Limiting the dangers of importing technology

It is by no means easy to fully investigate and evaluate the extent of know-how, and so transactions involving such secrets pose a greater risk than other technology deals.

Regulatory issues in technology import

Issues under PRC law will inevitably be encountered when importing technology from across the Chinese border. The transaction and its parties will be subject to regulatory controls, such as those for trade, foreign exchange and tax.

Foreign trade controls

The Ministry of Commerce (MOFCOM) and its local bureaus are the authorities in charge of technology import. Prohibited technologies may not be imported under PRC law. Restricted technologies require MOFCOM approval and a technology import permit. Technologies that can be freely imported and exported are subject to online registration. Once the procedure has been completed, the importer is issued a technology import-export contract registration certificate. Exchange control, bank, tax, customs and other procedures are then carried out on the strength of the permit or certificate.

The MOFCOM approval process:

Under Article 8 of the Measures for the Administration of Technology Import-Export Contracts, contracts for technologies that can be freely imported and exported must be registered online.

To do so, a business operator importing or exporting permitted technology must:

• Log onto the Technology Import and Export Contract Information Management System on the MOFCOM website (jsjckqy.fwmys.mofcom.gov.cn)
• Complete the registration process by providing: |
  • An application to register the technology import/export contract
  • A copy of the technology import/export contract (including a Chinese translation)
  • The documents evidencing the legal status of the parties to the contract.

MOFCOM may issue the operator a technology import or export contract registration certificate within three working days from the date of receipt of these documents.

Exchange controls

An importer will usually encounter exchange control issues when executing the contract and making payments. As the renminbi has yet to be fully internationalized, an overseas technology exporter will usually require the importer to pay in foreign currency, which involves working with a bank on three steps: opening a foreign exchange account, selling foreign exchange and making the payment. Opening an account and paying foreign exchange will usually be problem-free, but, at the foreign exchange sale stage, the bank will require the importer to provide the approval document issued by the exchange control bureau or other supporting materials.

These usually include the technology import contract, payment notice, technology import permit, technology import contract registration certificate, technology import contract data form and tax certificate for a payment to a foreign party. For a non-tax-resident, proof of legal status and the taxpayer identification number are also required.

Taxes

A recipient—in this case, the importer—is legally required to withhold relevant taxes when paying income sourced in China to a foreign non-tax-resident enterprise or individual. As the importer must provide a “tax certificate for payment to a foreign party” when purchasing foreign exchange, it must complete its tax withholding obligation or the relevant tax record-filing work before purchasing the foreign exchange and making the payment.

The main challenge the importer may face is that the withholding income tax rate of a foreign non-tax-resident is usually 10% of the transaction price. However, paying customs duties is not required when exporting technology to the PRC, and technology import transactions are exempt from consumption tax, value-added tax and business tax as well, meaning the parties are also free from paying both the urban maintenance and construction tax and education surcharge.

The key risks to a transaction

The foreign jurisdiction's export controls

Administrative approval requirements for technology import and export are not only imposed on importers. Most exporters of know-how are usually from Western developed countries, which, in an effort to maintain their competitive advantage, often restrict the export of certain technologies with their own regulatory gatekeepers. Take the U.S. as an example: the responsibility for export controls mainly lies with Department of State and the Department of Commerce. If the exporting party to a transaction cannot secure approval from its home jurisdiction, a smooth execution is impossible.

Insufficient due diligence

As know-how has practical value and must be kept confidential, it is difficult for the importer to conduct full-fledged due diligence prior to the transaction. This includes diligencing the freedom to operate (FTO), which involves investigating whether the application of the technology could infringe another's patent or violate other laws or statutes. The inability to access this data means certain risks cannot be accounted for.

The exporter's delivery

As the know-how being bought or sold mainly comprises intangible knowledge and services, the method of delivery can easily give rise to disputes. When delivering a medium that carries data, such as by storing information on an optical disk or portable disk drive, once the intangible assets are combined with the physical hardware, legal issues related to customs declaration and supervision may arise.

Governing law and dispute resolution

Countries have different ways of distinguishing know-how with respect to intellectual property (IP), as well as afford varying levels of protection. When selecting a dispute resolution institution, parties will consider factors including the legal background, language, culture and costs. As there is often a lack of trust between the importer and exporter at the outset of a transaction, the governing law and dispute resolution mechanism often become the areas where the differences of opinion are the greatest.

The seven solutions

In order to reduce the legal risks associated with technology import-export transactions, parties can consider the following key features while adhering to the realities of both the commercial and PRC regulatory climates:

1. Simultaneous transfer with IP registered in the PRC.

The foreign party can first register or purchase in the PRC a patent, trademark or copyright related to the know-how. After securing the “dominant” right, it can bundle and transfer it with the “recessive” know-how. This allows the flaws of the “recessive” subject matter to be made up by the “dominant” one.

2. Payment of the consideration for the know-how in stages: initial fee plus royalty.
As it is challenging for the importer to conduct full due diligence before the transaction, the consideration cannot be fully paid in one lump sum. The parties can opt for a method where the importer first pays a small “initial fee”, and the exporter delivers the technology and provides auxiliary services after the execution of the contract, followed by a pro rata “royalty” charge upon output from applying the know-how.

3. Retention by the exporter of the right to audit.

If the initial fee plus royalty payment method is opted for, the right to audit should be retained by the exporter. The exporter has the right to audit, at its own expense, the output value of the imported technology, on which basis the specific royalty fee is then calculated.

4. The exporter is responsible for delivery to the PRC and providing technical support.

As the exporter best understands the technology that it is transferring, it is better suited to control the risks associated with the delivery of the subject matter and any possible leakage. Accordingly, it is more reasonable for the exporter to bear these obligations.

5. Each party handles the technology import-export control approval procedures of its own jurisdiction. The exporter takes responsibility for obtaining approval from the export country and the importer does the same from the import country. If an approval cannot be secured due to the technology control measures of either jurisdiction, each party bears its respective legal liability.

6. The importer takes responsibility for withholding the various taxes (levies). As PRC law provides that the payee, or importer, withhold the domestic income tax of a foreign non-tax-resident and the relevant taxes arising from the transaction, the importer should specify in the technology import-export contract that it will withhold such taxes. The parties should not only specify the various applicable tax rates in the contract, but should also leave some room for flexibility to account for changes in tax laws or policies.

7. The importer selects the governing law and the exporter selects the dispute resolution institution. As the importer needs to bring the know-how into China, pay the consideration from China to overseas, and apply the actual technology in the country, the closest regulatory link to the technology import-export transaction is obviously PRC law. Meanwhile, once the exporter has delivered the know-how, what is largely left is the right to receive remuneration—the impartiality and efficiency of the dispute resolution institution would be its greatest concern. For these reasons, having the importer choose the PRC as the governing law and the exporter select the dispute resolution institution would be most practical.

When a strategizing and executing a technology import-export contract, of which the core of the deal is the key know-how, implementing these solutions will go a long way toward reducing transaction risks and markedly brighten the outlook of success.

Degang Ma, Partner
Jingtian & Gongcheng, Beijing

34/F, Tower 3, China Central Place
No.77 Jianguo Road
Beijing, 100025
China

Tel: (86 10) 5809 1011
Fax: (86 10) 5809 1100
Email: [email protected]

Mr. Degang (Robert) Ma graduated from Peking University Law School in 1998 with an LL.B degree in 1998 and an LL.M in 2011. He received his second LL.M degree in international IP law from IIT Chicago-Kent College of Law in 2014.

Mr. Ma has practiced law for 15 years, and served in a local court prior to joining Jingtian & Gongcheng as a partner in 2015.

Mr. Ma specializes in domestic litigation and arbitration, IP protection, international IP, trade and M&A. He has particular interests in the industries of IT, mineral resources, education and real estate.

Mr. Ma was admitted to the PRC bar in 1998 and passed the New York State bar examination in 2015. He is a member of the Beijing Lawyers Association. Mr. Ma is a native mandarin speaker and is also fluent in English.

China has seen a substantial increase in technology import businesses and has rolled out a series of incentives over the past several years to further encourage the transfer of key know-how into its domestic market. In fact, Liu He, former vice-chairman of the Development Research Center of the State Council, wrote in 2013 that, China's strategic opportunities to acquire cutting-edge technology and invest in infrastructure truly manifested after the 2008 global financial crisis when the country exerted a great influence on the world's economic recovery.

But acquisitions, transfers and import of such crucial and competitive technology are not without challenges. Improper navigation and handling of regulatory and commercial risks can not only break a deal, but can also result in heavy costs for both the importer and exporter for years to come.

“Technology acquisition” refers to the import of technology by China from developed countries. And, more specifically, according to the PRC Regulations for the Administration of Technology Import-Export, “technology import” means the act of transferring technology into the country from abroad by way of trade, investment or technical and economic cooperation. Such acts include the transfer of patents, patent application rights and licenses, know-how, technical services and other manners of technology transfer.

Some argue that the term “技术秘密”, which literally means technical secret, can be roughly translated as “know-how” under UK and U.S. law. It encompasses any method, expertise, technology or other information in fields such as industry, commerce and management that is kept confidential, can resolve a specific issue once exploited and has relatively great economic value. Generally speaking, a rights holder will make public and file a patent application for a new technology that can be cracked through reverse engineering, whereas a technology that cannot be cracked will be preserved as know-how.

It is by no means easy to fully investigate and evaluate the extent of know-how, and so transactions involving such secrets pose a greater risk than other technology deals.

Regulatory issues in technology import

Issues under PRC law will inevitably be encountered when importing technology from across the Chinese border. The transaction and its parties will be subject to regulatory controls, such as those for trade, foreign exchange and tax.

Foreign trade controls

The Ministry of Commerce (MOFCOM) and its local bureaus are the authorities in charge of technology import. Prohibited technologies may not be imported under PRC law. Restricted technologies require MOFCOM approval and a technology import permit. Technologies that can be freely imported and exported are subject to online registration. Once the procedure has been completed, the importer is issued a technology import-export contract registration certificate. Exchange control, bank, tax, customs and other procedures are then carried out on the strength of the permit or certificate.

The MOFCOM approval process:

Under Article 8 of the Measures for the Administration of Technology Import-Export Contracts, contracts for technologies that can be freely imported and exported must be registered online.

To do so, a business operator importing or exporting permitted technology must:

• Log onto the Technology Import and Export Contract Information Management System on the MOFCOM website (jsjckqy.fwmys.mofcom.gov.cn)
• Complete the registration process by providing: |
  • An application to register the technology import/export contract
  • A copy of the technology import/export contract (including a Chinese translation)
  • The documents evidencing the legal status of the parties to the contract.

MOFCOM may issue the operator a technology import or export contract registration certificate within three working days from the date of receipt of these documents.

Exchange controls

An importer will usually encounter exchange control issues when executing the contract and making payments. As the renminbi has yet to be fully internationalized, an overseas technology exporter will usually require the importer to pay in foreign currency, which involves working with a bank on three steps: opening a foreign exchange account, selling foreign exchange and making the payment. Opening an account and paying foreign exchange will usually be problem-free, but, at the foreign exchange sale stage, the bank will require the importer to provide the approval document issued by the exchange control bureau or other supporting materials.

These usually include the technology import contract, payment notice, technology import permit, technology import contract registration certificate, technology import contract data form and tax certificate for a payment to a foreign party. For a non-tax-resident, proof of legal status and the taxpayer identification number are also required.

Taxes

A recipient—in this case, the importer—is legally required to withhold relevant taxes when paying income sourced in China to a foreign non-tax-resident enterprise or individual. As the importer must provide a “tax certificate for payment to a foreign party” when purchasing foreign exchange, it must complete its tax withholding obligation or the relevant tax record-filing work before purchasing the foreign exchange and making the payment.

The main challenge the importer may face is that the withholding income tax rate of a foreign non-tax-resident is usually 10% of the transaction price. However, paying customs duties is not required when exporting technology to the PRC, and technology import transactions are exempt from consumption tax, value-added tax and business tax as well, meaning the parties are also free from paying both the urban maintenance and construction tax and education surcharge.

The key risks to a transaction

The foreign jurisdiction's export controls

Administrative approval requirements for technology import and export are not only imposed on importers. Most exporters of know-how are usually from Western developed countries, which, in an effort to maintain their competitive advantage, often restrict the export of certain technologies with their own regulatory gatekeepers. Take the U.S. as an example: the responsibility for export controls mainly lies with Department of State and the Department of Commerce. If the exporting party to a transaction cannot secure approval from its home jurisdiction, a smooth execution is impossible.

Insufficient due diligence

As know-how has practical value and must be kept confidential, it is difficult for the importer to conduct full-fledged due diligence prior to the transaction. This includes diligencing the freedom to operate (FTO), which involves investigating whether the application of the technology could infringe another's patent or violate other laws or statutes. The inability to access this data means certain risks cannot be accounted for.

The exporter's delivery

As the know-how being bought or sold mainly comprises intangible knowledge and services, the method of delivery can easily give rise to disputes. When delivering a medium that carries data, such as by storing information on an optical disk or portable disk drive, once the intangible assets are combined with the physical hardware, legal issues related to customs declaration and supervision may arise.

Governing law and dispute resolution

Countries have different ways of distinguishing know-how with respect to intellectual property (IP), as well as afford varying levels of protection. When selecting a dispute resolution institution, parties will consider factors including the legal background, language, culture and costs. As there is often a lack of trust between the importer and exporter at the outset of a transaction, the governing law and dispute resolution mechanism often become the areas where the differences of opinion are the greatest.

The seven solutions

In order to reduce the legal risks associated with technology import-export transactions, parties can consider the following key features while adhering to the realities of both the commercial and PRC regulatory climates:

1. Simultaneous transfer with IP registered in the PRC.

The foreign party can first register or purchase in the PRC a patent, trademark or copyright related to the know-how. After securing the “dominant” right, it can bundle and transfer it with the “recessive” know-how. This allows the flaws of the “recessive” subject matter to be made up by the “dominant” one.

2. Payment of the consideration for the know-how in stages: initial fee plus royalty.
As it is challenging for the importer to conduct full due diligence before the transaction, the consideration cannot be fully paid in one lump sum. The parties can opt for a method where the importer first pays a small “initial fee”, and the exporter delivers the technology and provides auxiliary services after the execution of the contract, followed by a pro rata “royalty” charge upon output from applying the know-how.

3. Retention by the exporter of the right to audit.

If the initial fee plus royalty payment method is opted for, the right to audit should be retained by the exporter. The exporter has the right to audit, at its own expense, the output value of the imported technology, on which basis the specific royalty fee is then calculated.

4. The exporter is responsible for delivery to the PRC and providing technical support.

As the exporter best understands the technology that it is transferring, it is better suited to control the risks associated with the delivery of the subject matter and any possible leakage. Accordingly, it is more reasonable for the exporter to bear these obligations.

5. Each party handles the technology import-export control approval procedures of its own jurisdiction. The exporter takes responsibility for obtaining approval from the export country and the importer does the same from the import country. If an approval cannot be secured due to the technology control measures of either jurisdiction, each party bears its respective legal liability.

6. The importer takes responsibility for withholding the various taxes (levies). As PRC law provides that the payee, or importer, withhold the domestic income tax of a foreign non-tax-resident and the relevant taxes arising from the transaction, the importer should specify in the technology import-export contract that it will withhold such taxes. The parties should not only specify the various applicable tax rates in the contract, but should also leave some room for flexibility to account for changes in tax laws or policies.

7. The importer selects the governing law and the exporter selects the dispute resolution institution. As the importer needs to bring the know-how into China, pay the consideration from China to overseas, and apply the actual technology in the country, the closest regulatory link to the technology import-export transaction is obviously PRC law. Meanwhile, once the exporter has delivered the know-how, what is largely left is the right to receive remuneration—the impartiality and efficiency of the dispute resolution institution would be its greatest concern. For these reasons, having the importer choose the PRC as the governing law and the exporter select the dispute resolution institution would be most practical.

When a strategizing and executing a technology import-export contract, of which the core of the deal is the key know-how, implementing these solutions will go a long way toward reducing transaction risks and markedly brighten the outlook of success.

Degang Ma, Partner
Jingtian & Gongcheng, Beijing

34/F, Tower 3, China Central Place
No.77 Jianguo Road
Beijing, 100025
China

Tel: (86 10) 5809 1011
Fax: (86 10) 5809 1100
Email: [email protected]

Mr. Degang (Robert) Ma graduated from Peking University Law School in 1998 with an LL.B degree in 1998 and an LL.M in 2011. He received his second LL.M degree in international IP law from IIT Chicago-Kent College of Law in 2014.

Mr. Ma has practiced law for 15 years, and served in a local court prior to joining Jingtian & Gongcheng as a partner in 2015.

Mr. Ma specializes in domestic litigation and arbitration, IP protection, international IP, trade and M&A. He has particular interests in the industries of IT, mineral resources, education and real estate.

Mr. Ma was admitted to the PRC bar in 1998 and passed the New York State bar examination in 2015. He is a member of the Beijing Lawyers Association. Mr. Ma is a native mandarin speaker and is also fluent in English.