Doing Business in China Seminar

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Doing Business in China Seminar

  1. 1. PRESENTED BY: DOING BUSINESSDOING BUSINESS IN CHINAIN CHINA OCTOBER 26, 2010
  2. 2. WELCOMEWELCOME  Opening Remarks  Introducing our Distinguished Panelists  MODERATOR: Mark Kelson – Manatt, Phelps & Phillips, LLP  Tao Xiong – Broad & Bright  Changchun Yuan – Broad & Bright  Jun Li – Broad & Bright  Jim Pitrat – SingerLewak
  3. 3. AGENDAAGENDA  General Introduction  Overview of China’s foreign investment regime  Due diligence in China  Structuring investment in China  Strategies to protect IP and other rights in China
  4. 4. GENERALGENERAL INTRODUCTIONINTRODUCTION
  5. 5. CHINA’S ECONOMIC GROWTHCHINA’S ECONOMIC GROWTH REMAINS HIGH IN SPITE OFREMAINS HIGH IN SPITE OF GLOBAL RECESSIONGLOBAL RECESSION  During the past 30 years, the average annual GDP growth rate is about 10%.  Despite the global crisis, China’s economy grew about 11.9% in the first quarter of 2010.  In the second quarter of 2010, China’s economy surpassed Japan’s, taking its place as the world’s number two economy.  Now China is so hot, so attractive – All roads lead to China.
  6. 6. FOREIGN INVESTMENTFOREIGN INVESTMENT IN CHINAIN CHINA  Since 1980, the average increase rate is 20% annually.  In 2008, actual foreign investment used was USD92.4 billion. In 2009, due to the global economic crisis, the investment used dropped 2.6%, but still reached USD90 billion.  Currently, China has more than 430,000 (including branches) FIEs, and investment made by foreign investors reached USD350 billion.  In 2009, China was listed as the number two most attractive country for investment after the United States.  According to the World Investment Report 2010 (United Nations on August 12, 2010), China will be the most attractive country for investment in 2011-2012.  Among the developing countries, China has been listed as first among the most attractive countries for 18 years.
  7. 7. ARGUMENTS IN CHINAARGUMENTS IN CHINA  Is China a good place for investment?  Complaints from investors:  heavily regulated market  bureaucratic barriers  foreign exchange control  IP protection  Local protectionism  fewer privileges (national treatment, tax, etc.)  tougher employment law
  8. 8. RISKS IN INVESTINGRISKS IN INVESTING IN CHINAIN CHINA  Doing business in China is an investment – like all investments – with risks.  Are risks in China any different from those in other countries?  Expert says: What makes overseas operations more complex for international investors is that many of the operational issues in China are exacerbated by the very fact that they are so far from the comforts of home, and from a familiar regulatory and legal environment.
  9. 9. CHINESE POLITICALCHINESE POLITICAL AND LEGAL SYSTEMAND LEGAL SYSTEM  Political System  Unitary state (central government vs. federal government)  Vertical relationship  Central government (Beijing)  Provincial  Municipal  County  Township  (Village)
  10. 10. CHINESE POLITICALCHINESE POLITICAL AND LEGAL SYSTEMAND LEGAL SYSTEM  Used to be a planned economy, in which government makes and implements economic plans  Many government agencies participate in market regulation  NDRC, MOFCOM, SAFE, SAIC, SASAC, CSRC, CBRC, SFDA  All of these agencies have their counterparts/ subordinates at various levels of government
  11. 11. CHINESE POLITICALCHINESE POLITICAL AND LEGAL SYSTEMAND LEGAL SYSTEM  Legal System  Civil law tradition (not common law)  Codified law (not case law) – precedents’ instructive function  Administrative regulations (too many, too complicated)  Local regulations
  12. 12. CHINESE POLITICALCHINESE POLITICAL AND LEGAL SYSTEMAND LEGAL SYSTEM  Court and trial system  Supreme Court – Beijing  High Court – Provincial Level  Intermediate Court – Municipal Level  Primary Court – County Level  In addition to these ordinary courts, there are special courts such as military court, maritime court and railway court  Litigation – One first-instance trial and one appeal
  13. 13. CHINESE POLITICALCHINESE POLITICAL AND LEGAL SYSTEMAND LEGAL SYSTEM  Legal Profession  Lawyers are licensed by the Ministry of Justice – qualified nationally  There is a national bar  A lawyer can practice anywhere in the country  Foreign lawyers in China are not allowed to give advice on Chinese law  Currently, China has 190,000 lawyers, one attorney for every 6,977 people.  In California, currently the number of active attorneys is 169,016 (if inactive lawyers are counted, about the same as China). Current population of California is 37,205,591, one lawyer for every 220 people.
  14. 14. LAW AND REGULATIONSLAW AND REGULATIONS CONCERNING FOREIGNCONCERNING FOREIGN INVESTMENTINVESTMENT  Market entry (foreign investment guidelines/catalog)  Company formation (Rep Office, JV, WOFE, Partnership, etc.)  Operation (capital requirement, foreign exchange control, tax, employment)  Incentives (tax holidays, preferential tax treatment, land supply, local financial subsidies, etc.)
  15. 15. RISKS IN CHINARISKS IN CHINA  Common risks  Regulatory and compliance risk  Socio-poli-economic risk (big picture, long-term strategy issue)  Integrity and corruption risk  IP risk  Business partner risk  Supply chain risk  Restructuring risk  HR and labor risk  Dispute resolution risk  Natural disaster
  16. 16. RISKS IN CHINARISKS IN CHINA  Some are overlooked, while others are exaggerated, e.g., Guanxi vs. normal business rules.  People often say “China is different,” and “China is all about Guanxi.”  Guanxi (government interference plays an important role in China; Chinese traditional culture pays attention to a close personal relationship).  People tend to strengthen personal relationships through gifts, kickbacks, etc. But if you take it for granted, then you may be in big trouble (anti business bribery laws in China, Foreign Corrupt Practices Act in the United States).
  17. 17. RISK MANAGEMENTRISK MANAGEMENT  Ordinary business principles and prudence should be followed (don’t only trust someone who has good connections) – biggest risks 1. business plan/feasibility study 2. due diligence 3. auditing 4. risk evaluation/countermeasures/preparation for unwanted surprises 5. partner screening 6. negotiation 7. contract draft and review 8. expert advice and opinion
  18. 18. DO YOUR HOMEWORKDO YOUR HOMEWORK  Like all other investments  Do your homework  Consult professionals
  19. 19. OVERVIEW OFOVERVIEW OF CHINA’S FOREIGNCHINA’S FOREIGN INVESTMENT REGIMEINVESTMENT REGIME
  20. 20. FOREIGN INVESTMENTFOREIGN INVESTMENT INDUSTRY CATALOGINDUSTRY CATALOG  Encouraged  Examples: software, certain high-tech businesses, high-end services (logistics, business process outsourcing, etc.)  Permitted  Examples: retail, wholesale distribution, services consultancy  Restricted  Examples: telecom (including Internet), insurance, bank, print and publishing (special approval required)  Prohibited  Examples: gambling, primary schools, etc.  The Catalog is amended from time to time, latest update as of October 2007.
  21. 21. FORMS OF ENTRYFORMS OF ENTRY  Greenfield investment  Creating a China entity from scratch  Governed by a special set of regulations and rules on the setup of FIEs (vs. Company Law)  Mergers and acquisitions  Direct onshore equity acquisition by offshore entity  Indirect offshore equity acquisition by offshore entity  Asset acquisition  Governed primarily by the Foreign M&A Regulations (the so-called “Circular 10”)
  22. 22. FORMS OFFORMS OF ESTABLISHMENTESTABLISHMENT  Representative office  Generally not permitted to “do business” in China  Limited functions: primarily marketing and liaison functions  May not enter into sales contract on behalf of offshore parent company  Joint ventures  Equity joint ventures (EJV) and Cooperative joint ventures (CJV)  Parties to an EJV share profits based on their respective shares in the equity investment, while parties to a CJV may split the profits disproportionately to their equity percentages.  CJV allows a foreign investor to accelerate its withdrawal of investment amount out of the CJV.  The highest authority of an EJV is the board of directors, while a CJV may be managed through a joint management committee.  Required for certain businesses (e.g., restricted industries)
  23. 23. FORMS OFFORMS OF ESTABLISHMENTESTABLISHMENT  Wholly foreign-owned enterprise (WFOE)  Increasingly popular and common form of establishment for foreign investors  Joint stock company (FICLS)  Capital of an FICLS consists of shares of equal par value  Paid-in capital at least RMB30 million  Existing FIEs must be converted into an FICLS when seeking a public listing in China  Foreign-invested partnership  Newly issued regulations in late 2009, allowing “foreign- invested partnerships” effective March 1, 2010
  24. 24. Company Name Reservation with local AIC Industry preapproval (if applicable) Obtain Approval Certificate from local MOC Obtain Business License from local AIC Tax registration Enterprise ID registration SAFE registration Finance registration Customs registration Statistic registration FOREIGN INVESTMENTFOREIGN INVESTMENT REGULATORS ANDREGULATORS AND ESTABLISHMENT PROCEDURESESTABLISHMENT PROCEDURES Note: The approval level of MOC may differ under various total amount and national industry guidance. Flow Chart
  25. 25. DUE DILIGENCE IN CHINADUE DILIGENCE IN CHINA
  26. 26. GENERALGENERAL CONSIDERATIONS FORCONSIDERATIONS FOR CHINA INVESTMENTCHINA INVESTMENT  Business objectives/scope  Industry specialties and products  Site selection issues  Overall business model  Entity selection  IP ownership and protection  Financing strategy  International structure  Foreign exchange control issues  Tax issues  Repatriation strategy  Exit strategy
  27. 27. DUE DILIGENCEDUE DILIGENCE IN CHINAIN CHINA  Common practices  Almost no central registration system for security interest  Court files are not public and mostly not searchable  Management interview very important (not all transactions are documented in China)  Key issues to watch – examples  Tax incentives and government subsidies  Land use rights and zoning  Social security payments
  28. 28. DUE DILIGENCEDUE DILIGENCE IN CHINAIN CHINA  Site selection issues  Location shopping: business model, local preferential policies, availability of labor and talents, etc.  Investment LOI or agreement with local governments  Caveat: Local government may not have the authority to sign the documents.  Know your business partner  Be engaging  Do homework (background check)  Be discreet – challenging or withdrawing
  29. 29. STRUCTURINGSTRUCTURING INVESTMENT IN CHINAINVESTMENT IN CHINA
  30. 30. U.S. Co. CHINA Op Co. STRUCTURES FORSTRUCTURES FOR CHINA INVESTMENTCHINA INVESTMENT  Direct ownership of Chinese company
  31. 31. U.S. Co. CHINA Op Co. HOLD Co. STRUCTURES FORSTRUCTURES FOR CHINA INVESTMENTCHINA INVESTMENT  Ownership through one or more intermediate holding companies  Treaty countries/territories: Hong Kong, Singapore, Barbados, Ireland, and Mauritius
  32. 32. INVESTMENT STRUCTURESINVESTMENT STRUCTURES – TAX CONSIDERATIONS– TAX CONSIDERATIONS  Investment structure has to be right from the beginning as later change may be taxable  Tax planning must be supported by economic substance  Overall tax rate  Taxation of income flows from China to ultimate investor  Deferral  Use funds for business purposes  Where current period repatriation or recognition of income in home country would increase tax burden  Exit  Minimize taxation on capital gain
  33. 33. DIRECT OWNERSHIP –DIRECT OWNERSHIP – CONSIDERATIONSCONSIDERATIONS  Treaty between United States and China would limit dividend withholding tax to 10%  Disposition of shares in China entity subject to 10% capital gains tax in China  Changes in shareholder(s) require regulatory approval of Chinese authorities
  34. 34. OWNERSHIP THROUGH AOWNERSHIP THROUGH A HOLDING COMPANY –HOLDING COMPANY – CONSIDERATIONSCONSIDERATIONS  Shares in Holdco may be transferred without Chinese government approval  Shares in Holdco may be transferred without Chinese capital gains tax – much more difficult to achieve after 2008  Increased focus on anti-avoidance and taxation of nonresident enterprises  More anti-treaty shopping rules  Taxation of indirect share transfers  Access to reduced dividend withholding tax rate – must show substantive business reasons, other than tax avoidance objective
  35. 35. BENEFITS OF ANBENEFITS OF AN INTERMEDIARY HOLDINGINTERMEDIARY HOLDING COMPANYCOMPANY  Allow U.S. Co. to establish an entity with its own terms and conditions without being limited to Chinese JV laws  Avoid future Chinese governmental approval on transfer of ownership in China entity, which saves time and money  Provide an additional buffer from potential liability arising from U.S. Co.’s China investment  Facilitate future financing strategies for China operations and expansion  Allows an opportunity for expatriate tax planning where appropriate (dual employment contracts, etc.) CHINA Op Co.
  36. 36. STRATEGY TO PROTECTSTRATEGY TO PROTECT YOUR IP AND OTHERYOUR IP AND OTHER RIGHTS IN CHINARIGHTS IN CHINA
  37. 37. HOW TO AVOID DISPUTEHOW TO AVOID DISPUTE AND PROTECT YOURAND PROTECT YOUR RIGHTS IN CHINARIGHTS IN CHINA  Due to legal and cultural differences, dispute easier to arise in cross-border transactions  Chinese companies become more litigious  More uncertainty in Chinese laws and regulations  More difficulty in enforcement
  38. 38. HOW TO MITIGATE RISKSHOW TO MITIGATE RISKS OF DOING BUSINESS INOF DOING BUSINESS IN CHINACHINA  Understand Chinese culture and local business practices  Plan carefully and move slowly  Form strong business relationships  Establish close relations with government officials  Localization of Management
  39. 39. MAJOR TYPES OFMAJOR TYPES OF DISPUTEDISPUTE  Dispute with Chinese Joint Venture Partners  Dispute with Suppliers and Distributors  IP Infringement  Dispute with Employees  Dispute with Government Authorities
  40. 40. HOW TO AVOID DISPUTEHOW TO AVOID DISPUTE WITH JV PARTNERWITH JV PARTNER  Is your partner able to deliver what you expect?  Take your time to select a right partner  Build trust with your partner  Have a detailed and practical JV Contract  Have a clear exit strategy
  41. 41. HOW TO AVOID DISPUTEHOW TO AVOID DISPUTE WITH SUPPLIER ANDWITH SUPPLIER AND DISTRIBUTORDISTRIBUTOR  Have clear criteria for supplier or distributor selection  Keep certain level of control over your suppliers and distributors  Take particular care for IP protection
  42. 42. HOW TO PROTECT IPHOW TO PROTECT IP RIGHTSRIGHTS  China does protect IP rights and makes the system work for your benefit  Register IP rights timely  Take both defensive and offensive measures  Educate your Chinese employees  Classify IP rights and limit their access
  43. 43. HOW TO AVOID LABOR-HOW TO AVOID LABOR- RELATED DISPUTERELATED DISPUTE  Know both national and local rules relating to labor and social welfare  Formulate work-related disciplinary rules and bylaws  Have a country-tailored and detailed labor contract  Be careful of the procedural requirements
  44. 44. HOW TO DEAL WITHHOW TO DEAL WITH PRC GOVERNMENTPRC GOVERNMENT  Make efforts and take time to build a trustful relationship with government  Know the scope and limits of each governmental authority  Set clear internal guidance on dealing with officials  Put all important things in writing
  45. 45. HOW TO RESOLVE AHOW TO RESOLVE A DISPUTEDISPUTE  Applicable Law Issue  Litigation vs. Arbitration  Choose a Favorable Venue
  46. 46. TITLE
  47. 47. Risks – considerations for companies doing business in China Accounting & control challenges in dealing with foreign subsidiaries Tax considerations from a U.S. standpoint
  48. 48. COMMON FOREIGN OWNEDCOMMON FOREIGN OWNED ENTITIES IN CHINAENTITIES IN CHINA -Wholly Owned Foreign Enterprise (WOFE) -Representative Office -Joint Venture
  49. 49. IP IN CHINA vs. IP NOT IN CHINAIP IN CHINA vs. IP NOT IN CHINA COST SHARING vs. COST PLUSCOST SHARING vs. COST PLUS -Transfer pricing requirement and enforcement in China -Transfer pricing requirement in U.S. -U.S. CFC rules and subpar F income -Holding company structure
  50. 50. CORPORATE TAXESCORPORATE TAXES IN CHINAIN CHINA -Corporate Income Tax (rate change in 2008, tax holiday grandfather treatment, new holiday for qualified industry and special zones) -Business Tax -Value Added Tax
  51. 51. PRC NEW TAX DEVELOPMENT :PRC NEW TAX DEVELOPMENT : REPRESENTATIVE OFFICEREPRESENTATIVE OFFICE -Circular 18 effective 1/1/2010 -Limited head count requirement -Using actual profit method to file quarterly CIT and BT -Other methods: “actual revenue-based method” (ETR 8.75%) or “cost plus method” (ETR 10.94%) -Minimum deemed profit rate for cost plus is 15% increased from previous 10% (the deemed profit rate stipulated in Circular 19 is generally in the range of 15%-50% dependent on the type of activities engaged by the nonresident enterprises) -Tax authority no long accept tax exemption applications -Treaty treatment
  52. 52. PRC NEW TAX DEVELOPMENT :PRC NEW TAX DEVELOPMENT : TRANSFER PRICINGTRANSFER PRICING -Circular 2 issued in 2009 focus on transfer pricing issues -500 transfer pricing tax officials by the end of 2010 with intensive training -167 cases closed in 2009 resulted in RMB 16.09B taxable income adjustment and RMB 2.09B additional tax -Transfer pricing report required if revenue > RMB 40M. A Benchmark report should be in place for revenue < RMB 40M
  53. 53. U.S. COMPLIANCE REQUIREMENTSU.S. COMPLIANCE REQUIREMENTS FOR FOREIGN ENTITIESFOR FOREIGN ENTITIES -Form 5471 – Information Return of U.S. Persons With Respect To Certain Foreign Corporations -Form 8858 – Information Return of U.S. Persons With Respect To Foreign Disregarded Entities -Form 8865 – Return of U.S. Persons With Respect to Certain Foreign Partnerships -TD F 90-22.1 - Report of foreign bank and financial accounts
  54. 54. RISKS – CONSIDERATIONSRISKS – CONSIDERATIONS FOR COMPANIES DOINGFOR COMPANIES DOING BUSINESS IN CHINABUSINESS IN CHINA
  55. 55. ACCOUNTING & CONTROLACCOUNTING & CONTROL CHALLENGES IN DEALINGCHALLENGES IN DEALING WITH FOREIGNWITH FOREIGN SUBSIDIARIESSUBSIDIARIES
  56. 56. www.BroadBright.com www.Manatt.com 310.312.4000 www.SingerLewak.com 877.754.4557 CONTACT USCONTACT US

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