Foreign Investment in China

China employment laws and foreign companies. One tough mudder.
China employment laws and foreign companies. One tough mudder.

The China Labor Bulletin just did a post revealing something my law firm’s China lawyers (especially our China employment lawyers) have sensed/felt for quite a while: China employees increasingly know their rights and have no compunction about doing what they can to enforce them:

While latest national LDAC case data compiles data only up to 2015, local government reports reveal more recent statistics, and tell stories of the rising rights awareness of workers.

A whitepaper on labour disputes from Guangzhou noted the increasing diversity of grievances raised by workers in recent years. Unpaid social insurance, for example, account for over 40% of all arbitration cases over the past three years. Women workers are an increasing portion of all cases, and are taking action against unequal treatment, illegal firings or wage cuts during pregnancy or maternity leave, and discriminatory hiring practices.

Though this article does not specifically address employment cases against foreign companies doing business in China, I would venture to bet that employment disputes between Chinese employees (and expat employees as well) and foreign companies have increased at an even faster pace. We see this in the number of emails we get from both employees (expats mostly) seeking to sue and from employers threatened with lawsuits. In virtually every employment dispute we take on as counsel, however, the parties eventually settle, meaning they never become a part of any Chinese government statistic.

I wrote on this last year for Above The Law, in an article entitled, China Employment Disputes: Settle, Settle, Settle: Attorney Dan Harris says there’s only one way to deal with labor disputes in China. That article started out with the following:

Every few weeks, one of our China lawyers gets an email from a foreign company (virtually always a WFOE) that is in a dispute with one or more of its China-based employees. These foreign companies are usually surprised to find themselves in such a dispute because they are of the view that they did nothing wrong. They too often believe that hiring my law firm will consist of us spending an hour or two reviewing the facts and the law and then telling them that they did nothing wrong and then making the case go away.

The only difference today is that we are getting those emails every single week, and usually more than one. But what hasn’t changed is what causes foreign companies to get themselves in this situation, nor what they need to do to get out of them. The two leading causes for the employment disputes we see are a failure to have a well-crafted set of Rules and Regulations combined with maladroitly handled employee terminations. See China Employee Termination: Avoid These Mistakes. We also have seen no slow down in foreign companies getting into big trouble for having “employees” in China without their actually having a China WFOE to serve as the employer. See Doing Business in China with Deportation or Worse Hanging Over Your Head.

Bottom Line: China wants foreign companies doing business in China for financial reasons and those companies that are not fulfilling their China financial duties, be it via taxes or employee payments are at risk.

China WFOE A while back (I am being intentionally vague here to avoid identifying anyone) a U.S. client company contacted me about shutting down its China WFOE and/or terminating all of its roughly 20 China employees in one fell swoop. The U.S. company had discovered rampant corruption among its employees and its CEO wanted all of this to be done “by tomorrow.” I am not kidding!

My response (modified to hide any identifiers and ` into one email) was as follows, with the client identified below as “Company A.”

I spoke with Grace Yang (our lead China employment lawyer) and with Steve Dickinson (our lead China corporate lawyer) and both agree that there is no way we can provide you with anything even approaching sound advice by tomorrow.

You essentially have two choices. One, you slink away in the middle of the night and neither Company A nor anyone who China might ever identify as having been associated with Company A ever goes to China again and Company A never conducts any business with China again. If (as I pretty much know will be the case) this does not appeal to you, then you must provide prior notice to the government because what you are proposing to do almost certainly constitutes what China calls a “mass layoff.” We will need to confirm with the authorities that such notice will be required because the definition of mass layoff varies depending on the local labor bureau. But we are virtually certain it will be.

Once we know exactly the layoff situation with which we are dealing, we can work with you to figure out the best, the fastest, and the cheapest way to accomplish it. If you have any employees who are pregnant or any employees for whom this will present a significant financial hardship, this will get even more complicated.

In addition to the employee issues, you also will need to work with the government in shutting down the WFOE itself and that can be an even longer and more drawn out process than dealing with the employment issues. We typically bring in accountants to assist with WFOE closures because taxes are so central to this. We have worked with a couple of very good accounting firms in ___________[Chinese city] and we would want to bring one of them in for this closure. This is going to take a substantial amount of legal work on our part, gathering up the facts, researching the law, and meeting with government officials.

What I can tell you at this point is that how we handle this will very much depend on the facts. It will depend on the size of the WFOE (my client contact did not even know how many employees the company had in its China WFOE]. The reason for the layoff. The types of employees you have: some may need to be differently than others. The location. The economy in your location. The labor bureau office. Your company’s history. Your company’s plans for the future, including not just China but other countries. I could go on and on and I’m sure Grace and Steve can and would add many more things to this list once we get going on this. We have seen these sorts of terminations/shutdowns done right and we have seen these terminations/shutdowns done wrong and usually when they are done wrong really bad things happen, like people being held hostage in China or seized by the government when they go over there a few years later. When they are done right, they take a lot of thought and a lot of varied expertise and, most importantly, a lot of time.

If what you are proposing is a mass layoff — and we are virtually certain it is — there are certain procedures that must be followed, and those procedures vary by district, by city and by province. If it is a mass layoff, almost everything will likely need to be made public and the language used in the public notice thus becomes absolutely critical. The last thing you want is for your terminations to become this week’s big issue for labor activists. We will need to meet with the employee/union representatives or all of the employees to discuss severance. What can go wrong there? Well, one of the last times I was in Beijing, the talk of the town was an investment banker who went to meet with employees in a situation not all dissimilar to this, but without a plan. He was literally beaten to death. That’s obviously a rarity, but it does show the need to have a well thought out plan in place before doing anything.

The labor authorities will get involved and they have tremendous power to correct anything they think wrong with the WFOE’s mass layoff proposal. And the last thing you want to do is start out too harsh and thus anger them from the get-go. On the flip side, if we can win over the local labor authorities with a good plan, we can likely get them to assist in the whole process.

The above is mostly just the labor issues. Closing down the WFOE will have its own issues, mostly relating to first clearing up the labor issues, and any debt and tax issues. The tax issues tend to be worst of all because once a company starts closing, taxes start coming out of the woodwork. That is why we also will almost certainly want to bring in a high level yet local tax accountant. Oh and employees almost always file a claim against the WFOE regardless of how good a severance package they get; they nearly always think they deserve more. Which is why it will almost certainly be worth it for you to pay each of them enough to get each and every one of them to sign a settlement agreement in addition to everything else. I understand why you do not want to pay most of your employees anything right now, but it will probably end up making financial sense to do so.

Our China lawyers continued working with this company on a strategy and as time went on, their anger subsided and they chose not to shut down or layoff all of their China employees. But for anyone out there thinking of shutting down their WFOE or laying off all or nearly all of your China employees and needing some ultra-quick advice, the above should do, with the usual proviso that China’s laws on this sort of thing are always changing and always hyper-local.

China complianceThe below post was written by Richard Bistrong, who recently returned from a long China trip where he met with all sorts of companies to assist them in their compliance efforts. Richard is CEO of Front-Line Anti-Bribery LLC  and a contributing editor of the FCPA Blog (a truly great blog, BTW). In 2010 he pleaded guilty to a conspiracy to violate the FCPA and served fourteen-and-a-half months at a U.S. federal prison camp. He now consults, writes and speaks about compliance issues. He was named to Compliance Week’s list of Top Minds in 2017 and was one of Ethisphere’s 100 Most Influential in Business Ethics in 2015. 

 

In today’s compliance environment, though we see a robust debate on what the new US administration might mean for anti-bribery compliance, the new ISO standard, and the recent DOJ “Evaluation of Corporate Compliance Programs” memo, those weren’t on anyone’s “what keeps me up at night” moments during my recent visits to  China. Yes, those are all meaningful topics for the field of practitioners, but from conversations at graceful Buddhist restaurants (with thanks to my hosts for indulging my vegan preferences) to live engagements and panels, much of the focus was on the “what happens when local customs conflict with the rules” dilemma. And that’s not to say that there’s an inherent conflict in China between ethical business practices and commercial success, but in an emerging market environment, with a young, dynamic and engaged workforce, the challenge is daunting, and not to be ignored.

The Importance of Defining Success. Compliance programs in China, like anywhere else, address the importance of lawful and ethical conduct, but during my visits, I saw a profound focus around “how to execute on both values and objectives,” in an environment where people are extremely focused on success, and the rewards of success. This desire to succeed manifests itself in a way that’s much different in an emerging economy than in a developed one. Employment with western based brands are coveted jobs, and commercial teams are anxious to demonstrate their ability to execute on financial objectives – in other words, to succeed. But that goal driven model often widens what’s a cultural and operational disconnect between the support functions at HQ and those forward based teams which are deployed in less supervised locales. And you can’t bridge those gaps with compliance paperwork and contracts.

Servant Leadership. One executive’s initiative was to call on mid-level leadership to be “servant leaders.” That really captured my attention, as he empowered his executive teams to push power down into the organization instead of up. As defined in The Center for Servant Leadership, a “servant-leader focuses primarily on the growth and well-being of people and the communities to which they belong.” Though traditional leadership generally involves the accumulation and exercise of power by one at the “top of the pyramid,” servant leadership is different. “The servant-leader shares power, puts the needs of others first and helps people develop and perform as highly as possible.” Yet another reminder as to why it’s so exciting to be back in the field — these are the business practices that one can only learn via immersion, and you don’t get that from the home office.

As to some more of the challenges, yes, anti-corruption was a big part of it, but not the only part. In China, corruption can intersect a work-force in both directions, as bribe payers as well as receivers. Commercial personnel who are responsible for dealer, intermediary and distributor networks might be subjected to requests for bribes, passed through those third parties to government officials — a set-up that’s familiar. But in China, employees are also exposed to the receiving side of corruption, as dealers might want to curry favor for discounts, product allocations or marketing allowances through corrupt offers.

In an environment based on relationships and hierarchy, that’s a complexity that might be hard to appreciate unless you are in front of it. It’s much more than anti-corruption compliance; it’s about ethical conduct in a broader sense, on hours and off. And those offers don’t come, or they don’t start, with brown bags of cash or numbered off-shore accounts. A dealer offering his beach flat for a holiday weekend to an employee might seem innocent enough, until a situation arises where that dealer might need a special allowance or discount. It’s a peril that often hides under the radar of friendship and association.  It’s part of what’s called the “dangerous charm” of third parties. After all, who wants to say no to a friend?

That’s just part of how I engaged in a discussion where there was an appreciation and focus on how to develop a commercial workforce free of conflict of interest, and how to inspire commercial leaders to embrace their roles as brand ambassadors. And those efforts were backed up, including by my own experience, with a “you can’t hide bad conduct behind your third parties,” and “what you don’t know can hurt all of us.” We spent a lot of time sharing with the workforce how they have an obligation to know the values and integrity of the people they do business with, and not to switch their ethical radar “off” after the third-party vetting process. In China, with state investment and divestment in industry and commercial entities, risk can quickly change over the life of a relationship.

In sum, those are just a few of the elements to which I was honored to engage. Having spent the better part of ten years living and working overseas 250 days a year, this was my first visit to mainland China. It left me wanting more, to return, and to read more about China’s role in today’s global economy along with its internal struggles as to how that gets implemented. China is experiencing what I heard called the “new normal,” where the period of exponential growth is slowing down, creating yet new challenges for commercial teams to succeed in a tightening marketplace. It’s a fascinating place, I found it personally contagious, and felt privileged to play some role in how to engage and inspire China’s commercial and compliance leaders to work together as each other’s ambassadors.

China joint venture lawyersOur own China lawyers have written countless articles on China joint ventures (for this blog, for AmCham, for the Wall Street Journal, for Above the Law,  and for many others), so it good when someone we know and respect says the same basic thing about them, which is that you should watch out.

The writer is my friend Randall Lewis, who has headed up Asia legal out of China for both Danone and ConAgra and who truly knows China. Last month Randall wrote about setting up joint ventures in emerging market countries. Randall stated that his article “is intended to be your general “watch-out” guide to avoid basic and simple joint venture mistakes.”

Randall begins his article by commenting on how people are wrong to believe that if they “set up a good platform for a business, agree on ownership percentages and the business plan/finances work. . . . the lawyers will work out the rest.” He then proceeds to list a ton of “common mistakes your commercial folks WILL make when taking your company into a foreign market. He makes clear that his list is “not hypothetical” as he has encountered every situation personally. Guess, what, our China lawyers have encountered every situation personally as well, and multiple times.

But without further ado, here are the more China-relevant mistakes Randall has seen and about which he wants to warn you, with my comments about China joint ventures in italics:

  • Commercial people frequently engage in detailed discussions with potential partners before discussing options, strategic structures and legal issues with their own legal counsel. This leads to promises being made and structures being agreed to that are completely against your own best interest and which benefit only your JV partner. Once these “agreements” have been made, it is difficult to change once you bring in legal counsel. In short, a wise approach is to consult legal counsel BEFORE you have discussions on structure, methods of investment, holding companies, corporate governance structures or just about anything outside of pure commercial matters and general alignment. Definitely true for China as well. 
  • Never take legal advice from your potential JV partner. This happens more often than you know. Your commercial people will start a discussion and the “local” will advise your team on what they can and can’t do in their country. This advice is more likely than not, 100% incorrect or misleading for a good reason; it is being given to take advantage of your company and to secure a structure not in your best interest. I wrote about this in China Joint Ventures, The Tide is Out: We have seen US companies that have put tens of millions of dollars into a Chinese joint venture, using no legal counsel at all, using the legal counsel of their joint venture partner, or using a local Chinese lawyer who has no experience with foreign joint ventures and no real incentive to protect the foreign company. 
  • If someone says; “we don’t need to involve the lawyers yet” or “we don’t need to have your legal counsel in the room for this discussion” or “we prefer to let the lawyers work out the contracts after we agree on XYZ,” stop immediately and ask yourself if that makes any sense.  Usually, excluding lawyers is not for cost savings or to do you a favor in terms of simplifying your discussions; it is, simply enough, to pull the wool over your eyes. True for China. 
  • If someone says “ we have someone that will act as our CEO/GM and CFO/finance people” be wary that you have enough control over key functions so that you don’t end up a financial investor in a JV vs a real partner. Keep in mind that if someone is appointed to an executive function by your partner, that person is more likely than not, viewing your partner as their “employer” vs the joint venture entity or your company. Their interest will be completely aligned with your partner and not to your company. 100% true for China as well. The key is control and one of the biggest mistakes we see is Western companies wrongly assuming that because they own 51% or more of the joint venture, they control it. See Avoiding Mistakes in China Joint Ventures.
  • When your partner says to you they will build your factory and secure all the licenses and permits for your new business, use caution! If you are in a JV and your partner is engaging in illegal behavior that violates the UK Bribery Act, FCPA or other local equivalent you may find yourself on the hook for all of your partner’s activities! In short, you need to be able to manage and control your partners activities beyond just signing a contract that obligates them to comply with your FCPA and UK Bribery Act obligations. Many times a JV partner will sign anything and proceed to do whatever they desire because they don’t understand the obligations, nor do they care or “that is not how they do things in their country”.  Way too many companies enter into contracts thinking they can trust their partner to follow the rules (hey, you have a contract) and then they get burned. This happens in China all the time.
  • Don’t be impressed by your partner’s government connections and think this is of great benefit to your new potential JV.  It is 99% possible, those connections will be used to benefit your partner in the future and to your detriment. I have seen more than my fair share of commercial people get overly excited about a “connected” potential partner only to find out a few years down the road that those connections are being used privately to do things and take actions the partner is not contractually or legally able to do. Definitely true of China.
  • Don’t be led to believe that if you have a controlling position at a Board level you are in control of your JV in many countries. For example, in China (and other locations), the right to control the Board does not give you effective control of the company. For actual control you need to control the appointment of the General Manager and ultimately the company “chop” or seal (which allows the possessor the power to make binding contracts on behalf of the joint venture company and to deal with the company’s banks and other key service providers).  In addition, your access to financial information and the ability to audit will not necessarily be assured unless you control the CFO position. Securing this finance position will also assure early warning of problems with the business and potential fraud. Agreed. See Avoiding Mistakes in China Joint Ventures.
  • Don’t let your partner convince your team that setting up a JV on a 50/50 basis with no mechanism to resolve a deadlock is a good idea.  I have seen more than my fair share of JVs that have 50/50 shareholding and no deadlock mechanism leading to a complete breakdown of the JV business.  This usually only benefits your local partner that had this as their goal from the beginning. Once the JV is successful (or they have what they need from the partnership) they manufacture a way to push you out so they either buy your interest (in a manner outlined by a local court) or exit to run a new business that looks identical to your own. We see one of these pretty much every year involving China joint ventures and they are never a good situation. 

Randall ends his article by calling for companies looking at doing a joint venture to “slow down, use caution, exercise common sense and surround yourself with advisors that challenge your assumptions and criticize your deal.” I can agree with that also.

China lawyers
Trading Babe Ruth was a big mistake. So what?
Donald Trump is that fantasy sports team owner who vetoed every trade involving Team China or Team Mexico (except his own, of course).  But now he’s become the league commissioner and he’s promised to fix or renegotiate all of those “bad” trade deals. Yikes.

Donald Trump and Peter Navarro, head of the newly formed White House National Trade Council, are always bitterly complaining about the huge trade deficit the United States has with China and other “bad” countries. But trade deficits should not be equated with unfair trade or with the alleged utter destruction of American manufacturing. This is like complaining that a baseball trade was so bad it caused the team not to win the World Series for, say, 86 years. Or, complaining that your team is suffering from a seven-to-one player trade deficit even though your team gave up seven players who were either nobodies, soon to be has beens, or never will bes, and your team gained a perennial All-Star or future Hall-of Famer in return.

The U.S. trade deficit with China does not mean the United States is losing to unfair trade. Trade of goods is just one part of what drives our economy. Though the United States may run a deficit in the trade of goods (both overall and with China), we run a surplus in the trade of services.  Also, China and Japan each own more than $1 trillion in U.S. Treasury bills, bonds, and other securities. Moreover, foreign companies are “insourcing” and purchasing U.S. assets, such as buying U.S. companies or investing in building new factories, shopping malls, hotels, etc. Harping on the United States’ trade deficit while completely ignoring other economic factors in which the United States has a surplus is an incomplete and misguided way to evaluate how the U.S. economy is performing. Full disclosure: my firm and especially our international trade and our China lawyers have a lot of skin in this game as we generate millions of dollars a year in services directly related to US-China trade.

Looking at trade balances between countries as if they were a zero-sum game to be “won” or “lost” does not make sense because countries don’t actually engage in trade with each other on a national level. Only companies and individuals in each country trade with one another. A trade (for fantasy league baseball players or for real life goods) happens only if both sides believe they are exchanging comparable value with each other. China exports boatloads of goods to the United States because U.S. companies and individuals see those imports as the best value for their specific needs. A good chunk of the imports contributing to the U.S. trade deficit are used to manufacture higher value-added products in the United States. The U.S. imports crude oil for U.S. refineries to produce gasoline and other higher-value petroleum products. Boeing airplanes include all sorts of parts imported from around the world. If Party A and Party B each a consensus that a trade is mutually acceptable, and there is no sign of fraud or collusion, why should the President/League Commissioner intervene and try to fix those so-called “terrible” trade deals?

Even those trades perceived to have been lopsided or unfair does not mean that the losing team on the deal needs rescuing or that the deal should be voided or undone. Teams make stupid deals all the time.

Every team hopes to avoid making bad trades, just as reducing the U.S. trade deficit is not wholly a bad idea. But reducing trade deficits by itself will not restore America’s manufacturing jobs any more than avoiding bad trade deals by itself will get teams a championship ring. The effects of a huge trade deficit or a bad trade deal, either in the market place or on the playing field, tend to work themselves out over time because there are so many other factors that go into the country’s economic performance or team’s performance. A good President/League Commissioner would know better than to try to fix every “bad” trade deal or trade deficit he doesn’t like.

Editor’s Note:  If you talk with people who regularly do business with China, especially people with companies that do business in China, they will mostly tell you that what they/we need is not so much higher duties on imports, but more pressure exerted on China to level the playing field for foreign companies doing business in China.

Negotiating with Chinese CompaniesJust read a post over at Andrew Hupert’s ChinaSolved Bog, entitled, 5 Negotiating Lessons from Sec. of State Tillerson’s Beijing Trip. Hupert, who I count among the foremost experts at negotiating with Chinese companies, uses Tillerson’s recent Beijing trip as the springboard for explaining five tips on how foreign companies should negotiate with Chinese companies.

Before I get to the five tips however, I want to highlight what I see as one of the best, one of the most realistic, and — most importantly — one of the most accurate descriptions on what it is like to negotiate with a Chinese company:

We’ve seen it before. The Chinese side raises their glasses of Mao-tai and proposes a long relationship of mutual understanding and joint cooperation. The western side “gambei’s” and then makes their own polite toast about “long term cooperation, success, and prosperity”.

Now, at this point the westerners feel they are done with the preliminary small talk, and are ready to begin the opening phase of the REAL negotiation.

The Chinese side feels they are running the new partnership, co-own the intellectual property, and will make all substantive decisions about operations, hiring, and distribution.

If you for any reason do not believe the above accurately reflects how the typical Chinese company views its dealings with foreign companies you should memorize the above and then in one year of dealing with China ask yourself again whether it is accurate or not, because it just is.

Now on to a some of the Hupert five.

That treacherous opening Chinese toast. Hupert notes how Tillerson, “like many western execs before him, . . . doesn’t seem to understand what the Chinese believe he’s agreed to. This is true. Our China lawyers almost never document a China deal without there being at least one issue on which our Western client believes the China side has agreed to something to which it has not. There are many explanations for why this always seems to be the case, ranging from cultural and language differences to the China-side penchant for agreeing to something to get something in return for that agreement and then retrenching from the previously agreed upon item after it has already succeeded in getting concessions from the Western side.

Manage the agenda, and then focus on individual deal points. Western negotiating protocol is to focus on the key negotiating goals, but Chinese negotiators “always” have a larger agenda. Or as Hupert puts it, “too many western executives fighting internal deadlines and hoping to satisfy their HQ sacrifice big-picture strategy for short-term deliverables.”

Watch the timing mismatch. “Don’t make real concessions now for longer-term promises.”  Western companies too often believe that if they make xyz concession to their Chinese counterparty now, their Chinese counterparty will make the next concession the next time around. Wrong. Where we see this a lot is with Western service companies cutting their rates to Chinese customers to “get into China now”  and “build loyalty, all with the plan to raise their prices later. Problem is that the Chinese company for whom you just cut your prices will view your loss leader pricing as their ceiling, not as a floor and it will move on to another naive Western company for its next contract. Or as Hupert puts it

You’re in the same boat – but who is the captain and who is the crew? Hupert concludes his post by highlighting how different perspectives so often can lead to problems down the road. Hupert uses the example of how it is “relatively easy to get a Chinese negotiator to agree in principle to a cooperative partnership,” but how that “cooperative partnership is viewed by the two sides will be very different. “Both sides tend to walk away thinking that they will have the power and authority to protect their interests and further their positions. In practice, however, Chinese tend to feel that they will call the shots on issues pertaining to China.”

For more on how to negotiate with Chinese companies, check out the following:

China lawyers for forming a China WFOEThe below is what our China lawyers have been telling our clients about China’s new rminimum capital requirements rules when forming a WFOE. Note that China the country has its laws/rules on this and many of China’s cities have their own rules on this as well. And in addition to the rules, you also must consider local “customs” in addition to what is on paper. With all of  these provisos, here is a fairly recent email we have been using with our clients for whom we are forming a Shanghai WFOE.

We are required to set forth the registered capital for the WFOE. The rules on registered capital have changed substantially in the past two years. Here is the basic current situation:

1. Registered capital is the amount of capital (not earnings) required to get a WFOE started. This amount is typically based on the amount of money needed by the WFOE before the WFOE starts earning sufficient income to cover the WFOE’s financial obligations. This amount is unique to every WFOE. For a WFOE that will build a petrochemical plant, the number may be over a billion dollars. For a two person consulting WFOE, the number is often quite small. For a WFOE that will _____________ and also ____________ in Shanghai, the number is somewhere in between.

2. China now has no formal requirement for the amount of registered capital. In general, the JIngan local government recommends that registered capital be at least equal to the first two years expenses of the WFOE. However, there is no fixed rule.

3. There is also no longer a requirement on when the capital must be contributed and there is no fixed rule on the amount of each contribution of capital. The rule is now a business standard: there must be enough capital to cover the operations of the WFOE. In particular, there must be enough capital to cover employee salaries, rent, utilities and government charges and taxes. It is a violation of law to start a business/WFOE in China if these basic expenses are not covered with a capital contribution. The government generally requires that the total registered capital be contributed within 20 years, which effectively means there is no time pressure on the contribution.

4. But it is a mistake to set the capital number too low. The source of both capital and income for this WFOE will be payments from the shareholder (your U.S. entity). Under Chinese law, payments from the shareholder that exceed the registered capital amount are treated as income to the WFOE and are taxed at China’s normal income tax rates. Capital contributions, on the other hand are not taxed.

5. The following are the two common approaches for determining the appropriate registered capital amount:

a. Use the local government recommendation of an amount equal to the first two years expenses of the WFOE (the “rule of thumb” approach).

b. Work with your accountant to determine an appropriate amount (recommended). If your accountant is not familiar with China (and most are not) and also able to handle international and cross-border accounting issues (again, most are not), let us know as we work with a number of such accountants and we would be happy to recommend one to you.

For us to assist you in determining an appropriate registered capital amount, we need to see the following:

i. Projected expenses for the first two years of WFOE operations.

ii. Projected sources of income to the WFOE in the first two years of WFOE operations:

a) As payments from the shareholder.

b) As payments from the affiliates of the shareholder (if any).

c) As income payments received from unaffiliated third parties (if any).

iii. Five year projected pro forma for the WFOE.

We do not need this financial data if you will make the decision working with your accountant or by adopting the rule of thumb method.

6. We need to provide the registered capital amount at the very beginning of the WFOE application process. You therefore should make the determination of the registered capital amount a top priority matter.

Please contact me if you have any questions on this.

China WFOE lawyerLast week I wrote a post on how our China lawyers have been receiving a steady onslaught of calls from American companies with “employees” or “independent contractors” in China, but no China business entity. The onslaught has continued, and now I know more about why.

China banks (owned by the Chinese government) are providing information to China’s tax authorities regarding account-holders who consistently receive money from foreign companies. China’s tax authorities are apparently going to these individuals and pressuring them into spilling the beans on why they are receiving their funds from overseas. Upon learning of a foreign (usually American) company that has “employees” or “independent contractors” in China, the Chinese government pounces.

If you are a foreign company operating in China without a China WFOE and you are trying to figure out what to do, your choices are relatively simple and stark.

But before I talk about your limited choices, I feel compelled to explain again why it is that so many foreign companies are still operating illegally in China. Chinese law limits hiring China-based employees to only Chinese legal entities. This means that if you are an American software company, you cannot hire someone in China to do your coding or to provide your support services. This means that if you are a Australian company selling widgets, you cannot hire someone in China to sell widgets for you. This means that if you are a British company that has your products manufactured in China, you cannot hire someone in China to do your quality control for you.

Any person (as opposed to a registered China business entity) performing employment-like services for you in China is your employee because China does not recognize independent contractors in anything other than extremely limited circumstances (and your circumstances do not qualify!). And Chinese law requires you pay both employer taxes and benefits on that employee. These employer taxes and benefits vary from city to city, but they usually total around 40 percent of an employee’s salary. China also mandates employers withhold around 15 percent of their China-based employees’ wages for individual income taxes. But those companies that do not realize they have employees in China are not doing that withholding either. Then on top of the employer and employee taxes, the foreign companies with employees in China are almost always going to be viewed by the Chinese tax authorities as “doing business in China” and that is because they almost always are. The foreign company is now almost certainly liable for having failed to pay its corporate taxes as well.

So when all is said and done, the foreign company owes a heck of a lot of taxes to the Chinese government, plus steep penalties, plus interest. Needless to say, the Chinese tax authorities salivate over collecting these taxes and interest and penalties.

In my previous post, I noted two common ways companies operating in China without an entity get caught:

One, we are hearing of long loyal “contractors” going to their employers and saying that if their employer does not double or triple their pay, they will report the foreign company to the Chinese authorities because their doing so will get them a tax amnesty (and perhaps even a portion of the taxes collected?). We are also hearing of vendors with whom the foreign company has no beef making essentially similar threats. Two, and most importantly, we are hearing that the Chinese government is poring over bank records and questioning people (your “employees”) who regularly receive funds unreported funds from overseas.

It is the second way of getting caught that is steeply rising.

What then should you do if you are right now operating in China without a Chinese company. You have essentially the following three choices:

  1. You double-down in China by getting legal. Quickly, but very carefully. If you want to operate in China for the long term and you can afford to do so, you form a Chinese company, almost certainly a WFOE. For a flavor of what this involves, check out The NEW Steps for Forming a China WFOE. Note that it is not inexpensive to form a WFOE and if you do so you will need to start paying your employer taxes and you will need to start withholding your employee taxes and you will need to pay income taxes to the Chinese tax authorities on the income you earn in China. If you are going to choose this tact, you should do so immediately because in our experience, if you get caught before you even commence the process of forming your China WFOE, your chances of avoiding having to pay back taxes are slim to none. But if you can  at least get going on forming your China WFOE, your chances of avoiding having to pay back taxes are shockingly good. But not only should you get legal fast, you should get legal in a way that neither tips off the Chinese government about your previous (illegal and untaxed) activities in China and in a way that works for both your vendors and your “employees.” If just one of your vendors or “employees” believes that your China changes will make things worse for them, you are at great risk of being ratted out to the Chinese tax authorities and seeing your China operations collapse.
  2. You ditch China entirely. If you either do not want to get legal in China or cannot afford to do so, your best course of action is to simply cease everything you are doing in China and leave. Doing this tends to anger vendors and “employees” and it certainly does not guarantee that you will always be safe from the Chinese tax authorities. So if you do this, we strongly recommend that neither you nor any of your foreign employees go to China for a long long time, preferably ever. For why this is so, check out How To Avoid Getting “Detained” in China and Why Your Odds are Worse than you Think. Both you and any of your foreign employees linked to your illegal operations in China are at risk both from your vendors/employees and from the Chinese government.
  3. You make your stand and you die a slow (or a quick) death in China. A third option is to just keep doing what you have been doing in China and do it until caught and closed down. Just as with ditching China entirely, if you do this you and your foreign employees should not go to China again. The added risks of doing this are that your China vendors and employees may seek to take advantage of your situation. Here are some of the examples of this that we have seen:
  • A vendor learns from one of your “employees” that you are not operating legally in China and uses the threat of informing on you to the government to raise prices.
  • Your employees use the threat of your illegal operations to get an increase in salary. I know you are probably thinking that your employees are also at risk for getting caught for not paying taxes, but trust me when I say that this is a classic case of asymmetrical warfare and if you think their risks/costs as a Chinese individual are anything approaching yours as a foreign company, you are just flat out wrong.
  • Your employees literally take over your China operations, leaving you with nothing in China. This is most common when your China personnel are designing or developing something for you for eventual sale, be it a physical product or software. The following two egregious examples nicely highlight how this sort of thing can happen. The first was a U.S. software company that for more than three years paid for an office in China and paid fifteen people to develop a piece of software. Then, when the software was finally completed, rather than turn it over to the US company, the China employees started selling it themselves. The US company came to my firm wanting to sue but how could it and for what? The other example was a US company that used its China operations to source and to oversee the manufacturing of licensed products for a very large US entertainment company. The US company owner was denied a visa to go to China and his employees in China used that as an opportunity to take over the China operations and they did so pretty much without missing a beat. They went to the US entertainment company and offered to continue with “business as usual” but at prices 20 percent lower than they had been. The US company said yes and the US company owner wanted us to sue. But sue whom and where and for what? How can you sue someone in China when you have never had a company there and everything you have done there has been completely illegal?

The above three options are your only reasonable choices, but we have twice heard of an additional option from potential clients, which really is not an option at all. Two companies under extreme pressure from their vendors/employees have made clear to us that none of the above three options are acceptable to them and they want our China lawyers to engage in what they call the “political” or “guanxi” option. Are you kidding me? Are we supposed to do the following:

Hi, we represent Company A. Company A is an American company that has been operating 100% illegally in China for the last _____ years. Despite having _____ [number] of employees in China, Company A has never paid an RMB in employer taxes nor has it ever contributed even one single RMB in employer benefits. On top of this, it has failed to withhold employee taxes and it has not paid anything in income taxes either. But despite these criminal law violations and despite it having no intention of even trying to get legal, we think it makes sense for you to not only allow Company A to continue flaunting Chinese law, but to lean on the vendors/employees with which Company A is having disputes.

Perhaps what they mean by politics/guanxi are bribes, but we will not even go there with them. There is no way any of my firm’s lawyers are going to risk jail time in China and the United States for anyone. Just no way. And of course, they shouldn’t either.

Oh, and note that a Hong Kong company is NOT the equivalent of a PRC company. For purposes of the above, it is the equivalent of having a United States company and having a Hong Kong company will NOT help you avoid the above problems, not even in the slightest. See Having A Hong Kong Business Does NOT Make You Legal in Mainland China and A Hong Kong Company Is NOT a Mainland China Company and a Hong Kong Trademark is NOT a Mainland China Trademark.

Bottom Line: If you are a foreign company operating in China but you are not on the gird there, get legal or not, but don’t be stupid.

 

China lawyersChina has greatly revamped its WFOE formation procedures, making WFOE formations easier in some ways and more difficult in other ways. See China’s New Foreign Investment Law — Less Than Meets the Eye.

Because the WFOE formation procedures are so new, our China lawyers have been getting a number of calls from Western companies whose WFOE formations have stalled or simply died out, usually stemming from an inability to work through the new system with the local authorities. One of the things our China attorneys do with our WFOE formations is to set out early and often the steps that must be followed and accomplished for our clients to come out on the other side with a spanking new China WFOE.

I was cc’ed on an email the other day from one of my firm’s China attorneys  to a client for whom we are working on setting up a China WFOE. The email does such a good job setting out what must be accomplished to form a WFOE under the new WFOE formation rules, I thought my reprising it here (taking out any and all identifiers of course and adding in a few links) could prove helpful to anyone out there looking to form a China WFOE.

Here goes:

 

As you know, the PRC government drafted a new foreign investment law last fall and also promulgated a new set of regulations concerning the procedure for registering WFOEs in China. Each local government has been working out their internal procedures for adapting to this new system. Your WFOE in _____________ will be one of the first WFOEs to make use of the new system.

We have been working closely with the ____________ authorities (the Administration of Industry and Commerce of AIC). The local AIC has finally made their basic decisions on the procedure they will follow for the formation of a WFOE under the Foreign Invested Enterprises (FIE) law and associated Ministry of Commerce (MOFCOM) regulations.

The steps in the application will be as follows:

1. WFOE name approval.

2. MOFCOM online registration.

3. Application to form WFOE submitted to local Administration if Industry and Commerce (AIC).

4. Issuance of business license by AIC.

5. Start of business processes: a) open bank accounts, b) cut and register chops, c) open tax and other government accounts, d) set up daily bookkeeping and reporting to the local government, e) execute written employment agreements with employees and open employee tax/social benefit accounts,.

We will be working through each step in order. I will shortly be sending you a series of emails on what we need for step one, the WFOE name approval.

Our team will work with you on Steps 1 to 4 above. With respect to Step 5, we will work with you on drafting your employment agreements for China and your employer rules and regulations. On the other procedures in Step 5, we can take you through all the procedures up to the point where you are ready to formally do business in China.

Step 5 will involve your needing to decide on the following:

  • Local bank.
  • Local bookkeeper.
  • Accountant for tax returns and annual audit and reporting to the parent entity (can be same as B, or different).
  • Employee payment processing and maintenance of employee social benefit accounts.

We must report these names during the formation process, so we will need an answer as soon as is practical. We, of course, are happy to assist you in finding appropriate service support.

As noted, I will send an follow up email explaining the name approval process and the current status.

Please contact me if you have any questions on this matter.

China and MexicoThe following is a guest post by Adrián Cisneros Aguilar.* A Spanish language translation is directly below the English version.

Mexico and China have never had particularly close economic ties. But recent comments by Qiu Xiaoqi, China’s Ambassador to Mexico, suggest things may be about to change. After referencing President Trump’s threat to reject the TPP and renegotiate NAFTA, Ambassador Qiu stated that China would be Mexico’s “ally in Asia” and was “willing to redouble efforts … to boost the development of relationships in the coming years.” These statements followed Chinese President Xi Jinping presenting the China-led Regional Comprehensive Economic Partnership (RCEP) as an alternative to TPP, and making state visits to Ecuador, Peru and Chile.

Mexican media seized upon Ambassador Qiu’s statements as evidence of a new era of Sino-Mexican friendship, particularly in light of the perceived hostility toward Mexico from President Trump. So-called “China consultants” in Mexico have also tried to capitalize, promoting their events with slogans such as: “if Trump erects a wall, China extends you a bridge.” Chinese oil companies have made no secret of their desire to participate in Mexico’s petroleum industry. And meaningful high-level meetings are taking place between the Chinese and Mexican governments Last month, State Councillor Yang Jiechi, met with then-Minister of Foreign Relations Claudia Ruiz-Massieu to resolve lingering issues relating to ill-fated Chinese projects in Mexico such as the Mexico City-Queretaro high-speed railway and the Dragon Mart Cancun, and discuss the adoption of an ambitious joint action program. As a major Mexican newspaper pointed out: “everything points to a good flirtation between Mexico and China.”

In part, this flirtation is driven by Mexicans’ fear that Donald Trump may seriously curtail access to the U.S., their largest market. Even some of my most open-minded clients have started talking about closing their accounts in the US and including China as part of their international strategy. Regardless of whether they’ve previously done business with or in China.

I am of course bothered by the trajectory of current events in the United States, but at the same time I don’t see much clear thinking about what China really wants from Mexico, and whether the kinds of ties proposed by China are really strategically sound for Mexico. China’s recent statements unsettle me for the following reasons:

  1. They assume Mexico is desperate for a new trading partner to hedge against losing access to the U.S. economy; that is, without the U.S. the Mexican economy is doomed.
  2. They assume Mexico requires another country to be its protector. Our economy may not be a juggernaut, but neither is it in dire straits. Many of our recent problems stem from the dramatic devaluation of the Mexican peso versus the US dollar after the presidential election.
  3. They improperly frame the current debate as a choice between the US and China. I am a firm believer in regional integration, particularly with China and other Asia-Pacific countries, because I think it makes Mexican companies more productive and more competitive. But President Xi’s and Ambassador Qiu’s statement that Mexican companies ought to turn to China only because the US is closing is wrongheaded. It should be in Mexico’s interest to go to China regardless of what happens with the U.S.
  4. They play upon Mexico’s inability to think beyond absolute terms: everything is either a “threat” or an “opportunity.” A more rational approach accepts that every bilateral relationship has ups and downs. But when the Mexican government states that “whatever Mexico and China achieve in their trade relationship will be the starting point for a new world economic order” and that the inauguration of President Trump “represents both the need to set new horizons and reinforce new paths [to] face this threat” (emphasis mine), we fall back on hyperbole when we should be confronting the true implications of making deals with China and the U.S.
  5. They are simply not based in reality. My own experience, which I see reflected in many pieces here on the China Law Blog, is that it is becoming more difficult to do business in and with China. Mexico’s trade deficit with China is almost  insurmountable, and investment flows between Mexico and China are virtually non-existent and show no signs of improving. Language and cultural barriers make it difficult for Mexicans and Chinese to follow each other’s laws and regulations, as do “unwritten” rules necessary to conduct business. And misconceptions prevent both Mexican and Chinese companies from realizing the full spectrum of business opportunities in the other’s market.

In my next post, I’ll take a closer look at the current economic relationship between Mexico and China.

 

*Adrián Cisneros Aguilar is the founder/CEO of Chevaya (驰亚), an Asia-Pacific internationalisation services company. Adrián has a Doctor of Laws from Shanghai Jiao Tong University and an LL.M. in International and Chinese Law from Wuhan University.

 


México y China nunca han disfrutado de lazos económicos especialmente estrechos. Pero, recientes declaraciones del Embajador de China en México, Sr. Qiu Xiaoqi, llevan a pensar que la situación está a punto de cambiar. Tras hacer referencia a la amenaza del Presidente Trump de rechazar el TPP y renegociar el TLCAN, el Embajador Qiu declaró que México tendría en China “un aliado en Asia”, y estaría dispuesta a “aumentar esfuerzos…para inyectar nueva energía en el desarrollo de estas relaciones en los próximos años.” Estas declaraciones siguieron a la presentación, por parte del Presidente Xi Jinping, del Acuerdo Comprehensivo Económico Regional (RCEP), liderado por China, como una alternativa al TPP, así como de visitas a Ecuador, Perú y Chile.

Los medios mexicanos tomaron las declaraciones del Embajador Qiu como la prueba de una nueva era en la amistad Sino-Mexicana, en especial a la luz de la percibida hostilidad hacia México de parte del Presidente Trump. Los supuestos “consultores sobre China” en México han tratado también de sacar partido de esto, promoviendo sus eventos con eslóganes como: “si Trump levanta un muro, China te tiende un puente.” Las petroleras chinas no han ocultado su deseo de participar en el sector de hidrocarburos de México. Y, reuniones significativas de alto nivel han tenido lugar entre los gobiernos de China y México. El mes pasado, el Consejero de Estado, Sr. Yang Jiechi, se reunió con la entonces Canciller, Sra. Claudia Ruiz-Massieu para resolver desencuentros pendientes en relación a proyectos fallidos chinos, tales como el tren de alta velocidad CDMX-Querétaro y el Dragon Mart Cancún, así como discutir la adopción de un ambicioso programa de trabajo conjunto. Como señaló un importante periódico mexicano: “todo indica que hay un buen coqueteo entre México y China.”

En parte, este coqueteo es impulsado por el miedo de los mexicanos a que Donald Trump restrinja el acceso los EE.UU., su más grande mercado, lo cual ha causado que muchas empresas del país incluyan a China en su estrategia internacional, en buena medida para cubrir sus apuestas respecto a los Estados Unidos.

Aun cuando estoy molesto por el curso actual de los acontecimientos en EE.UU., no veo mucho análisis objetivo acerca de lo que China realmente quiere de México, como tampoco estoy seguro de si la clase de lazos que China propone son estratégicamente adecuados para el país. Las recientes declaraciones de China me incomodan por las siguientes razones:

  1. Porque dan por sentado que México está buscando desesperadamente un nuevo socio comercial para resguardarse frente a la pérdida de acceso a la economía estadounidense. En otras palabras, que la economía de México está perdida sin los EE.UU.
  2. Porque asumen que México necesita de otro país para protegerlo. Nuestra economía no estará boyante, pero tampoco se encuentra en tantos apuros. Muchos de nuestros problemas recientes se derivan de la dramática devaluación del peso mexicano frente al dólar americano, tras las elecciones en ese país.
  3. Porque categorizan erróneamente al debate actual como una elección a hacerse entre México y China. Yo soy un firme creyente en que México debe integrarse con China y otros países de Asia-Pacífico, pues creo que ello volverá a las empresas mexicanas más productivas y competitivas. Sin embargo, el discurso del Presidente Xi y del Embajador Qiu respecto a que las empresas mexicanas deberían voltear a China solamente porque EE.UU. se está cerrando para ellas es equivocado y obstinado. Debería ser en interés de México que éste se acerque a China, independientemente de lo que ocurra en los EE.UU.
  4. Porque juegan con la incapacidad de México de pensar más allá de términos absolutos: todo es ya sea una “amenaza” o una “oportunidad.” Un enfoque más racional acepta que toda relación bilateral tiene sus altas y bajas. Pero, cuando el Gobierno mexicano declara que “lo que China y México logren hacer en su relación comercial será el punto de partida para un nuevo orden económico mundial” y que la toma de posesión del Presidente Trump “representa al mismo tiempo la necesidad de plantear nuevos horizontes y reforzar ante esta amenaza nuevos caminos” (énfasis añadido), seguimos cayendo en lo mismo, cuando deberíamos estar enfrentando las verdaderas implicaciones de hacer tratos con China y EE.UU.
  5. Porque simplemente no están fincadas en la realidad. Mi propia experiencia –y que veo reflejada en muchos de las entradas aquí en el China Law Blog– es que se está volviendo más y más difícil hacer negocios en y con China, y que las empresas que tienen éxito en este sentido son aquéllas que proceden con cautela. El déficit comercial de México con China es casi insuperable, mientras que los flujos de inversión entre ambos países prácticamente no existen y no muestran signos de aumentar. Las barreras de lenguaje y culturales dificultan a mexicanos y chinos el cumplimiento de la legislación del otro, así como de las “reglas no escritas” necesarias para hacer negocios. Finalmente, conceptos erróneos impiden a las empresas de ambos países visualizar el espectro completo de oportunidades de negocio en los mercados de cada país.

En mi próximo post, echaré un vistazo más a detalle a la situación actual de la relación económica entre México y China.

 

Adrián es fundador/Director Gral. de Chevaya (驰亚), empresa de servicios de internacionalización en Asia-Pacífico. Con experiencia práctica y teórica en China, Adrián es Doctor en Derecho por la Universidad Jiaotong de Shanghái y Maestro en Derecho Internacional y Chino por la Universidad de Wuhan, siendo el primer mexicano en obtener estos grados en China