China HR AuditIn part one of this series, I explained what has changed in China to make employer compliance — especially for foreign companies doing business in China — so important. In this part two, I explain what our China employment lawyers do in our HR audits to ensure that our clients are in compliance with China’s increasingly complicated, increasingly localized and increasingly important labor and employment laws.

An HR or employer audit will make sure you are complying with relevant employer laws (both national and local) and will reduce your regulatory, liability and lawsuit risks. Moreover, a comprehensive review and a full analysis can give you a clearer picture of what’s going on in your workforce and once you have the big picture, you can then determine (and we help our clients with this) the employer-employee problem(s) you need to remedy first.

We usually begin our HR audits by sending our clients a questionnaire to gain a basic understanding of their employer-employee situation in China.  We first ask our clients to provide the registered entity name and address (in both English and Chinese), as well as the official company registration document (usually: business license) for their China office(s). If you don’t have a China entity, there is no way your direct employment of a China employee is deemed legal under Chinese laws and your problems extend way beyond anything an HR audit can fix. See Doing Business in China with Deportation or Worse Hanging Over Your Head. We also ask our clients for an organizational chart of their China office(s), including the employee count for each location and a brief (1-2 paragraph) narrative describing how their China offices are organized and managed, including how HR matters are handled.

In order to complete a document review, we usually request all written employment documents used in their China office(s), specifically including any of the following:

  1. Documents containing job descriptions, including any postings on internal or external websites
  2. Offer letters
  3. Labor contracts (aka employment agreements)
  4. Rules and regulations (sometimes called an employee handbook or manual)
  5. Travel expense policies
  6. Non-compete agreements
  7. Intellectual property protection and/or confidentiality agreements
  8. Education reimbursement agreements
  9. Bonus agreements
  10. Settlement and/or severance agreements
  11. Other employment-related agreements (including company policies) presented or signed by any company representative, or signed by any employee
  12. Any documents filed with the local labor authorities

We want to review the executed copy of any and every document signed by an employee, including each individual employment agreement, along with any employment-related templates or forms used in their China offices. We ask our clients to advise if any of the above documents do not exist.

We also ask our clients to tell us of any any imminent employment related issues or questions they may have, such as imminent employment contract renewals, employment contract revisions in process, employee departures, and new hires. For example, if their China office is in the process of bringing in any new hires, we want to know about any potentially unresolved issues between the new hire and his/her previous employer. See Hiring Employees in China. Ideally, we would also review the employment documents executed by this person and his/her previous employer, but this is not always realistic.

If applicable, we also want to know how past terminations at the company were handled, and to that end we usually ask for a list of any former employees, including:

  1. their hire date
  2. their last date of employment
  3. whether the termination was voluntary or involuntary
  4. whether any severance payment was made
  5. any documents issued to the employee evidencing how the employment relationship was terminated
  6. a description of how the employer handled the transfer of social insurance and employee files.

Finally, we will want to know any particular HR problems the China office has experienced and any HR concerns they may have.

We then review the materials provided to us and we then prepare a written memorandum identifying any employment issues and providing recommendations and estimated costings for remedying the problems found. The time required to complete the audit depends on when the client responds to our questions and on what we find in the files. We then work with our clients to resolve issues that are raised by the audit.

The above may seem daunting at first, however your HR auditor would essentially handle most of the “dirty work” and it certainly beats being fined, named and shamed or criminally charged!

China employment lawChina’s Ministry of Social Security and Human Resources, Ministry of Foreign Affairs and Department of Education recently jointly promulgated new rules for new graduates from foreign countries without working experiences. These rules apply to foreign graduates who obtained their master’s degree or higher education in China and to foreign graduates who received advanced degrees from a well-recognized foreign institution (whatever that means). Those who meet either of the above qualifications must then meet the following additional qualifications to be eligible for China employment:

  • have graduated within the past year
  • be over 18 years of age
  • have no criminal record
  • have good grades (no lower than 80 out of 100 or B/B+) and no record of infractions during school
  • be in good health
  • have a specified employer and a position relevant to the job candidate’s field(s) of study
  • hold a valid passport or any other valid travel document in lieu of a passport

In addition, the candidate’s proposed salary cannot be lower than the local average salary. This will be vigorously reviewed as part of the work permit application.

The prospective employer will need to apply for a work permit for the foreign recent graduate and the authorities will usually require all of the following:

  • the candidate’s resume
  • a proposed letter of intent regarding the employment. This letter of intent must also specify the expected salary.
  • a report specifying why employing this individual is necessary, including certification that the position was advertised to Chinese candidates for at least 30 days
  • a certificate of no criminal record
  • all relevant diplomas
  • a school-issued certificate confirming the potential foreign employee has no record of infractions at school
  • relevant school transcripts
  • a medical certificate showing good health
  • a recent photo (within the last 6 months)

Once approved, the foreign employee can get a China Z work visa. The initial term of employment cannot exceed one year, but employment can then be renewed for subsequent terms of up to five years. Applications will be subject to the applicable national/local quota.

It should go without saying (but since I am a lawyer I am not willing to risk that) that you as the employer should have in place for this new hire all of the usual safeguards you use (or should use) with any of your other China employees, be they foreign or Chinese. In other words, you should at minimum, enter into an employment contract with this new hire.

Local labor authorities are expected to come up with specific measures and local standards in implementing these new rules. Those local standards likely will determine whether this new employment category will become a big deal or rarely be used. I will report back on what I learn from compiling and submitting these applications on behalf of clients.

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 NNN Agreement and China Product Development Agreement
Eight China counterfeiting myths go up in flames

1. There’s no way to protect my brand in China against counterfeits, so I may as well not try. This is both false and self-defeating. China offers a number of ways to protect your IP, and is getting better every year. The first and most important step is to file a trademark application in China as soon as possible to cover your goods and/or services. This will provide you with a first line of defense against counterfeiters and trademark squatters. Once your trademark is registered you will be able to submit takedown requests to Chinese e-commerce sites, request Chinese customs to seize goods, and bring lawsuits for trademark infringement. And, at the same time as you file your trademark application, you can begin to craft a comprehensive IP protection strategy that incorporates copyright and patent registrations.

2. My Chinese trademark registration for my blockbuster movie will allow me to take action against people using “my” trademark on other goods, like clothing or breakfast cereal or toilets. Trademark protection in China is limited by the classes and subclasses of goods and services covered by your registration. If you want protection for other products, you need to register in the appropriate classes AND subclasses to cover those products. For some companies this means registering in all 45 classes. For other companies it means figuring out which products or services you really, really don’t want someone else to be selling under your name. And for most everyone, it is critical to file directly in China and not in Madrid.

3. You can remove counterfeit goods from Chinese e-commerce websites with a US trademark. Alibaba has been amenable to removing listings from Alibaba and Aliexpress, its foreign-facing sites, with just a US or a European trademark registration. But to remove listings from domestic Chinese e-commerce sites like Taobao and 1688.com you typically must have a Chinese trademark registration. Many other e-commerce or social networking sites require a Chinese trademark registration and every site will take action more quickly with one. When counterfeit goods of your product are being sold, time is literally money.

4. China is the biggest source of counterfeit goods in the world. Totally true. According to the 2016 annual report from the U.S. Customs and Border Protection (CBP) and U.S. Immigration and Customs Enforcement’s (ICE) Homeland Security Investigations (HSI), more than 80% of all seized merchandise that infringed intellectual property rights came from either China or Hong Kong.

5. Chinese customs will seize counterfeit goods even if you only have a US trademark. Trademarks are national in scope, and with few exceptions a US trademark has no relevance in China. It certainly means nothing to Chinese customs. Imagine trying to convince U.S. Customs and Border Patrol to seize goods based on a Chinese trademark registration. It would never happen. If you want to be able to have Chinese customs seize infringing goods you need to have a Chinese trademark registration and you need to have registered that trademark again with Chinese customs.

6. The only way to have Chinese-made counterfeit goods seized is when they come in to the United States. U.S. Customs does actively inspect incoming shipments, but Chinese customs also actively inspects outgoing shipments. If you can provide the who, when, and where details about an upcoming shipment of infringing merchandise, you can have that merchandise seized by China customs.

7. My brand is famous outside China so that means the Chinese government will take action against counterfeit goods. No. Just no. The only way to be sure you have trademark rights in China is to register your trademark in China.

8. If I have my products manufactured in China, there’s nothing I can do to stop my manufacturer from selling them out the back door. Wrong. There is a lot you can contractually do to prevent your own manufacturer(s) from selling your own products as its products, starting with a China-centric NNN Agreement and/or NNN provisions in your manufacturing agreement. Using a China Product Development Agreement also often makes sense when you are in the early stages with your China manufacturer.

China employment lawyerThough most foreign companies doing business in China understand the importance of delicately handling their employee terminations, too many do not understand the need to pay special attention to employee resignations as well. This is because it is not at all uncommon for a Chinese employee to claim that his or her resignation was not voluntary, and that in fact he or she was compelled to leave the company because it failed to follow Chinese employment laws. This means that you as the employer need to be clear on the reason for all of your employee resignations and, more importantly, you need to maintain written records documenting what led to your soon-to-be former employee’s departure.

The first thing you should do with an employee who is resigning is to make sure that his or her resignation letter properly lists the reason for the resignation. If your employee tells you orally or by WeChat or QQ that he or she is leaving for a job with a “better fit,” but the resignation letter lists the reason as “compensation issues,” you have a problem. The Chinese labor authorities recently just made clear their intention to crack down hard on employer failures to pay employees and in response to this, this “bait and switch” resignation letter technique has become quite common. The employee who writes you this sort of resignation letter may turn around and sue you for allegedly due back wages, plus interest, plus penalties, plus attorneys’ fees.

If you get this sort of resignation letter, we suggest that you seek to clarify with your employee the compensation issues he or she is referencing in the resignation letter. Is your employee blaming you for having failed to pay wages on time or in full or both? If you approve your employee’s resignation letter by affixing your company chop to it resignation, you probably just admitted in writing to having violated China’s employee compensation laws. And by doing so, you have just opened your company up to a lawsuit you will almost certainly lose.

To the extent you have any outstanding issues with one of your resigning employees, the best solution is usually to resolve those issues with your employee via a properly drafted, properly executed Chinese language settlement agreement. Settlement agreements in China are like settlement agreements pretty much everywhere else in that the key is that it prevents any future claims or lawsuits. And just to scare you a bit more, our China lawyers are often called in to resolve matters for foreign companies in China with DIY settlement agreements that are either 100% ineffective or even worse, can be used against the foreign company as an admission of wrongdoing in a newly filed lawsuit.

Bottom Line: Treat all employee departures seriously. Document them and, if it makes sense to do so, resolve them with an appropriate settlement agreement.

China employment law complianceChina is serious about improving the situation for its workers. I repeat, China is serious about improving the situation for its workers.

I feel the need to repeat this because many foreign companies doing business in China believe decreasing economic growth will lead the government to favor foreign employers. Wrong, wrong, wrong. Foreign employers do not protest; Chinese employees do, and the Chinese government values stability above nearly all else.

Our China lawyers are seeing this play out in the following ways:

  • China”s government, courts and administrative bodies are getting tougher on foreign companies that do not comply with China’s labor and employment laws. Like pretty much everything else related China’s employment laws, the extent to which this is happening varies by location. See China Employment Law: Local and Not So Simple.
  • China employers that violate China’s labor protection laws will be named “and shamed.” Employers are also getting graded on their compliance with China’s labor and employment laws. I explain what this means below.

Beginning earlier this year, China enacted Measures for Announcing Major Violations of Labor Security and the Measures for Credit Rating Evaluation of Enterprise Labor Security Compliance. These measures evidence the government’s seriousness regarding employment law compliance and they give the government new powers to ensure compliance. According to the Supreme People’s Court, new labor disputes accepted by the Chinese court system totaled 483,311 in 2015, up a whopping 25 percent from the previous year. And I have no doubt that these numbers have been rising in a straight line upward ever since. China employees are getting smarter and more proactive about enforcing their legal rights against their employers, especially as against foreign employers.

The new measures include publicizing “serious” employer violations in newspapers and magazines and on TV. These public announcements will include the employer’s name, address, and registration code, along with the full name of the legal representative or key person in charge and the exact violation and fines or other sanctions imposed. Just imagine what this will do for your company’s reputation and your ability to hire new employees. Will individuals who have been named and shamed want to leave China? Will they have to do so?

In addition to naming and shaming, employers will receive A, B or C grades based on their compliance in various areas, including the following:

Employer grades will eventually be shared with various Chinese government agencies, including (it is widely believed), taxing authorities. In other words, if your company scores a C on its labor compliance, it may find itself at risk in all sorts of seemingly unrelated areas (beyond just fines for labor law non-compliance), such as income tax or environmental compliance. We expect China’s biggest cities with large numbers of foreign employers will get out in front of employer inspections and enforcement first and early.

Your job (pun intended) as a China employer is to get out in front on compliance as well. The best way to do this is to have an independent audit conducted on your employer-employee situation. As recently as a year ago, our China lawyers were rarely asked about “employer audits,” but hardly a month goes by these days without such a discussion. Foreign employers in China are seeing what is going on around them and they are reading the news. They recognize that the Chinese government now realizes there is lots of money to be made by fining foreign companies for failing to comply with China’s employment laws, while improving employee/citizen satisfaction at the same time. Our best employer audit clients are those who have already been fined, sanctioned or sued for employer violations. Our second best employer audit clients are those who know of someone in their own industry who has already been fined, sanctioned, sued or shut down over employment law compliance issues.

What exactly is an employer audit? An employer audit is little more than a review to make sure a company is complying with relevant employer laws (both national and local), all done with an eye towards reducing the company’s regulatory, liability and lawsuit risks. The nature of this review can range from focusing on one or a few employment law or compliance issues to a full on legal analysis of pretty much everything related to the company’s employer-employee relations. The review can range from just reviewing documents off-site, to one or more bilingual Chinese-English lawyers going to the employer’s facility(ies) for an on-site document review and to interview key personnel.

Employer audits begin with a review, but they virtually always continue with drafting or revising company documents and contracts and meeting with Chinese government officials to remedy problems found. There is no point in having your China employment law problems diagnosed without your then doing whatever you reasonably can to remedy them. See this Lifelock advertisement for a different (and much funnier) take on what I am talking about here.

Bottom Line. If you employ anyone in China, now is the time for you to get compliant. Compliance with China’s myriad and confusing and heavily local employment laws and regulations is no fun at all, but it sure beats your being named and shamed or fined or shut-down for non-compliance.

International Trade LawThe U.S. International Trade Commission (ITC) yesterday determined by a 3-2 vote that the domestic U.S. tire industry was not injured or threatened with injury by imports of truck and bus tires from China. Although the U.S Department of Commerce last month in its concurrent investigations had determined that Chinese truck and bus tires were dumped and subsidized, the ITC’s negative determination means no more antidumping or countervailing duties (AD/CVD) will be collected on imported Chinese truck and bus tires.

The ITC’s negative determination is a good indication that for all the protectionist rhetoric and trade saber rattling from the Trump administration, the ITC is not just going to rubber stamp every case filed by a petitioning domestic industry. The ITC will still decide its AD/CVD cases based on the extensive amount of industry data collected from its investigations and will not rely just on the alternative facts offered by petitioners.

This tires case was weak from the outset. First, it was brought only by the United Steel Workers (which represents the workers at the big U.S. tire factories) and not by the tire companies themselves. Unlike virtually all other AD/CVD cases, the domestic producers in this case did not want to sign their name to the petition. Some have speculated that the Steel Workers filed this and other tire AD/CVD cases to obtain negotiating leverage to try to extract production and wage concessions from the U.S. tire industry management.

Although the U.S. market for truck and bus tires in 2015 was about $6 billion dollars, U.S. producers supplied only 60 percent of that demand. U.S. truck and bus tire producers already are operating at full capacity, so even with new U.S. tire factories opening, imports are still clearly needed to meet U.S. demand. China was the leading import source of truck and bus tires with about $1.2 billion imported in 2015.

All the U.S. produced tires were of premium brands, whereas most of the Chinese tires were sold under lesser known or private label brands. Because consumers generally associate producers’ brand names such as Goodyear or Bridgestone or Michelin with quality and performance, Chinese tires not surprisingly were priced lower when sold under a private label. This price difference associated with the different brands reflects the distinct market segments; the higher priced premium U.S. brands did not really compete with the no-name generics or private label Chinese tires. Moreover, though tire prices declined between 2013 to 2015, this was due primarily to declines in raw material costs, primarily natural rubber.  Prices of U.S. tires sold to OEM customers fell at the same rate as prices for U.S. aftermarket sales, even though very few Chinese tires were sold to OEM customers. Chinese tires thus cannot be blamed for the price declines that were occurring.

The domestic tire industry also was performing quite well and thus had a hard time demonstrating it had been injured. The domestic industry was healthy as production, capacity utilization, shipments were all higher in 2015 compared with 2013. Employment, wages and productivity indicators also showed improvement. The domestic producers had high and rising profits (operating income = 20.7%; net income = 18.3%), even though prices had fallen. So, even as Chinese imports were increasing, U.S. tire producers were thriving.

Despite all of these facts, this case could have resulted in an affirmative injury or threat of injury determination based on the increasing volumes of low-priced Chinese import tires that reducing the domestic producers’ market share. An argument can also be made that the significant volume of Chinese tires caused the domestic industry to lose revenue and be less profitable than it would have been without the Chinese imports.

In its preliminary investigation, the ITC made an affirmative determination by a 4-2 vote that the domestic industry was injured or threatened with injury, but two of the six Commissioners changed their positions in the final investigation. Vice Chairman David S. Johanson had found a threat of injury in the preliminary investigation, but switched to a negative injury/ threat determination in the final. Commissioner Dean A. Pinkert voted affirmative in the preliminary determination but then abstained and did not participate in the final investigation. If either of these two votes had stayed affirmative, a 3-3 tie vote would have resulted in AD/CVD duty orders being issued. Given the closeness of the vote, I expect the United Steel Workers will appeal the ITC’s negative determination to the U.S. Court of International Trade

Ultimately, this ITC negative determination was not only a huge victory for the Chinese tire industry and for U.S. importers of those tires, but also for anyone who wants U.S. trade cases to be determined on the facts and the law  and legal arguments presented and not just on a protectionist trade policy. The vast majority of petitions filed have resulted in AD/CVD orders being issued, and it likely will continue this way for the foreseeable future.  Given the current political climate, however, it’s nice to see a negative ITC determination just to be reassured that the ITC still recognizes its obligation under U.S. trade laws to conduct investigations fairly and that not all AD/CVD petitions are deserving of trade remedy relief.

China employment lawyerEvery China employer should have a set of rules and regulations setting out employee and its employer duties and obligations. This document should cover all types of employees, including part-time employees. It also should at minimum, cover the following:

Many foreign employers wrongly assume that whatever they use in their home country is good enough for their China employee manual. This is virtually never true as the reason for having employee manuals is so different as between China and Western countries. Western companies often learn too late about these differences when one of their employees leaves or is terminated.

The following are seven common myths our China lawyers often hear about China employer rules and regulations:

Myth 1: It need not be in Chinese. Though having your rules and regulations entirely in English will not necessarily invalidate the entire document (this depends on where you are), it needs to be in Chinese so your employees can understand it. If you do not have a Chinese language version of your rules and regulations, you run the risk of a Chinese court finding it not binding on your employees because they could not understand it and you didn’t bother explaining it to them. Also, the local labor authorities may require a Chinese translation for audit purposes and you don’t want to be caught flat-footed when that happens. And whatever you do, do not just take your English language version and pay a translator to put it into Chinese. Your Chinese language rules and regulations are what the courts will be looking at to determine whether you acted properly or not, so you want that document to be written clearly (and in Chinese) for this purpose.

Myth 2: It need not be in English. You really should have an English translation done and make sure that too is good. You as the employer will need to refer to this document in making employee decisions (especially termination decisions). Unless all of your people who will be making these decisions are fluent in written Chinese, you need a well-written English version to serve as your roadmap on how to handle all sorts of decisions regarding your employees.

Myth 3: It need not be updated because it has a provision that says the outdated sections will automatically be replaced and superseded by then-current laws. Wrong. Both nationally and at the local level, China’s employment laws are constantly changing. It therefore behooves you to do an annual internal audit of the key elements of your employer-employee situation and this yearly employer review should include a review and an updating of your rules and regulations. You could be exposed to huge risks if you have been relying on a section that is contrary to the law. More on this in Myth 5. We also fairly often see rules and regulations that made sense for a company that had employees in just one China city, but no longer do now that the company has employees in three cities.

Myth 4: Employers do not need to follow any procedures in implementing the rules and regulations. You must make your rules and regulations available to every employee so they have an opportunity to read it before signing off on it. And if there is a worker’s union at your organization, you should hold meetings with them and obtain their comments and suggestions before implementing your rules and regulations.

Myth 5: By signing an acknowledgment of receipt, the employee agrees to everything in your rules and regulations, so it doesn’t matter if it conflicts with the law. Not sure why, but our China lawyers have been hearing this myth more frequently of late and it too is just plan wrong. Very wrong. Having a section in your rules and regulations that contravenes the law probably will not invalidate your entire document (though it conceivably could), but many China employment laws must be followed and cannot be contracted away. It does not matter that the employee gives his or her written consent, and it also does not matter that the employee acknowledged that he or she executed the written consent as a free and voluntary act.

Myth 6: Once published, employers can change anything they want at anytime without any notice because the employees are responsible for keeping up to date with the amendments. First, if your rules and regulations document sets forth an internal procedure for amending the rules and regulations, you should follow that. We usually recommend our clients give notice to their employees of any proposed change before implementation. For important issues concerning employees’ interests such as compensation, working time, rest and vacation time, labor security and health, insurance and benefits, employee training, labor discipline, the safest route is to give them prior notice before amending the rules, especially if the changes may have an adverse impact on them. At the very least, provide the employees with notice of the change and give them an opportunity to comment and ask questions. Doing this simple thing can only help you down the road.

Myth 7: The employment contract between the employer and the employee always takes precedence over the rules and regulations if there is any conflict between them. Wrong. Like so much else related to China’s employment laws, the legal interaction between your rules and regulations and your employee contracts depends on your location. The local law may require that the employment contract prevail over the rules and regulations even if the employer and the employee have a written agreement stating otherwise. Or the law may say that the employee gets to decide which to apply based on which the employee believes is more favorable to him or her and the employer has no say on that. The key here is that you know the legal situation in your relevant jurisdiction(s) and to the extent allowed by law, you make clear in both your rules and regulations and in your employment agreements how your rules and regulations interact with your employment contracts.

For more myths about China employment laws, check out:

 

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.

 

US-China trade warPresident Trump has already acted on some of his trade-related campaign promises. One of his first official actions was to withdraw the United States from the Trans-Pacific Partnership (TPP). Trump also floated the idea of imposing a 20% tax on all imported Mexican goods to pay for the US-Mexico border wall, but he appears to have backed off that idea, at least somewhat. Below I discuss how the Trump Administrations early trade actions may benefit China the most, instead of benefitting America “first.” I also discuss how China is not standing idly by, but rather is positioning itself to defend or retaliate against U.S. trade actions that target China.

  • Trump’s TPP Withdrawal. In signing the executive order withdrawing the United States from the TPP, President Trump merely signed the death certificate for a trade deal that was practically comatose well before he took office. Trump described the TPP (along with basically every other trade agreement) as a “bad deal” that would result in a “death blow for American workers.”  Many commentators, however, have noted that China will be the biggest winner from Trump’s abandonment of the TPP.  The TPP aimed to reduce trade barriers and tariffs across 12 countries, but specifically and tellingly did not include China. The TPP was part of a strategic U.S. pivot towards Asia that attempted to strengthen American economic ties in the region to counter-balance China’s increasing power there. With the demise of the TPP,  other Asian countries such as Australia, South Korea, and the Philippines, likely will be pulled even tighter into China’s expanding economic sphere of influence in the region. China also has been handed an opportunity to fill the political leadership void in the region created by Trump’s withdrawal from TPP.  China now could take the place of the United States in the TPP, but appears more likely to push for completing of its own proposed Regional Comprehensive Economic Partnership (RCEP), which includes many of the same Asian countries that were part of TPP, but not the United States. If RCEP is successfully negotiated, U.S industries stand to lose significant market share throughout the Asian countries that will have preferential rates with its RCEP partners, but not the United States.
  • Trump Floats, Then Walks Back, A Proposed 20% Tax on Mexican Imports. The Twitterverse exploded with people angry that avocados and tequila could cost more because of Trump’s proposal to impose a 20% tax on all Mexican imports.  White House spokesperson Sean Spicer rushed to explain that the idea of the 20% tax was not really a policy proposal, but just one example of the options for how to pay for the U.S.-Mexico border wall. Trump’s having paused after proposing a 20% tax on imported Mexican goods got a bad reaction (“Guacapocalypse!!”) and that may bode well for China exports to the United States, at least temporarily. During the campaign, Trump had proposed a 45% tax on all Chinese imports. But if U.S. consumers hated the idea of a 20% tax on Mexican goods, it seems likely that a 45% tax on Chinese imports would trigger even greater outrage because of the broader spectrum of goods from China that would be affected. Instead of a straight tariff on imports, however, Trump may now try to impose a border adjustment tax (BAT) similar to what House Republicans have recently started pushing. But calling it a tariff or a more complicated BAT won’t change the bottom line, which is that either option would make imports more expensive and US consumers would bear the brunt of those increased costs.

China thus far has publicly taken the high road and stated no one wins  in a U.S.-China Trade war. However, China also has taken the following steps to better position itself to defend, or to more aggressively retaliate, against the United States if Trump insists on escalating the trade war.

  • China’s WTO Challenge v. U.S. Continuing NME Status for China – China insists that when it negotiated the terms that allowed China to accede to the WTO in 2001, the United States agreed to treat China as a non-market economy (“NME”) in antidumping cases, but only for another fifteen years, after which it would be treated like all other market economy countries. Unfortunately for China, the Chinese negotiators for the 2001 US-China WTO Accession agreement were primarily politicos, and not lawyers. Because this agreement was not drafted precisely as the Chinese intended, the United States has been able to parse the language to come up with a plausible legal argument that the U.S.-China WTO Accession did not call for an absolute hard deadline for terminating China’s NME status, but rather provided only a conditional promise to terminate China’s NME status. The revocation of China’s NME status is a high priority objective among China’s leadership and immediately after the December 11, 2016 fifteenth anniversary of China’s WTO accession, China filed a WTO challenge against the United States’ continued application of NME status in antidumping cases against China.
  • China’s Increasing Opposition to U.S. AD/CVD Proceedings – China’s complaint against the United States’ refusal to grant market economy status will take many years to work its way through the WTO dispute settlement process. In the meantime, China will not just wait to see if the WTO will rule in its favor. China just within the past month has become more outspoken against U.S. Department of Commerce (DOC) determinations in AD/CVD proceedings against China.  China’s Ministry of Commerce (MOFCOM) recently issued press releases objecting to specific methodologies used by DOC and ITC to obtain inflated AD/CVD rates in a wide variety of cases involving off-road tires, biaxial geogrids,  hardwood plywood and amorphous silica fabric, carbon and alloy steel, and ammonium sulfate.  Previously, MOFCOM typically would only monitor the outcomes of DOC and ITC cases without commenting on any specific issues arising from U.S. AD/CVD proceedings. This recent increased activity from MOFCOM objecting to very specific and often technical AD/CVD legal issues in US investigations signals a more aggressive policy stance by the Chinese government to support Chinese companies subject to US AD/CVD proceedings.
  • China’s AD/CVD Actions against U.S. Exports to China – Not only is China playing more aggressive defense in U.S. AD/CVD proceedings, China is also starting to take the offensive and initiate its own AD/CVD cases against certain U.S. exports to China. On January 12, 2017, MOFCOM announced the final results in the AD/CVD investigations against dried distiller grains (DDGs)  from the United States and issued AD and CVD margins of 42.2%-53.7% and 11.2-12.0% that were higher than expected. DDGs is an ethanol by-product used as animal feed, and in 2015 China imported 6.8 million tons of DDGS from the United States worth $2 billion and was the single largest export market for U.S. DDGs producers. MOFCOM’s DDGs determination indicates that China is looking to use its own AD/CVD actions not only to score political points, but also to have an economic impact. It is rumored China already has received an AD/CVD petition against soybeans from the United States and is just waiting for an appropriate time to officially initiate these investigations, probably in reaction to a U.S. action against China.