China Tax and Financial Planning Briefing New Edition

--Concord, MA. December 10, 2008. WorldTrade Executive, Inc. announces the publication of its new corporate report, China Tax and Financial Planning Briefing, Second Edition.

Tax and financial regulation can have an enormous impact on the profitability of a transaction. The newly-released China Briefing is designed to update corporate CFO’s and counsel on recent changes and practices concerning China’s tax and financial regulation. It contains case studies and analysis from leading practitioners.

Important topics include:

• Audits in China: How do they Differ?
• China’s New Thin Capitalization Rules
• Update on Current Tax Issues Facing the Foreign Banking Sector
• Managing Your Channel Under the PRC Antimonopoly Law
• The Five Biggest Mistakes People Make in Non-Disclosure Agreements with Chinese Firms
• M&A Transactions in China: Managing Legal Risks and Pitfalls
• China Strengthens Its Transfer Pricing Policies
• Building a Tax-Effective Supply Chain in China
• New Tax Law Provides Relief to Investors in Chinese Companies Owned through US Holding Corporations
• Selling Chinese Goods to the US via Canada
• China Strengthens Its Transfer Pricing Policies

Other important topics cover transfer pricing, finding tax efficient ways to operate a supply chain, complying with the PRC’s new M&A rules, staying on top of the new Anti-Monopoly Regulations, issues relating to China’s Company Law, and China’s VAT.
WorldTrade Executive specializes in providing reports and periodicals concerning tax and legal issues in international markets. Its products include a family of periodicals covering tax strategies used by leading corporations to manage international tax issues, with regional editions focusing on tax planning for companies in China, Asia, Europe, South America and Mexico. It also has special reports on tax issues in markets such as Japan, Viet Nam, Mexico, Brazil, and Russia, and reports on transfer pricing.

For more information or to sign up for a free international tax briefing go to http://www.wtexec.com/tax.html or contact Jay Stanley at 978-287-0301 or at 2250 Main St., Concord, MA. 01742.

What to Expect from US Trade Agenda

excerpt from International Finance & Treasury
published by WorldTrade Executive, Inc.

By Steven J. Mulder (Greenberg Traurig)

Among the many outcomes from November’s historic elections was the election of several new Members of Congress who ran on a so-called “fair trade” platform that critics argue amounts to little more than protectionist stances on economic and trade policies. Those candidates that successfully ran on the fair trade platform argued that the trade policies of the Bush Administration have failed to provide meaningful benefits for average working Americans. Whatever version one may believe, it is clear that the pro-free trade voices in Congress have been diminished as a result of the elections.

Given that, we are likely to see a period of inactivity on the trade front in the 111th Congress, at least for the pending free trade agreements concluded by the Bush Administration with Colombia, Panama and Korea. The real question is how will the incoming Obama Administration address trade issues and can it work with Congressional critics of trade to create a “new path” for U.S. trade policy going forward?

There are any number of creative ideas floating around Washington on how the new President and 111th Congress may fashion a new consensus on trade policy. Some of the leading ones are creation of new fast track trade negotiating authority that allows much greater congressional input; doing away altogether with comprehensive, country-specific free trade agreements and instead limit them to defined “sectorals” -- for example, a “services” agreement with Japan that would include financial, legal and insurance services trade, but avoid the highly controversial matter of opening Japan’s agricultural economy to U.S. producers. Others argue that free trade agreements should include the highest standards for labor and environmental protections. (It should be noted that the pending free trade agreements contain such protections, yet they still face bleak prospects in Congress).

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Stock Options for Works Council Members in Germany: The Role of Oral Communications

Excerpt from EuroWatch
published by WorldTrade Executive

By Dr. Walter Ahrens (Morgan Lewis & Bockius LLP)

A recent judgment of the federal labor court underlines how important it is that the right legal entity within a group of companies grants stock options and that no misleading representations are made to the employees in this context. As the following case demonstrates, failure to sufficiently take these requirements into account can lead to unexpected financial consequences that can be substantial.

The plaintiff started employment in 1999 with a German company that was owned by a U.S. corporation. In 2000 and 2001 he received a total of 5,000 stock options from the U.S. parent corporation. In 2001 he became a member of the company’s works council. He was subsequently elected chairman of the works council and released from his obligation to work. German statutory law provides that in operations that regularly employ at least 200 employees, a certain number of works council members have to be released to enable them to fully engage in works council activities. These works council members are nevertheless entitled to the same pay and benefits as comparable employees and even take part in pay increases. This is intended to ensure that they suffer neither financially nor with respect to their professional development from their works council membership.

It probably does not come as a surprise that the plaintiff in this case did not receive any stock options from 2002 to 2005, while an employee whom the parties had agreed was comparable to the plaintiff did receive such options. The employee claimed the options from the German subsidiary in court, but lost in the first two instances.

The federal labor court set the appeal court judgment aside and remanded the case to the appeal court for further investigation. It held that the pay and benefits that works council members are entitled to may also include stock options. The court also made clear that payments and benefits that are provided by a third party and not by the employer, for example by another group company, are not to be taken into account in this context.

In this case, the U.S. parent corporation had gotten nearly everything right. The stock options had been granted by the parent corporation, and the employment contract between the German subsidiary and the employee did not include any stock options. Such clear distinction is also helpful from a conflict-of-laws point of view.

The reason, however, why the federal labor court nevertheless set aside the appeal court judgment was that the appeal court had not sufficiently taken into account the plaintiff’s submission that in his job interview, the German subsidiary had presented the stock options as an additional pay component. According to the court, this could mean that the U.S. parent entity’s stock options were benefits in addition to the regular remuneration agreed upon between the parties that could establish the employer’s secondary liability in accordance with the terms and conditions of the stock option agreements. What exactly had been said in the job interview and how it has to be construed will now have to be determined by the appeal court.

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Canada’s Prime Minister Announces Plan to Relax Foreign Investment Restrictions

Excerpt from North American Free Trade & Investment Report
published by WorldTrade Executive, Inc.

by Kim D. G. Alexander-Cook (Stikeman Elliott LLP)

Prime Minister and Conservative Party Leader Stephen Harper announced on September 12 that his party would seek to lift some of Canada’s restrictions on foreign investment if it is returned as the government in the October 14 federal election.

Currently, Canada’s Investment Canada Act requires review and approval of direct acquisitions of Canadian businesses by non-Canadians where Canadian assets exceed a $295 million (adjusted annually) threshold, with lower thresholds applying to direct and indirect acquisitions of Canadian businesses in four “sensitive sectors” — uranium mining, financial services, transportation services and “cultural” businesses. In addition, Canada has sector-specific legislation and/or foreign ownership restrictions in broadcasting, telecommunications, cultural industries, transportation services and uranium production. As well, the financial services sector is subject to ownership restrictions of general application (but not foreign ownership restrictions).

The Prime Minister announced that a Conservative government would open up the airline and uranium-mining sectors to allow increased foreign investment, "subject to negotiation with our trading partners and to considerations of national security." In particular, airline ownership limits would be raised to 49 per cent from the current 25 per cent, as long as Canadian companies were offered reciprocal rights in other countries.

Only foreign investments of more than $1 billion would be reviewed under the Investment Canada Act, up from the current level of $295 million that applies to direct acquisitions, with the change phased in over a four-year period.

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MANAGING CHANNELS UNDER THE NEW PRC ANTIMONOPOLY LAW

Excerpt from Practical China Tax and Finance Strategies
published by WorldTrade Executive, Inc.

By Lefan Gong, S.J.D. (Zhong Lun Law Firm)

With the new Antimonopoly Law (AML) effective on August 1, 2008, manufacturers, distributors and others are now subject to new rules that may significantly change their existing ways of doing businesses. Some of the automakers in China reportedly have already started making changes to agreements with their dealers to be in full compliance with the new law. Antimonopoly lawsuits were filed just within a few days after the AML took effect, marking a start of a likely new wave of litigation in China against large corporations, trade associations and even government agencies.

In particular, the AML will likely have a profound impact on channel management. For instance, Article 14 the AML prohibits “monopoly agreements” that fix resale prices or specify minimum resale prices. Now a host of questions emerge:

• Can a company use methods other than “agreements” to impose minimum resale prices on its distributors?
• Can a company suggest and advertise minimum retail prices for its products?
• Can it terminate those distributors that fail to obey such “suggested retail prices”?
• Can a franchisor continue to impose price and territorial restrictions on its franchisees?

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Audits in China -How Do They Differ?

Excerpt from Practical China Tax and Finance Strategies
published by WorldTrade Executive

by Tony Upson (Director of Assurance and Advisory at PKF Beijing)


If you are contemplating investing in or trading with a Chinese company or are already doing so, you will want to satisfy yourself about the company’s financial position and results and will no doubt consider the company’s financial statements. Do you know the differences between Chinese audits and financial statements, particularly for private companies, and Western standards?

Here are some items to consider:

Firstly, financial statements for unlisted Chinese companies are not generally on the public record. This is similar to the USA but dissimilar to Europe, where the financial statements of all limited companies are on the public record (in theory, at least). Financial statements of private companies in China have to be prepared for the tax authorities and various other government bodies.

Listed companies have to use modern Chinese accounting standards (Accounting Standards for Business Enterprises or ASBEs), which are similar to International Financial Reporting Standards (IFRS), but private companies often still use the previous system. This form of financial statements is of limited use to a potential investor or other trading partner. Unlike financial statements prepared under IFRS, they are not designed to provide information of use to investors. Areas where differences often exist between financial statements prepared under the old Chinese system and under IFRS include:

• accounting for land use rights as intangible assets rather than operating leases
• doubtful debt provisions based on ageing formulae, rather than realistic appraisal of recoverable amounts
• use of ‘standard’ asset lives and residual values, rather than realistic estimation
• deferral of expenditure such as start-up costs and R & D
• lumping together taxes on income with indirect, sales and other taxes
• deferred tax
• inclusion of the results of subsidiaries in the parent company’s individual accounts

In addition to these differences between the old Chinese rules and IFRS, unaudited financial statements of private companies often do not even comply with the old Chinese rules. Adjustments are only made when financial statements are audited and submitted to the tax bureau. So in Unaudited accounts it is common to find that:

• revenue recognition is on a cash basis rather than an accruals basis
• recognition of costs depends on whether an invoice has been received, not on whether the goods or services have been received.

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Canada: Trade Implications of Proposed Consumer Products Safety Act

Excerpt from North American Free Trade & Investment Report
published by WorldTrade Executive, Inc.

By Cliff Sosnow AND Elysia Van Zeyl
(Blake, Cassels & Graydon LLP)

The federal government recently introduced new legislation that, when passed, will dramatically increase the obligations of Canadian companies and impose particularly onerous requirements on companies that import consumer products from foreign suppliers. This legislation, referred to as the Consumer Products Safety Act, follows several recent high-profile recalls affecting toys, food, and pharmaceuticals.

Recalls Will No Longer Be Voluntary
When approved, Bill C-52 will provide the Minister of Health with extensive powers to deal with products that pose health or safety risks to consumers, including the ability to issue mandatory recalls. This new power represents a significant change from the current system whereby product recalls are entirely voluntary. The Minister will also be given the authority to ban any product that poses an “existing or potential hazard”. Moreover, the Minister will be granted the ability to disclose confidential company information in the absence of company consent where it is believed that a product poses a “serious and imminent” health risk.

New Ministerial Powers to Order Health Safety Tests
The proposed legislation empowers the Minister to order an importer or manufacturer to conduct tests on consumer products and to compile any information that the Minister considers necessary to verify compliance with the Act or regulations. The Minister may also require importers or manufacturers to provide documents that contain information on the results of such tests within the timeframe to be determined by the Minister. Failure to comply with any such order by the Minister is an offence under the Act.

These obligations could pose difficulties for importers who may not have access to thorough and accurate information from their foreign suppliers. Furthermore, considering that international suppliers may not be required to comply with equivalent standards in their home country, there is no guarantee that such information or records even exist. Thus, in the absence of full co-operation by foreign suppliers, importers may have to choose between conducting tests themselves and providing the requisite information, facing penalties, or choosing new sources of supply from co-operating foreign suppliers.

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More information on North American Free Trade & Investment Report

What Will Happen to US Trade Agenda This Year?

Excerpt from North American Free Trade & Investment Report
published by WorldTrade Executive, Inc.

By Steven J. Mulder
(Greenberg Traurig)

It was with a certain amount of amusement -- if not disbelief -- when I recently read in an “Inside the Beltway” publication that there was “Still a Big Trade Agenda” for Congress to address this year. Huh? Really? While there may be a lot of trade legislation pending in Congress, it seems unlikely Congress will be able to approve much of it -- particularly before the elections -- in the current political environment, where anti-trade sentiment is clearly on the rise.

For one thing, the “trade agenda” is largely a priority of the Bush White House and the Democrats are in no mood to grant anything the Administration wants in its remaining months. The Democrats in the House and Senate are expected to make major gains in the November elections and thus they seem willing to simply “wait out” President Bush on most major legislative initiatives, including trade-related measures.

The Colombia Free Trade Agreement is a perfect example. The agreement, concluded over a year-and-a-half ago, is strongly supported by the President, who rarely misses an opportunity to raise the importance of its passage.

The President formally presented the agreement under the so-called “fast track” rules for Congressional consideration of free trade agreements back in April (fast track protects free trade agreements from amendment and filibusters in the congress).

However, the President took his action without the consent of the Democratic leadership, which clearly does not want to have to deal with the agreement. No problem: Speaker of the House Nancy Pelosi (D-California) presented a Resolution to the House that simply removed fast track timeline (which vitiates the need for congress to consider it within 90 days), the Resolution passed with overwhelming Democratic support, and the agreement is now effectively “in limbo.”

Never mind that over 100 newspapers (even the New York Times!), too many former Democratic officials to count, and every business organization in the United States supports passage of the agreement -- unfortunately for the agreement, U.S. labor organizations have “drawn a line in the sand” against it and that would seem to be enough to stop its movement.

Supporters of the agreement are hoping that the Speaker will have a change of heart and allow the agreement to come up for a vote in a “lame duck” session of congress that would take place after the elections of November 4th. However, there is no assurance that such a session will take place. Democratic leaders are working hard to avoid such a scenario, but given that there is a range of “must pass” legislation that has to be enacted this year -- not the least of which are the 13 annual appropriations bill that keep the government running, none of which have been enacted at this point -- a lame duck session seems likely.

Other free trade agreements that are on the agenda include ones with Panama and Korea. For more information.

Managing Shop Committee Consultation in French Business Transfers

Excerpt from EuroWatch
published by WorldTrade Executive, Inc.

By Eric Cafritz, Frédérique Jaïs and Olivier Genicot (Fried, Frank, Harris, Shriver & Jacobson LLP)

French law requires employers to share information and consult with the shop committee in cases of M&A, and there are EU requirements as well.

There is controversy as to the appropriate time for management to disclose a transaction with potentially exposive labor consequences if the timing is wrong. It can also be surprising as to when the shop committee rules apply such as in cases where the transction is negotiated and managed entirely outside of France.

General Scope of Obligation to Consult with Shop
Committees with Respect to Business Combinations
Companies on both ends of acquisition transactions are required to inform and consult with their shop committees. Under Article L. 2323-19 of the Labor Code, an employer must inform and consult with the shop committee “regarding any modification in the economic or legal organization of the company, notably in the event of a merger, sale, (...), or acquisition or sale of a subsidiary within the meaning of Article L. 233-1 of the French Commercial Code.” The employer must consult with committee members regarding the effects that the contemplated transaction may have on employees.

Furthermore, where there are “exceptional circumstances affecting the employees’ interests to a considerable extent, particularly in the event of relocations, the closure of establishments or undertakings or collective redundancies,” the European shop committee (or, if applicable, the select committee),8 has the right to request a meeting with the employer so as to be informed and consulted regarding the contemplated transaction. It has the right to meet, at its request, the central management, or any other more appropriate level of management within the EU-wide company or group of companies having its own powers of decision, so as to be informed and consulted on measures significantly affecting employees’ interests.

Direct Changes of Control
The nature of the information and consultation duty differs as between the acquirer, the seller, and the target company.

With respect to the acquiring company, its shop committee must be informed and consulted prior to acquiring a stake in another entity. Although the acquisition of a stake is separately defined by Article L. 233-2 of the French Commercial Code as the acquisition of 10% to 50% of the share capital of another entity, the French Supreme Court has held that in the absence of a specific cross-reference to the Commercial Code in Article L. 2323-19 of the Labor Code, the acquisition of less than 10% of the equity of a target company triggers the obligation to inform and consult with the shop committee.

With respect to the seller, its shop committee must also be informed and consulted if it sells a subsidiary in which it holds more than 50% of the equity. According to case law, the seller’s shop committee must be informed and consulted no matter how insignificant the subsidiary may be to the seller.

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US Trade Act Proposed

Excerpt from North American Free Trade & Investment Report
published by WorldTrade Executive, Inc.

By Kenneth G. Weigel, Thomas E. Crocker and Eric Shimp
(Alston & Bird LLP)

The Trade Reform, Accountability, Development and Employment Act (TRADE Act) would seek to fundamentally change core tenets of U.S. trade agreements, mandate the renegotiation of several existing agreements, strengthen the role of Congress in trade policy, restrict fast track votes, and dilute the power of the federal government over the states in the area of trade and investment.
Fostered by core Democratic constituencies including ten major unions and NGOs, including Public Citizen and Friends of the Earth, the TRADE Act was launched on June 4. Democratic Representative Mike Michaud (ME) and Senator Sherrod Brown (OH) offered joint legislation aimed at a wholesale reform of the way the nation conducts trade policy. This bill will shape the debate over trade policy in Congress, on the campaign trail, and during the first year of the new presidential administration in 2009.

Key Provisions
The sprawling scope of the TRADE Act would compel key changes in U.S. trade policy, including:
• New objectives: Lays out new negotiating objectives, focusing specifically on trade and environment matters, and reducing the scope of provisions on investment and services disciplines.
• Trade agreement review: Mandates that GAO perform regular reviews of all existing trade agreements, examining data on job creation, wage levels, exports and imports, outsourcing and labor and environment issues. Criteria are clearly slanted to portray agreements as detrimental to the economy.
• Renegotiation: Compels the government to renegotiate all existing U.S. trade agreements, including NAFTA, to a) comply with new objectives and b) address faults found in review process.
• State opt outs: Would grant states the ability to reject all nontariff-related provisions of negotiated agreements (e.g., services, investment, government procurement, IPR). This particular provision is likely to cause significant problems for foreign trading partners who look to market access within the 50 states as a major benefit of FTAs with the United States.
• Services: Would move the U.S. to a positive list approach, thereby reducing potential market access gains for U.S. services providers in foreign markets.

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EC Recommends Limiting Auditors’ Liability

Excerpt from EuroWatch
published by WorldTrade Executive, Inc.

by Andrea Hamilton
McDermott Will & Emery

The European Commission has issued a Recommendation to limit auditors’ civil liability with the objective of promoting the market entry of auditing firms that would otherwise be deterred by the threat of unlimited liability.

By encouraging new market entries, the Commission hopes that its Recommendation will protect European capital markets by ensuring that sufficient auditing capacity exists to perform statutory audits of EU-listed companies. This Recommendation is based on a mandate contained in the 2006 Directive on Statutory Audit, and reportedly also on an increasing trend of litigation and issues concerning insurance coverage in the auditing sector.

Member States are free to decide on the appropriate method for limiting liability and set caps for liability if they wish.

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Working Time Directive Agreement Reached

From EuroWatch.
published by WorldTrade Executive, Inc.
By Daniel Kelly
McDermott Will & Emery

The Employment and Social Affairs Council, following a meeting in Luxembourg on 10 June 2008, has adopted a Common Position on both the Working Time Directive and the Temporary Agency Workers Directive.

The agreement on the Working Time Directive only became possible after Spain and other countries overcame objections to an opt-out that allows an increase in the weekly cap to 60 working hours. A distinction was also drawn between “active” and “inactive” on-call time, allowing greater flexibility for doctors struggling to keep average weekly working hours below the agreed limit. Agreement on the Temporary Agency Workers Directive was reached after, Member States were given the option of derogating from the requirement of equal treatment as of day one for temporary agency workers in terms of pay, maternity leave and annual leave.

The Council Common Positions will now be sent to the European Parliament for a second opinion. If they are passed, they will return to the Council of Ministers for a second round of approvals, at which stage they will become EU Law.

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Is Comparative Advertising Going to Become Easier in Europe?

Excerpt from EuroWatch
published by WorldTrade Executive, Inc.

By Sahira Khwaja (Lovells LLP)

In answer to a reference to the European Court of Justice (ECJ) from the English Court of Appeal, Advocate General Mengozzi has issued an opinion which may make it more difficult for brand owners to stop comparative advertising by competitors.

The questions arose in a dispute in the mobile phone market between O2 and Hutchison 3G. In 2004 Hutchison ran a TV advertising campaign comparing its new pay-as-you-go service with that of O2 and other operators, implying it was cheaper.

If the ECJ agrees with the Advocate General’s reasoning that use of a competitor’s trademark in a comparative advertisement should be controlled under the Advertising Directive and not the TradeMark Directive, this will affect brand owners’ ability to enforce their rights, in some countries at least. A brand owner will not be able to sue for trademark infringement but will have to take whatever action it can under the national law implementing the Advertising Directive.

In the UK, for example, this would have a major impact as enforcement of those implementing regulations is by public bodies (the Office of Fair Trading and local authority Trading Standard Services). These have limited resources and objections of this type would be low priority (unless there was likely to be serious damage to consumers). There is no private right of action under the regulations, and complaints must be made to the public bodies. These usually only act if the complainant has first followed the complaints procedure run by the Advertising Standards Authority (the voluntary industry body), which may take two or three months.

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Mexico Enacts Important Commercial Litigation Reform

Excerpt from Latin American Law & Business Report
published by WorldTrade Executive, Inc.

By Oliver J. Armas, Luis Enrique Graham and Salvador Fonseca
(Chadbourne & Parke LLP)

A new system of "preventive" appeals, contained in the recently enacted reforms to the Mexican Code of Commerce, is designed to substantially reduce the complexities that currently tend to complicate commercial proceedings in Mexico.

The current system of appeals in commercial proceedings in Mexico is rather complicated. There are, for instance, intermediate and final appeals; the type of appeal depends on whether the challenge is directed against a resolution issued by the judge during the proceedings (intermediate appeal) or against the final resolution on the merits of the case (final appeal).

Currently, when filing an intermediate appeal, parties have to put forward all of their arguments and allegations before the court of appeals, even though there is the possibility that the issues discussed in the intermediate appeal will become moot once a resolution on the merits is rendered by the court of first instance. The reforms intend to remedy that.

The reforms, which will become effective July 16, 2008, primarily concern the appeals process. A new system of “preventive” appeals aims at substantially reducing the complexities that currently tend to complicate commercial proceedings in Mexico. The reforms also include new rules regarding documentary evidence and testimony from fact and expert witnesses; grant more time (15 instead of 9 business days) to file an answer, and harmonize default rules.

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Foreign Investment in the U.S.: Proposed Regulations

Excerpt from North American Free Trade & Investment Report
published by WorldTrade Executive, Inc.

By David J. Laing and Mark D. Menefee (Baker & McKenzie)

On April 21, 2008, the U.S. Department of Treasury issued proposed regulations which would implement the Foreign Investment and National Security Act of 2007 (“FINSA”). FINSA was enacted in July 2007 in response to what some members of Congress perceived as a failure of CFIUS to investigate thoroughly some investments into the United States. These are proposed regulations to implement FINSA, and these proposed regulations are subject to public comment before final implementation.

The focal point for the government’s review of foreign acquisitions will continue to be the inter-agency Committee on Foreign Investment in the U.S. (“CFIUS”), which is chaired by the Department of Treasury and which has been expanded to include additional agencies. CFIUS is authorized to investigate any foreign investments resulting in “control” of a U.S. entity by a foreign entity.

The proposed regulations would not fundamentally change the general U.S. policy of openness to foreign investments. The proposed regulations clarify what transactions would be subject to review and investigation by CFIUS, and set forth new procedures for notifying CFIUS of proposed transactions. However, FINSA and the proposed regulations confirm that future investments in U.S. entities by foreign entities will receive significantly increased scrutiny by CFIUS.

The regulations also would create important new requirements for the parties who submit voluntary notifications to the government concerning proposed transactions, or who enter into “mitigation agreements” with the U.S. government to reduce specific risks to the national security identified by CFIUS.

Given these proposed regulations, as well as CFIUS’s recent shift toward undertaking much more detailed reviews of transactions, we believe the key to a successful foreign investment in or acquisition of a U.S. company will be to use enhanced due diligence measures to (1) determine promptly if the transaction is covered by the regulations and if it involves critical technologies or infrastructure; (2) voluntarily notify and consult with CFIUS to identify any possible concerns by the government; and (3) if CFIUS expresses particular concerns, be prepared to modify the transaction and/or implement specific compliance procedures.

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China: The M&A Due Diligence Process

Excerpt from Practical China Tax & Finance Strategies
published by WorldTrade Executive

By Lefan Gong (Zhong Lun Law Firm, Shanghai)

China has been going through an extraordinary period of mergers and acquisition activities. However, making successful investments and striking good deals in this turbulent market requires more than a gold-rush mentality. Investors doing M&A transactions in China are often faced with a number of unique risk and pitfalls, such as restrictions and limitations on deal structures, unfamiliar customs and practices, difficulty in discovering hidden liabilities and other problems, a “sellers’ market” created by a significant influx of investment capital, and a legal and regulatory system that is still in a state of flux.

An initial matter that a foreign investor needs to assess in setting its expectation is how the Chinese regulatory restrictions and the personal views of the applicable approval authorities may affect the structure and process of the deal. One of the first things that a buyer may want to look into is whether the target company, after being acquired by a foreign investor, can continue to conduct its business and operations in the same manner without becoming subject to additional regulatory restrictions.

There are still a number of business sectors in China that are not fully open for foreign investors, and in which such investors cannot establish wholly foreign-owned enterprises (“WFOEs”) or even joint ventures. A foreign investor should determine as early as possible whether there are percentage limitations on its potential ownership in an enterprise in a given industrial sector, as this will directly affect the deal structure. For example, if the target company is a conglomerate, some assets may need to be carved out to make sure the post-closing target company will steer clear of the sectors that are “prohibited” or “restricted” for foreign investment.

“Trust, But Verify” – the Assets You Acquire
In China, the verification of the ownership of assets can present substantial challenges. Publicly available information and government records, if they exist, may be inadequate or unreliable. For private companies, the internal documentation is usually not well kept and organized, and it may be insufficient to show what assets belong to whom. For the state-owned enterprises, the situation may not be significantly better, and requests for information often meet with reluctance and the “state-owned” attitude of secrecy.

It is important to realize that a target company’s assets may have been used in related-party transactions. For example, one company’s assets might have been pledged for another’s bank borrowings, and the same assets might have been used multiple times for making (registered) capital contributions in different companies. The buyer also needs to be extremely careful if substantial assets of a target company were bought from a bankruptcy auction of a state-owned enterprise. If the process was not properly supervised by the court and the case was not effectively closed, the sale could risk being overturned for reason of a flawed auction process.

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Europe Breach Notification Law Coming?

By Thomas Smedinghoff (Wildman, Harrold LLP)
Excerpt from Global Intellectual Property
Asset Management Report
published by WorldTrade Executive, Inc.

The European Union, along with
several other countries, appears to be moving toward
a security breach notification requirement.

The European Commission recently published a
proposal to amend the Privacy and Electronic
Communications Directive to require providers
of “publicly available electronic communications
services” that suffer a data breach to notify subscribers
whose personal information has been
compromised.

Proposals for breach notification
laws have also recently been made in Canada,
the UK, Australia, and New Zealand. See Proposed
Directive at http://ec.europa.eu/
information_society/policy/ecomm/doc/library/
proposals/dir_citizens_rights_en.pdf.

More Information on International Information & IP Law

Intellectual Property Holding Companies: Tax Panacea or IP Mistake

Excerpt from International Finance & Treasury
published by WorldTrade Executive

by Paul Dau, Paul Devinsky and Justin Hill
(McDermott Will & Emery LLP)

The potential tax advantages of IP holding company structures are significant and well known. The objective, from a tax planning perspective, is to transfer the enterprise’s proprietary intangibles to an owner in a tax-advantaged jurisdiction, and to minimize exposure to tax in other jurisdiction by carefully controlling how the new owner exploits the intangibles.

However, in the international context, failure to assess properly competing economic and legal considerations can lead to failure to meet objectives and runaway costs. In many cases, the holding company is a subsidiary within an international corporate group. Sometimes, although less often, the holding company is the parent company of the overall corporate group. Adoption of a suitable structure depends to a large extent on the headquarter jurisdiction, the mechanism by which the various synergies are anticipated to operate, and on the circumstances of the particular scenario.

Issues to consider in detail include which group companies have standing to enforce the intellectual property and how damages are calculated in that event. For example, solutions which perhaps work best from the tax or insolvency point of view can compromise standing to sue and entitlement to claim certain categories of damages. Think about it; if your holding company does not make any sales, why should it have any claim to lost profits damages?

Other issues to consider include what happens in the future to the intellectual property of the operating companies. For example, most businesses want to continually develop their intellectual property portfolios. Selecting an IP holding jurisdiction purely on the basis of tax or corporate considerations can leave the holding company in a position where it does not have access to the international intellectual property treaties required to develop efficiently and manage an intellectual property portfolio. Depending on the scale of the portfolio, this can have huge cost and time ramifications.

Depending upon where the intellectual property is generated there may also be issues with technology exportation to get it into the holding company. For example, while South Africa generally does not require inventors to obtain a license when first filing an invention overseas, it does have relatively onerous exchange control legislation. This means export of capital by South African residents (including intellectual capital) is traditionally prevented in the absence of South African Reserve Bank Approval. Failure to properly observe such legislation, and to account for it in the documentation can lead to the relevant technology transfer transactions being considered void.

If a business wants the freedom to undertake structured financing or securitization processes, other considerations arise. What happens when a business unit is to be divested (this may be required as part of the investors exit strategy)? Does the structure afford the necessary freedoms and will the transfer give rise to stamp duty type considerations which still apply in a number of European jurisdictions?

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Japan: Pitfalls of Failing to "Reasonably" Compensate Employee Inventors

Excerpt from Global Intellectual Property Asset Management Report (published by WorldTrade Executive) by Calvin Griffith, Michiru Takahashi, and Nobutaka Komiyama (Jones Day)

Foreign corporations with R&D facilities in Japan need to be thoroughly familiar with Article 35 of the Japan Patent Law and with the internal procedures and rules that should be followed to minimize the risks of a lawsuit from a disgruntled employee inventor.

The United States is generally considered a more litigious country than Japan, where customs traditionally favor a less confrontational approach to dispute resolution. But there is one exception—employee invention lawsuits. A recent series of lawsuits filed by aggrieved employee inventors against their employer companies, demanding “reasonable remuneration” for the employees’ inventions, has brought attention to this unique area of Japanese patent law—and raised concern in the business community. Japanese companies were shocked to find themselves facing the possibility of paying seven-figure sums in compensation for employee inventions, having expected that the compensation provided in the ordinary employment contract or internal employment regulations would be accepted by courts as reasonable. This stunning development in Japanese courts is based on Japan’s unique employee invention system under Article 35 of the Japan Patent Law, and foreign companies doing business in Japan, especially those with R&D facilities there, should be familiar with the provisions of Article 35 and the case law applying it.

Origin of the Fuss—
Article 35 and the Olympus Case

Japan has a unique employee invention system under Article 35 of the Patent Law. That article provides a number of important rights for employee inventors.

First, if an employee makes an invention that, by the nature of the invention, falls within the scope of the business of his employer and was achieved by acts within the employee’s duties for the employer (an “employee invention”), the right to obtain a patent on the invention originally belongs to the employee (Article 35, Paragraph 1). This is different from the practice in countries such as the United Kingdom and France, where the right to obtain patents for employee inventions originally belongs to the employer.

An employer, however, may enter into a contract with an employee or establish internal employment regulations providing in advance that the right to obtain a patent for any employee invention shall be assigned to the employer, or that an exclusive license for any employee invention shall be granted to the employer (established construction deriving from Article 35, Paragraph 2).

If an employer acquires the right to obtain patents for employee inventions from an employee, the employer must pay a reasonable remuneration to the employee (Article 35, Paragraph 3).
Prior to the Olympus case, Japanese companies believed that if they unilaterally established internal employee invention rules that set an amount of remuneration in exchange for the assignment of inventions from employees, such amount would be duly respected by Japanese courts as valid and binding. The amount of remuneration provided in those employment regulations was usually not high, frequently around just a few hundred dollars. The Olympus case changed the landscape.

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China: What Businesses are Open to Foreign Investors?

Excerpt from article in Practical China Tax and Finance Strategies prepared by By Janet Jie Tang , partner at the US law firm Akin Gump Strauss Hauer & Feld LLP and based in Beijing.

The threshold issue for every foreign investor investing in China is whether the business area it plans to invest is open to the foreign investor; if it is open, how open is open to the foreign investor. This threshold issue directly goes to the fundamental policy of the Chinese government regarding the Chinese industries.

One of the key legislations in this regard is the Catalogue Guiding Foreign Investment in Industries (the “Foreign Investment Catalogue”). The Foreign Investment Catalogue lists the business sectors where the Chinese government forbids, restricts (which means it is not forbidden but it is particularly regulated by the Chinese government) or encourages foreign investment. Anything outside of the Catalogue is deemed as a sector that the Chinese government allows for foreign investment. With the development of the Chinese economy and the adjustment of the industry policy due to such development, the Foreign Investment Catalogue, since it was initially issued in 1995, has been amended four times respectively in 1997, 2002, 2004 and 2007. The latest amendment became effective December 2007.

From the latest amendments to the Foreign Investment Catalogue, we can see the changes of the Chinese government’s attitudes towards foreign investment. For example,
(1) Purely export-oriented industries are no longer encouraged (this reflects our government’s adjustment of its policy on trade facing the tremendous trade surplus and rapid growth of the foreign exchange reserve in China);
(2) high-tech industries (such as new materials manufacturing) and certain service industries (such as modern logistics) are encouraged;
(3) For those industries involving natural resources that are non-renewable, they are either forbidden or restricted;
(4) For those business sectors, which may impact the national economic security, such as news websites, services of Internet audio-visual programs, business sites that provide Internet access services and Internet culture operations, they are no longer permitted for foreign investment, and now are forbidden for foreign investment.

For more information

Foreign Investment in the US: President Issues New Order

Excerpt of article by Reginald J. Brown, Lynn R. Charytan, Jamie Gorelick, Stephen W. Preston, Wilmer Cutler Pickering Hale and Dorr LLP in WorldTrade Executive's International Finance & Treasury

On January 23, President Bush issued an Executive Order (Order) amending Executive Order 11858, concerning foreign investment in the United States. The Order provides guidance concerning the implementation of the Foreign Investment and National Security Act (FINSA), which was signed into law on July 26, 2007. Such "guidance," which was issued pursuant to the President's "executive power" under Article II of the Constitution and under the Defense Production Act of 1950, has the full "force and effect of law" and is binding on the executive agencies that are members of the Committee on Foreign Investment in the United States (CFIUS or the Committee).[i]

The Executive Order has been the subject of speculation and some dispute for several months. Rumors abounded in CFIUS-watching circles that the Order was intended to empower the pro-business agency members of CFIUS, such as the Treasury Department, while reducing the role of the national security agencies. In response, the latter agencies, as well as members of Congress, made clear their view that this would undermine a key intention of the CFIUS reform enacted by FINSA.
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European Patent System: Significant Changes Introduced

By Sebastian Moore (Herbert Smith LLP)
in 1/15/2008 Issue of EuroWatch published by
WorldTrade Executive, Inc.

The European Patent Convention (“EPC 2000”) came
into force on 13th December 2007, introducing significant
changes to the European patent system and the text of the
original EPC 1973.

Stakeholders should be aware of how the changes to
the European patent system may affect the granting and
enforcement of European patents. Many of the changes
are complex and technical and, given the importance of
value attaching to patents, it is inevitable that some of the
questions arising out of the scope of these amendments
will need to be clarified by the EPO and the national
courts.

The EPC has been updated for a number of reasons.
In particular, account had to be taken of developments
in international law, including the TRIPS agreement and
the Patent Law Treaty 2000. For example, the EPC 2000
clarifies the fact that, in accordance with the requirements
of TRIPS, patents can now be granted for any inventions
in all fields of technology provided they are new and
comprise an inventive step.

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Selling Chinese Goods to the U.S. Via Canada – Not for Amateurs

By Greg Kanargelidis (Blake, Cassels & Graydon LLP)
excerpt from article in 11/30/07 North American Free Trade & Investment Report
published by WorldTrade Executive, Inc.

Canadian businesses are well positioned to take advantage of their
close proximity to the U.S. market and can, where sales are properly
structured, sell competitively to U.S.-based customers. This is especially
the case where Chinese-origin goods are shut out of the U.S.
market due to antidumping duty or countervailing duty orders.

Canada and Canadian businesses have a comparative advantage
in selling to U.S.-based customers over other suppliers, even
over U.S.-based suppliers of Chinese goods. This results
from the provisions of the North American Free
Trade Agreement (NAFTA) under which trade between
Canada and the U.S. has been fully duty-free for
qualifying goods since January 1, 1998.

Pursuant to NAFTA, goods shipped from Canada
to the U.S. qualify for duty-free importation, but only
if the goods qualify as “originating goods”. This means
that the goods must satisfy certain “rules of origin”
that are set out in NAFTA. The “rules of origin” range
from the general to the very specific. Where the Canadian
exporter is shipping goods comprising any percentage
of foreign content (subject to a de minimis test),
specific rules of origin at the tariff subheading or tariff
item level must be consulted to determine what level
of processing is necessary in Canada before the goods
may be entered into the U.S. as “duty-free”.

Where the Canadian exporter to the U.S. supplies
Chinese-origin goods, it is important that the specific
rules of origin for the goods be consulted and that
proper care is taken to determine whether the goods
have been sufficiently further processed or transformed
in Canada in order to qualify for duty-free
treatment on entry into the U.S. This may entail sufficient
further processing of the Chinese-origin goods
so that the further processed product is classified in a
different chapter, subheading or, in some cases, tariff
item of the U.S. Harmonized Tariff Schedule on entry
into the U.S.

For more on this topic, visit North American Free Trade & Investment Report
or WorldTrade Executive, Inc.

EC Adopts New Merger Guidelines

By Yannis Virvilis
of McDermott Will & Emery/Stanbrook LLP
published in 12/15/07 EuroWatch p. 3

The European Commission has adopted the final text of the long awaited Non-Horizontal Merger Guidelines. The Commission had previously launched a public consultation with the publication of the draft guidelines at the beginning of the year. The Guidelines apply to vertical mergers between firms that can have a supplier-customer relationship, and also apply to conglomerate mergers where firms are active on closely related markets. The text describes the market conditions that might lead the Commission to have concerns in non-horizontal mergers. In an attempt to increase legal certainty, the text provides a rather low "safe-harbour" of market share (30 per cent) and market concentration (postmerger HHI of 2000), below which it is unlikely that any concerns will arise.

Several articles on this topic appear in the most recent EuroWatch.

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