An overview of the regulatory landscape in China for foreign investors in 2010

1. AN OVERVIEW—CHALLENGES FOR SMEs IN 2010
A. PRC TAX REGULATORY ENVIRONMENT
 Plethora of new tax circulars issued in late 2009/early 2010
 China is trying to firm up its tax assessment and tax collection
 An uphill battle largely of its own making – not computerized. A benefit in a growing
economy, ……a liability in a slowing or maturing economy
 GFC inspired reform- due to significant drop in tax revenue from local and foreign
enterprises.—don’t believe official figures
 Representative Offices are being actively discouraged now as an investment vehicle.
SAT realize a lot of untaxed business activity is going on. Better to require WFOE
incorporation and capital requirements in a time of falling tax revenue.
 Kill the Chicken to scare the Monkey
 Present conflict between local tax bureaus giving unofficial tax incentives to attract FDI
and SAT stepping up collection of tax revenue
 Highlights-Tax Circulars in late 2009-2010
(a) Taxation Circular – 27 October 2009
Designed to again limit those offshore companies which can rely on DTA with China to
enjoy reduced withholding tax on dividends, royalties and capital gains.
Provides stringent definition of ―Beneficial Owner‖
(b) Taxation Circular 125—December 2009
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2. — retrospective from 1 January 2008
— limits ability of domestic enterprise to claim a foreign tax credit is respect of tax paid
by a subsidiary of the domestic enterprise in the foreign country in the relevant tax
year.
—applies mainly to a domestic enterprise with foreign subsidiaries earning income that
is taxed in the foreign country.
—can only claim FTC if domestic enterprise holds 20% of foreign subsidiary.
Note: if foreign subsidiary is residing in country with tax rate of less than 12.5% then
FTC not available.
— First sign that ―low or no tax‖ offshore holding companies are being frowned upon
by Beijing as investor vehicles.
(c) Taxation Circular 698 -- December 2009
— retrospective from 1 January 2008
— set alarm bells ringing.
—requires disclosure to SAT of ―offshore indirect transfers‖ of equity in a domestic
enterprise.
—investors have utilized offshore companies, e.g. BVI, Hong Kong, Seychelles,
Caymans to avoid PRC tax on capital gains by disposal of shares in the offshore
holding companies.
—discouraging the use of low tax offshore jurisdictions for PRC investment as SAT will
look at the ―indirect transfers‖ where the offshore holding company disposing its shares
is located in a country with an offshore tax rate less of than 12.5%.
—obligation within 30 days of the execution of the equity transfer contract, for foreign
investor to submit relevant documents to local tax bureau where domestic enterprise is
located.
Note: If SAT decides the equity transaction has ―no reasonable business purpose‖, it
may impose additional tax at domestic level or deem the local enterprise not to be
foreign owned.
With more and more tax information exchange agreements being signed between
China and BVI, HK etc it is clear full tax compliance is going to be on the agenda for
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3. foreign investors in the PRC in 2010.
Solution: look carefully at which DTA tax treaty countries for the investment vehicle.
Be prepared to be able to show that investor is paying tax in the offshore jurisdiction
and provide evidence of business operations payment of domestic tax, eg other third
party contracts, lease arrangements etc.
B．IP PROTECTION
Patents/ Trademarks and Copyright
—much more importance being attached to IP protection by both local and foreign
enterprises.
This stems from China now creating its own local IP and technology transfer from
China due to increased foreign investment.
At the SME level seeing an increased need for clients to register copyright, patents
and trademarks to operate in China.
—too often SME’s don’t take action to protect brands and IP until after establishing
China operations.
—State Trademark Office has undertaken to shorten TM registration process from
26—32 months to 10 months. Good development.
—Olive Oil Experience - Advised on JV for distribution
Sales agreement and TM agreement
Discovered potential JV partner had registered their TM in China in its
name. Increased cost and time spent to transfer application to enable registration of
TM and licensing.
Mantra: Register IP First/Ask questions later
With this in mind - review employment agreements
Consider – having employees execute a detailed ―Copyright and Trade Secret
Assignment Agreement‖ and ―Non-Disclosure and Confidentiality Agreement‖.
—make it clear in labour contracts ownership of new IP always remains with employer.
The New PRC labour law 2008 provided a good opportunity for employers to update
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4. labour contracts to cover these issues.
C. CORPORATE COMPLIANCE
 Ensure that anti-bribery and anti-corruption undertakings are signed by all
employees and their written undertakings filed with HR.
 Obtain third party supplier undertakings whenever possible including an obligation
to report employee misconduct.
 Be aware of ―whistleblower phenomenon‖ in 2010.
Local staff being encouraged to report on their foreign employer’s business and tax
compliance activities.
SAT does not have present resources to do across the board audits and prefers
the ―carrot and stick‖ approach.
 Not just a domestic issue, looks like ASIC in Australia will adopt stringent anti-
bribery compliance regulations which will no doubt extend to PRC operating
subsidiaries.
Trends —local and former employees are now reporting minor tax and
compliance breaches for reward to local SAIC and tax bureaus and WFOE
AND SMES are being increasingly subject to tax and labour audits with little
or no warning.
REMEMBER IN CHINA EVERYTHING IS NEGOTIABLE
D. PRC LABOUR LAW
All of the above dovetails into PRC labour law and regulations:
Beijing is mindful of increased unemployment rate.
—In this climate of downsizing employees are often being dismissed for under
performance.
—the employer must provide proper reasons for dismissal and ensure correct
compensation is paid for the dismissal.
The burden of proof is on the employer to show the employee has not fulfilled
the job description.
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5. —ensure contract properly spells out job details.
—ensure handbooks clearly state the evaluation system for performance and
follow the procedures.
Richard Kimber
Managing Partner
RHK Legal
Add: Suite 507, Jingan China Tower,
No. 1701, Beijing West Road,
Jingan District, Shanghai
Web: www. rhklegal.cn
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