By Richard Wigley of King & Wood’s Intellectual Property Group
China’s packaged software market is estimated to "grow from $4.7 Billion in 2008 to $8.3 Billion by 2013, with a five-year CAGR of 12.1%"1. China’s domestic software industry has, however, long suffered from the effects of rampant software piracy, making it difficult for domestic industry players to proportionally benefit from China’s economic rise over the past 30 years. Though the trials and travails of major global software companies, such as Microsoft, in China have been well-documented, domestic software companies, though with a seeming "home market" advantage, have often found it difficult to build viable business models in this environment. This environment for domestic software companies, however, appears to be changing for the better.
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
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.
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).
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).
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).