U.S. consulting companies are increasingly selling their services in China.  This is part of the general trend towards sales into China that we have noted.  In confirmation of this trend, we have recently worked with several U.S. based consultants in selling their services into China. The approach taken by U.S. consultants is consistently naïve and almost guarantees problems in China.

The most important issue in selling services to Chinese clients is how to get paid. The payment issue with service providers is far more complicated than with those who sell goods. Service providers must therefore focus carefully on the payment issue.  In drafting service contracts for service providers that will be providing services to Chinese companies, we typically put in provisions that mandate the following:

1. Payment must be received by the service provider before it begins work. It is not required that 100% of the fee be received in advance, but a substantial payment must be received in the U.S. company bank account before any work starts. In addition, it is essential that final work product not be transferred to the Chinese side until after final payment is received.

2. All payments to the U.S. side are net of Chinese taxes. That is, the Chinese side must pay a sum certain to the American service provider and that amount is payable regardless of the taxes the Chinese side is required to pay before making the payment to the foreign service provider.

These provisions are essential for two reasons. The first is the general reluctance of Chinese companies to pay full price for services. Chinese companies in general suffer from what I call the “contempt for the intangible.” Though they accept that they have to pay for hard goods like minerals or machinery, they resist being required to pay for intangibles such as consulting or design services.

This contempt for the intangible means that Chinese companies will often work actively to substantially reduce the amounts they have agreed to pay for services. The standard technique is to convince the service provider to start work before payment. Usually this is the result of protracted contract negotiations. The contract is finally signed several months late and the Chinese side now expresses panic that work must start immediately.

The foreign (American) service provider is then convinced to begin work before payment. Then, after considerable work has been done, the Chinese side will demand a reduction in the fee. The service provider is too deep in the project to refuse and is forced to accept a substantial discount. If the service provider has already provided the work product, the common result is that no payment of any kind is made.

The only way to prevent this from happening is to insist that no work begins until a substantial initial payment has been made. This often will kill the deal and the Chinese side will walk away. This is a good result. As my old boss used to say: “There is only one thing worse than working. That is working and not getting paid.”

The second reason is that the Chinese government is fundamentally hostile to payments made by Chinese companies to foreign service providers. It thus often happens that Chinese companies in good faith try to make the required payments but are prevented from making payment due to the actions of the Chinese authorities. How does this happen?

China still maintains strong controls over foreign exchange. When a Chinese company goes to make a payment to a foreign party it must convert RMB to the foreign currency. The local foreign exchange bank acts as the agent in determining whether the proposed exchange and transfer of funds meets with central government regulations and policy. The rules for service payments are unclear. As a result, the approach taken by one local bank may be completely different than the approach taken by a bank in another city.

Some of the problems that arise are as follows:

1.  The bank refuses to make the exchange on the ground that all payments for foreign services are suspicious. Though this is entirely contrary to Chinese law, this happens surprisingly often.
2. The bank rejects payment because the contracts and invoice are not sufficiently formalized or because the documents are not in Chinese and are therefore not reviewable by the bank. Many service providers are extremely casual about their contracts and invoices. Often, the fact that an invoice is not signed and sealed by the service provider will lead to the bank rejecting payment.
3. The most serious issue relates to taxes. Even in cases where all the work is done outside of China, Chinese banks uniformly will hold that some tax must be paid. The amount of tax is deducted from the payment made to the foreign party. There is no consistency in China on what tax applies and the amount of tax that will be imposed. Recently, we have seen the following:

• A 5% business tax imposed on the gross payment amount
• A 10% withholding tax imposed on the gross payment amount
• A 15% withholding tax imposed on the gross payment amount
• A 17% value added tax imposed on the gross payment amount
• A 20% income tax imposed on an imputed profit
• A 25% income tax imposed on an imputed profit
• A 30% income tax imposed on an imputed profit

It is also not uncommon for more than one of the above to be imposed on the same payment. As a result, the tax bill can be quite high.

The imposition of these taxes causes a number of problems:

•  Negotiation of the final amount can be time consuming. This delays payment.

• Because the amount of tax imposed is uncertain, the parties cannot predict in advance what it will be. To relieve this uncertainty, the foreign party should require that its payments be net of taxes. The Chinese side will resist this strongly. If the Chinese side agrees, then the Chinese side is responsible for payment of the tax. The Chinese side will then enter into even more protracted negotiations with the tax authorities, further delaying payment.

• The final result of this process is that even when a Chinese company in good faith intends to make payment, due to the actions of the foreign exchange bank and the local tax authorities, it may be impossible for the payment to be made. Even if the payment is made, it is never certain how much of the invoice payment amount will actually be paid to the foreign party.

There really is only one way the foreign service provider party can be assured of protecting itself against non-payment: refuse to work until payment is received in the bank account of the foreign party.  For more on the difficulties of doing service work for Chinese companies, check out Representing Chinese Companies. I See Some Light.

Well that someday is now.

And here’s the problem. I am not sure whether I am seeing something where there is nothing simply because the constant barrage of emails has worn down my critical thinking skills, or if for once, the e-mailer is right.  China is different than anywhere else.  Note though how I said “different” not anything having to do with morality.

So here’s the email:

I was booking a hotel the other day for a friend of mine coming into Shanghai and as a part of that, I compared the reviews of two American hotels in Shanghai. One of the hotels had a comment by a guest complaining about a very high level of noise. The manger of the hotel responded to that complaint with this:

Thank you for sharing with us your feedback on your recent stay. After looking into our records, we are unable to find any entry close to your comments. Hence, I think it is likely that you may have been given a room near the guest lift. During high occupancy there is heavy foot traffic in that area which may result in load voices. May I recommend that on your next booking you may request for a room not close to the guest lift. I hope this will be helpful. Look forward to welcoming you back soon.

You have to admit that no hotel manager anywhere else in the world would go online and treat a guest like this. The manager starts out calling the guest a liar because there is no record of any complaint and then he blames the guest for not requesting the right room.  Despite this, he still thinks the guest will return but just ask for a room not near the elevator the next time. This is typical of China and you know it.  Anywhere but China, the manager would apologize and say that he is looking into the problem and that it will be fixed. This lack of introspection and blaming the foreigner for everything is going to doom China to mediocrity.

Okay, so I hate to take one tiny incident and one hotel manager (at an American hotel no less) and say that it is going to doom a country of 1.5 billion people, but I really don’t have a very good response beyond that.  Do you?  My problem is that I cannot imagine a manager of a fairly high end hotel (American no less) saying something like this to a guest, much less online.  And yet the fact that a manager of a hotel in China said this does not surprise me at all, which means I must think this sort of thing is “typical of China.”  But at the same time, this really is just one person out of 1.5 billion and so I really do hate to use this tiny incident to extrapolate.

People, help me out here.  Should we view this one bad hotel manager as emblematic of China or is this just one tiny meaningless incident?  The phone lines are open…

The following is a guest post by Rogier Creemers. Rogier is a post-doctoral Research Officer in Oxford University’s Programme in Comparative Media Law and Policy.  Rogier “wrote his Ph.D. thesis on the relationship between media piracy in China, intellectual property law and media regulation, and globalization. His main research interests include the nexus between media policy and political change in China, with a particular focus on the processes of cooptation and confrontation between the vested regime and potential challengers.”  We thought Rogier’s expert take on China’s attempts to export its culture through film would make for an interesting post.

So without further ado, here’s Rogier’s post:

Amidst the flurry of cultural policy documents being flung at us since last autumn’s Communist Party plenum, a new export guidance catalogue for cultural products and services was published in the beginning of February. Like the draft Film Industry Promotion Law, which featured on this blog earlier, it is part of a push to get Chinese cultural industries to “march out,” so as to increase China’s soft power and its international competitiveness.

In the Chinese view, soft power seems to be something that is part of a zero-sum game. In the chaos of the international scramble for influence, good public relations can build up a desirable image, which in turn enables a country to weigh more on international decision-making. At least, that’s the theory. In reality, the billions that China has pumped into Confucius institutes, cultural exchanges, events like the London Book Fair, handing out free copies of China Daily, and State-sponsored highbrow films, have not been terribly successful in gaining international mind-share. As a painful example, when a screening of the Chinese film The Founding of a Republic, a China State-sponsored epic about the Communist victory in the Chinese civil war, was organized in New York, literally no-one showed up.

China’s new export catalogue essentially promises more of the same. It lists 29 categories of cultural products and services, and obliges all participating central ministries to approve and support a number of programmes and enterprises in international market expansion. The only criteria for this support listed in the catalogue are a certain minimum export value, international market potential and having products with Chinese characteristics. In other words, large Chinese media groups can get a lot of money for producing books about Peking Opera and films about large historical events in China. But what about international market potential?

One big problem here is the leadership’s insistence on the focus of Chinese culture, or at least the culture administration’s version of that. Generally, international audiences are not acquainted with the themes, plots and storylines that come obvious to any Chinese viewer. But perhaps most importantly, the export catalogue betrays a tendency of the culture administration to assume that what they want to say is what audiences want to hear. Recent cultural policy documents reiterate the paternalistic line that content should be “healthy and upward,” and should first and foremost have a “desirable social effect,” which essentially refers to treading the Party line. Until audiences are truly listened to and respected, Chinese cultural products will remain largely marginalized. Nonetheless, given the large amounts of money put in and the fact that profit from these ventures often isn’t taken into consideration, there may be interesting opportunities for foreign cultural and media enterprises for investment from China.

But even more importantly, the Chinese leadership treats cultural products in the same way it treats the highly homogenized, commoditized manufacturing goods industries which drove the first wave of Chinese growth. It hopes to ensure success for Chinese cultural products by improving inputs, optimizing processes, standardizing structures and procedures, and providing education and training to cultural specialists. Unsurprisingly, this results in highly homogenized, and frankly, rather boring Chinese films and television programmes, which do not strike a chord with foreign audiences. Cultural products aren’t assembly line products, and the greatest successes in Western film, television, literature and the arts often come from dark horses. JK Rowling, a single mother living on welfare would, in all probability, not have been able to write and publish Harry Potter in China.

A vibrant cultural sphere needs freedom and openness. It also needs to accept the freedom to fail; the recent Disney flop, to the tune of 200 million dollars shows that even the biggest names don’t have a fail-safe recipe. This is not to say that China doesn’t have great artists, writers, filmmakers and actors. Obviously it does, but a look at the domestic cultural market actually displays many of the same traits: a top-down mode of content production that alienated significant portions of the audience by insisting on values and historical narratives that do not take audiences into account. Still, there are independent Chinese film directors who manage to become successful. In its opening weekend, the low-budget film, Love Is Not Blind, grossed more than three Hollywood blockbusters combined, and out-earned the Party-supported Beginning of the Great Revival by more than 50% in its first week. Its secret? A certain, targeted audience, clever marketing and an engaging story. CCTV reported that the reason for low-budget success is the script. I’d go even further, regardless of technological dazzle and production values, in the end, all that matters, is the story.

Okay, so here are the comments and musings I have been hearing, with at least 100 expletives removed, and camouflaged a lot:

• When I joined the company, I really believed it wanted to become international.  I still think that was what it actually wanted five years ago, but it has gotten so far removed from that I do not think it even understands what that means any more.
• In my early days, the company was committed to spending the money to become international, but now it is focused only on next month’s revenues. We are financially sound, but “like just about every other Chinese company, our services/products have become completely commoditized” and the focus is only on keeping up earnings from month to month.  We have gone from talking about what sort of company we will be three years out to making sure we hit our numbers three months out.
• I am never going to work for a Chinese company again. “They just don’t get it.”
• We recently brought on a new American employee. When I asked what his qualifications were, I was told that he spoke fluent Chinese. After it became clear to me that was his only qualification, I commented that there are 1.5 billion people who speak Chinese and why don’t we start hiring Americans who actually can help us on the business side in the United States? The response was that we can’t afford those sorts of people. We can afford them. They are just not considered important.
• We have lost virtually all of the Westerners we initially hired because we refuse to compensate them accordingly. We are now in the process of losing all of our Chinese employees who truly understand the West as well. When I complain about our brain drain, I am told that I am “too concerned” about our employees and that anyone can be replaced. When I tell them how the American companies with whom we do business value continuity among the people with whom they work, they just shut me out.
• Our home office views our employees as rats that can easily be replaced on the treadmill.  Our employees are viewed as commodities. They truly do not seem to care when someone leaves.
• We used to communicate among the international offices in English, now it is just in Chinese. I continue to write in English because that was part of our plan towards becoming an international company, but I now get criticized for that and I have become known as the Chinese person who speaks Chinese but insists on speaking English.  There are still other Chinese in the company who want to speak and write in English, but I am sure most of those people will be leaving soon.
• The home office does not seem to value the knowledge of the United States that some of us bring to the table. They act as though we Chinese here in the United States can easily be replaced by a young graduate who has never been here, but speaks English. They seem not to appreciate that we are two very different countries and being able to speak English does not mean you know how to do things the American way.
• I am treated as suspect when I try to point out how things should be done in the United States, as though my believing there might be a better, non-Chinese way of doing something makes me anti-China.  It’s ridiculous. They don’t even seem to want the opinions of those of us here in the United States any more.
• Look at the Chinese companies that have done well internationally. Almost all of them are in commodity businesses and almost all of them succeed on price.  Our plan was to rise above that and we had the capabilities to achieve that, but not the willingness to stick it out and really try.  Not the willingness to spend the money long term to achieve this.
• Look at the big American companies doing business in China. They have adjusted to succeed over there.  Why are Chinese companies so unwilling to do that?
• Will a Chinese company ever be truly international?

Does the above jibe with what you are seeing out there? Are there Chinese companies that operate internationally in a way like Proctor & Gamble or Caterpillar or McDonalds or Mercedes Benz or Siemens or Samsung or Nestle operate internationally?  Haier?  Lenovo?  What, if anything, needs to change? Will it change? What about Dalian Wanda’s purchase of AMC? How do you see that going?

You tell me…

In my previous post, Aussiewood Film Finance And China Co-Productions. Ever The Twain Shall Meet?  I explained how a cash rebate equivalent to 40% of feature film production costs is available from the Australian government for films with “significant Australian content” if the producer incurred “qualifying Australian production expenditure” when making the film. This rebate is known as the “Australian producer offset.” In this post, I explain how “official” co-productions between Australia and China, and between Australia and certain other nations, are exempt from some of these requirements, making it easier to access this offset.

But first, what is an “official” co-production? For purposes of the Australian producer offset, an official co-production is one made under formal arrangements between Australia and the governments of various countries. These formal arrangements are treaties or memoranda of understanding. Australia has a co-production treaty with China and also with other countries, including Singapore, Canada and Germany.  Note that Hong Kong is not considered part of China for treaty purposes, so a China-Hong Kong-Australia co-production does not qualify as an “official” co-production.

For purposes of the Australian producer offset, the main advantage of an official Chinese co-production is that it does not need to have “significant Australian content.”  To qualify for the offset, it is only necessary for the producer to have incurred “qualifying Australian production expenditure” when producing the film. Another advantage is that it is not necessary for the Australian production company to be the only production company. Still, the film needs to comply with Screen Australia’s “International Co-Production Program Guidelines.” The guidelines are subject to modification under various formal arrangements, but here are some of the basic elements:

• The film may be based on an underlying work (such as a novel) from any country.

• The screenplay for the film must be attributed to a writer who is a national or permanent resident of one of the co-production countries, but a non-credited writer can come from a country without a formal arrangement with Australia.

• Generally, cast and crew must still come from an “official” co-production country, though one or a small number may come from other countries, particularly when required by the script or by financiers. Generally, credited roles which are not creative or technical roles and are not part of the making of the film, such as executive producers and assistants, need not be from the co-producing countries.

• The film must be made in an “official’ co-production country, though there are exceptions when filming is required on location in other countries.

• The proportion of the production budget raised by the Australian co-producer must be reasonably similar to the proportion of the budget spent on the Australian elements.

• The Australian producer’s financial contribution must be reasonably proportional to the Australian creative contribution and the Australian producer’s financial contribution must be reasonably proportional to the spend on Australian elements.

The bottom line is that the Australian producer offset is an attractive investment incentive for co-productions between China and Australia and between Australia and the other nations with which Australia has made formal co-production arrangements.

The blog post is by the Enter The Panda Blog (ETP), it is entitled “The Blacklist” and it touts its “blacklist” as follows:

After years of sourcing, recording, researching and reporting, ETP has an extensive list of companies that we have identified to have been involved in and partaken in scamming their customers or mishandling their orders.

We have a database of over 3500 companies worldwide reported for fraudulent, scamming behaviour and mishandling of orders. To ensure that they are not trying to contact you or are already doing business with you, simply contact us here and we can check it off this database and let you know. This is absolutely FREE, no strings.

We believe as clients and customers your faith in your supplier should be solid and all doubts cast aside. So over the last few years, we have been constantly building and updating this database, aiming to bring you the most complete blacklist available for free on the web.

Every time we have researched, performed due diligence and audited suppliers and manufacturers, they have been added to our database.

It’s not all bad! We also have an ever increasing database of factories that we have personally vetted and done business with ourselves that we know you can safely do business with. We only work with factories that adhere to international safety and quality standards, and meet our requirements for the Panda Whitelist.

Color (get the horrible pun?) me skeptical.  Very.  And here’s why.

There are obviously good and bad Chinese manufacturers and there are honest and dishonest Chinese manufacturers. But there are also good and bad American/Western buyers and honest and dishonest American/Western buyers. Bad and/or dishonest American/Western buyers might threaten to add and then add legitimately good Chinese manufacturers to a list like this, simply because they are mad at the Chinese manufacturer for not giving them the discount they thought they deserved, or whatever.  I see that sort of thing all the time. We must get 100 requests to sue Chinese manufacturers for every one we actually take seriously.  Half of the requests we instantly “toss” as being too small to warrant attorney time, but we also toss a large number of them because we quickly come to believe that the super-angry Western (usually American) company is the one at fault. How was the Chinese company supposed to know that you “needed” your product in 20 days when the purchase order made no mention of that?  Do you really think your Chinese manufacturer has violated the contract by simply seeking to enforce it against you even though your company is going through tough economic times?  Do you really think your Chinese manufacturer is the one who should have know the particular requirements for product X being sold in Kansas?  I could go on and on.

Just about every time we do a post on China manufacturing problems or scams, someone leaves a comment saying that such and such Chinese manufacturing company did such and such to them. We delete all such posts because we do not think it fair for a company to be besmirched in such a way, without their having been any sort of independent assessment at all. I think the same of the ETP list. How does ETP verify its information?  How can it?

I am not saying such a list is completely worthless, because it probably isn’t. I mean, I definitely look at product reviews on Amazon.com (though I am certain some of them are rigged) and I also oftentimes review tripadvisor.com before choosing a hotel in a strange city.  But, those sites typically have so many reviews that the over-gushers and the overly-furious can be discarded.  Even then though, I still use the reviews as just one factor in my choice.  So I guess I am not saying that one should completely ignore something like the ETP list, but I am saying that it should be just one tiny factor in your decision on who to use for your Chinese manufacturing.

In Manufacturing Your Product In China.The Extreme Basics we recommended that you first “do tons of internet research and then narrow it down to 4-5 [factories] and then fly to China and meet with those factories.”  And if you are not willing to do that, we suggested you hire a sourcing company to do that for you.  Incorporating the ETP list as one aspect of your “tons of internet research” would be just fine, but relying on it as the holy grail is probably not a good idea.

What do you think?

I just returned from the INTA conference in Washington DC, a gathering of nearly 10,000 intellectual property professionals from around the world.  A number of speakers at the conference emphasized how using customs to seize counterfeit goods can be a very powerful tool for protecting brand-owners from counterfeit goods.

The European Court of Justice recently set limitations on the ability of European Union (EU) customs agents to seize counterfeit and pirated goods.  The decision pertained to two joined cases—one case involved a shipment of electric shavers coming from China (with an unknown destination) that allegedly infringed on the design protection of a Philips product.  The other was a shipment of Nokia phones from Hong Kong bound for Columbia.  When Nokia applied for seizure of the phones, the request was denied because the goods were not bound for the EU market, and thus could not be considered counterfeit under EU regulations.   Nokia then brought a lawsuit against the UK customs office, but ultimately lost the case.

The European Court held that EU customs agents cannot detain suspected counterfeit goods unless the goods are actually bound for distribution within the EU or unless there are indications of fraudulent diversion into the EU market. This will impact the way brand owners seek protection through EU customs offices regarding counterfeit goods shipped from China, among other places.  It is now critical to understand the final destination of the goods and to look for possible leaks into the EU market—spotting fakes alone, is no longer enough to have the goods seized by EU customs authorities.

The courts in India also recently issued a decision relevant to counterfeit goods coming from China.  In a case involving gray market electronics imported from China, the Delhi High Court held that goods bearing an identical or deceptively similar mark to a registered trademark are considered infringing, even though Indian trademark law as written does not distinguish between the importation of genuine goods and fakes.  Under this holding goods imported into India using the same or a deceptively similar trademark will be considered infringing if they are imported without the permission of the registered trademark owner.

As for Indian Customs, trademarks can be recorded with the Controller of Customs and trademark rights may be enforced accordingly.  Indian courts have granted sweeping execution mechanisms by granting “John Doe” orders, allowing trademark owners liberty to perform unlimited raids for a period of two months in a local market.  In performing raids, local customs commissioners may be accompanied by police, breaking locks and seizing infringing goods.  It is my understanding from speaking with local practitioners that before these modernizations, enforcement measures were often hampered by information leaks and were too late to accomplish seizure of the goods in question.

You may be wondering why we are discussing IP enforcement measures in the EU and India, however the common theme in both places is that these sort of cases typically arise from imported counterfeit goods from China.  As a brand continues to grow in this global economy, protection and enforcement of IP rights is critical to maintain the brand’s identity and developing good will.  Seizure by customs officials is a powerful tool in achieving these goals.  Brand-owners concerned about the movement of counterfeit goods may record their trademarks with various customs authorities around the world, adding another layer to their strategy for brand protection. These recent changes in the EU and in India are likely to have major impact on anyone who manufactures goods anywhere, but especially in China.

I then told him of my disappointment with American wineries.  More than five years ago, at least a handful of good-sized wineries came to us with plans for going into China, but all of them backed out when they realized the money and time it would take for them to “make it there.”  China’s wine market is now dominated by French and Australian and Chinese wines and when it comes to everyday mainstream wines, U.S. wines are just not on the list. And because they were so late, I fear they never will be. At least two of the wineries who chose not to go into China have told me that they agree with this assessment.

Today I received the following email:

Dan,

I am a frequent reader and big fan of the China Law Blog. Back in the beginning of March, you posted a multi-part article titled “The End Of Cheap China, Part VI. Vietnam, Burma/Myanmar, Globalization, The Next Big Thing, And Falling Wages.” In this article you mentioned Myanmar and asked the readers what we thought of it as “the next big thing.”

I recently came across an article from the Economic Intelligence Unit called “Myanmar: White Elephant or the New Tiger Economy?” Although its an abbreviated version of the report (the full version requires a subscription), the article goes into adequate detail regarding Burma as a possibility for future investment. I attached the report to this email, so you could check it out.

To me, Burma seems like an intriguing possibility for future investment, but the government needs to undergo significant political reform in order for foreign companies to invest/relocate there.  With a large population, large quantities of untapped natural resources, and countless underdeveloped industries, Burma has much potential. We just have to wait and see how political and economic reforms play out. Also central to Burmese development is the reduction of military rule and the expansion of political opposition and ethnic minority rights.

What do you think?

I am of the strong view that the advantage goes to the first movers and we will in June be putting our money where our mouths are as both Steve and I head there on a fact-finding mission with a good friend/business consultant who is fluent in Burmese. We are going there on behalf of a non-American client, but we are not both getting paid to do so and we plan to stay much longer than necessary for just the one matter. While there, we plan to meet with and seek to establish relationships with pretty much each and every law firm in Rangoon with a semblance of an international practice and with various government officials regarding foreign (particularly American investment).  In other words, we plan on getting in on the ground floor of doing business in Myanmar/Burma so that when American companies decide economic and/or political reforms have sufficiently advanced for them to go there as well, we will be the American veterans in the field.  Are we putting tens of thousands of dollars (in billable time and expenses) at risk?  Yes, but we have no choice.  You either start doing business in Myanmar/Burma now or you may never get the chance.

What do you think?  And here’s another question for you. Why do American companies always seem to follow Korean and Japanese and French and German companies into places like Myanmar?  Politics? Conservative business culture? Short term profit mentality? Bigger market at home so less need to expand overseas?  You tell me.

UPDATE: Though I fear being burned at the stake, I cannot help but note that I wrote the above post on May 16 for publication at 3:00 am PST on May 17.  Only a few hours AFTER that, Secretary of State Hillary Clinton announced that the United States would be lifting its trade embargo against Myanmar and would be sending an ambassador there for the first time since 1990.  To quote Ms. Clinton, “Today we say to American business: Invest in Burma.”  This truly underscores the point of this post.  If you wait around for “perfection” in any particular country, you will probably fall behind your competitors who move in before that perfection is realized.

It starts out noting how “the Chinese spent $104 billion in U.S. exports in the last year — up 542 percent from 10 years ago.”  For more on how China has been greatly increasing its purchases of American goods, check out Selling Into China: The New Wave.  The clip then highlights a number of large and small U.S. businesses that are either trying to sell into China or have succeeded in doing so. Everyone is happy, everyone is at least a little bit jingoistic, and everything looks as easy as simply putting your product on the net and waiting for the hordes of Chinese consumers to come to you. Of course, real life (as opposed to the media’s portrayal of it) is quite different.

The clip completely fails even to touch upon the following extreme basics:

• Logistics
• Customs/Duties/Regulations
• Organizational structures
• Intellectual property
• Getting paid

So we will.

Logistics.  We are lawyers, not logistics people, but we know enough to know that if you are going to sell product into China, you need to figure out the best way to get it there and the cost of doing so and whether the costs are prohibitive or not.

Customs/Duties/Regulations. Just yesterday, I received an email from someone asking me why it was having to pay 18% at China customs for its food product, while one of its competitors was paying 7%.  The e-mailer wrote the letter as though we would have an answer right off the top of our heads, but our response was essentially that we had no clue.  We then talked of how it may be because of a difference in processing of the product, it may because of a difference in sizing of the product, it may be because of a difference in from where the product originates or was processed, or it may even be because one of the numbers was wrong.  We would need to know a whole lot more even to guess.  A few weeks earlier, someone had called me because China customs had just refused entry of their product into China because it did not meet China’s safety standards. The caller kept saying how it had “never even occurred” to him that China might have tougher safety standards than the United States.  Well, it should have. The U.S. Government has a very helpful website dealing with China customs.  Check it out before you ship.

Organizational Structures.  How exactly are you going to sell your product into China?  Are you going to do it exclusively from the United States? If so, you will not be able to take RMB unless you use some sort of intermediary.  Are you going to use a distributor in China to get your product sold? If so, will this be an exclusive or non-exclusive arrangement? Who will pay for marketing?  Who will repair the product when something goes wrong? How will you make sure that the distributor does not do something to tarnish your reputation? Or will you set up an entity in China (a Wholly Foreign Owned Entity (WFOE), a Joint Venture (JV) or a Representative Office) to handle your China sales?  Do you have even a basic understanding of how China retail works?

Intellectual Property.  If you want to prevent others from using your brand name or your logo in China, you absolutely must register those as a trademark in China and you should do so before you sell any product there.  For more on registering trademarks in China, check out WHEN To Register Your China Trademark. You face similar issues regarding copyrights and patents as well.

Getting Paid. Presumably, you are seeking to do business with China so as to increase your profits. Unfortunately, selling product internationally has a much higher risk of non-payment than does selling product domestically. We discussed this in The Basics Of Getting Paid When Selling To China:

If you are going to sell product into China (or anywhere else internationally), you should consider employing the following to increase your chances of not getting stiffed:

1. Secure all of the payment in advance. Sophisticated buyers typically will not accept this unless you put up a performance bond or open a standby letter of credit so that it can get its advance payment back. Note, however, that it can sometimes be difficult for Chinese companies to obtain government approval to make full payment in advance.
2. Conduct due diligence on your buyer.
3. Secure some of the payment in advance. This obviously will not guarantee you full payment, but it is better to lose some as opposed to all from a sale.
4. Secure a Documentary Letter of Credit. With this, you will be paid when there is documentary evidence you have shipped the product according to the terms and conditions of the letter of credit. Smart buyers typically require an inspection certificate to ensure the product complies with the specifications in the contract or the purchase order. This sort of letter of credit mitigates your risk because your buyer’s bank has irrevocably guaranteed to pay upon presentation of the required documents.

We generally recommend our clients secure this letter of credit from a major (not a tiny) Chinese bank, such as Bank of China, China Construction Bank, Industrial and Commercial Bank of China, China Development Bank, and Bank of Communications, or a  branch of a known American, Asian or European bank. WARNING:  We have seen more than our share of fake letters of credit.

To encourage exporting, many countries, including the United States, make it fairly easy and cheap to purchase insurance to cover an improper non payment on the letter of credit.

There are all sorts of variations on the above, but these are the basics.

So yes, Ms. Sawyer, selling into China is rife with great opportunities and we would be the last people to say “don’t do it.” But it is not nearly as simple as you portrayed it, at least if you don’t want to lose your shirt.

What do you think?

During the Beijing International Film Festival last month, several Hollywood executives and film producers expressed interest in the Australian producer offset and asked me whether their films might qualify for it. Though these sorts of inquiries tend to arise in connection with official Chinese co-productions, they also come up in connection with Hollywood projects with no immediate China connection.

In this post I will look at the Australian producer offset generally. There are significant exceptions to the rules in the case of an official Chinese co-production so I will look at the producer offset from the standpoint of an official Chinese co-production in a subsequent post.

Under the Australian producer offset, 40% of the production costs of certain feature films can be recovered by the producer, in cash, from the Australian Taxation Office. The producer offset is claimed in the production company’s annual tax return filed in Australia for the year in which the film was completed.

There are two major criteria for the producer offset: the film must have “significant Australian content” and the production costs must be a “qualifying Australian production expenditure” (QAPE). As we are about to see, it is possible for a film with substantial Hollywood involvement to satisfy the producer offset criteria, but there are a lot of moving parts.

Significant Australian Content

To qualify, the film must have “significant Australian content.”  This usually requires substantial Australian involvement in development and a substantial Australian creative contribution during production.

Screen Australia decides whether a film has significant Australian content by applying a points test. Screen Australia considers “significant” to mean “important,”  “notable,” or “of consequence.” Factors to be taken into account include:

• the subject matter of the film
• where the film is made
• the nationalities and places of residence of the people involved in production
• the details of the production expenditure.

No single factor is determinative.

Residency of cast and crew is considered using Australian tax law principles.  A person generally qualifies as an Australian resident if they have been in Australia continuously or intermittently for more than one half of the tax year. In considering nationalities and places of residence, particular attention is paid to the producer, writer, director, key cast and department heads.

Screen Australia may also consider factors like the following:

• the extent to which the film originated in Australia
• the extent of Australian creative control
• the extent of Australian copyright ownership
• the “length of association with Australia,” which is the extent to which an Australian producer, writer or director has been involved.

Qualifying Australian Production Expenditure

QAPE is also required to qualify for the producer offset. QAPE is expenditure on goods or services provided in Australia, expenditure for the use of land located in Australia, or expenditure on goods located in Australia at the time they are used. QAPE does not generally include development costs, distribution and promotion costs, or residuals and advances, but it can include the costs of an Australian lawyer on the film.

The QAPE must meet a certain monetary threshold, which is currently AUD 500,000 (about USD$500,000). In other words, you must spend at least this much on QAPE.  QAPE can usually only be claimed for filming expenses not incurred in Australia when the subject matter of the film reasonably requires the film to be shot outside of Australia.

Who Can Apply for the Australian Producer Offset?

Only a company can apply for the producer offset and that company must have “carried out or made the arrangements necessary” for the production of the film. In other words, it must be the production company.

International co-productions or joint ventures can qualify even if they are not official co-productions and even if they do not have significant Australian content. A recent example is Happy Feet Two, a Warner Brothers, Village Roadshow, Kennedy Miller Mitchell production filmed in Australia.

The company must be an Australian resident or a foreign resident with a permanent establishment in Australia and an Australian Business Number or “ABN.”  A permanent establishment is basically just a place, such as an office, through which business is conducted. Note that Australian companies are quick and easy to set up and they require only one Australian-resident director. A Special Purpose Vehicle or “SPV” — such as a company set up by the producers for producing the film — can qualify as the company that incurs QAPE.

Though the producer offset is often regarded simply as a means for funding one particular film, some producers see it as having potential to attract investment in the production company and its slate of projects. Mario Andreacchio, who produced and directed The Dragon Pearl, the first official Sino-Australian co-production, has substantial experience working with the producer offset. For Andreacchio, the important issue is what to do with the offset. According to Andreacchio, “sure, you can cash-flow it and put it in as part of the production company’s equity investment or you can even use it for publicity and advertising or sales costs, but the thing is that you are not necessarily investing in one film – you are investing in the production company and, potentially, all of its projects.” Andreacchio, who is now working on a slate of Sino-foreign co-productions, says that this latter point is often missed by producers and investors alike. “The producer offset does not necessarily need to be only used as  an alternative stream of financing for individual projects; it can also be used as a way to build up a production company. When you start working with a slate of projects, the offset opens up more opportunities for your investors because they can get a spread over a number of your projects.”

In my next post, I will discuss how to get the Australian producer offset in the context of a China co-production.