Thursday, April 19, 2007

The New Chinese Tax Law and Its Ramifications to Foreign Companies

On March 16, 2007, President Hu Jintao signed into law the new Corporate Tax Law of the People’s Republic of China (“New Tax Law”). It will come into effect on January 1, 2008. In comparison with the old corporate tax laws, the new tax law ushers in a unified corporate tax regime and it could have significant impact on both Chinese and foreign companies in China.

I. Legislative History

A. The Old Tax Law

Ever since the beginning of the economic reforms in the late 1970s and early 1980s, China has had a dual taxing system, one for domestic companies, and the other for foreign enterprises. The Interim Corporate Tax Measures of the People’s Republic of China (“Domestic Corporate Tax Law”) governs the taxing of all Chinese companies, withholding a tax of about 33%; while the Foreign Invested Corporation and Foreign Corporation Tax Law (“Foreign Corporate Tax Law”) applies to all foreign corporations, enjoying a tax rate of about 15%. The purpose of the dual taxing regimes is plainly to attract foreign investments, and such a purpose has been well served as China has become one of the world’s top recipients of foreign direct investments. However, the large tax incentive to foreign companies means a large competitive disadvantage to local Chinese companies, and they have been pushing for a change in the “discriminatory” treatment in their own country since the mid 1990s.

B. The New Tax Law

After almost ten years of internal debates and political struggles, the new tax law was finally approved by the National People’s Congress in March 2007 and was signed into law by the President of China. According to Chinese commentators, the new law is meant to balance the country’s continued need for foreign investments and a unified comprehensive tax code under which domestic and foreign companies at least compete on a plain field in terms of taxes. And according to Anthony Fay, a tax lawyer at White & Case’s Beijing office, “this new tax law is timely, and China views the tax code in parallel with the overall direction of where it would like to see the county headed.”

II. Important Changes

The following summarizes the major changes in the new tax law:

a unified corporate tax rate of 25% for both foreign and domestic companies;
a decreased rate of 15% for key high tech industry;
a decreased rate of 20% for small, low profit companies;
a decreased rate for environmentally friendly companies;
a five-year grace period for foreign companies to transition gradually to the 25% tax rate; and
This law does not apply to sole proprietors and partnerships.

III. Impact on Foreign Companies

To many foreign companies in or ready to be in China, the “New Tax Law” might look like “shock and awe” because it requires a hike of a whooping 10% in taxes due to the People’ Republic. Depending on a foreign company’s perspective to the new tax code, however, the “New Tax Law” does not mean all bad news. Quite on the contrary, it might mean new opportunities that a company would not otherwise have.

For example, the “New Tax Law” might incentive a foreign company to expand into other areas of investment opportunities inside China. Since the “New Tax Law” provides a tax break on high tech and environmentally friendly industries, a foreign company may look into bringing in new environment-related technologies into China, thereby taking advantage of the tax break. Furthermore, a foreign company may examine the possibility of expanding its investments into interior China where the local government might provide additional tax incentives taken away by the New Tax Law (Of course, moving to interior China presents logistic challenges. It is the topic of another day.).

IV. Conclusion

Good or bad, the New Tax Law has arrived, and it is the time for foreign companies to strategize on ways to either cope with or take advantage of the new tax code. For most foreign companies with current or future interests in China, the “New Tax Law” does not really offer them with an option to back out of China simply because of the economic importance of the Chinese market itself. Therefore, the “New Tax Law” presents another wrinkle in the many folds of challenges in doing business in a more and more globalized world.

Monday, April 16, 2007

What Foreign Companies Need to Know About Chinese Labor Law

Fast Food Giants in Chinese Hot Water

Kentucky Fried Chicken and McDonalds both grabbed news headlines in China in the last few weeks. This time, they were not noted for their famed fried chicken or burgers; they were in trouble with the Chinese authorities for alleged violations of local minimum wages regulation in the Southern province of Guangdong.

Forbes has an excellent article, reporting the allegations of violations:
A newspaper in the city of Guangzhou had charged that McDonald’s and two chains owned by Yum! , KFC and Pizza Hut, were paying their workers, mainly students, wages as much as 40% below the local minimum for part-timers of 7.5 yuan (97 cents) an hour.

According to provincial labor authorities in charge of investigating the alleged violations, the foreign companies did not violate local minimum wage regulations. But, the companies were cleared only because that the minimum wage protection does not extend to college students, who make up a large portion of the two companies stores in Guangdong province.

Negative Impact

Any PR specialist would probably conclude that the events unfolded in China constitute a PR disaster for the two fast food giants in the local market. And the local market, unfortunately for the companies, is one of the world’s fastest and most important markets for them. Even though they have been cleared for the minimum wage issue, they have not for alleged working hour violations. As the corporate executives in America wait for the other shoe to drop, the damage might have already been done to the companies involved. To the Chinese consumers, the companies look just like what Karl Marx described in his treatise on the cruelties of capitalists, greedy, blood thirsty creatures that suck every ounce of value out of their workers…

To mitigate the negative impact of the bad press, both McDonalds’s and Yum! agreed to more unions in China. The New York Times reported on April 10, 2007 that McDonald’s, following the footsteps of Wal-Mart, gave into governmental pressure and agreed the formation of unions in its 750 outlets in China.

In light of the recent events, foreign companies are likely to remain under scrutiny of both local government authorities and consumers. China Business Blog states that:

The All China Federation of Trade Unions (ACFTU) is planning to get 80 percent of foreign companies to sign up by the end of 2008, and anyone running an MNC in China might want to plan for the day when they knock on the door - and to make sure, well in advance, that the Union rep (or the undercover reporter that precedes him) will not find any low-hanging fruit in which to stew the company at China’s most efficient court – the Court of Public Opinion.

Lessons for McDonald’s, Yum! and Everyone Going to China

1. Know the Chinese Labor Law

Like many other laws and regulations, the Chinese regulations over labor issues are very complicated. The most fundamental piece of legislation is the Labor Law of the People’s Republic of China (“Labor Law”). Chapter Five of the Labor Law sets the standards for wages, and it states as follows:

Art. 48 China hereby institutes a minimum wage protection system. Minimum wage standard is to be determined by the government authorities in provinces, autonomous regions, and municipalities. And such governments shall register minimum wage standard with the State Council.
Employers shall not pay wages lower than local minimum wage standard.

Art.49 When ascertaining and adjusting minimum wage standard, local governments consider comprehensively the following factors:
(1) Employee’s situation and minimum living standard;
(2) Average wage level;
(3) Production rate;
(4) Employment situation;
(5) Economic development differences between regions.

In addition to the Labor Law, the Ministry of Labor Social Security issued the Regulation on Minimum Wage (“Wage Regulation”) in January 2004, which came into effect on March 1, 2004. Wage Regulation states:
Art. Five Minimum wages standard shall apply in two forms, monthly minimum wage and hourly minimum wage. Monthly minimum wage standard applies to full time employees; hourly minimum wage standard applies to part time employees.
Art. Six When ascertaining and adjusting minimum wage standard, local governments consider local minimum living expenses, city and township consumer price index, worker social security deduction and housing deduction, worker average wages, economic development level, and employment situation.

2. Due Diligence

As shown above in the Labor Law and Wage Regulation, local government (on the provincial and similar level) is left with the discretion to set the minimum wage standard. Therefore, minimum wages can differ significantly from province to province. Variations of minimum wage standards could be a source for trouble for foreign companies. Needless to say, both McDonalds’ and Yum had their first rate in-house counsel, large international law firm counsel, as well as local Chinese counsel examine labor regulations in different regions of China. However, somehow, somewhere details still failed them.

In addition to seeking legal counsel, foreign companies need to take additional due diligence measure to avoid brushes with the Chinese authorities, and more importantly bad PR in the Chinese press.

a. Communication with Local Department of Labor and Social Security
Wages Regulation stipulates in Article Four that people’s government above the county level bears the administrative responsibility of enforcing the minimum wage compliance. Therefore, it should serve a foreign company to have a local agent to seek clarification from relevant enforcing government bodies regarding minimum wage standard in specific regions.

b. Union organizations are given a rule in the enforcement of the minimum wage standards in China too. Specifically, union bodies have the legal right to report violation and request enforcement actions from relevant administrative government labor agencies. So, communication and corporation with such union organizations in labor matters such as minimum wages, working hours would also benefit foreign companies.

3. Doing More Than the Minimum

As a direct result of the alleged violations of McDonalds’ and Yum, foreign companies are likely to remain under the microscope for a long time. Providing local employees more than what is the minimum could be a proactive action against possible allegations of wrong doing. Compliance with the law is one matter; provisions beyond minimum local governmental requirement is quite another in that it proactively dispels suspicions of violation simply because working for a foreign company means higher wages (This is actually the overall general impression among professionals in China.). Meanwhile, higher wages and better pay packages will tend to attract top notch Chinese talents.

Thursday, April 12, 2007

The New Chinese Franchise Law

The last post is my attempt at translating the new Chinese franchise law, 《商业特许经营管理条例》. There might be other versions of the same law floating around. If anyone knows where I might find another version of translation, please kindly inform so I can see if I made any mistakes in my translation.

My comment on the changes, ramifications, and possible long term impact of this new law is forthcoming.

Regulations for the Administration of Commercial Franchising Operations

Order of the State Council of the People’s Republic of China-1
The 485th Order

The Regulations for the Administration of Commercial Franchising Operations, which was adopted at the 167th executive meeting of the State Council on January 31, 2007, are hereby promulgated and shall come into force as of May 1, 2007.

Premier Wen Jiabao

Chapter 1 General Provisions

Article 1 The Regulations are promulgated to standardize commercial franchising operations, enhance the healthy, orderly development of commercial franchising, and maintain orders in the market.

Article 2 All commercial franchise operations shall conform to the Regulations.

Article 3 Commercial franchise herein (franchise hereafter) refers to a contractual relationship whereby an enterprise (franchisor hereafter) with registered trademark, trade name, patent and other business resources grants a franchisee the right to use its business resources, and the franchisee operates under a uniform operational model and pays a franchise fee to the franchisor in accordance with terms of the contract.

Individuals and entities, which are not registered enterprises, shall not engage in franchising operation as franchisors.

Article 4 All franchise operations shall be conducted in accordance with the principles of free will, good faith and fair dealing.

Article 5 The Ministry of Commerce shall be responsible for the administration of franchise operations on a national scale pursuant to the Regulations. Commerce regulatory authorities of provinces, autonomous regions, municipalities and districts shall be responsible for the administration of franchise operations therein.

Article 6 Any entity or individual has the right to report activities in violation of the Regulations to commerce regulatory authorities. Such authorities receiving reports shall respond in a timely manner in accordance with the law.

Chapter 2 Franchise Operations

Article 7 The franchisor shall have a mature business model, and the capacity to provide a franchisee with operational guidance, technical support and training services.

A franchisor shall have at least two directly-operated units under operation for more than one year.

Article 8 The franchisor shall register a franchising operation with commerce regulatory bodies pursuant to the Regulation within 15 days of its first franchise contract. Franchise operations within provinces, autonomous regions and municipalities shall register with commerce regulatory authorities therein; franchise operations across provinces, autonomous regions and municipalities shall register with the Ministry of Commerce.

For registration, the franchisor shall provide the following documentations:
(1) A copy of business license or certification of business registration;
(2) A copy the standard franchise contract;
(3) Franchise operation manual;
(4) Marketing plan;
(5) Written affidavit of compliance with Article 7 and supporting documents;
(6) Other files and documents mandated by the Ministry of Commerce.

A franchisor, whose franchises either products or services, shall also provide documents evidencing lawful approval of such franchise operations.

Article 9 Commerce regulatory authorities shall register a franchise operation within 10 days upon receipt of a franchisor’s documents pursuant to Article 8, and notify the franchisor. Said regulatory authorities may request from a franchisor additional supplemental file and documents within seven days if a franchisor’s files and documents are not complete.

Article 10 Commerce regulatory authorities shall publish the name of registered franchisors on government websites and update such websites in a timely manner.

Article 11 To engage in franchise operations, the franchisor and franchisee shall execute a written franchise contract.

A franchise contract shall include the following:

(1) Basic information of the franchisor and franchisee;

(2) Content and the term limit of the contract;

(3) Type, amount and method of payment of franchise fee;

(4) Specific content and the method of providing operational guidance, technical support and training services;

(5) Requirements on the quality and standard of products or services and quality control procedures;
(6) Marketing or advertising of products or services;

(7) Consumer rights protection and responsibilities for remedial damages in franchise operations;

(8) Revision, cancellation and termination of the franchise contract;

(9) Responsibilities for breach of contract;

(10) Methods of dispute resolution;

(11) Other contractual provisions agreed to by the franchisor and franchisee.

Article 12 The franchisor and franchisee shall provide in the franchise contract that the franchisee can unilaterally cancel the contract within an agreed period of time.

Article 13 The term limit for a franchise contract shall be no less than three years, except for express agreement by the franchisee.

The above section does not apply to the renewal of a franchise contract between a franchisor and franchisee.

Article 14 A franchisor shall provide a franchisee a franchise operation manual, and provide a franchisee with franchise operations guidance, technical support and training services in the method agreed to in the contract.

Article 15 The standard and quality of franchise products or services shall conform to relevant laws, administrative regulations and other governmental regulatory measures.

Article 16 If a franchisor requires a fee from a franchisee prior to the execution of a franchise contract, the franchisor shall explain to the franchisee in written format the purpose, condition and method of return of such fee.

Article 17 A franchisor shall utilize the advertising fee collected from a franchisee for purposes agreed to in the franchise contract. A franchisor shall disclose to a franchisee the status of usage of the advertising fee in a timely manner.

A franchisor shall not engage in fraudulent and misleading activities in the course of advertising and publicizing a franchise. In its advertising, the franchisor shall not include content concerning a franchisee’s earnings results in the franchise operation.

Article 18 Without a franchisor’s permission, a franchisee shall not transfer the right to a franchise unit to others.

The franchisee shall not disclose or allow others to use a franchise’s trade secrets gathered in the course of operations.

Article 19 A franchisor shall provide yearly reports to commerce regulatory authorities regarding the franchise contracting status within the first season of each year.

Chapter 3 Information Disclosure

Article 20 A franchisor shall establish and implement a complete disclosure system in compliance with the regulations of the Ministry of Commerce.

Article 21 A franchisor shall provide franchisee written disclosures of information as required in Article 22 at least 20 days prior to the execution of a franchise contract, and the franchisor shall provide a franchisee a copy of the franchise contract.

Article 22 A franchisor shall provide the following information to a franchisee:

(1) the franchisor’s name, address, legal representative, registered capital, scope of business and basic information in franchising activities;

(2) the basic information about the franchisor’s registered trademark, trade dress, patent, patented techniques and operational model;

(3) the type, amount and method of payment of franchise fee (including whether a security deposit is required and the condition and method of return of any deposit.)

(4) the price of and condition therefor the provision of products, services, and equipments to the franchisee;

(5) the specific contents, method and implementation plans of continuous operational guidance, technical support, and operational training to the franchisee;

(6) the specific method of guidance and supervision with respect to the franchisee’s operational activities;

(7) the estimated initial investment for a franchise unit;

(8) the number, location, and operational assessment of all the franchisees inside China;

(9) the abstracts of audited accounting and audit statements of the past two years

(10) any litigation or arbitration involving the franchise operations in the past five years;

(11) the information on whether the franchisor and its legal representative engaged in major illegal operations

(12) any other information mandated by regulatory authorities within the Ministry of Commerce.

Article 23 The franchisor shall provide truthful, accurate, complete information to the franchisee. The franchisor shall not withhold relevant information or provide false information.

If material changes occur to information previously provided by the franchisor, the franchisor shall notify the franchisee of such material changes in a timely manner.

The franchisee may terminate the franchise contract if the franchisor withholds relevant information or provides false information.

Chapter 4 Legal Penalties

Article 24 A franchisor, who is unqualified under Section 2 of Article 7, yet conducts franchising operations, shall be subject to an ordered correction from commerce regulatory authorities, confiscation of profits, a monetary fine between 100,000 and 500,000 yuan, and a public reprimand.

Entities or individuals other than registered enterprises, who conducts franchising operations, shall be subject to an order from regulatory authority to cease illegal operations, confiscation of profits, and a monetary fine between 100,000 and 500,000 yuan.

Article 25 A franchisor, failing to register with appropriate commerce regulatory authorities pursuant to Article 8, shall be subject to an order from such regulatory authorities to register the franchise within a specified time and a monetary fine between 10,000 and 50,000 yuan; if the franchisor fails to register within the specified time, it shall be subject to a monetary fine between 50,000 and 100,000 yuan and a public reprimand.

Article 26 A franchisor in violation of Article 16 and Article 19 shall be subject to an ordered correction from commerce regulatory authorities, and may be issued a monetary fine less than 10,000 yuan; in case of a serious and egregious violation, the franchisor shall be subject to a monetary fine between 10,000 and 50,000 yuan and a public reprimand.

Article 27 A franchisor in violation of Section 2 of Article 17 shall be subject to an ordered correction from Administration of Industry and Commerce, a monetary fine between 30,000 and 100,000 yuan; in case of a serious and egregious violation, the franchisor shall be subject to a monetary fine between 100,000 and 300,000 yuan and a public reprimand; if a violation constitutes a crime, the franchisor shall be subject to criminal liability.

A franchisor engaging in misleading and fraudulent advertising shall be subject to penalties in accordance with the Advertising Law of China.

Article 28 A franchisor in violation of Article 21 and Article 22, reported by a franchisee and confirmed by commerce regulatory authorities, shall be subject to an ordered correction and a monetary fine between 10,000 and 50,000 yuan; in case of a serious and egregious violation, the franchisor shall be subject to a monetary fine of 50,000 and 100,000 yuan and a public reprimand.

Article 29 Criminal activities defrauding others’ money or property under the disguise of franchising shall subject the perpetrator to criminal liability; activities, not constituting a crime, shall subject an actor to penalties in accordance with the Law of Public Security and Punishment of China.

Those conducting pyramid sales under the disguise of franchising shall be subject to penalties in accordance with the Regulations Prohibiting Pyramid Schemes.

Article 30 Employees of commerce regulatory authorities engaging in abuse of authority, professional negligence and self-dealing shall be subject to criminal liability if such activities constitute a crime; if not a crime, such employees shall be subject to punishment in accordance with the law.

Chapter 5 Addendum

Article 31 Laws governing trademark and patent as well as administrative regulations shall apply to issues arising out of franchise operations concerning trademark licensing, patent licensing.

Article 32 Franchising organizations and associations are to, under the guidance of regulatory authorities within the Ministry of Commerce, formulate standards for franchising operations, strengthen professional self governance, and provide services to parties engaging in franchise operations.

Article 33 A franchisor conducting franchising operations before the Regulations goes into effect shall register the franchising with commerce regulatory authorities in accordance with the provisions herein within one year the from the date when this Regulations goes into effect; the franchisor failing to register within said exemption period shall be subject to penalties provided in Article 25.

The franchisor under the above section is exempt from Section 2 of Article 7.

Article 34 The Regulations shall go into effect on May 1, 2007.