China Law Insight : China Law Insight: China Commercial and Intellectual Property Lawyers and Attorneys, Full Service Law Firm: King & Wood

Background

The Anti-Monopoly Commission (AMC) is the advisory and policy arm amongst the list of agencies enforcing and implementing the Anti-Monopoly Law (AML).  Specifically, the AMC is responsible for organizing, coordinating, and providing guidance for implementing the AML (see Article 9, AML).  Functions of the AMC include drafting competition policies, formulating and issuing anti-monopoly guidelines and coordinating anti-monopoly administrative enforcement matters.

The AMC was established in 2008 with the enactment of the AML.  It consists of officials from the State Council and other government agencies.  Currently, the officials who serve on the AMC include:

(1) Director: Vice-Premier of the State Council;
(2) Vice-Directors:
a. Minister of MOFCOM;
b. Director of the National Development and Reform Commission ("NDRC");
c. Director of the State Administration for Industry and Commerce ("SAIC");
d. Vice-Secretary-General of the State Council.
(3) Commissioners:
a. Vice-Minister of MOFCOM;
b. Vice-Director of the NDRC;
c. Vice-Director of SAIC;
d. Vice-Minister of the Ministry of Industry and Information Technology;
e. Vice-Minister of the Ministry of Supervision;
f. Vice-Minister of the Ministry of Finance;
g. Vice-Minister of the Ministry of Transport;
h. Deputy Director-General of the State-owned Assets Supervision and Administration Commission;
i. Vice-Director of the State Intellectual Property Office;
j. Vice-Director of the Legislative Affairs Office of the State Council;
k. Vice-President of the China Banking Regulatory Commission;
l. Vice-President of the China Securities Regulatory Commission;
m. Vice-President of the China Insurance Regulatory Commission;
n. Vice-President of the State Electricity Regulatory Commission.
 

According to Mr. Shang, from 1 August 2008 (when the Anti-Monopoly Law was enacted) till the end of May 2011, the Anti-Monopoly Bureau of MOFCOM cleared 240 merger control filings, among which 233 (97%) were approved without conditions, 1 rejected, and 6 were approved with conditions.  [Note: On 2 June 2011, MOFCOM announced that a transaction between two Russian potash producers was cleared with conditions, bringing the conditional clearance figure from 6 to 7 (see our article entitled The Russian Potash Deal - first conditional clearance of 2011)].

During the Symposium, Mr Shang also said that amongst these 240 cases, 119 cases (about 50%) were cleared before or by the end of the Phase I review period (30 calendar days); and 117 cases (about 49%) were cleared before or by the end of the Phase II review period (90 calendar days).  Only 4 cases entered the extended Phase II review period (which spans for a maximum of an additional 60 calendar days).

Some Historic Data

• By the end of June 2009, MOFCOM accepted 58 merger control filings, among which 46 were closed without conditions, 2 closed with conditions and 1 prohibited.
• By the end of June 2010, MOFCOM accepted about 150 merger control filings, among which 120 were closed without conditions, 5 closed with conditions and 1 prohibited.
   

• MOFCOM officially accepted the Parties' merger control submission on 14 March 2011.  This filing entered into Phase 2 review on 12 April 2011.  MOFCOM decided to clear this transaction with conditions on 2 June 2011.
• During the merger control review, MOFCOM requested that the Parties submit the following information:  information to do with overlaps in relation to the types of quantity of potash products produced by the parties; information to do with pricing and the sales model of both parties; market share information (both Chinese and worldwide market shares); information to do with the potash industry.
• MOFCOM sought opinions from the following third parties: government departments, trade associations, suppliers, traders and industry experts in order to obtain a better understanding of the relevant products, distribution of potash, market definition, market structure as well as the production, operation and trading patterns of the potash industry.
• MOFCOM held that the relevant product market was the market for potassium chloride.   MOFCOM took into consideration that China is one of the largest importer of potassium chloride in the world, relying on import for nearly 50% of its domestic consumption.  MOFCOM  further noted that more than 50% of China's import of potassium chloride is derived from Uralkali, Silvinit and their affiliates. 
• MOFCOM noted that potassium chloride is a natural resource concentrated in a few jurisdictions.  The top 3 potassium chloride jurisdictions in the world possess more than 80% of the world's potash resources.  Global production and sales of potassium chloride are concentrated in the hands of a few companies.  The Parties' concentration would result in the world's second largest export supplier of potassium chloride.  The Parties' combined global market share will exceed 1/3 of the world's supply of potassium chloride.

MOFCOM was of the view that the transaction is likely to restrict or exclude competition.  In order to counter these anticipated anti-competitive effects, MOFCOM has imposed the following four conditions on the Parties:

a) the combined entity should continue to maintain its current sales practices and procedures.  The combined entity should continue to supply potassium chloride to China via direct trade.  In addition, the combined entity should continue to channel potassium chloride to China via rail or sea in a reliable and diligent manner;

b) the combined entity should continue to meet China's demands for potassium chloride (both in terms of volume and range of potassium chloride products), including potassium chloride containing 60% and 62% of potassium oxide.  In addition, the combined entity should continue to supply its customers in China the types and quantities of potassium chloride required for a variety of uses, including for agricultural use, industry use and "special industry" use;

c) in relation to price negotiations with Chinese customers, the combined entity should keep to the usual consultation processes (including taking into account the history of customer transactions and the unique features of the Chinese market).  The usual negotiations, including price negotiations in relation to spot trading or trading by contract (six months or a year) should apply;

d) every six months (or upon request), the combined entity should report to MOFCOM that it has complied to this list of conditions and commitments.  MOFCOM possesses the power to supervise and inspect the implementation of the above restrictive conditions.  MOFCOM also has the right to impose sanctions on the combined entity, should it fail to adhere to any of the above conditions.

Comments

The four conditions listed above are behavioral conditions drafted in very broad terms.  This leaves a lot of scope for MOFCOM to interpret these conditions as they see fit going forward. 

It is clear that the objective of these conditions are to ensure the stability of the adequate supply of potassium chloride into China. 

It is interesting to note that while MOFCOM has determined product market definition, they did not express a view on geographic market definition – however, in MOFCOM's decision, there are many references to the global nature of the potassium chloride industry – thus it is likely that MOFCOM analysed the deal from a global perspective.

Pursuant to the AML, if the combined entity does not adhere to the conditions listed above, they are at risk of facing a range of sanctions including: a fine of not more than RMB500,000; orders to cease implementing the transaction; and orders to divest within a stipulated period.
 

We have two observations to the above list.  First, the above list is by no means exhaustive.  We notice that in the annual reports the Committee on Foreign Investment of the United States ("CFIUS") filed to the US Congress, there are altogether 14 applications filed with CFIUS by Chinese acquirers from 2005 to 2009.  However, since the CFIUS review process is confidential, the reports only provide aggregated data by country and sector.
 
Second, a transaction scrutinized for national security concerns may nevertheless be approved if the structure of the transaction is modified to the extent that such concerns are eliminated.  For example, the proposed acquisition of OZ Minerals by China Minmetals Corporation was eventually approved by the Australian government after the parties submitted a revised proposal, excluding one of OZ Minerals' key mines, which caused the national security concern due to its proximity to Australian military facilities.

The new version of the Insurance Law that came into force October 2009 made it clear that insurance companies would have more investment channels are open for insurance funds, specifically, the 2009 Insurance Law stated that investing insurance funds in real estate was acceptable. In September 2010, the CIRC promulgated the Provisional Measures for Insurance Capital Investment in Real Estate. This regulation provides the basic outline of what the types of real estate projects that insurance companies can invest in. Although this regulation is in place, it appears that the CIRC is not ready to approve insurance companies investing real estate projects, but announcement can probably be taken as evidence that CIRC is moving closer to being ready to approve insurance companies investing in real estate projects. Also based on Chairman Wu's statements it probably can be assumed that the first real estate project that insurance company investing will be located in Shanghai, and it most likely be a housing project that is subsidized to keep its prices affordable.

If you have any questions about the potential for insurance funds to be invested in real estate development projects, or if you would like more details on the Provisional Measure for Insurance Capital Investment in Real Estate please contact us.

The information contained in this post is available at: http://www.chinadaily.com.cn/usa/business/2011-03/07/content_12130923.htm

There has been some speculation about the types of products that will be offered through the exchange and who will able to participate in it, but since there are no details at all about the exchange, including the fact that the CIRC did not provide a time line on when it expect to open the exchange, there is no way of knowing what to expect of a the potential Shanghai insurance exchange. However, the speculation is interesting because by considering opening an exchange it sounds like the CIRC could be open to more innovation in the Chinese insurance market, and some individuals have speculated that the CIRC is considering making the exchange more of a place where property and casualty policies, group life insurance policies, and reinsurance could be quickly and easily bought and sold, instead of a place where hard to place risks and excess or surplus lines are placed. In addition, if reinsurance if going to be available through the exchange it raises the possibility that foreign insurers and reinsurers will be able to be involved in the exchange in some capacity because China's WTO commitments state that China allow international insurers to write reinsurance business from outside of China.

If you would like more information about what a insurance exchange could potentially mean for the Chinese insurance market please contact us.

The information contained in this article is available at: http://www.chinadaily.com.cn/usa/business/2011-03/07/content_12130923.htm

• First, Cai Jiming (a CPPCC representative and an academic from Tsinghua University) called for the relevant authorities to consider "breaking up" Baidu into two business segments: its online search engine business; and all other online services.  Cai said that this was to ensure that Baidu does not abuse its dominant status in the online search engine industry;

• Second, some 30 NPC representatives submitted a proposal to amend the Anti-Unfair Competition Law²– in order to ensure that  "anti-unfair competition conduct" in the IT industry in China are being dealt with.

In relation to Cai's comments, we note that Hudong's Chief Executive Officer (Hudong is a company which also runs an online search engine; amongst other online services and platforms) made similar comments in the context of their allegation that Baidu has abused its dominance in the online search engine industry (see our article Wiki-Hudong against Wiki-Baidu – an abuse of dominance? dated 25 February 2011).

Pursuant to the Anti-Monopoly Law (AML), the only remedy available to the antitrust authorities for a breach of the prohibition against an abuse of dominance are fines (see Article 47, AML).  There isn't a divestiture or "separation of business" remedy in respect of breaches in relation to the prohibition against an abuse of dominance.  However, Article 45 of the AML provides that in the context of an investigation of an alleged monopoly act, antitrust authorities possess the power to cease such an investigation provided the business operator undertakes to adopt specific measures to eliminate the consequences of such conduct.  Thus far, there have been no public reports in relation to the operation of Article 45. If the antitrust authorities wish to "break up" Baidu as it were; then there is scope to rely on Article 45 as a source power for this outcome.  However, the "breaking up" of Baidu is by international standards quite a severe remedy and one which would indicate that antitrust and competition law is being run with an "iron hand" here in China.

Similar noises have been made in Europe in relation to Google.  From an economic policy perspective: we think there needs to be a balance between letting the "invisible hand" work its way around within an economy and imposing severe structural remedies such as the one listed above.

In relation to the proposal to amend the AUCL – it will be interesting to see what the proposed amendments are and how this would impact on the IT industry in China.  Of note is the fact that many private actions in relation to the AUCL and the AML in China have been taken up against IT companies.
                                                                 .   .   .   .   .   .

¹Specifically, these sessions are: the fourth session of the 11th National People's Congress; and the fourth session of the 11th National Committee of the Chinese People's Political Consultative Conference.

²The Anti-Unfair Competition Law (AUCL) was enacted with 1993 with the objectives of safeguarding the development of China's socialist market economy; encourage and protect market competition; prohibit unfair competition and to safeguard the legal rights and interests of business operators. The AUCL deals with many issues including: counterfeiting, commercial bribery, false representation, false propaganda; commercial defamation and restrictions on competition. As such, there are some overlaps between the prohibitions set out in the AUCL and the AML (but note that the financial penalties for a breach of the AUCL are lower than those pursuant to the AML)

As part of improving how bank based insurance sales activities are handled, the Chairman is asking local CIRC offices to pay attention to the letters and visits they receive from the public because these letters and visits will let them know how the insurance purchasers feel about the insurance industry's behavior the area that the local office is in charge of regulating. He believes that by focusing on insurance consumers' concerns the local CIRC offices will be able to stop activities that violate the insurance law and effectively protect the interests of insurers and insurance policy purchasers.

Moreover, he wants local CIRC offices to study the issues that insurance consumers are informing them are occurring, and he wants the local offices to provide their enforcement staff written instructions on how to effectively remedy the issues that the insurance consumers are concerned with so that illegal activities associated with bank based insurance policy sales will be reduced.

Specifically, the Chairman has asked that these written instructions address many topics, including, the following issues:

1. Local CIRC offices should instruct their staff to increase their observation of public opinion, and increase their enforcement of insurance agents information disclosures to insurance policy purchasers to ensure that insurance consumers interests protected.

2. The local CIRC office instructions must establish a system to improve the public's knowledge about insurance. The local offices should work with insurers, insurance associations, and insurance agents to develop a system to improve the public's understanding what buying insurance means, what insurance claims handling entails, what premium and insurance benefit payments mean, and what insurance policy dispute resolution entails. The overall hope for this education drive is to improve the publics understanding of insurance in order to make insurance consumers more savvy so that they can make better choices about their insurance purchases in the future.

3. The local CIRC offices should attempt to improve insurance contract dispute resolutions by increasing the number of mediation channels available through having CIRC staff push insurance companies to improve claims handling services and resolve policy disputes more quickly. The instructions should also tell CIRC staff to work with insurance associations to strengthen how they handle complaints, disputes, and how they promote efficient mediations. Finally, this the instructions should tell the CIRC staff to work with the judiciary to help improve mediation so that litigation in court is less necessary.

4. The local CIRC office should instruct their staff to increase how much credence they give insurance consumers'' complaint letters. The Chairman hopes that increasing the attention that the local office's pay to complaint letters will show that public that their concerns about the insurance industry are being effectively addressed, which will hopefully improve the public's faith that the CIRC is prioritizing their interests.

5. The local CIRC office should write instructions that tell their staff that they should provide the central CIRC feedback on the complaints they are receiving and the most effective methods they developed for addressing those complaints. Providing the central CIRC this feedback will help it understand more about the activities in the local insurance markets, and it can attempt to implement the most effective systems on a nationwide basis to improve the CIRC's regulatory activities throughout all China.

The Chairman's hopes that the local CIRC offices find creative ways to implement these directives for instructions that they should provide their staff. The Chairman hopes that this creativity will help the CIRC solve difficult problems and create best practices that will help the it improve its regulatory enforcement on issues that public has expressed concerns about. Furthermore, the Chairman hopes that the local staff implementing this directive will improve the CIRC's interaction with the public and its regulatory transparency. Finally, the Chairman states that the local CIRC offices should provide the central CIRC regular reports on how they are implementing this announcement so that the CIRC will know that the local offices are implementing its directives.

If you would like more details on Chairman Wu's announce, and the requirements that the CIRC has for the local office written instructions, please contact us. Or if you have any questions about developments in the Chinese bank assurance industry and the potential for international insurance institutions to enter it, please contact us.

The information contained in this post is available at: http://www.law-star.com/cacnew/201102/740068821.htm

The governing laws of the foreign-related intellectual property right relationships are provided in Articles 48-50 of this law. Firstly, the law at the locality where the protection is claimed shall apply to the dispute concerning the ownership and contents of intellectual property right. Secondly, a party may choose the laws applicable to the assignment and licensed use of intellectual property rights by agreement; otherwise, the laws at the habitual residence of the party whose fulfillment of obligations can best reflect the characteristics of this contract, or other laws which have the closest relation with this contract, shall apply. Thirdly, the laws at the locality where the protection is claimed shall apply to the liabilities for tort and for intellectual property; alternatively, the parties may also choose the applicable laws at the locality of the court by agreement after the tort occurs.

Resource: http://www.npc.gov.cn/npc/xinwen/2010-10/28/content_1602433.htm

Questions have been raised in relation to what sorts of transactions may be caught by this national security review process; how long the process; and about procedural fairness issues in relation to this process (see our article entitled "Will my transactions be subject to the National Security Review Regime?",  which deals with this issue; see also our article entitled "National Security Review regime formally established in China" for more background information in relation to the process).

China is not alone in relation to instituting a national security review process to review foreign-local transactions which may impact on national security issues.  There are similar processes in other jurisdictions as well, including the United States (US), Canada, Germany and Australia.

Several of our US-based clients have wondered about the differences and similarities between the US-equivalent of a national security review system (vis-à-vis foreign-local transactions) and the proposed Chinese regime. 

The table below sets out some high-level (mainly procedural) similarities and differences between these two regimes.  For precise details in relation to each of these regimes, please seek legal advice or consult the actual terms of the legislation and regulations set out in row 1 of the table below.
 

¹The notice is entitled "Notice on Establishing National Security Review Mechanism for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors".

Background

Specifically, Hudong has alleged that Baidu has abused its dominance by manipulating online search results and therein either lowering the ranking of, or eliminating Hudong Bai Ke (which refers to Hudong's wiki-like encyclopedia services) from online search results. 

Both Hudong and Baidu offer a spectrum of online internet services, including online "wikipedia"-like or encyclopedia-like services.  Hudong's wiki-like encyclopedia service is known as Hudong Bai Ke.  Baidu's wiki-like encyclopedia service is known as Baidu Bai Ke. 

According to Hudong, Baidu has allegedly either lowered the ranking of, or eliminated Hudong Bai Ke from its unpaid search results in favour of Baidu Bai Ke.  Hudong further alleges that Baidu has undertaken this conduct with the intention of driving out competition in relation to wiki-like encyclopedia services.

Hudong has requested that the SAIC launch a formal investigation into the above mentioned conduct of Baidu and has suggested that SAIC levy a fine of RMB790 million on Baidu.  The Chief Executive Officer of Hudong has also been quoted as suggesting that the SAIC should consider "breaking" Baidu's business up into two main segments: online search engine services; and other online services. 
 
Abuse of dominance?

Hudong has alleged that Baidu has breached the prohibition against an abuse of dominance pursuant to the AML.  They have made the complaint to the SAIC, which is the competition authority in charge of investigating and enforcing non-price related breaches of the AML.

Article 17 of the AML prohibits dominant business operators from abusing their dominant market positions.  Article 17 of the AML also lists examples of several types of conduct which, may, in particular, violate the provision; including: excessive pricing; predatory pricing; bundling; refusal to deal and so on.  It is clear that this list of examples of conduct which, may, in particular, violate Article 17 is not exhaustive.  This is evident because of the existence of Article 17(7) which is a "catch all" provision – this provision states that the antitrust authorities may stipulate other types of conduct which amount to an abuse of dominance.

Media reports in relation to this Hudong-Baidu complaint only state that Hudong has alleged that Baidu has abused its dominance.  However, the reports do not cite the particular provision which Baidu has allegedly violated.  Since Baidu's alleged breaching conduct does not "fit" neatly into any of the examples listed in Article 17 (e.g. refusal to deal; bundling etc), we think that Hudong's allegations have relied on Article 17(7) (the "catch-all" provision).

In order to establish a breach of Article 17, the SAIC would need to be satisfied that:
• Baidu is a dominant business operator in the relevant market;
• Baidu has abused this dominant position in the relevant market by undertaking the conduct mentioned above; and
• Absence of valid reasons.

It is unclear what would constitute the "relevant market".  If the relevant market is construed as "online search engine services"; then the SAIC would need to be satisfied that there is sufficient evidence to prove that Baidu is dominant in relation to this market.  We note that in a previous abuse of dominance court application against Baidu (the application was made by Tangshan Renren), the Beijing First Intermediate People's Court was of the view that Tangshan Renren did not provide sufficient evidence to prove that Baidu was dominant in the online search engine market.³

It is also possible that the SAIC would determine that the relevant market should be construed more narrowly – e.g. the online wiki-encyclopedia services market.  In this case; a few questions arise, including: Is Baidu Bai Ke a dominant wiki-encyclopedia service provider in China?  If not, has Baidu leveraged its alleged dominant position in the online search engine market to drive out competition in this narrower market?

Remedies

As mentioned above, Hudong has suggested that the SAIC impose a fine amounting to RMB790 million on Baidu.  It is, however, unclear how Hudong has come up with this amount of a proposed fine.

In addition, we note that the CEO of Hudong has suggested that SAIC may wish to consider breaking Baidu up into two business segments: its online search engine business and its other online services (no doubt including Baidu Bai Ke).  This is an interesting proposal. 

We note that pursuant to the AML, the antitrust authorities (including the SAIC) do not have the express power to impose a divestiture or structural remedy on Baidu.  Article 47 of the AML only lists the following remedies in relation to an abuse of dominance: fines, injunctions and damages.

However, Article 45 of the AML states that the antitrust authorities (including the SAIC) may decide to suspend an AML investigation process, if business operators undertake to adopt specific measures to eliminate "consequences" of their anticompetitive conduct.  Perhaps this is the provision that may provide a possibility that the business operator can offer a structure remedy to the anti-monopoly enforcement agency to terminate the investigation.

Other observations

The basis of this Hudong-Baidu complaint echoes the current European Commission (EC) investigation into conduct undertaken by Google.  Specifically, we note that on 30 November 2010, the EC announced that it decided to commence an antitrust investigation into allegations that Google has abused its dominant position in online search – following complaints by search service providers about unfavourable treatment of their services in Google's unpaid and sponsored search results coupled with an alleged preferential placement of Google’s own services. 

We think it is likely (given that China is a relatively new antitrust jurisdiction) that the SAIC will consider any decisions arising out of the EC-Google case as persuasive evidence in relation to this Hudong-Baidu complaint.

¹See: www.hudong.com

²See: www.baidu.com

³The Baidu-Tangshan Renren case had to do with paid online advertising services – the latter alleged that the former abused its dominance by manipulating search results when the latter reduced payments to Baidu.

As software is seen by the P.R.C. government as a key industry to develop, it has taken steps to provide support for domestic software companies. To this end, the State Council has recently released the "Circular of the State Council on Printing and Distributing Certain Policies on Further Encouraging the Development of the Software Industry and the Integrated Circuit industry" (hereinafter referred to as "the Circular")². For the purposes of this analysis of the Circular, only its impacts upon the "Software Industry" will be addressed.In the Circular, the State Council recognizes the challenges facing domestic software companies and notes that "comparing with the international advanced level, … problems still exist in China's software industry … as that the development foundation is weaker, enterprises do not have a strong technological innovation and self-development ability, the application and development level are in urgent need of improvement and that the industry chain needs to be improved³. The purpose behind the Circular, relating to the software industry, is noted by the State Council as “further optimizing the development environment for the software industry …, increasing industry development quality and level and cultivating a number of influential and strong leading enterprises....” The Circular divides its “Policies” into seven different sections (referenced herein) and various aspects of each will be addressed, as follows.

1. Financial and Tax Policies

In relation to software enterprises, the Circular notes that "[p]referential VAT policies for software shall continue to be implemented” and that “[e]ligible software enterprises …, which engage in software development and testing, information system integration, consulting and operation maintenance … and other businesses, shall be exempt from business tax and relevant procedures for them shall be simplified"⁴. In addition, the Circular notes that “eligible software enterprises within the territory of China may enjoy '2-year exemption and 3-year reduction by half' preferential enterprise income tax policy from the profit making year"⁵. Furthermore, the Circular notes that the "preferential period for any eligible software enterprise … to enjoy the '2-year exemption and 3-year reduction by half' ... preferential enterprise tax policy shall be calculated from the profit making year before December 31, 2017 till the expiry date.&rdquo⁶; It was recently estimated by Haitong Securities that “the income tax cut alone will provide an additional 5 to 10 percent profit to Chinese software companies this year"⁷.

2. Investment and Financing Policies

The aim of the policies would seem to be not only the growth of the domestic software industry, but also merger and consolidation, where appropriate. The Circular notes that "[r]elevant departments of the State Council and local government at each level shall give positive support and guidance to trans-regional restructuring and mergers carried out for the purposes of realizing resource integration and becoming bigger and stronger by software enterprises … and prevent obstacles in any form"⁸.

Regarding investments in software enterprises, in addition to traditional means of financing, such as "stocks [and] bonds"⁹ , the Circular notes that "[s]ocial capital shall be guided to establish venture investment funds through existing fund-of-funds and other capital and policy channels"¹⁰ , as well as allowing that "[e]ligible local governments may establish equity investment funds or venture investment funds mainly with a view to support the development of software enterprises…."¹¹ It is important to note that the State Council recognizes the importance of intellectual property ("IP") decisions and provides that [l]ocal government shall be supported and guided to establish a loan risk compensation mechanism and to improve the IP pledge registry system so as to actively promote software enterprises …to obtain loans pledged by IP and other intangible assets."¹²

3. Research and Development Policies

The State Council makes clear that "key support shall be given to the R&D of fundamental software, high-end software … and key application systems, as well as the preparation of significant technical standards"¹³. Specific to software enterprises, it is noted that they "shall be encouraged to make great efforts to develop software testing and assessment technologies, improve relevant standards, elevate software R&D ability, increase software quality, strengthen brand building and enhance product competitiveness."¹⁴  As noted in the Circular, the "Ministry of Science and Technology (MOST), NDRC, MOF and the Ministry of Industry and Information Technology (MIIT)"¹⁵; are among those governmental departments critical to R&D efforts in China's growing domestic software industry.

4. Import and Export Policies

The Circular provides that "[f]or software contracts concluded between software enterprises and foreign enterprises with a high credit rating, policy financial institutions may provide financing and insurance support within their approved business scope subject to the principles of conducting independent loan examination and keeping risk under control"¹⁶. As many software contracts require such financing support, having access to loans from "policy banks" is potentially valuable to China's young software companies. In addition, the Circular encourages that Chinese software companies "go abroad"¹⁷ in order to "establish an overseas marketing network and R&D centers…"¹⁸ with the assistance of the Ministry of Commerce.

5. Talent Policies

In regards to developing talent for the domestic software industry, the State Council is promoting a multi-pronged approach, including developing existing domestic talent, as well as pursuing and developing talent overseas. Regarding domestic talent, the Circular notes that "[l]ocal registered residence shall be given first to software … talents introduced by industrial bases (parks) and software schools … in universities established upon approval of the relevant departments of the State, and their spouses and minor children¹⁹. The ability to obtained such a permit or "hukou" in a major metropolitan area, such as Beijing or Shanghai, is highly sought after in China and the Circular provides a clearer path to a "hukou" for software professionals.

The return of the "sea turtles" or "hai gui" (meaning the return of young overseas-educated Chinese professionals) to China is promoted in the Circular, and this is consistent with P.R.C. governmental policy encouraging –often with monetary rewards- such movement of human capital. The Circular, however, goes beyond this concept by providing that "[a]nnual plans shall be prepared for implementing introduction and overseas trainings of software … talents, international training bases for software … talents shall be operated properly and foreign training channels shall be actively developed."²⁰ It would appear that the P.R.C. government recognizes that development of its software industry talent is not merely going to rely on improving quality of college and university graduates in China or attracting "hai gui" to return home, but requires a more global view and the policies of the Circular reflect this understanding.

6. Intellectual Property Policies

Efforts to improve enforcement of intellectual property rights in the P.R.C., such as recent government campaign ("the Campaign") in this regard ²¹, are consistent with the policies of IP enforcement promoted in the Circular. In both cases, there is a specific focus on ensuring that "copyrighted software [is used] by government organs"²². These efforts appear to be having some positive results in that it was reported that since the advent of the Campaign, there has been the "procurement of 53,915 software copies by 37 central government organs from October last year to Feb. 10, 2011"²³. As IP piracy is one of the main hurdles to overcome for domestic software providers, the Circular’s policies provide various solutions for rights holders and a focus on government institutions is a positive step.

7. Market Policies

The Circular’s policies in regards to the "market" are quite bold in regards to market practices. Firstly, the Circular promotes the outsourcing by enterprises of "information technology R&D and application businesses to professional enterprises" and also "encourage[s government organizations] to outsource general businesses in e-government construction and data processing work to professional software and information service enterprises…."²⁴ Furthermore, the Circular "encourage[s medium and large enterprises] to peel off their information technology R&D and application business departments to set up professional software and information service enterprises so as to provide service to the whole industry and society"²⁵. This focus on outsourcing software development and information services to more efficient organizations will only help improve the long-term heath of the Chinese software industry, as well as helping improve the efficiency of Chinese industry as a whole. In addition, in order to protect the market order, as well as data privacy, efforts to reduce unfair competition and to improve data privacy and protection shall be promoted, as outlined by the policies noted in the Circular.²⁶

Conclusion

The Circular covers a wide range of policies associated with the promotion of the domestic software industry in China and provides a strong framework for supporting industry growth. Underlying the Circular are many national, provincial, local, and industry-specific rules and regulations which are critical to the success of the policies outlined in the Circular. The Chinese software industry is growing rapidly and finding ways to not only thrive in China, but to spread its wings into new overseas markets and the policies outlined in the Circular will no doubt provide a welcome assist.

This publication is for informational purposes only and it does not in any way constitute a legal opinion.

1.IDC, China Software Market, found at http://www.idc.com/research/viewfactsheet.jsp?containerId=IDC_P4805§ionId=null&elementId=null&pageType=SYNOPSIS (last visited on February 24, 2011).

2.State Council of the P.R.C., “Circular of the State Council on Printing and Distributing Certain Policies for Further Encouraging the Development of the Software Industry and the Integrated Circuit Industy”, Promulgated and Effective as of January 28, 2011.

3.Ibid.

4.Ibid.

5.Ibid.

6.Ibid.

7.Wang Xing, China Daily, “Tax Breaks Boost Software Firms”, China Daily, February 11, 2011, http://www.chinadaily.com.cn/usa/business/2011-02/11/content_11993405.htm (last visited on February 24, 2011).

8.Supra 2.

9.Ibid.

10.Ibid.

11.Ibid.

12.Ibid.

13.Ibid.

14.Ibid.

15.Ibid.

16.Ibid.

17.Ibid.

18.Ibid.

19.Ibid.

20.Ibid.

21.Xinhua, “China to start new campaign against IPR violations”, Oct., 20, 2010, found at http://www.chinaipr.gov.cn/newsarticle/news/government/201010/974226_1.html (last visited on February 24, 2011).

22.Supra 2.

23.Xinhua, “China govt spends $6.25m on authorized software”, February 22, 2011, found at http://www.chinaipr.gov.cn/newsarticle/news/government/201102/1196517_1.html (last visited February 24, 2011).

24.Supra 2.

25.Ibid.

26.Ibid.

In this report, the Shanxi CIRC noted that it created a website where insurance purchasers and providers could directly ask it questions about its rules for the insurance industry. It believes that this this direct line of communication with the insurance regulator has helped promote consumers and insurance providers understanding of China's requirements for the insurance industry. Moreover, the Shanxi CIRC implemented policies to help promote electronic insurance policy premium payments to help reduce policyholders and insurers' ability to use illegally gotten funds to purchase insurance products and to prevent misallocation of insurance premium payments. Furthermore, the Shanxi CIRC noted the success of the online auto insurance information platform it has created that is allowing the Shanxi auto insurance market to become more efficient. Finally, the Shanxi CIRC noted that it felt like its effort to promote arbitration for auto insurance claims because of the experiment it has been running in Taiyuan city. This experiment created a arbitration commission for auto insurance disputes that the Shanxi CIRC believes has helped provide an efficient low cost way to resolve auto insurance claims.

Overall, the Shanxi Provincial CIRC considers this transparency project to be a great success, and therefore, there is a possibility that other provincial level insurance regulatory authorities or even the central government insurance regulatory authority could also implement similar projects to enhance the stability and growth in that province.

If you would like more details on the Shanxi CIRC's transparency project please contact us. Or if you would like more information on some of the policies that the Shanxi CIRC implemented that required insurers providers in Shanxi to adjust their internal policies or disclose additional information please contact us.

The information contained in this article is available at: http://www.sinoins.com/news/101215/55637.html

It establishes that after a foreign insurance institution has received approval from the China Insurance Regulatory Commission to open a foreign representive office the instituion has 90 days to register the representive office with the State Administration of Industry and Commerce. Failure to properly register a representative office or failure to adhere to the Chinese government's requirements for the activities that a foreign representative office can engage in will result in a fine of up to RMB 500,000 ($76,000 US dollars) being levied against the representive office, and this illegal activity could hinder a foreign insurance institution's ability to expand its activities in the Chinese market in the future.

If you have any questions about your representive office's registration and the scope of activities it can engage in within China please contact us immediately.

If you would like detailed information on the China Insurance Regulatory Commission's approval and registration requirements to set up a foreign representative office please contact us.

The recent upsurge in IP cases highlighted the need to create a more efficient process to handle IP-related cases. Through various reforms and improvements, the P.R.C courts have become more adept in handling their ever-growing caseloads. As disclosed by Hon. Justice Su Zelin, Vice President of the Supreme People's Court of P.R.China 'the fulfillment of the following specific contents of judicial reform have improved the judicial efficiency significantly: enlarging the application scope of the summary procedure to civil cases; widening the scope of mediation to cases to dissolve problems timely and to enhance the trial efficiency; optimizing the allot of judicial resources to improve the effective of judicial expenditure security and to make full use of the money". ² In this regard, the improved efficiency of the P.R.C courts has led to reducing the average time to process a foreign-related lawsuit from 233days to 172 days (2006-2010). ³

The protection of intellectual property rights is no doubt a key factor in the growth of the Chinese economy. In this regard, foreign companies must feel confident that IP-related lawsuits in the P.R.C. will be handled fairly and efficiently. The recent improvements in the efficiency of the P.R.C. with regards to adjudicating IP lawsuits point to an environment of improved intellectual property rights protection, which benefits both domestic and foreign companies alike.

^{1 http://www.chinaipmagazine.com/en/journal-show.asp?id=585}

^{2 http://jrn21.judiciary.gov.ph/forum_icsjr/ICSJR_China%20%28Su%20Zelin%29.pdf}

^{3 http://www.chinacourt.org/html/article/201012/02/438221.shtml}

According to the White Paper, recent efforts to deal with cases of commercial bribery have been focused in six major areas, namely engineering construction, the grant of land use rights, mineral resources exploration and mining rights, trade of property rights, the sourcing and marketing of pharmaceuticals, government procurement and the development of and trade in resources. There has been a broader focus in other areas including bank lending, securities and futures trading, commercial insurance, publishing and distribution, sports, telecommunications, electric power, quality control and environmental protection. The White Paper also refers to the launch of the crackdown on cross-border commercial bribery in which trans-national businesses operating in China were targeted.³

The White Paper notes that the investigation of cases involving corruption has been prioritized in response to the different characteristics of corruption at different stages of China's development. In that respect it notes that in the 1990s efforts were strengthened to investigate and deal with cases of corruption in the fields of finance, real estate and engineering construction while in the 21st century the focus has shifted to investigating and dealing with cases in which senior public officials have taken advantage of their control over personnel, judicial powers and rights of administrative examination and approval or administrative encforcement in collusion with lawbreaking businessmen, or have traded power for money or solicited and taken bribes and cases of corruption that cause mass disturbances and major accidents due to negligence.

The solution to corruption in these priority areas has been identified in the White Paper as involving the implementation of a strengthened system of administrative accountability, power restraint, supervision and transparency. The discipline inspection bodies of the CPC, committees of the National People's Congresses and People's Political Consultative Conferences acting independently but in coordination with the People's Courts and People's Procuratorates under the leadership of the National Bureau of Corruption Prevention of China, and the public via whistle-blowing hotlines and websites as well as via the expression of public opinion in the news media and on the internet have all been idetified as having important roles to play in this solution.⁴

The government acknowledges that the fight to combat corruption and build a clean government in China is still a difficult one and one which requires the active involvement of the public at large as well as the long-term education of the public and government officials to instill principles of integrity that are regarded internationally as essential to combatting corruption at its roots.⁵

Comments

Businesses operating in China should note that efforts to fight corruption are being strengthened in response to China's actual situation, especially in certain key industries and in relation to key post-holders. Where businesses are unlucky enough to fall victim to corruption in China, the White Paper makes clear that they have an 'unimpeded right' to complain and to take action through various channels including by filing a lawsuit. ⁶The White Paper also makes clear that in its efforts to combat corruption, the government will adhere to a constitutional and legal framework which protects the legitimate rights of those being investigated and prosecuted on suspicion of their involvement in corrupt acts.

¹  <http://english.gov.cn/official/2010-12/29/content_1775353.htm>

² <http://english.gov.cn/2011-01/10/content_1781680.htm>

³  White Paper, Chapter VI.

⁴  White Paper, Chapter IV.

⁵  <http://english.gov.cn/2011-01/10/content_1781680.htm>; White Paper Chapter VII

⁶  White Paper, Chapter IV

根据白皮书，近年来，重点查处的商业贿赂行为主要集中在六大领域，即工程建设、土地使用权和探矿采矿权出让、产权交易、医药购销、政府采购以及资源开发和经销。查处和打击范围还涉及其他领域，包括银行信贷、证券期货、商业保险、出版发行、体育、电信、电力、质检和环保等。白皮书还提及对跨国（境）商业交易中商业贿赂行为的打击。³

白皮书表示，中国政府针对腐败行为在中国发展不同阶段的不同特点确定查办案件的重点。在20世纪90年代，中国加大对金融、房地产、工程建设等领域案件的查处力度；进入21世纪，着重查处领导干部利用人事权、司法权、行政审批权、行政执法权等进行官商勾结、权钱交易、索贿受贿的案件以及导致群体性事件和重大责任事故的腐败案件。

白皮书中确定的对重点领域中腐败行为的治理方案包括加强行政审计、权力制约和监督以及提高公开透明度。在处理腐败现象中，中国共产党内部监督机构、人民代表大会相关委员会和中国人民政治协商会议相互独立，并在国家预防腐败局的统筹下与人民法院、人民检察院密切合作；而且，通过举报热线、举报网站的检举以及通过新闻媒体和网站发表公开意见的公众监督发挥了重要作用。⁴

中国政府承认中国反腐败行动和廉政建设仍然任务繁重，并需要公众的积极参与以及对公共和政府工作人员长期开展廉政教育，国际上普遍认为这是反腐败的根本。⁵

评论

在中国经营的公司应该注意，针对中国现状，尤其是针对一些关键领域以及掌握重要职权的官员的反腐败力度正在加强。在中国，如果某公司不幸成为腐败行为的受害者，白皮书对此明确表示，公众有权利举报或者通过包括起诉在内的各种渠道采取行动。⁶ 白皮书还表明，在致力于反腐败的同时，政府将根据宪法及法律制度保护被调查或者被举报涉嫌参与腐败行为的嫌疑人的合法权利。

¹ <http://www.gov.cn/zwgk/2010-12/29/content_1775173.htm>

²<http://www.gov.cn/ldhd/2011-01/10/content_1781174.htm>

³ 白皮书第六节。

⁴ 白皮书第四节。

⁵ http://www.gov.cn/ldhd/2011-01/10/content_1781174.htm>；白皮书第七节。

⁶ 白皮书第四节。

During that workshop, the NDRC also listed some 10 instances of price-related breaches of the AML and / or Price Law 1997 – investigations and enforcement actions against the breaching entities were undertaken by provincial or local price authorities. 

The following table sets out details to do with these 10 breaches (from publicly available information).

Comments

The above list of cases aren't an exhaustive list of public enforcement cases to do with the AML and the Price Law. It is interesting that in the NDRC's press releases, they have listed some of the above price cartel breaches as being both in breach of the AML as well as the Price Law.

As far as we are aware, the NDRC (along with its related provincial authorities) does not keep a systematic "public register" of enforcement cases pursuant to the AML and the Price Law on their website. They are not statutorily obliged to do this. Pursuant to the Price Law, there are no express provisions which deal with the publication of decisions or enforcement actions. Pursuant to the AML, Article 44 states that the authority may release or make its decisions or enforcement actions public.

In light of the above, it is currently challenging to keep track of how many enforcement decisions or cases there have been, pursuant to the Price Law and the AML.

 The revision of these penalty regulations have not been undertaken in isolation. These revisions have been undertaken as part of a larger State Council policy to curb inflation and to “stablise” commodity prices. 

There are some similarities in relation to the objectives of the Price Law 1997 and the Anti-Monopoly Law (AML); but these objectives are not identical. The former aims to protect consumer interest and to “promote the sound development of a socialist market economy” by price regulation. The latter aims to protect consumer interest and promote fair competition by prohibiting anticompetitive conduct.

The main provision within the Price Law 1997 which is often thought to “overlap” with the prohibitions within the AML is Article 14. This article outlines the boundaries and operation of Article 14 of the Price Law 1997 and outlines the similarities and differences between this provision and some of the provisions within the AML.

Concluding remarks

As outlined above, there are some similarities between the prohibitions set out in Article 14 of the Price Law 1997 and the prohibitions set out pursuant to the AML. Some may argue that the wording of Article 14 of the Price Law 1997 is “looser” in scope and thus there may be less elements to prove in terms of establishing a contravention of Article 14, compared to establishing a contravention of the AML. 

Recently, the NDRC has announced that it imposed fines on green bean distributors and a frozen food association for fixing prices (in breach of the Price Law 1997). In respect of the AML, the NDRC has announced that it has imposed remedies on a number of business operators in a spectrum of industries, including business operators in the rice noodle, explosives, tennis, insurance, internet café, tea and milk industries for price collusion.

As a Chinese company involved in this sector, there are a number of actions that you can take. The first step is to retain counsel to liaise with the Chinese Government to help the negotiators understand the issues and the potential impact to your business if sanctions are implemented. The current schedule permits comments by interested parties in the US on before November 15, 2010. You may consider reaching out to your customers and partners in the United States to encourage them to weigh into the debate. You may also wish to collaborate with others in the market to defray to the costs of the defense and lobbying efforts. 

SECTION 301 OF THE TRADE ACT OF 1974

The United Steelworkers (USW) submitted a Section 301 petition to the United States Trade Representative (USTR) on Sept. 9, 2010 (19 U.S.C. 2411-2420; “Section 301”). The petition alleges that China employs a wide range of World Trade Organization (WTO)‐inconsistent policies that protect and unfairly support its domestic producers of wind and solar energy products, advanced batteries, energy-efficient vehicles, and other clean technology industries. Under Section 301, the USTR has 45 days to decide whether to respond to the petition by initiating an investigation or denying it. In this instance, the USTR initiated the investigation on Oct. 15, 2010. The USTR has elected to delay the government to government consultation for the purpose verifying or improving the petition to ensure to prepare for consultation with China. The USTR has published a summary of the petition and is seeking public comment (75 FR 64776-64778 October 20, 2010). During this time the USTR will also be seeking information and advice from petitioner and advisory committees. Public comments and advisory committee advice will be taken into account by the USTR to improve and verify the petition. Section 301 does not require the U.S. government to wait for authorization from the WTO before instituting remedial enforcement actions, but the U.S. has committed to abiding by the WTO dispute settlement mechanism. Failure to obtain approval by the WTO before issuing sanctions would be a violation of the US commitments to the WTO.

If the country to country consultation fails, the US is likely to proceed to the WTO Dispute Settlement Process.

WTO DISPUTE SETTLEMENT PROCESS

Consultation: The countries in the dispute must first meet and try to settle their differences through consultation. If they are unable to come to agreement, they may ask the WTO director-general to mediate the case. Only after mandatory consultation has failed can the complainant (USA) request adjudication by a panel. However, the parties are free to settle on a mutually agreed solution at any later stage of the proceeding, including after a panel has been selected.

The request for consultation formally initiates a dispute in the WTO by the complainant. Unless otherwise agreed, the respondent (China) must reply to the request for consultation within 10 days and must enter into consultation, in good faith, within a period of no more than 30 days after the date of receipt of the request. Failure to respond will allow the complainant to immediately proceed to the establishment of a panel. If the respondent complies with the consultation requirements, then the complainant must wait the minimum 60 days after the date the respondent received the request for consultations before requesting a panel. However the consultation period can end earlier if both parties agree that the consultations have failed to settle the dispute. The 60 day requirement is a minimum requirement and the parties may allow themselves more time for consultation. 

Panel: The complaining party may request the establishment of a panel to adjudicate the dispute if a settlement is not reached during the consultation stage. The complainant may do so any time after the 60 day minimum period has elapsed, but also earlier if the respondent fails to respond or if both parties mutually agree. The respondent has the opportunity to defend itself during this stage if it disagrees with the complainant on either the facts or the correct interpretation of the obligations or benefits under the WTO agreement. The ruling of the Panel, once adopted by the DSB (Dispute Settlement Body), is binding.

The request for establishment of a panel initiates the adjudication phase. Once the panel is established, its first task is to draw up a calendar for the panel’s work. The panel will address each complaint on a case-by-case basis. During the panel review process, before the first hearing, each side presents its case in writing to the panel. The parties present their case at the panel’s first hearing. At the second hearing the countries submit written rebuttals and present oral arguments. Either side can present experts on scientific or other technical matters, but the panel may consult other experts or appoint an expert review group to prepare an advisory report. The panel then submits a first draft of the descriptive part to the countries and gives them two weeks to comment. After the first draft they submit an interim report, which includes findings and conclusions, to the countries, giving them one week to ask for a review. The review period must not exceed two weeks. During this period the panel may hold additional meetings with the countries in dispute. A final report is then submitted to the countries, and then circulated to all WTO members three weeks later.

As a general rule, a panel will issue the final report to the parties within six months from the date when it was established. Generally the reports should not exceed nine months from the date the panel is established; but in practice, panel proceedings take an average of 12 months. 

The panel ruling is not binding until it is adopted by the DSB. The DSB must adopt the report no earlier than 20 days, but no later than 60 days after the date of its circulation to all members, unless a party to the dispute formally notifies the DSB of its decision to appeal or the DSB decides by consensus not to adopt the report.

Appeals: Either side can appeal a panel’s ruling, but the appeal must be based on points of law such as legal interpretation and not on reexamining existing evidence or new issues. There is no clear deadline of when the appeal must be filed, but the appellant must notify the DSB of the decision to appeal before it adopts the panel report (between 20-60 days after the report has been circulated). The appeal process begins when a party to the dispute formally notifies the DSB of its decision to appeal. The notice of appeal must include a brief statement of the nature of the appeal, including the allegations of errors in issues of law covered and legal interpretations of the panel.  Appellate review proceedings must generally be completed within 60 days, and no longer than 90 days from the date when the appeal was filed. 

Implementation: The losing country must inform the DSB, at a meeting within 30 days after the adoption of the report(s) that it intends to implement the recommendations and rulings of the DSB. They must then immediately comply with the rulings, but if immediate compliance is not possible they will be granted a reasonable period of time for compliance. In the event of prohibited subsidies, the subsidizing country must withdraw the subsidy without delay and specify the time-period for this withdrawal.

CONCLUSION

There is a risk that the US will proceed with a WTO action as to some portion of the renewables and cleantech industries in China. If you are a manufacturer at risk of losing business if sanctions are implemented, you need to proactively lobby against measures that may hurt your business. In addition to liaising early with the Chinese government, you should analyze your business model and assess what changes could be made to lessen the impact. We strongly suggest that you hire counsel to coordinate industry’s discussion with the government negotiators. At King and Wood, we have already begun to discuss the Section 301 petition with lawyers in Washington to better understand the US perspective. If you are interested, we can discuss with you a proactive plan to better protect your interests through this process.

King and Wood is a Chinese law firm and not qualified to render advice relating to US laws. To the extent specific US law is implicated, we coordinate with US counsel on such matters.

Instead of restricting participating Hong Kong companies to minority interests in CDM projects in China, according to the Supplementary Notes it is now possible for qualified Hong Kong companies to own all or a majority stake in CDM projects in China without the need for a local joint venture partner. This is because Hong Kong companies which are successful in obtaining approval from the EPD would be recognized as a Chinese enterprise when applying to China’s National Development and Reform Commission (NDRC) for CDM projects.

To be eligible under the Supplementary Notes, a Hong Kong company that meets the following criteria may apply for a letter of certification from the EPD:-

1. being a company registered and set up in Hong Kong, with its principal location of business operation or its headquarters situated in Hong Kong;

2. the executive director of the company should be a PRC national or a holder of a Hong Kong Permanent Identity Card; and that more than half of the board members should be PRC nationals or holders of Hong Kong Permanent Identity Cards; and

3. the ratio of non-tradable shares should be over 50% if the Hong Kong company is listed.

Under the Supplementary Notes, a Hong Kong company does not need to have a minimum number of years of business operation in Hong Kong. In addition, the Supplementary Notes do not contain any restriction on the shareholding structure of the Hong Kong company if it is not listed. In other words, as long as a Hong Kong non-listed company meets the first two conditions set out above, even newly incorporated Hong Kong companies wholly owned by a foreign party is eligible to apply for the letter of certification.

Companies meeting the above requirement will need to engage qualified China Appointed Attesting Officers when making the necessary declaration and for submission of the required documentary proof.

Further, a Hong Kong company when applying for the letter of certification must submit a business license of the CDM project company to the EDP. In other words, a CDM project company must have been established in China before its Hong Kong shareholder can enjoy the benefits under the Supplementary Notes.

In summary, the Supplementary Notes provides new and substantial opportunities for foreign investors to fully own and operate, through qualified Hong Kong companies, CDM projects in China, without the need for a local joint venture partner.

If you have any question on the above, you may contact Andrew Tan, Partner at Andrew.tan@kingandwood.com.hk or +852 2848 4848
 

1. Scope and effective date

Circular 698 stipulates the tax position and administrative treatment on capital gains of non-resident enterprises generated from their disposals of equities in resident enterprises. However, the tax issues for gains from transfers of H-shares, Chinese tax resident listed red chip companies and B-shares are not addressed by the circular. The circular was promulgated by the SAT on 10 December 2009, with retroactive effect starting from 1 January 2008.

2. Calculation of gains of equity transfer

Under Circular 698, the income of an equity transfer is equal to the amount of equity transfer proceeds minus the original investment/acquisition cost, which would be normally subject to withholding tax at 10%, unless the relevant tax treaty provision stipulates a lower rate. Particularly, retained earnings and after-tax reserves (if applicable) attributed to the transferor’s equity may not be deducted from the transfer price for the purpose of calculating capital gains. This is the first time that the SAT officially clarified the treatment of reserves and retained earnings. In addition, where the original shareholder acquires the equity through multiple investments or purchases, the equity transfer cost should be determined on a weighted average basis.

3. Indirect transfer

“Indirect transfers” refers to the situation where foreign investors indirectly transfer the equity in resident enterprises by disposing of the shares of offshore holding companies. According to Circular 698, if foreign investors (de facto controlling parties) indirectly transfer their equity in a resident enterprise, and the transferred offshore holding company is located in a country (or territory) with effective tax rate less than 12.5% or no income taxation on residents’ foreign sourced income, then they should, within 30 days upon the conclusion of equity transfer contract, submit relevant materials to the in-charge tax bureau where Chinese resident enterprise is located. These documents include the equity transfer contract; a report addressing any reasonable business purpose for establishing the offshore holding company, information on the operating activities, personnel, finance and properties of the offshore holding company, and its relationships with resident enterprises, etc. In case the indirect transfer transaction is viewed by the tax authorities as having no reasonable business purpose or abusive use of treaties or forms of investment vehicles, the local tax bureau may report the case up to the SAT for further assessment. If confirmed, the tax authorities may re-characterize the equity transfer based on economic substance or even deny the existence of offshore holding company in the transaction.

4. Group transfer of equity in multiple companies

Circular 698 also addresses the scenario where foreign investors (de facto controlling parties) transfer equities of several onshore and/or offshore companies in one transaction. In this case, the resident target enterprise shall submit to the competent tax bureau the master transfer contract and sub-contract concerning the resident target enterprise. If no sub-contract is available, then the resident target enterprise shall furnish detailed materials/methodology for the purpose of accurate allocation of transfer proceeds among companies involved. Otherwise, the tax authority may deem the respective transaction consideration by reasonable means.

5. Election of tax treatment for special reorganization

Where an equity transfer covered by Circular 698 qualifies for a tax-deferred special reorganization, as stipulated by the circular No. 59 “Notice on Enterprise Income Tax Issues for Corporate Restructuring” and the company elects to enjoy special tax treatment, it shall obtain approval from tax authorities at the provincial level.

K&W Observations:

Circular 698 remains silent on the issue as to whether capital gains on H-shares and B-shares (as well as tax-resident red chip companies listed on a stock exchange), are subject to tax. Some have expressed the view that Circular 698 deliberately sets aside the issue of transferring publically listed shares and it is more likely than not that the gains for trading public shares will not be taxed in China. However, it may be premature to reach that conclusion as it is expected that the SAT may issue a separate ruling to clarify the issue.

Circular 698 now formally clarifies the method for calculating the taxable income from an equity transfer. Even though undistributed profits and after-tax reserves may no longer be deducted from equity transfer consideration, for tax planning purposes, some structures are still viable to decrease the tax cost including the distribution of existing dividends, and allowing the transferor to retain the right to current-year dividends.

The most significant development is that indirect transfers are now officially under the scrutiny of the PRC tax authorities, which will significantly impact offshore holding company structures. Circular 698 sets forth substantial disclosure and compliance obligations, and offshore equity transfer arrangements without a sufficient business purpose may be taxed in China. China tax authorities have sent strong signals to attack tax avoidance arrangements in the form of overseas transactions or holding structures. It will be interesting to see how the tax authorities will in reality enforce the circulars.

Finally, it remains unclear whether the reporting requirements of Circular 698 will apply to indirect equity transfers that have already been consummated prior to the issuance of the notice.

We will closely monitor further developments with respect to Circular 698’s implementation and local enforcement, as well as any further clarification on listed company shares and follow up with future blogs as soon as information is available.

According to Circular 601, a beneficial owner refers to a person or any organization that has both ownership and right of control over the income or the assets or rights generating the income. An agent or a conduit company is not regarded as a beneficial owner. A conduit company is defined as a company established in a tax-exempt or low tax rate jurisdiction for the purpose of avoidance or reduction of taxes or the transfer or accumulation of profits, and where the company does not engage in substantive business activities like manufacturing, distribution or management. No further guidance is provided as to what constitutes management activities and whether such activities must be carried out by personnel or may be conducted at board level.

The determination of beneficial owner is to be conducted on a case-by-case basis, based on information provided by the taxpayer when applying for treaty benefits. The Circular further states that the following factors would be unfavorable in determining whether a company is the beneficial owner of an item of income, without indicating how these factors are to be weighed:

(a) The applicant is obligated to transfer all or most of (such as more than 60%) income to   a resident of a third country (region) in the stipulated time period (such as twelve months upon receipt of income);

(b)  The applicant does not or barely engages in other operating activities except for holding the income derived from the assets or rights;

(c)  When the applicant is a company, the applicant’s assets, business scale and personnel could not reasonably match the income;

(d)  The applicant has no or little right of control or disposal of the income or its underlying assets or rights; nor does it assume any or hardly any risks;

(e)  The income is non-taxable or tax-exempt in the other contracting country (region), or even if it is taxable, the tax rate is extremely low;

(f)  The lender to a loan agreement that generates interest income has another loan agreement or deposit contract with a third party; the amount, interest rate, and the time of conclusion with respect to the third-party contract are similar to those of the first loan agreement.

(g)  The licensor to an agreement on copyright, patent, and technology licensing or transfer has a contract to obtain the rights by license or transfer from a third party.

It appears clear that a single purpose vehicle (SPV) set up for a single Chinese investment will not satisfy the requirements for beneficial ownership under the Circular. It is less clear whether a holding company that holds several investment subsidiaries, but does not have its own management personnel, would qualify as a beneficial owner. The local tax authorities appear to have considerable discretion to make that determination, given the broad statement in the notice that a beneficial owner should have substantive business operations, the lack of any weighting in the identified negative factors, and the fact that even a multi-investment holding company would trigger at least two of the criteria set out above, and perhaps one or two more, depending on how these criteria are interpreted.

Companies are well-advised to review their holding company structures immediately, and consider restructuring out of SPVs, assuming they need to take advantage of the dividend withholding tax exemption. Companies with multiple investment holding companies need to exercise caution before applying to distribute dividends, and may consider injecting personnel and operating assets into their holding companies, if feasible, while keeping alert to further developments in the actual enforcement of Circular 601.