Business Intelligence

 

Business Intelligence

Government role in business environment

Since 1949, the government has been responsible for planning and managing the national economy.  In the early 1950s, the foreign trade system was monopolised by the state.  Nearly all domestic enterprises were state-owned and the government set prices for key commodities, controlled the level and general distribution of investment funds, output targets, wage levels, employment targets and energy resources.  In the countryside from the mid-1950s, the government established crop patterns, set price levels and fixed output targets for all major crops.

Since 1978 when economic reforms were instituted, the government role in the economy has receded to a considerable degree.

 

 

  A major objective of the reform programme was to reduce the use of direct controls and to increase the role of indirect economic levers. 

 

Industrial output by state enterprises has slowly declined, although a few strategic industries such as the aerospace industry today remain pre-dominantly state-owned.  Major state-owned enterprises still receive detailed plans, however, they have been increasingly affected by prices and allocations that were determined through market interaction and only indirectly influenced by the central plan.  Since restrictions on foreign trade have been reduced, there have been broad opportunities for individual enterprises to engage in business with foreign firms without much intervention from official agencies.  Though private sector companies still dominate small and medium sized businesses, the government still plays a large part in the bigger industries.  The fact that over a 1/3 of the Chinese economy is state-owned is testament to this.  Yet foreign-owned companies hold significant stakes.  The public sector is mainly made up of state-owned enterprises.

 

 

Business contracts and negotiation

The Chinese understanding of a contract is quite different from a Westerner’s point of view.  Formal contracts themselves are a fairly new concept for the majority of Chinese companies.  Chinese business people complain that there are too many “seemingly unnecessary” legal clauses in a foreign contract that they find confusing and puzzling, the specially phrased legal contents incomprehensible.  At the same time, while western business people also find much terminology difficult to understand, they are more likely to accept this is normal practice.  The language is one of the biggest issues that contributes to the difficulties on the negotiation table.  Contracts are generally written in English with a Chinese version as a reference, and to translate a contract from one language to another is no simple task.  Because of the legality and the indefinite nature of language, the translated version does not always work for the other party.  A high quality translation in which you have huge confidence is no doubt a good starting point.

It is also recommended to be cautious before having a lawyer present in a business meeting.  China is more of a moral society than a legal one.

 

Whenever unexpected circumstances arise, they are typically sorted out through the strong relationship bonds that exist.  In the face of a lawyer, the Chinese can adopt a highly guarded attitude and the situation can be soured from the start.  

 

 

Chinese business people and Westerners often approach negotiations from opposite poles: since commercial law is part of our everyday lives, the Western approach is to start with a contract, altering it as necessary and signing the final revised version.  Traditionally, commercial law has scarcely existed in China and would indicate a lack of faith in the partner with whom the contract is to be signed.  Accordingly, even today and in many cases, a signed contract is merely regarded as a symbol of progress, with the completed contract only demonstrating that both sides have grown close enough to develop a trusting relationship.  A negotiation in China can be a long, drawn-out process.  As the Chinese business person prefers to do business with people they know and are friendly with, the process is treated as part of the development of a solid relationship. 

 

Researching the market

Some companies are lucky enough to find a suitable Chinese partner with relative ease, either through their own network of contacts or existing customers, or through internet enquiries.  However, for the majority it involves many trial-and-error attempts, a significant investment of time and a few intensive visits to China. 

It is essential to carry out some market research prior to visiting.  With the advent of the internet, collating information has been made very easy.  However, finding a reliable and current source can be a challenge. 

 

Frequent communication with the potential candidates, cross-referencing and in-depth research are vital.

 

There are a variety of international and Chinese research companies available, which tend to charge more but are better equipped to cater for a Western company’s requirements.  Chinese research companies may charge less and may also have better information channels.

Having researched the market on paper and checked out this information with anyone you know who has worked with China, it is essential to visit the market yourself.  This will give you a personal understanding of the scale and feel of the country, the chance to soak up the vibrant entrepreneurial atmosphere.  The UK government organises missions for companies to visit China and line-up meetings with potential candidates.  While this can be general and not specifically targeted, for the first couple of visits, they provide a good overview of the market.  Another good starting point would be a well researched trade fair where you will be able to talk to many potential direct suppliers, customers and partners all under one roof.  Meanwhile, you can also investigate the Chinese market as a whole in terms of product variety and quality.  At the same time, if you could manage to visit a few relevant companies or factories, it would make your trip even more worthwhile. 

 

 

Considering the complication of the market place, the language and the potential, working with a trusted China specialist will be well worth it; it would save time and money.

 

 

Due diligence

The phrase ‘due diligence’ refers to the careful investigation of a company and its assets, undertaken in order to identify and assess its value and any significant factors that may affect its future performance.  Due Diligence studies are essential in measuring the value in an acquisition, merger or joint venture, and in negotiating the terms of a deal.  The process must be undertaken by people qualified in the various aspects of the business e.g. technology, legal, financial, environmental, marketing, etc.

It is critical to identify the acceptable risks and ensure that the people required to sign off against them are aware of them.  It is also important to ascertain what could go wrong, what the hurdles are and who signs off against the deal.  It is important to be clear as to who leads the due diligence team and to make sure they are appraised of their objectives and deadlines.  Finally, it is vital to be patient.  Sufficient time must be allowed for due diligence.

 

Foreign presence in China

 

• Representative offices (ROs)

Representative offices are an inexpensive and low-risk way for organisations to establish a presence in China while they are still conducting research and understanding the market.

In addition, if a company does not need to invoice locally for services or products, an RO is an effective way of managing these goods and services on behalf of the parent company, and facilitating trade between the organisation and Chinese counterparts.  However, ROs cannot invoice for services or sales directly in China.  They can introduce business to the parent company and become the liaison for areas including orders, shipping, payment of taxes, repatriation of payments from clients etc.

ROs are permitted to:

• conduct market research
• monitor quality control and purchasing activities
• undertake sales and marketing administration for sales conducted between the parent company and China
• administer group activities being undertaken elsewhere in China

ROs are not permitted to employ local Chinese nationals directly, but must use semi-government sponsored agencies.  There is a formal process for this that has simplified significantly as more and more businesses choose this route.

• Joint ventures (JVs)

JVs enable organisations to enter the market that may be restricted to foreign-invested companies, and gain access to existing sales points and distribution channels.  There are generally two types of Joint Venture formats with different legal foundations: Equity Joint Ventures and Co-operative Joint Ventures.

An Equity Joint Venture (EJV) is a limited liability corporation, which is a legal entity in China, and is more rigid in its contractural structure.  There must be a board of directors and a contractually appointed management team, which has legal responsibility for the day to day running of the business.   Investors in an EJV decide corporate strategy inpartnership, and each partner owns a proportion of equity share (in equipment, money, rights to the use of a site, factory buildings, industrial property rights, etc.)  They also share the risks, profits and losses according to their share of the equity. The international partner in an EJV is required by law to take a minimum stake of 25% with no upper limit (there are some exceptions, however).  Once an EJV expires, it is liquidated but its lifespan can be extended and the international partner is permitted to repatriate their share.

Co-operative Joint Ventures (CJVs) are constructed in a similar legal structure to an EJV but with more flexibility allowing investors to define their obligations.  They can be structured either as a limited liability company or as a non-legal person.  They are often put in place to manage a short, time-critical project.  CJVs can operate as a board of directors (or management committee if non-legal status), and require a general manager.   The profit sharing ratio does not have to equate to the equity stake.  Under a CJV, the Chinese party provides the JV with the people, property and resources it needs, while the international partner brings financial investment, technology or equipment, materials etc.  This can help a company ease its way into China while managing the level of risk.  The links between both parties need to be managed carefully and can be prone to cultural, language and business issues often leading to lengthy delays and potential failure.

• Wholly foreign owned enterprises (WFOEs)

A Wholly Foreign Owned Enterprise (WFOE) or ‘woofie’ is a limited liability company set up under Chinese company law from international investment alone.  A WFOE has become the most popular business structure for foreign companies in China.  It alsoincludes a JV that is jointly owned by two international investors, and an international office set up in China. Like a JV, the ownership of a WFOE is in the form of equity interests, and there are no shares issued.  A lot of them also have definite, albeit extendable, terms of operation.  These have been popular due to their flexibility, and because the international investor has more autonomy over the operation without Chinese input.  In addition, more industry sectors are being introduced to enable China to fulfil its WTO obligations, without the need to enter into an agreement with a local partner.  Furthermore, the threshold of registered capital is being lowered enabling SMEs to enter the marketplace.

There are several advantages to WFOE:

•  Autonomy of decision making without Chinese influence

•  Being able to function as a business rather than just an office

•  Being able to invoice in RMB and to pass on these profits to parent companies

•  Protection of intellectual and technological practices

•  Efficiency and control over the destiny of the company

It is dangerous to underestimate the importance of Chinese influence on a business - through cultural know-how, relationship building, localised knowledge and contacts.

• Foreign invested commercial enterprises (FICE)

Foreign Invested Commercial Enterprises or FICE permit companies to establish operations in retailing, wholesaling, franchising, as an agent or broker and import/export, distribution and retailing by businesses already trading in China.  Registered capital requirements are lower than for WFOE manufacturing licences, and recently introduced regulations have made the applications procedure quicker for most industries.

FICE applications can be approved at a local level, making them simpler to process.  Limitations apply to certain industries, and a foreign investor’s share can be restricted to 49% if it has more than 30 retail outlets in China distributing certain goods from different brands and suppliers.  These products include items such as books, newspapers, cars, medicines, salt, agricultural chemicals, crude oil and petroleum.

Trading is limited to 30 years for foreign companies established in the developed coastal areas;  and 40 years for those established in the Western areas.  Foreign companies must also “possess a sound reputation and comply with Chinese law”.

 

Central Chinese business structures

• State-owned enterprises

City-based State-Owned Enterprises (SOEs) are primarily large businesses operating in key sectors such as the postal industry, communications, transportation, pharmaceuticals, energy and heavy industry. There are reforms in place to stimulate the economy, largely focusing on giving these businesses the freedom to manage their own affairs with complete financial accountability.  The state is also reducing its holdings in a number of SOEs by allowing them to convert into companies limited by shares under Company Law and to list their shares on domestic and foreign stock exchanges. The overall number of SOEs has also reduced as a result of mergers and acquisitions.

• Collective enterprises

Collective Enterprises (COEs) are formed by individuals and domestic businesses in rural areas (where approximately 60% of the population resides). The idea of COEs was to foster the rural economy and increase employment opportunities.  These are predominantly in the light industrial sector and produce consumer products, and can be quite entrepreneurial despite their size.  Their volume has shrunk during the period of sustained reform.

 

• Private enterprises

This term refers to privately owned, often service-oriented businesses.  Private Enterprises are becoming an ever more important source of growth and employment in China, although they are often located in the coastal provinces, and they remain relatively small.

 

• Companies limited by shares

A Company Limited by Shares is very similar to the companies found in other countries where shares can be offered to the public.  The minimum amount of registered capital is RMB5 million.

For Company Law to apply to them, SOEs, COEs and private Enterprises must be converted into one of two types of companies: Limited Liability Companies and Companies Limited by Shares.  This will help with international investment and globalisation. 

 

• Limited liability companies

A Limited Liability Company is a legal entity in which the investors’ liability is limited to the investment they have made into the company.  The company itself is only liable for its obligations based on its total assets, and must have less than 50 shareholders.  Capital contributions may be made in cash or in tangible and intangible assets, and the minimum capital requirement is RMB30,000.

 

Legal issues

• Intellectual property rights (IPR)

As in the UK, it is key to register any intellectual property you are keen to preserve with the correct authority.  China has signed up to the WTO agreement on Trade-Related Aspects of intellectual property rights (TRIPs agreement) as well as other intellectual property rights legislation. These apply to licensing imported technology, trade secrets protection and Customs enforcement of IPR.  China is also seeking to reform IP law to ensure that it complies with the WTO’s TRIP’s protocol.  There is also a set of laws covering most issues concerning patents, copyrights, trademarks and licensing.

 The main relevant laws are:

•  The Patent Law (1985, amended 1993)

•   The Trademark Law (1983, amended 1993)

•     The Copyright Law (1991)

•     The Unfair Competition Law (1993)

 

• IPR protection

The main problem IP owners face is poor enforcement of the law.  It is broadly accepted that general copyright is the most poorly protected area, while the authorities crack down on people who infringe copyright on registered trademarks fairly effectively.  More fundamentally, many government officials in China and the police have yet to be convinced that infringement of intellectual property can be a serious crime.  The Chinese authorities are aware of these problems and they are in the process of being addressed.  From a practical point of view, Customs Officials have the authority to seize shipments of pirated goods.  In order to help with the enforcement of this, it maintains a database where foreign companies can record all their Chinese IP registrations.

In the process of doing business with China, it is important to ensure that a thorough investigation of all the options for IPR protection is undertaken.  China does, in fact, have a well-developed intellectual property system in place to protect IP.  It is safest to appoint an individual in your organisation to ensure that all registrations are completed fully and correctly in accordance with the relevant regulations.  IPR registration can be expensive but it is good insurance against problems that may arise later.  Proper registration is your strongest weapon against any IPR infringements.  To be extra safe, it is recommended to seek the assistance of an experienced lawyer or IPR consultant and in the case of any problems, it is advisable to inform the Embassy, Chamber and relevant Trade Association, as they may be able to help.

 

Trademarks

Trademarks guarantee the origin of goods and services.  Trademarks are registered by the Chinese Trademark Office, which is a section of the State Administration on Industry and Commerce (SAIC).  Trademarks take about 18 months to register and are done so on a first-to-file basis, not first-to-use, and are valid for 10 years from the date of registration. Renewal is possible for periods of 10 years at a time.

Service companies can register their trade names as ‘marks’ in the same way that trademarks for goods are registered.  However, this does not apply to wholesale and retail marks.  It is important for international companies or individuals in China that are in the process of applying for registration of a trademark or that have trademark-related issues to appoint a trademark agent designated by the state.  Any issues will first be put to the Trademark Review and Adjudication Board, and if they cannot come to a solution, the issue will then go to the People’s Court.

 

Patents

Patents are granted for a monopoly right for a design, an invention, or an improvement in a product or process.  Applications are made to the State Intellectual Property Office (SIPO) on a first-to-apply basis, which differs from many other countries.  Types of patents are:

•   Invention: “any new technical solution relating to a product or procedure or relating to an improvement in a product or procedure”.

•  Utility models: “any new technical solution fit for practical use relating to the shape of a product, its structure, or combinations of the shape or structure of the product”.  This is easier to attain than the invention patent.

•         Designs: “any new design of the shape, colour, pattern, or a combination, creating an aesthetic feeling and suitable for industrial application”.  This is also relatively easy to achieve.

Patent protection is 20 years for inventions and 10 years for utility models and designs.  It takes around 8 months to apply for designs and utility models, while inventions take much longer, sometimes as much as 6 years. To pursue a claim against an infringement taking place while the patent is pending, you must serve notice on the person or company that is making the infringement, advising them of your intention.  Legal recourse can then be taken once the patent has been granted.  The patent only applies to applicant rights in China.

 

Copyright

Copyright prevents other people from copying the work of an author.  However, copyright protection in China is comparatively poor, as there is no official route for copyright registration.  The legal framework is not the main problem although there are some anomalies with the Berne Convention, and other gaps, which the latest revision of the law is intended to eliminate.  The National Copyright Administration is responsible for copyright administration and enforcement.

China’s copyright law protects copyrights (including those on works of fine art) for 50 years plus the life of the author, or in employment situations, 50 years from first publication.  Works of applied art are protected for 25 years. 

Databases are not protected.  It is important to bear in mind that copyright can belong to employees rather than employers, and it may therefore be advisable to sign licensing agreements with key employees. Under the law, copyrights can be licensed for 10 years although these are renewable.

 

Licensing

Licensing can be simple i.e. licensing to another party, or licensing by an international investor to the joint venture in which it is investing.  The Chinese government strongly encourages technology transfer, and as a result, the Chinese side of the agreement may be inclined to see licensed technology as transferred technology.  Many foreign investors with valuable IP prefer wholly owned investments to prevent the risk of abuse within a JV.

 

Chinese currency and foreign exchange controls

The renminbi(“people’s currency”) is issued by the People's Bank of China, the monetary authority of the PRC. The ISO 4217abbreviation is CNY, although it is also commonly abbreviated as "RMB". The Latinised symbol is ¥.

From 1st January 1994, the People's Bank of Chinapegged the RMB against $US quoting the midpoint rate based on the previous day's prevailing rate in the interbank foreign exchange market.

Since that date, the RMB has been held in a floating exchange-ratesystem managed primarily against the $US. On 21st July 2005 China revalued its currency by 2.1% against the $US and since then has moved to an exchange rate system that references a basket of currencies and has allowed the renminbi to fluctuate at a daily rate of up to half a %.

There is a complex relationship between China's balance of tradeand inflation, measured by the consumer price indexand the value of its currency. Despite allowing the value of the yuan to "float", China's central bankhas decisive ability to control its value with relationship to other currencies. The inflation experienced in 2007, reflecting sharply rising prices for meat and fuel, was probably related to the worldwide rise in commodities used in animal feed or as fuel. As a result, rapid rises in the value of the yuan permitted in December 2007 are likely to be related to efforts to mitigate inflation by increasing the value of the RMB.

As it is still classed as a developing country, China continues to impose strict legislative controls over international trade.  However, to continue its outward facing public policy development and to relieve pressure on RMB revaluation, some relaxation of this control has been allowed. There is now free convertibility permitted on current accounts whilst restricted convertibility is retained on capital accounts. 

A company with international investment will need to obtain approval from China’s foreign exchange authorities for most kinds of capital account transaction.

 Those Chinese banks that have been authorised to buy and sell RMB against hard currencies are referred to as designated foreign exchange banks (DFXBs).

 

Evolving Chinese financial reporting

 As a developing country, China is subject to the vagaries of evolving rules and regulations.  The result is behaviour that could be construed as dishonest and deceitful, and worse, may lead to corruption and criminal activity.  Be aware that in playing the system, local managers can undermine the business and make it a target for dishonest dealings.  Fundamental to any operation is a sound financial reporting and audit system.  So companies should ensure their due diligence is thorough and impose tight financial controls and accounting systems.  Local staff will need to be managed and trained to meet the westernexpectations and standards of  internationalbest practice.

 

Accounting and tax systems in China

As China has entered the world trade arena, its accounting systems have undergone a  process of change, as the country adopts International Accounting Standards and International Financial Reporting Standards operated by the International Accounting Standards Board. 

The tax system in China is in a state of flux with many planned changes expected to be introduced over the coming years.  Like any other country, tax evasion is punishable by law, so tax planning should be an integral part of setting up a business in China.  There are several investment incentives, profits tax liabilities and VAT obligations that need to be considered to ensure a company is as financially efficient as possible.

The State Administration of Taxation (SAT) is responsible for tax administration in China.  It is the equivalent of the Inland Revenue in the UK.  Tax incomes are channelled to two entities – the State Tax Bureau , which funds central government, and the local tax bureau, which funds local government.  Every organisation has to register with both bureaus.

Visit www.english.mofcom.gov.cnfor some of the regulations in English.

 

The key taxes for a foreign investor are:

• Business tax

Business tax is payable against turnover by all firms and individuals

implementing the following enterprise:

• undertaking taxable services such as communications, transport, construction, finance and insurance, telecommunications, culture, entertainment and service industries
• transferring the provision of intangible assets
• selling immovable properties

Tax payable is calculated by the turnover multiplied by the tax rate.  Tax rates range enormously depending on the business sector.  They are usually calculated, filed and paid to the local tax bureau every month with which an organisation must first register.  It will then issue the company with a form showing all the taxes due. 

• Foreign enterprise income tax

In 2007, corporate income tax law was altered to unify the tax rates for foreign and domestic organisations.  The income tax rate is 25% for all companies.  The Enterprise Income Tax Law effective from 1st January 2008 is a tax on profits, based on the end of year audit and paid annually. 

• Consumption tax

Consumption tax is levied once against certain luxury or other goods such as cosmetics, cigarettes, alcohol, petrol, shampoo etc manufactured, processed or imported into China.

• Withholding tax

Witholding tax applies to foreign companies without a legal presence in China and is usually charged at the rate of 10%.

• VAT

VAT is levied to any company selling, manufacturing, processing or repairing goods and is applied to the importation of raw materials and equipment.

• Individual income tax

Income tax is applied to all members of staff whether they are expatriate or local staff.  China’s tax bureau is increasingly clamping down hard on expatriates who under-declare on their IIT, and on the companies that employ them. The change to IIT in November 2006 by SAT introduced the ‘Trial Individual Income Tax Self Reporting Regulation’.  This rules that individuals who earn in excess of RMB120,000 must self report their income tax together with other personal information within three months of the end of the tax year.

For more information on accounting and tax visit www.dezshira.com