a. Foreign investment in China
c. M&A in China
d. Distribution, Purchase and Licensing
e. Chinese labor law
f. Chinese contract law
g. Chinese public procurement law
h. Chinese corporate law
i. Chinese tax law
j. Protection of intellectual property
a.1 Foreign companies, intending to operate in China through an own office or a production facility, may usually choose from the following four legal forms:
- Representative Office
- Wholly Foreign Owned Enterprise - WFOE,
- Joint Venture – JV
a.2 A representative office is a dependent branch of a foreign company. Representative Offices can be used primarily to enter the Chinese market and to initiate and maintain contacts in China. This narrow scope follows from the fact that representative offices do not have their own legal personality and, therefore, with a few exceptions, cannot engage in direct business, buy or sell goods or accept payments in China. Furthermore, representative offices can hire local staff only through licensed recruitment agencies (such as FESCO, CIIC or China Star).
Our consulting services concerning the establishment of representative offices include:
- Eligibility review of the chosen office location
- Preparation of all necessary application documents
- Guidance on/Following through the whole establishment procedure
- Appointment and registration of the chief representative and other representatives
- Employment of other staff
a.3 Wholly Foreign Owned Enterprises ("WFOE") are companies incorporated under the laws of PRC by foreign companies as their wholly owned subsidiaries. In most cases, the WFOE is the most appropriate legal form for operating a foreign-invested business in China, as a WFOE is controlled by its foreign parent company alone without involvement of a Chinese partner. A WFOE is usually incorporated in the form of a limited liability company (GmbH) and the whole registration process normally takes 2-4 months. The essential steps of registration are the collection of the application documents (e.g. notarization and authentication of the business register excerpt in Germany, preparation of the Articles of Associations), the registration of the company name, the application for the business license to the local Administration for Market Regulation (hereinafter "AMR") and the registration of the WFOE with the Ministry of Commerce (hereinafter referred to as "MOFCOM"). The previous requirement to obtain approval for doing business was removed by the partial reform of the company law in the autumn of 2016. Following the reform, an approval is only required for investments in business sectors that are listed as prohibited or restricted in the current foreign investment guidance catalogue.
For the establishment of a production plant further steps are required, including an environmental impact assessment. Like the office location, the chosen production site must be too approved for foreign-invested companies.
Following the reform of the company law, the capital required to set up a WFOE can be determined in most cases by the company itself. In practice there are significant local differences in terms of registration timeframe and procedures. Before starting an establishment process, it is always advisable to first seek the dialogue with the local authorities in order to clarify in advance the fundamental feasibility of the project.
Our consulting services concerning the establishment of WFOEs include:
• Review of the eligibility of the selected office and production facilities
• Acquisition of land use rights for the construction of a production plant
• Preparation of all necessary application documents
• Guidance on/Following through the whole establishment procedure
a.4 A joint venture (hereinafter "JV") is an incorporation of foreign and Chinese companies. It is usually founded as a Limited Liability Company. In China, there are two forms of JV: Equity JV and Contractual JV.
The equity JV is an independent legal entity. It divides the risk, the loss and the profit among participants according to their equity shares. Investment contributions may take the form of contributions in cash or in kind or in the form of technology and know-how transfer. The equity shares of foreign investor should generally be at least 25%.
The contractual JV is a more flexible investment opportunity than the equity JV. It can be established as a legal person or as an enterprise without legal personality for a project. Greater flexibility is also achieved by the fact that the distribution of profits can be determined freely in the contract (regardless of the share ratio).
The establishment process of a JV is similar to that of a WFOE, but there are usually lengthy negotiations with the Chinese partner(s). While in the early stages of China's economic reform and opening-up since 1978, JVs were the only legal form that allowed foreign companies to operate directly in China, it is now that WFOEs are granted access to almost all sectors (major exceptions exist e.g. in automobile production). The pros and cons of a JV should therefore be weighed well before a foreign investor chooses this legal form.
Above all, the advantages of a JV are that with a suitable Chinese partner, a larger business volume can be achieved much faster than a foreign enterprise working independently. In particular, Chinese partners typically bring a workforce already familiar with the industry, an existing clientele and manufacturing facilities into the partnership.
On the other hand, it is much more time consuming to establish a JV than to set up a WFOE. Also, the foreign partner must give up part of future profits according to the share ratio of the participants, and there is almost always a significant know-how transfer to the Chinese partner. After all, JVs, from our experience, usually work well only when both partners benefit from each other in the cooperation. As soon as the Chinese partner can produce the products of the JV themselves or the foreign partner has understood the market sufficiently, JVs often disintegrate.
In addition, JVs with potential competitors are highly risky. Therefore a JV contract should always include a liquidation plan in the event of termination of the JV. Furthermore, the foreign partner should not, as far as possible, disclose its core technology, but only provide components for assembly in the JV. The know-how of the foreign partner should be clearly defined; components that will be provided by the foreign partner must be listed and priced.
The JV agreement should also include clauses that protect the foreign partner from being pushed out by the Chinese side through some common tactics. These protective measures include provisions according to which in the event of a boycott by the Chinese side the Board of Directors remains able to act, and which give the foreign partner the right to sell its shares for a reasonable price to the Chinese partner under certain conditions or to take over the shares of the Chinese partner. Finally, technology should in general be provided not as an investment contribution but as a license, as in such cases no official assessment on the value of the technology is required and the license agreement can be terminated in case of conflict.
Our consulting services concerning the establishment of JVs include:
- Negotiation of the joint venture contract
- Determination of strategic investment structure, for example, through setting up in an off-shore jurisdiction a special purpose vehicle as the shareholder of the JV
- Determination of share-holding structure of the JV as well as the long-term customer-supplier relationships between the JV and its investors
- Due Diligence concerning the assets to be contributed by the Chinese investor if not only cash
- Review of the eligibility of the selected office and production facilities
- Acquisition of land use rights for construction of a production plant
- Preparation of all necessary application documents
- Guidance on/Following through the whole establishment procedure
a.5 The possibility for foreign companies to set up a partnership in China has only existed since 2010. Foreign companies or investors can set up a partnership together with other foreign or Chinese legal or natural persons; or participate in an already existing partnership. Partnership enterprises are comparable to German partnerships (such as OHG and KG).
For the establishment of a partnership there is basically no MOFCOM approval required. Registering the company with local AMR is sufficient for it to start business. A special license is only required if restricted business areas are involved, or if the licensing requirements for partnerships requires it or if a prior approval is explicitly specified.
The advantage of a partnership is the simple establishment process. However, this advantage was significantly offset by the reform of the Chinese company law in the autumn of 2016. In addition, the legal status of such an entity is still unclear and therefore carries risks. Furthermore, the authorities of some locations have never implemented the rules on partnerships, so that the establishment of a partnership is sometimes in fact impossible.
Our consulting services concerning the establishment of partnerships include:
Investment restructuring is often required if the business has for a long period of time performed quite well, or sometimes the initial expectations of investment are not met. Other reasons may be changes in the foreign parent company, in particular the acquisition by another company which also has presence in China. Finally disputes among the partners of a JV may as well call for organization restructure.
Chinese law allows various forms of restructuring, such as (a) merging of several companies, (b) transfer of business operations from one company to another, (c) establishment of a direct holding company by foreign investors provided that a certain size threshold is met. This holding company then acts as the new shareholder of the existing mainland China subsidiaries, (d) transfer of shares, and also (e) the closure of businesses.
In addition, Chinese law also contains provisions pursuant to which certain changes concerning the shareholders abroad also impose legal consequences in China, especially from a tax point of view.
For the restructuring of a JV it is necessary to reach an agreement between the partners, if the JV contract does not already contain clear instructions on this matter. There are a broad range of choices for the restructuring. They range from a simple liquidation and distribution of remaining assets among the partners, to the takeover by one of the partners or the transfer of all shares to a third party. The transfer of the shares of the foreign partner to a third party - including another company affiliated to the original foreign investor - will be substantially simplified if the foreign investor holds its shares in an offshore jurisdiction through a special purpose vehicle. Then, the share transfer or exit by transfer can take place through the transfer of this holding company, which is often quicker and easier to implement in an offshore jurisdiction such as Hong Kong or Singapore.
In almost all cases, restructuring measures in China have tax consequences that shall be taken into account when choosing the forms of the corporate restructuring.
Our consulting services concerning corporate restructuring in China include:
- Preparation of the restructuring strategy based on comprehensive study on legal, practical and tax aspects (in cooperation with specialized local experts)
- Preparation and negotiation of contracts required for the restructuring
- Communication with employee representatives and management of labor issues
- Preparation of all required application documents
- Guidance on/Following through the overall restructuring process
- Handling applications for permits according to antitrust regulations where applicable
Apart from the establishment of a new JV with a Chinese partner, taking over an existing Chinese company is another choice to acquire local market within shortened period.
Adequate due diligence prior to the acquisition of a Chinese company, is absolutely essential. Since provided reports and contracts are often forged, a potential buyer should always ask himself: Are the received information regarding the target company plausible? Do the impressions of the production facilities gained through site visits match the claimed revenues by the seller? Can existing customers confirm the market position of the target company? The study to answer these questions shall not be delegated to external consultants without adequate knowledge of the industry.
M&A transactions require in principle an asset valuation by a licensed valuation company in China. In addition, acquisition of state-owned assets, including state-owned companies, always requires approval by the State Asset Administrative Authority. The purchase price cannot be lower than the prescribed value. As the evaluator may choose between three valuation methods and there are numerous licensed valuation companies competing with one another, they may possibly exert influence on the valuation result.
In the past, any transfer of the shares owned by Chinese parties to foreign companies could not take effect until approved by relevant authorities. However, on 30th July 2017, the MOFCOM issued a regulation that abolished the mandatory approval requirement for the takeover of Chinese companies by foreign companies and replaced it with a filing procedure.
In recent years, the examination and approval by the MOFCOM in relation to the competition law have become increasingly important. Depending on the complexity of the transaction, this can take several months. Although the relevant rules set deadlines for decision-making, they do not begin to run until the ministry confirms that it has received all the necessary documentation from the applicants. The ministry therefore has a very wide margin in terms of processing time. For most of the major international transactions within recent years, Chinese approval was granted last. Furthermore, The MOFCOM also increasingly combines its permits with certain conditions.
Finally, it has to be aware that a new review mechanism from the aspect of national security - the so-called National Security Review – will be conducted for large transactions. According to our knowledge this has so far not yet led to a refusal of a takeover proposal, but its provisions are formulated so vaguely that changes in the political conditions in the future may present new challenges to foreign investors.
We have already been involved in several major international M&A transactions and have also been involved in the proceedings before the MOFCOM.
Our consulting services concerning M&A transactions in China include:
- Identification of suitable acquisition targets
- Lobbying with relevant authorities to gain policy support for the project
- Coordination of the entire due diligence process with participants of specialised financial and other advisors
- Conducting legal due diligence investigation
- Drafting and negotiation of contracts necessary for the acquisition
- Preparation of all required application documents
- Guidance on/Following through the entire acquisition process
- Preparation of permit application regarding competition law where applicable
In addition to the establishment or acquisition of companies in China, it is also possible to enter the Chinese market without involving direct investment and local recruitment. For instance, sale of products can be achieved directly from Germany, or through cooperation with Chinese sales agents or distributors, or by granting license.
d.1 Distribution from Germany
The legal requirements for distributions directly from Germany to China are rather low. A conventional purchase contract, which can be subjected to the laws of any jurisdiction selected by the parties, is sufficient. For dispute resolution, the parties may agree on any court or arbitral tribunal. As there is no convention on mutual enforcement of court decisions between Germany and China, choosing a German court from enforcement point of view only makes sense if the Chinese business partner also has assets in Germany. Therefore in practice, the parties usually agree on arbitration.
It should also be aware, that the enforcement of any claims against Chinese debtors in China is extremely difficult. Therefore it is advised to include risk-minimizing payment clauses in the contract (e.g. advance payments by instalment according to the progress of service delivery).
Although documentary credits (Dokumentenakkreditive) are a good alternative and usually offer sufficient protection, a confirmation about documentation by a western bank should always be requested as Chinese banks require very strict compliance with the agreed documents. Due to the policy of foreign exchange control, however, this payment method is not always accessible to Chinese buyers.
Customs procedures in China tend to be very strict too. In order to avoid problems during customs clearance, the foreign supplier should communicate closely with its Chinese costumer in preparation of the delivery. Furthermore the supplier should also request the costumer’s instructions in writing and then proceed exactly according to these instructions. In doing so, some problems may be avoided; and on the other hand, the Chinese customer is reasonably obliged to share some of the risks.
The same applies to any product certifications that might be required, in particular those required by the CCC (China Compulsory Certification) regulation. It is advisable to contractually specify that certificates are in the costumer’s responsibility, so that the foreign seller fulfils his obligations by just following the costumer’s instruction.
In addition, extra caution should be given to price inquiry coming from unknown sources. For some years, organized gangs in China send out large numbers of such price inquiry to foreign companies. Once replied, the foreign company will then usually be invited to come to China for contract negotiations, and be asked to bear significant costs in connection with the negotiations, such as overpriced dinner invitations and gifts for supposed end customers. After making those expenditures, the formerly “interested” buyers are no longer reachable.
Our consulting services on supply relationships to China include:
- Credit check of Chinese customers, in cooperation with specialized credit reviewers
- Drafting and negotiation of sales contracts, including complex facility supply contracts (Anlagenlieferverträge)
- Formulation of terms of payment
- Implementation from legal perspective of customs clearance and product certification procedures, in cooperation with specialized partners
- Supervision from the technical perspective of product certification procedures, in cooperation with specialized technical consultants
d.2 Cooperation with Chinese sales agents and distributors
Due to the size of China’s territory and the necessity to build personal relationships with certain costumers, many foreign companies choose to cooperate with Chinese sales agents and distributors.
When selecting sales partners, industrial knowledge and professionalism should always be checked in details. The qualification of a potential partner is often reflected by its personal connections with managers of a potential major customer or with the competent supervisory authorities, which involves significant risks on regulatory compliance issues and uncertainty for a long-term business relationship.
It is suggested that a nationwide distribution network should be organised on two levels. On the first level, a master agent who is responsible for import, attending fairs and promoting products, customer service and acting as the technical centre of the products. On the second level, regional or industry- specific sub-agents who perform the actual order acquisition based on their knowledge of each customer.
The contracts with sales agents and distributors should be structured in a way that on the one hand the Chinese partners have sufficient security to plan ahead and to make the required investments to build up the business. On the other hand, the foreign partner shall be able to end the partnership, if the expected marketing performance is not fulfilled or it is suspected that improper means such as corruption are used to acquire orders.
Our consulting services concerning the cooperation with Chinese sales agents and distributors include:
- Structuring of the sales activities
- Identification and check of suitable sales agents
- Drafting and negotiation of the agency or distribution agreements
- On-going monitoring of the lawfulness of sales activities
Licensing is usually initiated by potential Chinese licensees. It is advised that caution should always be exercised when granting license. On the one hand Chinese law provides several mandatory rights for – generally Chinese parties- Licensees. In particular, the licensee is entitled to further develop the provided technology and the intellectual property right of the new development automatically goes to the licensee. On the other hand, it is practically difficult to prevent the gained know-how by the licensee from being used by a third party but with no involvement of the licensor. Finally, the reports on the generated income from the licensed know-how do often not reflect the truth.
Licensing should therefore, as far as possible, be limited to cases where the licensee is obligated to buy parts and components from the licensor in order to apply the licensed technology for product production. Where the technology to be licensed is not valuable for the licensor anymore, the negotiation shall be strived to set the licensing fee as equivalent to the price of technology transfer.
This is of course different, if the licensee is an affiliated company with the licensor. Especially in case of JVs, it is often an advantage not to inject required know-how as an investment contribution, but in the form of a license agreement with the JV. By doing so, the know-how does not need to be evaluated by the competent authority and the license agreement can be terminated in the event of a breakup of the JV.
In any case, licensing of technology in China is always subject to registration. Without proof of such registration licensees may not transfer the royalties abroad.
It should be aware that royalties are subject to a withholding tax and, where applicable, also subject to VAT.
Our legal services concerning licenses to Chinese licensees include:
- Drafting and negotiation of the license agreement
- Registration of the license agreement
- Advice on relevant tax issues
d.4 purchasing from Chinese suppliers
Business activities do not only consist of distribution, but also of procurement, which is often the first business activity made by foreign companies in China.
China now has the largest manufacturing sector in the world, the supply of Chinese goods is extensive, and the manufacturing levels extended. Therefore, there is a huge potential for foreign companies to find products suitable for their own businesses.
However, the differences in product quality between Chinese suppliers are immense, without being able to form general categorizations. Irrelevant of State-owned or private, there are both reliable suppliers as well as those that do not yet meet Western demands.
In preparing purchasing from China, especially for a small quantity of products and only on an occasional basis, it has to be considered that the price advantage will quickly be offset by the higher cost of contract preparation and performance, transport costs and often long and uncertain delivery time.
Finally, supply by a Chinese company frequently is subject to an upfront transfer of know-how for production and quality control. This is particularly likely if the ordered products must meet certain European quality standards that Chinese suppliers are often not familiar with. This presents a significant risk of loss of know-how, which should be prevented by clear rules included in the purchase agreement and breach of those rules should trigger contractual penalties. These rules include, for example, that tools, made especially for the execution of the contract shall be the property of the purchaser and shall not be used for any other purposes; that the purchaser always has access to the supplier's factory; and that all technical documentation shall be returned or destroyed after the execution of the purchase contract. However unfortunately, even a very well written contract cannot guarantee that the provided know-how will not be misused especially for Chinese competitors.
In any case, it is always recommended to visit the Chinese supplier before placing an order, to learn about his capabilities and to agree on precise production and quality assurance processes. Advance payments should only be made by instalments based on goods delivery, if at all; and if possible, the status of service performance should be checked before the individual payments are made. The technical supervision of particular production process can be assigned to specialized companies such as the TÜV-organisations.
Our consulting services concerning purchasing from Chinese suppliers include:
- Identification of potential suppliers
- Conducting comprehensive audits of suppliers in cooperation with specialised technical consultants
- Drafting and negotiation of purchase agreements
- On-going monitoring of continuous production and proper delivery in cooperation with specialized technical advisors
Chinese labor law can be divided into individual and collective labor law. In the area of individual labor law the employer has the obligation to conclude written contracts with his employees. With the exception of employees at management level, overtime, work on weekends and public holidays are in principle to be monetarily compensated. Employees now enjoy quite extensive protection against dismissal and entitlement to adequate labor protection.
Post-contractual non-competition clauses can be agreed, however, they are only effective if the employee receives a compensation for the duration of the agreed non-competition period. In practice, the enforcement of such non-competition clauses is (other than the payment obligation of the employer) very difficult.
As long as the applicable regional minimum wages are attained, the employer is relatively free to determine the remuneration of its employees.
In collective labor law, the Chinese legislator has been trying for some years to strengthen the role of trade unions and works councils. Employees have the right to establish a works council if the company reaches a certain number of employees. The trade union, which from a German point of view resembles more like an administrative authority than as an employee representation. It encourages the employees to take this step and also exerts considerable pressure, particularly on foreign-invested companies, to conclude a collective labor contract with the works councils.
In other areas, local trade union officials frequently try to force, especially foreign-invested companies, to take certain actions or representations. From our experience, the denial of such requests shall usually not be punished if they are not based on a clear legal basis.
The actual participation rights of the employee representatives are, however, limited. Moreover, in most cases, the works councils are very cooperative with the management team, and the management can usually influence the council elections by nominating certain candidates. Strikes hardly take place except in the case of mass layoff.
In foreign invested companies, the position of the management team is actually still quite strong, as the demand for well-qualified and English speaking employees often exceeds the supply. This has caused significant annual wage increases for a long time. Nevertheless, the employee turnover is still high.
Labor disputes are usually first heard before a local arbitration tribunal. Either party, not satisfied with the arbitral award, may submit their dispute to a competent court.
Our consulting services concerning Chinese employment law include:
- Drafting of individual and collective labor contracts
- Drafting of operational manuals and other internal regulations
- Advice on how to deal with union representatives and works council
- Implementation of employee participation procedure, especially during mass layoffs and corporate restructuring
- Support labor law proceedings at courts and arbitration tribunals in cooperation with local law firms
In its structure, Chinese contract law is similar to the German. Contracts come into existence through offer and acceptance. Different from Anglo-American law, there are no rules of consideration in contract law. However, according to prevailing opinion, China does not recognize a formal "Abstraktionsprinzip” as in German law.
The principle of Freedom of Contract is generally speaking respected. Especially in the case of contracts with foreign connections, the parties are free to choose the governing law. Special contract laws, which were quite common in the early phase of the Chinese economic reform and opening-up, are now practically only relevant to JV contracts.
In practice, most Chinese contracts are rather short and with incomplete details. But this can also be different, especially in cross-border transactions. The use of general terms and conditions (GTC) is possible, but in fact rather unusual.
However, should the use of GTC be desired in China, it should be noted that the Chinese contract law provides for stricter restrictions and controls on GTC than German law. Furthermore, China has so far lacked detailed legal regulations and court decisions on the application of GTC, in particular for conflicting GTC.
Furthermore, under the Chinese contract law, GTC are only incorporated into the binding contract if the GTC provider respects the principle of equity and informs the other party in a reasonable manner of the terms that exclude or limit its liability. At the request of the other party, the provider must explain the clause in question. It is definitely advisable to send the GTC in writing before concluding the contract and to obtain a written confirmation of receipt.
Based on above observations, we recommend negotiating individual contractual terms with Chinese business partners.
Our consulting services concerning contract law include:
- Drafting and negotiation of all types of contracts
Due to the structure of the Chinese economy, the state sector is still the largest purchaser and contract holder, especially in the area of massive infrastructure development. Apart from government direct procurement, orders given by state-owned enterprises are also subject to the public procurement law.
Depending on the characteristics of the project, the Chinese regulations normally require an open tendering procedure as a general rule. In particular, major purchases of capital goods have to be put out for public tender. If the qualified bidders are not restricted to Chinese entities, then foreign businesses shall be allowed to submit their bids.
In order to have a realistic chance of success, it is necessary to get in touch with the Chinese buyer and introduce own products at a very early stage of the process - usually before publication of the tender. For this purpose, it is often helpful to involve a specialised sales representative. Despite the tender procedure, the ultimate decision is usually made by the management according to the appropriateness of the product.
It should be noted however, that a winning bid does not mean a concluded contract. Instead, more comprehensive contract negotiations are often followed.
Our consulting services concerning public procurement procedures include:
- Guidance through the entire tendering process
- Preparation of the legal documents for the tender
- Negotiation of contract terms
A broader interpretation of the Chinese corporate law includes not only the rules governing the internal organisation of the companies, but also various licensing and registration requirements that are necessary for the establishment and the continued existence of these companies.
h. 1. For a Limited Liability Company, which is the usual legal form for foreign companies in China, the Chinese company law provides that the internal structure must always have the following four organs:
- The shareholders' meeting/the shareholder
- Supervisory Board
- Board of Directors
- A General Manager
Yet two major deviations from this structure are permitted by law: Instead of a supervisory board it is possible to have one or two individual supervisors. In contrast to the regular supervisory board, no employee participation is required in this simplified structure.
For smaller companies, it is also permitted to combine the functions of the Board of Directors and the General Manager in one person - the Executive Director. In fact, most foreign-invested companies only have a purely nominal Shareholders' Meeting, a Supervisor and an Executive Director. The Executive Director has far reaching responsibilities to lead and represent the company.
The organisational structure (Organstruktur) needs be included in the articles of association of the company.
Although provisions on the personal liabilities of the company organ do exist in Chinese corporate law, it is in practice only relevant if the person has committed misconducts in his/her function.
h. 2. In contrast to Germany, freedom of trade does not exist in China. All business activities are subject to regulatory registration and/or approvals of the authority; this applies in particular to foreign-invested companies.
Specifically, the requirements for registration and/or approval vary in practice widely from location to location. In any case, prior to the start of a project, it should be discussed with the local regulatory authorities accurately and bindingly, what requirements actually apply.
The various permits and/or registrations required to operate a business in China must be renewed at regular intervals. Due to the high number and importance of these documents, it is highly recommended to create a uniform calendar for this and to entrust a certain person taking care of all the deadlines.
For further information on other aspects of Chinese corporate law, please see the chapters concerning "Foreign direct investment" and "Restructuring".
Our consulting services concerning Chinese corporate law include:
- Advice on company structure
- Preparation of the company's Articles of Association
- Advice on personal liabilities that may be encountered by company personnel
- Handling application and renewal of permits, licenses and registrations, etc. where applicable
In China, the most important tax items for companies and employees are the corporate income tax, value added tax and the individual income tax, to which the progressive tax rate applies according to the income level.
For a long time, two-tiered tax system applied to different business transactions in China. On the one hand, deliveries of goods and assets were subject exclusively to value added tax (VAT), a sales tax with possible deduction of input tax, and on the other hand services were subject to the non-deductible business tax (BT). The difference between the VAT (deductible) and the BT (non-deductible) led to problems and confusions. To alleviate the weakness of this two-tiered system, a pilot project on value added tax was launched on 1 November 2012 in Shanghai, which was extended nationwide from 1 August 2013. Gradually, the taxation of various services (except for assembly and engineering services) was converted from BT to VAT. From 1 May 2016, the Chinese government has now completely abolished BT. Thus; deliveries of both goods and services are subject to deductible VAT, albeit with different tax rates. BT is no longer applicable.
Further relevant is the taxation on corporate profits generated in China. In addition to the 25% corporate income tax, foreign-invested companies had in the past been required to deduct a withholding tax of 10% on the profits to be distributed to shareholders abroad. The withholding tax was reduced to 5% in the course of the renegotiation of the German-Chinese Double Taxation Agreement ("DBA") in 2014. The new DBA came into force on 1.1.2017.
Also, a non-resident company (without a branch or a subsidiary in China) that has a so-called permanent establishment (“PE”) in China is subject to corporate income tax, both on the revenue it receives from within China and on foreign sourced revenues, which have a close connection to the PE in China. The tax rate is currently 25%.
A PE may, for example, be a place where the company does business, has an administrative unit, provides services over a period of time or maintains a production facility or a workshop. It is often overlooked but worth mentioning that performing assembly and testing services constantly for a long period of time to the equipment sold to China is considered as having a PE in China from the tax law perspective, therefore taxable.
Generally speaking, the Chinese government often uses tax instruments to adjust and shape its economy. Therefore impressive tax exemptions or benefits may sometimes be available, which shall not be neglected. It is advised to negotiate with relevant local authorities to make sure that all available tax exemptions, allowance or subsidies, etc., applicable to that specific project will be granted.
From an organizational point of view, it should be noted that there are two parallel tax offices, national and local tax offices; the national one has offices in each city. They deal with different types of tax; every company operating in China has to deal with both tax offices.
Our consulting services for the Chinese tax law include:
- Advice on tax regulations and various tax impacts when formulating the structure of the Chinese project
- Referring clients to professional and highly experienced tax consultants
The protection of intellectual property, especially of foreign companies in China, remains one of the most problematic areas. Firstly, the laws and regulations required for effective legal protection are still very general and incomplete, and sometimes less protective for foreigners than for Chinese. On the other hand, even the existing regulations are still hardly enforceable by the Chinese authorities, especially the interim/injuction measures against infringement acts.
The situation is further compounded by poor sense of wrongdoing of the violators and, finally, very lengthy administrative procedures.
In order to at least get this limited protection, it is essential that patents and trademarks are registered as early as possible in China. Unfortunately, it is very common for specialized IPR pirates to register unprotected foreign patents and trademarks as soon as they become known in China, in the event that the claimant omitted to do so. It is therefore not advisable to postpone an application for cost reasons.
Another particularity of China is that copyrights can be brought to the China Copyright Centre for registration. By doing so, the applicant will receive a certificate identifying him as the author of the designated work. In this way, prosecution of infringement cases can be significantly facilitated and accelerated. For example, on the IP protection platforms of Alibaba, evidence of ownership of rights may be provided by presentation of the Copyright Certificate, while in other cases without the Certificate, numous documents on the origin of the work and the first publication need to be provided.
Finally, in disputes over intellectual property rights, the claimant or petitioner is required to provide a broad range of evidence. Even in cases where authorities act on their own initiatives or investigate by law on highly suspected situations, the submission of extensive documentation by the legitimate right holder is in most cases essential.
Our intellectual property protection consulting services in China include
- Formulation and implementation of intellectual property protection strategies
- Registration of intellectual property rights (trademarks, utility model and designs, copyright), in cooperation with specialized Chinese IP agents
- Investigation on cases, in cooperation with specialized investigators
- Participation in proceedings on intellectual property rights both against Chinese Internet platforms such as Taobao or WeChat and directly against infringers, possibly in cooperation with specialized Chinese IP law firms
- Challenging unauthorized trademark registration
With the advancement of technology, Chinese lawmakers have created a comprehensive code of conduct in the Cybersecurity Act, which came into force on June 1, 2017. It applies to all companies active in electronic commerce in China. It includes regulations on data protection, IT security and general behaviour on the Internet.
Under the cybersecurity law, foreign and Chinese companies are obligated to take extensive data protection measures. This includes, for example
- the provision of internal and external data protection regulations, which determines what kind of personal and important data are collected and processed by the company,
- observance of basic data protection rights for data subjects, such as consent requirements, information and cancellation claims, or
- the requirements for storing data in China and the obligation to carry out security checks when transferring data abroad.
In addition, extensive technical and organizational measures must be taken to maintain an adequate IT security level. These include, for example, the provision of an internal security management including an emergency plan for cybersecurity emergencies such as cyber-attacks or the provision of technical and organizational measures to secure cybersecurity.
Our privacy and IT security consulting services include:
- Examining and advising on data protection relevant processes, in particular for the collection, storage and transferring of data between Germany and China
- Advice on the implementation of the requirements of the IT security law, e.g. in the form of employee training
- Drafting and review of contracts with providers of software and IT products
- Guidance on security checks and certification processes for providers of software or IT products.
For more than 10 years by now, corrupt actions, i.e. the granting of unlawful benefits in business competition as well as in contact with government officials, were to be prosecuted according to German criminal law, even such misconducts were committed abroad. This results in considerable legal risks for German companies in countries such as China.
For one, in China, building business relationships with government officials and business partners is vital to business success, often associated with hospitality, invitations, gifts, and the like. However, these are normally taken as unlawful benefits under the German law, it therefore must always be made sure that they still remain within the limits of the permissible. This is not always easy; as such invitations are traditionally much more expensive in China than in Germany.
On the other hand, direct bribery is more common in China than in Germany. In addition to restraining own employees from involvement of corruption offenses, it is important to ensure that sales agents, consultants, and other service providers working for the company do not use commissions and fees received for bribery to obtain orders and/or approvals for the company.
Finally, of course, the Chinese anti-corruption rules are to be observed too. While in the past corruption proceedings against foreign companies were hardly brought forward in China, this situation has changed significantly in the recent years. The sanctions according to Chinese law are draconian. Penalties against companies are often in the hundreds of millions, and against individuals directly responsible for the misconducts go as far as death penalty.
To avoid such risks, we recommend a holistic approach combining a variety of coordinated measures:
- Establishing a clear code of conduct for all employees
- Training on these guidelines for all employees
- Inclusion of anti-corruption clauses in all contracts with external service providers, which allow refusal of payment and termination of the contract in case of a suspicion of corruption,
- Formulation, implementation and documentation of standardized internal processes for all corporate activities that are in danger of corruption
Our consulting services in the area of corruption prevention & compliance include:
- Advice on all applicable German and Chinese laws as well as possibly laws of other jurisdictions
- Creation of internal processes for guaranteeing legally compliant company activity, in particular in dealing with external Chinese service providers
- Preparation of a code of conduct tailored to Chinese situations
- Employee training in all compliance-relevant areas
- Advice on the handling of individual cases
In addition to the recommendation for investment and acquisition opportunities/targets, offered in cooperation with our partners, we support Chinese companies on all legal issues related to investment and acquisition in Germany. Thanks to our many years of experience in Sino-German businesses, we can not only provide our Chinese clients with accurate legal advice, but also transfer the content of the consultation into a context that is understandable from a Chinese perspective.
Our consulting services concerning direct investment and acquisition of shares by Chinese in Germany include:
- Implementation of company establishment procedures
- Negotiation and drafting of corporate purchase agreements for share/asset deals
- Conducting legal due diligence investigation on target company in mergers and acquisitions
- Advice on immigration law, in particular the application for long-term residence permits and work permits
- Facilitation of cultural integration: from the Chinese perspective assisting Chinese investors adapting to German culture.
In principle, the Chinese courts are responsible for the dispute procedures. The procedure usually contains two instances where the second instance heard by the court of higher level is final, in other words, there is the possibility of appeal and revision. However, the judiciary in China is not fully independent, but get intervened by instructions. This applies both to the individual judge and to the courts as such. Above all is usually the Communist Party. Corruption is not rarely seen in legal proceedings.
In contractual relationships, it is possible for the parties to agree on arbitration to exclude the jurisdiction of Chinese courts. If there is sufficient foreign connections, foreign arbitration tribunals can also be selected. China's leading arbitration institution is CIETAC, the China International Economic and Trade Arbitration Commission based in Beijing. Since the CIETAC Rules of Arbitration enable the parties to decide many procedural issues, it is advisable to formulate the arbitration clause in details and to specify all essential provisions, such as the number and selection of arbitrators and the language to be used in the procedure.
However, as mentioned above, the enforcement of claims against Chinese debtors in China is very difficult and always involves a lot of time and expense. In addition, judgments of German courts are not enforceable in China due to the lack of enforcement agreements and actual mutuality. Decisions of international arbitration tribunals are generally enforceable in China.
Regarding the enforcement, local protectionism in China shall also be aware and considered. The reasons for this unsatisfactory situation are, firstly, that the court responsible for the enforcement is usually at the debtor's domicile. It often tends to protect the interests of local businesses and therefore does not act very actively. Secondly, there is no “Anfechtungsgesetz” in China, so that rescission by the creditor of any asset transfers by the debtor to another person to avoid enforcement of binding decisions, is not possible. Finally, the possibilities of interim relief, which could secure subsequent enforcement access to the debtor's assets at the time of initiating a dispute procedure, are still very insufficient in China.
Therefore, even before initiating a legal procedure, the chances of success of a later enforcement procedure shall be considered in advance. As a result, it is often more economical to try to persuade the debtor into a settlement and to make a voluntary payment.
Our debt enforcement & litigation consulting services include:
- Drafting dispute resolution clauses according to respective legal relationship
- Preparation of debt enforcement strategies
- Representation in arbitration
- Representation in litigation and enforcement proceedings in cooperation with Chinese law firms
- Conducting settlement negotiations