PRC Corporate Issues in IT Industry July 2015 Frank Niu, Partner of Beijing Office

Table of Contents 2 1.Chinese IT Industry Background 2.Overview: Foreign IT companies doing business in China 3.Investment Structure 4.Market Access Approval 5.Registered Capital and Contribution 6.Cyber Security 7.Tax 8.China's New Foreign Investment Law 9.Pitfalls and Tips 10.Dentons in China

3 Chinese Software Service Industry Revenue Trend Billion RMB % Source: National Bureau of Statistics of the People's Republic of China Chinese IT Industry Background

4 Performance of IT Industry in 2014 Products or ServicesRevenue(billion USD) Growth rate (%) Software Business Gross Revenue 、 Software product 、 Information system integration services 、 IT consulting services 、 Data processing and storage service 、 Embedded system software 、 Integrated circuit design Source: National Bureau of Statistics of the People's Republic of China

Chinese IT Industry Background 5 Top 4 Chinese Players RankCompanyRevenue 2014(million USD) 1Huawei Technologies Co Ltd ZTE Corporation Haier Group Founder Group

Chinese IT Industry Background 6  The growth of the revenue is slow and staple  The new IT services is getting more popular  The export of software continues to be sluggish  The Middle West China IT markets become increasingly active  IT revenue from main cities keep growing rapidly Main Trends in Chinese IT industry

Foreign IT companies doing business in China 7  Cross-border trade -Equipment sales -Technology license  Investment 1. Greenfield investment - Establish Foreign Investment Enterprises(FIEs) (1)WOFE (2) Joint Venture -Establish a representative office(RO) - Foreign Invested Partnership 2.M&A Equity Joint Venture Cooperative Joint Venture

Investment Structure 8

9 1.Representative Office (RO)  A liaison office of its parent company / no legal person status.  Limited business scope: - may only engage in a limited number of activities (data collection, market research, technical support, R&D). - Subject to limited exceptions (law, accounting and consulting firms), an RO may NOT engage in profit-making activities, receive revenue for services, or sign contracts. 2.Wholly Foreign Owned Enterprise (WFOE)  Preferred business vehicle for foreign investors. -Limited liability company wholly owned by one or more foreign investors -Flexible corporate governance, pays tax in China and can repatriate profits to investor's home country

3.Equity Joint Venture  A limited liability company formed between one or more Chinese parties and one or more foreign parties.  Profits and losses are based on the ratio of each party's respective equity interests/capital contributions (cash, technology, property, etc.).  Relatively inflexible management structure  Falling out of favor with MNCs. 4.Partnership  Commonly used by VC and PE investors  Ordinary partnership  Limited partnership 10

5.Offshore holding company 11  Choice of the incorporate site - Hongkong - Switzerland  Mode of operation: -Technology license  Profit: -Royalty  Benefits: -TAX -Management efficency -Better protection for IP Offshore Onshore Technology license Royalty Holding Co. PRC Co. Parent Co. 100% IP Co.

Market Access Approval 12

13 1.Foreign Investment Industrial Guidance Catalogue (effective on April 10, 2015) Categories: “encouraged”, “restricted”, “prohibited”, or “permitted” “Encouraged” and “Permitted” : a foreign investor generally may set up a WFOE. An exemption from import tariffs for equipment for “encouraged” projects. “Restricted” : generally open only to joint ventures, and in some cases the joint ventures must be majority Chinese owned or contributed. Enterprises engaging in manufacture of IT equipment and the software development belong to the "Encouraged Catalogue"

2. NDRC Approval 14 General All other projects only require filing with local NDRC.  Provincial governments enact implementing rules. Approval AuthorityProjects NDRC  Encouraged sectors + total investment amount ≥ USD 300 million + requiring Chinese majority  Restricted sectors (other than real estate) + total investment amount ≥ USD 50 million Provincial Government (no delegation to lower level)  Real estate projects  Restricted sectors (other than real estate) + total investment amount < USD 50 million Local Government (provincial governments decide at which level )  Encouraged sectors + total investment amount < 300 million + requiring Chinese majority

3. MOFCOM Approval 15 MOFCOM Approval of FIEs Approval AuthorityFIE MOFCOM  Encouraged sectors + total investment amount ≥ USD 300 million  Restricted sectors + total investment amount ≥ USD 50 million Local MOFCOM (local MOFCOM could delegate the approval authority to lower MOFCOM)  Encouraged sectors + total investment amount < 300 million  Restricted sectors + total investment amount < USD 50 million

Registered Capital and Contribution 16

1. What does registered capital mean? 17  Equity contribution by shareholders, may be increased, but generally cannot be reduced  Greater flexibility and autonomy in capitalizing a company  Forms of capital contributions: cash, intellectual property right, land use right, or other non-monetary properties that may be assessable and transferrable  Removal of the requirement for cash contribution, benefits companies in high-tech, entertainment, and modern service businesses.

18 2.Technology is qualified as the capital contribution  Technology may be contributed as the registered capital  Technology license is often part of the joint venture arrangement  The value of the technology as capital contributions shall be assessed and verified  No limit for the ratio of the technology contribution

19 3. Proportion of Registered Capital to Total Amount Total Amount of Investment(million USD) Registered Capital/Total Amount of Investment <3>7/ * >1/ * >2/ * >36>1/3 *represents the minimum requirement of the Registered Capital(million USD))

Cyber Security 20

1. Obligations of Network Operators 21  Requirement for Network products and services -No malicious programs -Prior consent from users if the network product need their information; -prompt notice of any security flaws and leaks  Tiered network security protection system -Formulate internal security management systems and operating rules -Prevent computer viruses and network attacks -Record and track the status of network operations and preserve network logs -Data classification, back-up of important data, and encryption  Provide necessary technological support and assistance for the needs of national security and criminal investigation

2. Protection for the network information security 22  Network operators shall establish and complete user information protection systems,  Obtaining the consent of the person whose data is gathered.  Keep users' personal information strictly confidential and must not disclose, sell distort or damage them.  Real identity system  Manage the information published by users

3. Monitoring, Early Warnings, and Emergency Response 23  The State establishes network security monitoring and early warning and information bulletin systems and mechanisms for network security emergency response efforts.  Government can take temporary measures regarding network communications in certain regions, such as shutting down internet access in emergency situations.

Tax 24

25  Enterprise Income Tax -For a new established IT software company, the income from the first and second fiscal year will be exempted from enterprise income tax and for the income earned from the third to fifth year, the enterprise income tax will be reduced by 50%. -Royalties received by a foreign company from China are subject to withholding income tax at 10%, which may be reduced by tax treaties. -Foreign companies with at least one permanent establishment in China, the royalty fee should be included in the enterprise income, which shall be taxed at the rate of 25%.

China's New Foreign Investment Law 26

China's new Foreign Investment Law  Still under drafting, but could be enacted soon.  The case-by-case approval of foreign investments will be completely abolished, and replaced by a foreign investment reporting and disclosure system.  Foreign investments will be generally accorded national treatment unless they fall under a "negative list".  Represents further liberalization of governmental control of foreign investments in line with international best practices.

Pitfalls and Tips 28

Pitfalls and Tips 1.Know the rules China is moving to a rule-based economy, and more disciplined and transparent market. Foreign investors are expected to follow the rules more than local players. The rules may be complicated in many areas and opaque in some, leaving local authorities and officials to adopt interpretations and practices that vary from location to location. Be careful with the "hidden rules" or "connections" that may expose foreign investors to great compliance risks and costs.

Pitfalls and Tips (continued) 2.Know your local partners Avoid dealing with dubious partners at the beginning of a relationship. Subsequent solutions, including legal remedies, may be difficult or come with high costs. Use all means available to perform KYC: public information, market consultants, trade associations, law firms, industry insiders, etc. Different types of Chinese entities may have different motives or concerns in similar transactions, e.g. state-owned enterprises (SOEs) must act in line with government policy and strategies, and private enterprises may be more profit oriented but tend to ignore legal risks.

Pitfalls and Tips (continued) 3.Deal with government authorities and officials properly Despite the decrease in approval requirements for foreign investments in general, foreign investors in highly regulated areas (such as energy and agriculture) must still obtain a range of regulatory approvals. Follow the procedures correctly, enlist assistance from professional advisors and service providers, and keep good track of written communications with governmental authorities. Meet with officials in charge face-to-face and make your case in a clear and consistent manner.

Pitfalls and Tips (continued) 4.Transaction structure is key to success. Foreign investors should properly structure their investments into China so as to minimize risks, obtain tax efficiency and other benefits, and most importantly, have the ability to exit the investments when things go wrong. Use offshore holding companies or other vehicles, but note the tax implications in both China and home jurisdictions. Maximize legal protections in transaction agreements, such as rights of first refusal, call and put options, deadlock solutions, and appraisal rights. These concepts are largely recognized by Chinese law.

Pitfalls and Tips (continued) 5.Prepare for the worst: disputes in China. Litigation is generally not a preferred solution - It is never easy to litigate in Chinese courts, and enforcement of foreign court judgments in China is even more difficult. Arbitration is generally a favored form of dispute resolution in contracts with Chinese partners and customers. It is fast, flexible, more predicable and commercially oriented. The most commonly chosen arbitration institutions and venues include China's CIETAC, ICC, Hong Kong, Singapore, Stockholm and London.

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Questions? 3625 August, 2015