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DOING BUSINESS IN China

02 | Doing Business in China

ContentSintroduCtion 03

aBout dLa PiPer 04

our PeoPLe 05

eConoMiC and reGuLatorY inFraStruCture 08

Access to the PRC Through Hong Kong ................................................................................................................................................09

Closer Economic Partnership Arrangement (CEPA) .......................................................................................................................... 12

One Belt One Road ..................................................................................................................................................................................... 15

SettinG uP Your BuSineSS 18

Business and Investment Structure .......................................................................................................................................................... 19

Franchise .........................................................................................................................................................................................................29

Employment Law Challenges .....................................................................................................................................................................32

Employment ...................................................................................................................................................................................................36

Dispute Resolution ...................................................................................................................................................................................... 41

PRC Bankruptcy Provisions .......................................................................................................................................................................47

oBtaininG FinanCinG in China 53

Private Equity and Venture Capital ..........................................................................................................................................................54

Investing in a Chinese Company Mergers and Acquisitions ..............................................................................................................58

Payments and Customs Import and Export ..........................................................................................................................................62

ContinuinG LeGaL reQuireMentS 66

Taxation .......................................................................................................................................................................................................... 67

Anti-dumping and Countervailing Duty Law .........................................................................................................................................72

CSR Compliance in the PRC ..................................................................................................................................................................... 74

Anti-bribery and Anti-corruption Compliance ....................................................................................................................................78

www.dlapiper.com | 03

In the wake of the most punishing economic downturn in 70 years, China now features prominently in the plans of global investors and companies searching for growth. Having successfully navigated the financial tsunami, China’s continued dynamism and increasingly sound economic management track record prove attractive to managers, investors, entrepreneurs, and consultants alike.

However, opportunity is never without risk. An increasingly competitive business environment, coupled with growing friction in the global trading system, signals the rise of new transnational challenges. On a local level, corporations must understand, implement, and adhere to a continuously evolving rule of law.

While China’s appeal continues to grow, a new dynamic is emerging, promising a profound shift for the international economic and business landscape. It’s no longer just an eye-catching domestic market of 1.3 billion individuals. Locally-born businesses are now eager and poised to take on the world. Be they domestic start-ups with humble beginnings or well-established multinationals that span the globe, China is demonstrating its value as a partner and multiplier for businesses.

DLA Piper expects an increasingly fast evolution in China’s legal, regulatory, and commercial environments. Dramatic changes, heightened motivation, and a growing willingness to assume the role of a major financial and trading partner shape China’s progression in both policy and practice.

The fifth edition of “Doing Business in China” emphasises our commitment to enabling clients’ success by providing comprehensive, up-to-date industry knowledge and insightful future forecasts. Positive feedback to earlier editions has demonstrated its constructive value when planning and executing business and investment strategies.

Written with our broad range of clients’ interests in mind, the guide’s approach is extensive yet comprehensive. Beginning with economic and regulatory insights – such as China’s commitments to the World Trade Organisation – we offer practical tips for managing a multitude of situations, such as setting up a business. We also evaluate laws affecting employment, the environment, and taxation. In response to readers’ and clients’ requests for advice on navigating China’s corridors of power, our government affairs team drew upon their extensive experience to formulate tips and tactics for effectively liaising with officials.

DLA Piper closely follows recent developments affecting clients’ businesses. The addition of two chapters provides analysis and approaches for responding to the newly-implemented insolvency and restructuring, and Corporate Social Responsibility (CSR). An amplified focus on sustainability and anti-corruption provisions are significant developments impacting all businesses engaged in China, irrespective of structure or origin.

We would like to thank our partners, lawyers, and professional support staff who have contributed to this guide. Developed from practical experience and genuine knowledge, their inspiring thoughts reinforce our success as one of the leading international business law firms in Asia.

introduCtion


ABOUT dLa PiPerDLA Piper is a global law firm with located in more than 30 countries throughout the Americas, Asia Pacific, Europe, Middle East and Africa, positioning it to help companies with their legal needs anywhere in the world.

DLA Piper now has offices located in Bangkok, Beijing, Hong Kong, Seoul, Shanghai, Singapore and Tokyo. In addition, we have country practices that focus on Indonesia, Myanmar and Vietnam, as well as experience in other jurisdictions within the region, including India, Malaysia and Cambodia.

Engaging in these dynamic markets requires a first-hand knowledge of local legal and regulatory environments. Around 80% of our lawyers are local lawyers, so our legal solutions reflect pragmatic assessments of risk and reward, based on real understanding of local law and business.

For more information, please visit us at www.dlapiper.com

http://www.dlapiper.com


our PeoPLe

Paul Chen Hong Kong t +852 2103 0808 [email protected]

Claudio d’agostino Shanghai t +86 21 3852 2111 [email protected]

Gloria Liu Hong Kong t +852 2103 0570 [email protected]

heng Loong Cheong Hong Kong t +852 2103 0610 [email protected]

Melody he-Chen Hong Kong t +852 2103 0602 [email protected]

Mike Suen Hong Kong t +852 2103 0574 [email protected]

terry o’Malley Chair, Asia Committee t +1 619 699 4785 [email protected]

Sammy Fang Hong Kong t +852 2103 0649 [email protected]

CorPorate

anti-BriBerY and CorruPtion

Qiang Li Shanghai t +86 21 3852 2168 [email protected]

roy Chan Shanghai t +86 21 3852 2188 [email protected]

Kevin Chan Hong Kong t +852 2103 0823 [email protected]


Johnny Choi Beijing t +86 10 8520 0709 [email protected]

Julia Gorham Hong Kong t +852 2103 0818 [email protected]

Carolyn dong Hong Kong & Beijing t +852 2103 0505 [email protected]

Paul Lee Hong Kong t +852 2103 0886 [email protected]

edward Chatterton Hong Kong t +852 2103 0504 [email protected]

Scott thiel Hong Kong t +852 2103 0519 [email protected]

horace Lam Beijing t +86 10 8520 0600 [email protected]

Yan Zhao Shanghai t +86 21 3852 2166 [email protected]

eMPLoYMent

FinanCe & ProJeCtS

iPt

Stewart Wang Shanghai t +86 21 3852 2080 [email protected]

Sheng Wu Hong Kong t +852 2103 0708 [email protected]

Liu, Wei Beijing t +86 10 8520 0688 [email protected]


Mark Fairbairn Hong Kong t +852 2103 0878 [email protected]

Jonathan Leitch Hong Kong t +852 2103 0811 [email protected]

ashley Bell Hong Kong t +852 2103 0809 [email protected]

daniel Chan Hong Kong t +852 2103 0821 [email protected]

anderson Lam Hong Kong t +852 2103 0722 [email protected]

Peng tao Hong Kong t +852 2103 0511 [email protected]

doris ho Hong Kong t +852 2103 0759 [email protected]

Patrice Marceau Hong Kong t +852 2103 0554 [email protected]

Susheela rivers Hong Kong t +852 2103 0760 [email protected]

Wayne Ma Hong Kong & Shanghai t +852 2103 0808/+86 21 3852 2088 [email protected]

Lillian duan Shanghai t +86 21 3852 2169 [email protected]

reStruCturinG

tax

reaL eState

Or your usual contact at any of the DLA Piper offices worldwide.


eConoMiC and reGuLatorY inFraStruCture


aCCeSS to the PrC throuGh honG KonG

The advances in PRC’s economy have precipitated dramatic changes in its culture, infrastructure and legal regime. As the historical gateway to China, Hong Kong has been working its economic engine, constantly transforming itself to adapt to China’s changing needs. While China is now the pre-eminent destination for foreign investment, Hong Kong remains a key launch pad for investing in China, as well as for the Asia-Pacific region. For example, Hong Kong continues to be a point of access for outsourcing China-made products. It is the place where many of the most experienced Chinese business partners are based, and it provides a convenient location (on China’s doorstep) for foreign investors to hold and administer their China investments (including foreign investment enterprises), to set up regional head offices, and to direct pan-Asia operations.

BuSineSS, FinanCiaL and reGuLatorY inFraStruCture

Besides its geographic location, Hong Kong also offers a solid infrastructure that is capable of catering to the many needs of foreign business operators. It provides a dynamic business environment in which funds can be raised for investments in China. It is both a duty free port and an international financial centre, where many major foreign banks and local banks are present. Moreover, Hong Kong does not impose any restrictions

on currency trading. The Securities and Futures Commission (“SFC”), an independent non-governmental statutory body, is responsible for regulating the securities and futures markets in Hong Kong. The Shanghai-Hong Kong Stock Connect kicked off in November 2014 and the scheme provides global investors access to the Chinese stock market. The launch of the Shenzhen-Hong Kong Stock Connect scheme in late 2016 is also expected to further enhance the capacity of the existing Shanghai-Hong Kong Stock Connect, particularly with the increase in the quotas for southbound trade.

Hong Kong also enjoys a reputation for having an efficient civil service and streamlined, non-invasive bureaucracy. It provides the option of bilingual communications in both Chinese and English, including audio-visual and print media in both languages as well as advanced telecommunications and information technology.

LiFeStYLe and enVironMent

Quality of life is an important consideration for multinational corporations wishing to set up regional offices abroad and seeking a suitable location for their expatriate staff. Hong Kong offers a variety of residential accommodation and international schooling options as well as social, recreational and cultural facilities to suit an expatriate’s needs.


Hong Kong is also home to one of the world’s most wide-reaching and efficient public transportation systems. In the past few years, the Hong Kong government has been actively promoting electric vehicles aiming to reduce pollution. The first franchised battery-powered electric bus was put into service in September 2013 and the first registration tax for e-vehicles is waived until March 2017. The city’s central geographic location in the Asia Pacific region and its state-of-the-art airport allow easy access to all key cities throughout the region for business and recreational travel.

ruLe oF LaW

Hong Kong’s common law legal system is broadly based on the English model, with rule of law as its core concept. This legal system is separate and distinct from that of the legal system in China, which is based on a civil law legal system. The Basic Law of Hong Kong (a statute enacted by the National People’s Congress of the PRC) ensures that this separation of legal systems shall continue for 50 years beginning from the 1997 Handover of Hong Kong to China.

Hong Kong possesses a legal tradition based upon the freedom of corporations to structure their investments and operations according to their business needs. After an eight-year comprehensive exercise to rewrite the Companies Ordinance (Cap. 32), the new Companies Ordinance (Cap. 622) commenced on 3 March 2014 and provides a modernised legal framework for the incorporation and operation of companies in Hong Kong. Also, the new Competition Ordinance came into full effect on 14 December 2015, which aims to enhance Hong Kong’s free market economy. The Hong Kong legal system also features comprehensive regulations governing intellectual property, and enforcement system for the protection of intellectual property rights. All of these characteristics make Hong Kong a sound forum for the execution of contracts or the resolution of disputes by an independent judiciary, or by the experienced and internationally renowned Hong Kong International Arbitration Centre. Hong Kong law also provides for the enforcement of foreign judgments in civil and commercial matters, as well as the reciprocal enforcement of PRC judgments.

taxation

Hong Kong’s taxation system is based on the principle of territoriality where profits from a trade, business or profession are taxed only if they arise in or derive from (commonly referred to as “sourced in”) Hong Kong.

Under the territoriality principle, residence of a particular taxpayer is not relevant to the determination of the assessability of its profits to tax. Rather, what generally matters is where the activities that are the source of profits took place; if abroad, then it is likely that the profits will be exempt from tax. For instance, a trading company established in Hong Kong would not be subject to tax in Hong Kong if the contracts giving rise to the trades are negotiated and concluded outside of Hong Kong.

Hong Kong also does not tax capital gains, as well as most dividends and interest, so that a holding company in Hong Kong is not taxed on income or gains from ownership of foreign properties. And finally, other than its Mandatory Provident Fund regime, Hong Kong does not impose any payroll tax, turnover tax, sales tax, value added tax, gift tax so that the cost of doing business is not inflated with the panoply of taxes and other charges commonly seen in other jurisdictions.

Where profits are taxable, the corporate tax rate is currently 16.5%, while individuals are taxed at progressive rates on their net chargeable income starting at 2% and ending at 17%; or at a standard rate of 15% on net income (i.e. income after deductions), whichever is lower.

Hong Kong has a double tax agreement with China which offers qualifying Hong Kong tax residents preferred withholding tax rates on dividends, interest, and royalties, and certain capital gains upon disposition of an investment in Mainland China, as well as clear permanent establishment rules. Hong Kong’s common language and culture with the Mainland allows tax authorities to work in close cooperation with PRC authorities and to ensure consistent application of the tax agreement. The efficient systems and sound procedures have helped identify taxpayers who are eligible to benefit from the tax agreement, they also provide sufficient evidence to the PRC authorities of their eligibility.

Furthermore, as of January 2016, Hong Kong has 40 tax agreements in force, one in negotiation with commitments to continue expanding its tax agreement network both regionally and around the world.

Hong Kong does not have a formal transfer-pricing regime, however. The issue of transfer pricing has become more prominent with the trend likely to continue as Hong Kong moves to implement some or all of the BEPS (Base Erosion and Profit Shifting ) proposals. Hong Kong has already begun a consultation for the adoption of the common reporting standard and automatic exchange of information. Going forward, in light of upcoming changes


in China, it is quite possible that Hong Kong will adopt formal transfer pricing rules and procedures to keep up with China and its regional neighbours.

Deciding on a Hong Kong holding or operating structure upon entry to China (and other jurisdictions in Asia Pacific) is a complex exercise, but Hong Kong’s territorial tax system and expanding tax treaty network offers unique advantages for the mainland or regional investor. When the time comes to face taxation in a post BEPS world, Hong Kong will undoubtedly continue to be the jurisdiction of choice in Asia Pacific for holding or operating companies targeting China and Asia Pacific.

eStaBLiShinG a BuSineSS VehiCLe and StruCturinG China ProJeCtS throuGh honG KonG

A foreign investor seeking to set up a business presence in Hong Kong may establish:

■ a representative office;

■ a branch office of an overseas company; or

■ a Hong Kong private limited company.

It is also possible to establish partnerships and/or acquire an existing business, though the private limited company is the most commonly used business vehicle amongst foreign investors. Under the new Companies Ordinance, a court-free amalgamation procedure of wholly-owned companies within the same group has also been introduced. There is no general restriction on a foreign investor’s ability to hold shares in, or be a director of, a Hong Kong private limited company.

A private limited company can be incorporated fairly quickly (in about seven to ten business days), and the incorporation process is simple and can be conducted online. Moreover, the regulatory requirements governing its administration are relatively uncomplicated. Investors seeking a quicker route to setting up operations in Hong Kong may also consider purchasing a so-called shelf company, which is a “ready-made” company that was previously incorporated for the sole purpose of sale.

A private limited company can be held by a sole shareholder and administered by a sole director. These need not be Hong Kong residents and may be one and the same individual or corporation, except that a company which is a member of a corporate group to which a listed company is a member may not have a corporate director. All Hong Kong companies are also required to have a company secretary to assist with maintaining its books and records (amongst other responsibilities). Unlike shareholders and directors, the

company secretary must ordinarily reside in Hong Kong (in the case of an individual) or have its registered office or place of business in Hong Kong (in the case of a corporation).

A foreign investor planning to set up operations in China may begin by establishing a Hong Kong private limited company to act as a holding company for its China project. This might take the form of a joint venture with a local Hong Kong partner with experience in the PRC in the relevant industry. Alternatively, the foreign investor may establish its own subsidiary in Hong Kong. Subject to the requirements of Chinese laws and regulations, the joint venture company or subsidiary company could establish a foreign investment enterprise in China in the form of a Sino-Equity Joint Venture (“eJV”) or Co-operative Joint Venture (“CJV”) with a local Chinese partner, or a Wholly Foreign-Owned Enterprise (“WFoe”), which would be a 100% subsidiary of the joint venture company or subsidiary company.

One of the key benefits of using such Hong Kong based investment structures is that it may serve to accommodate the administration of the foreign investor’s regional corporate group and the rights and obligations of shareholders close to the location of the China project. This can make both logistical management and communications more efficient as oppose to handling such matters from the foreign investor’s home jurisdiction. At the same time, it allows the foreign investor to benefit from all of Hong Kong’s underlying geographical, and operational advantages.

A multinational corporation that uses third party distribution networks for its products in China and other parts of Asia may find Hong Kong an excellent location to base its pan-Asia distribution hub. A Hong Kong subsidiary can act as master distributor for Asia, linking up its various distribution agreements with Asian distributors under a master distribution agreement with the Hong Kong subsidiary.

Furthermore, through the Closer Economic Partnership Arrangement between Mainland China and Hong Kong (“CePa”), Mainland China accords Hong Kong preferential treatment in accessing its market through trade in products and the establishment of foreign investment enterprises providing services in the Mainland. Foreign investors establishing manufacturing facilities, or who have already established service companies in Hong Kong, may benefit from the concessions to market access to China available under CEPA, provided that they comply with CEPA requirements. For more information, please refer to our chapter on CEPA.

http://www.cr.gov.hk/en/publications/docs/4-e.pdf


CLoSer eConoMiC PartnerShiP arranGeMent (CePa)

Upon its accession to the WTO in December 2001, China has agreed to a progressive timetable for the liberalisation of its market to WTO member states. As part of its commitment, in June 2003, the first phase of the Closer Economic Partnership Arrangement between Mainland China and Hong Kong (“CePa”) was executed by the governments of China and Hong Kong (individually the “Side” and collectively the “Sides”). Since then, further phases of CEPA have been progressively executed. The two Sides have broadened and enriched the content of CEPA and signed ten Supplements between 2004 and 2013, expanding market liberalisation and further facilitating trade and investment. In December 2014, the Agreement between the PRC and Hong Kong on Achieving Basic Liberalisation of Trade in Services in Guangdong (“the Guangdong Agreement”) was signed under the framework of CEPA, enabling early realisation of basic liberalisation of trade in services with Hong Kong and Guangdong.

On the basis of the Guangdong Agreement, the two Sides continued with discussions and on 27 November 2015, signed the Agreement on Trade

in Services (“the agreement”), extending the geographical coverage to the whole PRC for basic liberalisation of trade in services.

CEPA was executed to provide enhanced mutual market access for each Side in one another’s territory. It also contains provisions dealing with general facilitation measures for bilateral trade and investment between the Sides. Since Hong Kong imposes few restrictions on foreign trade and investment, CEPA’s liberalisation measures largely consist of concessions granted by the PRC with respect to products originating in Hong Kong and various service sectors. These concessions have accelerated or, in some cases, increased Hong Kong’s access to the Chinese market as compared to other WTO members.

CEPA takes the form of a free trade agreement and is the first such instrument to be executed between the Sides. It is, however, an arrangement between two separate Customs as opposed to a bilateral agreement between two nations since the Sides are part of one state, the People’s Republic of China.


ProduCtS

Products originating from Hong Kong and which comply with the relevant CEPA rules of origin, as certified by a CEPA Certificate of Origin (“CePa Co”), are eligible for importation into China from Hong Kong at zero tariff. This concession is not granted to any other WTO member state (at the time of writing). The product categories listed in CEPA cover nearly all Hong Kong products, with the exception of certain products prohibited from being imported into the country. Such prohibited products include electrical, medical and chemical waste products as well as wild animal products (such as tiger bone).

SerViCeS

CEPA also grants concessions within specified service sectors to CEPA-qualified service providers (including foreign-owned and managed Hong Kong companies). These are known as Hong Kong Service Suppliers under CEPA (“hKSS”).

CEPA service sectors include distribution (wholesale, retail, franchising and commission agency services), advertising, banking and financial services, securities and futures, information technology, telecommunications, airport services, insurance, legal and accounting services, logistics, transportation, warehousing and storage, real estate and construction, trademark and patent agency, tourism, human resources recruitment services, audio-visual, convention and exhibition, printing and publishing, research and development, medical, dental and management consultancy. As individual HKSS, eligible Hong Kong professionals in certain professions may qualify to practise or carry out certain activities related to their profession in China, depending on the nature and extent of the specific CEPA concessions for each profession.

Generally speaking, for a Hong Kong Company to qualify as a CEPA HKSS, the main requirements are:

■ Incorporation in Hong Kong: the company must be incorporated in accordance with the Companies Ordinance (Cap. 32) and has obtained a valid business registration certificate and licence to provide the services in question, if any such licence is required in the service sector concerned. The Hong Kong branches of overseas companies are excluded from this since they are not incorporated in Hong Kong.

■ Three to five years of substantive business operation in Hong Kong in the relevant service sector: this depends on the sector concerned. The nature and scope of the Hong Kong services must encompass the nature and scope of the services intended to be provided in the Mainland. Liaison offices and so-called “mail box companies” are excluded due to their lack of substantive business.

■ The company must have fulfilled its profit tax payment obligations (if any) in accordance with the laws of Hong Kong during the above described period.

■ Compliance with requirements relating to local staffing: over 50% of the staff used to carry out the substantive business must be residents staying in Hong Kong without limit of stay, or Mainland Chinese holding one-way permits for Hong Kong.

■ Compliance with requirements relating to business premises: the scale of the business premises must be commensurate with the scope and scale of the business operations.

This demonstrates CEPA’s relevance not only to large corporations but also to Small and Medium Enterprises (“SMes”), since compliance with the HKSS definition does not necessarily relate to size. Instead, it requires a rational link between the extent of the business facilities and the nature and scope of the business being operated. Administratively, it is even possible for a Hong Kong company to utilise the business history of its wholly owned subsidiaries to fulfil the above requirements.

The following are examples of benefits that have been granted to HKSS through CEPA:

■ CEPA has given qualified HKSS a head start in the establishment of Wholly Foreign-Owned Enterprises (“WFoes”), or allowing higher foreign shareholdings in sino-equity joint ventures, in certain CEPA service sectors. For example, since 11 December 2004, the PRC has largely opened its distribution sector pursuant to its WTO commitments. HKSSs, however, enjoyed a general first move advantage, ahead of this date, in the establishment of distribution WFOEs (excluding the distribution of certain restricted products). Restrictions on the distribution of some restricted products are also gradually removed under subsequent phases of CEPA.

■ HKSS banks have benefited from reduced registered capital requirements and other financial requirements for the establishment of PRC branches.


■ CEPA has allowed PRC branches of HKSS banks to engage in insurance agency business.

■ CEPA has granted HKSS access to the PRC market in the logistics sector (a sector which does not in fact appear in its WTO schedule of service sector concessions).

■ In the professional job placement sector, HKSS can establish a joint venture with a majority foreign shareholding, whereas other foreign investors are restricted to a minority shareholding, at the time of writing.

trade and inVeStMent FaCiLitation

CEPA also contains provisions on Trade and Investment Facilitation (“tiF”) between the Sides in order to improve and streamline bilateral trade and investment.

The seven areas covered by the TIF provisions are: (i) trade and investment promotion; (ii) customs clearance; (iii) product quarantine and inspection, food safety and quality assurance; (iv) e-commerce; (v) transparency in laws and regulations; (vi) SMEs; and (vii) Chinese medicines and medical products.

an orGaniC aGreeMent

CEPA is a flexible, continuously expanding scheme. Due to its flexible nature, various forms of co-operation between the Sides that have not been specifically written into the text have been grouped under the umbrella of CEPA. Such measures have served to boost both the economies.


“One Belt, One Road” is a development strategy and framework, proposed by the highest levels of PRC Government that focuses on connectivity and cooperation among countries along two main routes, the land-based “Silk Road Economic Belt” and oceangoing “Maritime Silk Road” which run through the continents of Asia, Europe and Africa, connecting vibrant East Asian economies at one end and developed Western European economies at the other, while encompassing 65+ countries along the route. The One Belt One Road initiative (“oBor”) covers countries as diverse as Singapore, Georgia, Kenya and the Netherlands. OBOR offers enterprises opportunities to leverage off this initiative and for powerful partnerships to be established between international and Chinese enterprises.

oVerVieW oF “one BeLt, one road” initiatiVe

The initiative was first introduced by China’s President Xi Jinping during his visits to Central and Southeast Asia in September and October 2013. The strategy underlines China’s push to take a bigger role in global affairs, and its need to export China’s production capacity in areas of overproduction such as steel manufacturing

and infrastructure construction. However, the OBOR initiative is a broad initiative and captures everything from regional arts festivals and book fairs through to the establishment of the US$100 billion Asian Infrastructure Investment Bank (“aiiB”), the US$100 billion BRICS New Development Bank and the US$40 billion Silk Road Infrastructure Fund. In March 2015 China’s National Development and Reform Commission (“ndrC”), Ministry of Foreign Affairs and Ministry of Commerce jointly issued the Visions and Actions on Jointly Building Silk Road Economic Belt and 21st Century Maritime Silk Road (“Visions and actions Plan”) for the OBOR initiative, which, similar to a strategy paper, acknowledges that the OBOR is a pluralistic and open process of co-operation which can be highly flexible and does not seek conformity.

However, at its core OBOR demonstrates a high level political commitment in China to work with OBOR countries to increase trade investment and facilitation and interconnection between participating countries. A key focus of this is on reducing barriers to trade – both overcoming literal barriers (such as inadequate port, rail and road infrastructure), to overcoming less tangible barriers (such as reducing tariff, and easing customs and quarantine processes).

RUSSIAMoscow

Beijing

XianCHINA

Silk RoadEconomic Belt

NETHRotterdam

Venice

ITALYGREECE

Athens

EGYPT

KENYANairobi

Colombo

INDIA

Kolkata

IRAN Dushanbe

TURKMEN

UZBEKKAZAKHSTAN

KYRGTAJIK

Fuzhou

INDONESIA

Jakarta21st-CenturyMaritime Silk Road

one BeLt one road – China’S neW outBound trade initiatiVe


OBOR calls for an improvement on the region’s infrastructure, with a call for greater energy and power interconnections and to establish a secure and efficient network of land, sea and air passages across the key routes. Additionally, the initiative calls for greater policy co-ordination (such as opening free trade areas and improving co-operation in new technologies) and financial integration (such as carrying out multilateral financial cooperation in the form of syndicated loans and supporting foreign countries to issue RMB denominated bonds). Furthermore, whilst the OBOR is firmly rooted in the Silk Road’s thousand year old heritage, it also clearly looking to the future – greater e-commerce interconnectivity and advancing the construction of fibre optic cables is encouraged.

one BeLt one road in aCtion

Since OBOR’s 2013 launch, we have seen the successful launch of the Asian Infrastructure Investment Bank (AIIB), the BRICS New Development Bank and the Silk Road Infrastructure Fund (“SrF”). The former two institutions (AIIB and BRICS New Development Bank) are not exclusively directed towards the OBOR (although they are indeed relevant), but the latter, SRF, as the name suggests, has OBOR projects as a prime focus.

Additionally, Chinese regulators have continued to lay the regulatory and diplomatic foundations to support the OBOR initiative. Domestically, under the guidance of the March 2015 released Visions and Actions Plan (which lays out the broad strategy of the initiative (see above)), Chinese regulators have issued a series of supporting guidance. This includes China’s State Administration of Taxation notifying of tax services and improvements contemplated for the OBOR route and the Ministry of Transport drafting supporting plans and measures. Additionally a number of Chinese provinces have published guidance notes and plans relevant to their local areas, for example Guangdong, Hunan, and Henan. Each of these localised plans focuses on the geographical benefits and respective strengths of each province. For example the Guangdong plan focuses on developing shipping and cross-boundary infrastructure in the Pearl River Delta (covering the Guangdong-Shenzhen-

Hong Kong and Macau bay area); whilst the inland province of Henan plans on positioning itself as an access point for the opening up of China’s inland regions to the outside world.

On the international front, China’s diplomats have been busily engaging with relevant counterparties, with international agreements or memoranda issued jointly with a diverse range of countries to further the aims of OBOR for both nations’ benefit.

internationaL CoMPanieS SuCCeSSFuLLY utiLiSinG oBor oPPortunitieS

In this context, a large portion of China’s foreign investments and trade going forward are expected to take place in OBOR countries. However, the OBOR is not only outward looking from China – it is a two-way street, with OBOR’s Visions and Actions plan specifically welcoming companies from all countries to invest in China and encouraging Chinese companies to participate in infrastructure construction and undertake other investments in other countries along the route.

Key industries for the OBOR initiative include: infrastructure and projects; energy and power; transport and logistics; information technology and industrial development; and financial markets.

Successfully implementing projects along the OBOR will not be without risks and challenges. Overcoming these risks will require thorough due diligence exercises and robust partnership and joint venture arrangements. More importantly success will depend on enterprises finding the right partners and having the right support networks providing a thorough understanding of local conditions, regulators, market players and, more generally “ways of doing business” in both China and the foreign host jurisdictions. This will be essential to be able to adequately identify, quantify and overcome risks and opportunities; to achieve this, an on the ground presence and knowledge of suitable partners and relevant contacts (both for foreign parties in China; and for Chinese parties in the foreign jurisdiction) is a perquisite.


Importantly, whilst China has allocated significant capital and resources towards implementing OBOR, China cannot implement the OBOR alone. Success of this initiative requires co-operation between Chinese enterprises and foreign counterparties in a raft of sectors and regions, covering everything from small scale trade and investment, to the delivery of large

scale multi-jurisdictional game-changing infrastructure...and consequently the OBOR initiative offers countless opportunities for foreign companies to partner with Chinese companies, enterprises and financial institutions.


SettinG uP Your BuSineSS


BuSineSS and inVeStMent StruCture

Investment from any country or territory outside the PRC, including Taiwan or the Special Administrative Regions of Hong Kong and Macau, constitutes foreign investment in China. Although China has encouraged foreign investment for over 30 years, the legal framework still contains restrictions for investors and mandates a wide range of government approvals and requirements that may be unfamiliar to enterprises doing business in China for the first time.

LiMitation on ForeiGn inVeStMent ProJeCtS

The Provisions for Guiding the Direction of Foreign Investment categorizes foreign investment projects as “encouraged”, “permitted”, “restricted” or “prohibited”. Specific types of foreign investment that fall into these are listed in the Foreign Investment Industrial Catalogue (the latest version was promulgated on 10 March 2015, and effective as of 10 April 2015, the “Catalogue”). The Catalogue should be the primary guidance for foreign investors to ascertain the feasibility of the potential investment in a specific industry in China and whether any fundamental restriction (e.g. the limitation

on the percentage of foreign shareholding) would apply, and should be consulted at an early stage of an investor’s China business plan. In general, they include:

encouraged

■ projects that involve advanced or new technology

restricted

■ projects in areas that are technologically backward, or belong to certain sectors that China is in the process of gradually opening up (e.g. banking, telecommunications, legal services)

Prohibited

■ projects that threaten public interest and national security or that may cause serious environmental pollution are prohibited (e.g. weapon manufacturing, postal business, publication business, compulsory education)

Projects not listed in the Catalogue are generally considered permitted and may not have fundamental restriction.


aPProVaL authoritieS

Foreign investment in China is subject to a system of multi-tiered approvals. The key approval authorities and procedure usually include:

■ Ministry of Commerce or its local counterparts (“MoFCoM”) – MOFCOM is the primary authority approving foreign investment. For establishment of Foreign Invested Enterprise(s) (“Fie”), the approval from the competent MOFCOM is a requirement. The category under the Catalogue and the investment amount will determine whether approval at the provincial, municipal or district-level MOFCOM will be required;

■ State Administration of Industry and Commerce or its local counterparts (“aiC”) – AIC is the business registration authority. Registration at the competent AIC is required after obtaining MOFCOM’s approval.

Additionally, separate approvals of the FIE’s business scope may be necessary, if the business to be undertaken falls under the supervision of a particular government agency. For example, an FIE that manufactures pharmaceutical products would need its business scope approved by the State Food and Drug Administration or its local counterparts, while an FIE engaged in certain kinds of information technology works may require an approval from the Ministry of Industry and Information Technology or its local counterparts.

In addition to these main authorities, other authorities would also be involved in the establishment and operation phases of the FIE. For example, for matters in relation to foreign exchange, the State Administration of Foreign Exchange or its local counterparts (“SaFe”) may be involved. Land use and real property matters may be subject to the supervision of the State Land Administration Bureau or its local counterpart. For Joint Ventures where a Chinese State-owned Enterprise is to contribute its tangible assets as its capital contribution into the JV, then the State-owned Assets Administrative Commission will be involved in approving the asset appraisal and contribution. For environmental impact assessment, especially for manufacturing enterprises, the Environmental Protection Bureau and its local counterparts may be involved. Specific and preferential tax treatment is approved by the State Administration of Taxation along with the State Council.

In addition to the foregoing, for fixed–assets foreign investment projects, depending on the classification of the project pursuant to the Catalogue and the total investment amount, the approval or record-filing at National Development and Reform Commission or its local counterparts (“ndrC”), as applicable, may be required prior to MOFCOM’s approval. In practice, fixed–assets foreign investment projects should include projects involving infrastructure construction (e.g. construction of factories or buildings) or technical innovation (e.g. reconstruction and innovation for new equipment and technology).

It is always important to ensure that all required governmental approvals have been obtained from the proper level and proper agency of the Chinese government. Otherwise, certain administrative punishment or fines may be imposed on the FIE.

ForeiGn inVeStMent StruCtureS

Foreign investment in China typically takes the form of either a Joint Venture (“JV”) or a Wholly Foreign-owned Enterprise (“WFoe”). JVs were the first investment structure allowed and therefore were the most common vehicles in the early stages of China’s development. Since China began to liberalize its investment policies, and particularly after its accession to the World Trade Organization, WFOEs became the preferred FIE structure in most unrestricted industries.

JVs and WFOEs each have their own benefits and disadvantages. Many foreign investors are attracted to the WFOE vehicle because it allows the foreign party to have complete control over the management of the enterprise, major financial decisions, and the use of intellectual property rights. JVs allow foreign investors who are new to the China market to work closely with a local partner that may have significant contacts with the local business community, specific geographic or industry knowledge, and experience with government relations.

A JV can be either a Sino-Foreign Equity Joint Venture (“eJV”) or a Sino-Foreign Cooperative Joint Venture (“CJV”). JVs with foreign ownership of more than 25% will enjoy treatment given to foreign-invested enterprises.


eQuitY Joint VentureS

An EJV is an independent legal entity with limited liability. The JV partners contribute capital to the enterprise and enjoy rights to a percentage of the profits equal to its contribution to the registered capital. Capital contributions may be in cash or in-kind (e.g. land use rights, buildings, intangible assets or equipment).

The in-kind contributions should undergo a valuation so that the parties’ respective equity contributions may be determined. The required valuation prices can impact the commercial flexibility of the parties.

The EJV contract must also set out a schedule for contributions of registered capital. During the term of the EJV, the parties may not withdraw their contributions to the registered capital, nor transfer or assign their equity interests without prior governmental approval. Any transfer of equity interest is also subject to the consent of the JV partner.

The management and operations of an EJV is governed by a board of directors (the highest authority of an EJV) and the managerial staff, who are responsible for the day-to-day operations of the EJV. The chairman of the board, who must also be the EJV’s legal representative, may be either a Chinese or foreign national. In practice, in an EJV contract, the parties would agree on which party appoints the chairman and the vice chairman would normally be appointed by the party that does not appoint the chairman.

Managerial staff consists of a general manager, management personnel such as chief financial officer or deputy general manager and other board-appointed officers. It is common that if one party has the right to nominate the general manager, the other party will have the right to nominate the chief financial officer or deputy general manager.

EJVs must prepare quarterly and annual accounting statements for distribution to the JV partners, the local tax bureau and other Chinese authorities. The annual accounting statements must be audited by a Chinese registered accounting firm. While the foreign party has the right to conduct a separate audit of the EJV’s accounts (at its own expense), such audits are not binding under Chinese law.

Profit distribution is based on the computation of the after-tax net profits of the EJV. For EJVs, allocation into the EJV’s reserve fund, bonus and welfare fund for the EJV’s employees and an enterprise expansion fund are required. The actual amounts to be allocated may be determined by the board of directors and are usually calculated as a fixed percentage of the after-tax net profits. Any sums remaining after such deductions may

be distributed to the parties in accordance with the ratio of their capital contribution in the EJV.

Profit distributions are not compulsory and profits may be retained for distribution in later years. The term of EJVs can be agreed by the parties in the EJV contract and is subject to the approval by the competent authority. An EJV will expire at the end of its term unless the parties and the approval authority agree to extend the term.

CooPeratiVe Joint VentureS

The essential characteristic of a CJV is its flexibility. A CJV is often established as a company with limited liability and legal person status, but the law allows it to be a non-legal person enterprise without the protection of limited liability.

Compared to an EJV, the legal regime offers more flexibility to the investors of a CJV, where the profit-sharing ratio does not necessarily have to reflect the ownership interest ratio of each investor but may be negotiated by the shareholders based on their contractual agreements. The parties may provide cooperation conditions instead of injecting capital contributions into the CJV.

A CJV’s management structure can be in the form of a board of directors or a joint management committee. It is likely that the limited liability-type CJV would have a board of directors and its management system would be similar to that of an EJV. A CJV without legal person status is required to establish a joint management committee. There must be at least three members on the board of directors or joint management committee.

CJV accounts must be audited and verified by an accountant (engaged individually or jointly by the parties) registered in China. A CJV without legal person status must keep unified account books and the parties must also keep their own separate account books. Profits and losses may be shared in accordance with a contractual formula that may or may not reflect the parties’ corresponding capital contributions to the registered capital of the CJV. The term of the CJV should be specified in the CJV contract and the renewal of which should be subject to the parties’ agreement and the approval of the relevant government authorities.

A foreign party’s investment in a CJV may be repatriated, in full or in part, prior to the expiration of the term of the CJV, as long as the CJV contract provides that ownership of all of the fixed assets of the CJV shall revert to the Chinese party upon expiration of the CJV term. Thus, CJV contracts commonly include a clause providing for this reversion of assets.


In practice, the CJV mechanism of investment is normally intended for large investments such as joint venture Build-Operate-Transfer projects, infrastructure projects and hotel ventures etc., and therefore may not be well-suited for every type of investments.

WhoLLY ForeiGn-oWned enterPriSeS

Currently the most frequently utilised foreign investment vehicle in China is the WFOE. A WFOE typically takes the form of a limited liability company. The equity interest in a WFOE is entirely owned by its foreign investor or investors. At one time, a WFOE was permitted only to be used as an investment vehicle if it either utilised advanced technology or exported a minimum of 50% of its products. These restrictions are no longer in place, and WFOEs may be established in a wide variety of industry sectors. In the latest revision to the Catalogue, the total number of “restricted” items, for which foreign investment may be subject to certain restrictions on foreign shareholdings or specific approvals, was reduced by 50% compared to the previous version.

The day-to-day operations of a WFOE are controlled solely by its management, with the highest authority being a meeting of the shareholders. A WFOE should either have a sole executive director (if the WFOE is small in scale) or a board of directors consisting of 3-13 members.

Accounting rules applicable to WFOEs are identical to those of EJVs. All accounting records must be kept in Chinese, and for those written in a foreign language, notes in Chinese must be included. Only Chinese-registered accountants may verify annual financial statements. WFOE account books must be maintained within China, and annual financial statements must be submitted for the record to the local financial and tax authorities. Allocations to a reserve fund and a bonus and welfare fund for employees must be made.

WFOEs could remit its profits to its foreign investor abroad, except that they may not distribute profits until they have made up for losses, if any, in preceding years.

A WFOE may be terminated prior to the end of its stated term according to the same general procedures applicable to EJVs, with the important exception that all decisions regarding termination, sale or restructuring can be made by the WFOE’s shareholders and should be approved by the relevant governmental approval authority.

rePreSentatiVe oFFiCeS (“reP oFFiCe”)

A Rep Office may be established in China by a foreign company or other economic organization. The establishment of a Rep Office in China requires the approval of the relevant governmental authority. Upon approval, the Rep Office must register with authorities including the AIC, the public security bureau, the tax administration and customs. A Rep Office is not a legal person and may not engage in direct business (profit-making) operations. It is treated like a branch of its non-PRC parent. The Rep Office can engage in “business liaison” activities and perform marketing and market research activities on behalf of a foreign enterprise.

ForeiGn-inVeSted CoMPanieS LiMited BY ShareS (“FiCLS”)

A FICLS is a limited liability company whose capital is divided into equal shares. FICLS is the only form of FIEs that can be listed on China’s stock exchanges. A FICLS may be newly established by way of promotion or public offer, although in practice, it is not common to set up an FICLS as a greenfield project but rather by acquisition. Other form of FIEs may also be converted into a FICLS subject to satisfactory of certain conditions and government approval.

The founders of a FICLS are restricted to a three-year lock-up period after listing during which they cannot dispose of their shares.

aLternatiVe ForeiGn inVeStMent VehiCLeS

The Chinese government has taken steps in recent years to facilitate RMB denominated investments by foreign parties, in large part to encourage the internationalization of the RMB. As a result, several new channels are available to foreign corporations and funds for structuring their investments in local Chinese companies.

ForeiGn inVeSted inVeStMent enterPriSe (“Fiie”)

FIIEs are usually set up by foreign investors to carry out investment activities in China. An FIIE can be set up as a WFOE or an EJV. Pursuant to the Provisions on the Establishment of Investment Companies by Foreign Investors (商务部关于外商投资举办投资性公司的规定), the requirements for establishing an FIIE are relatively high. For example, the foreign investors should


(i) have total assets of more than USD 400 million, with at least one established FIE in China with actual paid-in registered capital exceeding USD 10 million; or (ii) has established ten or more FIEs in China with actual total paid-in registered capital exceeding USD 30 million.

ForeiGn inVeSted Venture inVeStMent enterPriSe (“FiVie”)

A RMB fund may now be established pursuant to the Foreign-Invested Venture Investment Enterprise Administrative Regulations (外商投资创业投资企业管理规定) (“FiVie regulations”). Pursuant to the FIVIE Regulations, a foreign venture capital fund may establish a fund with one or more Chinese partners. The fund, referred to as an FIVIE, is a Chinese entity and its investments are denominated in the local currency, RMB.

The principle advantage to the FIVIE investment vehicle is that it can deploy funds directly and quickly to Chinese portfolio companies without establishing an offshore structure, and such portfolio companies are eligible for listing on the onshore and offshore stock exchanges. However, there are uncertainties regarding the tax treatment of the foreign fund upon exit from the investment. Also, the portfolio companies which the FIVIE would invest can only be unlisted high and new technology enterprises.

ForeiGn PartnerShiPS

On 25 November 2009, the State Council released the Administrative Measures for Establishment of Partnerships within China by Foreign Enterprises and Individuals (外国企业或个人在中国境内设立合伙企业管理办法) (the “Foreign Partnership Measures”), which became effective on 1 March 2010.

The Foreign Partnership Measures permit a foreign entity or individual to establish foreign invested partnerships (“FiP”) in China with one or more other foreign parties or by partnering with domestic individuals, entities or other organizations.

In addition, an FIP may be established by registering with AIC and does not require prior approval from MOFCOM. Foreign investors in an FIP may make their investments either in exchangeable foreign currencies or in legally acquired RMB. The Partnership Law provides substantial flexibility in terms of structuring the partners’ commercial relationship. For instance, under the Partnership Law, profit distribution can be set

according to the partnership agreement, and the ratio need not correspond to the partners’ respective capital contributions.

It is important to note that the Foreign Partnership Measures do not explicitly replace or invalidate existing laws and regulations concerning foreign investment, such as the Foreign Investment Industrial Catalogue. Instead, existing restrictions and regulation of foreign ownership in certain industries will still apply to FIPs, as do provisions concerning taxation, foreign exchange, customs and other matters that apply for FIEs in general.

QF SCheMeS

QF schemes in relation to inbound foreign investment into capital market primarily include QFII scheme and QFLP schemes.

The QFLP scheme refers to Qualified Foreign Limited Partner (“QFLP”) scheme. This scheme enables qualified foreign investors (acting as the limited partners) to set up a private equity fund with a qualified domestic entity (acting as the general partner). The fund may be established in the form of a limited partnership or a limited liability company, and is permitted to carry out private equity investment, subject to the approved quota (i.e. the maximum investment amount approved by competent authorities). The operation of a QFLP is under close supervision of financial administration, SAFE and other competent authorities. Currently, the QFLP scheme is only available in a limited number of trial areas including Shanghai, Beijing, Tianjin, Chongqing and Shenzhen.

The QFII scheme is viewed as a significant development as China gradually opens its highly restricted securities market. Under the scheme, qualified foreign institutional investors (“QFii”) are permitted to invest in Chinese securities markets subject to approved quotas and the administration of China Securities Regulatory Commission. Different eligibility criteria (e.g. minimum paid-in capital) apply to different types of QFII applicants, including fund managers, insurance companies, securities companies, commercial banks and other institutional investors. Based on the regulation promulgated by SAFE on February 2016, the calculation method and the application procedure of the quota has been changed, and the timeline required for remittance of investment principal has been removed.


VariaBLe intereSt entitieS (“Vie”) StruCture

VIE structure has been used as a way for foreign investors to invest in industries in which foreign investment is restricted or prohibited under the Catalogue. Under a VIE structure, the foreign investor would indirectly control, through certain contractual arrangements, a domestic operating entity which is able to carry out certain business not open for direct foreign investment in China. Such contractual arrangements enable the foreign investor to control the operation and share the profits of the domestic enterprise, and the financial results of the domestic enterprise would be consolidated by the foreign investor. VIE structures are mainly used for offshore financing and listing. However, there has been no specific regulations issued by the government regarding the VIE structure to date.

ProCeSSinG and aSSeMBLY arranGeMentS

These arrangements are where a Chinese party processes materials or assembles parts supplied by a foreign party. In most cases, the foreign party also provides the manufacturing equipment. Under this arrangement, the foreign party retains title to all imported materials and the final processed product, with the Chinese party receiving a fee or a portion of the finished goods. Whether the Chinese party retains the manufacturing equipment at the end of the term of the arrangement is negotiable. The foreign party is permitted to conclude such processing and assembly arrangements with qualified “operation units” only. Other than approvals from commercial authorities, operation units must also comply with Customs requirements pertaining to the submission of relevant documentation and recording of subsequent imports of parts, materials and equipment.

aCQuiSition oF ChineSe CoMPanieS

In addition to greenfield foreign investment projects, acquisition of Chinese companies has developed significantly and become an important way for foreign investors to access the PRC market.

Acquisition of an existing Chinese company enables the foreign investor to acquire the licenses, approvals or permissions required to engage in the business of particular industries and may shorten market entry. Moreover, the foreign investor may, through due

diligence, assess the situation of the target company and the relevant market as well as any potential problem that may arise.

Under PRC law, acquisition of FIEs and acquisition of non-FIE Chinese companies are regulated by different regulations. Acquisition of FIE is mainly regulated by the Several Provisions on Changes in Equity Interest of Investors in Foreign-invested Enterprises. Acquisition of non-FIE Chinese companies is mainly subject to the Provisions on Acquisition of Domestic Companies by Foreign Investors (“M&a rules”). For any acquisition of listed companies, separate sets of takeover rules apply.

Foreign acquisition of a Chinese company may generally be structured in two different ways, i.e. an equity transaction or an asset transaction. By taking over all or part of the equity of the target company, the foreign investor may enjoy the established market position of the target company, but as in other jurisdictions, it will be exposed to the risk of existing liabilities associated with the target company.

An asset deal will avoid historical liabilities by allowing the buyer to cherry-pick the assets to be transferred. However, in practice, asset deals are in fact less popular because of the potentially higher tax burden, the need for new operation licenses and the difficulty and time required to transfer each and every asset within a short period of time.

Foreign investors’ acquisition of Chinese companies is also subject to the Catalogue and government approval.

For acquisition of an FIE, approval from the original approval authority that has approved the establishment of the FIE in the first place will be required. Additional approvals may also be sought if the FIE is in a regulated industry or if it is a listed company. After completion of the approval process, the change in equity of the FIE will need to be registered with the original AIC or its local counterparts.

For acquisition of a non-FIE Chinese company, approvals from NDRC and MOFCOM are usually required. If the target company owns a well-known trademark or a historical Chinese trade-name, declaration to MOFCOM must be made. Additional approvals may also need to be sought if the FIE is in a particular industry or if it is a listed company. After the completion of the approval process, the acquisition must also be registered with AIC or its local counterparts. Other registration procedures with SAFE, custom offices etc. will also be followed.


One of the key points noteworthy is that, in addition to the above transaction approvals, if the foreign acquisition of a Chinese company meets certain criteria, it is also subject to antitrust review and/or national security review. These reviews can be very time consuming and may introduce uncertainties to the transaction timing. Foreign investors should take them into consideration when planning the acquisition.

draFt ForeiGn inVeStMent LaW

MOFCOM released the PRC Foreign Investment Law for public comments (“FiL”) on 19 January 2015 for public comments until February 2015, but the formal FIL has yet to be adopted into law. If adopted, the new FIL will replace the existing Sino-Foreign Equity Joint Venture Law, Sino-Foreign Cooperative Joint Venture Law and Wholly Foreign-Owned Enterprises Law and it is clear that once adopted, the new FIL’s impact on foreign investment in the PRC will be far-reaching and comprehensive.

Two key definitions to understand before delving into the FIL are “Foreign Investor” which includes persons who do not hold Chinese nationality, and enterprises established pursuant to the laws of other countries and “Chinese Investor” which includes persons of Chinese nationality, the Chinese government and any PRC enterprise that is under the control of a Chinese Investor. Any PRC enterprise that is under the control of a Foreign Investor will also be viewed as a “Foreign Investor”.

The concept of “actual control” is introduced by FIL. Under the FIL, a domestic enterprise actually controlled by foreign investors (e.g. WFOE) will be treated as a foreign enterprise and may be subject to certain requirements or restrictions on foreign investments. Correspondingly, the foreign investments carried out by foreign entities which are under actual controlled of domestic investors (e.g. round-trip investment) can be regarded as investments made by domestic investors and therefore is not subject to restrictions on foreign investment.

The FIL covers traditional activities within the scope of foreign investment (e.g. green field investments and M&A), but now also covers other areas such as the provision of financing for one year to invested companies,

the right to use domestic land and ownership of domestic properties and also control of a PRC enterprise through contracts and trusts. Also captured is any offshore transaction that results in a change of control of a Chinese company. No doubt, the expansion of the types of activities that are considered foreign investment raises concerns for foreign companies, many of which have designed structures intended to provide flexibility and avoid entanglement in the PRC legal system.

It is also clear that under the FIL, VIE structures would be clearly regarded as a type of foreign investment which would have to comply with the FIL. Under the FIL, the current rationale for implementing a VIE structure would likely no longer exist and it is likely that they would no longer be viable in many instances, since contractual control would be treated the same as a direct investment.

When the FIL goes into effect, an existing foreign-invested enterprise has to, within three years, change its organizational form and organizational structure pursuant to the Company Law, the Law on Partnership Enterprises, the Law on Sole Proprietorship Enterprises and other relevant laws and regulations.

The FIL represents a new stage in the legal framework governing foreign investment activity in the PRC. While some elements can be viewed as a logical development and refinement of existing practices, others represent arguably a radical departure from the existing framework.

Free trade ZoneS

The State Council has, in the past two years, set up four Free Trade Zones (“FtZ”) in Shanghai, Tianjin, Fujian and Guangdong respectively, which are intended as test precedents for the rest of China.

Closely linked with the establishment of the FTZs is China’s first use of a “negative list” approach to regulate foreign direct investment (“Fdi”). Compared with the Catalogue used in other parts of China, the “negative list” takes the opposite approach, i.e. any sector not listed on the “negative list” is allowed to be invested in by foreign capital with reduced government oversight, which may bring more economic opportunities for foreign investment in the FTZs.


The first negative list had been published in the Shanghai FTZ in 2013, with 190 sectors listed as restricted or prohibited for FDI, The number of restricted or prohibited sectors was reduced to 139 one year later in 2014 and was further reduced to 122 on 8 April 2015 when FTZs in Tianjin, Guangdong and Fujian were set up and the negative list was made applicable to all four existing FTZs.

ShanGhai PiLot Free trade Zone

Located in the Pudong New Area of Shanghai and launched on 29 September 2013, the Shanghai Pilot Free Trade Zone is China’s first free trade zone. The Shanghai FTZ, as of the end of 2015, consists of five areas, including the bonded area, Lujiazui area, Jinqiao area, Zhangjiang area and the World Expo area.

New policies in Shanghai FTZ can generally be grouped into four categories:

■ financial reforms, covering (i) loosening of controls over the RMB capital account, (ii) liberalization of interest rates, (iii) expansion of RMB cross-border business, (iv) encouraging the development of shipping finance and the freight index derivatives, and (v) gradually granting licenses for new cross-border financial products;

■ simplifying administration processes and expanding market access, covering (i) negative list approach, (ii) simplifying procedures for incorporating FIEs, and (iii) simplifying approval process for outbound investments;

■ upgrading of customs supervision framework; and

■ creation of a competitive regulatory and tax environment.

tianJin PiLot Free trade Zone

Tianjin Pilot Free Trade Zone was officially launched on 21 April 2015, consisting of three areas: Binhai New Area Central Business District, Dongjiang Bonded Port Zone and Tianjin Bonded Port Zone (including the Airport Economic Zone), covering 119.9 square kilometres. The main objective of Tianjin FTZ, located in the northern marine and industry hub of China, is to focus on the areas of shipping logistics, financial leasing and high-end manufacturing (including aviation and aerospace industry and high-end equipment manufacturing) and the regional integration of Tianjin, Beijing and Hebei Province.

GuanGdonG PiLot Free trade Zone

Guangdong FTZ, launched on the same day as Tianjin FTZ, consists of three areas: Guangzhou Nansha New District, Shenzhen Qianhai Shekou Area and Zhuhai Hengqin New District and covers 116.2 kilometres. The Guangdong Pilot Free Trade Zone aims at the integration of the Pearl River Delta (Guangdong, Hong Kong and Macau), and focuses on liberalising the service trade, exploring new regulatory systems (such as supervision systems regarding Customs and finance etc.) and providing more favorable opportunities to Hong Kong companies under the Mainland-Hong Kong Closer Economic Partnership Arrangement (CEPA).


FuJian PiLot Free trade Zone

The Fujian Pilot Free Trade Zone, approved by the State Council on 12 December 2014, consists of bonded zones in Xiamen, Fuzhou and Pingtan with an area of 118.04 square kilometres. Given its geographical location and the Economic Cooperation Framework Agreement (ECFA) signed between the PRC and Taiwan in 2010, Fujian FTZ is focusing on free trade and cooperation with Taiwan and investment in the fields of finance, tourism, agriculture and marine science and technology. Under the “One Belt and One Road” policy, Fujian FTZ is expected to be a key area for the development of Maritime Silk Road of China.

ContraCt LaW

The PRC Contract Law (“Contract Law”) provides legal recourses for those faced with the occasional business partner that fails to honour a contract. In addition, the Supreme People’s Court released an Interpretation II on Several Issues Concerning the Application of the Contract Law (“interpretation ii”), which became effective on 13 May 2009. This was a significant move of the Supreme People’s Court aimed at further protection of business contracts.

In addition to setting forth the various requirements for contracts of all types, the Contract Law also delineates a number of instances where a contract can be either void (i.e. have no legal validity at any time), rescinded at the option of a party, or valid but unenforceable in China.

One aspect of the Contract Law that is often overlooked by foreign investors is that certain contractual deficiencies – such as lack of fairness and violation of social norms, which may not be significant in other jurisdictions – can render a contract unenforceable in China.

the FairneSS reQuireMent

Article 5 of the Contract Law requires that the parties to the contract adhere to the “principle of fairness”. A Chinese judge or arbitrator would typically have the discretion to decide what is or is not fair, and the standards used by judge or arbitrator may be different to the standards customarily used by the parties. At a minimum, a fairness requirement must be included in the wording expressing the rights and obligations of the parties to the contract, otherwise the contract may be held void, rescindable at the option of the innocent party, or unenforceable against the innocent party.

Standard CLauSeS

Standard clauses refer to clauses that are formulated in anticipation by a party for the purpose of repeated usage and that are not a result of consultation with the other party during the conclusion of the contract. The Contract Law requires that a party that provides standard clauses which have the effect of exempting itself from liabilities or limiting its liabilities should draw the other party’s attention to such clauses in a reasonable manner.

Pursuant to the Interpretation II, reasonable manner may include using special wordings, symbols or fonts to highlight the points and explaining the standard clauses based on the other party’s requests. Further, if there is more than one possible interpretation of a standard clause, the interpretation in favour of the other party should apply. In the event of discrepancies between a standard clause and a non-standard clause in a contract, the non-standard clause should prevail.

Article 9 of the Interpretation II provides that if a party providing standard clauses fails to fulfill its obligations of alerting and explaining the standard clauses under Article 39 of the Contract Law, resulting in the other party failing to note the terms on the exemption or limitation of its liabilities, and the other party applies for revocation of the relevant standard clauses on that basis, the People’s Court will uphold such application.

exeMPtion CLauSeS

An exemption clause, whether standard or non-standard, is void under the Contract Law if it purports to do any of the following:

■ excluding liability for bodily harm caused to the other party; or

■ excluding liability for property losses due to willfulness or gross negligence.

inVaLid CLauSe and ContraCt

Under the Article 40 and Article 52 of the Contact Law, a clause (including a standard clause) is void if it involves any of the following:

■ exempting the party providing the standard clause from liability, increasing the liability of the other party and depriving the other party of a major right;

■ using fraud or coercion to conclude a contract, harming the interests of the State;


■ engagement in malicious conspiracy to harm the State, collective or third party interests;

■ an illegal objective being disguised in legal form;

■ harming the interests of the public; or

■ violation of mandatory provisions of law.

If a contract, or a portion of a contract, is rendered invalid, the party at fault may be liable for damages to the other party or even third parties as a consequence of its performance of the contract, and any property obtained under the contract shall be returned.

the SoCiaL aCCePtaBiLitY reQuireMent and non-VioLation oF LaW

Article 7 of the Contract Law requires that the parties to a contract respect public morals and avoid disturbing social or economic order or harming the interests of the public. The Article also requires the parties to comply with laws and administrative regulations; however, it is difficult to determine when a contract becomes unenforceable due to a violation of an applicable law. Where the main purpose of a contract involves the violation of law, the entire contract is naturally rendered invalid. However, where the violation is deemed only a minor infraction, or the non-compliant portion of the contract can be severed, either the entire contract or the valid clauses of the contract may remain in force. In practice, a clause regarding the severability of the clauses may be included in a contract to deal with this issue.

JuriSdiCtion oF ChineSe ContraCt LaW

The Contract Law is largely based on the UNIDROIT General Principles of International Commercial Contracts (a document largely reflecting the principles of contract law as seen in Western European civil law systems) albeit with some special rules and some variations.

While non-Chinese parties often prefer to choose another legal system for reasons of familiarity and greater certainty, the content of Chinese law is, broadly speaking, within the normal expectations of most non-Chinese parties, and can usually be agreed to as part of a wider compromise.

The restrictions imposed by Chinese law on the parties’ ability to choose a non-Chinese governing law depend on whether the contract is considered to be “foreign-related”. Contracts with the following characteristics may be regarded as “foreign-related”:

■ a party or both of the parties concerned is/are a foreign citizen(s), a legal person(s) or other organization(s) in a foreign country or a person(s) without nationality;

■ the habitual residence of a party or both of the parties concerned is outside the territory of China;

■ the subject matter is outside the territory of China;

■ the legal facts that establish, change or eliminate civil relations occurred outside the territory of China; or

■ other situations that may be recognized as foreign-related civil relations.

Thus, any contracts lacking the elements outlined above would have to be governed by Chinese Law.

Meanwhile, parties to a foreign-related contract are permitted to choose a non-Chinese governing law save that:

■ foreign law will not be applied in situations related to protection of employers’ interests, food or public health safety, environmental safety, financial safety such as foreign exchange administration and anti-trust or anti-dumping cases.

■ foreign law will not be applied where it conflicts with the public interests of China; and

■ foreign law will also not be applied if the relevant choice of law represents an attempt by the parties to seek to avoid Chinese mandatory laws, regulations or prohibitions.


While the business concept may not have a long history in the PRC, western and local franchise brands have developed significantly in China over the past 20 years. In the early 1990s, the PRC government did not formally regulate franchising. To help develop the industry, regulate the market and protect the rights and interests of Chinese franchisees and customers, the PRC government in 1997 issued the Interim Measures on Regulating Commercial Franchise Operations. The China Chain Store and Franchise Association (“CCFa”) – a nationwide, non-profit franchise membership association was also formed. Around the same time, the franchise market started to grow rapidly and the market was gradually opened to foreign investment, along with a series of new regulations on commercial franchising activities being promulgated.

Current FranChiSe reGuLationS

Currently, the key regulations on franchising in China include the following, collectively the “Franchise regulations”:

■ Administration of Commercial Franchises (promulgated by State Council on 6 February 2007 and effective as of 1 May 2007; hereinafter referred to as the Regulation);

■ Administrative Measures for the Record Filing of Commercial Franchises (promulgated by the Ministry of Commerce and effective as of 1 February 2012; hereinafter referred to as the Filing Measures); and

■ the Administrative Measures for Information Disclosure of Commercial Franchises (promulgated by the Ministry of Commerce and effective as of 1 April 2012; hereinafter referred to as the Disclosure Measures);

eLiGiBLe FranChiSorS

In accordance with Franchise Regulations, the following requirements must be met by the franchisor before a franchise is sold or offered:

■ two plus one requirement

The enterprise must own at least two stores that have been in operation for more than one year. This requirement also applies to Master Franchisees.

■ Filing requirement on PrC registered business resources

For filing purpose, the franchisor must own business resources registered in China, i.e., registration certificate of trademark, patent, or other operation

FranChiSe


resources relating to franchise. Under current practice, a trademark registration certificate or IP registration certificate is preferred. If such registration is not available, a Copyright Registration Certificate of the enterprise logo and a Notice of Acceptance of Trademark Registration Application are possible options to satisfy the requirement for registration of business resources.

diSCLoSure oBLiGationS

A franchisor shall disclose the following information to the franchisee in accordance with the Franchise Regulations at least 30 days prior to entering into the franchise contract with the franchisee. If there are any major changes to the information provided in the Initial Disclosure, the franchisor shall notify the franchisee in a timely manner.

■ the name, domicile, legal representative, registered capital, business scope and basic information about the franchisor and the franchise;

■ basic information relating to the franchisor’s registered trademark, enterprise logo, patent, proprietary technology and business model;

■ the type, amount and payment method of franchising fees (including whether a deposit is collected and its terms and method of return);

■ prices and conditions of products, services and equipment provided to franchisees;

■ specific content, methods and implementation plans to continually provide instruction, technical support, sales training and other services to franchises;

■ specific measures for guiding and supervising the business activities of the franchisee;

■ the investment budget for the franchise outlet;

■ the quantity, location and operational status of all franchisees in China;

■ summary of accounting and audit reports of the last two years, provided by accounting firms;

■ its litigation or arbitrations status relating to the franchise in the last five years;

■ records relating to any major breach of law by the franchisor or its legal representatives; and

■ other information required by the Ministry of Commerce (“MoFCoM”).

Article 5 of the Disclosure Measures set out further details of documents required for disclosure.

FranChiSor FiLinG

a) initial franchisor filing

The franchisor shall complete a record filing within 15 days upon the signing of its first franchising agreement in China with MOFCOM or its local counterparts.

The following documents are required to be submitted for record filing:

■ Materials outlining the basic situation of the franchise.

■ Information regarding the distribution of all franchisees within China.

■ The franchisor’s market plan.

■ The enterprise business licence or other certificate evidencing legal status.

■ Registration certificates of trademarks, patents or other business resources related to the franchise.

■ Materials evidencing the satisfaction of the “2+1” rule, which refers to the franchisor having conducted franchising activities, owning at least two stores for not less than one year.

■ The first franchising agreement signed in China.

■ A sample franchising agreement.

■ A catalogue of the franchise operation manual (with the page of each chapter and total pages of the manual specified; and where the manual is provided electronically, the total number of pages in print shall be provided);

■ Relevant department approval documents for products or services that require approval prior to the sale of the franchise.

■ The franchisor’s promise bearing the signature and stamp of its legal representative.

■ Other documents as may be reasonably required by the department.


Where any of the above documents are established outside the territory of the People’s Republic of China, the document shall be notarised (with its Chinese translation provided) and certified by the consulate of the People’s Republic of China in that country (or through an equivalent certification process that is provided under a treaty signed between the PRC and that country).

b) on-going filing obligations

Franchisors filed with the MOFCOM are required to update its filing with the MOFCOM within 30 days if any of the following changes occurs:

■ Incorporation Information

■ Business Resources (e.g. trademarks, patents, enterprise logos used for China franchise business)

■ Distribution of the franchised units in China (e.g. Addition/deduction of franchised units)

c) annual filing

Franchisors filed with the MOFCOM are required to submit an annual report including the following information through the MOFCOM online filing system http://txjy.syggs.mofcom.gov.cn/between Jan. 1 to Mar. 31 every year.

■ Number of franchise agreements in the preceding annual report

■ Number of new franchise agreements (after the preceding annual report)

■ Number of terminated franchise agreements (after the preceding annual report)

■ Number of franchise agreements in performance

■ Number of franchised stores

■ Turnover of franchised stores

■ Number of directly owned stores

■ Turnover of directly owned stores

reGuLatorY PenaLtieS

MOFCOM has the authority to enforce Franchise Regulations, and it can also impose fines for up to RMB500,000 for violations. More significantly, MOFCOM can publically announce a violation which of course carries reputational risks for franchisors. There is also a possibility for criminal penalties.


eMPLoYMent LaW ChaLLenGeS

eMPLoYMent LaW ChaLLenGeS

On 1 July 1997, the People’s Republic of China (“PrC”) resumed the exercise of sovereignty over Hong Kong, which became the Special Administrative Region (“hKSar”) of the PRC. The Basic Law of the HKSAR (“Basic Law”) came into effect also on 1 July 1997 and is the constitutional document for the HKSAR.

The Basic Law contains the concept of ‘one country, two systems’ and expressly provides that the laws previously in force in Hong Kong, such as the common law, rules of equity, ordinances, subordinate legislation and customary law will continue to be maintained, except any laws that contravene the Basic Law. The Basic Law expressly states that the HKSAR courts may refer to precedents of other common law jurisdictions when making decisions. Furthermore, it states that the Courts of Final Appeal and the judiciary of the HKSAR are given the power to invite judges from other common law jurisdictions to participate in the judicial process. Given the marked similarity between much of the legislation in the HKSAR and the legislation in England and Wales, in practice, this means that there is very heavy reliance upon the authority from the English courts in the field of employment law.

The Hong Kong Employment Ordinance (Cap. 57) (“employment ordinance”) sets out a statutory framework to govern many aspects of the employment contract by incorporating a number of key terms and conditions into every contract of employment that falls within its coverage. The Employment Ordinance is fairly inflexible in its drafting, yet difficult to understand. For example, the provisions of the Employment (Amendment) Ordinance which came into effect on 13 July 2007 provided a revised calculation of an employee’s wages in relation to payment for the relevant statutory entitlements by calculating the employee’s average daily (or monthly) wages in the 12 months prior to the specified date. The revised calculation would arguably include such payments as a one-off sign-on bonus which may have a significant impact on an employee’s average daily wages in the first few months of employment.

The PRC employment laws are complex, meaning that employing in the PRC can be unpredictable and difficult to assess in terms of risk. Difficulties arise for employers in this complex legal system that could vary from region to region and differ not only in legal content but also in terms of local enforcement. Employers are still grappling


with the significant piece of legislation that came into effect on 01 January 2008, the PRC Labour Contract Law (LCL), which has been implemented in different ways from region to region.

Another key issue for foreign companies is that only a PRC entity can enter into effective labour contracts in the PRC. This means that a representative office of an overseas company is forced to construct its employment contracts using the artificial layer of a labour agent such as the Foreign Enterprise Service Company (“FeSCo”). This leads to an unusual arrangement, whereby the employer in law is frequently far-removed from the day to day control of its employee who, in all but name, is employed by the representative office of the foreign company. There are many practical issues that arise out of this arrangement, not least the challenge that the foreign company faces in protecting its confidential information and intellectual property or enforcing a non-competition covenant, when formally it does not have a direct employment relationship with the individual working.

Against this background, there are some unusual elements of Hong Kong and PRC employment law which frequently cause difficulties for employers. We have summarised some of these below.

terMination

In contrast to many other jurisdictions, including Australia, employers in Hong Kong are not bound by any statutory procedural formalities in relation to carrying out terminations of employment. Furthermore, there is no ‘unfair dismissal’ regime in Hong Kong to provide a remedy for employees whose employment has been unfairly terminated simply as a matter of process. However, the Employment Ordinance does provide remedies to employees whose employment contracts have been terminated in a manner which does not comply with the requirements of the Employment Ordinance or whose employment has been unreasonably terminated in order to extinguish or reduce a right, benefit or protection awardable under the Employment Ordinance. However, these protections are fairly limited. Unusually, in Hong Kong, either party (not just the employer) can terminate the employment contract by making a payment in lieu of the notice period.

By contrast in the PRC, even terminations by mutual agreement trigger statutory severance, and in most cases, termination would practically involve paying

additional severance on top of statutory severance. If mutual termination is not an option due to lack of agreement with the individual, it is difficult to bring the relationship to an end and even poor performers are heavily protected under PRC law. An employer who wishes to terminate on poor performance grounds needs to invest a considerable time and effort to increase the likelihood of such a termination being deemed lawful. This includes establishing that the individual does not meet the role requirements, engaging in significant efforts to retrain the individual and seeking other employment options within the same organisation. Even if all fails, any termination would require a 30 day notice or payment in lieu, along with payment of statutory severance. In addition, the LCL provides that if the employer terminates the labour contract of the employee in the wrong way, the employee may ask for reinstatement of his/her original position or payment of double statutory severance. This means that getting dismissal wrong may damage the business operation or management.

Given the difficulties terminating an employee in in the PRC, a fixed term contract could be one option to lawfully bringing employment relationships to an end. However, the LCL can make it difficult for employers at times. Such as when an individual’s fixed term labour contract is renewed twice, it is required that any new contracts need to be on a non-fixed term or indefinite basis, which brings all the protection to the employee. In addition, severance is payable upon the expiration of a fixed term contract. This means increased financial burdens for employers and greater difficulties in bringing unsatisfactory labour contracts to an end.

hoLidaYS and annuaL LeaVe

In Hong Kong, employees are entitled to 12 paid Statutory Holidays under the Employment Ordinance. However, it is not uncommon for employers in Hong Kong to enhance this entitlement and allow employees to take General Holidays – which are the 12 statutory holidays plus an additional five holidays – as paid holidays. In the PRC, the number of public holidays has been increased to 11 days since 1 January 2008.

In Hong Kong, anyone that is employed under a continuous contract of employment for a minimum period of 12 months is entitled to paid annual leave. This is calculated on a sliding scale from seven days upto 14 days depending on length of service. There is also a clear implementation of annual leave entitlements in


the PRC. So long as an employee has had at least one year’s service in a company, he or she will be entitled to paid annual leave of between 5 and 15 days depending on the length of service, in addition to public holidays. If employees are unable to take their annual leave due to business needs, employers are required to pay employees

300% of their daily salary (effectively 200% as this includes salary paid in the normal payroll), for each day of untaken annual leave. Certain employees will not be entitled to annual leave at all. These include employees who are entitled to a winter and summer vacation (where the total days’ vacation is more than their annual leave entitlement), employees who have taken at least 20 days’ fully paid personal leave in any leave year, or employees who have taken a certain period of sick leave (depending on continuous service).

diSCriMination

Discrimination legislation in Hong Kong provides similar protection to employees to that of Australia. The Sex Discrimination Ordinance (Cap. 480) (“Sdo”), Disability Discrimination Ordinance (Cap. 487) (“ddo”), the Family Status Discrimination Ordinance (Cap. 527) (“FSdo”) and the Race Discrimination Ordinance (Cap. 602) (“rdo”) prohibit certain forms of discrimination in the workplace and elsewhere in Hong Kong. The SDO renders unlawful acts that discriminate against persons on the grounds of sex, marital status, pregnancy and sexual orientation as well as victimisation. The DDO makes discrimination against a person on the ground of disability unlawful. Sexual Orientation, victimisation and vilification on the ground of a person’s or a person’s associate’s disability (defined as a person’s spouse, a person living with a person on a genuine domestic basis, relative, care giver, or another person who is in a business, sporting or recreational relationship with the person) are also deemed unlawful. The definition of a disability is very wide, it includes a disability that: presently exists; previously existed but no longer exists; may exist in the future; or is imputed to a person. The FSDO renders unlawful acts when one discriminates against a person on the grounds of family status (i.e. the status of having responsibility for the care of an immediate family member). The RDO came into force on 10 July 2009 and makes it unlawful for employers to discriminate against an employee on the grounds of race (which includes colour, descent or nation of origin or ethnic origin of a person but interestingly,

grounds such as nationality, citizenship, resident status, length of stay or indigenous villager status of a person are not grounds of discrimination under the RDO).

In the PRC, several laws and regulations have been drafted, revised or passed concerning the protection of the rights of some groups such as women, the disabled, minority ethnic members, HIV carriers and Hepatitis B carriers. The protection of equal rights in employment is included in these laws or regulations. The PRC Employment Promotion Law (“ePL”) states that the employee shall not be discriminated against on the basis of nationality, race, sex or religious belief. It also extends the anti-discrimination protection to rural workers who are employed in cities who should be granted the right of employment equal to that of urban workers and carriers of infectious diseases (but who are otherwise healthy and whose condition does not affect their ability to work). Perhaps most importantly, under the EPL, employees in the PRC are given a legal basis to bring a civil claim for unlawful discrimination against their employers in the People’s Court. However, in practice, it remains generally difficult for employees to bring claims on the basis of discrimination.

trade unionS

Although Hong Kong residents have the right and freedom to form and join trade unions, the level of participation in trade unions is relatively low and, in fact, Hong Kong enjoys a relatively harmonious climate of industrial relations.

The PRC Government believes that it is important to establish all levels of trade unions to represent and protect the legal rights of employees. Therefore, PRC companies are facing pressure from the government and the local federation of labour union to set up a company-level labour union. However, strictly under the Trade Union Law, a company-level labour union is to be initiated by the employees rather than the employers. Once the labour union is established, the employer must contribute and pay funds to its labour union in an amount equal to two percent of its total wages on a monthly basis. In addition, the labour union will be involved in collective negotiations and must be informed of any unilateral termination made by the employer. Due to government supervision and company funding, company-level labour unions are generally cooperative rather than adversarial.


BeneFitS

The Employment Ordinance in Hong Kong sets out a rather unusual entitlement to sick leave – there is an entitlement to accrue ‘sickness allowance’ at a rate of two paid sick days each month in the first year of employment and four paid sickness days each month thereafter. The maximum accumulation at any one time is 120 days. These accrued days are paid at a rate of four-fifths of the employee’s average daily wages (calculated over the previous 12 months) but payment is only due when an employee is off sick for four consecutive days or more. Once the employee is off for at least four days all the sickness days are deemed subject to the sickness allowance up to the accrued maximum.

In the PRC, subject to local requirements, employers and employees are generally required to make contributions on a monthly basis for social security benefits in pension, medical, unemployment and housing. Furthermore, employers are required to contribute towards social security benefits for work-related injury and child bearing. In total, the employer’s contribution towards all the social security benefits generally amounts to around 40% of the employees’ monthly salary (although the employees’ monthly salary for calculation is capped at three times the local average salary).

WorKinG hourS

For the first time in Hong Kong’s legal history, a Minimum Wage Bill was passed. Starting from 1 May 2015, minimum wage was raised to HK$32.5 per hour, and it applies to all employees, subject to limited exceptions including some students and live-in domestic workers. The Bill is intended to set a statutory minimum hourly wage in Hong Kong.

However, apart from the mandatory provision of rest days, there is no regulation on maximum working hours in Hong Kong (except in regard to the employment of children and young persons) although the Bill will impose upon employers an obligation to keep records of the total number of hours worked by an employee in a wage period. There is no requirement to pay overtime as long as the obligations with regards to the payment of the minimum wage are complied with.

Under PRC labour law, standard working hours are eight hours a day, 40 hours a week. For employees who have worked more than the standard working hours, employers must pay employees a specified overtime rate (of between 150% and 300% of the employee’s daily salary rate or hourly salary rate depending on when the employee carried out the overtime). The exception to this is work carried out on a rest day which can be compensated with time off in lieu. However, overtime worked during a normal working day or on a public holiday must be compensated for with money, not time. The maximum overtime, which can be arranged for an employee, is three hours per day and 36 hours per month. These inflexible overtime requirements are often ignored and not fully adhered to. Certain employees may be eligible for exemption to the standard working hours rules, in which case special working hour rules will apply.


eMPLoYMent

The principle employment laws in China are the PRC Labour Law, which became effective on 1 January 1995, and the PRC Employment Contract Law, which became effective on 1 January 2008. The PRC Labour Law, PRC Employment Contract Law and other laws and regulations issued by the Central government are generally applicable nationwide. There are also local regulations and rules issued by provincial, municipal and other lower level authorities that are only applicable to relevant local regions.

eMPLoYMent ContraCtS

All enterprises in China, including both domestic enterprises and foreign invested enterprises, are required to have written employment contracts with their employees.

The employment contract is required to include the following information:

■ name, domicile and legal representative or main person in charge of the employer;

■ name, domicile and resident ID card number or other valid identity document of the employee;

■ term of employment;

■ job description and place of work;

■ working hours, rest and leave;

■ remuneration;

■ social insurance;

■ labour protection, working conditions and protection against occupational hazards; and

■ other matters which laws and regulations require to be included in employment contracts.

A probation period can also be stipulated in the employment contract. The permissible term of the probation period depends on the term of the employment contract but cannot, in any event, exceed six months. Once an employee has completed two fixed-term contracts, an open-term contract should be concluded in most circumstances with limited exceptions. Additionally, if an employee has been working for an employer for at least 10 years and proposes or agrees to renew his or her employment contract, an open-term employment contract is required.

Unlike most other entities in China, representative offices are not allowed to employ staff directly. They must hire the services of individuals through designated


labour agencies under a third-party arrangement. Under this arrangement, the labour agency will employ the individual and the representative office will enter into a service contract with the labour agency for the services of the individual.

It is common practice for the representative office to have a separate side agreement with the employee covering issues such as confidentiality obligations and company policies.

traininG ContraCtS

An employer may impose a reasonable minimum service period only if it provides “special funding” and gives the employee “professional technical training”. Liquidated damages may be imposed on an employee for breach of the minimum service period. However, the amount of liquidated damages may not exceed the training expenses paid by the employer.

reMuneration and BeneFitS

Full time employees are required to be paid at least once per month in readily available funds (i.e. payment in kind is not permitted). Wages are required to be paid directly to employees or to any other person designated by an employee. Local authorities determine the minimum wage standards each year, which vary from city to city.

Employers are generally prohibited from making deductions to an employee’s wages, but the following are circumstances where deductions are permitted:

■ individual income tax of the employee;

■ the portion of social insurance that shall be borne by the employee;

■ alimony or other sums determined by a court; and

■ where the employee’s personal action caused loss to the employer and deduction is clearly provided for in the employment contract, but deduction in this situation may not exceed 20% of the employee’s monthly salary.

All employers and employees are required to contribute to basic social insurance and housing fund schemes. Mandatory social insurance consists of pension, medical, maternity, unemployment and occupational injury insurance. The amount the employer and employee must contribute every month is stipulated by local regulations.

PerMiSSiBLe hourS oF WorK

There are three classifications for permissible hours of work, namely the Standard Working Hours System, the Flexible Working Hours System and the Comprehensive Working Hours System.

Under the Standard Working Hours System, working hours shall not exceed eight hours per day and 40 hours per week. The employer must allow employees at least one rest day per week.

Under the Comprehensive Working Hours System, working hours are comprehensively calculated on a periodic basis. However, the average working hours per day and per week are required to be similar to that required under the Standard Working Hours System. Prior approval from the local labour authority is required before an employer may implement the Comprehensive Working Hours System.

The Flexible Working Hours System allows an employer to require certain employees, such as senior managers, salespersons, and others whose work cannot be measured under the Standard Working Hours System, to work in excess of 40 hours per week without paying overtime compensation. Prior approval from the local labour authority is also required in most situations before an employer may implement the Flexible Working Hours System.

An employer may extend working hours to meet production or operational needs after consulting with the labour union, if any, and employees. Overtime is generally limited to one hour per day; however, in special circumstances, overtime can be extended to three hours per day as long as it does not exceed 36 hours per month. The above limitations to overtime do not apply in the following circumstances:

■ in emergencies, when the life and health of the employees and property are threatened due to natural disasters, accidents or other causes;

■ urgent repairs that are necessary when production equipment, transportation lines or public facilities are in danger, and are affecting production and public interests; and

■ other cases as provided for by law or administrative decrees.


oVertiMe iSSueS

An employee working under the Standard Working Hours System is entitled to receive overtime pay as follows:

■ for overtime worked during normal working days, 150% of the average hourly wage of the employee for each hour of overtime worked;

■ for overtime worked during rest days (e.g. Saturday and Sunday) and if no extra rest can be arranged thereafter, or in lieu of 200% of the average hourly wage of the employee for each hour of overtime worked; and

■ for overtime worked during statutory holidays (i.e. public holidays), 300% of the average hourly wage of the employee for each hour of overtime worked.

LeaVe

Employees are entitled to a minimum amount of annual leave, ranging from five to 15 days, based on the number of years the employee has been in the workforce. Other types of leave employees are entitled to include the following:

■ medical leave;

■ marriage leave;

■ bereavement leave;

■ home leave;

■ maternity leave; and

■ paternity leave

terMination oF an eMPLoYMent ContraCt

An employee has the right to unilaterally terminate an employment contract for any reason upon giving his or her employer 30 days’ advance written notice. In certain circumstances, an employee may terminate an employment contract immediately without notice. Such rights, however, have not been granted to the employer. An employer may only unilaterally terminate an employment contract in certain limited circumstances, namely where the employee:

■ is proven not to satisfy the conditions for employment during the probationary period;

■ materially breaches the employer’s rules and regulations;

■ commits serious dereliction of duty or practices graft, causing substantial damage to the employer;

■ has additionally established an employment relationship with another employer which materially affects the completion of his work with the employer, or refuses to rectify the matter after the same is brought to his or her attention by the employer;

■ causes the employment contract to be invalid due to use of deception, coercion or taking of the employer’s difficulties, to cause the employer to sign the employment contract;

■ is prosecuted for criminal liability;

■ can engage neither in his or her original work nor in other work arranged for him or her after the set period of medical care for an illness or non-work-related injury;

■ is incompetent and remains incompetent after training or adjustment of his or her position; or

■ is unable to reach an agreement with the employer on amending the employment contract where a major change in the objective circumstances relied upon at the time of conclusion of the employment contract renders it un-performable.

In the last three situations, the employer is required to provide the employee with 30 days’ advance notice.

SeVeranCe

Employees are entitled to statutory severance in the following circumstances:

■ the employment contract is terminated by the employee for certain types of violations by the employer;

■ the parties mutually agree to terminate the employment contract after such termination was proposed by the employer;

■ the employment contract is terminated by the employer on any grounds requiring 30 days’ prior notice to the employee;

■ the employment contract is terminated by the employer as part of a collective dismissal;

■ the employment contract is a fixed-term contract that ends, unless the employee does not agree to renew the contract after the employer offers to do so on the same or better terms;


■ the employer has its business license revoked, is ordered to close down or decides on early liquidation; or

■ other circumstances prescribed by law.

Severance is payable at a rate of one month’s average monthly wage for each year of service with an employer. For periods of service of less than six months, half month’s average monthly wage is payable to an employee. Severance is capped at three times the average municipal monthly wage in the location of employment and generally shall not exceed 12 months’ wages.

non-CoMPetition reStriCtionS

An employer can require certain employees, such as senior management, senior technicians and other employees with confidentiality obligations, to be subject to non-competition restrictions. The scope, territory and term of the competition restriction must be agreed between the employer and the employee. The post-termination non-competition term cannot exceed two years and the employer is required to pay compensation to the former employee on a monthly basis during such period. Generally, the amount of compensation can be agreed by the parties, but in some locations in China, the minimum amount of monthly compensation to be paid to the employee for the post-termination non-compete obligation is set by law.

CoMPanY ruLeS

Adoption or revision of company rules that have a direct bearing on the immediate interests of employees requires:

■ discussing the rules with all employees or an employee representative congress;

■ allowing proposals and comments to be submitted by the employees or employee representative congress;

■ consulting with the labour union or employee representatives regarding the rules;

■ finalizing the policy by the company; and

■ publicly communicating the final version of the rules to employees.

eMPLoYMent and reSidenCY reQuireMentS For exPatriateS

Expatriates are required to meet the following basic criteria in order to work in China:

■ be at least 18 years of age and in good health;

■ have the professional skills and appropriate vocational experience (usually two years or more) required for the intended position;

■ have no criminal record;

■ have a definite employer; and

■ have a valid passport.

The position for which an employer recruits an expatriate must be one for which there are special requirements and for which, for the time being, there are no suitable domestic applicants. Before employing an expatriate, an employer must first apply for an employment licence and the expatriate must first obtain work and residence permits.

LaBour unionS

All labour unions in China are organised under the leadership of the All China Federation of Trade Unions (“aCFtu”), which is the only legal labour union in China.

Under the ACFTU, there are local federations of labour unions at the provincial, municipal and county levels, and labour unions by sector and industry. Below the local federations are the labour unions established at the company level.

The principle legislation governing unions in China is the PRC Labour Union Law, which was effective on 27 October 2001. The rules on union establishment within the PRC Labour Union Law and related regulations are somewhat vague, but the generally accepted view is that an employer is not required to establish a union on its own initiative, but that it may not obstruct its employees or the upper level labour union if either of those parties attempt to establish a union within the company.


Once a labour union is established at the company level, the employer’s major obligations will include:

■ making a monthly payment of 2% of the total wages (including salary, bonus, allowance and subsidies) of all employees to the labour union fund;

■ maintaining the employment of the labour union’s full-time chairman, deputy chairman and committee members during the periods they remain in their positions, subject to certain exceptions;

■ giving advance notice to the labour unions of the reasons for unilaterally terminating an employee’s employment. If the labour union expresses any views the employer is required to consider such views;

■ allowing the labour union representatives to attend board meetings if issues that affect the personal rights and interests of the employees will be discussed (e.g. wages, welfare, labour safety and social insurance); and

■ consulting with the labour union regarding proposed rules and regulations of the employer which directly involve the personal interests of employees.

Due to government supervision and company funding, labour unions are generally cooperative rather than adversarial.

LaBor diSPatCh

Labor Dispatch is one of alternative hiring methods in China but it plays a diminished role nowadays. Under this arrangement, the labor dispatch service provider is the legal employer of the dispatch worker (entering into an employment contract) and the company is the user entity. The labor dispatch company is normally a company approved to provide general labor dispatching services under its business license.

Labor dispatch employees may only be used in three limited positions: temporary, substitute or auxiliary. The total number of labor dispatch employee must not exceed 10% of the overall employees (including labor dispatch employees) of the user entity. These rules are not applied to the representative office of overseas companies.

The fees charged by the labor dispatch company are calculated mainly and directly based on the salary of the dispatch workers. The user entity can normally require dispatch employees to comply with its internal policies, work under its instruction, and undergo performance review by the user entity.

Although the labor dispatch company signs the employment contract with the dispatch workers, employer liability falls jointly on the labor dispatch company and the user entity, and usually the labor dispatch company shifts all of the liability to the user entity through the commercial agreement between the two entities.

Hiring dispatch workers into positions other than the three types of positions outlined, or engaging with an unqualified labor dispatch service company, may result in the workers being deemed direct hire employees, and a fine imposed on the user entity.

StaFF outSourCinG

Under this arrangement, the user entity and the outsourcing company enter into commercial agreement in relation to the outsourcing service. The outsourcing company is normally a company approved to provide the specific service under its business license.

The fees charged by the outsourcing company are not calculated based on the salary of the workers the outsourcing company uses to provide the service, but on the value of the service or the size of project.

The user entity is not allowed to have direct control or management over the outsourcing employee. Instead, it must be done through the outsourcing company. The risk of joint employment liability is less than the labor dispatch arrangement as long as the user entity does not have direct management of outsourcing employee, does not require them to comply with entity’s internal policies (except very few provisions such as workplace safety and security rules), and administer them separately from the direct hire employees.

The rules with respect to labor dispatch and staff outsourcing have changed since 2013 and government enforcement action in this space is being closely watched.


diSPute reSoLution

With an increasing number of foreign investors penetrating in to the Chinese market, the number and scale of commercial disputes are also increasing quickly. If a dispute cannot be settled through negotiation between the parties, the case must be submitted for litigation or arbitration. Mediation is not a mandatory instrument for resolving disputes in China.

LitiGation in China

There are four levels of courts in China: 1) the basic People’s Court; 2) the Intermediate People’s Court; 3) the High People’s Courts and 4) the Supreme People’s Court. Most major cases involving a foreign party fall under the jurisdiction of the Intermediate People’s Court. Court decisions may be appealed once, but the judgment of the second instance is final and binding upon the parties immediately.

Although it is certainly necessary for foreign investors to take note of the peculiarities of the Chinese judicial system before becoming involved in a dispute, the court system in China is reasonably fair with the assistance of experienced counsel. The loyalty of the judiciary to the government should be kept in mind. When “sensitive” cases (meaning cases considered to affect government

policies and interests or certain individuals or entities favoured by the government) are brought to court, great pressure is placed on the judges not to embarrass the government or cause any inconvenience to the favoured party with an adverse judgment.

However, lawyers should be informed in advance if the case is to be handled as a “sensitive case” and steps can be taken to diffuse the sensitivity.

The plaintiff must pay a fee stipulated in the court rules and calculated as a percentage of the amount at issue in the claim. The defendant must pay a similar fee if any counter-claim was filed. This fee is kept by the court regardless of the result of the case. Additional fees will be charged if the court hires any witnesses, expert advisors, translators, valuators or any other specialists whom the court feels could be helpful in the resolution of the case. Pursuant to the PRC Civil Procedure Law, all evidences generated/obtained outside China including the Power of Attorney in the litigation proceedings shall be notarized and authenticated.

A case involving a foreign party is usually heard by a panel of three judges. All of the arguments and evidence must be in Chinese according to the PRC Civil Procedure Law. The hearing will also be in Chinese, and translation may


be provided at the request of the parties concerned at their expense. Foreign parties wishing to retain lawyers as agents to bring an action on their behalf must appoint PRC lawyers from local firms.

During the course of the court proceedings, the judges will usually make an attempt to mediate the case. If a mediation agreement is reached by and served to the parties, it will become legally effective. If the mediation effort fails, the court shall render a judgment without delay.

To recognize and enforce a Chinese court judgment by foreign court, there must be either bilateral treaty or multilateral international convention between China and the concerned foreign country. Unfortunately, up to now, there is no such mutual judicial assistance between China and its several major business partners, such as Japan, the US and the UK.

In December 2014, the Supreme People’s Court published its interpretation (the “Interpretation”) on the application of the amended Civil Procedure Law, which came into force on 1 January 2013 (the “2013 Civil Procedure Law”). In respect of the foreign-related civil procedures, amongst other things:-

1. in addition to the other circumstances, a case might also be treated as foreign related, if the habitual residence of either party or both parties is located outside the territory of China (Article 522 of the Interpretation);

2. to prove his/her identity, a foreign individual shall submit his/her passport and other certificate (but it is unclear whether or not the passport and other certificate still needs to be notarized and legalised in the usual way) (Article 523 of the Interpretation);

3. as to foreign enterprise or organisation, the power of attorney issued to its representative to participate in the court proceeding in China on its behalf had to be notarised and legalised in the country of its registration, but now such document can also be notarised and legalised in a third country where the foreign enterprise or organisation has registered and established a place of business (Article 523 of the Interpretation); and

4. as to service on the principle person in charge of a foreign enterprise or organisation who is in China, the Interpretation makes it clear that such principle person includes director, supervisor, and senior executive of the foreign enterprise or organisation (Article 535 of the Interpretation).

arBitrationS in China

The past few decades have witnessed the dramatic evolution in Chinese arbitration, with many promising improvements in arbitration systems and services.

Arbitration in China is regulated by the Arbitration Law, the PRC Civil Procedure Law, the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards (“new York Convention”) and various judicial interpretations issued by the Supreme People’s Court. The arbitration rules of the China International Economic and Trade Arbitration Commission (“CietaC”) and other arbitration institutions are not legally binding but also play an important role in China.

Theoretically, the arbitral awards made in China shall be recognized and enforced in more than 140 countries and regions pursuant to New York Convention.

arBitration inStitutionS in China

In the past, Chinese arbitration commissions were divided into foreign-related arbitration commissions and domestic arbitration commissions. Only CIETAC and the China Maritime Arbitration Commission (“CMaC”) had the capacity to accept foreign-related cases. Presently, all arbitration commissions are allowed to handle both domestic and foreign-related arbitration disputes. However, pursuant to the PRC Civil Procedure Law, PRC Arbitration Law, domestic arbitration cases and foreign-related arbitration cases are subject to different procedural administration and judicial supervision.

Foreign investors frequently refer disputes to CIETAC, which has established a reputation for fair and efficient dispute resolution services and handles 800 to 1,000 cases per year.

Special issues in relation to CIETAC arbitration.

As a result of the dispute between CIETAC Beijing headquarters and its Shanghai office as well as ShenZhen Sub-Commissions on the allocation of the jurisdiction of arbitration cases, CIETAC Beijing suspended the authorizations to CIETAC Shanghai and CIETAC Shenzhen in August 2012 by announcing that any arbitration clause selecting “CIETAC Shanghai/Shenzhen Sub-Commission” as the arbitration institution must be submitted to CIETAC Beijing. On the other hand, CIETAC Shanghai and Shenzhen jointly announced they are independent and duly established arbitration institutions under PRC Arbitration Law. Furthermore, CIETAC Shanghai changed its name to Shanghai


International Arbitration Center or Shanghai International Economic and Trade Arbitration Commission (“ShiaC”); CIETAC Shenzhen changed its name to Shenzhen Court of International Arbitration or South China International Economic and Trade Arbitration Commission (“SCia”). New arbitration rules designed by SHIAC and SCIA both provide that SHIAC and SCIA have authority to accept cases in which “CIETAC Shanghai/Shenzhen Sub-Commission” was designated as the arbitration body.

In 2015, the Supreme People’s Court finally issued a judicial interpretation which came into force on 17 July 2015. The contents can be summarised as follows:-

1Where the parties agreed to

submit disputes to “Arbitration by CIETAC South China Sub-

commission” or “CIETAC Shanghai Sub-commission” before the renaming of the

two former sub-commissions

SHIAC or SCIA shall have jurisdiction



commission” or “CIETAC Shanghai Sub-commission” after the renaming of the two former

sub-commissions (including date of the renaming) but

before 17 July 2015

CIETAC shall have jurisdiction

note: in case arbitration has been commenced with SHIAC or SCIA, and the respondent did not challenge the

jurisdiction, SHIAC or SCIA shall have jurisdiction.



commission” or “CIETAC Shanghai Sub-commission” before the renaming of the

two former sub-commissions

SHIAC or SCIA shall have jurisdiction

2015 CietaC arBitration ruLeS

The latest amended CIETAC arbitration rules is effective as of 1 January 2015 (the “2015 Rules”).

arBitration Court

Pursuant to Article 2 of the 2015 Rules, Arbitration Court instead of Secretariat will perform the functions in accordance with the rules.

MuLtiPLe ContraCtS

Pursuant to Article 14 of the 2015 Rules, a party may commence a single arbitration concerning disputes arising out of or in connection with multiple contracts, provided that:

1. such contracts consist of a principal contract and its ancillary contract(s), or such contracts involve the same parties as well as legal relationships of the same nature;

2. the disputes arise out of the same transaction or the same series of transactions; and

3. the arbitration agreements in such contracts are identical or compatible.


ConSoLidation oF arBitrationS

Pursuant to article 19 of the 2015 Rules, CIETAC may consolidate two or more pending arbitrations into a single arbitration at the request of a party if:

1. all of the claims in the arbitrations are made under the same arbitration agreement;

2. the claims in the arbitrations are made under multiple arbitration agreements that are identical or compatible and the arbitrations involve the same parties as well as legal relationships of the same nature;

3. the claims in the arbitrations are made under multiple arbitration agreements that are identical or compatible and the multiple contracts involved consist of a principle contract and its ancillary contract(s); or

4. all the parties to the arbitrations have agreed to consolidation.

Once consolidation is determined, the arbitration proceedings shall be consolidated into the proceeding that was commenced first. It will make the arbitration more efficient and may avoid the conflict in the awards made by different tribunal on related disputes.

interiM MeaSureS

Under current PRC Arbitration Law, neither arbitration commission nor arbitral tribunal has the power to order interim measures. The arbitration commission shall forward party’s request for interim measures to the competent People’s court.

Considering the CIETAC arbitration proceedings may be conducted outside China and the local procedural law may allow arbitral tribunal to order interim measures, Article 23 of the 2015 Rules allows:

1. a party to apply to the Arbitration Court for emergency relief in accordance with the applicable law or the agreement of the parties; and

2. the arbitral tribunal, at the request of a party, to order any interim measure that it deems necessary or proper in accordance with applicable law.

The interim measure may take the form of a procedural order or an interlocutory award.

BenChMarK For SuMMarY ProCedure

According to Article 56 of the 2015 Rules, the Summary Procedure shall apply to any case where the amount in dispute does not exceed RMB 5,000,000 (used to be RMB 2,000,000 under the 2012 Rules). Accordingly, more cases will be able to take advantage of the three-month fast process under Summary Procedure.

SPeCiaL ProViSionS For honG KonG arBitration

CIETAC has established the CIETAC Hong Kong Arbitration Center in the Hong Kong Special Administration Region, which means pursuant to Articles 73 to 80 of the 2015 Rules, the seat of CIETAC arbitration can now be Hong Kong.

JudiCiaL interPretation on arBitration LaW

The Supreme People’s Court promulgated its interpretation on several issues relating to the application of Chinese Arbitration Law (“the Judicial interpretation”) on 8 September 2006. The Judicial Interpretation consolidates the opinions in previous separate judicial interpretations and focuses on the judgment of the validity of arbitration agreement and challenges to arbitral award.

VaLiditY oF arBitration aGreeMent

According to Chinese Arbitration Law, a valid arbitration agreement must designate the name of the arbitration institution. The Judicial Interpretation makes such requirement flexible by providing that even if an arbitration institution is not expressly designated, the arbitration agreement will not be invalid if the arbitration institution can be ascertained under the applicable arbitration rules stated in the arbitration agreement.

reCoGnition oF the PrinCiPLe oF KoMPetenZ-KoMPetenZ

The Judicial Interpretation provides that once an arbitration institution has decided on the validity of an arbitration agreement, the People’s Court will not accept any application to challenge such decision. However, it is just a partial recognition of the principle of Kompetenz-


Kompetenz. In the event that one party contests the competence of the arbitral tribunal and files a request with the People’s Court to decide on the validity of the arbitration agreement, while the other party requests the arbitration institution to confirm its competence, the People’s Court’s jurisdiction over the competency issue is given priority.

ForeiGn inStitutionaL arBitration in China

Under PRC Arbitration Laws, only the bodies named under the Laws will be allowed to conduct arbitration proceedings. It has been uncertainty and heated debate for number years as to whether or not the PRC courts will enforce an award granted by a foreign arbitral tribunal/body which conducted its proceedings in China and whether such award will be regarding as a domestic award or a foreign award. The Judicial Interpretation keeps silent on this issue. In a recent case in 2009, the Ningbo Intermediate People’s Court ruled that an ICC award issued by a Beijing seated tribunal as non-domestic award which can be enforced under the New York Convention.

the honG KonG internationaL arBitration Centre (“hKiaC”)

On 20 November 2015, HKIAC opened a representative office in Shanghai making HKIAC the first foreign arbitration institution to establish a formal presence in Mainland China.

the SinGaPore internationaL arBitration Centre (“SiaC”)

On 25 January 2016, SIAC also announced the opening of its third overseas representative office in Shanghai.

the internationaL ChaMBer oF CoMMerCe (“iCC”)

On 24 February 2016, ICC announced its opening of a representative office in Shanghai’s Free Trade Zone. It was said that the decision to establish an office in Shanghai followed two Supreme People’s Court of China decisions published in 2014 to uphold arbitration agreements that subject relevant disputes to ICC Arbitration in Shanghai and Beijing.

However, the Supreme People’s Court’s decisions only affirm the validity of the arbitration agreement according to which the arbitration shall be conducted in China by

foreign arbitration institutions, the uncertainty of the enforcement of the award through such proceedings remained.

arBitration-reLated deVeLoPMent in the 2013 CiViL ProCedure LaW

The 2013 Civil Procedure Law contains the following developments in relation to arbitration procedures.

inJunCtiVe reLieF aLLoWed

Previously only asset and evidence preservations are stipulated in Civil Procedure Law and injunctive relief is only stipulated in intellectual property laws and maritime law. In practice, courts seldom grant injunctive relief even in intellectual property cases. Article 100 of the 2013 Civil Procedure Law allows the party to request for and the court to order on injunctive relief. Such provision shall be applied to both litigation and arbitration cases.

Pre-arBitration PreSerVatiVe MeaSureS aLLoWed

Article 101 of the 2013 Civil Procedure Law allows preservative measures to be taken prior to commencement of arbitration proceedings, which were not allowed under PRC Arbitration Law. As the new Civil Procedure Law is promulgated later than PRC Arbitration Law, the provisions in the 2013 Civil Procedure Law shall prevail.

It is still unclear whether such Article 101 can apply to the request for preservative measures where the proposed arbitration is to be conducted by foreign arbitration body outside China.

enForCeMent aWardS

In China, the system of enforcement of arbitral awards is threefold, depending on the domestic, foreign-related or foreign nature of the arbitral awards. The enforcement of foreign arbitral awards, i.e. awards rendered by an arbitral tribunal with its seat outside China, is ruled according to the New York Convention, which China adopted in 1986. However, the enforcement of “foreign-related” awards, i.e. awards rendered in an international arbitration by an arbitral tribunal with its seat in China, and the enforcement of domestic awards are ruled by the Chinese Arbitration Law and Civil Procedure Law. One must note the special treatment given to “foreign-related” arbitral awards. The courts examine only the procedural aspects of a foreign-related arbitral award, whereas for domestic


arbitral awards both procedural and substantive issues are scrutinised. However, despite the favourable treatment granted to foreign-related awards, the practice of scrutiny is still not totally compliant with the standard of scrutiny established for foreign awards in the New York Convention. Foreign investors should note that there is a time limit of 2 years for the enforcement pursuant to the Civil Procedure Law.

Mediation in China

Mediation is not a mandatory proceeding to resolve the dispute. The whole process of mediation must be conducted under the consent of the parties. The mediation process stops immediately where one of the parties refuses to continue. Unlike arbitration, where the arbitral tribunal is entitled to arbitrate the dispute and render an award if an arbitration agreement has been reached by the parties even where one party later refuses to submit their dispute to arbitration, the settlement of mediation is completely based on the consent of the parties, and mediators have no capacity to render a decision without the agreement of the parties. The three types of mediation in China are court mediation, arbitration mediation and administrative mediation.

Court Mediation

This is also called judicial mediation. Based on the principle of party autonomy, judges in China routinely attempt to encourage the parties to settle their dispute, frequently in the later stage of a court proceeding. The mediation procedure is essentially a supervised settlement negotiation. If the mediation is successful, the parties will reach an agreement stating the details of the settlement. The agreement thus issued by the court is binding on the parties and is enforceable as a judicial judgment. However, if no mediation agreement is reached or if one party revokes the settlement before it is served, the court must render a judgment without delay.

arBitration Mediation

An arbitral tribunal is also entitled to conduct mediation before or after the commencement of arbitration upon the consent of the parties. Where the parties have reached a settlement agreement before the arbitration procedures, they may request the arbitration institution to constitute an arbitral tribunal to render an arbitral award in accordance with the terms of the settlement agreement. If a settlement is reached through mediation during the course of arbitration, the arbitral tribunal will render a consent arbitral award in accordance with the terms of the settlement agreement. In both situations, the arbitral award will be binding upon the parties. If the parties failed to settle their dispute through mediation, however, the arbitral tribunal must resume arbitration procedures immediately.

adMiniStratiVe Mediation

Administrative mediation refers to mediation that is conducted with the involvement of administrative authorities such as the People’s government, the public security authority (for disputes related to injury or damage suffered as a result of a traffic accident), or the marriage registration authority (for marital disputes).

ConCLuSion

Foreign investors may resolve their disputes in China through litigation, arbitration and mediation. However, in view of the unresolved problems existing in the Chinese judicial system, including the intervention of the government, delays in judgements or local protectionism, it would be more advisable for the foreign investor to select arbitration or mediation as the method for dispute resolution.


PrC BanKruPtCY ProViSionS

The Enterprise Insolvency Law of the People’s Republic of China (“eiL”, also known as the Enterprise Bankruptcy Law) governs the bankruptcy process in the PRC and has been in effect since 1 June, 2007.

FraMeWorK

applicability and accessibility

The EIL applies to all ‘enterprise legal persons’, including private companies, foreign enterprises, limited liability companies, and companies limited by shares, as well as state owned enterprises (“Soes”). Bankruptcy of natural persons and partnerships are not covered by the EIL.

With regards to financial institutions such as banks and insurance companies, the relevant authority of the State Council may apply for their restructuring or bankruptcy pursuant either to the EIL or other relevant laws.

LiQuidation, reStruCture, CoMProMiSe

The EIL offers three different types of bankruptcy proceedings:

■ liquidation (or “bankruptcy”);

■ restructuring (also termed “revival”); and

■ compromise (or “settlement”) by way of a composition deed (or “settlement agreement”) with creditors.

It also allows for the conversion of restructuring and compromise proceedings into bankruptcy proceedings, which in turn can be terminated if the debtor or a third party has repaid all the debtor’s debts.

CoMMenCeMent oF BanKruPtCY ProCeedinGS

Under the EIL, a creditor, the debtor, or, in the case of a financial institution, the relevant authority of the State Council may apply to the People’s Court (the “Court”) to bankrupt or restructure a debtor.

When a creditor has applied for the bankruptcy of a debtor, the debtor or an investor whose capital contribution accounts for more than 10 percent of the debtor’s registered capital may apply to the Court for restructuring, prior to a declaration of bankruptcy. The debtor only may apply for compromise, and also must do so prior to a declaration of bankruptcy.

Once it receives a bankruptcy application, the Court has 15 days to decide whether to accept the application. This gives the Court a great deal of latitude in deciding whether to accept a bankruptcy application.


the teSt For inSoLVenCY

Once the Court decides to assume jurisdiction, it must decide whether the debtor in question is insolvent. A debtor must meet two criteria to be deemed insolvent:

■ the debtor must be unable to pay its debts when due; and

■ the debtor’s assets are not sufficient to repay all of its debts or it is obviously incapable of repaying its debts.

To be able to apply to the Court, a creditor need only establish that the debtor cannot pay its debts as they fall due.

aPPointMent oF an adMiniStrator

As mentioned above, the Court is required to appoint an administrator upon acceptance of the bankruptcy application. Article 24 of the EIL provides that the administrator shall be either:

■ a “liquidation group” comprised of personnel from relevant departments and agencies; or

■ an intermediary organisation established in accordance with the law, such as a law firm, accounting firm, or bankruptcy liquidation firm.

The local courts maintain a panel of qualified professional institutions from which they chose the administrator, which includes “reputable individuals with relevant professional qualifications”. Foreign firms are not included on these panels.

roLe oF the adMiniStrator

The Court appoints the administrator, who takes custody of the debtor’s property and administers the business and estate of the debtor. The EIL does not provide creditors with the ability to select the administrator or set the administrator’s remuneration, which is based upon a set percentage of the total value of the company’s assets.

Either the debtor can remain in possession for the implementation of a restructuring plan, similar to Chapter 11 in the United States, or the administrator can manage the restructuring under a system similar to that followed in the UK and Australia.

The administrator must carry out its duties and report to the Court and is subject to monitoring and supervision by the creditors. The creditors may apply to the Court to replace an administrator if they think the administrator is unable to carry out its duties in a lawful or impartial manner or if there are circumstances that would prevent

the administrator from carrying out its duties competently. An administrator can also resign, but only on the basis of a “justifiable reason”, and must obtain prior approval from the Court. In all instances, final discretion regarding administrators rests with the Court and not with the creditors.

MoratoriuM and SuSPenSion oF ProCeedinGS

After the Court accepts an application for bankruptcy, all ongoing civil proceedings and arbitrations relating to the debtor are suspended until the administrator takes over the management of the debtor’s property and assets. In practice, this is meaningless as the Court is required to appoint an administrator upon accepting the bankruptcy application. Once an application is accepted there is no period of protection in which a compromise or restructuring could take place – an administrator is appointed immediately.

In other jurisdictions, the period of the stay typically lasts from the date of the application for bankruptcy until the declaration of bankruptcy, the last date for compliance with a restructuring plan in the case of a court-based restructuring, or the dismissal of the bankruptcy proceedings.

Unfortunately, a broader moratorium on creditor enforcement action was not incorporated in the EIL. This would have given restructuring efforts some realistic hope of success, providing the debtor with some breathing space from creditor actions so as to formulate a restructuring plan.

CreditorS and the CreditorS’ CoMMittee

The EIL provides for the establishment of creditors’ meetings and creditors’ committees. The creditors’ meetings allow unsecured creditors to participate in the following activities:

■ verifying creditors’ claims;

■ applying to the Court to replace the administrator and examine its expenses and remuneration;

■ supervising the administrator;

■ electing and replacing members of the creditors’ committee;

■ deciding on the continuation or cessation of business of the debtor;


■ adopting restructuring plans and composition deeds;

■ adopting plans for the management of the assets of the debtor;

■ adopting plans for converting the bankruptcy assets into cash at current prices; and

■ passing and adopting plans for the distribution of property in bankruptcy.

Secured creditors may vote on all of the above matters except for the following:

■ verifying creditors’ claims;

■ voting on composition deeds; and

■ plans for the distribution of the debtor’s assets, unless they waive their right to priority in relation to the distribution of assets.

A resolution will be passed by a majority of the creditors present at the meeting holding 50 percent or more of the total unsecured claims. Resolutions passed at these meetings are binding on all creditors, though any creditor may, within 15 days of the passing, ask the Court to revoke a resolution that violates any law or harms that creditor’s interests. This leaves significant opportunity to delay the process.

The creditors’ meeting may also appoint a creditors’ committee of no more than nine members and delegate some of its powers to the committee. Notably, the creditors’ committee must include a representative of the workers’ union of the debtor, and the members of the committee are required to be approved by the Court.

CoLLeCtion, PreSerVation, and diSPoSition oF ProPertY

The EIL puts into effect measures to protect the assets and business of debtors particularly by the appointment of an administrator. The debtor must comply with quite onerous obligations to hand over assets, seals, and books to the administrator. The debtor’s representative may not move from his or her residence or hold any director or senior management positions in any other enterprise once the ruling on acceptance by the Court of the application for bankruptcy is served on the debtor.

treatMent oF ContraCtuaL oBLiGationS

The administrator has discretion to perform or terminate contracts entered into by a debtor prior to the acceptance of the bankruptcy application. The administrator must

provide notice to the other contracting parties of its decision. Failure to do so within two months of the acceptance of the bankruptcy application by the Court will result in the deemed termination of the contract.

This requirement puts an obligation on the administrator to make some relatively quick decisions, often based upon very limited information. This could result in the deemed termination of valuable contracts by default, of which the administrator is unaware.

treatMent oF FrauduLent or PreFerentiaL tranSaCtionS

Administrators upon application to the Court have the power to reverse certain transactions involving property of the debtor entered into within a period of one year before the Court accepts the bankruptcy application. These include gifts, transfers at an undervalue, security given for unsecured debts, early repayment of debts that have not fallen due, and abandonment of rights to repayment.

Similar provisions exist to void transactions that occurred within six months of the acceptance of the bankruptcy application when the debtor was insolvent and continued to pay creditors. In these circumstances, the administrator may apply to the Court to revoke these transactions, unless the debtor’s assets may benefit from such transactions.

Certain acts involving the debtor’s property are automatically invalid. Those acts are the concealing or transferring of property to avoid debts and the fabrication of debts or acknowledgment of debts that are not genuine. The EIL empowers administrators to recover property obtained as a result of such transactions.

Other related provisions include the ability to require investors to fully pay their capital contribution obligations, the barring of debtors from making distributions to their investors during restructuring unless approved by the Court, and the recovery of irregular income and corporate property improperly acquired by directors, supervisors, and senior managers of the debtor.

direCtor and oFFiCer LiaBiLitY

The EIL does not expressly address director and officer liability for insolvent trading (denoting engaging in business when an enterprise is already insolvent). However, it does impose civil liability on directors, supervisors, and senior managers who commit a breach of their obligation of loyalty or due diligence, causing the enterprise to go bankrupt. Penalties for this include being prohibited from


acting as a director, supervisor, or senior manager of any enterprise for three years from the day of the conclusion of the bankruptcy procedures.

StaKehoLder riGhtS, PrioritieS, and reCourSeS

The EIL provides additional recourse for creditors in bankruptcy proceedings within two years of the conclusion of the bankruptcy procedure. During that period, if it is discovered that additional property exists (for example, property that has been transferred to the directors, concealed or sold at an undervalue) the creditors may apply to the Court.

It is expressly provided that, after the conclusion of a bankruptcy procedure, creditors may still pursue guarantors of the debtor and other joint debtors for amounts owed under the guarantees. However, amounts paid under the guarantee will not be recoverable by guarantors against the debtor after the bankruptcy has concluded.

reStruCturinG

Commencement and Period of restructuring

A creditor or a debtor may directly apply to the Court to restructure the debtor. An application can be made on the basis that:

■ the debtor is insolvent (applying the test for insolvency outlined above); or

■ it is “obviously likely” that the debtor is unable to pay its debts.

If a creditor has already applied for the bankruptcy of a debtor, the debtor or an investor holding 10 percent or more of the registered capital may also file an application to restructure the debtor. They can do this after the Court accepts the application, but before the debtor is announced bankrupt.

The restructuring period lasts from the day which the Court approves the restructuring until the termination of the proceedings and appears to be unrestricted, subject to the stipulations in the restructuring plan.

ForMuLation, aPProVaL, and iMPLeMentation oF a reStruCturinG PLan

The EIL places the responsibility for preparing the restructuring plan on either the debtor or administrator, depending upon who the Court has decided should

manage the business and property of the debtor when restructuring is applied for. The EIL does not provide guidance or criteria for the Courts to use in deciding whether the debtor should remain in possession or whether an independent administrator should be in control of the restructuring. Relevant criteria would include whether the debtor has acted honestly in the pre-restructuring period, but the Court is left with a very wide discretion.

Once the Court orders the restructuring of the debtor, a restructuring plan must be submitted to both the court and the creditors’ meeting within six months. A three-month extension is available on “justifiable grounds”. The Court is then obliged to convene a creditors’ meeting to vote on the plan within 30 days of receiving it.

The EIL requires specific matters to be included in the proposed restructuring plan. These include:

■ the debtor’s business plan;

■ the categories of creditors;

■ a debt adjustment scheme;

■ a debt repayment scheme;

■ the time frame for execution of the plan;

■ the time frame for monitoring and supervising execution of the restructuring plan (the supervision period); and

■ any other plans which are beneficial to the debtor’s restructuring.

While the Court has the ultimate authority to approve a restructuring plan, subject to some detailed guidelines, the main aim is to obtain the approval of the restructuring plan by all classes of creditors. The debtor’s investors can only vote in respect of the restructuring plan if their rights will be adjusted in the restructuring plan.

At the creditor’s meeting, creditors are grouped into different classes, as follows:

■ secured creditors;

■ creditors owed work entitlements such as wages, medical and disability subsidies, pension expenses, and old-age insurance;

■ creditors owed taxes (ie tax authorities); and

■ ordinary creditors (unsecured creditors).

There is an option for the Court to establish a sub-class of small claims within the category of unsecured creditors.


The draft restructuring plan is adopted at the creditor’s meeting when each class adopts the plan. A class adopts the plan when:

■ a simple majority of the creditors attending the meeting agree to the plan; and

■ the amount of the debt the agreeing creditors hold exceeds two-thirds of the total debt in that class.

The restructuring plan may be approved by the Court even if some classes refuse to vote or vote against it, provided that secured creditors, workers, and the tax authority are fully paid, unsecured creditors are no worse off than if the debtor went to liquidation, and the plan is feasible. The administrator is given the power to lobby members of a class that has voted against the plan to try and get them to change their vote. Nonetheless, once a plan is approved it becomes binding on the debtor and all creditors.

Once the plan has been approved by the Court, the debtor is responsible for its implementation. At this point, if the administrator is in control of the debtor’s affairs, it must hand over all property to the debtor. The administrator’s role is to then supervise the implementation of the plan. The debtor is required to report to the administrator on implementation throughout this supervision period. Finally, when the supervision period has expired, the administrator submits a supervision report to the Court, and its duties terminate on that date.

terMination oF the reStruCturinG PLan

During the restructuring period, the Court may declare the debtor bankrupt upon an application made by the administrator or a materially interested party if:

■ the debtor’s business position and the status of its assets continue to deteriorate and there is little prospect of a turnaround;

■ the debtor engages in fraud, reduces its assets in bad faith, or commits other acts that are clearly adverse to the creditors; or

■ the administrator is unable to perform his/her duties due to acts by the debtor.

The Court may also declare a debtor bankrupt when no restructuring plan is submitted to the Court and the creditors’ committee within the six-month period referred to above, or during the additional three-month extension period. Equally, the debtor will be declared bankrupt when the restructuring plan is not approved by the Court, following the holding of a creditors’ meetings. If the debtor

is unable to implement the restructuring plan or fails to implement it, the Court may, upon application by the administrator or a materially interested party, terminate the plan and declare the debtor bankrupt.

MoratoriuM For SeCured CreditorS

Under the EIL, secured creditors are expressly precluded from exercising their security rights during the restructuring period. They may, however, exercise their rights if they can show that their security may be damaged or its value greatly diminished.

Subject to this exception, the EIL does erode secured creditors’ rights. Secured creditors appear to have no greater voting rights than unsecured creditors, and can be prevented from enforcing their security even if they vote against the plan but the Court still approves it. Secured creditors are not permitted to stand outside the restructuring process as they are in liquidation (unless they agree otherwise). This is a departure from the usual position of secured creditors. Notably, most other jurisdictions (except the US) are reluctant to bind secured creditors to restructuring plans without their consent.

StaBiLiSinG and SuStaininG BuSineSS oPerationS

Whilst the EIL does not explicitly recognise priority funding for the ongoing and urgent business needs of a debtor during the rescue process, it does permit an administrator to borrow and grant security over the debtor’s assets.

diSCharGe oF a PLan

When the Court terminates a restructuring, promises made by the administrator or the interested party to forgive debt as part of the plan are no longer binding on the creditor. Any repayments made to the creditors as a result of the restructuring plan remain valid and the unpaid amount is treated as a debt in the bankruptcy. Creditors may continue to receive distributions only when other creditors of the same rank as theirs have been repaid the same proportion of their debt. Also, any security given for the restructuring plan shall remain valid.

CoMProMiSe (SettLeMent)

Whilst the EIL contains no specific mention of informal workouts or alternative procedures such as debt write-offs, rescheduling, and debt-equity conversions, compromise provisions exist that might make these possible.


Once the debtor and creditors have arrived at a composition deed, the debtor (and the debtor only) may apply to the Court to accept jurisdiction over the matter. The debtor may also apply for compromise after the Court has accepted jurisdiction over the matter, but prior to a declaration of bankruptcy.

Once the requisite approvals have been obtained from the Court, the Court will hold a creditor’s meeting to vote on the composition deed. A resolution adopting the composition deed must be agreed to by a majority of the creditors attending a creditors’ meeting, and the amount of the debt they represent must exceed two-thirds of the total debts unsecured by property. Once the creditors’ meeting and Court have approved a composition deed, it becomes binding on all parties.

Compromise by way of a composition deed is not without risks. Secured creditors cannot exercise their priority repayment until the Court allows the compromise. Further, if a debtor is unable to implement the composition deed, the Court may, upon the request of the creditors, order the termination of the composition deed and declare the debtor bankrupt. In other words, once an informal workout arrangement becomes formalised into a composition deed, a debtor can become exposed to liquidation.

diSCharGe oF a CoMProMiSe

When the Court terminates a compromise, promises made by creditors to adjust debts as part of the compromise become invalid. Any repayments made to the creditors as a result of the compromise remain valid and the unpaid part is treated as debt in bankruptcy. The creditors may continue to receive distributions only when other creditors of the same rank as theirs have been repaid the same proportion of their debt. Also, any security given for the compromise shall remain valid.

inStitutionaL and reGuLatorY FraMeWorK

role of Courts and its officers

The Court retains original jurisdiction on all bankruptcy matters. There is no specialised bankruptcy court or specialised division within the Court qualified to adjudicate specifically on insolvency matters. The Court at the place of the debtor’s domicile is where the filing should be made.

The EIL prescribes trial procedures for bankruptcy cases. Unless otherwise specified, China’s civil procedure law applies to bankruptcy cases. The EIL does not include provisions to allow for the ready access to court records or hearings. There are provisions, however, that require the disclosure of information on the debtor.

In recent years, the Chinese courts have had very few bankruptcy cases, however, it is predicted that this will change in 2016.

inteGritY oF the PartiCiPantS

Penalties exist for those failing to comply with the EIL. The Courts have the power to penalise senior executives for mismanagement of insolvent enterprises. Members of senior management also can be held civilly liable for the failure to carry out their duties, and they may be forbidden from holding director or senior management positions in any future enterprise for a period of time. Furthermore, related personnel of debtor enterprises may be held personally liable for failing to attend creditors’ meetings without justified reasons after being serviced with a summon by the Court, for refusing to submit or submitting untrue statements, or for concealing assets or engaging in other activities that prejudice the creditor’s right to receive payment from its debtors if the debts occurred within a year of bankruptcy. Similar penalties exist for administrators that are not diligent, responsible, truthful, and honest. Notably, there are no provisions to ensure the integrity of creditors.

adMiniStratorS

The administrator plays various roles during the course of bankruptcy proceedings. The provisional role they play prior to the creditors’ meeting is different to the roles they play after the meeting, after the approval of a restructuring plan or a compromise plan, and once the company is in liquidation.

In each of these phases, it is necessary to be aware of how the administrator’s powers and duties change, and how the appropriate qualifications change, so as to ensure that appropriately qualified administrators are performing these roles. Administrators are expected to be diligent, fully responsible, truthful, and honest in the performance of their duties; they may be fined by the Court and may have to compensate creditors, debtors, or any third parties for causing loss and damage.


oBtaininG FinanCinG in China


PriVate eQuitY and Venture CaPitaL

The PRC has become one of the premier destinations for large pools of investor capital. Investments in Chinese companies have been amongst the top performers globally in terms of capital returns to investors. Companies like Baidu.com, Focus Media, New Oriental, Fuqi International, and Tencent have demonstrated that funds with a China presence can provide substantial returns to investors (for example, the initial investors in Tencent enjoyed returns of greater than 300 times the amount of invested capital).

Venture fundraising in China saw a record high in 2007 and again in 2008, and had stayed strong until 2012. Although in 2012 and 2013, the venture fundraising in China declined due to the deteriorating global economic environment, the PRC private equity activities in 2014 revived strongly. An aggregate venture investments reaching US$35.4 billion has been injected into China. Despite the influx of foreign capital into China, the PRC regulatory system governing foreign investment in China is not always fully transparent or designed to encourage foreign venture capital or private equity investment. However, the Chinese government has been taking steps to improve the existing regulatory environment. The Catalogue for the Guidance of Foreign Investment Industries (Latest amended in 2015) (the

“amendment”) has either loosened or cancelled the restrictions on foreign investments into China. For example, the Amendment promulgated a new investment policy that relaxes the access of foreign investors to many fields, in particular, automobile, electronic and other manufacturing sectors. In addition, the number of business sectors that require foreign investors to establish a joint venture with Chinese investors has been substantially reduced.

reGuLatorY reStriCtionS

A number of key industries are classified as “restricted”, meaning that any foreign investment in the sector is heavily regulated by the Chinese government. Although PRC regulations governing these sectors are beginning to liberalise, the progress continues to be slow. In particular, foreign investment remains restricted. The Amendment demonstrates the Chinese government’s determination to further open up access for foreign investors to the domestic market, especially in manufacturing, real estate and service industries under the Amendment. Certain areas remain restricted to foreign investment such as in the telecommunications, new media, wireless applications and Internet sectors. Content-driven industries such

http://Baidu.com


as IPTV broadcasting, new media publishing and digital content streaming, for example, are all “hot” industries, however they are difficult for foreign investors to access without guidance from innovative legal and business counsel. Although in the telecommunication industry, foreign investors are now permitted to own no more than 50% of the registered capital in a Joint Venture (as defined below) which provides telecommunication related services.

In addition, certain recent PRC laws that attempt to address the increase in foreign investment have actually created greater ambiguity with regard to their implementation and enforcement. For instance, in 2005, the State Administration of Foreign Exchange’s (“SaFe”) issued the notorious Circular 75, which imposes registration requirements on all PRC residents prior to the establishment of an offshore holding company. Circular 75 itself replaced two circulars issued earlier in the year by SAFE that perhaps had an unintended effect of freezing venture capital investment into China for a period of six months. On 4 July 2014, SAFE issued a Circular on Issues relating to the Administration of Foreign Exchange in respect of Offshore Investments, Financings and Round-trip Investments by Domestic Residents through Special Purpose Vehicles (“Circular 37”). Compared to Circular 75, Circular 37 clears the ambiguity of the definition of “Special Purpose Vehicles” and removes the 180-day timeline for remitting profits back to China.

In 2006, the Ministry of Commerce and several other regulatory bodies jointly issued the Provisions on the Merger and Acquisitions of Domestic Enterprises by Foreign Investors (“M&a rules”), effective on 8 September 2006. The M&A Rules were last amended on 22 June 2009. On 19 January 2015, the Ministry of Commerce (“MoFCoM”) issued for public comment a draft Foreign Investment Law (“draft FiL”), upon promulgation of which will significantly reform the administration of foreign investments in China.

More recently, in the wake of the world-wide financial crisis, the Chinese government moved quickly to adopt measures intended to bolster employment, boost domestic demand and encourage foreign investment. The government’s actions during these years have generally been favourable towards foreign investment.

The most significant step taken from the perspective of venture capital investors may have been the adoption by MOFCOM of the Circular on Further Improvement of the Examination and Approval Process Regarding Foreign

Investment [Shang Zi Han No. 7](2009)] (“Circular 7”), which became effective on March 5, 2009. Circular 7 was adopted on the heels of a more general statement of policy announced by MOFCOM on March 4, 2009 setting forth general principles and public policies targeted at encouraging additional foreign investment as well as promoting key domestic industries. Pursuant to Circular 7, MOFCOM delegated its approval authority over a number of categories of investments and merger and acquisition activities to its local counterparts. If an investment or acquisition is under certain financial thresholds and relates to industries identified by the government as encouraged or permitted, such a transaction can now be approved by MOFCOM’s local counterparts.

As a result, many investments or acquisitions that previously would have been required to be submitted to central MOFCOM can now be approved locally, which greatly shortens and simplifies the corresponding approval process.

Also, the government has established three new free trade zones in the country, namely the Shanghai Free Trade Zone, Shenzhen Qianhai Free Trade Zone and Tianjin Free Trade Zone (“Free trade Zones”). The government provides several preferential policies to the Free Trade Zones. For example, governmental approval is no longer a mandatory requirement for foreign investments in a non-prohibited sector. Only governmental filing is required. In addition, tax preferential policies have also been implemented within the Free Trade Zones which are also attractive to foreign investors.

CurrenCY exChanGe

If a venture backed company will have Chinese resident shareholders, prior registration by the Chinese shareholders with China’s State Administration of Foreign Exchange is required as a condition to closing the investment. Such registration is critical as if it is not obtained, the company’s operating subsidiary may have difficulty in the future in repatriating dividends or other distributions to its offshore holding company and the offshore holding company may not be able to consolidate the financial results of the Chinese subsidiaries.

In 2015, SAFE issued more rules to loosen the currency conversion after the government launched certain pilot programs in the Free Trade Zones. For example, Circular on Notice of the State Administration of


Foreign Exchange on Reforming the Administration of Foreign Exchange Settlement of Capital of Foreign-invested Enterprises, which came into effect on 1 June, 2015, allows Foreign Invested Entity (“Fie”) to convert all foreign currency in its capital account into RMB at its own discretion. However, the capital account is prohibited to be used in the following ways:

1. expenditure out of the business scope of the FIE or not consistent with PRC laws/regulations;

2. investment into securities (unless laws or regulations provide otherwise);

3. RMB entrusted loans (unless included in the business scope of the FIE);

4. repaying intercompany loans (including advanced payment of third party loans);

5. repaying RMB sub-lent to third party bank loans; and

6. purchasing real estate not for FIE’s use (unless the real estate transactions are part of the business activities of the FIE).

Though foreign exchange restrictions continue to present obstacles for foreign capital in China, it is widely believed that the continued loosening of the Renminbi’s tie to the US dollar will further benefit the investment climate. With the continued relaxation of currency exchange controls, obtaining liquidity from investments made in China should gradually become easier for foreign investors.

taxation

Although China’s tax laws are less established than those of more developed nations, sufficient regulations and laws exist that, so long as a foreign investor is well advised with respect to various tax provisions, taxation issues can be managed effectively.

The Chinese government has not adopted specific tax schemes to attract venture investments, they are generally treated in the same fashion as other forms of investment by offshore investment vehicles such as joint ventures or wholly-foreign owned subsidiaries.

However, a venture capital enterprise formed as a legal person enterprise in China is considered a tax resident in China for tax purposes and as such it is subject to enterprise income tax on its worldwide income, a major disadvantage that, until its application to foreign funds and their non-China portfolio companies are clarified, it will continue to discourage participation in such

investment vehicles by foreign venture capital funds. The two major regulations in relation to the indirect tax are the State Administration of Taxation’s Circular 698 issued in December 2009 (“Circular 698”) and the Announcement of the State Administration of Taxation on Several Issues concerning the Indirect Transfer of Property to the Enterprise Income Tax of Non Resident Enterprises issued in February 2015 (“Announcement 7”), Circular 698 and Announcement 7 both stipulate that an direct transfer of PRC assets (including equities of PRC domestic companies) by a non PRC resident enterprise maybe taxable in the PRC. However, Circular 698, Announcement 7, creates a safe haven for normal trading of listed shares and tax treaty exemption. Announcement 7 clarifies the reporting system that it can be conducted by the transferee, transferor and/or the transferred Chinese entity. Both Circular 698 and Announcement 7 impose a withholding obligation on the buyer. If the withholding obligation has not been fulfilled by the buyer, there will be penalty on both sides of the buyer and the seller.

exit StrateGY

Investment exit remains a primary concern for foreign investors, and identifying the appropriate investment exit strategy for a particular investee enterprise is critical. While public offering on an offshore stock exchange continues to be a favoured exit approach for many venture and private equity funds due to higher perceived valuations, trade sales and secondary portfolio sales that have gained in importance as access to the capital markets have been negatively impacted by both the financial crisis and new regulatory hurdles introduced by the Chinese government to encourage listings on the local Chinese stock exchange.

oFFShore LiStinGS

In particular, since the promulgation of the M&A Rules, offshore listings of venture-backed companies, while still legally permissible, have been confronted with additional layers of approval at the Ministry of Commerce and the China Securities Regulatory Commission. As such, only a small number of venture-backed companies established after 2006 have been able to list overseas, and in the majority of such limited cases, such listings were affected through reverse take-overs or similar arrangements.


trade SaLeS

In general, putting commercial considerations aside, the most efficient way to exit an investment in China is via an offshore trade sale whereby the investor transfers its equity interest in the holding company at the offshore level, thus by-passing certain of the more burdensome Chinese regulatory, taxation and foreign exchange hurdles mentioned above.

StartinG a Venture CaPitaL Fund in China

The most common investment structure for a foreign venture capital fund is still an offshore limited partnership, often established in the Cayman Islands or a similar offshore jurisdiction. The fund can be invested directly in its portfolio companies, the majority would establish an offshore parent company to receive the funds and to serve as the holding company for operations located in China. The Chinese government has also adopted regulations permitting foreign firms to establish investment funds within China. The Foreign-Invested Venture Investment Enterprise Administrative Regulations (“FiVie regulations”) were jointly issued by various Chinese governmental authorities with the goal of facilitating foreign venture capital and private equity investment into China through the creation of new special purpose investment called a foreign invested venture capital enterprise, or FIVCE. A FIVCE can hold interests in multiple enterprises simultaneously using well-established foreign investment vehicle structures.

Depending on its structure, an FIVCE may be either a legal person FIEVCE or a non-legal person FIEVCE. Legal person FIEVCEs have a separate legal identity from their investors under Chinese law and can be established in the form of a Joint Venture (“JVs”) or WFOE, each of which has been commonly used investment vehicles for foreign direct investment.

In addition to regulations in the jurisdiction of incorporation of the fund, a venture fund investing in China needs to take particular care to take account of “permanent establishment” when setting up its local office as well as where its investment professionals reside and sign the definitive documentation for each investment. In particular, this may occur if the venture fund engages in investment management or consulting businesses directly instead of through a separate Chinese fund management company.

As such, venture funds considering a Renminbi-denominated fund will typically engage a local management company, and must meet the following requirements:

■ it must be engaged in venture investment management as its primary business;

■ is must have at least 3 venture investment professionals each with at least 3 years of investment experience;

■ it must have an adequate internal control system.

If due care is not taken, the foreign fund may become subject to onerous taxation rules for venture capital enterprises operating in China and worse still, may expose its world-wide income to China taxation under PRC Enterprise Income Tax Law and its implementation rules.

In addition, the Provisional Measures on Supervision and Administration of Privately-offered Investment Funds have been promulgated on 21 August, 2014. The fund manager is required to register, submit and file the fund information to the Asset Management Association of China, a quasi-government regulatory agency.


inVeStinG in a ChineSe CoMPanY

MerGerS and aCQuiSitionS

When China was first opened to foreign investment in the late 1970s, most modern industries were either non-existent or in their infancy and the majority of foreign investment could be considered “green field” investments. Fast-forward to the year 2016 and China now boasts more than 100 firms in the Fortune 500. Consequently, foreign investors looking to enter the Chinese market have increasingly turned to acquisitions of existing Chinese companies and, in doing so, they must navigate a maze of laws and regulations governing foreign direct investment.

aCQuirinG eQuitY VerSuS aCQuirinG aSSetS

Foreign acquisitions of Chinese companies may generally be structured in two different ways, i.e. an equity transaction or an asset transaction. By taking over all or part of the equity of the target company, the foreign investor may enjoy the established market position of the target company as well as any relevant licenses, personnel, assets, expertise and goodwill. However, as in other jurisdictions, the foreign investor will also be exposed to the risk of existing liabilities associated with the target company.

An asset deal will avoid historical liabilities by allowing the buyer to cherry-pick the assets to be transferred. However, in practice, asset deals are in fact less common due to the potentially higher tax burden, the need for new operation licenses and the difficulty and the logistical difficulty of transferring each and every asset within a short period of time.

indireCt oFFShore aCQuiSition oF ChineSe CoMPanieS

If the target Chinese company is already held through an offshore holding structure, then acquiring that offshore holding company to indirectly acquire the Chinese company generally requires no approval from Chinese government authorities, except in relation to anti-trust or national security reviews. Additionally, even though such an acquisition occurs purely outside of China, it may nevertheless have Chinese tax implications.

ForeiGn direCt aCQuiSition oF ChineSe CoMPanieS

As with green field investments, foreign direct acquisitions of Chinese companies are subject to the Provisions for Guiding the Direction of Foreign


Investment (the “Catalogue”). The Catalogue is a key factor in whether a foreign acquisition will likely be approved and, if so, what percentage of equity foreign investors will be permitted to hold in the Chinese company. However, the Catalogue is not always definitive or strictly binding on relevant Chinese government authorities and there are always apparent exceptions, such as a foreign investor being permitted a higher or lower percentage of equity than suggested in the Catalogue or being prohibited from investing altogether in spite of the Catalogue’s provisions.

In addition, acquisition of foreign invested enterprises (“Fie”, being Chinese companies with existing foreign investors) and acquisition of non-FIE Chinese companies (Chinese companies without existing foreign investors) are further subject to different additional regulations and approval requirements. Acquisition of FIE is mainly regulated by the Several Provisions on Changes in Equity Interest of Investors in Foreign-invested Enterprises. Acquisition of non-FIE Chinese companies is mainly subject to the Provisions on Acquisition of Domestic Companies by Foreign Investors (“M&a rules”). For any acquisition of Chinese listed companies, separate sets of takeover rules apply (see discussions below under “Foreign Investment in Listed Chinese Companies”).

For acquisition of an FIE, approval from the original approval authority that approved the establishment of the FIE in the first place will be required. Additional approvals may also be sought if the FIE is in a regulated industry or if it is a listed company. After completion of the approval process, the change in equity of the FIE will need to be registered with the original AIC or its local counterparts.

For acquisition of a non-FIE Chinese company, MOFCOM approval is usually required. If the size of the acquisition reaches certain thresholds or if the target company triggers certain other criteria, such as if it falls under the “restricted” category under the Catalogue, then NDRC approval may be required. Further, if the target company owns a well-known trademark or a historical Chinese trade-name, declaration to MOFCOM must be made.

Additional approvals may also be needed if the target company is in a particular industry with dedicated regulators, such as insurance, healthcare or banking. After the completion of the approval process, the acquisition must also be registered with AIC or its local counterpart. Other registration procedures with SAFE, custom offices etc. will also be followed.

ForeiGn inVeStMent inVoLVinG State oWned enterPriSeS

Private investments involving a state-owned enterprise (“Soe”) may be subject to additional approval and valuation procedures. These requirements stem from a policy concern that state owned assets are not acquired by foreign investors at an undervalue amount.

In general, any private acquisition, whether by a foreign or Chinese investor, into an SOE or into a company whose shareholders include an SOE will require filing and notification with, and subsequent approval from, the relevant state owned assets authority, which would normally be MOFCOM for financial institutions or the State-owned Assets Supervision and Administration Commission (“SaSaC”) for most other enterprises. In addition, the target of the acquisition must undergo valuation to ascertain its fair value.

The procedure of valuation is governed by the Enterprise State-owned Asset Valuation Interim Provisions, which are administered by SASAC. A qualified Chinese valuation firm must be appointed, only certain valuation methodologies are normally unused and the valuation report must be filed with the competent branch of SASAC. The agreed price to be paid for the acquisition must be no less than 90% of the fair value stated in the valuation report unless special approval is obtained.

The valuation requirements do not apply to private acquisitions of listed shares from a state owned shareholder and a method of benchmarking against the average trading price of such listed shares is used. However, it will still be necessary to make the relevant filings to and obtain approval from the competent state owned assets authority.

inVeStMent in ForeiGn LiSted ChineSe CoMPanieS

For this publication, the definition of foreign listed Chinese companies includes Chinese incorporated companies whose shares are directly listed on a foreign stock exchange, such as H-shares listings in Hong Kong, as well as “China Concept Stocks”, which refer to companies technically incorporated and listed in foreign jurisdictions (including Hong Kong) but whose business activities are predominantly carried out in China, such as through Chinese subsidiaries or VIE structures.


Acquisitions of shares in foreign listed Chinese companies by foreign investors generally require no approvals from Chinese government authorities and the rules which do apply will predominantly be those of the foreign jurisdiction and the stock exchange. If the Chinese company is listed on a foreign stock exchange that is generally open to foreign investors, such as in Hong Kong, then foreign investment into that Chinese company would generally be open to foreign investors. This presents a fast, simple method of foreign investment in the underlying Chinese assets.

ForeiGn inVeStMent in ChineSe LiSted CoMPanieS

Foreign investors may also invest in B-shares listed on Chinese stock exchanges with minimal need for Chinese government approval, although there are currently few companies with B-shares attractive for foreign investment.

In contrast, A-shares listed on Chinese stock exchanges are only available for foreign investment through limited methods. One method is the QFII scheme discussed earlier in the “Business and Investment Structures” chapter on page ??. A foreign investor may apply to become a QFII but must satisfy numerous criteria and the application process can be extensive. However, many existing QFIIs provide asset or investment management services, in reality, make investments in A-shares on behalf of other foreign investors as clients, usually for a fee. Significant drawbacks of the QFII regime include designated investment quotas and the purely financial nature of the investment.

A second method is to acquire A-shares through the Shanghai-Hong Kong Stock Connect which was launched in October 2014. This program allows investors on the Hong Kong stock exchange to acquire eligible shares listed on the Shanghai stock exchange through their local securities brokers, and vice versa. However, there are currently a limited number of stocks eligible for the Shanghai-Hong Kong Stock Connect and trading volume is significantly limited. A similar program between the Shenzhen and Hong Kong stock exchanges is expected to be launched later in 2016.

A third method is a foreign strategic investment under a regime established by the Measures for the Administration of Strategic Investment in Listed Companies by Foreign Investors (外国投资者对上市公司战略投资管理办法). Under this regime, foreign investors may acquire A-shares by meeting the following criteria:

1. the foreign strategic investor acquires the A-shares through transfer by agreement, placement of new shares or other methods prescribed by laws and regulations;

2. the total shares acquired by the foreign strategic investor cannot be less than 10% of the total number of issued shares of the Chinese company regardless of whether the acquisition is made in one or multiple stages;

3. the acquired A-shares will be subject to a three year lock-up;

4. the foreign strategic investor is still subject to other applicable maximum foreign shareholding limits as prescribed in the relevant laws and regulations (including the Catalogue) and must obtain MOFCOM approval; and

5. where the strategic investment involves shareholders of state-owned shares, the relevant provisions on the administration of state-owned assets must be complied with.

At a policy level, foreign strategic investments may be more likely to receive MOFCOM approval if the target company operates in industries designated for growth and advancement according to either the Catalogue or other policy factors. The foreign strategic investment would also be subject to any other applicable listing rules or Chinese securities laws and regulations.

anti-MonoPoLY reVieW

In addition to the approvals discussed above, a foreign acquisition of a Chinese company, including an indirect offshore acquisition, may further require antitrust review by MOFCOM if certain thresholds are triggered. Any foreign strategic investment in A-shares must also make a pre-merger notification with MOFCOM.


nationaL SeCuritY reVieW

If foreign investment in Chinese companies, whether through acquiring equity or assets, triggers certain criteria, a further national security review may be required. These criteria are set out in the Notice of the General Office of the State Council on Establishing the Security Review Mechanism for Merger with and Acquisition of Domestic Enterprise by Foreign Investors, according to which national security reviews are required for the following:

1. acquisitions by foreign investors of any domestic defense industry enterprise or any enterprise which supports the defense industry, any enterprise adjacent to key or sensitive military facilities, or any other enterprise related to national defense or security; and

2. acquisitions by foreign investors of any domestic enterprise engaging in a sensitive area, such as important agriculture products, important energy and resource products, critical infrastructure, critical transportation systems, key technology or equipment, and in each case affecting national security; provided that actual control of the domestic enterprise is transferred to foreign investors after the transaction.

The national security review is be conducted by a panel co-chaired by NDRC and MOFCOM and involving the ministries relevant to the target company. It will assess the following:

1. the impact of the transaction on national security, including China’s domestic production capacity, domestic service capacity and related equipment and facilities needed for national security purposes;

2. the impact of the transaction on China’s economic stability;

3. the impact of the transaction on China’s social order; and

4. the impact of the transaction on China’s research and development capacity for critical technology relevant to national security.

National security reviews can be time consuming and may introduce uncertainties to the transaction timing. Interestingly, foreign investment into Chinese financial institutions is currently specifically excluded from national security review but may be subject to other review procedures to be announced in the future.


PaYMentS and CuStoMS

iMPort and exPort

Import and export in China is regulated by the General Administration of Customs (“GaC”), a ministerial department under the State Council of the PRC. The GAC is the leading authority of Customs administration in China and is responsible for the united administration of all Customs activities throughout the country.

Due to China’s dramatic increase in import and export trade volumes, China Customs is now playing an exceedingly important role in the development of foreign trade and investment in the Mainland.

iMPort to China

Only entities incorporated in China and registered with China Customs with import rights can act as the importer of record (“ior”) in China. Other entities, such as representative offices of a foreign company or Chinese incorporated company with no import rights need to entrust a third party import and export agent to act as the IOR and import goods on their behalf.

China Customs, as part of its ongoing reform, has adopted uniform Customs clearance procedures at all levels, which has led to a dramatic improvement in the predictability and certainty of this process throughout

China. The documentation requirements for importing products into China, which are similar to those required in many other countries, include the following:

■ declaration form;

■ required attachments to the declaration form;

■ bill of lading/manifest or other shipping list;

■ commercial invoice or a pro forma invoice;

■ packing list;

■ import contract;

■ import agency contract (if a Customs broker is engaged);

■ import licenses or permits (if applicable).

Customs declarations must be made by licensed Customs declaration agents who have passed a national examination and are properly registered with Customs. An IOR can perform Customs declaration through its own employees who are licenced Customs declaration agents. Alternatively, it can engage a registered Customs broker to complete customs formalities on its behalf. The customs broker is required to “truthfully, correctly and entirely” keep all declaration records for a minimum of three years.


Historically all the above-mentioned documents were submitted to local Customs electronically followed by a hard copy. In recent years however, China Customs has implemented pilot programs in various cities, encouraging importers to use the Electronic Data Interchange (“edi”) system.

Under the EDI system, the customs clearance procedure essentially involves the following basic steps.

First, the importers or Customs brokers need to fill out the declaration form in writing. The declaration form, together with other supporting documents, need to be scanned into electronic format and transmitted electronically through the EDI system to the “electronic data examination centre”.

Next, the electronic data examination centre will automatically check the format of the data, and then transfer it to different Customs officers according to the specific type of goods declared. The Customs officers will check the valuation and classification of each entry, which will be released and sent back to the local Customs house. Subject to a risk analysis of the goods, the local Customs office will determine whether a physical examination is necessary or not.

Third, if a physical examination is necessary, China Customs will either examine the goods or take samples from them. The examination can be performed at a contained examination station, a Customs facility or, if the appropriate arrangements are made, at the importer’s premises. Other border agencies, such as the State Administration on Quality Supervision Inspection and Quarantine (“aQSiQ”), may also inspect goods within their jurisdictions. Some goods are subject to mandatory AQSIQ inspections, and others random inspections. The good news is that, in recent years, examinations conducted for non-transparent reasons have decreased.

Finally, it is possible that the imported goods will complete the above procedure and be released on the same day that the Customs declaration is made, as long as all duties and taxes are paid. However, goods can be released prior to the completion of Customs formalities if the importer provides a security.

As a result of China’s WTO accession, it now charges basically four types of import tariffs: general tariffs, Most-Favoured-Nation tariffs, preferential tariffs and a special preferential tariff.

It has in recent years made substantial tariff reductions in many sectors. Recently, the GAC issued the new tariff implementation proposals effective starting from 2016, under which the tariff rates of many commodities have been further lowered.

There are special concessions covering tariffs on goods exported from Hong Kong, Macau and Taiwan to Mainland China. It has also entered into regional free trade agreements with ASEAN, Pakistan, Chile, New Zealand, Singapore, Peru, and Costa Rica. It is also a signatory to the Asia-Pacific Trade Agreement. Starting from 1 January, 2016, China’s new free trade agreements with South Korea and Australia also came into effect. To enjoy the preferential tariff or special preferential tariff, the proper classification and origin of the concerned goods are essential.

In addition to import tariffs, value-added tax (“Vat”) and consumption tax (but only for some products) are charged. All importers of goods into China must pay value-added tax. The normal VAT rate is 17%, except for certain goods (e.g. cereal and edible vegetable oils, books, newspapers and magazines, tap water, heaters, air-conditioning, hot water, coal gas, liquefied petroleum gas, natural gas, biogas and coal products for residential use) whose import is subject to a 13% rate.

Lastly, some imports are subject to import licensing requirements, in which case a license needs to be obtained prior to import Customs declarations. Such requirements are usually imposed because the import of the concerned goods and/or technology is restricted, or for statistics purposes. Certain goods and/or technologies are prohibited from being imported.

Border protection and enforcement for intellectual property rights

In recent years, China Customs has attached great importance to the border protection of Intellectual Property Rights (“iPr”). Customs enforcement of IPR protection in China has proven effective and efficient for IPR holders.

Customs’ IPR protection essentially covers three types of IPR: trademarks, copyrights (including relevant rights) and patents. Even though IPR registration is not mandatory under the Customs’ IPR border protection regime, it is crucial if the IPR holder wants to ensure Customs enforcement of their IPR. Each registration is valid for 10 years, and can be extended upon application. Each extension is 10 years.


According to the Regulations of the People’s Republic of China on the Customs Protection of Intellectual Property Rights, there are two major enforcement systems for China Customs IPR protection: “enforcement on duty” and “enforcement upon request”.

China Customs normally only enforces active protection measures (“the enforcement on duty protection”) on IPR that have been registered with the GAC. Unless specifically requested by the IPR holder, China Customs will not initiate any action against pirated products or other goods suspected of IPR infringement if the IPR has not been registered.

Depending on the enforcement of each of the two IPR protection systems, Customs and the rights holder have different responsibilities. The major differences between the two systems are:

■ when an IPR holder applies to China Customs for protection of their rights and detention of the goods, the holder is not required to register the IPR with the GAC. Although the IPR registration is not a pre-condition for the IPR holder to apply with China Customs for IPR protection, when the IPR holder applies to detain the goods, the holder is still required to submit relevant certificates evidencing that it has the ownership of the IPR.

■ in addition to presenting the written application for detaining the goods and providing the security (which must be up to the value of the goods) to Customs, the IPR holder is also required to provide certain information and evidence relating to the IPR infringement.

■ the most significant difference between the two systems is that under the “enforcement upon request” approach, Customs does not conduct any independent investigation into the suspected IPR infringement of the imported or exported goods and instead merely follows the court’s decision at every step. Therefore, the IPR holder has to play a more active role to initiate the court proceedings to protect their legitimate IPR.

exPortS out oF China

In China, Customs requirements applicable to importers are similarly applied to exporters.

For example, exporters must go through similar declaration procedures with Customs and submit the relevant documents. The translation requirements of documentation associated with the export declaration are the same as that for import procedures.

In addition, the exporters are also required to truthfully declare:

■ the name;

■ tariff number, specifications and type;

■ price;

■ charge for carriage, insurance and other relevant charges;

■ origin;

■ and the quantity of the exported goods.

Customs will then examine said declarations, and may also conduct a procedural examination on the declared contents and a substantive verification after the goods are released (post-exportation audit).

Nonetheless, China Customs traditionally adopts a comparatively lenient approach towards export declarations than import declarations in practice, as most exported goods do not result in the levy of duties. The overall examination rate for export goods is declining.

The Customs clearance procedure is comparatively simple and efficient throughout the country. All or part of the VAT paid by the exporter in China will be refunded by the tax authority if certain conditions are satisfied. However, problems do arise when, under certain circumstances, an exporter seeks to apply for export VAT refund but the tax authority does not agree with the refund rate on the ground that the classification of the exported goods is incorrect. In this case the exporter and the tax authority will need to negotiate and agree on the proper classification of the concerned goods, and the amount of VAT that is refundable.

Customs duties paid upon import are usually non-refundable, unless the imported goods are found to be defective or do not comply with the previously agreed specifications. Problems will also arise if an exporter seeks to apply for Customs duty refund on such a ground. In such a case, the exporter must fulfil the following conditions:

■ there must be problems with the quality or specifications of the imported goods;

■ the goods must be re-transported out of the Customs territory;

■ the goods must be in their original state; and

■ the application for duty refunds must be submitted within one year from the date of duty payment.


To prove that they fulfil the above conditions, the company should provide the following evidence:

■ the inspection certificate from a Local AQSIQ;

■ notarized photograph and video records to show the original state of the goods;

■ the agreement between the importer and the original exporter (i.e., the overseas seller) on return of the goods; and

■ an export declaration form.

China Customs is currently transitioning from arbitrary discretion and uncertainty to rule-based administration, and the legal system governing it is gradually evolving into a modern Customs administrative practice. It will take time for China Customs to streamline and optimise its regulatory system and implementing procedures.

A comprehensive, well-prepared and pre-emptive Customs compliance strategy is essential for a multinational enterprise hoping to ensure successful trade and investment performance in China. Equal importance should be attached to both the China Customs regulatory system and its implementing practices.

Establishing a long-term, effective interactive communication mechanism with the GAC, the customs districts at local levels, as well as the local in-charge Customs house is very helpful for multinational companies in carrying out their business strategies in China.


ContinuinG LeGaL reQuireMentS


taxation

Of the many types of taxes levied in the People’s Republic of China (“the PRC” or “China”), those that most affect Foreign Invested Enterprises (“FIEs”) and Foreign Enterprises (“FEs”) are:

■ enterprise income tax;

■ individual income tax;

■ business tax;

■ value added tax;

■ consumption tax;

■ real estate tax;

■ urban land use tax;

■ stamp duty;

■ deed tax;

■ land value added tax;

■ vehicle and vessel purchase tax;

■ vehicle and vessel use tax;

■ city maintenance and construction tax; and

■ resources tax.

enterPriSe inCoMe tax

Enterprise Income Tax (“eit”) applies to enterprises with income derived from production and business operations and other income in accordance with the new Enterprise Income Tax Law of the People’s Republic of China (“enterprise income tax Law”), effective from 1 January 2008. Enterprise Income Tax Law unifies the old enterprise income tax laws applying to foreign and domestic enterprises in China and a single set of laws shall then apply to all enterprises (including domestic enterprises, FIEs and FEs) for EIT purposes.

reSident enterPriSe and non-reSident enterPriSe

Under the Enterprise Income Tax Law, all enterprises will be classified as either a “Resident Enterprise” or a “Non-Resident Enterprise”.

A Resident Enterprise refers to (i) an enterprise that is incorporated in China pursuant to PRC law, or (ii) an enterprise that is incorporated pursuant to the laws of a foreign country but has its place of effective management in China. A Resident Enterprise shall be subject to EIT on income derived both from sources inside and outside China.


A Non-Resident Enterprise refers to an enterprise that is not incorporated in China nor has an place of effective management in China. A Non-Resident Enterprise shall be subject to EIT on its PRC-sourced income as well as any overseas income that has an effective connection to its establishment(s) in China.

taxaBLe inCoMe

FIEs are Resident Enterprises pursuant to the Enterprise Income Tax Law, and are subject to EIT on their worldwide income sourced inside and outside China. Where an FIE pays foreign income taxes outside the PRC, a corresponding foreign income tax credit is generally allowed for income tax paid in other countries with respect to its foreign sourced income derived by its overseas subsidiaries and/or overseas branches. The foreign tax credit is, however, limited to the PRC EIT payable on the same amount of income.

A Non-Resident Enterprise is subject to EIT with respect to income sourced from the PRC, including active operation income derived from its permanent establishment in the PRC, and passive income derived from its investment in or transaction with entities in the PRC. A Non-Resident Enterprise with a permanent establishment in the PRC would be subject to EIT on all income sourced from the PRC and attributable to the permanent establishment. A Non-Resident Enterprise without a permanent establishment in the PRC but receives income such as dividends, interests, rentals, royalties, capital gains and other passive income from the PRC with be subject to EIT on a withholding basis.

tax rateS

Effective from 01 January 2008, the standard EIT rate is 25%. Reduced tax rates may be available for those enterprises engaging in specific industries, which will be discussed below.

The withholding tax rate applying to interests, rentals, royalties, capital gains and other passive income derived by Non-Resident Enterprises in China is 10% which may be further reduced according to the applicable double tax treaty concluded between mainland China and other countries.

tax inCentiVeS aVaiLaBLe to FieS

Under the Enterprise Income Tax Law, there are no special tax incentives for FIEs. The tax incentives are mainly industry and technology oriented incentives, and are equally available to both FIEs and domestic enterprises. These include the following:

eit exeMPtion/reduCtion

■ Enterprises engaged in key infrastructure projects supported by the government (a three-year EIT exemption followed by a three-year 50% deduction on EIT rate);

■ Enterprises engaged in eligible environmental protection, energy or water saving projects (a three-year EIT exemption followed by a three-year 50% deduction on EIT rate);

■ Small-scale and low profit enterprises (a preferential rate of 20% applies);

■ Qualified high and new technology enterprises (a preferential rate of 15% applies);

■ Qualified advanced technology service enterprises (a preferential rate of 15% applies);

■ Enterprises deriving income from agriculture, forestry, livestock, fishing industry (full or half EIT rate reduction);

■ Venture capture enterprises investing in non-listed small and medium-sized high technology enterprises (extra deduction of 70% of the investment amount against the taxable income after holding the investment for two years); starting from 01 October 2015 enterprises investing in a non-listed small or medium-sized high-tech company via a venture capital limited partnership (extra deduction of 70% of the investment amount against the taxable income specifically derived from the investment via such a venture capital limited partnership after holding the investment for two years).


additionaL deduCtion

The Enterprise Income Tax Law also provides the following deductions:

■ Super deduction of R&D expenses for the development of new technology, new products and new production processes;

■ Super deduction of salaries paid to disabled workers and other employees who are encouraged to be employed by the government;

■ Accelerated depreciation on R&D equipment and fixed assets;

■ Accelerated depreciation on fixed assets by means of shortened depreciation lives or accelerated depreciation methods, for technological advancement reasons if necessary; and

■ Tax credit based on certain percentage of the investment in special equipment purchased for purposes of protecting the environment, reducing the consumption of energy or water, increasing manufacturing safety, etc.

tax treatieS

China has double tax treaties with a number of jurisdictions that seek to avoid taxation of the same income in more than one jurisdiction. In other words, any tax paid in one contracting state with respect to an income shall be allowed as a credit against the tax on that income payable in the other contracting state. Generally, double tax treaties cover income tax (including both enterprise income tax and individual income tax), but not turnover taxes (e.g. business tax, value added tax, etc) that may be payable. As of December 2015 China has entered into double tax treaties and arrangements with 104 countries and regions (including Hong Kong and Macau Special Administrative Region, Taiwan Region), the majority of which have been effective.

other taxeS

Business tax

Business Tax (“Bt”) is levied on enterprises and individuals that provide labour services, transfer intangible assets or sell immovable property in China, at the rate of 3% or 5% depending on the type of taxable activities performed by the enterprises or individuals in China.

Starting from 1 January 2012, China has been experiencing a Value Added Tax (“Vat”) Reform to replace BT with VAT nationwide. By the end of 2015, VAT has replaced BT in the sectors of transportation, modern services cultural and creative services, logistics-related auxiliary services, leasing of movable and tangible assets, attestation and consulting services, broadcasting and telecommunication.

Following the China Premier’s final announcement of the nationwide pilot VAT Reform, under which the remaining four BT sectors of real estate, construction, financial services and consumer services would be subject to VAT effective from 1 May 2016, the Ministry of Finance (“MoF”) and the State Administration of Taxation (“Sat”) of China jointly issued the detailed implementation rules on the VAT Reform pilot program, namely Circular on Comprehensively Promoting the Pilot Program of the Collection of Value-added Tax in Lieu of Business Tax (“Circular 36”) on 23 March, 2016. Accordingly, BT has completely retired from China’s tax system.

Value added tax

VAT was only imposed on enterprises and individuals that sell goods, provide processing, repair and replacement services, or import/export goods. VAT Reform started in 2012, and now applies to all service sectors historically subject to business tax.

The VAT rate ranges from 6% to 17% for different types of goods, services and business activities in China.

■ 17% is applicable to (i) sales, imports and in some cases, export of tangible goods, (ii) processing, repair and maintenance services, and (iii) leasing of movable and tangible goods;

■ 13% is applicable to certain special goods such as electricity, water, gas, books and fertilizer;

■ 11% is applicable to transportation, post and basic telecommunication services, construction, real property leasing services, sales of real property, transfer land use rights; and

■ the 6% VAT rate is applicable to value-added telecommunication services, modern services, cultural and creative services, logistics-related auxiliary services, attestation and consulting services, financial services, consumer services, etc..

Aside from the above, preferential VAT exemption or refund treatments are also available to domestic service providers that export services or intangibles


to overseas service recipients. Circular 36 however introduces a new requirement that the relevant services or intangibles must be used/consumed entirely out of China for domestic taxpayers to enjoy such preferential treatment. In particular, the new requirement stipulates that the recipient of the export services or intangibles must be physically located outside China and should not be connected with any moveable or immovable assets inside China.

Depending on the scale of business operation and sophistication of accounting systems, there are two categories of VAT taxpayers, i.e. General VAT Payers (“GVP”) and Small-Scale VAT Payers (“SVP”).

■ GVPs, whose business scales are above the prescribed thresholds and have sound accounting systems, shall calculate their VAT payable using the input VAT/output VAT crediting system

■ SVPs, whose business scales are below the prescribed thresholds and may not have sound accounting systems, shall calculate their VAT payable based on a simplified formula and a lower simplified VAT rate of 3%

Under the input VAT/output Vat crediting system, output VAT is computed based on the GVP’s sales or service revenue, by applying the applicable VAT rate to the sale/service value. The VAT paid by the GVP for purchase of fixed assets, tangible goods and services are the input VAT, which can be used to offset the output VAT. The VAT payable is the net amount of output VAT after offsetting available input VAT credits.

In addition, input VAT paid on importation/local purchase of materials for the production of exported goods can be fully or partially refunded in accordance with the prevailing export VAT refund policy. The refund rate may vary from 3% to 17% depending on the type of goods exported from China.

Consumption tax

Consumption Tax (“Ct”) is levied on manufacturers, processors, importers and sellers of certain consumer products, such as tobacco, alcoholic beverages, cosmetics, jewels, luxury watches, golf equipment, gasoline and automobiles.

For taxable consumer products, consumption tax payable is calculated based on (i) the sales value and a fixed tax rate, (ii) the sales volume and a fixed tax amount per unit of volume, or (iii) a composite of both.

urban real estate tax

Urban Real Estate Tax (“uret”) is payable by the individual or corporate owners of the properties situated in China. URET is calculated based on the original value of the property or, if the property is leased out, the rental income of the property.

If URET is calculated based on the original value of the property, a statutory deduction of 10% to 30% of the original value will be allowed. URET will then be levied at the rate of 1.2% of the net value. The specific rate of deduction shall be determined by the local government and may vary from city to city.

If the property is for rent, URET is calculated based on the rental income at 12%.

StaMP dutY

Stamp Duty (“Sd”) is levied on enterprises and individuals that conclude or receive any of the following documents:

1. documents issued for a purchase and sale transaction, process contracting, property leasing, commodity transportation, storage and custody of goods, loans, property insurance, technology contracts, engineering project reconnaissance and design contracts, construction and installation project contracts and other documents of a contractual nature;

2. documents involved in the transfer of property by purchase, sale, inheritance, gift, exchange or division;

3. documentation of rights or licences; and

4. other documents declared to be taxable by the tax authorities.

SD is calculated at a fixed rate according to the contract amounts (ranging from 0.005% to 0.1% depending on the nature of the taxable documents) or at a fixed amount per document. Specific SD exemption may be available to certain types of contracts or documents.

Individual Income Tax (“iit”) is imposed on all individuals (including local PRC and foreign nationals) residing in or earning income from the PRC in accordance with the Individual Income Tax Law of the People’s Republic of China (“iit Law”) and the Detailed Rules for the Implementation of the Individual Income Tax Law of the People’s Republic of China (“Detailed Implementing Rules”).


taxation oF indiViduaLS WorKinG in China

An individual who is domiciled in China is subject to IIT on all of his worldwide income regardless of type (i.e. wages and salaries, capital gains, dividends, interest, rent, etc). The Detailed Implementing Rules define the term “wages and salaries” to include cash awards, bonuses, allowances, subsidies and other compensations received by an individual for the tenure of employment.

An individual who is not domiciled in China is subject to IIT on “PRC-sourced income” mainly depending on how long the individual stays in the PRC. For the purpose of determining the individual’s tax liability, only the days on which the individual was actually present in China are counted. The day on which the individual leaves, enters, enters and leaves, or makes multiple entries shall be counted as a whole day for this purpose.

Notwithstanding the above, certain types of PRC-sourced income (such as royalty, interest or rent) are subject to IIT, irrespective of whether the individual spends any time in China during a calendar year.

taxaBLe inCoMe

An individual who is not domiciled in China, i.e. foreign nationals residing in China for not more than five “full” consecutive years (a foreign individual who is based in the PRC but spends more than (i) 30 days on a single trip or (ii) 90 days in the aggregate outside the PRC during any calendar year will not be considered to have spent one “full” year in PRC for tax purposes) is generally subject to IIT on “PRC-sourced income”. The term “PRC sourced income” is defined to include “income from personal services provided inside the PRC because of the tenure of office, employment, the performance of a contract, etc”.

In addition, the following items, among others, derived by foreign nationals working in China are “temporarily exempted from IIT”:

1. reasonable allowances for housing, meals and laundry services received in a non-cash form or on a

reimbursement basis;

2. reasonable one-off relocation costs on a reimbursement basis;

3. reasonable allowances for business trips both inside and outside the PRC;

4. allowances for the expatriate’s language training, and children’s education in China, provided the costs are supported by valid invoices and approved as reasonable by PRC tax authorities; and

5. home leave pay for the expatriate, whereby the expenses are restricted to the expatriate’s travel expenses and shall not exceed two trips to return to his/her home (including the residence of his/her spouse or parents) during a single calendar year.

tax rateS

Pursuant to the New Amendment to IIT Law passed on 30 June 2011, IIT charged on wages and salaries will be at a progressive rate from 3% to 45% with seven brackets. Further, the New Amendment increases the standard deduction to RMB 3,500. The New Amendment has become effective since 1 September 2011.

tax WithhoLdinG oBLiGationS

Any entity or individual that pays income on which IIT is payable must act as a withholding agent. If a withholding agent fails to withhold or collect tax as required, tax authorities will pursue with the taxpayer the tax that should have been withheld or collected, as well as the corresponding interest, penalties and/or surcharges. At the same time, a penalty will also be imposed on the withholding agent in this regard.

Since 1 January 2000, the withholding requirement has also applied to wages and salary payments made by the parent or affiliated company outside China to expatriate employees of the entity in China. Accordingly, the entity in China is obligated to withhold taxes on wages and salary payments made to the PRC and expatriate employees by either (i) the parent or affiliated company outside China; or (ii) the entity in China.


anti-duMPinG and CounterVaiLinG dutY

While Chinese products are often targets of anti-dumping and countervailing duty investigations across global markets, Chinese producers also have the ability to protect themselves by requesting the Chinese government to initiate anti-dumping and countervailing duty investigations against products imported into China. With the elimination of most import quotas and the reduction of many tariff and non-tariff trade barriers, Chinese products face increasing competition from foreign imports, particularly chemical products and other basic inputs. Chinese industries, like their counterparts in other countries, have increasingly sought to strike back by invoking the country’s anti-dumping and countervailing duty provisions.

China initiated seven anti-dumping investigations but no countervailing duty investigation in 2014 and three antidumping investigations and no countervailing duty investigations in the first half of 2015. This shows a decrease when comparing with the number of initiations in 2012 and 2013.

Chinese anti-dumping actions are designed to address circumstances in which imports are being sold at less than their “normal value” to the extent that they are

causing, or threaten to cause, material injury to the domestic industry, or will materially and negatively affect the establishment of a domestic industry. Where this is deemed to be the case, special anti-dumping duties are imposed on future imports from the targeted country at the level of the dumping margin. In certain cases, these special duties are so high that they effectively close off the Chinese market to foreign imports. As dumping margins are usually assigned specifically to each exporter, it is vital that companies defend themselves in order to obtain the lowest dumping margins to give them a competitive edge over their rivals.

Chinese countervailing duty actions are designed to address circumstances in which the exporters are subsidized by its home government and therefore export their products at an unfair price to the extent that they are causing, or threaten to cause, material injury to the domestic Chinese industry, or will materially and negatively affect the establishment of a domestic industry. Where this is deemed to be the case, special countervailing duties are imposed on future imports from the targeted country at the level of the subsidy margin. The same as dumping margins, subsidy margins are usually assigned specifically to each exporter.


The prevailing law governing Chinese anti-dumping actions is the Anti-dumping Regulations of the People’s Republic of China (“ad regulations”), and the Countervailing Duty Regulations of the People’s Republic of China (“CVd regulations”) for countervailing duty actions, the most recent amendments of which became effective on 01 June 2004. The AD Regulations and CVD Regulations are very similar in nature to the provisions of the WTO Anti dumping Code and Countervailing Duty Code, although they contain much ambiguity. By drafting the rules in this way, China follows an approach taken by many WTO members. As a result, transparency in China’s investigative procedures remains a concern for foreign investors. It appears that the decisions on antidumping investigations and countervailing duty investigations can be affected by the political atmosphere.

Under the current legal regime, Chinese anti-dumping and countervailing duty actions are conducted by the Ministry of Commerce (“MoFCoM”) by the Bureau of Trade Remedy and Investigation (“Btri”), which is responsible for the initiation, investigation and determination of anti dumping and countervailing duty actions. MOFCOM is the ultimate authority in charge of the investigations, and makes all of the official announcements.

GeneraL ProCedureS

First, MOFCOM will announce its decision to initiate an anti-dumping and/or countervailing duty investigation upon its own initiation or in response to a petition from interested parties. BTRI will then issue questionnaires and require the companies exporting the subject product to China to submit their response, including a Chinese translation, within 37 days. Subsequently, BTRI may issue supplemental questionnaires to the respondents or hold public hearings on specific issues. They will then convene a meeting for interested parties with MOFCOM officials before a preliminary determination is made. Similar to US and European practices, MOFCOM officials may also perform on-site verification at the respondent companies’ premises to verify the completeness and accuracy of the information provided in the questionnaire and supplemental responses. The final determination is made within 12 to 18 months from initiation of the anti-dumping and/or countervailing duty investigation. At that time, MOFCOM will assign individual anti-dumping duty and/or countervailing duty rates for each respondent

company, and Chinese Customs will begin the collection of import anti-dumping duty and/or countervailing duty on the imported subject products.

There are four basic conditions that must be established in a Chinese anti-dumping and/or countervailing duty investigation for the authorities to determine that a dumping duty and/or a countervailing duty shall be imposed:

■ the product must have been sold to China at “dumping prices” or have been subsidized by the exporting country government;

■ economic injury must have been suffered by the Chinese industry producing the product;

■ the “dumping prices” or “subsidized prices” must have caused economic losses; and

■ the imposition of anti-dumping duties and/or countervailing duties must be in accordance with China’s public interests.

Exporters can influence these proceedings by

1. registering with Chinese government agencies;

2. compiling and supplying supporting information in response to government “questionnaires”; and

3. appearing at government hearings. By being actively involved in the anti-dumping and countervailing duty investigation process, producers and exporters may be able to establish that they are not dumping and/or not subsidized and/or that the Chinese industry is not suffering from material economic injury, and therefore no dumping duties or countervailing duties should be imposed. Even if dumping or subsidy is found, the individual exporter’s input of information on the record may result in the lowest dumping margin or subsidy margin possible.

With respect to anti-dumping and countervailing duty actions filed in jurisdictions outside of China, foreign investors seeking to establish export oriented manufacturing businesses in China should take into account the threat of antidumping and countervailing duty actions against China-made products brought by foreign governments, such as the United States and the European Commission.


CSr CoMPLianCe in the PrC

Companies that are courageous in designing their CSR strategies in China, rather than merely focusing on minimum compliance will reap the commercial rewards. Use the core resource of your company to tackle the pressing social issues and the Government will acknowledge your contribution. Look at the example of the state sector in fulfilling legal compliance requirements in the field of CSR. Be strategic in planning, promoting and profiling your CSR initiatives. Leverage your core resource, consult local employees and ask the CEO to promote the initiative. Spend time with local Governments to understand their concerns and be flexible with your corporate offering. Appoint dedicated managers to respond in times of natural disaster. In the current environment foreign companies that do not actively promote CSR may not ‘lose their license’ to operate in the community but they may lose the goodwill of patriotic purchasers which can be just as costly.

WhY CSr WiLL Be iMPortant to China

The Government promotes Corporate Social Responsibility in China for three reasons;

1. To reduce the risk of instability arising from wealth disparity;

2. To ensure appropriate corporate contribution to natural disasters; and

3. To promote China as a responsible global citizen as it competes internationally.

Wealth distribution

China lacks civil society. There is a vacuum of volunteer institutions to redistribute resource e.g. NGO’s, philanthropic and religious societies. Through CSR, companies are being called upon to fill this vacuum. Recent media reports showed that 0.4 % of the population or the country’s 450,000 millionaires, possess 70% of the Mainland’s wealth. A priority of Government is to use CSR to facilitate creative wealth redistribution to reduce the gap between rich and poor, urban and rural. The Government’s 13th five year plan focused not merely on the production of wealth, but also on its judicious redistribution. CSR is seen as an instrumental part of its strategy to provide a bridge between the Government and the people.

disaster Management

The second use of CSR to the Government is to harness corporate resource efficiently in times of natural disaster. The Lushan earthquake in May 2013 alerted companies


again (5 years since the major Sichuan quake of 2008) of the need to have an effective disaster response strategy in place. The Government realizes that that they alone cannot tackle the increasing incidence of natural disasters (sometimes due to global warming) and have called upon companies and NGO’s to play a combined role.

Global Profile

Chinese companies, like Alibaba, Huawei and Lenovo are becoming the multinationals of the future. When President Xi-Jingping launched his ambitious 13th Five Year Plan, he provided an explanatory video in English for the first time, showing China is interested in courting and participating in global markets. CSR plays an important role in helping Chinese companies to compete effectively overseas. As China invests heavily in Europe and the US and moves deeper in Africa, CSR is seen as a way to generate soft power with foreign governments and to attract ethical investors. Ultimately it makes Chinese goods more competitive abroad.

hoW CSr CoMPLianCe WiLL Be enForCed

The Government may wish to encourage a CSR agenda but how will it be enforced? The answer very much depends on what type of company you are operating. There are three types of companies in China; 1) state-owned-enterprises; 2) private Chinese business and 3) foreign business.

Each is controlled by a separate ministry. SASAC (State-Owned-Assets Supervision and Administration Commission) for state-owned-industries. ACFIC (All China Federation of Industry and Commerce) for the private Chinese business and MOFOM (Ministry of Commerce for the People’s Republic of China) for Foreign Companies.

SASAC, ACFIC and MOFCOM will use CSR as a determining factor for deciding whether to renew the practicing licenses of companies in China. CSR activities and reporting are compulsory for all SOE’s.

While not compulsory for foreign companies, CSR contribution is increasingly taken into account during the pitching process for new work in China. The Government often has the last say in which companies win tenders so in order to have a competitive chance in the bidding process it is sensible to align your company with the 13th Five Year Plan which emphasizes corporate commitment to “balanced development” which essentially means helping the government reduce the wealth divide in health and education.

What FaCtorS ShouLd CoMPanieS ConSider When undertaKinG CSr in China?

Companies need to consider the following issues when setting up a CSR strategy in China:

Government Focus

The Government in China is adept at understanding the social issues that matter most in each province. Start with the 13th ‘Five year plan’ and select a social issue that is of current concern e.g. climate change, unemployment reduction, education or healthcare.

disaster relief

Ensure your company has a strict policy of how it will react in times of natural disaster in China. Who will make the contribution? With which NGO will you cooperate? Will you give cash, corporate or human resources? Will the CEO make a statement? What will happen to workers in your firm from the affected region? How will you create a sustainable response in the case of an ongoing emergency?

Leverage Core resource

Use the core resource of your company to contribute to the country’s social agenda. ‘Micro’ your product for the masses rather than the rich few to cultivate tomorrow’s customers in developing economies. For example Cisco provides healthcare via webcam to remote regions of China. Nord Anglia provides training for rural teachers from across China. BMW Foundation provides a global network for budding social entrepreneurs. Microsoft provides IT training for unemployed migrant workers. Mohammad Yunnus created ‘down-scaled’ banking to reach the poor. Citibank and JP Morgan followed suit with their own forms of micro-credit.

non-profit engagement

Non-profit activity is increasingly encouraged in China but within certain increasingly well-defined limits. There are three types of NGOs: 1) Government charity, 2) Foreign NGOs and 3) local Grassroots NGOs. Select one that is well recognised and well run. Develop a relationship with the management to provide a consistent quality of pan-China CSR delivery. However, be very aware that you check who funds the NGO and who manages its operations. Due diligence on your non-profit partner is important.


Pilot Projects

Start small. Consult local staff about what project they want to do. Get the CEO to lead it from the front once a project is selected. Learn from past experiences to refine and adapt the program for other locations and cultures. If possible, ‘network’ the projects to produce global connectivity and a sense of international achievement.

Practical steps that foreign companies may take to effect sustainable CSR in China are:

■ Imbue vision statement with CSR philosophy;

■ Appoint internal CSR, Risk Management and Ethics Committees;

■ Switch marketing strategies from direct advertising to raising brand awareness via social engagement projects;

■ Integrate CSR strategy into business functions including performance management review criteria;

■ Create partnerships with NGO’s and Chinese Government Charities to execute environmental, social and educational projects; and

■ Update Employee handbooks to anticipate equal rights and disability awareness legislation.

CoMMerCiaL BeneFit oF CSr CoMPLianCe in China

The most rapidly expanding companies in developing countries like China use CSR as a strategy to engage tomorrow’s consumer. The key customer (ultimately) for most companies in China is the Government. The four key priorities of the Xi and Li Administration is 1) East to West (e.g. Shanghai to Chongqing enrichment); 2) Urbanisation; 3) Production to consumption (equality of income); and 4) Resolution of social issues e.g. environment, education, healthcare and protection of the elderly. CSR programs aligned with these priorities are the key way in which companies can engage Government and win the hearts and minds of new consumers.

Three companies that do this well in China are Nord Anglia, SSP and Jaguar Land Rover. Under their CSR program E3 (equal education for everyone), British School Beijing (Nord Anglia) and Dulwich College train 100 rural teachers per year from across China in creative

teaching methods. Investing heavily in this program, they host 25 teachers from across China per term at their school to work in conjunction with their staff and pupils. In return British School Beijing has been recognized as the only Government approved training school for Chinese students which will have positive repercussions for their future expansion.

SSP International is another UK company that understands that CSR is Government and media relations in China today. SSP is a food travel company that selects and manages the restaurant outlets in airports and at rail stations. In May 2014, via a CSR project called “Going Places” they invited 13 students (aged 13-16) and three teachers from Shandong to visit a city for the first time. Covering the cost of transport and accommodation, the students were able to take a train for the first time, stay in a hotel, learn about international travel, take part in a cooking competition, visit the Pudong science museum and undertake interview training. SSP staff really went the extra mile to make them welcome. In return ten Shanghai media covered the event including Pudong television.

Jaguar Land Rover worked with Chinese NGO Soong Ching Ling Foundation to help rural children access better education and eye care. Having made a substantial donation to the Government Foundation, they help to promote rural development using this vehicle. As a result of this work they have been asked to front the British Chamber of Commerce in China, CSR forum and to speak at the European Chamber in Beijing.

The most convincing reasons to make CSR corew to corporate strategy in China are as follows:

Cultivate tomorrow’s Consumers

China is still a relatively wealth divided country. Companies use CSR to gain first entry advantage to new markets. Today’s impoverished will be tomorrow’s purchasers.

recruit and retain the Best

CSR tackles global issues: healthcare, climate change and social development. Globally minded graduates will be attracted and retained by companies with inspiring CSR programs.


Post Credit-crunch Branding

CEOs no longer want to be profiled boarding a corporate jet on the front of Fortune magazine. It looks greener, leaner and more aligned with the times to be seen holding a shovel in Sichuan.

risk Management

The Sichuan earthquakes (2008 and 2013) revealed seismic cracks in the CSR strategies of most companies in China. If CSR was central to the company strategy they reacted quickly, proportionately and compassionately.

CSR savvy companies had:

■ Experienced CSR staff to advise on response strategy;

■ Existing relationships with non-profits in China to receive donations;

■ CSR projects from other countries that could be adapted for Sichuan;

■ Established relationship with Government officials in rural China;

■ Knowledge of proportionate and sustained response to rebuilding;

■ Provided the right combination of personnel, product and profit to rebuild;

■ Empathised with staff originating from Sichuan and offered counseling; and

■ Sent their CEO to the earthquake site to show moral leadership from the front.


China does not have one single legislation governing anti-bribery and anti-corruption (“aBaC”) offenses. Instead, China’s ABAC regime is comprised of a number of laws and regulations, including the Criminal Law, Anti-Unfair Competition Law (“auCL”), the Interim Provisions on Prohibiting Commercial Bribery (“iPPCB”), and other rules and regulations issued by the Communist Party of China (“CPC”), the Chinese government and various governmental authorities (herein collectively referred to as the “aBaC regime”).

oFFenCeS

China’s ABAC regime categorizes criminal bribery offences into two types of bribery conduct: (i) official bribery, and (ii) commercial bribery. To be prosecuted under the Criminal Law for either a criminal official bribery or commercial bribery, certain prosecution thresholds have to be met. Apart from these criminal offences, provisions under the AUCL set out a commercial bribery offence from an administrative law perspective. Different from criminal offences, there is no specif ic threshold as to what constitutes an administrative commercial bribery offence. This gives the Chinese regulator in charge of enforcement, the Administration of Industry

and Commerce (“aiC”), a wide discretion in determining whether a specif ic conduct constitutes an administrative commercial bribery offence.

In addition, government officials and CPC members are also subject to disciplinary actions under various “gift rules” and other ethics codes and measures issued by the CPC that govern ethical behavior and the handling of gifts received by CPC members. However, these govern the conduct of CPC members only. For example, the “gift rules” (i) only apply to the recipient of gifts and not to the parties providing the gifts, (ii) they apply to state functionaries who accept gifts in the course of carrying out official duties or when interacting with foreign countries but fail to turn over the gifts to the State in accordance with CPC rules and ethics codes, when the amount is fairly large.

oFFiCiaL BriBerY

The following criteria constitute a criminal violation of an official bribery offence under the Criminal Law:

1. an offer of property to a State Work Personnel1 (“SWP”) or a public entity2 ;

2. in return for a benefit, or for the assistance to obtain a benefit;

oVerVieW oF the ChineSe anti-BriBerY and anti-CorruPtion reGiMe


3. the amount involved meets the required threshold or certain requisite conditions if the amount involved is below such threshold; and

(1) there is corrupt intent to bribe the SWP.

Article 93 of the Criminal Law defines SWP as individuals who:

■ perform public services in legislative, administrative, or judicial agencies or the military;

■ perform public services in State-owned enterprises (“Soes”), institutions, or civil organizations;

■ have been assigned by the government or SOEs to non-state-owned enterprises, institutions, or civil organizations to perform public services (e.g., a deputy general manager of a Sino-foreign joint venture company who has been sent to the JV by the Chinese party which is an SOE); or

■ perform public services according to law.

“Public services” include services performing organizational, leadership, supervisory, management, and similar functions on behalf of state organs, SOEs, public institutions, and civil organizations. These are mainly public affairs functions connected with authority and duties to supervise and manage state property.3

For example, doctors who work at public medical institutions and perform public services (such as taking leadership roles, including directors and department heads) are deemed as SWPs. Doctors who work at public medical institutions, but do not perform public services (such as doctors who only perform operational or technical functions) should be deemed as non-SWPs.

CoMMerCiaL BriBerY – CriMinaL oFFenCe

Commercial bribery is categorized into two types: criminal commercial bribery and non-criminal commercial bribery. Commercial bribery does not

involve an SWP. To constitute a criminal commercial bribery offence under the Criminal Law, the following criteria will have to be satisfied:

1. an offer of property to a member of a company or enterprise;

2. in return for an improper benefit, or for the assistance to obtain an improper benefit;

3. the amount involved meets the required threshold or certain requisite conditions if the amount involved is below such threshold; and

4. corrupt intent on the part of the offender.

CoMMerCiaL BriBerY – adMiniStratiVe oFFenCe

Non-criminal commercial bribery is generally defined as the act of giving benefits (or utilizing other methods) to the other party for the purpose of selling or purchasing merchandise. These include off-the-book discounts, kickbacks, rebates and commissions, including non-cash payments such as consulting fees, promotional fees, sponsorship of tours or seminars inside or outside China, service fees, research fees, or the write-off of such fees.

Under PRC law, any discounts, rebates, or commissions (or other similar sales arrangements) should not constitute commercial bribery if these are paid or provided according to a legitimate method (such as the arrangement as provided in a contract), and have been properly recorded in the company’s accounts. Lack of accounting or false accounting can be treated as a commercial bribery from an administrative enforcement perspective. Promotional gifts of a small value in accordance with proper commercial practices are generally acceptable.

1 SWP includes officials who perform public services in state offices (such as government agencies); people who perform public services in State-owned enterprises (“SOEs”), institutions, or civil organizations; people assigned by the government or SOEs to non-SOEs to perform public services; and those who perform public services according to law (such as political representatives).

2 A Public Entity includes SOEs, public institutions, and public enterprise units.

3 Circular of the Supreme People’s Court with the Summary of Symposium Minutes on Trial of Economic Criminal Cases by Courts Nationwide (Chinese translation: 最高人民法院关于印发《全国法院审理经济犯罪案件工作座谈会纪要》的通知) (effective from November 13, 2003).


PenaLtieS

Official Bribery

Individual offenders shall be fined and sentenced to short-term criminal detention or imprisonment up to 10 years, or even life imprisonment. Their properties shall be confiscated. Corporate offenders shall be fined and individuals in charge of corporate offenders (such as their legal representatives), as well as individuals directly responsible for the acts in question, shall be subject to criminal detention or imprisonment (usually up to 3 years).

CoMMerCiaL BriBerY – CriMinaL oFFenCe

Individual offenders can be fined and sentenced to detention or imprisonment (usually up to 10 years). Corporate offenders can be fined. Individuals directly in charge of these companies and individuals directly responsible for the offending acts can be fined and sentenced to detention or imprisonment (usually up to 10 years) depending on the seriousness of the offence.

CoMMerCiaL BriBerY – adMiniStratiVe oFFenCe

An administrative commercial bribery offence conducted by employees shall be deemed as the act of the employer and is punishable by fines, confiscation of any illegal gains, and revocation of the offending company’s business license.

enForCeMent aGenCieS

The following government agencies are responsible for ABAC related enforcement in China:

■ Anti-bribery and Embezzlement section of the People’s Procuratorate office (public prosecutors’ office);

■ Economic Crimes Investigation section of the Public Security Bureau (i.e. the Chinese police);

■ AIC;

■ Central Committee for Discipline Inspection; and

■ National Bureau of Corruption Prevention.

reCent deVeLoPMent

On 25 February 2016, China’s State Council released proposed draft amendments to the anti-bribery provisions of AUCL. The proposed AUCL amendments indicate an attempt to update China’s commercial bribery laws to reflect current market conditions. We summarize below key changes of the proposed amendments:

■ Extend the scope of the administrative commercial bribery offence;

■ Prohibit indirect bribes through any third parties, including entities and individuals;

■ Strengthen the books and records provision for transactions relating to payments of economic benefits;

■ Impute employees’ commercial bribery to the employer; and

■ Increase various penalties imposed for commercial bribery.

The proposed amendments, if passed by the National People’s Congress, will overhaul China’s administrative commercial bribery regime, and will potentially create signif icant impact for companies doing business in China. It is possible that the amended AUCL will be passed by the National People’s Congress in early 2017.

DLA Piper is a global law firm operating through various separate and distinct legal entities. Further details of these entities can be found at www.dlapiper.com.

This publication is intended as a general overview and discussion of the subjects dealt with, and does not create a lawyer-client relationship. It is not intended to be, and should not be used as, a substitute for taking legal advice in any specific situation. DLA Piper will accept no responsibility for any actions taken or not taken on the basis of this publication. This may qualify as “Lawyer Advertising” requiring notice in some jurisdictions. Prior results do not guarantee a similar outcome.

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