China trademark registration

The month of wine-related posts continues!

We started with China, Wine and Tariffs, continued with China Trademarks: Wine Labels in China, and I will now examine the Nice classes to use on wine-related trademarks in China.

This may seem like an obvious question – if you’re selling wine, then you should register in Class 33, which covers alcoholic beverages (except beer). Class 33 only has one subclass, so you don’t even need to worry about filing in multiple subclasses. A single registration for “wine” will also cover aperitifs, bitters, ciders, sake, vodka and whiskey (and everything in between). And if all you want to do is ensure that you can sell your product in China, then you can stop here.

But for most brand owners, it’s not enough just to ensure that you can continue your operations. You also want to prevent trademark squatters from coopting your mark in other ways. In China, the trademark examination system is quite mechanical: all items in a subclass are deemed similar to every other item in the subclass – and only to those items. There are a few exceptions with certain goods and certain subclasses (i.e., goods in a certain subclass that are considered similar to those in another subclass), but those are predefined and laid out in Chinese Trademark Office (CTMO) publications. Everything else is fair game, because it’s not considered “similar” under CTMO practice.

Also, as we have explained previously in China Trademarks: Register in More Classes, Take Down More Counterfeit Goods, CTMO practice allows (if not encourages) trademark applicants to file in classes far beyond the scope of what they actually manufacture or sell. This is a double-edged sword: it allows trademark owners to extend brand protection as broadly as they like (if cost is no object), but on the other hand it also allows trademark squatters the latitude to engage in mischief, like applying for Star Wars brand instant noodles.

So when you’re filing a trademark application, you should think about two sets of classes: (1) which classes you need to protect your own goods/services, and (2) which classes you want to keep out of the hands of third parties.

If you’re a winemaker, you probably don’t care if someone takes the brand name of your wine and uses it on telescopes. But you probably would care if someone used it (for example) on corks (Class 20) or beer (Class 32). I just did a quick search on the CTMO website and yes, Penfolds has registrations in both classes.

What are you doing to protect your wine brand in China?

China lawyers
Halfway for a China WFOE is not good enough. Photo by Jacqui Sadler

Earlier this week, I wrote about how China’s economic slowdown should impact how you do business in China and even with China. Today I focus on why this slowdown (and if you are an American company, the US-China trade war which is precipitating that slowdown) are why now is not the time for you to be operating quasi-legally in China.

And yet, there seem to be as many companies operating this way in China right now. For nearly a decade now, we have been stressing the need to have a WFOE if you are going to be doing business in China. Along these lines we have stressed again and again how independent contractors are almost never legal in China and how if you have “employees” in China you need a WFOE. For more on this and for how our tone on this has become increasingly strident as the Chinese government has consistently and unrelentingly stepped up both its enforcement of this requirement and the penalties for failing to comply. For more on this, check out the following posts from the following years:

  1. Doing Business in China Without a WFOE: Will the Defendant Please Rise. In this post from August, 2018, we wrote about how our China lawyers are increasingly hearing of foreigners getting arrested and imprisoned for operating in China without a WFOE.
  2. Doing Business in China with Deportation or Worse Hanging Over Your Head. In this post from March, 2017, we wrote about how our China lawyers were increasingly hearing of foreigners (especially Americans) getting deported from China and being cut off from doing business in China for having operated in China without a WFOE.
  3. China’s Tax Authorities Want You. In this Forbes article from May, 2015, I wrote about how our China lawyers were increasingly hearing of foreigners getting hit for massive taxes for having operated in China without a WFOE.

With all the pressure to have a WFOE in China, our China attorneys are now increasingly hearing of foreign companies forming a China WFOE but then continuing to operate illegally in China. This is more common than you would probably think and it also seems more common than ever.

Let me explain.

Forming a WFOE is not the same thing as operating legally in China. In fact, it is so different that around a decade ago my law firm made the decision not to simply form WFOEs for clients and then walk away. At that time we ceased doing what we called pure WFOE formations. Instead, if anyone wanted us to form a WFOE for them, we would do so only if they retained our law firm for what we called a WFOE formation package. Our explanation for this was that operating legally in China with a WFOE requires a lot more than just a WFOE and we did not want to charge clients to form a WFOE only to have them get in trouble with China’s authorities for operating illegally. One of the things we always (as in 100% of the time) require as part of our WFOE formation work is what we call our China employment package, which consists — of among other things — our drafting dual language China-specific employment contracts for all WFOE employees and Employer Rules and Regulations to go with those. See China Employer Rules and Regulations: A Must Have No Matter Your Size.

Unfortunately, many law firms and companies that do WFOE formations are not concerned with launching China WFOEs that operate illegally from day one. I say this because in the last year or so our China lawyers are hearing more and more from foreign companies with WFOEs in China that are operating illegally in China. I find this very distressing because it strikes me as so illogical. Why spend the substantial time and money to form a WFOE if doing so is not going to make you legal in China? Why form a WFOE telling the Chinese government that you are there only to make it so much easier to be discovered for operating illegally.

What are these WFOEs doing illegally? Two main things, both centered around trying to reduce costs by avoiding taxes. One is setting up a WFOE and doing various things to illegally reduce the WFOE’s income taxes. We get maybe one call every six months from someone caught for this and we tell them that the only solution is to try to negotiate down the total figure for back taxes, interest and penalties, and to do that from outside China. The other thing is China WFOEs that hire China “employees” through their foreign company and not through their WFOE. They do this to avoid having to pay the approximately 40% on salaries China employers are to pay in employer taxes and benefits and to avoid having to withhold the approximately 20% they are to withhold on behalf of their employees for their employees’ individual income taxes.

Way back in 2010, we did a post, Operating Illegally In China. Half-Assing It Does Not Help. In that post we explained how operating quasi-legally so greatly increases your risk of getting caught that you would actually be better off operating fully illegally. Back then, the issue was forming a company with a Chinese citizen (which though less common today than back then, is still an issue). Here was our position on that back then (and now too):

Legally, you pretty much cannot go into business with Chinese citizens without a joint venture. China recently started allowing partnerships, but the impact of that is still not clear.

You pretty much have two options:

1. You form a WFOE and you own it. Forming a company in Hong Kong is no different for China purposes than forming one in the United States, so forget about Hong Kong for a moment. [For an update on why having a Hong Kong company does not cut it, check out American Companies in China without a WFOE and the Impact of Donald Trump and US Tariffs and Why Hong Kong is not the Answer.] Forming a WFOE can be very expensive, in large part depending on the Chinese city in which you will be forming it.

2. You let your fiancé, her mother and cousin own the entire business. You do this and you are exposing yourself to losing whatever you put into the business. Twice, I have had men break down and cry right in front of me because they went into business with their fiancée and her family and they put 3-8 years of their lives into the business, only to be completely and unceremoniously booted out once it really started to make the big money. These are just the ones who cried. I can tell you about the guy who invested millions in condos with his fiancée and her mother, only to leave China for a few weeks and return with all of the condos sold and his fiancée and mother in law gone. Vanished.

My emails often lead to pushback, with the person complaining of how China makes things so difficult for the “little guy” and then their explaining how they know of how these things usually turn out for the foreigner, but in their case it will be different because:

a. Their girlfriend/fiancé/wife’s family would never be anything but above board.

b. Their girlfriend/fiancé/wife’s family is so “connected,” it makes sense for them to go into business with them.

They then usually ask us to write up a contract that protects them “as best as possible.” We tell them that we will not do that because those contracts are usually not enforceable in China and we are not in the business of writing contracts we know will not work.

In that same post I wrote about an email to me from my co-blogger, Steve Dickinson, to me, which went as follows:

If these people are going to go illegal in China, they should go 100% illegal. That is, enforcement either through really strong family connections (your father knows her father) or enforcement through gangsters and the like. I know people who have succeeded this way but I don’t know anyone who has succeeded with an illegal contract. This is not because contracts don’t work in China, because you and I have won enough China contract cases to know that they do.

It is because the Chinese judges are totally on to these sorts of arrangements and they know they violate or seek to evade Chinese law. They therefore have and will continue to deem such contracts void. Why do people live in this fantasy world thinking that somehow they are so different or that they have discovered the solution? Why do they think a Chinese court would enforce a contract designed to evade the law?

Take an alternative example. Remember John Smith’s [yes, it is an alias] company we formed in Beijing a few years ago? Not sure if you remember this, but that investment was with his Chinese wife. However, we did that as a very formally organized WFOE and left the wife and her family with the irregular side of the deal. His US company is the only shareholder and he runs the board. His company has had no trouble and he has had no trouble because he is legal and secure. His US LLC [and with it, the China WFOE] were just purchased by _______ [a pretty big name U.S. company]. The reason the purchase was successful is that the whole company was “clean” and therefore it could be purchased by a foreign public company.

I then went on to say that “as lawyers we are never going to tell our client to go full illegal, but in my role as a blogger, I have to think going full illegal would probably make better sense than paying a lawyer to draft a void contract. I think people know this, but their rightful discomfort at operating illegally makes them want to clutch on to something that will allow them to justify (however falsely) their actions.”

We also used to frequently see the same sort of thing by companies seeking to justify operating illegally in China with a Representative Office instead of a far more expensive WFOE. We has this to say about this situation way back in 2010:

Every couple of weeks my firm gets an email or a phone call from a small business that is seeking to justify forming a Rep Office in China instead of a Wholly Foreign Owned Enterprise (WFOE). These small businesses typically go into advocacy mode explaining why their business can and should be a Rep Office in China. They then go on to explain that they simply cannot afford to form a WFOE in China due to the minimum capital requirements, the legal fees, and the taxes.

They then want me to condone their Rep Office plans but I never do.

In fact, the increasing number of these requests has caused me to get even blunter than usual, and my most recent response exemplifies this:

What you are describing doing as part of a Rep Office is definitely not proper for an RO. Not even close.

In terms of minimum capital required, because it is Dongguan, it is likely to be pretty high. Sorry.

You pretty much have two choices. You can operate completely off the grid and risk getting shut down, or you form a WFOE. Probably the worst thing you could do would be to form an RO that operates illegally because that will just draw attention to how you are operating illegally.

I get the sense that the people contacting us on these things are hoping that they somehow have found THE loophole that nobody else has found and that if only they can get the blessings of an attorney for what they are doing, that their operating illegally will somehow not be illegal. I wish I had some magic oil I could sell (for a helluva lot of money) that I could sprinkle on illegal China businesses to make them legal, but I have no such thing.

Those who think they are going “sorta” legal by forming what is clearly an illegal Rep Office in China are very similar to those who think they are “sorta” protecting themselves legally by doing a “sorta” joint venture with their girlfriend. I wrote about those people in a post, entitled, “Operating Illegally In China. Half-Assing It Does Not Help.

I went on to explain how forming a Rep Office that then operates as though it were a WFOE “will just serve to let the Chinese government know where you are and what you are doing and will make it easy for them to realize that what you are doing requires a WFOE.” I then made clear my frustration with these sort of quasi-legal schemes:

What really drives me crazy about all this though is that on at least three occasions, companies for whom we have refused to form Rep Offices have written to tell me that “so and so” entity formation company is willing to form the Rep Office for them, as though this mere fact means my firm was wrong in declining to take money to do something we know will eventually not work.

And though I take no happiness from this, I will note that one of the three companies that went ahead and formed a Rep Office against our advice did contact us about a year later to tell us that the Chinese government was now making them form a WFOE.

It is frustrating to hear about the latest round of foreigners believing that going half-way with their China WFOE is enough, especially as most of these people we are hearing from do not even know they are operating illegally because they were told otherwise by the “experts” they hired. These companies that are hiring and paying their China employees outside their WFOEs seem to believe the following make what they are doing legal, but they don’t:

  1. Setting up a Hong Kong business and paying the employees from that. Wrong. This is no different than paying your China employees from the United States. If you are going to have employees in China you need to pay them through a legal China entity, not from overseas. See Having A Hong Kong Business Does NOT Make You Legal in Mainland China. See also, China Expat Pay: Splitting with Hong Kong is 100% Illegal and 200% Dangerous.
  2. Hiring only expat employees in China. Wrong. Expats working in China need to work for a legal China entity just like everyone else.
  3. Hiring only Hong Kong or Taiwan (or Singapore?) citizens. We have heard this one many times over the years, in large part because citizens from these places often claim to their employers that they can and should be treated differently because they are from these places. Wrong. A China-based employee is a China-based employee and a China-based employee needs to work for a legal Chinese company, be that a WFOE, a Joint Venture or a Chinese domestic company. Yesterday, in China Employment Law Update: China Work Permits no Longer Needed for Taiwan, Hong Kong and Macau Residents, our lead China employment lawyer, Grace Yang, wrote about how citizens of these places no longer need work permits to work legally in China. Just since then our China lawyers have received a couple emails from people who seem to believe this work permit change means people from these regions can legally work in China without being directly employed by a legal China entity. Wrong. This work permit change has no impact on this.

Doing business in China with employees in China? Don’t do it half right because you are only increasing your risk.

 

China attorney

In 2012, I wrote an article for the Wall Street Journal, entitled, China’s Slowdown and American Business. There was a slowdown happening in China at that time and the China lawyers at my law firm were “feeling it” from the emails and phone calls we were getting from foreign companies doing business in or with China. My WSJ article sought to address the issues our lawyers were seeing back then. Since that article, China has gone through intermittent slowdowns and during each of those we see pretty much the same same issues each time. Because China is again going through an economic slowdown — due in large part to a trade war that is only going to get worse– I thought now would be a good time to reprise that article and write again about how to handle a China economic slowdown. For more on China’s economic slowdown, see this CNN article from today, The trade war is deepening the gloom at Chinese factories.

China lawyers
China’s Economy is Slumping

The Wall Street Journal chose the following subheading for my 2012: “Hardly a week goes by without complaints about payment problems or bankrupt debtors.” If I were to choose a new subheading for this post today, it would be “Hardly a day goes by without complaints about getting  bad product and hardly a week goes by without someone asking about what will be required for them to shut down their China WFOE.”

The following are the key points from my Wall Street Journal that apply with at least equal force today:

Regulation. The best assumption to make is that the Chinese government will respond to the slowdown by attempting to minimize citizen discontent so as to keep its hold on power.

Sourcing Problems. The slowdown is changing Chinese company interactions with foreign companies. Chinese exporters, particularly those that compete with companies from lower-wage countries like Vietnam and Bangladesh, are suffering—in particular in low-tech, low-wage industries such as textiles, clothing, shoes and low-end electronics and toys. Foreign companies that do business with Chinese companies in these industries must be on their guard. Hardly a week goes by without one of the China lawyers at my firm getting a call from a Western company experiencing problems. Sometimes the Western company has paid for a product and the company it paid no longer exists. Sometimes the company still exists but it needs “more money” from the Western company to buy raw materials for the product it already promised to produce.

Foreign managers need to understand what is happening in their own industries within China. This might mean visiting your Chinese factory, warehouse or office to look for warning signs of a company in distress. Or it might mean taking out insurance to cover your China business or transaction. A number of Chinese manufacturers are owned by Taiwanese, Singaporean or Hong Kong companies, and sometimes it is possible to secure guarantees from the foreign parent.

The key is to be proactive: If you find yourself in a bad situation with a Chinese company going under, there usually is no remedy after the fact. Bankruptcy in China more often than not consists of a company shutting down in the middle of the night and its owner fleeing to another town.

The key to weathering China’s slowdown will be for foreign companies to go back to basics …. focus on scrupulous regulatory compliance; and renew focus on due diligence at a company-to-company level. Above all, no Western company doing business in China should blithely assume that a slowdown won’t affect it.

Updating the article, the biggest change from 2012 to today is the massive increase in Chinese companies willing to risk their relationships with the very same foreign companies with whom they currently do business. We wrote about this previously in Your China Factory as your Toughest Competitor. But it is now not just factories; our China lawyers are seeing this in all industry sectors, especially technology. Our China lawyers have become fond of pointing out that “since you will essentially be educating your Chinese party in how to compete with you, you need contracts that will at least limit what they can do when they do so.”

Why are China companies now so willing to risk losing out on business with existing customers to go into business competing with them? When times are bad, greater risk becomes necessary to pay employee wages and to stay alive.

China’s manufacturing sector has taken a hit from migration of international business to lower wage and cheaper countries across South East Asia. Since President Trump’s first round of tariffs, our international manufacturing lawyers have seen a near 50% increase in work involving Vietnam (mostly), Indonesia, India and Malaysia. And with one or more of these countries coming up in so many of our conversations with clients, we are quite certain this migration to SE Asia will only increase, no matter what happens on the trade war front. With manufacturing moving elsewhere, many Chinese companies rightly believe they need to do something different and heir seeking to compete with their own customers is that something different.

We are getting at least two calls/emails every week from companies seeking help in trying to remedy/stop their Chinese suppliers from using their molds or their information or their customers to compete with them. We have gotten more calls in the last three months from companies whose China factories are now directly competing with them than in probably the three years before that combined. Chinese factories are more confident and willing now than they have ever been about going out into the world with their own products, and more willing to toss their foreign customers to the curb early. In nearly all instances there is little we can do. Though it might be possible to sue these Chinese companies, without rock-solid China-specific contracts in place, such lawsuits seldom make economic sense. See China Contracts: Make Them Enforceable Or Don’t Bother.

We Chat business for foreign companies

Every couple months one of our China lawyers will get an email from someone asking us one of two things:

1. Does my company really true need a China WFOE to get a WeChat business account?

2. What is the bare minimum China WFOE I can form that will still allow me to get a WeChat business account?

Our short answer to the first email was “yes” and our short answer to the second email was that even the bare minimum China WFOE is still time consuming and expensive to form and time consuming and expensive to operate.

But today folks, our answers just changed. Because people, starting today, our short answer to the first question will be “no” and our short answer to the second question will be “why are you even asking us this question when no China WFOE is necessary to get a WeChat business account.

What gives?

What gives is that what has long been rumored — and like almost everything else related to China, falsely believed by many anyway — has now occurred. It is now possible to for a foreign company to get a WeChat business account a/k/a a WeChat Official account without needing a China WFOE. It does not allow WeChat Pay or APIs yet, but it has the core WeChat features. In other words, you can get your business on there and market, market, market.

China Skinny (I have told you before and I will tell you again that this is one of the very few China newsletters worth subscribing to) came out yesterday with an article on the new rules for getting an official WeChat account and, most importantly, step-by-step instructions on how to do exactly that.

It will cost you $99 but compared to having to form and operate a WFOE, it will no doubt be worth it.

 

 

China tariff lawyers

In talking with one of our international trade lawyers yesterday I learned that September 6th is the next key date regarding the $200 billion round of tariffs against China imports. This is the due date if you want to submit comments on your particular category of products in an effort to get that category removed from the tariff list.

It is already too late to submit comments regarding the first two tariff lists — the first $34 billion list and the second $16 billion list. However, if your product is on either of these lists, you still can make a product exclusion request. The product exclusion request process for the Second list will be similar to the process set up for the first list, but no deadlines have been established yet.

Decisions on exclusion requests typically require/hinge on the following:

  • Identify the product you want excluded.
The U.S. list of targeted products is identified by the Harmonized Tariff Schedule (HTS) number used to declare the product when imported into the United States. A company must identify the commercial name of the product, the HTS number for the product, and any other industry designation of the product under a recognized standard or certification (For example, ASTM or DIN).
  • Describe the product based on physical characteristics.
Physical characteristics can include, but are not limited to, chemical composition, metallurgical properties, and dimensions. This description distinguishes your products from other products subject to tariffs. A significant concern when considering exclusion requests is whether granting a specific exclusion request will create a loophole which other products will also be able to exploit.
  • The basis for requesting an exclusion.
Reasons for the exclusion request include, but are not limited to, the following: The product is unavailable from a domestic U.S. supplier; thus, imports are needed to fill a demand no U.S. supplier can meet. There are certain requirements only the 
import supplier can satisfy. The company has been put on allocation by domestic suppliers. There are no alternative suppliers in a country outside China.
  • The names and locations of any producers of the product in the United States and in foreign countries.
  • Total U.S. consumption of the product by quantity and value for each year for the past three to five years (2013 – 2017)
  • Projected annual consumption for the next few years (2018- 2020), with an explanation of the basis for the projection. 
Total U.S. production of the product (or possible substitutes) for each of the past three to five years.
  • Discussion of why the U.S. products (or possible substitutes) cannot be used in place of the imported products.
  • A viable narrative detailing why your company deserves the exclusion it is requesting. This typically includes the history of your company (e.g. fifth generation family-owned), the products produced by your company, the strategic significance of your company’s products, the number of workers in your company, and your company’s annual sales.

Successful comments result in the removal of tariff line items from the tariff list, contrasted with successful exclusion challenges which result in the removal of specific products from the tariff line item. In other words, the requirements for the exclusion process are much more product specific. This means if you have nine different types of widgets, you will need to make nine different product exclusion requests. 
The reasons given by the USTR for invoking the China tariffs center around Chinese practices of stealing or extorting intellectual property from U.S. companies. There have already been many opposing comments and exclusion requests submitted for the first two waves of proposed China tariffs noting that the tariffs have no relation to the premise of protecting U.S. companies. Many have also objected to the catastrophic effect these tariffs will have on certain American companies while likely having very little effect on how China respects U.S. intellectual property.

It is important to note that out of the first round of $50 billion in tariffs, comments led to $16 billion (32 percent) being removed. If your product or products are on any of the lists, it almost certainly behooves you to try to get them off. Your biggest risk of doing nothing is having to go up against one or more of your competitors that did do something and succeeded and whose costs are now a lot less than yours.

But you do need to reach out to an international trade lawyer FAST.

 

China lawyers fraudMost of what we write about frauds involving China usually are frauds perpetrated by Chinese companies against foreign companies. But as a reader recently pointed out to me the other day, frauds perpetrated within foreign companies “are at least as common and as damaging.”

I agree, and today’s post highlights six of the most common frauds our China lawyers see.

Before I talk about internal company fraud, I want to quote a long-time client and friend on how to deal with these. This person is from Europe but his “business empire” extends pretty much around the world and it includes some extremely difficult places in which to do business — places that make China look like a piece of cake. Once when I told him that I was convinced that people in one of his business (in a country usually prefaced with the words “war-torn”) were skimming fairly large amounts from his company his response was something like the following:

My goal is not to stop all internal theft as that would be impossible. My goal is to keep my eye on the prize and the prize is to maximize profits and to succeed wildly. And so as much as I hate company theft, my cracking down on it has to come at the right time and in the right way. I am not going to decimate a booming business by firing those who helped me build it even if they are stealing from me. In the meantime though, if you think you know who is stealing from me, let me know so that I can act when the timing is right.

I have used the “keep your eye on the prize” line at least 100 times in various speeches and I especially like that line when talking about stopping counterfeits. See How to Protect Your IP from China.

When it comes to internal company fraud, this means it is critically important you do whatever you can to prevent and/or root out the sort of fraud that will destroy your company, but far less important that you stop employees taking home pens. What to do with the far more common in between sorts of frauds is going to depend on the specific nature of your situation.

In any event, here are the top six China internal company frauds:

1. No real company. No real employees. This one was incredibly common ten years ago, but far less dangerous then. It is less common today but far more dangerous. See Doing Business in China Without a WFOE: Will the Defendant Please Rise. With this fraud, your “general manager” or someone else with a lot of power will charge your company to set up a China WFOE and then for years acts as though you have a China WFOE, but you don’t. The spoils from this fraud can be huge and ongoing. Suppose your WFOE generates $4 million in income a year and pays $1 million to its “employees” in salary. If there were a real WFOE, China income taxes would be around $800,000 a year and employee taxes and benefits would be another $400,000 or so. Now imagine this “WFOE” does not exist and so it also has no real employees. Someone other than your company is now clearing about $1.2 million a year by not paying taxes. Even worse, at some point (likely very soon in light of the harshest crackdown ever against operating in China without a legal entity) your fake WFOE will get shut down by the authorities (and rightly so) and you will then get hit with a massive tax bill that includes back taxes, plus interest, plus penalties, plus worse. See China’s Tax Authorities Want You.

How do you spot this one? We have had a couple companies come to us after learning that their general manager was living in a multi-million dollar condo and driving a $100,000+ car on a salary that could in no way sustain such a lifestyle. This is one way to spot this fraud, but the better way is to do the research to confirm your China WFOE is in fact a China WFOE and that all of your WFOE “employees” are in fact WFOE employees.

2. Overstated or Understated Income. Not sure which of these two is more common but they both happen fairly often. Overstating income is usually done to meet performance goals or to prevent a company from being shut down. Understating income is usually done to hide that someone is improperly taking money from the company. Overstated income can mean your company sinks money into an enterprise it probably should abandon. Understated income means you owe taxes and interest and penalties of which you were not aware. How do you stop these? Financial audits, financial audits, financial audits. It also helps to have someone in your company who cares about and understands what is happening in China and this usually comes from visiting the China WFOE often.

3. Friends and Relatives and Side Companies. Using friends and relatives as your China WFOE’s suppliers and paying more for the “privilege” is incredibly common. If the friends and relatives suppliers are charging 1 to 5% more you may never catch it and it may not be all that big of a deal if you don’t. But when our China lawyers are brought in on these situations, we typically see more like 30 to 50% in up-charging. I cannot tell you how many times we have worked with an American or a European company that terminates its China sourcing agency only to learn (usually from the factories that were actually making their product) that in addition to the 5% fee it knew it was paying its sourcing agent, it also was paying a 40% skimming premium. See Hidden commissions between China factories and sourcing agents. Even more common (at least in terms of what our China lawyers see) are outside companies set up by your own general manager. How do you stop these fraudulent supplier deals? You monitor pricing and you monitor who owns your suppliers. You also need to be very clear in your Employer Rules and Regulations (and pretty much every other place possible) that you will not tolerate supplier fraud.

4. Bribes. This one is too multi-faceted and complicated and important for me tot cover in the depth it deserves so I will opt to be incredibly brief. Bribery is bad for your business and you need to do what you can to prevent it. China Bribery: Not Smart and not Necessary.

5. Side Door Sales. This fraud is very profitable and hence very common. Imagine you can charge $800 for a widget which cost you literally nothing to develop or make or market. Imagine also that you have people calling you every day to buy this product. Now imagine that one of your employees is doing this with your product. We see this sort of thing most often in the following two situations:

  1. The China WFOE makes and sells a product all within China, or it makes the product in China and sells it to SE Asia or to some other emerging market country not so much on the foreign company’s radar.
  2. The China WFOE is in a business where it both buys and sells a product. As an example, a fish brokerage company that buys fish in China and then sells that fish worldwide might have an employee who uses company assets to buy $500,000 worth of fish and then sells that fish for $525,000 and then pays everyone back without anyone ever being the wiser. Or what if your employee is in cahoots with an employee at the fish company and they do the deal without any money even changing hands until your employee gets paid? What if your employee is siphoning off 50% of your business with this scheme? What if your employee becomes so successful at it that he or she no longer needs your money to do these transactions because he or she has built up its own funding, but he or she keeps using your good reputation and your marketing dollars to further his or her own business? What is amazing about this fraud is that nearly every time this sort of employee is terminated he or she already has a company set up to ready to compete against the foreign company a day or so after the termination.

How do you stop this sort of fraud? With Employer Rules and Regulations that make clear this will not be tolerated. With non-compete and non-solicitation agreements/provisions that prohibit this. And then you sue.

6. Fake Employees. Would you know if your China WFOE had 200 employees, not the 250 employees to whom it is allegedly paying salaries and benefits? If you answered in the negative to this, you should do something immediately so you can answer positively the next time because putting non-working friends and relatives on payroll is a classic China fraud. This one is particularly commonly used by Chinese companies in China Joint Ventures to zero out profits so there never have any profits that need to be shared with the foreign JV partner.

What are you seeing out there?

China tariffs wine

Jim Boyce’s ebullient, edifying Grape Wall of China blog (yes, about wine in China) has an interesting take on China’s imposition of an additional 15% tariff on American table wine. In two recent posts (see here and here), the latter a direct response to a pot-stirring story on Al Jazeera, he basically tells everyone to chill out.

It’s not that the tariffs won’t hurt the U.S. wine industry – they will. But they need to be viewed in context. As Boyce explains, only a small percentage (about 12.5%) of U.S wine is exported, and of that only 3.7% went to China. In short, only 0.4% of U.S. wine goes to China and will be subject to the additional tariff.

Moreover, U.S. wine has been facing headwinds in China for several years. From 2011-17, China doubled the amount of wine it imported, but the U.S. market share of those imports fell by more than 50%, decreasing in actual numbers from 16.1M liters to 14.2M liters. The problems U.S. wine faces in China are complex and multi-factored, and often intertwined with historical, political, or cultural backstories. Other countries (particularly France) were early entrants to the Chinese wine market and have retained a huge first mover advantage. Other countries spend more money on marketing and brand presence in China. And let’s not forget that even before China imposed the additional 15% tariff, U.S. wine already faced a 14% tariff, unlike wine from countries with China free-trade agreements (such as Chile, New Zealand, and Australia). Like I said, selling wine in China is complex. I could write a whole month of blog posts about it.

None of this is to minimize the very real pain some American winemakers (as Boyce notes) are feeling. Different winemakers have different selling strategies, and some have invested substantial amounts in developing or maintaining their market presence in China. At a conference I attended years ago, a high-end Napa winemaker told a cautionary tale about how he had been approached by several Chinese buyers who wanted to purchase the winery’s entire production run for the year (presumably to serve as the in-house wine for a large state-owned enterprise). It was a cautionary tale because such sales would be one-offs, providing a large cash infusion but with no long-term benefit, because there wouldn’t be any repeat purchases and little to no increase in brand awareness. The only way such a deal would make sense is if the winemaker was about to retire. Instead, the way to succeed in China was to cultivate distributors, retailers, and consumers who would become long-term brand adherents. And that takes time, money, and patience.

If you take a step back and look at these tariffs from China’s perspective, it’s pretty clear they are a win-win. They get to strike back at Trump in a highly visible, prestigious area of commerce. Chinese consumers are (for the most part) unaffected, because they have numerous credible alternatives available from countries with which China is not in a trade war. Meanwhile, the effect in the US is in states that overwhelmingly oppose Trump in any event: the top 5 wine-producing states – which control more than 96% of all production, are California (at 80%), Washington, Georgia, New York, and Oregon. And Georgia’s production in 2017 seems anomalous, rising more than 140% from 2016 according to the Alcohol and Tobacco Tax and Trade Bureau. (But even if the 2017 numbers are accurate, Georgia only accounts for 4.4% of US wine production.)

For more on China and wine, check out the following:

 

 

 

 

 

China tariff lawyer

This is part two in what will no doubt be a continuing and long running series on what American companies can and should be doing in light of the ongoing trade war between the United States and China. In part 1, I discussed how our  China lawyers are getting a slew of phone calls and emails from companies looking at massive tariffs being imposed on their products imported into the United States and wondering what they should do.

That first post focused on what companies facing tariff problems should NOT do:

They should not have their China products shipped to Taiwan or to Malaysia or to Thailand or Vietnam or anywhere else and then have those products shipped to the United States as though they are not from China. Doing this sort of transshipping can and does lead to massive fines and to JAIL TIME. I am not kidding. I am starting out with a post on what not to do because the risks from this one thing far exceed the benefits of the things we will be discussing in our subsequent posts.

And yet, many are telling us that their Chinese factories are suggesting these exact sort of transshipments and giving assurances that they are legal or that nobody ever gets caught, neither of which are remotely true. Step back for just a second and ask yourself why you are even considering taking legal advice about United States customs law from a Chinese factory owner or salesperson who has all the incentive in the world to sell you Chinese products and very little incentive to keep you out of jail. Please, please, please don’t fall for that. Please.

But what should you do? The below is the sort of plan our international trade lawyers (working in tandem with our China lawyers) are mapping out for companies needing our help:

The first and most obvious thing to do is to figure out how your products will be impacted. Has the United States imposed tariffs on your products? Is it planning to do so? Just this first step is more complicated than many realize both because it is not always clear whether a specific product comes within the classification of a product against which tariffs have been imposed and because the media has been less than clear in distinguishing between existing and upcoming tariffs.

If one of your products is on a U.S. tariff list, your next step is to figure out what you can do about that. Surprisingly enough, you do have options. The U.S. Trade Representative will accept comments until September 6 on whether entire categories of products listed on the third wave of proposed tariffs — the $200 billion in imports from China — should be exempted. And later waves of U.S. tariffs will have later dates by which comments must be made. Out of the first round of $50 billion in tariffs, comments led to the removal of $16 billion (32 percent), which shows there is real value to challenging these tariffs.

But even if your product is not exempted due to challenges, you can make what is called an exclusion request. These too have their deadline dates and these exclusion requests typically include the following:

  • Identify the product you want excluded. The U.S. list of targeted products is identified by the Harmonized Tariff Schedule (HTS) number that is used to declare the product when imported into the United States. A company needs to identify the commercial name of the product, the HTS number for the product, and any other industry designation of the product under a recognized standard or certification (for example: ASTM, DIN).
  • A description of the product based on physical characteristics (for example: chemical composition, metallurgical properties, dimensions) so your product can be distinguished from other products that would still be covered by the tariffs. A significant concern in considering exclusion requests is whether granting a specific exclusion request will create a loophole many other products can also use.
  • The basis for requesting an exclusion. Is the product unavailable from a domestic U.S. supplier and thus imports are needed to fill a demand no U.S. supplier can fill. Are there certain qualification requirements only the import supplier can satisfy? Have you been put on allocation by domestic suppliers? Are there alternative suppliers in any country other than China?
  • The names and locations of any producers of the product in the United States and in foreign countries.
  • Total U.S. consumption of the product by quantity and value for each year for the past three to five years (2013 – 2017) and projected annual consumption for the next few years (2018- 2020), with an explanation of the basis for the projection.
  • Total U.S. production of the product (or possible substitutes) for each of the past three to five years.
  • Discussion of why the U.S. products (or substitute products) cannot be used in place of the imported products.
  • A good story why your company deserves the exclusion it is requesting. This typically includes the history of your company (e.g., fifth generation family-owned), the products produced by your company, the strategic significance of your company’s products, the number of workers in your company, and your company’s annual sales.

The difference between the comment process and the exclusion process is that successful comments lead to the removal of tariff line items from the list whereas successful exclusion challenges remove specific products from the tariff item. In other words, the requirements for the exclusion process are much more product specific; if you have six different types of widgets, you will have to make six different product exclusion requests.

The first deadline for a product exclusion list is October 9th for the first $34 billion list.  USTR has not yet set up Product Exclusion requests for the $16 billion, not to mention the $200 billion list.  So we are still waiting on that.

There have already been many opposing comments and exclusion requests submitted for the first two waves of proposed China tariffs. Many of the opposing comments have noted how the proposed tariffs on the Chinese products have nothing to do with  Chinese practices of stealing or extorting intellectual property from U.S companies, which are the reasons claimed for invoking the China tariffs in the first place. Many have also objected to how these tariffs are not likely to change how China respects intellectual property  rights, but will have a catastrophic effect on certain American companies.

A U.S. exclusion process will likely proceed fairly slowly because there are so many exclusion requests already in the pipeline for the steel and aluminum tariffs, though a successful exclusion request likely will result in a refund of any tariffs paid. Waiting for a tariff refund is not the best thing in the world, but requesting such a refund will be the best path for many. Our trade lawyers are representing companies in more than a dozen industries that are seeking to have their products excluded from tariffs.

In part 3, we will discuss what actually makes a product “Made in China” for purposes of United States tariffs and what you can legally do to take your products outside that classification.

 

China WFOE formation

I do mean to sound alarmist here.

Almost since this blog’s inception, we have written about how if you are doing business in China you need a Chinese legal entity, be it a Wholly Foreign Owned Entity (WFOE), a Joint Venture (JV) or a Representative Office (RO). And pretty much each time, our writings on this get more emphatic and more strident. Today they reach a whole new level. Today we warn you about jail time because that is what we are hearing is happening in China right now.

In the last two years our stridency on this issue has gone into hyperdrive. Today I want to SCREAM that if you are doing business in China without a Chinese legal entity you should probably leave China immediately and consider what to do in China from the safety of your own country.  I will explain why I am saying this shortly.

In March of 2017, in Doing Business in China with Deportation or Worse Hanging Over Your Head, I had the following to say:

We have frequently been writing of late on how China has like never before been tracking down foreign companies (especially U.S. companies) that are operating in China without having a business entity (a WFOE or a Joint Venture) that allows them to legally do so. See Donald Trump and Your China Business: Double Down, Ditch It or Die and Donald Trump and Your China Business: Double Down, Ditch It or Die, Part 2. In China’s defense (not that its decision to rigorously enforce its own laws needs any defense), the new WFOE formation rules enacted last year do actually make it somewhat faster, cheaper and easier to form a WFOE.

Anyway, since we started hitting this issue hard here on the blog, we have gotten an even greater stream of emails from people who have been “caught” by the Chinese government and from people who want to know what exactly they need to do to get legal. But the most interesting emails come from those who either fully or partially refuse to believe what has been happening in China and how at risk they are. About half of the emails sent to our China lawyers evidence at least some aspect of this and about half of those mention forming a company in Hong Kong as an option for solving all problems.

So let me say right here and right now that forming a company in Hong Kong will not do a thing to make you legal in Mainland China. Nor will forming a company in Macau or Taiwan or Singapore. If you are doing business in the PRC/Mainland China, you need a PRC legal entity, such as a WFOE or a Joint Venture. See Having A Hong Kong Business Does NOT Make You Legal in Mainland China. See also A Hong Kong Company Is NOT a Mainland China Company and a Hong Kong Trademark is NOT a Mainland China Trademark. If it were otherwise, virtually nobody would go through the agony and the costs of forming a WFOE; they would instead pay some accountant in Hong Kong about USD$1,000 and have an HK company in less than a week. Please, please, please do not fool yourself into believing otherwise!

The below email is an amalgamation of two emails I received just this morning, both involving people with United States and Taiwan passports.

I came across your law blog and would like to ask a question. I’m in a slightly strange situation, professionally and nationality wise, and I I wonder if you might be able to offer me guidance.

I am a US/Taiwan dual national living and working as a freelancer in Shanghai, which is my base. I work in the _________ business on a contract-to-contract basis. Though my Taiwanese friends are always telling me not to worry about things like taxes, the more established and successful I become, the more I think I should be figuring out how to get legal in China and make myself legitimate, business-wise.

I am a ________________ and I do other related things. For example, I’ve just been asked to __________ on a relatively large project. Sometimes I am paid in RMB and other times I am wired foreign currency to accounts I hold overseas. Sometimes because I am not a legal business the companies I work for negotiate discount rates from me because my not having a China company precludes them from getting a tax deduction for their payments to me.

As I progress professionally, the amounts I charge and get paid keep increasing and I worry about what all of this means for the long term.

A friend has suggested I go to Hong Kong to set up a WFOE. However, I know some of the rules are different for Taiwanese nationals who wish to set up businesses in China.

It is not my ambition to have a big company or service but I also know that this gray area situation may not be sustainable forever. I also want to know if any of this might affect me as a U.S. citizen. At the moment, I just file federal taxes online.

Please let me know if you have encountered cases such as my own, and if you might be able to point me to resources that would enable me to best formalize my situation.

Many thanks.

Our response is always something like the following:

Setting up a company in Hong Kong will not help you one bit in terms of getting legal in China. You need to re-think what you are doing because as you get bigger you become a bigger target. I do not know how China treats Taiwan citizens, but if you are an ethnic Chinese there on a US passport, you are probably at the top of the list. My advice is that you start doing something and fast. You should consider either leaving China or setting up a WFOE in China that employs you. If you leave China you can do some business in China without triggering the need to have a WFOE in China, but because you provide services there, you will still be required to pay income tax there. So long as you are paying your United States taxes, the U.S. very likely does not care what you are doing or where you are doing it; your big concern should be the PRC, especially since you live there. The bigger you get, the more likely it is that someone will rat you out or that you will be noticed by the Chinese government. Productive legitimate businesses do not operate with this sort of hammer poised to hit them on the head. What you should do is weigh the various costs and benefits of your various alternatives and decide on one.

Then just last month, in American Companies in China without a WFOE and the Impact of Donald Trump and US Tariffs and Why Hong Kong is not the Answer I wrote again how American companies are at increased risk of serious trouble for operating in China without a WFOE:

If you are an American company doing business in China, you don’t need me to tell you how so many things have changed for you over the last year or so, and so I won’t.

But I do need to tell you — somewhat urgently — that if you are operating in China without a legal Chinese entity, you need to stop. Like right now.

Back in March, we did a post, Doing Business in China with Deportation or Worse Hanging Over Your Head in which we discussed how “China has like never before been tracking down foreign companies (especially U.S. companies) that are operating in China without having a business entity (a WFOE or a Joint Venture) that allows them to legally do so. See also Donald Trump and Your China Business: Double Down, Ditch It or Die and Donald Trump and Your China Business: Double Down, Ditch It or Die, Part 2. Our thesis — based on what we were seeing on the WFOE front and on other crackdowns involving even things like bar fightsvisasexpat taxescannabis, and employment law — was that China was toughening up enforcement against foreigners and foreign companies in China on all fronts, but especially against Americans and American companies as a sort of a slow and not terribly public retaliation against President Trump.

With all the talk now about US tariffs against China, legal enforcement in China against American companies operating in China without a WFOE has gone into hyperdrive. One of our readers, herself a China lawyer, recently wrote me to let me know how ridiculous she thought I was for believing Beijing would “quietly” go after American companies. My response to her was that we had no idea whether China’s stepped up legal enforcement is being directed from Beijing or is more in the nature of a slow and quiet and yet widespread uprising against the United States being mounted by government officials throughout China.

We can debate who is leading this enforcement charge and even the reasons for it, but to me the most important thing is that if you are an American company and you are not in full compliance with Chinese law you are at greater risk now than you have ever been. If you are doing business in China, especially if you are doing business there “through” a Chinese citizen you are paying, you need to think long and hard about your China company formation options.

Whenever we write about how China is getting tougher with such and such a law, we invariably get emails and/or comments saying how idiotic and/or unfair we are for criticizing China for enforcing its laws. Just so the record is clear, we have not said that and we are not saying that; we are as neutrally as possible merely writing on what we are seeing and we would be more than happy to leave it to the legal philosophers to put these sort of real-life China business and legal issues into some larger context.

In addition to the stepped up enforcement of China’s WFOE requirements, we are also seeing a massive uptick in American companies forming Hong Kong Companies or consulting WFOEs in ill-advised efforts to get legal. So let me use this blog post to once again make clear, forming a company in Hong Kong does not do a thing to make your business operations legal in Mainland China:

Nor will forming a company in Macau or Taiwan or Singapore. If you are doing business in the PRC/Mainland China, you need a PRC legal entity, such as a WFOE or a Joint Venture. See Having A Hong Kong Business Does NOT Make You Legal in Mainland China. See also A Hong Kong Company Is NOT a Mainland China Company and a Hong Kong Trademark is NOT a Mainland China Trademark. If it were otherwise, virtually nobody would go through the agony and the costs of forming a WFOE; they would instead pay some accountant in Hong Kong about USD$1,000 and have an HK company in less than a week. Please, please, please do not fool yourself into believing otherwise!

In fact, the more you get on the grid in China without actually doing everything the right way in China, the more you make your illegality more obvious and easier to spot. See Quasi-Legal In China. Not the Place You Want to Be andQuasi-Legal in China. Not the Place You Want to Be, Part II.

We are also hearing from many American (and some European companies as well, but we’ll save that for a subsequent post) companies that formed their WFOE in China the “fast and easy way.” Some less than reputable WFOE formation companies will tout how they can form China WFOEs quickly and cheaply and for only around USD $15,000 in minimum capital. What these WFOE formation companies typically then do is form your company as a consulting WFOE in an “easy” China city. Please don’t fall for this. If your WFOE is not going to be in the consulting business, it cannot legally operate as a WFOE in China and it will get shut down. See How To Form a China WFOE. Scope Really Really Matters, Part II. And if your WFOE is going to be operating in Xi’an you do not want it to be formed in Shenzhen, for just a whole host of reasons.

If you are not complying with Chinese laws it is important you move quickly to get into compliance. But it is also important that in moving quickly you not expose yourself to even more and potentially greater problems. To borrow from a famous legal quote, you should move to get legal in China with all deliberate speed.

China company formation done wrong is not going to be your answer.

Today I write to say that things have reached another level for people of all nationalities doing business in China without a legal entity. Today I write to say that doing this — whatever your nationality, puts you at extreme risk of being arrested and put in jail. I cannot go into much detail but I can tell you that over just the last three days I have heard of three instances (in three different Chinese cities) where foreigners (from three different countries) were put in jail for operating in China without a business license and failing to pay taxes on their China income. Jail. Prison. The clink. The slammer. The real thing people. The real thing. One of these cases also involves vague allegations of custom violations, claims for which the Chinese government has never been shy about imprisoning foreigners. See China Customs Violations and How to Avoid Jail Time.

Why are these arrests happening now? I posit the following two explanations:

  1. The arrests are happening because China is concerned about its economy and/or its general situation in light of US trade tariffs.
  2. The arrests are happening as just another “stepping up” of China tax collection efforts.

Again though, these arrests are not just of Americans. It is so early in the criminal law process that it is not clear to me how serious these charges are against those arrested. Will they merely be deported? Have they been arrested with the goal of getting evidence against others? What is it going to take for these people to be freed? Will paying off their taxes with interest and penalties be enough to get them released? See China’s Tax Authorities Want You. Will paying some part of the taxes be enough to get them released? What taxes are being pursued? Income taxes? Employer taxes? Both? Most importantly, is China serious about putting these people in jail for an extended period and if so, for how long.

No matter what the reasons for this most recent and most alarming crackdown, if you are in China right now and if you believe you or your company might be operating in China without a Chinese company when you should have a Chinese company, if I were you I would leave China quickly. I just would. And if you do get detained on your way out, you should as quickly as you possibly can retain a top-tier Chinese criminal lawyer in the city in which you arrested.

That is all. Sorry.

 

UPDATE: A loyal reader emailed me to note how this is the second day in a row that we have warned people not to do something at risk of going to jail. Yesterday, in China Tariffs and What to do Now, Part 1, I passed on advice from my law firm’s international trade lawyers regarding the criminal risks relating to changing the country of origin via transshipping to avoid the tariffs the US is imposing on products from China. This reader pointed out how the devolution of free trade is increasing the risks for companies that operate internationally. I agree with that assessment, but note that it is particularly true for those who are not careful and who are willing to operate close to the line between legal and illegal. Your thoughts?

ADDITIONAL UPDATE:  A Chinese lawyer friend of mine sent me an email stating that “the point here is that operating in China without a WFOE is illegal. This also applies to Internet/SaaS operations operating in China illegally, and you and I both know plenty of those. So long as the operators of these illegal Internet/SaaS operations stay out of China, they will avoid jail. But what about their partners who are operating in China? And what about when they take a two week business trip to China to check up on the situation there? Do you think companies really understand the fire they are playing with here?”

China lawyers

Because of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments or phone calls as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a super fast general answer and, when it is easy to do so, a link or two to a blog post that provides some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.

For obvious reasons, our China lawyers have been getting the following question a lot lately: is China still a good place to make my xyz product?

My response when I get this question is typically as follows.

For most companies in most industries, yes. Where else are you going to have your xyz product made? Have you looked at any other countries? Have you found any that can make them for anything even approaching the prices you are getting in China? If you are big enough that you can set up your own factory in Vietnam or Thailand or Mexico or Indonesia or wherever, we should talk about that. Otherwise, you should probably do what most companies your size are doing and that is to continue to have your products made in China while always keeping a watchful eye for opportunities to diversify your supply chain.

What are you seeing and thinking?