BizChina

My clients know way more about their businesses than I do. My job as lawyer is to tell them how I perceive the legal risks and rewards of whatever they are doing and then work with them to help them decide how to proceed. I contribute on the legal side, they on the business side.

Every so often, my firm gets a client who has the "perfect" agreement that it has been using forever and they want us to make it work for China. Okay, no problem. Most of the time.

Other times though we face a real battle and that battle really rests on how one defines "perfect." Sometimes our clients consider the perfect contract to be one that just really really protects them. In every single way. Late delivery? Chinese company has to pay a massive amount in liquidated damages? One item out of one hundred not quite up to snuff? Again, the Chinese company has to pay liquidated damages well beyond any possible harm to our client. Payment by our client? Payment by our client? Ten percent now, the rest upon delivery and confirmation of quality. Oh, and the Chinese manufacturer must not make any even similar product for any other company.

All of the above is well and good, but the reality is that the only Chinese companies that sign such agreements are doing so for Wal-Mart or are doing so, knowing full well they will never abide by it. So when confronted by clients who absolutely insist on these "perfect" contracts and refuse to listen to our advise regarding the realities of the Chinese market, we go ahead and write the contract per the clients instructions. We then sit back and wait a few months for them to return to us to write a brand new contract that someone will actually sign. Or sometimes, the client comes back to us and tells us they no longer want to try to do business in China because nobody there is reasonable.

The best contracts are not perfect for any one side; the best contracts are those that provide the most protection possible, while actually working in the real world.

What are you seeing out there?

Shanghaiist just posted my list of "China’s top 5 business law trends of 2010," which list included China stepping up its tax collection efforts. Drastically.

Speaking of drastically, I just read a really excellent article by a swarm of O'Melveny & Myers lawyers, entitled, "China Adopts Controversial Vodafone-style Extraterritorial Tax and Disclosure Rule," discussing China's just circulated Circular 698. The O'Melveny article summarizes an "amazing" part of that circular as follows:

However, Article 5 of Circular 698 then takes an amazing leap. It [Article 5 of Circular 698] states that foreign entities are required to disclose all indirect transfers of PRC resident enterprises to the PRC tax authorities in cases where an intermediate holding company through which such transfers are made are located in a low tax jurisdiction or such jurisdiction exempts income tax on foreign-sourced income. In this case, the foreign enterprise making the indirect transfer must disclose the following documentation to the PRC tax authority in the location of the PRC resident enterprise within 30 days of executing the transfer contract:

i. Equity transfer agreement/contract;

ii. Representations regarding the relationship between the foreign entity and holding company being transferred in terms of “capital, operation, sales and purchase etc.”;

iii. Representation regarding the operation, employees, bookkeeping, and assets of the holding company being transferred by the ultimate foreign entity;

iv. Representations regarding the relationship between the holding company being transferred by the ultimate foreign entity and the PRC resident enterprise, in terms of “capital, operation, sales and purchases;”

v. Representations regarding the reasonable business purpose with respect to the transfer of the holding company; and

vi. Other materials requested by the tax authority.

The article then very nicely lays out some truly extreme examples of where foreign companies may be required to report to China on their foreign M&A activity and then asks the following series of questions relating to whether the circular is "even legal:"

(1) Is there a legal basis under any validly promulgated PRC law or administrative regulation which imposes information reporting obligations and tax with respect to such indirect transferors? How does an interpretive circular like 698 derive its PRC legal authority?

(2) Does the PRC general anti-abuse rule (“GAAR”) in the EIT grant virtually unlimited power to the PRC tax authorities concerning transactions, including matters of extraterritorial jurisdiction? How does one sentence in a quasi-civil law statute encapsulate an entire doctrine?

(3) Is there a colorable theory under international legal principles to assert extraterritorial jurisdiction over the numerous parties potentially described in Circular 698?

(4) Will the enormous administrative complexities and burdens created by the disclosure mean erratic compliance and result in grossly unfair application of the rule? Can most foreign entities comply?

(5) Will local PRC tax bureaus be staffed with the resources, training, and other administrative infrastructure to deal with those disclosure actually submitted?

This circular is so far out of the norm and so likely to cause an uproar I suspect much of it will never come to pass. No matter what though, it is a great indicator of China's strong desire to increase its taxing powers, especially with respect to foreign companies.

For more on Circular 698, check out the following:

-- Detailed Analysis of of Circular 698, on the China Tax Insights Blog.

-- "China Reinforces Tax Administration of Share Transfers by Non-resident Enterprises," by the Mayer Brown law firm.

-- Tax Alerts by PriceWaterhouse and Deloitte.

UPDATE: China Tax Insight just did a new post on Circular 698, entitled, "One Last Post on Circular 698," taking Deloitte to task for saying "Circular 698 creates some legal questions as to whether the Chinese government has the right to tax foreign companies."

With few exceptions, the business law trends I see for China in 2010 are not all that different from what I would have seen last year or even the year before. The Chinese government’s primary goal is to stay in power (I think this is true of virtually all governments) and that goal usually drives the enactment and enforcement of its laws. The big, overarching trend I see for China in 2010 is its continuing to more strictly enforce its laws, particularly those that apply to business, and even more so those that apply to foreigners.

The Chinese government wants to satisfy its own citizens so as to maintain its own legitimacy and one of the best ways to do that is to show a desire to protect the citizenry against foreigners. China’s current economic strength is leading many in its government to believe China has little to no need for foreign investment and so I see law enforcement against foreigners continuing to increase.

I see the following five key things happening on China’s business law front in 2010:

1. China will step up even further its crackdown on foreigners in China violating its visa/immigration laws. If you lack an employee visa, you may be at risk.

2. China will increase its efforts to root out and shut down illegal and unregistered foreign businesses. I have seen ample evidence of this already happening in the last 3-6 months and I have no doubt this will continue. Providing jobs to Chinese citizens does not let you off the hook.

3. China will increase its tax collection efforts. This has been going on at a rapidly accelerating pace over the last six months or so. If your China operations are not making a healthy profit, do not be surprised if the government imputes healthy profits to it. In particular, the government will look very closely at your transfer pricing and in many cases it will not like what it sees.

4. China now sees itself as a full-fledged economic power and with that perception we can expect it will be stepping up its anti-monopoly monitoring of mergers and acquisitions. I predict China will seek to impose at least some conditions on all mergers and acquisitions that touch on China, if only just to show that it can.

5. The number of cases brought by employees and resolved in their favor will continue rapidly increasing. This will be particularly true with respect to foreign companies as this will be a great way for the government to show its willingness to protect its own.

* This is my December 31, 2009, post on Shanghaiist.

Just finished a very interesting and very nicely done three part series over at the brand spanking new View to China blog, written by London based lawyer, Geraldine Johns-Putra. The series is on the five big issues confronting China in its ascension to superpower status and it is entitled, "China as the next Superpower? Top 5 Make or Break Issues." Part 1 is here, part 2 is here and part 3 is here.

I recommend it.