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.
When a company decides to make investment in the China video gaming sector, it must first find the answers to the issues of i) whether foreign investment is allowed in China video gaming sector; and ii) whether there are any special operating licenses requirement, in addition to the general business license requirement.
Issue: Whether foreign investment is allowed in the China video gaming sector?
The answer to this issue depends on the business nature of the video gaming company. In particular, whether it is a company engaging in online video gaming operation (“Online Video Gaming) or a company engaging in video gaming production (“Video Game Production”).
For company engaging in Online Video Gaming production, since Article 8 of Regulation on Telecommunications of the PRC classifiwes Online Video Gaming as value-added telecommunication business, according to “Administration of Foreign Investment in Telecommunications Services”, a joint venture with a local partner with more than at least 50% of control is required (“JV”). However, for engaging in Video Game Production, a foreign company is allowed to establish a Wholly Owned Foreign Enterprise with the business scope of software development (“WOFE”).
The differences between establishing a JV and WOFE are too many. The main differences are as follows:
1. Timing: A WOFE can be established in less than a month, in comparison to a much longer time frame for JV due to the involvement of negotiation.
2. Control: An owner of WOFE has 100% of its control and ownership, while in a JV, its control and ownership need to be shared with the local partner. Given the fact that the Chinese regulations allows foreign investors to be only a minority shareholder of a JV that engages in Online Video Gaming, the controls right of JV often becomes one of the critical points of negotiation.
3. Licenses: JV allows foreign investor to use the licenses of the Chinese parties, which otherwise is not available.
Issue: Whether there are any special operating license requirement, in addition to the general business license.
Similar to the above, the answer to this issue differs depending on the business nature of a company, mainly whether it is Online Video Gaming or Video Game Production.
For Online Video Gaming, it requires the following three licenses:
1) Increment Telecommunication Service Management permit,
2) Network Culture Business Permit; and
3) Network Press Permit.
It is important to note that some of the permits mentioned above can only be issued to domestic enterprise. Thus, the only way for a foreign company to use those permit is through a JV with a local qualified partner.
For Video Game Production, there is no specific license requirement. A foreign company needs to simply file a WOFE application with the business scope of software manufacture.
Issue: Are there any preferential treatment for investing in video game sector?
The answer is yes. While the new Tax Law of PRC (“Tax Law”) provided uniformed tax rate for all enterprises of China and abolished the previously “tax preferential treatment” enjoyed by foreign invested enterprise, a video game operator could still receive tax preferential treatment by qualifying as a high-technology company. Due to the fact that new Tax law is very recent, and what constitutes a “high technology company” is not clearly defined, until there is such a clarification, there is a strong argument for making this assertion.
Other than tax, there are other preferential treatment such as free land or office spaces, should a company decides to establish in an area that is focused on attracting high-technology companies, such as the high technology zone established by major domestic cities.
The video game industry in China includes the production, sale, import/export, and playing of video games. Due to rampant piracy, the retail packaged game market in China is almost nonexistent, whereas the online game market experiences tremendous success. Korean gaming companies originally supplied the majority of online games to Chinese game operators, which resulted in the Korean companies taking about 60% of the profits in China. Concerned about the dominance of Korean gaming companies, the Chinese Government focused on developing its local online gaming industry and raising the standard of Chinese gaming companies. The main government bodies governing the gaming industry are the Ministry of Culture (“MOC”) and the General Administration of Press and Publications (“GAPP”).
Media, including video games, in China are subject to strict censorship policies. China’s Ministry of Culture has a committee that screens imported online video games before they are allowed into the Chinese market. Games that fall into any one of the following categories are banned from importation: (1) Violating basic principles of the Constitution; (2) Threatening national unity, sovereignty and territorial integrity; (3) Divulging state secrets; (4) Damaging the nation’s glory; (5) Disturbing social order; and (6) Infringing others’ legitimate rights. Examples of banned games include the following: Command & Conquer: Generals – Zero Hour (for “smearing the image of China and the Chinese army”); The Sims 2 (for having a “negative influence” on Chinese youth); and Hearts of Iron (for “distorting history and damaging China’s sovereignty and territorial integrity”).
Issue: Local Protectionism
The Chinese Government uses various regulations to keep out foreign online game companies. The most recent regulation issued by the General Administration of Press and Publication (GAPP) states, “the [GAPP] will postpone the examination, approval and licensing of foreign company products if the companies are sued or targeted for arbitration actions by Chinese online game companies.” The GAPP will not continue consideration of the products until after the complaints have been resolved.
Because of the high amount of software piracy in China, many foreign game companies have been reluctant to enter the Country’s market with single player or console games. Instead, they have focused on selling online titles such as online multiplayer games as income from these titles comes largely from subscription fees rather than the purchase price of the title itself. Nintendo claims that, as of February 14, 2008, China remains the primary source of pirated Nintendo DS and Wii games. On the other hand, China insists that it is making an effort to crack down on piracy, especially in anticipation of the Olympic Games this summer. Chinese officials report that the state had convicted 4,322 people for piracy in 2007.
Issue: Brand Protection
Brand protection in the video game industry is more important than ever before due to trends toward service-based revenue models (such as advertising and merchandise) and growth of online communities. Trademarks are protected on a “first to register” basis in China. Thus, trademark rights would be lost in China if a third party is the first to register one’s mark. In such cases, China’s Trademark Law does offer protection to well-known marks. However, a well-known mark status is very difficult to prove in China. Therefore, it is wise to register one’s trademarks in China even before entry to the Chinese market.
Once trademark rights are secured in China, the rights holder can enforce its rights through direct negotiations, or through administrative, civil and criminal enforcement proceedings. Foreigners in China find the Chinese judicial and administrative systems difficult to understand and navigate. However, there is an intellectual property protection system in place in China, and with the right assistance, companies can enforce their intellectual property rights.
With development costs increasing, many gaming carriers have opted to obtain the license for operating online game titles from both domestic online game developers or foreign online game distributors. When pursuing licensing, one must know whether the game was developed by a Chinese national. Under the 1991 Software Regulations, where a Chinese national licenses or assigns a software program developed within China to a foreigner, approval from the relevant administrative department is required. The 2002 Software Regulations clarified that when approving the transfer of ownership or licensing of software to foreigners, the relevant authority is required to take into consideration of China’s technology import and export legislations and policies.