Welcome to the Third Annual Greenebaum China Business Summit.

Welcome to the Third Annual Greenebaum

China Business Summit

Opening Remarks

Robert L. Brown, Esq. Chair, China Team

Greenebaum Doll & McDonald502/[email protected]

China: The New Franchising Frontier

Sean P. Gallagher, Esq. Greenebaum Doll & McDonald

502/[email protected]

Product Distribution

• China: Population of 1.3 billion

• How do I put my products in the hands of consumers?

Methods of Distribution

• Company owned stores

• Distributorships and dealerships

• Franchising

What is Franchising?

• Trademark license

• Payment of franchise fee

• Significant assistance or significant control

Why Franchise?

• Availability of capital

• Allocate the risk of failure of any single unit to the franchisee who owns and operates that unit

• Knowledge of franchisee

Measures for the Regulation of Commercial Franchise

• Issued by the Ministry of Commerce• Effective February 1, 2005• To promote “healthy and orderly development of

commercial franchising”• Commercial Franchise Regulation pending before

the State Council – stay tuned

Disclose, Disclose, Disclose!• What?

– Financial information, estimated initial investment, sources of products and supplies, information on existing and terminated franchises. All disclosures “requested” by a franchisee – Yikes!

• When?– At least 20 days prior to signing franchise agreement (or anytime at the request of

a franchisee?)• Why?

– Liability for economic losses caused by inadequate disclosures or misrepresentations.

Relationship Rules• Term: Not less than 3 years.• Standard of performance.

– Franchisor must operate in accordance with the principles of fair dealing, honesty and trustworthiness.

• What does that mean?• Implied covenant of good faith and fair dealing?

• Filing of Franchise Agreement.– Implications are unclear.

Foreign-Invested Enterprise

• Two company-owned units in China for more than one year prior to offering franchises for sale?

• Cross-border franchising?– Unclear whether it falls under Franchise Measures.

International Expansion into China and Elsewhere.

• Understanding which countries (such as China) have franchise specific laws.

• Type of disclosure documents.– International Disclosure Document.

– Traditional UFOC with a country-specific wrap.

– Geographic or language-specific disclosure document.

• To disclose or not to disclose – that is the question!– Talk with your attorney early in the process.

Foreign Investment and Recent Changes to China’s Corporate Law

Haifeng HongGreenebaum Doll & McDonald


Foreign Investment in China• Foreign Direct Investment by Vehicle Type

(January-November 2004 and 2005)

Foreign Investment Type

Number of Projects Contracted FDI Value ($billion)

2005 2004 %change 2005 2004 %change

Total FDI 39,679 39,291 1.17 $167.21 $135.04 23.99

EJVs 9,347 10,289 -9.04 $28.84 $24.15 19.82

CJVs 1,054 1,216 -12.75 $7.65 $6.89 11.90

WFOEs 29,239 27,746 5.57 $128,83 $103.29 24.62

Foreign-invested shareholding ventures

39 40 -2.50 $1.90 $0.71 226.77

Note: FDI=foreign direct investment; EJVs=equity joint ventures; CJVs=cooperative joint ventures; WFOEs=wholly foreign-owned enterprisesSource: PRC National Bureau of Statistics

Foreign Investment in China

Industry UpdatesIndustry Updates• Distribution Rights

Definition: to sell imported or locally sourced goods directly at the wholesale or retail levels within China

Previously, domestic import-export agents and distributors are necessary

July 2005: PRC Ministry of Commerce issued application procedures through which FIEs can obtain distribution rights


Industry UpdatesIndustry Updates• Banking

Liberalization since 2001; Remove restrictions by Dec 1, 2006

Expanded local presence: Seven more citiesReduced minimum operating capital requirement:

RMB100 million ($12.4 million)Foreign Banks’ Stake Acquisitions

Foreign Investment in ChinaWhat to Watch in the Near Future?

• Income Tax unificationOfficial Rate: 33%Post-adjustment: Foreign Invested Enterprises (FIE)

(11%) v. Domestic Companies (23%)Unified Legislation in 2007 expectedPrediction on Unified Legislation:

current incentives available for projects existing prior new tax regime

new corporate income tax: around 25%tax incentives based on industry and geographic location


What to Watch in the Near Future?• The Antimonopoly Law

Expected to be passed in late 2006Increased access to certain markets dominated by State

Owned Enterprises (SOEs)“Public Interest" concern


What to Watch in the Near Future?• Intellectual Property Rights

U.S.- China Joint Commission on Commerce and Trade (JCCT): July 2005

to increase criminal prosecutionsto criminalize the export of counterfeit goodsto accede WIPO Internet treaties by June 2006 and combat

internet piracy

Recent Changes to China’s Corporate Law

New LawNew Law• New Legislation• Amendment of the Corporate Law

Passed on October 27, 2005, effective on January 1, 2006

Background


I.I. Relaxation of the Rules Governing the Relaxation of the Rules Governing the Establishment and Investment of a CompanyEstablishment and Investment of a Company

• Minimum Capital Contributions Joint stock companies: RMB5 million (US$619,594) Other LLCs: RMB30,000 (US$3,718)

• New criteria for a company’s investment in other companies

No limitation on a company’s total investments in other companies

Joint and several liability to the invested companies’ debts


II.II. Improvement to Corporate GovernanceImprovement to Corporate Governance

• Minority Shareholders Protection Access to the accounts of the corporation Resort to courts to revoke relevant resolution made in

violation of convening procedures or voting methods as required by articles of the corporation or law: 60-day limitation

Derivative lawsuit against directors or senior managers


II.II. Improvement to Corporate Governance Improvement to Corporate Governance (cont’d)(cont’d)

• Employee’s Right-to-Know Important corporate issues Decisions affecting the company

• Legal Representative Chairman of BOD Managing director or Manager Under old law: only chairman of BOD


III.III. Piercing the Corporate Veil Piercing the Corporate Veil • Jointly and Severally Liability for Corporation’s

Debt Abuse of independent legal status of a corporation Intentionally remove the corporation’s debts

• Cause material loss to creditors of the corporation

Summary

• An Evolving Market• Opportunity v. Risk

Note: The information included in this presentation is based on the following sources:* The China Effect, China Business Review, April, 2006 * Foreign Investment in China, The US –China Business Council, January, 2006* Changes to China’s Corporate Law, Greenebaum International Letter, Issue 1, 2006

Tax Aspects of Structuring Investments in China

Gregory S. ShumateGreenebaum Doll & McDonald


General U.S. International Tax Concepts

• U.S. taxes its U.S. citizens, resident aliens and U.S. corporations on their world wide income

• Objective of doing business in China: Maximize Repatriation of Earnings through Minimization of Worldwide Tax By:Deferring US TaxUtilizing Foreign Tax CreditUtilizing Income Tax Treaty ProtectionExpense Allocation

Phase 1:Start-Up Phase-- Direct Sales• Direct Sales to Chinese Customers• Minimum Foreign Presence in Start-up Phase• Objective: No China Income Tax on Business Income• Local Law Taxable Business Presence• U.S.-China Income Tax Treaty

Separate Standard under Treaty - Avoidance of Permanent Establishment (“PE”)

Office or other fixed place of business in China---PE Employees or dependent agents in China who habitually conclude contracts on

behalf of U.S. company and has ability to bind U.S. company--PE Factory or inventory storage, display, delivery, 3rd party processing, purchase of

goods & merchandise in China—No PE 6 month construction projects and 12 month service contracts—No PE Web based sales, phone, mail order, fax or other non-China based sales office—

No PE

Advantages/Disadvantages of Direct Sales

• Advantages include simplicity, no need for establishment of an international structure, minimal tax planning and no China income tax

• No substantial financial investment• Consider Export Incentives: DISC to reduce U.S.

income tax rate on exports• Disadvantages include no foreign presence or

control over local marketing, sales, quality control, delivery, etc.

Phase 2: Representative Office

• Overseas Expansion Phase: Branch office not permitted, so a Representative Office is an option

• Liason, marketing support, market research and information gathering

• No profit motive, so no fixed place of business and no China tax

Phase 3: Taxation of Foreign Investment Enterprises

• Choice of EntityChina/Foreign Equity JVCooperative JVWholly Foreign Owned EnterpriseForeign Invested Shareholding Company

• All treated as Corporation for US tax purposes• Deferral of U.S. income tax until profits are repatriated or

application of anti-deferral rules (i.e., CFC, Subpart F rules)• Indirect Foreign Tax Credits applies to dividends

Holding Company Structure• Defer U.S. tax and redistribute profits to foreign subsidiaries without

U.S. repatriation through use of holding company structure. • Controlled Foreign Corporations (“CFC”), Subpart F and anti-deferral

rules• Passive income and foreign base sales and service income• Manufacturing and same country exceptions to Subpart F• Check the box (Form 8832) on lower tier subsidiaries (disregarded

entities) to prevent Subpart F income• Fail definition of CFC through ownership rules• Favorable Holding Company Jurisdictions

NetherlandsHong Kong (HK and PRC separate countries for US tax purposes)Cayman Islands

Foreign Tax Credit

• FTC partially alleviates Double Tax Problem • Foreign Tax Credit Limitation• U.S. will tax profits that are subject to a lower rate of tax in

another country• Thus, deferral of U.S. tax is usually preferred• Declining worldwide tax rates vs. higher U.S. tax rate• Direct vs. Indirect Foreign Tax Credit

Third Annual GreenebaumChina Business Summit

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Welcome to the Third Annual Greenebaum China Business Summit.

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