Knowing the System

Legal issues are a frequent cause of concern to business people, especially in an unfamiliar and frequently changing legal environment such as China. Understanding the fundamentals of Chinese real estate, taxes, contract practices, intellectual property protection, and finance builds a foundation for success in China’s markets.

Getting to grips with tax

The taxation regimen in China involves many technical details and is in constant flux. For example, VAT rates have recently varied from 13 to 17 percent depending on the product. Exports were not charged the tax and small businesses paid only a 4 to 6 percent rate. The special incentive tax rates for foreign investment in special economic zones have mostly ended, while the business tax on turnover has recently varied from 3 to 20 percent. Consult a local accountant for guidance on the latest tax situation.

Understanding property

The Chinese constitution now provides protection for individual and company property rights. There are two types of land rights—allocated and granted. Allocated rights are where a state-owned or related organization receives permission to use land indefinitely, usually with an annual fee, but cannot sell it or use it as security. Allocated rights can be cancelled at any time, and should be avoided by foreign investors. Granted land rights are for a definite period of time, usually 70 years for homes, 50 for factories, and 40 for stores and offices, and are available to individuals and companies, including foreigners. They are similar to the renewable ground leases common in Western countries, but haven’t yet existed long enough for the renewal provisions to be implemented in practice.

The Chinese tax landscape (2008)

Protecting intellectual property

Enforcement of patents, trademarks, copyright, and trade secrets varies from province to province, but is constantly improving. China has a “first to patent” priority rule, so don’t wait until your products are on the market—patent everything, especially designs.

Copyrights should be registered to clearly establish ownership, and you should check the records of existing trademark registrations carefully and file in the correct categories. Registered marks and “famous brands” receive adequate protection in China, and the situation is improving. Ask a trusted advisor to help create an appealing Chinese version of your company name and brands, and submit any applications very early (now would be best!).

Trade secrets are difficult to protect through the courts, so a multi-layered IP protection strategy is recommended. Consider modularizing production, and making at least one key element of your product in your home country. Restrict storage, access, and download rights on your network. Implement employee education, contractual protection, and personnel and partner investigation.

Intellectual property protection: the software industry

Software was once considered virtually unprotectable in China, where pirate versions of computer applications costing up to $500.00 per copy were sold for ¥15—about $2.00. Several strategies have helped convert this supposedly hopeless situation into a Chinese success story, including incorporating programs into dedicated memory chips; providing software online; distributing applications through government mandated programs; using extensive customizing so that enterprise software was less useful when copied; employing sophisticated online activation procedures; and lowering the price to match Chinese incomes. While these methods may not apply directly to your firm, the intellectual property protection of your products and services in China can usually be improved if you approach these issues with creativity and an open mind.

Working with financial services

China is aggressively reforming its financial sector into Western-style commercial banks, insurance companies, and capital markets. The transition is not complete, and policy considerations sometimes outweigh market-based concerns. It is not always possible for private Chinese firms to receive full service from these institutions, much less foreign-owned companies.

China’s financial sector is gradually opening to foreign financial institutions, so if your familiar financial service partners have not already opened offices in Beijing, Shanghai, and Shenzhen, chances are that they will soon. China enjoys an excess of venture capital (VC) funding, and VCs compete aggressively to fund the best business plans, so your start-up might have a better chance in China than at home.

Using contracts

Contracts are enforceable in China through negotiation, mediation, arbitration, or court judgement. Arbitration is given a number of legal advantages and so is the preferred method. When drafting a contract with a Chinese partner, consider the following—you should be able to answer “yes” to every question:

• Have you checked and verified the ownership, structure, reputation, and solvency, and even the existence of the Chinese partner?

• Have you asked for payment in advance of delivery and requested security and letters of credit?

• Have you specified the method, time, and currency of payments?

• Have you verified that you will be able to convert any Chinese currency into that of your home country?

• Are the provisions of your contract clear of conflicts with local, national, WTO, and your home country’s laws and regulations?

• Do powerful Chinese individuals or organizations have a clear interest in the success of your business?