Blakes: Doing Business in China
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Blakes: Doing Business in China Blakes: Doing Business in China Document Transcript

  • Doing Business in ChinaMONTRÉAL OTTAWA TORONTO CALGARY VANCOUVER NEW YORK CHICAGO LONDON BAHRAIN AL-KHOBAR* BEIJING SHANGHAI**Associated Office Blake, Cassels & Graydon LLP | blakes.com
  • A disciplined, team-driven approach focused squarely on the success of yourbusiness. Over 550 lawyers in 12 offices across Canada, the United States,Europe, the Middle East and China — Montréal, Ottawa, Toronto, Calgary,Vancouver, New York, Chicago, London, Bahrain, Beijing and associatedoffices in Al-Khobar and Shanghai. Among the worlds most respectedcorporate law firms, with expertise in virtually every area of business law. Blakes Means Business.
  • BLAKES GUIDE TO DOING BUSINESS IN CHINABlakes Guide to Doing Business in China is intended as an introductory summary. Specific adviceshould be sought in connection with particular transactions.Blake, Cassels & Graydon LLP produces regular reports and special publications on Canadianlegal developments. For further information about these reports and publications, please contactAlison Jeffrey in our Toronto office by telephone at 416-863-4152 or by email atalison.jeffrey@blakes.com. CONTENTSI. Introduction ..................................................................................................................................... 1 1. Overview of Government and Law in China .............................................................................. 1 2. Structure of Government ............................................................................................................... 1 2.1 National People’s Congress................................................................................................... 2 2.2 State Council ............................................................................................................................ 2 2.3 Ministerial Departments ........................................................................................................ 2 2.4 Regional and Local Governments ........................................................................................ 2 2.5 Judiciary ................................................................................................................................... 2 2.6 Special Development Zones .................................................................................................. 2 2.7 Hong Kong and Macao .......................................................................................................... 3 3. Legal System .................................................................................................................................... 3II. Establishing a Business Vehicle in China .................................................................................. 4 1. Representative Office...................................................................................................................... 4 2. Limited Liability Company ........................................................................................................... 5 2.1 Incorporation: China v. Canada ........................................................................................... 5 2.2 Business Scope Requirements ............................................................................................... 5 2.3 Capitalization Requirements ................................................................................................. 6 2.4 Selecting an Ownership Structure ........................................................................................ 8 3. Investment Process ......................................................................................................................... 9 3.1 Establishing a New Company............................................................................................... 9 3.2 Acquisition of Existing Company .......................................................................................10III. China’s Business Law Environment .......................................................................................... 11 1. Tax Law ...........................................................................................................................................11 2. Employment Law ...........................................................................................................................12 3. Intellectual Property Law .............................................................................................................13 3.1 Patent Rights ..........................................................................................................................13 3.2 Trade-Mark Law ....................................................................................................................14 3.3 Foreign Registration ..............................................................................................................14 4. Competition Law ...........................................................................................................................14 4.1 Regulation of Monopolies ....................................................................................................14 4.2 Regulation of Unfair Competition .......................................................................................15 5. Foreign Exchange Law ..................................................................................................................15 6. Import and Export Law .................................................................................................................16IV. The Next Steps ............................................................................................................................... 17V. China Practice Group Contacts................................................................................................... 18BLAKE, CASSELS & GRAYDON LLP Contents Page 1
  • I. INTRODUCTIONO ver the past several decades, the People’s Republic of China (China) has shifted from a closed, state-planned economy to an increasingly open and internationally integrated marketplace. This trend is only expected to increase in the future, as China continues to establish its position as oneof the world’s foremost economic powers. Given China’s prominence on the global stage, businesses,investors and states around the world are constantly developing and honing their “China strategy”.Canadian businesses and investors are no different in this regard.This guide is intended to provide a basic understanding of the legal issues involved in setting up andoperating a business in China. In the following sections, we will review the main business vehicles thatmay be employed to enter the Chinese market. We will also provide a brief overview of the following keyareas of China’s business law environment: tax law, employment law, intellectual property law,competition law, foreign exchange law and import/export law.It is important to note that there is no template for establishing and operating a business in China. Theapproach in any given case will depend upon numerous factors such as the industry, business activities,size and specific location of the business. As such, this guide should be viewed simply as a generalstarting point for the road ahead.This information is current as of March 1, 2013.1. Overview of Government and Law in ChinaBefore discussing China’s business vehicles and legal environment, it is helpful to review the structure ofgovernment and the legal system in China. This will provide useful context for many of the issuesdiscussed in this guide.2. Structure of GovernmentThe Chinese government regulates the private sector much more than the Canadian government.Canadian businesses and investors can expect to have significant interaction with government authoritiesin many aspects of their China operations. As such, it is important to have a basic understanding of thestructure of government in China.China employs a centralized government model. Each level of government is generally structured withthe same bodies and departments, and is responsible to the next higher level of government, although inpractice it is not uncommon for government departments to be more closely aligned horizontally thanvertically. In this regard, the central (or national) government is China’s highest level of authority,followed in turn by the provincial, municipal and county levels of government – and lower levels in somecases. We will briefly describe the main bodies of the central government: the National People’sCongress, the State Council, and the Ministerial Departments.Page 1 BLAKE, CASSELS & GRAYDON LLP
  • 2.1 National People’s CongressThe National People’s Congress (the NPC) is China’s highest legislative authority. The NPC consists ofrepresentatives elected by the provincial People’s Congresses throughout the country. Although the NPConly convenes once a year, it appoints a standing committee to exercise certain of its powers while not insession. The NPC also appoints China’s president, the head of state.2.2 State CouncilThe State Council, which is loosely equivalent to a “cabinet”, is China’s highest body of stateadministration. The State Council’s primary role is to implement the state policy formulated by the NPC.The State Council fulfills its role by enacting legislation and by overseeing China’s national ministerialdepartments and provincial level People’s Governments. The head of the State Council is referred to asthe Premier of China.2.3 Ministerial DepartmentsChina’s ministerial departments are empowered to supervise and administer the law and policy withintheir respective administrative portfolios. The main ministerial departments that foreign businesses willencounter are the National Development & Reform Commission (the NDRC), the Ministry of Commerce(the MOC), the State Administration for Industry and Commerce (the SAIC), the State Administration ofForeign Exchange (the SAFE) and the General Administration of Customs (Customs). The ministerialdepartments enact legislation, regulations and policy statements to direct activities within theirjurisdiction.2.4 Regional and Local GovernmentsEach level of government below the central government has its own People’s Congress, People’sGovernment and ministerial departments. The levels of government below the central government mayalso enact legislation, regulations and policy statements within the scope of their jurisdiction. Althoughsuch legislative efforts must generally comply with the efforts of the higher levels of government, inpractice it is common to see local governments enacting policies that are not necessarily in line withcentral government edicts. This is a primary cause of confusion for foreign investors, who are often notable to reconcile competing, and sometimes contrary, statutory requirements.2.5 JudiciaryThe judiciary in China is appointed or otherwise approved by the People’s Congress corresponding to thelevel of the court. For example, the NPC appoints or otherwise approves the judges sitting on China’sSupreme Court, and any given provincial People’s Congress appoints or otherwise approves the judgessitting on its provincial courts.2.6 Special Development ZonesIn the initial stages of opening its economy, China made extensive use of a variety of special developmentzones (under various names). These zones operated under special rules designed to facilitate foreigninvestment , while allowing for a sheltered, more gradual economic transition in the areas of ChinaPage 2 BLAKE, CASSELS & GRAYDON LLP
  • outside the zones. In recent years, some of the formal incentives that were initially used to attract foreigninvestment in the zones have been phased out. For instance, special development zones no longer havethe power to grant tax incentives that are not otherwise contemplated by the national tax laws. Despitethese changes, it still makes sense to base certain investments in special development zones.2.7 Hong Kong and MacaoIt should be noted that Hong Kong and Macao, while part of China, operate under different systems ofgovernment and different legal systems than mainland China. This guide is focused on the principalmainland China business vehicles available to foreign investors and the laws of mainland China ofprimary interest to foreign investors, and will not address the unique circumstances in Hong Kong andMacao. It should be further noted that investors based in Hong Kong and Macao are generally subject tothe same mainland China foreign investment rules as any other foreign investor.3. Legal SystemAs Canadian investors and businesses consider entering the Chinese market, it is important tounderstand some of the key differences between the legal systems in China and in Canada.China’s legislative bodies have enacted a tremendous volume of statutes, regulations, policies, directivesand other forms of legislation in the past several decades. Despite this abundance of legislation, the stateof the law on any given point is sometimes difficult to determine with certainty. It is not uncommon, forexample, to encounter vague, ambiguous or contradicting legal provisions, or to discover areas withrespect to which the law is silent.Where legal uncertainty is encountered in Canada, legal and business professionals look to the courts andquasi-judicial bodies (tribunals and commissions, for example) to provide an authoritative and bindinginterpretation upon which they can structure their affairs. In China, however, the body of published caselaw is sparse, and is generally not binding on other courts and quasi-judicial bodies. This serves toempower China’s administrative authorities, which often have significant discretion in the manner inwhich they choose to interpret and apply the law. Administrative policy can vary, frequently from case tocase and over time, and can be rigid, formalistic and bureaucratic. This often requires foreign businessesand investors to be flexible in their approach to achieving their objectives.Foreign businesses and investors are often concerned about the enforceability of their legal rights inChina. Given that most judicial rulings in China are unreported, it is difficult to reliably assess the successrate of foreign investors and businesses before the Chinese courts. It is possible to mitigate the risk posedby Chinese judicial proceedings in some cases by negotiating the use of foreign courts or alternate disputeresolution mechanisms. Under Chinese law, foreign arbitration decisions are generally enforceable,subject to similar public policy exceptions that are common in most jurisdictions. Judgments issued byforeign courts are generally not enforceable in China. It should be noted that Chinese courts do not havethe same inherent authority as common law courts to grant so-called “equitable remedies” such asinjunctions and specific performance. Similar remedies are sometimes provided by statute, but aregenerally more limited in their scope and application. That being said, as a general rule Chinese courts doconsider the equities in any given matter.Page 3 BLAKE, CASSELS & GRAYDON LLP
  • II. ESTABLISHING A BUSINESS VEHICLE IN CHINABefore establishing a business vehicle in China, Canadian investors and businesses should first determinewhether such a business vehicle is in fact required. In some instances, the intended business activities canbe performed without spending the time and incurring the costs involved in setting up a Chinesebusiness vehicle. This is often the case where a foreign business intends to enter into contractualrelationships with counterparties in China, but does not intend to establish a presence in China, such ascertain exporting and importing activities and offshore manufacturing arrangements.There are some industry-specific exceptions allowing foreign businesses to establish a registered presenceand conduct narrow or limited business activities in China through a branch office, such as certain oilexploration and development, construction, engineering, and banking activities. Of course, the use of abranch office negates the limited liability that is available to foreign investors who establish subsidiariesin China. Generally, if a foreign business intends to establish a presence in China, a Chinese businessvehicle will be required.There are numerous types of business vehicles that can be established in China. For the purposes of thisintroductory guide, we will focus on the two business vehicles that are most commonly used by foreignbusinesses and investors: representative offices, and limited liability companies, either by way of awholly foreign-owned enterprise or an incorporated joint venture.1. Representative OfficeA representative office (RO) is essentially a registered office of a foreign company in China. ROs arerelatively easy and inexpensive to establish, though they are limited in their permitted scope of activities.Many foreign businesses choose to open an RO in China as a way to explore the market before making amore substantial investment.One of the main differentiating factors between ROs and limited liability companies is the relative ease ofthe RO approval process. As will be discussed in the next section, the Chinese government conducts anactive review and approval process with respect to the establishment of foreign-invested limited liabilitycompanies. In the case of ROs, approvals are generally granted relatively quickly and as a matter ofroutine, as long as the establishing company is a legitimate enterprise which has been in existence for atleast two years prior to application. Establishing an RO can take as little as four to six weeks in a non-specialized sector. It should be noted, however, that in areas of China that have benefited from an influxof foreign investment, ROs are no longer as welcome as they once were.As a result of the relatively streamlined approval process, ROs are much less expensive to establish thancompanies. In addition, ROs are not subject to the minimum investment requirements imposed oncompanies and their investors.Although an RO is an easier and less expensive vehicle to establish than a limited liability company, it isalso significantly limited in its permitted scope of activities. Under Chinese law, an RO is considered to bean extension of its establishing company, and does not have the status of a “legal person”. In this regard,Page 4 BLAKE, CASSELS & GRAYDON LLP
  • an RO is generally only permitted to act as a liaison between the Chinese market and the establishingforeign company. Such liaison activities are restricted to research, marketing, technical exchanges withChinese companies and other activities that facilitate business between the Chinese market and theforeign company. In other words, an RO is generally not permitted to conduct business activities such asbuying and selling goods and services either on its own behalf or on behalf of the foreign investor. As aresult, an RO will not be appropriate if a foreign investor wishes to establish an operating entity in China.In addition, ROs do not offer limited liability protection to their “parent” companies.2. Limited Liability CompanyIn many cases, doing business in China will require foreign investors to establish or acquire a Chineselimited liability company. In this section, we will describe Chinese aspects of company formation andmanagement that may not be familiar to foreign investors, the various ownership structures that may beemployed by foreign investors, and the options of incorporating or acquiring a Chinese company.2.1 Incorporation: China v. CanadaIn Canada, corporations can be established with relative speed and ease. Investors are required toprovide basic information about the structure of the company but do not need to specify a business planor a scope of intended business activities. Incorporations may be completed in one or two days ifrequired, and may take on forms ranging from an empty shell to a fully capitalized and organizedcompany. In effect, the incorporation process allows investors to form a company without committing toa corporate structure, a set of business activities, or a level of capitalization commensurate with itsintended business activities.In China, the incorporation process is much more regulated and bureaucratic, often requiring review andapproval by several branches of the Chinese government. The review process includes an examination ofthe structure, business scope and capitalization of the proposed company (discussed in more detail laterin this guide). Based on this review process, the authorities determine whether or not the proposedcompany should be approved, and what requirements or restrictions should be imposed upon thestructure and operations of the proposed company.From the foregoing, it should be evident that incorporation in China is a much more complicated, time-consuming and expensive process in China than in Canada. In the next two sections, we will examine inparticular the business scope and capitalization requirements involved in China’s incorporation process.These requirements, which are not found in the Canadian incorporation process, are important tounderstand when setting up a company in China.2.2 Business Scope RequirementsIn China, it is not possible to incorporate a company to perform a general range of business activities. Theincorporation process requires investors to specify a business scope which describes the company’sproposed business activities – such as buying, selling, distributing, providing services, importing,exporting, etc. – and the industry sectors in which it will conduct such activities. Once formulated, theproposed business scope is subject to review and approval by the Chinese authorities.Page 5 BLAKE, CASSELS & GRAYDON LLP
  • The PRC Foreign Investment Industrial Guidance Catalogue (Revised) (the Industry Catalogue) is the mostimportant tool for determining whether activities in a proposed industry sector will be acceptable. TheIndustry Catalogue, which is jointly issued by the NDRC and the MOC, classifies industries into threecategories: encouraged industries, restricted industries and prohibited industries. Any industries that arenot listed in the Industry Catalogue are deemed to be permitted industries.Generally speaking, proposed companies that intend to conduct business in:• encouraged or permitted industries will be approved more readily;• restricted industries will often be subject to more time-consuming and higher-level examination; or• prohibited industries will not be approved.Beyond categorizing investment, the Industry Catalogue also specifies any restrictions that apply toforeign-invested enterprises operating in certain industries. In some industries such as oil and gasexploration, automobile manufacturing, and cargo shipping, a company cannot be established by aforeign company without a Chinese partner. In such cases, the Industry Catalogue may also specify thatthe Chinese partner must hold a minimum amount of investment or control in the joint venture.The business scope is one of the central points that is reviewed and approved by the Chinese authoritiesas part of the incorporation process. It must be precise and correspond to the type of business thecompany will undertake once established. Chinese companies are not entitled to enter into businessactivities beyond their approved business scope. Should a company wish to expand or change itsoperations post-incorporation, it will need to apply to the appropriate government authorities to amendits business scope. It should be understood that regional regulators will often apply boilerplate businessscopes when conducting their review of applications, regardless of whether such formulations areentirely appropriate. As such, business scope is often a point that is subject to negotiation with theapproval authorities.2.3 Capitalization RequirementsIn Canada, it is quite common for corporations to be formed with only a nominal amount ofcapitalization – one share issued for one dollar, for example. This is not an available option in China,although minimum capitalization requirements have been relaxed in the past few years. In this section,we will discuss the capitalization concepts of “total investment” and “registered capital” as they apply tothe establishment of limited liability companies in China.When seeking to establish a company in China, a foreign investor is required to determine theappropriate level of total investment for the proposed company. The total investment can be generallyexplained as the total amount of funding (whether debt or equity) required to bring the proposedcompany to the point that it is able to conduct its proposed business operations without financial supportfrom its parent(s) or other source of financing. At least a specified portion of the total investment of acompany must be contributed in the form of an equity investment by its parent(s). This minimum equityinvestment is referred to as the registered capital.Page 6 BLAKE, CASSELS & GRAYDON LLP
  • The relationship between total investment and registered capital is set out in the chart below: Total Investment (US$) Ratio of Minimum Specified Minimum Investment Registered Capital to (US$) Total Investment Less than or equal to 7/10 $3-million Greater than $3-million, up to ½ Where the total investment is and including $10-million $4.2-million or less, registered capital may not be less than $2.1-million Greater than $10-million, up 2/5 Where the total investment is to and including $30-million $12.5-million or less, registered capital may not be less than $5-million More than $30-million 1/3 Where the total investment is $36-million or less, registered capital may not be less than $12-millionIn a typical case, the registered capital of a foreign funded company can be paid in a lump sum or ininstalments. If the registered capital is paid in a lump sum, it must generally be paid within six months ofthe issuance of the company’s business licence (the date of incorporation). If the registered capital is paidin instalments, the first instalment must generally be no less than 15% of the registered capital or theminimum capital requirement for the company as provided by law (typically 30,000 to 100,000 RMB),whichever is greater. The first instalment must generally be paid within three months following theissuance of the business licence, with the remaining amount being paid within two years afterestablishment.It should be noted that registered capital is, in part, a commitment to the state. Failure to contributeregistered capital on time or at all may result in fines and other legal action by the Chinese authorities, inaddition to causing damage to the investor’s credibility in China. In some cases, the authorities willpermit a portion of the registered capital to be contributed in assets such as new equipment or intellectualproperty. In such cases, the value of such assets needs to be formally determined by an appraisalcompany authorized to practise in China.Each investor contribution to the registered capital is evidenced by an auditor’s report (called a capitalverification report) which must be filed with the Chinese authorities. Following preparation of a capitalverification report, the company is obliged to issue a current “investment certificate” to the investorevidencing the total amount of registered capital contributed by the investor to date.Both the registered capital and the total investment of a company must be approved by and registeredwith the Chinese authorities, and may only be modified following an additional approval process.Although there has been a decrease in the statutory minimum registered capital requirements ofcompanies over the past few years, regulators still have discretion to require that registered capital begreater than the minimum requirement, and may refuse to approve the establishment of a foreign-invested enterprise where there is concern that the registered capital will not be sufficient to bring theenterprise to a productive level.Page 7 BLAKE, CASSELS & GRAYDON LLP
  • The portion of the total investment above the amount of the registered capital is not a financialcommitment on the part of the investor. Instead, this amount represents the total amount of additionalfunds the company may raise by way of debt. In the event that a limited liability company runs out ofworking capital and all its total investment has been contributed, it will only be able to obtain additionalfunds through an increase to its registered capital and total investment, which increase must be approvedby the government. As government approvals may take several weeks to obtain, a lack of proper cashflow planning may leave the company in financial difficulties. Therefore, the amount of total investmentand registered capital of a company should be determined strategically. Investors need to balance thedesire to limit their investment risk in China against the risk of cash flow problems.2.4 Selecting an Ownership StructureThere are two types of companies that are generally used by foreign investors:1. a wholly foreign-owned enterprise (“WFOE”, commonly pronounced as “woofee”) formed by one or more foreign investors; or2. a Sino-foreign joint venture formed by one or more foreign investors and one or more domestic Chinese companies.We will discuss each of these structures below.2.4.1 Wholly Foreign-Owned EnterpriseA WFOE is a Chinese company that is wholly owned by one or more foreign investors. The mainadvantage of a WFOE is that the foreign investor (assuming a sole shareholder) has complete control overthe management and financial affairs of the company. Several foreign investors may partner to establish aWFOE either by investing directly in the WFOE or by jointly establishing an offshore entity to establishthe WFOE.Establishing a WFOE is relatively simple in comparison to establishing a Sino-foreign joint venture.Although the required documentation is similar (with the significant exception of the joint venturecontract), such documentation does not need to be negotiated and settled between a foreign investor anda Chinese party. This reduces both the cost and time required to complete the incorporation process.2.4.2 Sino-Foreign Joint VenturesAs discussed earlier, the Industry Catalogue requires foreign investors to partner with a Chinese party inorder to do business in certain industry sectors. Even where the Industry Catalogue does not make thisexplicit requirement, the government authorities may choose to impose this requirement at theirdiscretion. The law also requires that, in certain industry sectors, the Chinese party must obtain andmaintain a majority position in the joint venture. In such cases, a foreign investor will not be able to investin a Chinese limited liability company unless the investment is structured as a Sino-foreign joint venturein the manner specified by the law and administrative authorities.Where a joint venture with a Chinese party is not required, foreign investors should consider carefullywhether there is a genuine advantage to working with a local partner. There are several points toconsider in this regard. Chinese partners will often resist managing the joint venture in accordance withPage 8 BLAKE, CASSELS & GRAYDON LLP
  • the foreign party’s practices, which can be a source of friction between the parties and may even lead tobreaches of the law of the foreign investor’s home jurisdiction. In dispute situations, the Chinese partnerto the joint venture will often have the upper hand, no matter how carefully agreements are drafted,simply because they are familiar with the system. In most Chinese jurisdictions, foreign investors canwork directly with government and regulators without the assistance of a local business partner. In thisregard, promises of access to or special treatment from local government should not form the basis forestablishing a business relationship.There are two types of Sino-foreign joint ventures under Chinese law: the equity joint venture (EJV) andthe co-operative (or contractual) joint venture (CJV), both of which can be established as limited liabilitycompanies.In an EJV, each party may contribute registered capital in the form of cash, land, buildings, intellectualproperty, equipment and/or technology. The parties then share in the management, profits, risks andlosses of the joint venture in proportion to their relative equity interests.CJVs are similar in many ways to EJVs but have the potential to be more flexible in certain aspects. UnlikeEJVs, the profits, risks and losses of CJVs may be allocated between the parties in a proportion that differsfrom the equity contributions of the parties. It may also be possible for the foreign party to recover itsinvestment before the end of the term of the CJV although the quid pro quo in this situation is that theChinese investor will be entitled to receive the fixed assets of the CJV upon its dissolution, and for theparties to contract out management of the joint venture to a third party. CJVs may also be formed asunincorporated joint ventures, although this is a less frequently employed structure (no limited liabilityfor the investors being the main disadvantage).3. Investment ProcessForeign investors can invest in Sino-foreign joint ventures and WFOEs by establishing a new company orby acquiring an equity interest in an existing company. We will discuss both of these options below.3.1 Establishing a New CompanyEstablishing a new company allows the investor to design the company according to its needs, includingthe internal structure as well as the external relationships and activities of the company.In order to incorporate a company, the foreign investor (in conjunction with its Chinese partner, if any)must prepare and submit an application package for review and approval by the Chinese authorities(typically the NDRC and the MOC). The package notably includes a feasibility study describing theproposed company, including the proposed company’s business scope, corporate structure, proposedpremises, capitalization, basic profit and expense projections, environmental impact, energyrequirements, land requirements, and other aspects on a case-by-case basis. The package also includes theproposed articles of association of the company, which describe the internal parameters and governanceof the proposed company in a manner similar to the bylaws of federally incorporated companies inCanada. If the nature of the proposed business requires prior review or approval by other branches of theChinese government, such approvals must be included in the package. It will also be necessary to providedocumentation establishing the credit and reputation of the investor(s). In the case of Sino-foreign jointventures, the foreign investor must additionally negotiate and execute a joint venture contract with itsChinese partner. This joint venture contract must then be submitted as part of the application package.Page 9 BLAKE, CASSELS & GRAYDON LLP
  • The nature and size of the investment in a foreign-invested company and the proposed business scope ofthe company will dictate whether local, provincial or central government approval is required. Centralgovernment approvals, since they invariably involve larger investments or investments in key sectors,tend to take longer than local and provincial approvals.It is realistic to budget for a time period of between three to six months from the date the application for aforeign-invested company is submitted to the date of incorporation. It is, however, customary forgovernment authorities to request documents and additional clarifications that may slow down theprocess.3.2 Acquisition of Existing CompanyForeign investors generally prefer to establish new companies rather than acquire some or all of theequity of an existing Chinese company. It can be difficult to identify an appropriate acquisition target,particularly since Chinese companies may be reluctant to provide information (in a timely fashion or atall) that foreign investors might normally expect to receive in a due diligence process. Still, in certaincases, investors may wish to take advantage of an existing structure or market position of an establishedcompany as opposed to building a business from the ground up.As with incorporating a new company, the authorities will be involved in reviewing and approving thedocumentation necessary to allow a foreign business to acquire some or all of the equity of a Chinesecompany. In particular, the authorities will review the substance of the purchase agreement to assess itscompliance with Chinese corporate law and to determine whether or not the proposed compensation andstructure of the transaction is acceptable. The authorities will also review the suitability of the investor inthe same way as they would if the investor was incorporating a new company.It will likely take several months or longer to acquire an existing Chinese company depending on the sizeand complexity of the transaction. If the Chinese company is not currently a foreign-invested enterprise,additional approvals will be required to transform the company from a wholly Chinese-owned companyto a foreign-invested enterprise. Similar approvals will be required in the event that the investor’sproposed acquisition would change a Sino-foreign joint venture into a WFOE.Page 10 BLAKE, CASSELS & GRAYDON LLP
  • III. CHINA’S BUSINESS LAW ENVIRONMENTIn the previous sections, we examined the business vehicles that a foreign investor may use to enter theChinese market. In this section, we will provide an overview of certain key aspects of China’s businesslaw environment. Canadian businesses and investors may find that certain business laws andadministrative regimes do not operate the way they might expect. It is not uncommon for foreigninvestors to encounter legal and administrative stumbling blocks where they are least expected. As withall areas of doing business in China, the best approach is to gather as much information as possible, planand prepare accordingly, and remain flexible and patient if plans need to be modified as events unfold.We will provide a background overview of the following areas of China’s business law environment:1. Tax Law2. Employment Law3. Intellectual Property Law4. Competition Law5. Foreign Exchange Law6. Import/Export Law1. Tax LawThere are numerous forms of taxation that Canadian businesses and investors may encounter in China. Itis important to note that China’s tax laws operate in the context of the tax treaty formed between Chinaand Canada. This treaty provides rules for the levy of tax on both individuals and enterprises, and setsout provisions designed to eliminate or mitigate instances of double taxation. We will provide anoverview of China’s income tax regime and certain other taxes that are commonly encountered.The taxation of enterprise income in China is governed by the Enterprise Income Tax Law and itsassociated laws and regulations. An enterprise’s taxable income is primarily based on whether acompany is considered to be a “resident” or a “non-resident” of China. Resident companies are thosecompanies established under Chinese law or foreign companies with management or control based inChina. Resident companies are subject to income tax on their worldwide income within the taxationperiod. Non-resident companies are subject to tax on their income relating to their China operations. Ingeneral, the enterprise income tax is 25% on the taxable income of a resident business. Non-residentbusinesses may be subject to a reduced tax rate, as may qualifying small businesses or businessesoperating in certain encouraged geographic zones or industry sectors.China also has several forms of tax that may be levied depending on the nature of a transaction. TheValue Added Tax (VAT) is a tax generally payable on the production, sale and importation of goods(generally tangible goods), and certain types of services. In general, the VAT is designed to pass theultimate payment of the tax to the end consumer of the goods or services. The Consumption Tax is a taxPage 11 BLAKE, CASSELS & GRAYDON LLP
  • payable on certain non-essential or luxury consumer goods. The Business Tax is a tax payable on theprovision of services (that are not covered by the VAT), and the transfer of intangible and real property.The tax rate for these taxes varies depending on factors such as the industry at issue and the particularcircumstances of the payor.There are numerous other taxes that may apply depending on the specific business activities at issue.Foreign investors should always seek advice on the taxes that may apply in any given case as part of theirdecision to do business in China.2. Employment LawThe relationship between employers and employees is heavily governed by statute in China. The lawprovides basic minimums with respect to most aspects of the employment relationship, and in some areasstipulates the terms that must form the basis of the employment contract. In recent years, China hasestablished certain state-administered social insurance programs for employees. These programstypically involve contributions from both employers and employees (through payroll deductions), andprovide benefits such as medical insurance, injury and disability insurance, unemployment insurance,old age pension, housing fund and other benefits. Employers and employees are free to negotiate suchaspects as salary, job description, vacation entitlement, and other benefits above the minimums providedby law.Employment contracts in China may be formed on an open-term, fixed-term or task-specific basis.Employers are often reluctant to form open-term contracts, as they are not permitted to terminateemployment relationships except in the event of serious dereliction of duty, protracted illness andsimilarly high thresholds. For this reason, employers generally prefer to structure their employmentrelationships on a fixed-term or, less commonly, on a task-specific basis. However, it is to be noted thatfixed-term agreements also have limited benefits since the law provides that, following two consecutiverenewals of a fixed-term employment contract, it will automatically be treated under the law as an open-term contract.Employers are often concerned about their ability to protect their business interests in relation to past andpresent employees. Chinese law recognizes the concepts of confidential information and trade secrets,and provides protection against theft or misuse thereof. China’s patent legislation also containsprovisions that generally deem intellectual property developed by an employee in the context of his orher employment to be the property of the employer, although additional compensation for the inventormay be required. In any event, the employment agreement should carefully set out the employee’sconfidentiality and use of intellectual property obligations, as well as the employer’s entitlement tointellectual property created by the employee.Chinese law also permits the use of post-employment non-competition arrangements, although theydiffer from their Canadian counterparts in numerous respects. Unlike in Canada, a non-competitionclause in China must provide the employee with compensation throughout the non-competition period.The exact parameters of the compensation are not specifically addressed in the law, although in practicethe amount is generally between one-half to two-thirds of the employee’s typical compensation, paid on amonthly basis. An employer and an employee are also permitted to negotiate a penalty that will apply ifthe employee breaches his or her non-competition obligations. As in Canada, non-competition clausesshould be drafted as narrowly and fairly as possible to increase the likelihood of enforcement. The termPage 12 BLAKE, CASSELS & GRAYDON LLP
  • of the non-competition obligation must not exceed two years after the expiry or termination of theemployment relationship.3. Intellectual Property LawIntellectual property protection is a key consideration for companies entering the Chinese market. In thissection, we will provide an overview of patent and trade-mark rights in China. Investors may also wishto register domain names and copyrights in China. In the subsequent Competition section, we will alsodiscuss certain unregistered forms of intellectual property protections such as confidential informationand trade secrets.3.1 Patent RightsThere are three different types of patents in China: invention patents, utility model patents and designpatents. As a simplified explanation, invention patents relate to innovative new products, processes andimprovements thereof, utility model patents relate to innovative aspects of the shape and structure of aproduct, and design patents relate to certain aesthetic aspects (colour, shape and pattern) of thepresentation of a product. Invention patents are the most robust of the three patents, involving ameticulous review process that takes several years to complete, and providing protection for a period of20 years from the date of filing. Design patents and utility model patents have a less meticulous andlengthy review process, and provide protection for a period of 10 years after the date of filing. Each ofthese patents provides protection throughout China (excluding Hong Kong and Macao).China’s patent system works on a first-to-file basis. For invention and utility model patent applications,patent examiners will review the purported invention or utility model and the relevant “prior art” todetermine whether or not the purported invention or utility model is novel, creative (ingenious) andpractical. Design patent applications are examined on the basis of whether the design infringes upon awell-known existing design or another registered design. Both foreign and domestic prior art and designsare reviewed in determining patentability.China is a party to the Patent Co-operation Treaty (PCT). In this regard, a Canadian company that wishes toprotect its innovations in China may apply directly to the Chinese patent authorities or may applyindirectly through the PCT or “international” process. Timing is critical in either of these processes, andearly consultation with a legal adviser is encouraged to ensure that the window of time for patentabilitydoes not expire.The enforcement of foreign-owned patent rights in China remains an area of concern for foreign investorsand businesses. It is difficult to determine with certainty the degree to which foreign patent rights may besuccessfully enforced against local infringers. As noted, the judicial system is not based on precedent andis generally neither transparent to the public nor independent. Where patents are successfully enforced,the remedies available to the successful party are often not as robust as those in Canada. For thesereasons, the enforceability of patents in China remains a business risk that must be factored in whenentering the Chinese market.Page 13 BLAKE, CASSELS & GRAYDON LLP
  • 3.2 Trade-Mark LawTrade-mark protection in China is based on a first-to-file system. Unlike in Canada, the use of a trade-mark itself will not establish a property right to such trade-mark. There is an exception in the case offamous trade-marks – Nike, Coca-Cola, and similar globally recognized trade-marks – which receiveprotection under the law whether or not they have been registered as trade-marks in China. In general,however, trade-mark rights can only be acquired by filing a trade-mark in one or more classes of goodsand services.Registered trade-marks remain in effect for 10 years, with subsequent 10-year extensions being available.Trade-marks protect against infringing uses on the same or similar goods as those specified in the trade-mark registration. As with patent protection, enforceability of trade-mark rights remains unpredictable.Trade-mark infringement, particularly in relation to consumer goods, remains a significant problem inChina.China is a party to the Paris Convention for the Protection of Industrial Property, and in that regard it ispossible for a person to obtain priority rights to marks previously filed by the person in other party states.As with the PCT process for patent registration, timing is critical and it is important to consult with legalcounsel as early as possible.3.3 Foreign RegistrationMany forms of intellectual property protection in China may be registered by foreign businesses withouta Chinese business vehicle. In this regard, foreign businesses may wish to consider protecting certainintellectual property rights in China in preparation for future entry to the Chinese market or to pre-emptthe registration of competing intellectual property claims.4. Competition LawChina has consolidated and expanded regulatory schemes in recent years to regulate monopolisticbusiness structures and commercial practices, and to regulate certain forms of unfair competition.4.1 Regulation of MonopoliesUnder China’s Anti-Monopoly Law (AML) and its associated regulations, there are three generalcategories of prohibited activity:• business mergers and combinations that unduly restrict or eliminate competition (the M&A Category);• collusive business agreements (the Collusion Category); and• abuse of dominant market position (the Dominant Position Category).The M&A Category, which is a relatively new feature of Chinese law, is administered by the MOC, andregulates concentrations of business operators that may influence, eliminate or restrict competition. In thevast majority of cases, the reviewed transactions have been approved, albeit with certain restrictions insome cases. The Collusion Category is administered by the SAIC, and regulates agreements betweenPage 14 BLAKE, CASSELS & GRAYDON LLP
  • competing business operators that, among other things, artificially control the price or supply ofcommodities, restrict the purchase or development of new technologies, or involve the joint boycott ofcertain transactions. The Dominant Position Category is administered by the NDRC, and regulates certaintactics when employed by businesses with a dominant market position, such as selling below cost, tiedselling, selling commodities at unfairly high prices or buying commodities at unfairly low prices, andrefusing to trade with certain parties without justification.4.2 Regulation of Unfair CompetitionThe PRC’s Anti-unfair Competition Law provides some of the same marketplace protections that areembodied in the statutory and common law of Canada. The law prohibits such acts as passing off theregistered trade-marks and enterprise name of another party, selling products below cost, obtaining andusing the trade secrets of other parties, tied selling, collusion among parties to a tendering process, andlibel and slander of a competitor’s products. In particular, it is not permissible to obtain trade secrets froma party where doing so would breach such party’s confidentiality obligations (for example, employeesand other parties bound by confidentiality agreements). The remedies for acts of unfair competitioninclude an accounting of damages suffered by the injured party, state-administered fines, and cease-and-desist orders.5. Foreign Exchange LawChina’s currency is called the Renminbi or, most commonly, the RMB. Unlike the Canadian dollar, theRMB is a controlled currency that is generally not freely tradeable outside China, although exceptions aredeveloping. The RMB is ultimately monitored and controlled by China’s State Administration of ForeignExchange (SAFE). In the past, all foreign currency exchanges involving the purchase or sale of RMB weresubject to SAFE review and approval. Since becoming a member of the WTO in 2001, however, China’sforeign currency policy has become increasingly less restrictive.Foreign currency transactions in China are categorized as pertaining to the “capital account” or the“currency account”. From a company’s perspective, capital account transactions refer to the transfer ofownership of a non-financial asset (other than inventories) or the forgiveness of a debt. Capital accounttransactions are typically large and infrequent. Current account transactions may generally be defined astransfers other than capital account transfers. Most transfers in the ordinary course of business, includingthe issue of dividends and the repayment of foreign debt, are current account transfers.Foreign currency exchanges involving RMB are less regulated for current account transactions. If properdocumentation is in place, many such transactions can be processed with little or no review of theunderlying transaction. In contrast, the exchange of RMB in the context of capital account transactions isstill quite regulated in China. Such transactions are subject to SAFE review and approval, among otherprocedures.When contemplating transactions involving the purchase or sale of RMB, it is always advisable toconsider whether or not the conditions for the exchange will satisfy SAFE and its delegated banks. Insome cases, it is a prudent step to seek review and approval from SAFE prior to executing a transaction toensure that problems will not be encountered at a later stage. However, as with most pre-approvalsissued in China, there is still a risk that a different conclusion will be reached on formal review.Page 15 BLAKE, CASSELS & GRAYDON LLP
  • 6. Import and Export LawAs a member of the WTO, China’s system of tariffs and duties is structured in accordance with the WTOagreements and other bilateral and multilateral trade agreements. As in Canada, the applicable tariff orduty, if any, depends on several factors, most notably the nature of the particular good at issue. China hasput in place certain mechanisms – such as bonded zones and processing trade arrangements – that can beemployed to import and re-export goods with reduced or eliminated tariffs and duties.In China, companies are not permitted to engage in import or export activities unless they first undergo aregistration process provided by law. It is also possible to conduct import and export activities using aqualified agent as an intermediary. Unless otherwise provided by law, qualified importers and exportersare permitted to conduct import and export activities without restrictions and subject to certainprocedural requirements. In some cases, the law of China imposes special licence and quota requirementson the import and export of certain goods and imposes special licence requirements on the import andexport of certain technologies. The law also prohibits the import and export of certain goods andtechnologies. The goods and technologies that are subject to certain restrictions or prohibitions areupdated in catalogues released by the authorities from time to time.Page 16 BLAKE, CASSELS & GRAYDON LLP
  • IV. THE NEXT STEPSIn this guide, we have emphasized the value of conducting due diligence and understanding legal andbusiness standards prior to establishing a business vehicle in China or otherwise doing business inChina. The first step should be to gather as much information as possible to determine whether and towhat degree it makes sense to enter the China market. In some cases, it may make sense to establish arepresentative office to get a better understanding of whether a larger commitment in the future makesgood business sense.If a business case can be made for entering the China market, the next step is to formulate a strategygoing forward. At this stage of the process, investors should consider enlisting the help of experiencedlegal advisors. With offices in Canada, the United States, China, London and the Middle East/Gulfregions, Blake, Cassels & Graydon LLP has extensive experience working with Canadian businesses andinvestors to achieve their objectives in China. We would be happy to discuss how we can help you andyour business formulate and implement your China strategy.Page 17 BLAKE, CASSELS & GRAYDON LLP
  • V. CHINA PRACTICE GROUP CONTACTSFor further information, please feel free to contact one of our China Group members:BEIJING VANCOUVERRobert Kwauk Bill MaclaganTelephone: 011-8610-6530-9001 Telephone: 604-631-3336Facsimile: 011-8610-6530-9008 Facsimile: 604-631-3309Email: robert.kwauk@blakes.com Email: wsm@blakes.comPeter Morley MONTRÉALTelephone: 011-8610-6530-9001 Denis BoudreaultFacsimile: 011-8610-6530-9008 Telephone: 514-982-4004Email: peter.morley@blakes.com Facsimile: 514-982-4099 Email: denis.boudreault@blakes.comTORONTORobert Granatstein CALGARYTelephone: 416-863-2748 Michael LaffinFacsimile: 416-863-2653 Telephone: 403-260-9692Email: robert.granatstein@blakes.com Facsimile: 403-260-9700 Email: michael.laffin@blakes.comAndrew PollockTelephone: 416-863-2431 UNITED STATESFacsimile: 416-863-2653 Geoff BelsherEmail: andrew.pollock@blakes.com Telephone: 212-893-8223 Facsimile: 212-829-9500 Email: geoff.belsher@blakes.comPage 18 BLAKE, CASSELS & GRAYDON LLP
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