China pens rules for ventures

Since the downfal of the "gang of four," the People's Republic of China has steadily shifted its emphasis from ideological purity to economic development. This trend has been accompanied by China's willingness to increase is contact with the West, at least in terms of obtaining financial and technological assistance, to hasten its drive toward modernization. As a result of these new policies, the People's Congress promulgated the Statute on Joint Ventures last July 1. The statute allows foreign participaton not only in the management but also in the ownership of an enterprise. It is a radical departure from past practice.

As it promulgated the statute, China set up the Commission for Foreign Investment and the China International Trust & Investment Corporation to facilitate forming joint ventures and transferring capital and tehnology from abroad.

Because the statute contains general principles rather than specific guidelines, the Chinese are drafting other statutes and regulations necessary to apply the statute. Among those under active consideration are detailed rules to enforce the statute, tax laws for joint ventures and foreign personnel, corporation law, laws relating to the protection of industrial property, customs and tariff laws, foreigh-exchange regulations, and accounting laws. Until these laws are enacted, Chinese authorities will negotiate specific details and incorporate any understandings into each joint-venture agreement. Types of joint ventures encouraged

Chinese officials have indicated that they particularly welcome proposals for transferring technology and for ventures that will enable China to earn hard currency within a relatively short period. For political as well as economic reasons, those involved in promoting joint ventures with foreigners would like to see quick successes so that they might quiet opposition from those who have doubts about recent developments. Although the statute provides that a joint venture's products may be sold domestically at this juncture, products intended primarilym for Chinese markets are not encouraged.

Up to the time of this report (February 1980), although no joint ventures have actually materialized, negotiations are reportedly under way for 40 to 50 joint ventures, and two "agreements" on construction of a hotel in Peking and a woolen-goods factory in Xinjiang (Sinkiang) have been signed. Capital contribution and control

A minimum ownership of 25 percent is usually required for foreign participation in a joint venture; maximum foreign ownership is not expressly stated. However, some officials may not want, for ideological and political reasons, to accept a joint venture that gives foreign participants more than 50 percent ownership. Two joint-venture agreements mentioned above require 51 percent capital contribution by the Chinese participant.

The statute stipulates that cash, other tangible property, industrial property, and use of land in China can all constitute capital contributions. It seems to require that contributions be expressed in monetary terms agreed upon by all participants and set forth in the joint-venture agreement and the articles of association. This requirement raises problems in determining the value of the contribution made by each party, a difficulty complicated by China's planned economy, which is marked by public ownership and price regulation. In attributing an "international price" to their capital contribution, the Chinese may use as a gauge the price for similarly situated land in the home country of foreign participants or in Hong Kong. The same principle may apply to material, technology, or labor provided by the Chinese.

Regardless of the percentage of capital contribution by the foreign partner, the statute ensures Chinese control of management. Profit and expenses, taxation

Article 7 of the statute says:

The net profit of a joint venture shall be distributed between the parties to the venture in proportion to their respective shares . . . after the payment of . . . income tax on its gross profit . . . and after deductions there-from as stipulated in the Articles of Association of the venture for the reserve funds, the bonus and welfare funds for the workers.m

The difficulty of determining "gross profit" will undoubtedly arise unless Chinese and US participants can agree on similar accounting priciples. For example, it is not clear from the statute which items will constitute deductible expenses. Similarly, the size and method of depreciation and the treatment of depreciation in the financial statement is uncertain. The treatment of depreciation will affect not only "gross profit," and therefore the amount of tax, but also net profit, and therefore the return to foreign participants.

Although there is no tax law per se for joint ventures or for foreign participants and employees, the statute does refer to taxes on both the income of the joint venture and on the income of foreign personnel working in China. The Chinese authorities are considering laying a withholding tax on profit to be remitted abroad. In setting the tax rate, they will take into consideration the fact that most developed countries offer tax credits to their firms investing abroad. While the statute permits remittance of the foreign participants' share of the profits and of income earned by foreign personnel working for joint ventures, it is quite possible that there will be restrictions on the percentage remittable.

The statute provides two tax benefits for the joint ventures. Conclusion

The promulgation of the statute itself will not guarantee an increase in joint ventures. It is still too early to predict that the high expectations, created by recent events in China and the most-favored-nation status the US has granted china, will be fulfilled. Apparently continuos nurturing on both sides is required.

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