It is therefore imperative that all companies in China understand the types of behaviours that are illegal under China’s criminal and anti unfair competition laws. This article discusses China’s legislation on commercial corruption and offers advice on preventing acts of fraud, embezzlement and bribery in China-based businesses.

The number of corruption cases that are investigated in China has been rising ever since the launch of a concerted anti-corruption campaign, which has implicated officials of all levels. Although the anti-corruption campaign has focused mainly on state corruption and public officials, the campaign has also touched upon the private sector, including foreign companies and multinationals. The most high-profile bribery case involving a foreign MNC was the 2014 case in which the British pharmaceutical company GlaxoSmithKline (GSK) was fined RMB 3 billion (£350,000) for bribing doctors and hospitals to promote its products.

What are the most common types of commercial corruption in China?

Some of the most common types of corruption seen in commercial settings are those involving bribery authorised by senior management, which often involves gaining benefits that are in the interest of the company itself. This may involve bribery of clients or channel partners in exchange for services or products, including tangible and intangible favours, such as the promise of more orders, better promotional channels or increased website traffic.

Bribery committed by individual employees, meanwhile, is more commonly conducted for personal interest and can include acts of nepotism by people in sales, purchasing or management positions buying products or services from relatives or friends.

The main pieces of legislation penalising commercial corruption in China are:

• The Criminal Law of the PRC (the “Criminal Law”: 1979; revised 2020)
• The Anti Unfair Competition Law the PRC (the “Anti Unfair Competition Law”: 1993)
• The Supervision Law of the PRC (the “Supervision Law”: 2018)

The Criminal Law penalises extortion and bribery of a public official, commercial bribery and embezzlement. This law states that foreigners who commit a crime against the State of China or a Chinese citizen outside of Chinese territory are still liable for punishment under criminal law, provided the crime is punishable by minimum fixed-term imprisonment.

In 2021, the Criminal Law was amended to increase the penalty for bribery in the private sector to be equal to that of the public sector. Previously, the penalty for bribery for “non-state functionaries” was lower than for state functionaries.

Meanwhile, under the Anti Unfair Competition Law, commercial bribery is classified as an “act of unfair competition” and is punishable by law.

In 2018, China passed the Supervision Law and established a new government body, the CCDI, to act as an anti-corruption supervisory body over all levels of government. Notably, it also enables the CCDI to seek international cooperation to extradite individuals that are involved in corruption cases who may have left or fled China, or seize, freeze, or confiscate their overseas assets.

How to prevent corruption in your company

There are a few steps that companies can implement to reduce the risk of corruption among employees.

Reimbursement policy
Formulating a detailed reimbursement policy can help identify suspicious behaviours that may constitute fraud or corruption. This should include a detailed description of the types of expenses that are eligible for reimbursement and under which circumstances employees can be reimbursed, as well as details on expenses and scenarios that are not considered reimbursable.

Code of conduct for hiring vendors
To prevent favouritism when hiring vendors, it is important to implement a code of conduct that employees must follow when searching and vetting potential suppliers. This may include formulating vendor selection procedures and implementing mechanisms for conducting background checks to ensure there is no conflict of interest in hiring them.

It is also advisable to delegate the responsibility of hiring vendors to several employees and implement a tiered approval procedure to avoid the decision being given to one sole employee. This will reduce the risk that one employee will seek to hire a certain vendor solely for personal benefit.

Management of company chops
Finally, it is also important to maintain firm management over the use of company chops to prevent their misuse. Company chops provide a strong legal basis in China and can be misappropriated by employees to sanction contracts, processes and more without the company’s knowledge.

To do this, it is advisable to form an internal policy for the use of company chops and ensure strict supervision of their use during daily operations. This policy may include measures such as implementing a tiered approval policy for the use of the company chop and ensuring the company chop is kept in a safe and never used without the knowledge or permission of the persons in charge.

It is also advisable to delegate the responsibility of managing and overseeing the use of the company chop to more than one employee to avoid giving too much power to one individual. Many foreign companies in China will often give the responsibility of managing the company chop to one employee, often the legal representative, which reduces the ability of the company to maintain independent oversight over how it is used and increases the risk of its misuse.

What to do if you discover corruption in your company

There are several steps that a company should take in the event that an act of embezzlement, fraud or bribery is discovered, depending on the type and severity of the violation.

The first step is to initiate an independent investigation of the incident, carried out either by an internal audit and compliance team or by a third-party company.

Depending on the outcome of the investigation, the company can then decide how to proceed, which may include actions such as:

• Persuading the employees involved to resign
• Terminating the employees involved for reasons such as severe violation of the labour contract, code of conduct or staff handbook
• Terminating contracts and services with vendors involved
• Carrying out public relations or crisis management campaigns if the situation has been revealed to the public and caused damage to the company’s reputation
• Reporting the situation to the police if it cannot be resolved between the parties involved

Note that reporting a case of internal corruption to the police is an unlikely step to take in practice as it runs the risk of jeopardising the company’s reputation and may implicate the company itself for legal liability. This step is usually only necessary if the company is required to defend itself legally in cases where its reputation or credibility is at stake.

In addition, although it is illegal under Chinese law, it is fairly unusual for the police to investigate cases of commercial corruption by individuals. Exceptions are usually made in cases where the activity causes harm to consumers, the State, or other stakeholders, or the scope of the illegal activity is particularly large or egregious.

Get immediate access to the China market with Launchpad, CBBC’s flagship market entry service. Call +44 (0)20 7802 2000 or email enquiries@cbbc.org now to find out more.

A version of this article was first published as ‘How to prevent and deal with corruption in your China business’ by Dezan Shira & Associates’ China Briefing.

The post How to Prevent and Deal with Corruption in Your China Business appeared first on Focus - China Britain Business Council.

Importing from China provides huge opportunities for UK businesses. As FOCUS readers will no doubt be aware, China replaced Germany as the UK’s largest import partner in 2021, with £62.8 billion worth of goods and services being imported. Done correctly, importing from China can reap huge rewards and benefits such as immediate upscaling and lower input costs. Done badly, it can create huge issues not only to the bottom line, but reputationally.

So what is the best way UK businesses can best protect themselves once they have developed a relationship with a potential supplier? This article sets out common issues UK parties face when importing from China, and offers solutions for what can be done to prevent or limit their impact. The article focuses on what issues may arise when dealing with parties in China rather than domestic issues such as regulatory, sanctions, import restrictions, authorisations, customs and tax issues.

The most common things that can go wrong

The potential problems that importers face are varied and industry-specific; issues life science entities face will differ from those in the construction sector. However, the most common issues include:

• Payment, non-delivery or delayed delivery
• Quality of goods supplied
• Supply chain and transportation shortages (especially in the current global environment and following the Covid-19 restrictions in China)
• Intellectual property infringement where proprietary information has been provided to assist in the manufacture of goods

How can a company protect itself from these common mistakes prior to entering the market?

The potential impact of the issues outlined above can be prevented or limited through clear written agreements. Prevention is better than cure. The best way UK importers can protect themselves is upfront by ensuring that all key requirements are covered in a signed written contract. This helps reduce any misunderstandings between the parties.

At a minimum, contracts should contain:

• Details of the quality and quantity of what you are purchasing
• Agreed price and payment method
• What UK regulatory requirements the products need to conform to
• Delivery terms (including dates), and who has responsibility for each stage of the delivery process
• Provisions for how any intellectual property or proprietary information will be protected (for example, if you need to provide this for a Chinese supplier to manufacture)
• A dispute resolution clause

If the commercial value of what is being imported justifies it, you may wish to instruct a lawyer to help prepare the agreement to ensure that all key issues are covered.

In respect of the dispute resolution clause, think carefully about where your counterparty has assets or receivables or where you would need to enforce any judgment to protect your rights. This will dictate what forum may best suit your needs if something goes wrong.

If your Chinese counterparty has assets and/or receivables in the UK or Europe, an English Courts’ jurisdiction clause should help you be able to enforce any judgment against them. Alternatively, if the counterparty only has assets and/or receivables in China or in a jurisdiction where enforcement of English judgments can be problematic, consider whether another court jurisdiction or dispute resolution process will provide you with the best chance of protecting your rights.

For example, China and Hong Kong now have an arrangement regarding the reciprocal enforcement of arbitration awards between each state. Hong Kong Arbitration before the HKIAC may therefore provide UK parties with a system of law and process they are more familiar with whilst providing them with a mechanism to enforce in Mainland China.

It should be added that at the time of producing this article, there were reports that a Chinese court has enforced an English judgment in China. The decision is currently unreported. But it could demonstrate a significant development if Chinese courts start to routinely enforce English court judgments.

That position may soon arise in any event. China has signed but has not yet ratified the Hague Convention on Choice of Court Agreements 2005. If China ratifies that Convention then there will be a convention between the UK and China which provides for the enforcement of each other’s judgments in the context of exclusive jurisdiction agreements. Reports from China suggest that the Chinese Ministry of Foreign Affairs has indicated they wish for the Hague Convention to become effective in China as soon as possible, but it is not clear when that will be.

If something goes wrong what are the legal steps a company can take?

If a situation that might lead to a dispute arises, it is always best to seek out some preliminary legal advice first. Often, early communications or decisions can worsen the legal position of a party in dispute – for example inadvertent waivers of rights, termination of business relations without proper cause, or statements of fact that harm the legal position. These should be averted by seeking legal advice early on, if possible.

The route to resolution of a dispute will depend on the circumstances. However, if an independent body (such as a court or arbitral body) is required to make a judgment, then as set out above, the agreement should determine which of these forums a case should be pursued in.

If your agreement does not specify the forum, your lawyers will direct you as to which would be the possible and preferred option in the circumstances. Relevant factors will include: the location of parties; the law applicable to the agreement; and where services are performed. In the situation where no forum is specified and a dispute is likely to be referred to a court or similar, it is important to act fast, as leaving the decision could allow the other party to determine where the dispute will be heard.

The legal costs of bringing or defending a claim will depend on the circumstances, however, costs for the likely phases of work can be estimated at the outset.

What government or other bodies can help?

If things do go wrong with your Chinese supplier, consider contacting bodies such as the China British Business Council or the UK Department for International Trade China to see if they can assist.

Whilst they will not be able to judicially resolve a dispute, bodies such as these tend to have longstanding relationships in the regions they operate within to promote UK business and therefore can help seek guidance from local bodies to see if an amicable resolution can be achieved.

Often disputes arise from misunderstandings which can be resolved quickly once the misunderstanding has been understood. However, it is always worth speaking to a lawyer to ascertain what steps you need to take to protect yourself.

This article is part of a series on importing from China. See all the articles in the series below.

Part 1: How to source a manufacturer in China
Part 2: How to source and manage suppliers
Part 3: How to ship products and navigate customs

Click here to read our Exporting to China series

Get immediate access to the China market with Launchpad, CBBC’s flagship market entry service. Call +44 (0)20 7802 2000 or email enquiries@cbbc.org now to find out more.

The post Importing from China: Legal recourse if things go wrong appeared first on Focus - China Britain Business Council.

Commercial dispute settlement in China is set to become (slightly) more ‘foreign company-friendly,’ following three important changes that China has made to its commercial arbitration framework. The result of these changes is that foreign firms accessing the China market through Hong Kong or through the Shanghai Lingang Free Trade Zone can take steps to improve the extent to which any interactions with Mainland China are protected under the laws of the People’s Republic of China (hereafter referred to as PRC law or the PRC legal system).

Beijing made these changes to improve the scope of Chinese legal protection for investors exporting capital overseas, but the Ministry of Justice and the Supreme Court’s push to internationalise the country’s commercial arbitration frameworks have resulted in improvements in how foreign firms can interact with China’s commercial arbitration systems, too.

Background

China’s businesses are ‘going out’ and doing business overseas like never before. The value of trade between China and the European Union alone is worth approximately €1 billion each day. More broadly, China is now the second-largest capital-exporting country in the world (behind the United States). As of 2018, over 27,000 Chinese enterprises have invested in 188 countries and established 43,000 Chinese-invested enterprises overseas. In the UK, there are 838 Chinese-owned companies currently trading, according to Grant Thornton’s Tou Ying Tracker – an increase on the 795 companies identified in 2019.

However, as the number of Chinese companies looking to engage with foreign markets increases, so too does the number of commercial disputes involving a Chinese party. As such, since the late 1990s, civil servants involved in China’s judicial affairs have paid close attention to ensuring that adequate legal protections exist under PRC law for Chinese firms as they invest greater amounts of capital overseas and conduct more cross-border business.

What steps has China made?

Over the last few years, China has taken three important steps to improve its capacity in international commercial arbitration.

Firstly, in 2019, it signed up to the Singapore Convention on Mediation (formerly known as the United Nations Convention on International Settlement Agreements Resulting from Mediation). An agreement regarding international recognition of mediated disputes, the Singapore Convention – which came into force in September 2020 – not only provides China (and any of the other 53 signatories currently lacking one) with a specialised law on commercial mediation, it also tidies up other inconsistencies across China’s legal system regarding the role of arbitration in international trade – such as where PRC law requires disputes to be settled judicially rather than through arbitration. This makes the situation far clearer for a foreign company considering pursuing a Chinese party through arbitration – a welcome step towards improving the business environment.

Secondly, the Supreme People’s Court (SPC) of the People’s Republic of China and the Department of Justice of Hong Kong introduced the Arrangement Concerning Mutual Assistance in Court-Ordered Interim Measures in Aid of Arbitral Proceedings by the Courts of the Mainland and of the Hong Kong Special Administrative Region (HKSAR), which came into effect on 1 October 2019. The Arrangement is important for arbitrations concerning Mainland Chinese parties or assets because it makes Hong Kong the first (and, to date, the only) seat of arbitration outside Mainland China where parties can access the PRC court system in pursuit of Interim Measures in aid of offshore arbitration – be they foreign or domestic.

What type of arbitration institutions exist in China, and which disputes can they handle?

Finally, foreign arbitration institutions have been permitted by China’s Ministry of Justice to administer foreign-related arbitrations in Shanghai’s Lingang Pilot Free Trade Zone (Shanghai Lingang FTZ), effective January 2020. That was a significant step forward in foreign/Chinese commercial arbitration because foreign arbitration institutions were previously restricted in their marketing and promotional activities in Mainland China and were not allowed to administer arbitration anywhere in the country. Now, offices established in the Shanghai Lingang FTZ can oversee proceedings that arise from civil and commercial foreign-related disputes in international commercial, maritime and investment sectors. Most helpfully, for UK companies at least, foreign arbitration institutions can use English when mediating a dispute.

As Matthew Erie, a professor at the University of Oxford Centre for Socio-Legal Studies, points out, “Taken together, these developments open the gate to foreign arbitration institutions in China … as such, they provide a foundation for conforming China’s arbitration institutions with international expectations, a helpful step forward for Sino-foreign resolution.”

But what do these developments mean in the context of UK-China commercial disputes, and do they mark a significant improvement to China’s business environment?

What should I know about the PRC Arbitration Law? What does it say about ‘foreign-related arbitration?’

Arbitration has long been an issue for foreign companies in China; procedurally opaque and geared up to support domestic companies, it can be hard to understand from the outside looking in. That can leave some UK companies needing to resolve issues in China feeling that commercial arbitration is not an option for them. But China’s regime is improving.

Firstly, China did not have a specialised law on commercial arbitration on its books until last year, when it adopted the Singapore Convention that introduced a framework setting out general standards addressing mediator qualification and confidentiality. Before that, companies looking to settle cases could either take matters to the courts for judicial proceedings or go through institutional arbitration. The second point to note is that institutional arbitration in China has been covered by PRC Arbitration Law since 1994 (with an amendment in 2007). However, the Arbitration Law focuses on institutional elements of commercial mediation, such as which types of cases can be administered through arbitration and those which require a judicial decision, but it does not outline provisions for issues such as mediator qualification and confidentiality. As a result, it has delivered an arbitration regime that foreign-invested companies have often felt was insufficient.

Unlike most other jurisdictions in Asia, China’s Arbitration Law does not find its basis in the UNCITRAL Model Law on International Commercial Arbitration (1995, as amended 2006). As a result, the Arbitration Law diverges in important respects from international norms, most notably in the way that it established a bifurcated system separating ‘domestic’ and ‘foreign’ related arbitration. This bifurcation affects which type of arbitration institutions can accept which type of dispute and the extent to which an outcome remains legally valid in Mainland China – bad news for British businesses doing business with Chinese partners.

What is the Shanghai Lingang FTZ?

Established in 2013, the Shanghai Lingang FTZ has emerged as an incubatory space for international dispute resolution in China. Since 2015, foreign arbitration institutions have been able to benefit from a range of incentives to set up a representative office in the FTZ to expand the zone’s capacity for handling foreign commercial disputes involving other wholly foreign-owned enterprises (WFOEs).

A game-changer for UK companies with interests in Hong Kong or across the GBA, these measures see foreign firms treated the same as domestic ones when it comes to applying for Interim Measures from PRC courts.

As a result, the Hong Kong International Arbitration Center (HKIAC); Singapore International Arbitration Center (SIAC); International Chamber of Commerce, International Court of Arbitration (ICC); and the Korean Commercial Arbitration Board have all set up representative offices within the FTZ.

The next breakthrough came in 2016: China’s Supreme People’s Court issued an opinion that – while not an amendment to any law – provided foreign parties invested in China with greater assurance that arbitration agreements determined by a Foreign-Related Arbitration Commission would be recognised under Article 18 of PRC Arbitration Law (the piece of legislation placing the decisions of foreign-related arbitration committees under question, see Table 2). Formally known as the ‘Opinion on Judicial Protection’, foreign arbitration institutions registered within the Shanghai Lingang FTZ can use this precedent to administer arbitration disputes for WFOEs within the FTZ – which now covers an area of 119 square kilometres.

Other innovations for foreign arbitration institutions within the Lingang FTZ include that parties to arbitration can use English, and that well-known foreign arbitration institutions can register with the Shanghai Municipal Bureau of Justice to allow them to conduct arbitrations for business disputes.

Together, these make dispute resolution in Mainland China more accessible to foreign parties.

What is the “Arrangement Concerning Mutual Assistance in Court-Ordered Interim Measures in Aid of Arbitral Proceedings by the Courts of the Mainland and of the Hong Kong Special Administrative Region”?

A game-changer for UK companies with interests in Hong Kong or across the GBA, these measures see foreign firms treated the same as domestic ones when it comes to applying for Interim Measures from PRC courts.

Interim Measures provide a party going through arbitration with immediate or temporary protection of rights and property, pending a decision by an arbitration commission, be they foreign or domestic. They are often used by one party against another to ensure the protection of assets and evidence when seeking an award – i.e., ensuring that the party one is taking action against will still exist when proceedings conclude. In the past, Chinese courts would only grant Interim Measures to arbitration proceedings administered by domestic arbitration commissions. As a result, foreign parties entering into arbitration with a Chinese party through a foreign-related arbitration commission had no guarantee that the individual or business they were taking action against wouldn’t change the structure of their assets as the case was proceeding to render them legally unable to pay a court-mandated final award. The Arrangement Concerning Mutual Assistance relaxes this restriction and allows PRC courts to grant interim relief to support Hong Kong-seated arbitration – it is the first such mechanism to allow PRC courts to offer interim relief in support of arbitrations taking place outside of Mainland China.

The CBBC View

The Shanghai Lingang FTZ Measures and Arrangement Concerning Mutual Assistance are huge improvements vis-a-vis the internationalisation of China’s cross-border commercial dispute regime. Moreover, they will facilitate increased business between mainland Chinese and foreign companies.

UK companies with interests in China should welcome these changes because they introduce two new ways of structuring their presence in and around the market to provide for greater peace of mind when entering into contracts with a Chinese partner:

• Base operations located in Shanghai’s Lingang FTZ thereby eligible to settle a dispute through foreign arbitration
• Utilise the terms of the Arrangement Concerning Mutual Assistance to ensure that the Chinese party at the receiving end of a dispute settlement claim remains to pay a reward at the end.

China still has a long way to go regarding the development of an international and transparent commercial arbitration regime, but the above are steps in the right direction.

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China is a territory rich in potential for UK tech companies, with a hunger for technology and innovation. Yet organisations wanting to capitalise on these opportunities must sometimes overcome high legal and regulatory barriers. China is increasingly open to overseas tech investors and the burden of regulation is lower than ever before. Yet there are still likely to be some significant legal, commercial and ethical differences with the UK that tech businesses would be wise to acquaint themselves with.

Lists and licenses

Chinese regulations have loosened up considerably over the last few years, as the government works to bring high-tech firms and investment into the country. There are hundreds of development zones in China focused on technology and innovation, while the reform of China’s Foreign Investment Law in 2019 has also reduced many concerns for foreign tech firms around IP rights and tech transfer.

Yet, companies still need to check that they can legally operate in China before they start setting up a new business or Chinese office. This starts with consulting two negative lists – the Foreign Investment Negative List and the Market Access Negative List – to ensure that their work doesn’t constitute a restricted or prohibited activity. The lists aren’t particularly extensive, and you can find guidance on them here. They may also need to seek any licenses, permits and approvals that working in specific sectors might require, just as any local Chinese company would.

What’s more, the Chinese government has an Unreliable Entity List, which restricts or prohibits companies named on the list while operating in China. Though there may be little chance your company will end up on the list, this could affect your plans if you rely on suppliers that do.

Though there may be little chance your company will end up on China’s Unreliable Entity List list, it could affect your plans if you rely on suppliers that do

It’s best to do your research early. There are licenses to operate a website or a web-based service, along with customs and licensing restrictions that govern the import or manufacture of IT equipment or electronic goods. To obtain these licenses, products may need independent testing from accredited laboratories, while technical documents and product samples may need inspection. Technologies related to encryption, virtual private networks or cybersecurity may also be subject to additional controls. A new UK government website, aimed specifically at tech businesses setting up in China, has guidance and a range of useful resources that can talk you through some of the basic requirements and help you work out your initial steps.

China’s Corporate Social Credit System (CSCS) is another consideration. This applies to all companies working in China, without exception, and rates them across a range of government-selected metrics, with the government collecting relevant data on how each company is meeting or failing to meet its goals, with appropriate penalties and rewards. Don’t get too nervous – many of the metrics cover basic practices, such as paying taxes on time and holding all requisite licenses – but companies are also expected to meet environmental and product quality standards and ensure that any partners comply too. You can meet all of your CSCS goals, yet still get penalised for using a supplier that has failed to meet theirs.

On top of this, China also has its own workers’ rights regulations, covering everything from how you work with independent contractors, to employee handbooks and written contracts.

This might seem like a lot of red tape to get through, but your best tool to cut through it is preparation and research. There are many legal advisers and market entry consultancies that can help firms to navigate these regulatory barriers, and working with local consultants or specialists who understand your industry can help you meet your legal requirements and counter any regulatory challenges.

The Digital and Tech China website has some useful info on the areas to look into before hiring or going into partnership with local companies or consultants, and you can also get useful advice from the China Britain Business Council (CBBC) and the Department for International Trade, and techUK, the body that supports UK tech businesses looking to work internationally. CBBC also offers a basic due diligence service to help you vet Chinese suppliers and partners.

Intelligence and security

Tech businesses tend to have a large digital component, making them all the more likely to be affected by China’s cyber security and data regulations. China’s Cyber Security Law includes provisions on how data is collected, stored and transferred. In some circumstances, companies may need to seek government approval for the cross-border transfer of personal data or important data, and as a general rule of thumb data should be located on Chinese servers.

In some circumstances, companies may need to seek government approval for the cross-border transfer of personal data, and as a general rule of thumb data should be located on Chinese servers

It’s also worth being aware of China’s National Intelligence Law. This states that all Chinese organisations (as well as Chinese citizens) are obliged to provide support and assistance to state intelligence bodies and keep secret any state intelligence work they become aware of – or party to. The same applies to Chinese subsidiaries of Western multinationals. These laws may affect how you decide to structure your China business, how data is controlled and how you manage your core IP, so it’s wise to get advice on potential issues early on. You can find out more about these laws and their likely impact by heading to this UK Government online resource.

Protecting IP

IP protection is one area where Chinese regulations have improved, making it easier for foreign businesses working in China to protect their intellectual property and trademarks. Keep in mind, though, that the onus remains on UK tech companies to file any necessary patents and obtain copyright protection before they launch. China, like many markets, has a first-to-file trademark system, so international trademarks are not automatically protected unless they are registered in China first. This leaves the way open for a Chinese entity to register your trademark, then use it to block your product or request a payment for its transfer.

Copyright and IP problems still cost UK businesses in China millions of pounds every year, but it’s really just a case of ‘forewarned is forearmed.’ Thanks to the IP-protection legislation that emerged with the Foreign Investment Law, UK firms now have more legal protection over IP and can request enforcement relief. Meanwhile, the UK Intellectual Property Office has an online IP Health Check tool you can use to identify and secure your IP assets, and there’s a range of useful information about intellectual property in China on this dedicated UK Government page. Understand both the value of your assets and the risks, and your halfway to securing your IP.

UK regulations count

UK businesses that want to work in China still need to consider relevant legislation back at home. Most recently, the UK government announced a package of measures to help ensure UK companies are not complicit in, or profiting from, human rights issues in Xinjiang. The UK government also has restrictions around selling products into China that might have military applications or be used in human rights abuses. The UK has export controls that state which strategic military and dual-use items need specific authorisation and an export license, and it’s only sensible to check any products or services being sold against these first.

Business operations in China are also covered by the UK bribery act, which ensures that UK businesses operating in other territories avoid improper business activities, particularly in public procurements. Since 2016, China has had its own tighter anti-bribery legislation, too. You can avoid falling foul of either law by monitoring your company’s activities and following due diligence on local representatives and partners. You can find advice here to help ensure that both you and any Chinese partners or employees stay on the right side of the law.

Resolving disputes

Conflicts and disputes can emerge between businesses in China, just as they do in the UK, and this may put UK companies in contact with China’s complex court system. There are many different types of court, ranging from the Central Supreme People’s Court to local Basic People’s Courts, and the processes and outcomes can vary according to the court’s type or location. Cases can be long and challenging to resolve, which might explain why many foreign companies prefer to resolve them through arbitration as opposed to litigation. In fact, arbitration clauses are built-into many contracts, setting out how things will work in the event of a dispute.

Written contracts and agreements are as crucial in China as they are elsewhere, but need to be drawn up in compliance with Chinese law and stamped with the official red stamp of the partner company. Again, bringing in local legal expertise is a sensible idea. For IP disputes, China now has two specific IP court divisions in Beijing, along with Internet Courts in Beijing, Guangzhou and Hangzhou to handle any disputes over online products and services. Again, your safest bet before any legal action is to refer to a local legal expert.

Meeting all these legal and regulatory requirements can be a challenge, but it’s part and parcel of doing business inside China. There are opportunities out there for high-tech firms to take advantage of, but you have to lay the legal groundwork first.

This article was published in partnership with china.theweek.co.uk, techUK and CBBC.org.  Visit the digital and tech China hub to learn more. 

The post What are China’s legal requirements for foreign tech companies? appeared first on Focus - China Britain Business Council.

Part 4: Corporate taxes

China’s current tax framework was put in place after the tax reforms of 1994 to meet the needs of its socialist market economy. Since the beginning of the 21st century, the Chinese State Administration of Taxation has made a series of adjustments and improvements to its tax system, guaranteeing the government’s revenue stream and contributing to the country’s rapid economic growth.

Overview of PRC taxes

There are 18 different kinds of taxes in China, which can be divided into three categories according to their nature.

• Goods and services taxes, including VAT, Excise Tax, Vehicle Purchase Tax and Customs Duty.
• Income taxes, including Corporate Income Tax and Individual Income Tax.
• Property and behavioural taxes, including Land Appreciation Tax, Real Estate Tax, Urban and Township Land Use Tax, Arable Land Use Tax, Deed Tax, Resources Tax, Vehicle and Vessel Tax, Stamp Duty, Urban Maintenance and Construction Tax, Tobacco Tax and Vessel Tonnage Tax.

The major taxes are summarised below.

Corporate Income Tax (CIT)

Tax resident enterprises (TREs) are subject to corporate income tax on their worldwide income. In general, a company is regarded as a TRE in China if it is incorporated in China or effectively managed in China.

Non-TREs are taxed on their China-sourced income only. However, if the non-TRE has an establishment in China, non-China source income effectively connected with the China establishment is also taxed.

Corporate residents of China are taxed on their worldwide income, including income from business operations, investments and other sources. A foreign tax credit is allowed for income taxes paid in other countries. This credit is capped at the Chinese income tax level payable on the same income calculated under the Corporate Income Tax Law.

Taxable income

Taxable income generally includes profits, capital gains and passive income, such as interest, royalties and rents. Dividends received from a foreign entity are also included in taxable income but qualifying dividends received from another resident enterprise are tax exempt.

The taxable income of a company is the amount remaining from its gross income in a tax year after the deduction of allowable expenses and losses.

*Foreign enterprises are subject to a 10% withholding tax rate instead of a 25% income tax rate. The tax rate may further reduce subject to double tax treaties signed with other countries/regions.

**Net operating losses for high and new technology enterprises and technology-based small and medium-sized enterprises can be extended up to 10 years.

Tax year

The tax year is the calendar year.

Corporate Income Tax filing

Enterprises are required to file provisional CIT returns with the local tax authorities within 15 days of the end of each month/quarter. Annual CIT returns have to be filed on or before 31st May following the end of the tax year.

Value-Added Tax (VAT)

VAT is levied on the sale of goods, imports, services and sales of intangible assets and immovable properties.

There are two types of VAT payers:

1. General VAT payers (0%, 6%, 9%, 13%): Enterprises whose sales revenue during a business period of not more than 12 months or four quarters exceeds RMB 5 million or those who have a sound accounting system. For general VAT taxpayers, input VAT can be credited against their output VAT.
2. Small-scale VAT taxpayers (3%): Enterprises who don’t meet the conditions of being general VAT taxpayers.

Consumption Tax

A consumption tax is imposed on specified categories of luxury and environmentally unfriendly goods including cigarettes, alcoholic beverages, high-end cosmetics, jewellery, gasoline, automobiles, and batteries. The tax liability is calculated based on the sales amount and/or the sales volume, depending on the goods concerned. Consumption tax is not recoverable but is deductible as an expense for CIT purposes.

Urban Construction and Maintenance Tax/Education surcharges

The surcharges are levied based on the amount of VAT or consumption tax paid.

Customs duty

Customs levy import and export customs duties in accordance with their regulations. Customs is responsible for imported VAT and consumption tax. The import customs duty categories include the normal tariff, the most favoured nation tariff, the temporary tariff and the conventional tariff.

Real Estate Tax

Real Estate Tax is levied annually on the owners, users or custodians of houses and buildings. The tax rate is 1.2% of the original value of buildings.

Stamp duty

All companies and individuals that execute or receive any kind of taxable documentations are regarded as obligatory payers of stamp duty, with rates varying between 0.005% and 0.1%.

Environmental taxes

Under this relatively new taxation that began in China on January 1 2018, companies that directly discharge pollutants into the environment need to pay taxes on taxable pollutants, meaning air pollutants, water pollutants, solid wastes and noise. Tax is calculated based on the volume of the pollution.

Foreign exchange controls

China is a foreign exchange-controlled country. The PBOC and State Administration of Foreign Exchange regulate the flow of foreign exchange in and out of the country and set exchange rates through a ‘managed float’ system.

FIEs are allowed to purchase and sell foreign currency in their designated foreign exchange account while overseas payments can be directly processed through banks. However, due to the enhancement of regulations on confirming transaction authenticity and compliance, it is strongly recommended that supporting documents are prepared in case of any inquiries by the relevant authorities.

Tax treaties

China has a broad tax treaty network. Most of China’s treaties are based on the OECD model treaty, providing relief from double taxation on all types of income, limiting the taxation by one country of companies resident in the other and protecting companies resident in one country from discriminatory taxation in the other. As of Q1 2020, China had signed tax treaties with 102 countries and two special administrative regions.

Anti-tax avoidance rules

China has transfer pricing, thin capitalisation, cost-sharing and controlled foreign company (CFC) rules, as well as a general anti-avoidance rule (GAAR). Tax law and policy are developed jointly by the State Administration of Taxation (SAT) and the Ministry of Finance. The SAT is the body charged with collecting tax and enforcing compliance.

Major Tax Incentive Policies

By means of promoting some key sectors, the government has introduced several tax incentive policies, including various tax reductions and exemptions. These include but are not limited to:

New high-tech and qualifying advanced-technology service enterprises

These are eligible for a reduction in the CIT rate from 25% to 15%. These enterprises have to meet the criteria and are subject to assessment in order to qualify.

Large deduction for R&D expenses from Jan 1, 2018 to 31 Dec, 2020

R&D expenses are not converted into intangible assets and can enjoy an extra 75% deduction. If expenses have been converted into intangible assets, they can be amortised at the rate of 175% of the costs of the intangible assets.

Technology transfer

For the technology transfer income obtained by resident enterprises nationwide from the transfer of non-exclusively licensed rights to use technology for five years or more, technology transfer income not exceeding RMB 5 million shall be exempted from CIT. The portion exceeding RMB 5 million shall be subject to CIT, but the tax rate is halved.

Dividends between resident companies

The investment proceeds obtained by a resident enterprise from its direct investment in any other resident enterprises can enjoy CIT exemption.

Small and thin-profit enterprises from 1 Jan, 2019 to 31 Dec, 2021

Companies need to meet the below criteria to qualify as a small and thin-profit enterprise:

CIT Reduction:

Incentives for small-scale VAT taxpayers from 1 Jan, 2019 to 31 Dec, 2021

• If the total monthly sales volume does not exceed RMB 100,000, or the quarterly sales volume does not exceed RMB 300,000, if one quarter is taken as a taxable period, companies are exempted from paying VAT.
• VAT surcharges and other taxes such as Stamp duty and House Property Tax shall be levied at a reduced rate of 50%. The company has to be a small-scale VAT taxpayer in order to enjoy the 50% reduced rate on Resource Tax, Urban Maintenance and Construction Tax, Real Estate Tax, Urban Land Use Tax, Stamp duty, Cultivated Land Occupation Tax, education surcharges and local education surcharges.

Additional input VAT deduction

Taxpayers that provide postal, telecommunication, modern and living services accounting for more than 50% of their total sales are also eligible for these additional VAT input deductions:

VAT refunds for excess VAT Input

A new pilot VAT refund mechanism was introduced on April 1 2019, allowing refunds of excess input VAT credits for a broad range of businesses in China.

Exemption from relevant governmental funds

Since January 1 2016, enterprises with a total monthly sales volume of less than RMB100,000 or quarterly sales volume less than RMB 300,000 – when one quarter is taken as a taxable period – are exempted from paying educational surcharge and local educational surcharge.

Incentives for Stamp duty

Since mid 2018, the stamp duty levied on the capital account book set up by taxpayers was reduced by half according to the total amount of paid-in capital and capital reserve. Of the new capital injection, which goes into an enterprise’s paid-in capital, the newly injected part is required to pay stamp duty.

Individual Income Tax (IIT)

Residence rules

A tax resident is defined as:

• A person who is domiciled in China, or;
• Any individual who is not domiciled in China but has resided in the jurisdiction for a total of 183 days or more within a tax year.

Tax residents are taxed on their worldwide income.

Non-tax resident individuals are subject to IIT only on their PRC sourced incomes. Thus any remuneration from foreign employers to individuals is exempted from IIT provided that the remuneration is not borne or paid by any permanent establishment in China

Exemption (six-year rule)

In 2019, the new IIT Law introduced a special relief that allows resident taxpayers who do not have domiciles in China to be taxed only on their China-sourced income if the following conditions are met:

• The taxpayer has not been resident for more than six consecutive years (this was previously five years) in each of which:
• The taxpayer has resided for at least 183 days in China and
• Has not left China for more than 30 days in a single trip in the previous six years
• The remuneration is not borne or paid by any permanent establishment or individuals in China

It is important to note that the six-year rule starts counting from 2019 and it will interrupt any worldwide tax obligations under the previous five-year rule until the taxpayer resides in China for another 6 years. Moreover, any trips outside China of more than 30 days will ‘reset the clock’.

Starting from 2019:

Rates and tax brackets

Deductions and allowances

Deductions for resident taxpayers (domiciled and non-domiciled) include the below categories for both foreign and Chinese nationals:

• Education of children
• Continuing education
• Medical treatment of chronic illnesses
• Mortgage interest
• Housing rent
• Support for elderly parents

Taxable income

(Monthly income – Social insurance and housing fund [personal portion] – Deductions – Exemption)* corresponding rate – quick deduction

Tax year

The taxable year is every year from 1 January to 31 December.

Tax filing due date

Monthly income in the form of wages shall be declared in the same period in which it originated.

Employment income

For IIT purposes, the taxable employment income refers to all compensation received by an employee (monetary and in-kind) for the work carried out for the employer. It normally includes:

• Base salary
• Bonuses
• Profit share
• Allowances
• Any other income related to the employment

The tax authorities have also established that certain types of income granted to foreign employees can be treated as exempt provided that the amounts are reasonable and supported by official invoices and receipts.

A non-exhaustive list of exempted benefits includes the following:

• Housing allowances
• Language training allowances
• Children’s education allowances
• Meal allowances
• Laundry allowances
• Home trip travel allowances

It is important to note that according to the new IIT Law, the aforementioned benefits will be considered exempt until the end of 2021.

Income from interest, dividends, rents and transfer of properties

Such incomes are generally taxed at a flat rate of 20%. Lower rates can be applied depending on specific factors such as the nature of the entity paying out the dividend/interest.

PART 5: Sector-specific opportunities in China

Read the full report here

To learn more about accessing the China market contact wilson.barrie@cbbc.org for more information

The post China Business Guide Part 4: The Tax system appeared first on Focus - China Britain Business Council.

Part 3: The legal system

The new Foreign Investment Law regime

It has been over 30 years since China promulgated its first law on FDI (Foreign Direct Investment), the Sino-foreign Equity Joint Venture Enterprise Law, from which China has gradually established a complicated but comprehensive legal framework for foreign investment. The year 2019 arguably saw the most significant legislative move in this area in recent times, with the Foreign Investment Law (FIL) of the PRC enacted on 15 March 2019, coming into force on 1 January 2020. The FIL replaced the Sino-foreign Equity Joint Venture Enterprise Law, Sino-foreign Contractual Joint Venture Enterprise Law, and Wholly Foreign Invested Law, the three basic and most fundamental laws governing foreign investment.

The FIL has led to great changes to the legal regime of forging investments, among others, demonstrating the Chinese government’s determination to further open up to foreign investors. Highlights of the new law are summarised below.

National treatment

FIL replaced the case-by-case investment approval system with a system consisting of national treatment in conjunction with a ‘negative list’ for foreign investment. Under this system, except as required under the negative list, the competent PRC authorities are to treat foreign investors with at least the same degree of accommodation as Chinese investors.

The negative list refers to a list of industry sectors in which foreign investment is restricted or prohibited. Foreign investment in industries not listed on the negative list is permitted. The latest version of the negative list, the Special Administrative Measures for Foreign Investment Access (Edition 2020), went into effect on July 23 this year. The negative list has been regularly updated over the years to liberalise investment in various industries.

A more relaxed and efficient foreign investment administration system

The case-by-case foreign investment approval requirement for FIEs has been replaced with an online reporting requirement with the Ministry of Commerce, greatly simplifying the administration of foreign investment. With this, most foreign-invested companies can directly apply for company establishment registration or other corporate changes, including equity transactions, by filing with the State Administration of Market Regulation (SAMR) or its local counterparts.

Protection of intellectual property rights

Responding to foreign investors’ concerns about IP protection in China, the FIL clearly makes provisions for China to protect the IP of foreign investors and FIEs. Administrative authorities shall also not, directly or indirectly, force foreign investors or FIEs to transfer technologies to them in any administrative procedures. In early 2019, the State Council amended the Regulation on the Administration of the Import and Export of Technology and removed a number of restrictive provisions in technology import contracts, such as the ownership of technology improvement, which is often a point of controversy in technology license agreement negotiations.

Comprehensive protection of foreign investment

Responding to foreign investors’ concerns that they may be subject to discriminatory restrictions or otherwise treated less favourably than domestic PRC enterprises, the FIL explicitly provides a series of rights to investors, including:

1. Local governments at all levels must lawfully honour policy commitments made to foreign investors and FIEs and perform all contracts concluded with foreign investors in accordance with applicable laws.
2. The State’s various policies in support of enterprise development will be applied equally to FIEs and Chinese enterprises in accordance with generally applicable relevant laws.
3. The State protects FIEs’ right to participate in government procurement activities through fair competition.
4. FIEs may seek financing in China via the public offering of shares, issuance of corporate bonds or other securities.
5. Foreign investors enjoy full discretion in remitting into or out of China, in Renminbi or any other currency, their contributions, profits, capital gains, and other legal income according to law.

Key compliance requirements 

In the spirit of the new Foreign Investment Law, which aims to grant consistent national treatment to all FIEs in China and also create a fair environment for both Chinese and foreign companies, several developed cities such as Beijing and Shanghai have introduced their own implementation measures to further optimise the business environment for FIEs since late 2019.

As mentioned, since the legal and regulatory framework governing foreign investment in China is dominated by the new Foreign Investment Law, the 2020 Negative List for Foreign Investment (listing the prohibited and restricted industries for foreign investment), the Company Law and other laws regulating specific industries, such as banking, insurance and pharmaceuticals, a newly established FIE in China should meet the following compliance requirements:

• Formal registration with the tax authorities, foreign exchange, labour and social insurance, customs office and any other relevant authorities responsible for regulating specific industry and/or business operations relating to the newly set-up company. For instance, a wine retailer should obtain a wine retail permit while a medical device manufacturing company should get a manufacturing and a distribution licence for the trading of medical devices from the National Medical Products Administration. Only after such a permit or licence or filing has been obtained or made can the newly set-up company lawfully and fully start its business operations.
• Ongoing compliance requirements, which mainly include monthly tax declarations, annual CIT return and IIT return reports, monthly social insurance and housing fund contributions for employees, and enterprise annual/joint reports.

The Chinese government is constantly enacting new laws to match developing business and regulatory needs. This consequently poses new compliance challenges for FIEs in terms of factors such as cybersecurity and personal data protection.

 PART 4: The tax system

The post China Business Guide Part 3: The legal system appeared first on Focus - China Britain Business Council.

Unlike most of the rest of the world, the use of carved seals (or chops) is still part of the business environment in China, owing to a longstanding tradition with its roots in the imperial history of the Middle Kingdom. The importance of seals comes from a historical mistrust of signatures as a result of the study of calligraphy and the number of forgeries that could occur in a territory as huge as this one, where written official orders could rule the destinies of hundreds of thousands, even millions, of people. As with signatures, seals have distinctive traits, but these have to be registered at the Police Security Bureau right after being issued as part of the post-incorporation formalities for Chinese corporate entities, both domestic and foreign-invested.

To add to the complexity, seals are only available in one style for each type of seal, with five or six different types of seal needed – each one with a different use. If a seal is lost, a public announcement has to be made in a local newspaper to notify anyone who may be affected.

If a seal is lost, a public announcement has to be made in a local newspaper to notify anyone who may be affected.

Considering their importance and the extreme trust that custodians need to have from business owners, anybody who’s in possession of these items is deemed as authorised to use them and can, therefore, bind the company and its representatives with rights and obligations. However the fact that they are usually used to verify a required signature in person (for example in a notary public’s procedures), means that foreign investors can always entrust the physical control and safeguarding of these tasks to third-party service providers.

What are corporate seals used for and when?

The below analyses each type of Chinese company chop one by one, in descending order of importance:

Company seal

Available in an oval or round shape, the company seal is the main chop on which all the other seals depend and are carved. It is the company’s official sign of validation of official documents. Businesses use the company chop for all legal documents as it can cover almost all the functions of other chops, except for the customs chop and the invoice chop.

The official company chop can be used for all letters, official documents, employment and commercial contracts, and introduction letters, certificates, documents to open bank accounts or for the submission of any official documents at any governmental office.

The company seal usually features (and acts as the only official record of) the English name of a company, which will then be shown on each and every document certified using it. Apart from any records including this reference, English trading names are neither shown nor registered anywhere else in the jurisdiction of mainland China, since simplified Chinese is the only official and accepted language.

Legal representative seal

The most important role in corporate governance (according to Chinese Company Law), and the only individual that can represent the company in public hearings or actions, is its legal representative. Holding their own seal with their name on it, always in a square or rectangular shape, the legal representative of a company can use it to exercise any relevant rights and obligations. It’s very rare to have a legal representative seal on its own on documents, as either the company seal, finance seal, legal representative seal are usually required as additional ‘signatures’. It is frequently used in banking operations, since a company’s legal representative can either use an original signature or their personal chop to authorise bank transactions.

As legal representative seals feature the name of the individual you’ve appointed to that role in Chinese characters, the moment your legal representative is replaced, their seal needs to be destroyed and re-issued in the name of their successor. Due to its relevance to the individual acting as a legal representative, this seal is either in their possession at all times or stored with a third-party provider if their domicile is not in the People’s Republic of China. Given their great importance, whenever holding both seals in-house, it’s highly recommended to not store them in the same safe or under the same employee’s custody.

The moment your legal representative is replaced, their seal needs to be destroyed and re-issued in the name of their successor.

Finance seal

As the name suggests, the finance chop is mostly required in treasury and banking operations, including bank account openings or closings, the issuance of checks (although this is becoming less and less popular), and certifying any statutory document in the finance department. These include accounting books, tax filings and compliance communications with the SAT (The State Administration of Taxation). Always in a square shape, the finance seal features no English characters, showing only the company’s Chinese name.

Customs seal

Trading and manufacturing entities with filings at the General Administration of Customs are entitled to a seal that can certify their import or export declarations when clearing their goods in or out of China. Just like the company seal, this usually comes in either a round or oval shape, and only features the entity’s Chinese name.

Invoice (fapiao) seal

Among the few official documents for which a company doesn’t need either the company seal or the legal representative seal are official invoices – also known as VAT Special Invoices. Paper version invoices are only valid when showing an invoice seal on the lower left side of the document.

Contract seal

Among the non-compulsory seals available for corporate entities is a separate ‘contract seal’, which is used to execute commercial agreements as long as the parties involved recognise its validity. Despite its flexibility, it still cannot be used for employment contracts or rental tenders – the company seal is irreplaceable for these types of agreements.

In many cases, companies use their contract chop for signing other types of contracts with their employees or executing agreements between salespeople and clients. Overall, the contract chop grants less authority than the company chop, so it’s a more useful one to give to others for delegating authority.

Safeguarding the usage of seals

Just like a company’s payment threshold authority and purchasing limitations, procedures for the application and the usage of seals should be integrated with an entity’s standard bylaws.

Corporate entities can also establish additional layers of security for minor chops by ensuring that each stamping request is confirmed by affixing the company seal or requiring one or more senior executives’ original signatures next to it.

Keeping a record of all applications for using or affixing corporate seals can definitely help investors in making sure that staff misuse doesn’t go unnoticed or unreported. The officer in charge of such procedures should be one who does not handle or hold any seals in order to obtain a healthy maker-checker flow.

What could go wrong?

Local and international business news outlets are full of examples of seals causing trouble when fights erupt over the control of a company, or when senior executives are sacked while being the ones physically holding seals in their hands.

The best advice when considering the use of outsourced solutions to trusted providers is to not put all your eggs in one basket, and to learn to hedge against risks. This can be made part of a local subsidiary’s culture from day one by empowering several departments and executives with a bonus-malus system paired with internal control channels to spot and immediately report any anomalies.

Hawksford is an established provider of company registration and outsourced corporate services in China. Hawksford offers a company secretarial service that will manage your chops by implementing a usage procedure tailor-made to your needs to strengthen internal controls and protect your business. 

Call +44 (0)20 7802 2000 or email enquiries@cbbc.org now to connect with CBBC staff who can advise on company chops and other Chinese legal requirements.

The post Everything you need to know about company chops and seals in China appeared first on Focus - China Britain Business Council.

The risk of your business partner failing to perform its contractual obligations is part of doing business. In normal times, this risk is more acute for foreign firms unfamiliar with local legal environment and culture. And these are not normal times. The full global impact of COVID-19 has yet to be felt, but its impact on Chinese business is already palpable.  Even after several weeks, many Chinese businesses have yet to return fully to work, logistics remain problematic, people returning from locations outside their workplace are quarantined for 14 days, and companies are facing regulatory and compliance pressures – all of which have stretched company resources, disrupted capabilities and produced a spike in clear signs of financial distress on the part of counterparties.

Contract performance risks have risen sharply in this environment.  A number of businesses have reported that they have received force majeure certificates from their counterparties in China, which were issued by the China Council for the Promotion of International Trade (CCPIT) in support of the counterparties’ claims for relief from breach-of-contract liability amid the COVID-19 epidemic. As of 20 April, over 7,000 force majeure certificates had been issued by the CCPIT and its local branches.

Sympathy from foreign firms for Chinese companies facing this multitude of pressures is evident. However, the natural result of these pressures is an inability to meet contractual obligations and make payments. The slowdown is having a genuine impact on Chinese business to pay debts, but also presents an ideal opportunity for less scrupulous firms to delay payments. Some of the questions that have been asked:

• How do I trust my partner when they tell me they cannot pay as COVID-19 has impacted their cash flow?
• Our counterparty has defaulted on a contract and said they are going into receivership. Due to travel restrictions we cannot visit them and have no on-the-ground information. How do we verify this is true, and how can we get paid?
• Prior to Chinese New Year we received a court order requiring our customer to pay outstanding debts. We want to understand the long-term impact this will have on our business if we insist on them complying with that order.
• Our counterparty sent us a force majeure certificate issued by the CCPIT, claiming that the COVID-19 epidemic prevents them from performing their obligations and hinting they want to be excused from performing their obligations. We want to understand what strategy we can use to respond and protect our interest while avoiding lengthy and costly dispute resolution processes and preserving important business relationships.

We are all suffering from information overload, trying to monitor for daily updates on the progress of COVID-19 in China and now globally, but obtaining actionable information about specific impacts on a local level can be frustrating. Despite these unusual times, these questions are quite typical – ultimately relating to understanding a counterparty’s current operating condition and prospects – information which is not readily available in the Chinese public record, and analysing external factors that may influence their ability to perform their obligations and remain a viable long-term business partner. However, through a combination of smart public domain research, discreet enquiries with those familiar with the company and our substantial experience with business practices and culture, we can obtain the insights you need to focus your strategy:

Counterparty monitoring

Is the company genuinely under pressure because of its location, industry or unique circumstances which is preventing them from performing its obligations? What local government regulations may protect the company if it refuses to perform? Are there indications, to the contrary, that the company is back to business?

Fit to sue

What is the actual perceived status and operations of the company on the ground? Are there signs of financial distress, missed payments or contractual disputes? Are other companies in the industry and locality facing similar difficulties? Would it likely be willing to expend the time and resources necessary to arbitrate or litigate the matter? Is the company known to be aggressive and contentious when it faces difficulties with its partners?

Protecting your business

If you take an aggressive approach in China against the company, how much do you really know about them? How significant an employer/taxpayer are they locally, and therefore how influential? How well-connected politically are they? Are you aware of their local reputation? Could aggressively pursuing the company in the short term have a long-term impact on your future success in the area or in the industry?

Building negotiation strategy

What is the significance of this company to your business and your reputation in China? What are your ultimate objectives? What exactly is the counterparty seeking to achieve by declaring force majeure? What grounds is the force majeure claim based on? What is the likelihood of the claim prevailing in a formal dispute resolution proceeding and what is the likely cost? What stakeholders should you proactively engage with to mitigate risks arising from the force majeure claim and from potential disruption to your operations and your supply chain? What strategies can you use to explore options with the company and reach a mutually satisfactory resolution?

Through a combination of targeted enquiries with sources familiar with the subject company, a comprehensive review of the latest available information on the company and the region,  and substantial experience with the local business environment and culture, you can gain insights towards next steps, and build a strategy for success.

Rosie Hawes is a Partner at Control Risks and leads the firm’s Business Intelligence practice in Greater China and North Asia.

Jessica Pyman is a Partner at Control Risks and is responsible for all aspects of business intelligence services delivered in the Asia Pacific region.

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Overlooking the more obvious consequences that closing a company may entail in terms of staffing and strategy, problems may arise when not all company owners officially close down operations, leaving their business dormant for years. Not producing revenue does not make the company invisible to the Chinese financial bodies, which still view quiescent companies as active entities.

As a result, not communicating the shutdown of operations may have serious consequences – both for the company and its legal representatives. Companies’ reputations may be put in jeopardy as the business will be fined between RMB 2,000 to RMB 10,000 per year and blacklisted, thus making it extremely difficult to carry out deregistration later on.

Besides, legal representatives may face difficulties in carrying out ordinary banking transactions, starting another business or even moving out of the country.

The following 11 steps show how a WFOE should carry out its closing procedure:

1. Form a liquidation committee and prepare an internal plan

The first step when closing a WFOE is to form a liquidation committee, which generally consists of any three or more people designated by the shareholders.

The committee formulates and implements an internal liquidation plan for assets and creditors, for the termination of employee’s contracts, and the conclusion of the lease. Later in the liquidation process, the committee will be responsible for notifying the creditors of the business closure, preparing the liquidation report to submit to the authorities, and other administrative tasks.

2. Liquidate the assets

At this stage, the liquidation committee should also begin selling the company’s assets and – in the following order – pay liquidation expenses, any outstanding employee salaries or social security payments, tax liabilities, and then any other debt owed by the WFOE.

The company can start liquidating creditors only after the first step’s liquidation plan has been approved by the board of shareholders. After it has settled all debts, the liquidation committee can distribute the remaining returns among the shareholders. If the company’s assets are unable to settle the debts, it will need to file a bankruptcy declaration with the court.

3. File a record with the State Administration for Market Regulation

The liquidation committee must notify the State Administration for Market Regulation (SAMR) of their intent to close the WFOE by submitting a shareholder resolution. The document should contain the names of the members that have been appointed to form the liquidation committee.

4. Newspaper announcement

The company will then submit a statement to a provincial- or state-level newspaper and the newspaper should inform creditors of the business closure and ask them to declare their claim.

Creditors then have 45 days to handle unpaid accounts, and not until this period has passed can the company proceed to the next step.

A formal announcement in a news publication is one of the steps needed to close a WFOE

5. File a record with the Ministry of Commerce

A shareholder resolution similar to that submitted to the SAMR also needs to be submitted to the Ministry of Commerce (MOFCOM).

6. Begin terminating employee contracts

In theory, all employee contracts can be terminated if the company decides to shut down, but in practice, several issues may delay the process. Local bureaus may at times impose their own labour restrictions on companies, or – in case employees are eligible for workplace injury compensation – the HR bureau may request that an injury assessment is completed after the injury has stabilised.

Thus, businesses should begin terminating employee contracts as early as possible. Companies should calculate their termination fees and ensure that employees in key positions return important property, such as company chops, financial statements, financial books, key passwords, and computers before they depart.

7. Tax clearance and de-registration

The tax de-registration process will usually take around four to eight months, during which time the tax authority will collect a series of relevant documents such as the signed board resolution, evidence of lease termination, and three years of tax filing records. After the company settles all tax liabilities, it will be allowed to deregister from its value-added tax (VAT) corporate income tax, individual income tax and stamp duty obligations.

Businesses that have been operating for more than one year will then be required to complete an audit, which, along with unissued invoices, VAT invoices, and equipment, can then be brought to the tax bureau for review.

If the review is successful, the tax clearance certificate will be issued, in which case the business will have successfully deregistered from all its tax obligations.

8. SAMR de-registration

To obtain the SAMR de-registration, the liquidation committee must submit the liquidation report, together with the shareholder’s resolution report. The latter should confirm the amount of money that is left in the company, the completion of tax clearances, the termination of all employee contracts, and that all creditor claims have been settled.

After this step, the company will obtain a SAMR de-registration notice, and will no longer exist as a legal entity.

9. Deregister with other departments

Where relevant, the business must also deregister at the State Administration of Foreign Exchange (SAFE); at the Social Insurance Bureau, and at the Customs Bureau. It should also cancel its licenses, such as production licenses, food distribution licenses, and submit a de-registration for systems, applications and products (SAP).

10. Bank account closure

Most WFOES will have at least three different company bank accounts. The RMB basic account must always be the final account to close as it is the WFOE’s primary account and is most closely monitored by China. The capital and general account will typically be the first accounts to be closed.

11. Cancel company chops

Once all the other steps are completed, the company can cancel the company chops with the Public Security Bureau. This must be the very last process as many of the previous de-registration steps will require the company chops.

The post Closing down a WFOE in 11 steps appeared first on Focus - China Britain Business Council.

As the coronavirus outbreak continues, enterprises in China are experiencing enormous challenges in the management of employee relations. The nationwide implementation of epidemic prevention and control measures has exerted varying degrees of pressure on enterprises, affecting their production, operation and employment arrangements. Some employees cannot return to work, and others are not able to work to capacity. As the epidemic continues, some enterprises may suffer from a partial or complete labour surplus.

In response to these problems, state and local governments have issued a series of policies to encourage enterprises affected by the epidemic to adopt flexible employment arrangements (such as salary adjustment, work shift rearrangement, work hour reduction, and rest day rearrangement), with an aim to avoid or minimise layoffs.

If an enterprise still experiences serious difficulty after adopting flexible employment arrangements, it may have to find a way to deal with the redundancy, to minimize cost of labour. There are mainly two types of plans available: (1) suspend the enterprise’s operation while retaining the employment relationship with employees until operations are resumed, and (2) terminate the employment relationship with some or all employees. In this article, we describe each plan’s conditions, requirements, and practical points.

I. Suspending operations

The current laws and regulations do not provide a clear process or premise for the suspension of operations. Enterprises affected by the epidemic can consider suspending operations as the situation demands. There are, however, certain issues to watch for:

1.              There must be a proper reason for suspension, such as lack of need for production due to decreasing orders or an inability to operate due to traffic restrictions.

2.              An enterprise deciding to suspend operations must explain to employees, in writing, the reason for and length of the suspension, as well as tasks to be fulfilled and compensation standard during the suspension period. The enterprise must also hear the employees’ opinions and answer their questions.

3.              Compensation. For a suspension that is within one pay period, the enterprise must pay the rates stipulated in the employment contract. If the suspension lasts longer, the enterprise may pay based on the amount of work done according to a new rate agreed by both parties (but it cannot be lower than the local minimum rate). For employees without work, the enterprise should pay a living subsidy in accordance with local standards. In Shanghai, the subsidy must not be less than Shanghai’s minimum wage. In Jiangsu and Zhejiang, it should be no less than 80 percent of the local minimum wage.

4.              Though the law does not explicitly require enterprises to send any report to the labour and social security department in advance of a suspension, it is recommended that an enterprise communicate with its local labour and social security department in advance and operate under their guidance.

II. Planning a layoff

If the enterprise still suffers from a labour surplus and experiences a business crisis after taking the above-mentioned measures, a layoff may be inevitable. Under the law, an enterprise can consider the following plans to terminate some or all of its employees:

1.  Termination by mutual agreement

According to Article 36 of the PRC Labor Contract Law, an employment contract may be terminated in writing by the employer and employee’s mutual agreement. The agreement to terminate should contain the date of termination, amount of compensation, settled wages and expenses, and the employer’s disclaimers. An employer is advised to retain all written communications, records, and fully executed mutual termination agreements with its employees.

2.  Termination based on a major change in circumstance

Under the PRC Labor Contract Law, Article 40, Section 3, where there is a major change in circumstance rendering performance of an employment contract impossible, and the two parties fail to agree on an amendment, the employer may unilaterally terminate the contract. In the current epidemic, it is believed that if the epidemic has sufficient impact on an enterprise that it constitutes a major change in circumstance as recognised by common judicial practice, the employer can consider terminating its employees.

However, different local adjudication bodies adopt different standards in assessing what constitutes “a major change in circumstance rendering performance impossible.” Thus, employers must carefully assess whether the epidemic truly presents a serious obstacle to the performance of their employment contracts.

Two types of employees cannot be terminated based on a major change in circumstance: (1) employees that meet the requirements in Article 42 of the PRC Labor Contract Law (for example, female employees undergoing pregnancy, confinement or lactation), and (2) carriers, suspected carriers, and persons having been in close proximity to carriers of the novel coronavirus who are either quarantined or placed under medical observation, as well as employees who cannot work due to quarantine or other emergency measures implemented by the government (collectively referred to as “employees that are not terminable due to the epidemic.”)

3.   Mass Layoff

Under the PRC Labor Contract Law, Article 41, a qualified enterprise requiring a termination of (1) twenty or more employees, or (2) few than twenty but no less than 10 percent of the employer’s workers, may implement a mass layoff. But even with a mass layoff, the enterprise cannot terminate an employee whose termination is forbidden by law (including employees that are not terminable due to the epidemic (as defined above) and employees specified in Article 42 of the PRC Labor Contract Law).

An enterprise planning a mass layoff should first assess whether it meets all legal requirements for such a layoff. But since no uniform standard for determining whether an enterprise conforms to the four situations authorising a mass layoff is seen in today’s legal practice, a decision for mass layoff must be carefully evaluated on a case-by-case basis. In addition, an enterprise must satisfy the procedural requirements for a mass layoff, including giving the labour union or all its employees a 30-day advance notice to explain the situation, hearing the labour union or employees’ opinions, and reporting to the local human resource and social security department after seeking labour union and employees’ opinions.

4.  Ending employment due to dissolution

Article 44 of the PRC Labor Contract Law permits ending an employment contract when an employer decides to dissolve the company. An enterprise needing to close and dissolve as a result of the epidemic may end its contracts with the employees.

III.  Conclusion

Enterprises can reduce the cost of labour and stabilise employee relations by making full use of one or more flexible employment arrangement measures permitted and encouraged by the government. If, after taking these measures, an enterprise still needs to reduce the size of its workforce, it should formulate and implement appropriate redundancy plans to comply with the law and minimise labour disputes.

This article was written by Tracy Liu and Larry Lian of Jingtian Law firm

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