China's System for the Administration of Technology Import Contracts: Recent Developments

The following article seeks to explain how the Chinese government regulates and administers technology import contracts, with the first section providing a brief introduction to the basic regulatory and administrative regime applicable to such contracts. Different government policies applied to technology import contracts are also discussed, giving foreign licensors a thorough overview of the regulatory regime governing such contracts, as well as insights into key risks and potential opportunities.

TECHNOLOGY IMPORT CONTRACT ADMINISTRATION IN CHINA

Definitions of the international trade in technology vary broadly depending on the jurisdiction in question. In China this would refer to the trade of technology and/or its carrier⁵ by various means and is regarded as a different type of transaction from the trade of goods.⁶ As reflected in the technology import report by MOFCOM, in China the trade of technology is considered to encompass both the assignment and licensing of intellectual property rights or know-how, as well as the purchase of plants and key equipment.

Under Chinese law, technology import contracts refer to those contracts in which technology is transferred by means of trade, investment or economic and technological cooperation between a foreign and Chinese entity.⁷ Common types of technology import contracts include:

i. Transfers of patent rights or rights to apply for patents;

ii. Licences granted under patents for using or producing patented inventions;

iii. Trade secret licences; and

iv. Technology service contracts.⁸

Other types of contracts defined as technology import contracts include:

i. Contracts for the license or transfer of exclusively-owned technology;

ii. Contracts for the license of computer software;

iii. Contracts for the license or transfer of trademarks containing licensed patents or exclusively-owned technology;

iv. Contracts for technological consulting;

v. Contracts for cooperative design;

vi. Contracts for cooperative research;

vii. Contracts for cooperative development: and

viii. Contracts for cooperative production.⁹

In general, technology may be imported into and exported from China freely except as otherwise provided by applicable laws or regulations.¹⁰ Both exported technology and imported technology are segregated into three categories: i) technologies that can be freely imported or exported ('free trade technologies'); ii) technologies with import and export restrictions ('restricted trade technologies'), and iii) technologies whose import or export is prohibited ('prohibited trade technologies').¹¹ In practice, one of the important first steps in any technology-related transaction involving China or a Chinese person or enterprise is to check if the relevant technology is among the restricted trade technologies or prohibited technologies.

MOFCOM and local competent authorities are responsible for the administration of technology import contracts. They are responsible for both registration of such contracts and the issuance of registration certificates. MOFCOM is exclusively in charge of licences for importation of restricted trade technologies. The State Administration of Taxation (SAT), the State Administration of Foreign Exchange (SAFE) and other authorities also are involved in certain administrative matters related to imports. There is a unified administration system governing all technology imports and exports, other than when certain circumstances arise in which technologies are transferred to FIEs as investments by foreign investors ('technology as an investment'). In respect to contract registration and foreign exchange, contracts for the import of technologies that are submitted together with documents or applications for the approval of FIEs will be dealt with in the same way as investments in the form of technologies.

Under the regulations governing registration, import contracts covering free trade technologies are required to be registered, while import contracts covering restricted trade technologies are subject to licensing control rather than registration. Those technologies that constitute 'technology as an investment' are administered pursuant to the approval and registration process for the establishment of FIEs, rather than through the import contract systems described previously.

LEGAL FRAMEWORK FOR THE ADMINISTRATION OF TECHNOLOGY IMPORT CONTRACTS

The PRC Foreign Trade Law(中华人民共和国对外贸易法), as amended and taking effect as of July 1, 2004, sets forth the basic principles regarding matters of China's foreign trade. The PRC Foreign Trade Law(中华人民共和国对外贸易法) defines "foreign trade" as the import and export of goods and technologies and the international trade in services.¹²

Under the Foreign Trade Law, the following regulations constitute the legal framework for the regulation of technology import contracts:

i. PRC Regulations for the Administration of Technology Imports and Exports (Decree [2001] No.331 of the State Council - 中华人民共和国技术进出口管理条例, promulgated by the State Council and taking effect as of January 1, 2002;

ii. Measures for the Registration of Technology Import and Export Contracts (技术进出口合同登记管理办法)promulgated by MOFTEC and taking effect as of January 1, 2002;

iii. Procedures for the Administration of Technology Prohibited or Restricted from Import (禁止进口限制进口技术管理办法), promulgated by MOFTEC and the former State Economy and Trade Committee and effective as of January 1, 2002; and

iv. Catalogue of Technology Prohibited or Restricted from Import by China.

These lists are expected to be revised from time to time.

MOFCOM is, however, entitled to independently or in collaboration with the relevant authorities impose restrictions or prohibitions on the import of particular technologies on a temporary basis upon the approval of the State Council.¹³ In addition, other government authorities, such as SAFE, SAT, and the Trademark Office, promulgate regulations to deal with issues regarding technology import contracts. These regulations will be further discussed below.

ADMINISTRATION IN RESPECT TO IMPORT CONTRACT EXECUTION

The following discussion explains how the administration is involved in connection with contract execution. Being aware of these administrative procedures will assist licensors in structuring workable schedules for providing technology and receiving payment.

Pursuant to the Regulations for the Administration of Technology Imports and Exports, it is necessary to follow the process set forth below in respect to executing technology import contracts:

Contracts for Free Trade Technologies

In relation to free trade technologies, parties may freely enter into contracts, and the contracts may take effect upon the execution by the parties. However, the importing Chinese party is required to register the contract after its execution. The party in China, usually the licensee, must register the import contract at http://info.ec.com.cn and submit a copy of the import contract and an application letter and documents evidencing the legal status of the contracting parties to MOFCOM or local competent authorities. MOFCOM is in charge only of certain significant projects, such as projects that are financed or partly financed by state fiscal budgets, projects that involve loans granted by foreign governments or international financial institutions, and those approved by the State Council.¹⁴

Despite the fact that the registration can be filed on-line, documents are still required to be submitted in hard copy. The registration is complete and a Registration Certificate for Technology Import Contracts issued within three days of receiving the documents. There are certain terms within technology import contracts that sometimes must be recorded. Once any of these terms has been amended, the licensee is required to go through the above-mentioned dual registration system. Suspension of performance or cancellation of a registered import contract is required to be recorded with MOFCOM or the competent local authorities. Without the registration certificate, the licensee can not proceed to import physical property or make payments via the foreign exchange system. Even though there is no express time limit concerning registration, it is very important for the licensee to complete this process as soon as possible to ensure that both parties can follow their obligations under the contract.

Besides the above mentioned documents, in practice the licensee is required to produce a 'Data Sheet of Technology Import Contract' and to have it reviewed and stamped by the local competent authority. Despite it being one part of the registration procedure, the requirement of the Data Sheet is not provided for under the regulations set out under the previous section of this paper, but rather, in those released by SAFE in regard to outbound payments and MOFCOM's Notice on the Establishment of an On-line Administration System for Import Contracts. A Data Sheet is also required for the import of restricted trade technologies.

Restricted Trade Technologies

Imports of restricted trade technologies are subject to licences issued by MOFCOM. The process is as follows:

A simpler process is also available, under which a contract may first be executed and submitted to MOFCOM, together with the application letter for approval of the technology import and for a licence for the importation of the technology. Under this simpler process, however, the time required for examination by the authority and obtaining the import licence is the same as in the above more involved process.

In light of the above process, the contract takes effect only on the date of the issuance of the licence. Among the documents required to be submitted, the licensee must submit both a Data Sheet and the approval or approvals of other authorities, if required. MOFCOM handles the review of the documents and the import contract. The time periods set forth above commence only when complete applications with required materials are received by the authorities. In light of this, it is prudent for the contract to impose certain obligations on the licensee to ensure the timely completion of these procedures. For example, the contract can specify that timely handling is a precondition for delivery of the technology, or for the completion of any subsequent duties of the licensor. A foreign licensor should also note that any amendments to imported technology contracts require the licensee to go through the same process as for a new licence.¹⁵

The dual registration system described in the previous section - 'Contracts for Free Trade Technologies' - is also applicable here: The licensee is required to register the contract at the above referenced web-site¹⁶ in addition to submitting all hard copy documents.

ADMINISTRATION IN TERMS OF PAYMENT OF CONSIDERATION

Technology import contracts usually include one of the following forms of consideration:

i. A lump sum consideration, under which the consideration is paid by certain specified dates or milestones;

ii. Royalty consideration, where a royalty is generally set at a certain percentage of the licensee's corresponding net sales, profit, or the number or value of products manufactured or sold by the licensee. A royalty may be either a fixed royalty or a sliding or running royalty; and¹⁷

iii. A combination of initial payment and royalty consideration, which helps reduce the risk to licensors and licensees in the sense that licensors will collect a certain portion of the consideration soon after the contract becomes effective and the licensees will pay most of the consideration after they have received and applied the technology licensed under the contract to their production processes.

If a technology import contract does not set forth a specific and definite basis for calculation of payment, royalty consideration or other considerations, disputes may arise. To ensure accuracy, each technology import contract should include an auditing clause, which provides the licensor's right to check the accounts and other records of the licensee and requires the licensee to provide a certificate issued by an accounting firm.

To make payments to overseas licensors, SAFE requires authorized foreign exchange banks to examine the authenticity of technology import contracts by examining certain documents. These documents generally include: the certificate of the import contract's registration or licence for the technology contemplated for import; the Data Sheet; documents verifying the due registration of the licence or transfer of intellectual property rights and certificates demonstrating that tax has been duly paid. These documents vary depending on the nature of the transaction. For instance, where the sales amount is linked to the payment of a royalty as consideration, SAFE requires the examination of the authenticity of the sales amount. In such a case, the licensee is required to present to the bank a certificate verifying the authenticity of the sale amount, issued by an independent accounting firm.¹⁸

Pursuant to a recent MOFCOM and SAT circular,¹⁹ income tax is not exempted or reduced if the royalty rate is more than 5% (income tax reduction is discussed further below). MOFCOM has clarified that the 5% referred to here is 5% of the net sale amount. If an initial payment is agreed by the parties, MOFCOM takes this into account as well. Given that income tax amounts to a flat 20% on the amount of royalty, foreign licensors should consider the full tax implications when structuring royalty rates to ensure that the maximum benefit is achieved. To achieve this goal, the parties should consider calculating the royalty on the basis of net sales because this is the figure MOFCOM uses when determining tax reductions.

ADMINISTRATION OF IP RIGHTS CONTAINED IN TECHNOLOGY IMPORT CONTRACTS

In general, technology import contracts comprise licences or the transfer of rights relating to patents or trade secrets and rights related to trademarks and copyrights, including software. The administration of intellectual property rights in China overlaps with regulations governing technology import contracts in regard to registration.

For example, according to the Implementing Rules for the PRC Patent Law(中华人民共和国专利法实施细则), amended and effective as of July 1, 2001, contracts for patent licences, transfers of patent rights etc. must be registered. This requirement is in addition to the general requirements concerning technology import contracts, which also require registration certificates for patent licences or patent rights transfers. This is also the case with trademark and copyright licence and registration. Due to the confidentiality of trade secrets, the registration certificate of a corresponding import contract and the respective Data Sheet will satisfy the authenticity review.

A registration certificate of a contract for the license of transfer of intellectual property rights allows the licensee to pay royalties to an overseas licensor, and such registration of intellectual property rights also serves to prove the existence of the licensor's and the licensee's rights in China. To this extent, registration helps the licensor and the licensee to protect their lawful rights in China.

In certain respects, however, the administration of technology import contracts is stricter than the administration of intellectual property rights. For example, relevant software registration related laws encourage the registration of contracts for software copyrights, software copyright licences and their transfers in order to provide more protection of intellectual property rights.²⁰ The foreign exchange policy for technology import contracts requires a copy of software copyright licences sealed with 'copyright contract registration' by the Copyright Protection Center of China, or a confirmation of the contract registration, to be presented for authenticity review.

Registration of software copyright licences is regarded as an option under the intellectual property rights administration regime. Registration is, however, compulsory under the import contract administration regime where the software licence fee is made to an overseas entity. Where a trademark licence is involved in an import contract, a certificate for the registration of the trademark licence is required to be presented before payments can be made. However, because only the licence of a registered trademark can be registered in China, the consideration for the trademark licence may not be paid if the trademark or its licence contract is not registered. Given this, before executing an import contract, foreign licensors should verify their ability to register both their intellectual property and the licence or transfer of such intellectual property in China.

TAX REDUCTIONS AND EXEMPTIONS

Overseas licensors are required to pay Chinese tax on royalties received from Chinese licensees, but such tax may be reduced or even exempted in certain cases. To encourage technology imports, MOFCOM and SAT have released some policies to reduce the taxes levied on overseas licensors. Some recently promulgated regulations have clarified the procedures and criteria required to qualify for reduction and exemption.

Business Tax²¹

Licensors are required to pay business tax in China on the income derived from import contracts. The licensees are required by law, furthermore, to deduct corresponding tax including the business tax amount before remitting the consideration to foreign licensors. As of October 1 1999, the income resulting from a transfer of technology, including a licence, may be exempted from business tax. Technology service fees that are not related to or derived from technology assignments and trademark license fees included in technology transfer income are nevertheless subject to business tax.²² Until recently, a certificate permitting such an exemption has been required. As it now stands, however, it is not required to gain administrative approval for business tax exemptions.²³

It should be noted that considerations paid for trademark licences and other forms of consideration that are not entitled to tax exemptions should be described separately from those forms of consideration paid for an assignment or transfer of technology. Without this, the tax authority may exempt only up to 50% of the total contract consideration from the business tax.²⁴

Income Tax

Any foreign enterprise that has no permanent establishment or place of business in China, but that derives profits, interest, rentals, royalties and other income from within the country, is required to pay income tax calculated at the flat rate of 20% on such income, imposed by means of withholding.²⁵ Such tax shall be withheld from the amount of payment by the licensee.

If the technology covered by an import contract falls under Article 66 of the Implementing Rules for the PRC Foreign-invested Enterprise and Foreign Enterprise Income Tax Law and is considered as advanced or the import contract contains preferential conditions, the overseas licensor may be approved for income tax²⁶ reduction or exemption (please see box: Article 66 of the Implementation Rules of Income Tax Law on FIEs).

A recent circular²⁷ provides criteria with which to judge whether a contract contains terms which are considered not to be preferential to licensees. Specifically: where the technology in question is a restricted trade technology; where there are in the contract serious restrictive and other clauses that do not conform to the Regulations for the Administration of Technology Imports and Exports; or where the consideration is paid by the means of royalty at a rate of more than 5%.

Pursuant to the Regulations for the Administration of Technology Imports and Exports, serious restrictive clauses are those which have the effect:

i. To require the licensee to accept additional conditions unnecessary for technology imports. For example, the purchase of unnecessary technology, materials, products, equipment or services;

ii. To require a licensee to pay royalties on expired patent rights or patent rights that have been declared invalid, or to bear certain expenses relating to such rights;

iii. To restrict the right of the licensee to improve the technology provided by the licensor or to restrict the use by the licensee of improvements;

iv. To restrict the licensee in obtaining similar or competing technology from sources other than the licensor;

v. To unreasonably restrict the sources from which the licensee may purchase materials, spare parts, products or equipment;

vi. To unreasonably restrict the licensee regarding the volume of products produced, categories or sale prices;

vii. To unreasonably restrict export routes of the products which are made by the licensee by using the technology imported.

The recent Circular on Several Issues Concerning the Implementation of Tax Agreements and Individual Income Tax Laws on Individuals with no Domiciles in China sets forth only criteria of non-preferential terms. There are no clear criteria to judge whether a tax reduction or exemption can be approved. Foreign licensors are more likely to be able to obtain favourable tax treatment if they have the assistance of the licensees. It is recommended that the licensor discusses with the licensee or seeks MOFCOM's or its local competent authorities' comments before entering into any agreement.

CONCLUSION

In other countries, imports and exports of technology may not be distinguished from transactions of goods. It is important to understand that in China, technology imports and exports are regarded as different from the trading of goods and import contracts related to technology trade are prepared as a minimum in order to be registered. Performance of import contracts is supervised not only superficially, but also substantially in the sense that along with other registrations the contents of such contracts (and of any amendments thereto) are required to be recorded and void of any certain restrictive provisions.²⁸

The administrative regime regarding technology import contracts remains in transition. This is reflected in the prevailing dual registration system. It may at times prove burdensome for foreign licensors to follow these restrictive rules, particularly when some procedures are not expressly described or provided in any single regulation or law. The regime tends to be strict on foreign licensors in that the administration tends to focus on whether transactions are legitimate and actually carried out. There are no measures or penalties, however, provided to anticipate a licensee's abuse of the related intellectual property rights. The protection of intellectual property rights after the execution of an import contract is often the primary concern of foreign licensors. If the administrative regime was modified to include intellectual property right protections for the subjects of technology import contracts, it would greatly encourage foreign licensors to import technology to China. One possible approach would be a publicly available list of licensors and licensees which have been found to have maliciously abused intellectual property rights, in addition to standard registration systems.

To the end of furthering growth of technology imports in China, MOFCOM intends to release its Opinions on Further Enhancing the Technology Introduction Business later in 2005. The authorities hope that this will augment and clarify the categories of encouraged technologies, restricted technologies and prohibited technologies for importation. This is to be done by making foreign investment in high-tech industries, including telecommunications, biotechnology and software, more attractive. The establishment of research and development centers in China, encouraging policy-oriented banks²⁹ to promote loans on favourable terms for the purposes of technology importation, and the promulgation of more government policies supporting technology importation and creation will also accelerate the development of China's technological base.

* John C. Roebuck and Aaron Milchiker also contributed to this article.

Endnotes

1 Through the end of 2004, China had received foreign investment totaling US$5.6 trillion. Taxes paid by FIEs account for more than 20% of China's total tax income. 'Transition of Foreign Investors' Investment Structure in China', http://www.mofcom.gov.cn/aarticle/s/200508/20050800229023.html

2 The GDP of China increased by a factor of 36 between 1980 and 2004. GDP per capita has increased 23-fold over the same period. The ranking of China's economy, meanwhile, has risen from number 12 to number 7 in the world. http://www.wtoguide.net/Get/boao2005/220534705.htm

3 'Technology Imports Increased 30% in the First Five months of 2005', Department of Scientific and Technological Development and Trade in Technology, MOFCOM, http://kjs.mofcom.gov.cn/aarticle/ztxx/dwmyxs/u/200506/20050600136635.html -

4 Article 2 of the Tentative Procedures for the Administration of the Examination and Approval of Processing Trade (加工贸易审批管理暂行办法), effective as of June 1, 1999. "Processing trade" is defined as the business activity in which all of or part of the imported raw materials, intermediate materials, spare parts, components and packing materials (hereinafter referred to as the imported materials) in bond are processed or assembled by domestic enterprises and finished products are re-exported. The definition also includes processing of materials provided by foreign businesses and processing of imported materials.

5 "Carrier" refers to the form which contains the technology. For example, a piece of imported equipment would be considered a carrier for the technology contained in that equipment.

6 Please refer to Section 2.

7 PRC Regulations for Administration of Technology Import and Export Regulations (中华人民共和国技术进出口管理条例, Decree [2001] No.331 of the State Council), promulgated by the State Council and taking effect as of January 1, 2002.

8 Measures for the Registration of Technology Import and Export Contracts (技术进出口合同登记管理办法) promulgated by MOFTEC, predecessor of MOFCOM, and taking effect as of January 1, 2002.

9 This more detailed definition is included in the Circular on Strengthening the Administration of Foreign Exchange Sale and Payment Related to Technology Import Contracts (对外经济贸易部，国家外汇管理局关于加强技术进出口合同售付汇管理的通知), promulgated by MOFTEC and SAFE on February 20, 2002 and taking effect as of March 1, 2002.

10 Article 14 of the PRC Foreign Trade Law (中华人民共和国对外贸易法)

11 Articles 16 and17, ibid. Restricted trade technologies and prohibited trade technologies are restricted or prohibited based on a number of considerations, including the following: i) safeguarding national security or public interest; ii) protecting people's health and safety and protecting the environment; and iii) establishing or accelerating the development of a particular domestic industry.

12 Article 2 of the PRC Foreign Trade Law (中华人民共和国对外贸易法)

13 Article 18 ibid

14 Article 4 of Measures for the Registration of Technology Import and Export Contracts.

15 Article 16 of the Procedures for the Administration of Technology Prohibited or Restricted from Import (禁止进口限制进口技术管理办法)

16 Article 14 ibid

17 This method involves dividing the basis of calculating royalties into several levels according to the monetary amount of the royalties, such that the higher the level is, the lower the royalty rate is.

18 Administrative and Operative Rules on Non-trade Foreign Exchange Sales and Payments and Domestic Residents' Individual Foreign Exchange Income and Payments (国家外汇管理局关于下发《非贸易售付汇及境内居民个人外汇收支管理操作规程》), promulgated by SAFE on March 18, 2002, taking effect as of May 1, 2002.

19 Please refer to (3) of Section 7 of the circular.

20 Measures for Computer Software Copyright Administration, (计算机软件著作权登记办法), promulgated by the National Copyright Administration of China (NCAC) and effective as of February 2, 2002.

21 Enterprises and individuals are required to pay business tax in connection with their provision of taxable services, the transfer of intangible assets and/or the sales of immovable properties within the territory of the PRC. This rate is 3% or 5% depending on the transaction.

22 Notice on Implementation of Relevant Tax Issues in relation to the Decision on the Realization of Industrialization, Promotion of High-Tech, Enhancement of Technology Improvement by the Central Committee of China Communist Party and the State Council (关于贯彻落实(中共中央国务院关于加强技术创新，发展高科技，实现产业化的决定)有关税收问题的通知), promulgated by Ministry of Finance and SAF on November 2, 1999 and taking effect as of October 1, 1999.

23 Circular on Domestic Entities and Individuals Not Required to Submit a Business Tax Certificate where Paying Technology Transfer Fees Overseas (关于境内机构及个人对外支付技术转让费不再提交营业税税务凭证的通知), promulgated by SAF and SAFE on March 7, 2005 and taking effect on the same day.

24 Circular Regarding Clarification on Business Tax Exemptions for Technology Assignment by Foreign Enterprises and Foreign Individuals (国家税务总局关于明确外国企业和外国个人技术转让收入免征营业税范围的通知), effective October 8, 2000.

25 Article 19 of the PRC Foreign-invested Enterprise and Foreign Enterprise Income Tax Law (中华人民共和国外商投资企业和外国企业所得税法), Order [1991] No.45 of the President of the People's Republic of China promulgated on April 9, 1991 and taking effect as of July 1, 1991.

26 This is referring to taxes required to be withheld.

27 Circular on Procedures for the Examination and Approval of Enterprise Income Tax Reductions and Exemptions for Technology Imports (关于技术进口企业所得税减免审批程序的通知), promulgated by SAT and MOFCOM on April 15, 2005.

28 Article 29 of the Regulations for the Administration of Technology Import and Export (中华人民共和国技术进出口管理条例).

29 In China, policy-oriented banks are banks founded and invested in by governments and handling financing and credit transactions to cope with government's particular economic policies and intentions. China Development Bank, The Export-Import Bank of China and Agricultural Development Bank of China are the principal policy-oriented banks.