China Makes Strides in Regulatory Reform

The past year has been a good one for regulation in China—that is, if “more” means better.

Various bureaucracies in the country have been churning out drafts, circulars, laws, and statutes by the pound. Many have dealt with issues vital to the operation of multinationals in China: antitrust regulation, equity compensation, and more. But lawyers and accountants familiar with what’s been published warn that compliance matters may not be any more clear in 2008 than they were before.

The Anti-Monopoly Law, for example, was enacted last summer after 12 years of debate and is scheduled to go into effect next August; it is China’s first-ever try to regulate antitrust issues. Many say the AML is well conceived and places restrictions on government monopolies created by the Communist Party long ago, but questions still abound on whether large foreign companies such as Microsoft and Intel might be ensnared by some new interpretation of the AML.

The Enterprise Income Tax Law also went into effect at the start of 2008, creating a uniform tax rate for both foreign and domestic companies. Taken together, those laws and other related efforts by Chinese bureaucrats give new hope that businesses will receive more of two things in short supply in China: certainty and clarity about regulation.

“Generally, people have applauded the effort,” David Blonder of the law firm Chadbourne & Parke says of AML. “It brings transparency.” But he and others quickly add that the new laws also bring new problems in regard to how to enforce them, and ultimately may accomplish little to help international companies navigate their way through China.

Exhibit A: the validity of prior “circulars,” which are roughly equivalent to guidance issued by regulatory agencies in the United States. The recent antitrust and taxation laws do build on prior legislative and administrative guidance (which, in some cases, have been on the books for decades), so the question for many lawyers and compliance executives is what will remain and what will be superseded by the new laws.

“In some cases there may be a greater lack of clarity,” says Jeff Kadet, a senior adviser at Deloitte & Touche in Shanghai. “Through December 31, we had a great body of circulars that had accumulated over the past 20 to 25 years. All of a sudden we don’t know which circulars are still valid. We expect eventual guidance on which circulars will survive, but that may take a while.”

The laws themselves may not be much help. As legislation goes, they are sparse documents that lay out the broad framework for what corporations must do but leave many details to later interpretations and enforcement documents. That is often the case in China: The intent of the law may be clearly stated but hard to follow, until the relevant bureaucracies have weighed in on the original document. Companies seeking to adhere to the letter of the law may find too few letters to work with.

Potter

“The legislative structure in China involves primary legislation, which we now have, which is relatively high-level and expresses general principles,” says Alex Potter, an antitrust expert at the Freshfields law firm. “The implementing regulations will be promulgated by the enforcement agencies themselves. Then we will have a better idea how things will be enforced.”

Kadet uses the U.S. tax code as a comparison: Where most people would need a small forklift to carry a copy of the U.S. tax code, China’s Enterprise Income Tax Law has only 60 articles; even its more detailed implementation rules have only 133 articles. “The U.S. is very rules-based,” he says. “Here there is more of a principles-based system.”

Some legal and compliance experts worry that lack of supporting documentation will leave corporations at the mercy of bureaucrats who may not fully understand the issues at hand. The gaps left by the tax law, for example, will very often be handled by local Chinese officials. That raises the possibility of uneven interpretation and enforcement across the nation’s many provinces.

Creative interpretations of the law could be a particular problem for those facing the Anti-Monopoly Law. That statute has the potential to be a useful protectionist or industrial policy tool; the government may at times be motivated to rule against foreign companies more than local companies in an attempt to support domestic industry. Notably, the law has a national security provision, and China has often considered economic strength as an element of national security. The lack of detailed codification invites Chinese officials to rule broadly or narrowly when it suits them.

Han

“One question our clients like to ask is, ‘What does the new law mean to us?’” says Michael Han, a lawyer with Freshfields in Beijing. “‘Will it bring a level playing field, or is it another means of trying to regulate our business activity in China and put us in a disadvantageous position?’ At this point no one can provide a clear answer.”

“It is a question of how enforcement policy is rolled out over time,” Potter adds. “If it is done in a xenophobic fashion, then we have real issues of having to compete with one hand tied behind our back.”

Still, many China experts stress that the regulatory changes are an overall good. The Chinese central government does want to improve its business environment, not complicate it. While cases where the law is applied unfairly are bound to arise, over time the legal environment should not be terribly problematic for multinational companies. Where ambiguity crops up, lawyers and accountants say companies should follow international best practices and document their activities.

They also say that companies should look for guidance wherever it can be found. Kadet notes, for example, that books have been published in Chinese that describe how the tax law was drafted. While these books are not official, they may give insight into how legislators were thinking—and they probably will be the books local officials read when they are figuring out what they’re supposed to do.

The interactive process of compliance, the same process that has been used in China since the 1970s, is still critical. Sitting down with the officials and explaining what your company plans to do will often result in valuable guidance. The tax or antitrust enforcement officers will often provide an indication of their view in situations where the law is lacking in clarity. Indeed, when the legal principles are particularly complex, government officials are eager to learn from others and respect the opinion of those they are assigned to regulate.

“As a civil law country, China doesn’t recognize case law,” says Joseph Lee, a tax partner at Ernst & Young. “But that doesn’t mean that practices that they come across will not be relevant. From time to time they will absorb experience and through that experience, they will formulate policy.”

So while the new laws are good news, their enactment does not mean that the business of compliance has been transformed in China. It is still a matter of dealing with ambiguity, taking educated bets, and making a case to the bureaucrats. The laws are better, but the problems are still very much the same.

“It’s not like living in Poughkeepsie,” Kadet quips. “Do we think there will be more clarity? I think eventually that will happen. But we are not going to wake up tomorrow and see much with crystal-clear clarity.”