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

In the United States, consider the examples that Andreessen cites in his article. With the fall of Borders earlier this year, Amazon is now the largest bookseller in the US; but through the power of software, Amazon is beginning to emerge as a threat to the traditional retail industry. The most dominant and rapidly growing distributors of music, movies, and television programming are companies like Netflix and Apple (through its iTunes service), both of which sell and stream their content entirely online. The world’s fastest growing telecom company is Skype (purchased by Microsoft earlier this year). The fastest-growing recruiting company? The newly-listed LinkedIn. Even the multi-billion dollar gaming industry is being taken over by online gaming providers such as Zynga and leaving behind traditional hardware manufacturers such as Sony and Nintendo.

Parallel developments are also taking place in China, where the social, political, and regulatory landscape have made the domestic internet sector notoriously difficult to penetrate for foreign players. Fast-growing consumer e-commerce websites such as Alibaba’s Taobao and 360buy.com are squeezing the market share of traditional brick and mortar retail businesses. Online video providers such as Youku.com and Tudou are beginning to partner with media production companies such as Time Warner and Disney to provide paid video-on-demand services.

As the retail industry begins to migrate online and the prospects of e-commerce have become more lucrative for small businesses, the online sales of counterfeit goods have also spiked in recent years. Likewise, the more primitive methods of copying DVDs or sharing media through the web are now giving way to streaming media websites that often contain copyrighted movies or television programming. The result is that the battle between intellectual property infringers and enforcement efforts to contain them is increasingly taking place online and within the bounds of software platforms operated by third parties such as Taobao and Youku.

Rather than employing litigation tactics or notifying the authorities, shutting down a retail operation for counterfeit goods now often involves notifying consumer-to-consumer or business-to-consumer software platforms of the infringing activities. Similarly, rather than seeking to destroy countless DVD copies of copyrighted content, removing infringing media from mass distribution involves corresponding with online video-sharing platforms. In both cases above, the platform provider risks exposure to secondary liability if it is notified of infringing content and fails to make sufficient efforts to remove such content or accounts.

Thus, as infringement activities become consolidated onto online software platforms, whether these activities be the sale of counterfeit goods on an e-commerce site or the distribution of a copyrighted content on an online video site, the methods of monitoring and controlling intellectual property infringement are changing.

The traditional view of the IT sector is that the internet has transformed the way we obtain, process, and communicate information, whether that information is in the form of a study in an academic journal or the latest status update from a friend on Facebook or Renren. However, in this new world of software-dominated companies, the internet is not only a means of manipulating information, but a means of providing consumer goods, entertainment,  and services (the list goes on). How this will continue to shape the future of intellectual property enforcement in China remains to be seen.

(Contributed by Peter P. Li)

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.

B. Corporate sales model

Since corporate users usually need a large number of licensed copies of the software, the suppliers do not usually provide corporate users a CD-ROM for each of the copies. Instead, corporate users are provided with a master copy and a certain number of licenses. From the view point of the Copyright Law, this sales model does not affect the relevant legal relationships which refer to the transfer of ownership of the medium, the transfer of the copy of the software and copyright licensing.

Under the corporate sales model, software is usually resalable as in the traditional sales model, if the sale involves the transfer of the medium carrying the software such as a master copy on a CD-ROM. However, if the corporate client only purchased the license right to use the software -- for example, only paid for an increase in the number of software users -- based on the current practice, it would be difficult to implement a lawful resale. In practice, the judges may also evaluate a sales activity according to the PRC Anti-Monopoly Law or the PRC Anti-Unfair Competition Law on a case-by-case basis.

C. Online sales model

The increased usage of the Internet and the expansion of bandwidth have caused fundamental changes to the sale of software. Software suppliers do not need to provide CD-ROM for their products; instead, they may direct their clients to the designated websites where the clients can download the software. After downloading the software on their computer, the clients can install and activate the software with the registration code or serial number provided by the software suppliers. Compared with the first two sales models, the possession of the medium containing the software does not shift from the suppliers to their clients. Therefore, this type of sale only involves transferring the copy of the software and licensing.

Online sale of software is merely an act of licensing. According to the Regulations on the Protection of Software Copyright, the copyright owner is entitled to all copyrights which are not clearly mentioned otherwise and the licensee shall not sub-license such rights. Therefore, unless otherwise specifically stated in a written agreement, reselling software by transferring registration codes or accounts infringes the copyright of the software owners and is prohibited by the existing PRC laws.

D. Sales of distributed software

As the Internet evolves, software no longer runs on stand-alone computers, instead, the actual running of software requires simultaneous running of both server software and the client software. A typical example of distributed software is online game software, where the distributors of online game software are also acting as server providers. These companies only provide clients with the installation software for clients' computer with related use right license for logging on to the server. The sale of this type of software involves the license of the client terminal software and the server software, and the scopes of the said two licenses are also different. The license of the client software includes the authorization for client terminal software installation, copying and operation, and the license of the server software only grants the clients use right to access the server from their terminals. In other words, the former license grants the client's use right under the Copyright Law, and the latter license merely allows the functional use of the software for the purpose of visiting a server.

The scope of license for distributed software varies since such software usually differentiates between client terminal software and server software. Therefore, whether distributed software can be resold and to what extent it can be resold should be decided on a case-by-case basis.

Theoretically, the exhaustion of rights is equally applicable to software, which is a form of work. In practice, however, problems arise when the software is "licensed" to public users, since the "doctrine of exhaustion of rights" only applies to the distribution methods of "sale" or "gifting". Under such circumstances, software licensing will not trigger the exhaustion of distribution rights. However, the sale of software will inevitably involve licensing and is usually subject to software licensing agreements. Therefore, the key factor which determines whether the exhaustion of distribution rights occurs depends on when a sale of software constitutes "sale" and when it constitutes "license"; this factor also determines whether a resale of software constitutes copyright infringement. Different jurisdictions have developed their own approach towards this issue.

In the United States, for example, ProCD Corp. v. Zerdenberg, the United States Court of Appeals for the Seventh Circuit established three criteria on how to distinguish a sale activity from licensing:

1. Purchasers of mass-market software pay a single purchase price rather than a series of royalties;

2. The software publisher does not retain title to the "product" as a security interest; and

3. The rights of the licensee to the software copy are perpetual, like the rights of a purchaser pursuant to a sale

China has developed its own criteria for the applicability of the doctrine of exhaustion of rights with a reference to the theories and laws of other jurisdictions. Under Chinese criteria, the rights are exhausted if the software is distributed by way of transfer of ownership, otherwise, it should be deemed as "license" only.  On May 14, 2008, the Shanghai High People's Court rendered the final decision in respect of copyright infringement on Shanghai Shanjun Industrial Ltd., Zheng Feng v. Shanghai Jiliang Software Technology Ltd. In this case, a third party legally acquired a set of copyrighted software by Shanghai Jiliang Software Technology Ltd. ("Jiliang") and resold it to Shanghai Shanjun Industrial Ltd. ("Shanjun"). Shanjun later resold the software to another company, which is also a third party to the case. Jiliang sued Shanjun for copyright infringement.

The court held that "the copyright owner enjoys the right to distribute the original work or copies of such work by transferring proprietary rights to the public. However, once the copyrighted work or the copies are initially sold or gifted to the public under the license of the copyright owner, the copyright owner will no longer enjoy the right to control further resale of the work or its copies. In other words, the party that legally acquired the ownership of the original copyrighted work or its copies may resell or gift such work or copies or provide them to other parties without seeking further license from the copyright owner.”

The above analysis of the Court of the Second Instance has great significance for software related copyright matters in China. It not only defines the doctrine of exhaustion of distribution rights for the first time in China, but also confirms that the application of the doctrine should be determined by whether the distribution involves the change of the ownership of software. Instead of following the traditional method of merely distinguishing "sale" from ‘license", the Court instead uses a more pragmatic approach.