendments, the Administrative Measures for the Establishment of Partnership Enterprises in China by Foreign Enterprises or Individuals (Draft) (the “Draft FIP Regulations”). The Drafted FIP Regulations have been returned to the Ministry of Commerce for further refinement.

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On July 6, 2009, the China State Administration for Taxation (“SAT”) issued a Notice Regarding Enhancement of Supervision and Investigation of Cross-border Related Party Transactions (the “Notice”). The Notice aims at preventing overseas companies from shifting losses to their related-parties in China against the backdrop of the financial downturn.

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In order to encourage more multinational companies to set up regional headquarters in the capital, the Beijing Municipal Government recently issued general rules and implementing regulations (the "New Rules”) to establish detailed policies on the treatment of regional headquarters. The New Rules not only lower the application requirements for regional headquarters, but also offer generous subsidies and rewards, and other preferential policies. Some highlights include the following:

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Due to the global financial crisis and economic downturn, foreign companies are faced with more challenges and risks associated with international purchase transactions with Chinese suppliers. As a result, it is suggested that foreign companies take steps to reduce costs and control risks when purchasing commodities in China.

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Since 2006, China has implemented a string of policies designed to restrict foreign investments in the real estate industry. Recent actions, such as the State Council Order No. 546 promulgated at the end of 2008, which repealed the rigorous treatment of the urban real estate tax, have curbed some of the most onerous of these restrictions; however, the Chinese real estate market remains heavily regulated. As a result, China's attitude toward foreign investment in local real estate may be best characterized as conservative.

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A recent agreement by the People's Bank of China ("PBC") has expanded a critical process for conducting business in China: currency settlement. On March 12, 2009, the PBC declared a foreign exchange payment arrangement (hereinafter referred as to the “Arrangement”) between mainland China and Hong Kong in conformity with the Memorandum of Foreign Exchange Payment Arrangement between achieved by the PBC and the Hong Kong Monetary Authority (“HKMA”). The Arrangement was executed on March 16, 2009.

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China's Ministry of Commerce (MOFCOM) has released new Rules on Overseas Investment ("New Rules"), which will make it easier for Chinese enterprises to get approval to invest overseas. The New Rules will go into effect on May 1, 2009.

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On November 19, 2008, China’s Ministries of Commerce, Foreign Affairs, Public Security and Justice jointly issued a Guideline on Cross-border Investigation and Litigation of Fugitive Foreign Investors (hereinafter referred as to the “Guideline”). 
 

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In January 2009, China's State Administration of Industry and Commerce issued the Rules on the Registration of Share Investment as Capital Contribution ("Rules"), which will go into effect on March 1, 2009.  "Share investment as contributions to capital" means the investment of a company through an investor's shares of another company.  The Rules will facilitate the share investment and improve the efficiency of its use.
 

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Recent changes to Chinese tax law has dramatic tax implications for foreign investors in the People's Republic of China.  Despite the changing tax landscape, there are still opportunities to take advantage of current tax law.

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On October 23, 2008, China and Singapore signed the China-Singapore Free Trade Agreement (CSFTA), which is the first comprehensive bilateral Free Trade Agreement between China and an Asian country. The Agreement will come into effect on January 1, 2009, once both sides have completed the necessary legislative processes. It is believed that the CSFTA, concluded after two years of negotiations, will enhance China-Singapore bilateral economic relations by further decreasing or removing barriers to trade.

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China is raising export tariff rebates for certain exports to help producers cope with smaller profit margins as a result of slacking market demand, the CNY’s appreciation and rising production costs.

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The world is facing a financial crisis, as large numbers of small and medium enterprises (SMEs) throughout Southeast Asia face bankruptcy.  More than 20% of SMEs in Vietnam are on the edge of bankruptcy, while SMEs in Korea are going bankrupt because of increasing difficulties in obtaining loans from banks that are haunted by unrecoverable bad debts (especially the SMEs located in China that were invested by Korean enterprises).  China has seen about 67,000 SMEs collapse in the first half of this year.  The past 5-10 years, a total of 1.4 million SMEs have gone bankrupt.   

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On August 1, 2008, the State Administration of Taxation (SAT) and the Ministry of Finance (MOF) announced several changes in export tax policies.  The export tax rebate for textiles and clothing was increased from 11% to 13%.  Large export companies are speculating that this increase will boost their profits.  Certain chemical products will not be included in the tax rebate increase.

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Electronic sports games ("E-sports games") have been sweeping across China as elsewhere in the world, and the sector in China is developing at a rapid and accelerating pace. More and more foreign E-sports companies are taking aim at the Chinese market.  With E-sports games gaining tremendous popularity in China, more and more foreign companies are aiming at the Chinese market.  However, upon entering China with enthusiasm, foreign enterprises are often paralyzed by Chinese regulations.

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One challenge for foreign investors in China is moving profits generated by their Foreign-Invested Enterprises (FIEs) out of China at reasonable cost.  Foreign investors commonly do so through dividends, interest, and royalties paid to them by their FIEs subject to a withholding tax of ten percent.  However, bilateral agreements on double taxation create opportunities for withholding tax savings.  An attractive way for withholding tax savings is by establishing FIEs through a Hong Kong Special Purpose Vehicle (SPV).

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Why Invest in the Chinese Bio-Industry

The Chinese Government is placing significant emphasis on developing and expanding China's biotech and pharmaceutical sectors, using a variety of tax breaks, government inducements, and other incentives. The goal is to make China the leader in global life sciences industries. This priority effort poses significant opportunities for foreign investors.

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Earlier this year, China surpassed the U.S. as having the No. 1 online Internet user base in the world.  Concurrent with that development, the China video gaming sector enjoyed explosive growth.  Today, the China video gaming sector remains extremely hot for investment.

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